UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





FORM 20-F








(Mark One):


 ̈
Registration Statement pursuant to Section 12(b) or (g) of the Securities Exchange Act of 1934




OR




x
Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934




For the fiscal year ended December 31, 2010




OR




 ̈
Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934




For the transition period from             to




OR




 ̈
Shell Company Report pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934




Date of the event requiring this shell company report




Commission file number: 001-33535







SPREADTRUM COMMUNICATIONS, INC.


(Exact name of Registrant as specified in its charter)




Not Applicable


(Translation of Registrant’s Name into English)




Cayman Islands


(Jurisdiction of Incorporation or Organization)




Spreadtrum Center, Building No. 1


Lane 2288, Zuchongzhi Road


Zhangjiang, Shanghai 201203


People’s Republic of China


(Address of Principal executive offices)




Dr. Leo Li, President and Chief Executive Officer


Telephone: (8621) 5080-2727


Facsimile: (8621) 5080-2996


(Name, Telephone, E-mail and/or Facsimile Number and Address of Company Contact Person)





Securities registered or to be registered pursuant to Section 12(b) of the Act:





Title ofEach Class

Name of Each Exchange on Which RegisteredOrdinary Shares*

NASDAQ Global Market




*
Ordinary shares are not traded in the United States; rather they are deposited with Citibank, N.A., as Depositary. Each American Depositary Share represents three (3) Ordinary Shares.




Securities registered or to be registered pursuant to Section 12(g) of the Act:




None




Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:




None







Indicate the number of outstanding shares of each of the issuer’s classes of capital stock as of the close of the period covered by this report. 144,819,613 ordinary shares, par value US$0.0001 per share, as of December 31, 2010.




Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes   ̈    No   x




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 15(d) of the Securities Exchange Act of 1934.    Yes   ̈    No  x




Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 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  x    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   ̈    No    ̈




Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.





Large Accelerated filer    ̈
Accelerated Filer  x
Non-accelerated Filer   ̈




Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:





U.S. GAAPx
International Financial Reporting Standards as issued by the International

Accounting Standards Board ̈
Other   ̈




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 Exchange Act).    Yes   ̈    No   x








TABLE OF CONTENTS





PagePART I


6Item  1.
Identity of Directors, Senior Management and Advisers

6Item  2.
Offer Statistics and Expected Timetable

6Item  3.
Key Information

6Item  4.
Information on the Company

27Item  4A.
Unresolved Staff Comments

48Item  5.
Operating and Financial Review and Prospects

48Item  6.
Directors, Senior Management and Employees

65Item  7.
Major Shareholders and Related Party Transactions

72Item  8.
Financial Information

76Item  9.
The Offer and Listing

77Item  10.
Additional Information

78Item  11.
Quantitative and Qualitative Disclosures About Market Risk

83Item  12.
Description of Securities Other Than Equity Securities

83PART II


84Item  13.
Defaults, Dividend Arrearages and Delinquencies

84Item  14.
Material Modifications to the Rights of Security Holders and Use of Proceeds

84Item  15.
Controls and Procedures

84Item  16A.
Audit Committee Financial Expert

85Item  16B.
Code of Ethics

85Item  16C.
Principal Accountant Fees and Services

85Item  16D.
Exemptions from the Listing Standards for Audit Committees

86Item  16E.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers

86Item  16F.
Change in Registrant’s Certifying Accountant

86Item  16G.
Corporate Governance

86PART III


87Item  17.
Financial Statements

87Item  18.
Financial Statements

87Item  19.
Exhibits

88





CONVENTIONS THAT APPLY IN THIS ANNUAL REPORT ON FORM 20-F




Unless otherwise indicated, references in this Annual Report to:




•
“ADRs” are to the American depositary receipts that may evidence our ADSs;




•
“ADSs” are to our American depositary shares, each of which represents three ordinary shares;




•
“China” or the “PRC” are to the People’s Republic of China, excluding, for the purpose of this Annual Report only, Hong Kong, Macau and Taiwan;




•
“RMB” are to the legal currency of the People’s Republic of China; and




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




The “Glossary of Technical Terms” found at page 3 sets forth the description of some of the technical terms used in this Annual Report.




Unless the context indicates otherwise, “we,” “us,” “our company,” “the company,” “our,” and “Spreadtrum” refer to Spreadtrum Communications, Inc. and its subsidiaries.


1


FORWARD-LOOKING STATEMENTS




This Annual Report on Form 20-F includes forward-looking statements that relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to differ materially from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. Words such as, but not limited to, “believe,” “expect,” “anticipate,” “estimate,” “intend,” “plan,” “likely,” “will,” “would,” “could,” and similar expressions or phrases identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and future events and financial trends that we believe may affect our financial condition, results of operation, business strategy and financial needs. Forward-looking statements include, but are not limited to, statements about:




•
anticipated trends and challenges in our business and the markets in which we operate;




•
our ability to anticipate market needs or develop new or enhanced products to meet those needs;




•
expected adoption of our products, in particular baseband and radio frequency semiconductors that support TD-SCDMA;




•
our ability to compete in our industry and innovation by our competitors;




•
our ability to protect our confidential information and intellectual property rights;




•
our ability to successfully identify and manage any potential acquisitions;




•
our ability to manage expansion into international markets;




•
our need to obtain additional funding and our ability to obtain funding in the future on acceptable terms;




•
our ability to manage growth; and




•
economic and business conditions in China.




All forward-looking statements involve risks, assumptions and uncertainties. You should not rely upon forward-looking statements as predictors of future events. The occurrence of the events described, and the achievement of the expected results, depend on many events, some or all of which are not predictable or within our control. Actual results may differ materially from expected results. See the information under “Item 3.D Key Information—Risk Factors” and elsewhere in this Annual Report for a more complete discussion of these risks, assumptions and uncertainties and for other risks and uncertainties. These risks, assumptions and uncertainties are not necessarily all of the important factors that could cause actual results to differ materially from those expressed in any of our forward-looking statements. Other unknown or unpredictable factors also could harm our results. We undertake no obligation, and specifically decline any obligation, to update publicly or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this Annual Report might not occur.


2


GLOSSARY OF TECHNICAL TERMS





2G/2.5G

2G/2.5G refers to the second generation wireless communications standard, which includes GSM, CDMA, i-DEN, TDMA, GPRS and CDMA2000 1x.3G

3G refers to the third generation wireless communications standard, which includes WCDMA/UMTS, CDMA 2000 1xEV-DO and TD-SCDMA.AAC

Advanced Audio Coding. AAC is a standardized, lossy digital audio compression scheme. AAC was designed as an improved-performance codec relative to MP3. AAC was promoted as the successor to MP3 for audio coding at medium to high bitrates.AAC+

An enhanced AAC format that delivers sound stream in as little as 32 kbps.AVS

Audio Video Coding Standard. AVS is a video compression technique developed by PRC companies and supported by the PRC governmentBluetooth

An open industry standard for providing short-range and low speed wireless transmission of digital voice and data in the 2.4GHz band. This standard supports both point-to-point and point to multipoint applications.CDMA

Code Division Multiple Access. A digital technology that assigns codes to data being transmitted, allowing more efficient usage of radio frequency spectrum in comparison to TDMA or FDMA based technologies.CDMA 1x

The original 2G-based CDMA technology (also known as IS-95A/B).CDMA2000 1x

A 2.5G/3G CDMA technology that doubles voice capacity in comparison to the original 2G-based CDMA technology (also known as IS-95A/B) and also supports high-speed data of up to 153 kbps peak rates.CDMA2000 1xEV-DO

An evolution of CDMA2000 1x that provides peak data rates of up to 2.4 Mbps.CMMB

China Multimedia Mobile Broadcasting. A mobile television and multimedia standard developed and specified in China by the State Administration of Radio, Film, and Television (SARFT), which has been described as being similar to Europe’s DVB-SH standard for digital video broadcasting from satellites to handheld devices.CMOS

Complementary Metal Oxide Semiconductor is a technology using metal oxide semiconductors for constructing integrated circuits. CMOS technology is used in microprocessors, microcontrollers, static RAM, image sensors, data converters, highly integrated transceivers and other digital/analog circuits.DMB-T

Digital Multimedia Broadcasting—Terrestrial. DMB-T is a digital terrestrial television broadcasting standard that has been adopted as China’s national standard for terrestrial television.EDGE

Enhanced Data rates for GSM Evolution. A 2.75G upgrade to GPRS that provides higher data rates (up to three times the throughput) by using improved modulation and coding techniques to the packet switched technology.FDMA

Frequency Division Multiple Access or FDMA is an access technology that is used by radio systems to share the radio spectrum. The terminology “multiple access” implies the sharing of the resource among users, and the “frequency division” describes how the sharing is done: by allocating users with different carrier frequencies of the radio spectrum.FTA

Full Type Approval. FTA is the official certificate of conformance to GSM/GPRS standards specified by the Global Certification Forum.GCF

GCF certification is a certification based on requirements defined by the Global Certification Forum, an independent industry body, which provides network compliancy requirements and testing for GSM mobile devices.GPRS

General Packet Radio Service. A data focused upgrade to GSM which introduces packet switching to the normally circuit switched technology. This allows data to be transferred only when information is actually being sent or received rather than occupying an entire circuit as GSM does normally during voice conversations.GSM

Global System for Mobile communication. A FDMA/TDMA-based 2G standard, which allows eight time slots per frequency channel.


3





H.264

Also known as MPEG-4 AVC (Advanced Video Coding), H.264 is a video compression that offers significantly greater compression than its predecessors. In addition to improvements in perceptual quality, the standard is expected to offer up to twice the compression of the current MPEG-4 ASP (Advanced Simple Profile). This standard can provide DVD-quality video at under 1Mbps, and is considered promising for full-motion video over wireless, satellite, and ADSL Internet connections.HSDPA

High Speed Downlink Packet Access. Also known as (i) WCDMA Release 5, an advancement on WCDMA which improves throughput to peak data rates of 14 Mbps, or (ii) TD-SCDMA Release 5, an advancement on TD-SCDMA which improves throughput to peak data rates of 2.8 Mbps with 1.6 MHz frequency bandwidth.HSUPA

High Speed Uplink Packet Access. As specified in (i) WCDMA Release 6, an advancement on WCDMA which improves uplink throughput to peak data rates of 5.7 Mbps, or (ii) TD-SCDMA Release 7, an advancement on TD-SCDMA which improves uplink throughput to peak data rates of 2.2 Mbps with 1.6 MHz frequency bandwidth.HSPA

High Speed Packet Access. TD-SCDMA based 3G networks that support both HSDPA and HSUPA data for improved download and upload speeds.Java

An object-oriented software programming language that can be executed on many operating systems.JPEG

Joint Photographic Experts Group. JPEG is a standards committee that designed an image compression format. The compression format they designed is known as a lossy compression in that it deletes information from an image that it considers unnecessary. JPEG files can range from small amounts of lossless compression to large amounts of lossy compression.Mixed-signal

The combination of analog and digital technology on one integrated circuit.Motion JPEG

Motion JPEG is an informal name for multimedia formats where each video frame or interlaced field of a digital video sequence is separately compressed as a JPEG image.MP3

MPEG Level 3 is an audio file format, based on MPEG (Moving Picture Expert Group) technology. It creates very small files suitable for streaming or downloading over the Internet.MPEG4

Moving Picture Experts Group Compression Standard Version 4. MPEG4 is a technology for compressing voice, video and related control data and is one of the MPEG (Moving Pictures Experts Group) international standards.OFDM

Orthogonal Frequency Division Multiplexing. OFDM is an FDM modulation technique for transmitting large amounts of digital data over a radio wave. ODFM works by splitting the radio signal into multiple smaller sub-signals that are then transmitted simultaneously at different frequencies to the receiver. OFDM reduces the amount of crosstalk in signal transmissions.PTCRB

PCS Type Certification Review Board.RISC

Reduced Instruction Set Computing. A type of processor architecture that processes programs more quickly than conventional microprocessors by using smaller, faster, less complex sets of instructions.TCP/IP stack

An implementation of the TCP/IP communications protocol. Network architectures designed in layers, such as TCP/IP, OSI (Open System Interconnection) and SNA (Systems Network Architecture) are called “stacks.”TD-SCDMA

Time Division Synchronous Code Division Multiple Access. A 3G standard mainly focused on the China market that uses Time Division Duplex (unpaired) in comparison to Frequency Division Duplex (paired) transmission in order to improve frequency efficiency level.TDMA

Time Division Multiples Access. The general term refers to a technology which assigns certain time slots to bits of data in order to increase the throughput on a given frequency band. TDMA also refers to the 2G technology also known as D-AMPS (IS-54) Global Mobile Systems 26 May 2004 89 and Digital PCS (IS-136) which splits each frequency band into three channels thereby tripling the available bandwidth.


4





UMTS

Universal Mobile Telecommunications System. A 3G standard that uses WCDMA technology with a data capacity of up to 2Mbps.USB

Universal Serial Bus. A serial bus standard to connect devices that is commonly used in the computer industry and wireless handsets.WCDMA

Wideband Code Division Multiple Access. Also known as UMTS, a 3G technology that uses CDMA based technology with a wider spectrum (5 MHz carriers versus 1.25 MHz for CDMA) to provide higher data throughput rates. Based on the standard, the peak rates can be up to 2 Mbps in local areas and 384 kbps in wide areas.WMA

Windows Media Audio. WMA is a proprietary compressed audio file format developed by Microsoft Corporation.


5


PART I




Item  1.
Identity of Directors, Senior Management and Advisers




Not required.




Item  2.
Offer Statistics and Expected Timetable




Not required.




Item  3.
Key Information




A.
Selected Financial Data




The following selected consolidated statements of operations data for the three years ended December 31, 2008, 2009 and 2010 and the selected consolidated balance sheet data as of December 31, 2009 and 2010 have been derived from our audited consolidated financial statements, which are included in “Item 18. Financial Statements” in this Annual Report on Form 20-F. The selected consolidated financial data should be read in conjunction with our audited consolidated financial statements and related notes and “Item 5. Operating and Financial Review and Prospects” in this Annual Report on Form 20-F. Our consolidated financial statements are prepared and presented in accordance with generally accepted accounting principles in the United States, or U.S. GAAP or GAAP.




Our selected consolidated statement of operations data for the years ended December 31, 2006 and 2007 and our consolidated balance sheet data as of December 31, 2006, 2007 and 2008 have been derived from our audited consolidated financial statements, which are not included in this Annual Report on Form 20-F.





For the Year Ended December 31,2006


2007


2008


2009


2010(in thousands of USD, except per share and per ADS data)Consolidated Statement of Operations DataNet revenue

$
107,075


$
145,466


$
109,937


$
105,070


$
346,338Cost of revenue


63,476



79,969



68,033



66,876



193,873Gross profit


43,599



65,497



41,904



38,194



152,465Operating expenses:Research and development


18,521



32,297



42,877



37,039



58,687Selling, general and administrative


11,254



16,282



21,998



20,539



20,188In-process research and development expense per Spreadtrum USA acquisition


—



—



6,612



—



—Impairment loss of goodwill


—



—



32,345



—



—Impairment loss of long-lived assets


—



—



17,984



—



4,486Provision for loss commitment


—



—



3,013



—



—Income (loss) from operations


13,824



16,918



(82,925
)


(19,384
)


69,104Other income


1,617



5,166



4,448



1,092



6,220Income (loss) before income taxes


15,441



22,084



(78,477
)


(18,292
)


75,324Income tax expense (benefit)


1,055



1,017



201



1,024



8,130Net income (loss)

$
14,386


$
21,067


$
(78,678
)

$
(19,316
)

$
67,194


6





For the Year Ended December 31,2006


2007


2008


2009


2010(in thousands of USD, except per share and per ADS data)Earnings (loss) per ordinary share:Basic

$
0.96


$
0.29


$
(0.60
)

$
(0.14
)

$
0.47Diluted

$
0.14


$
0.16


$
(0.60
)

$
(0.14
)

$
0.43Earnings (loss) per ADS:Basic

$
2.87


$
0.87


$
(1.79
)

$
(0.43
)

$
1.42Diluted

$
0.42


$
0.49


$
(1.79
)

$
(0.43
)

$
1.28Weighted average number of ordinary shares used in earnings (loss) per share calculationsBasic


15,015,724



73,037,662



131,510,359



134,431,135



141,739,261Diluted


102,027,673



128,745,085



131,510,359



134,431,135



157,342,529Consolidated Balance Sheet DataCash and cash equivalents

$
47,254


$
157,038


$
57,762


$
37,809


$
82,195Total assets


104,102



236,922



152,878



219,094



508,217Long-term loan, current portion


576



685



3,658



—



—Long-term loan, non-current portion


3,842



3,423



—



43,935



45,299Other long-term obligations


—



1,954



1,034



5,463



5,483Total liabilities


45,160



49,026



31,461



104,523



309,634Preferred shares


80,201



—



—



—



—Total shareholders’ equity

$
58,942


$
187,896


$
121,417


$
114,571


$
198,583




See note 21 to the Consolidated Financial Statements for an explanation of the method used to calculate basic and diluted net (loss) income per ordinary share.


7




B.
Capitalization and Indebtedness




Not applicable.




C.
Reasons for the Offer and Use of Proceeds




Not applicable.




D.
Risk Factors




The following risk factors could materially and adversely affect our future operating results, and could cause actual events to differ materially from those predicted in our forward looking statements relating to our business.




Risks Related to Our Business




We do not expect to sustain our historical rates of growth in revenue and our revenue improvement since the third quarter of 2009 may not continue.




We experienced significant growth in revenue from 2003 to 2007. However, in 2008 and during the first half of 2009, we experienced dramatic rates of decline in revenue. Our revenue increased by 35.9% from 2006 to $145.5 million in 2007, but then declined by 24.4% in 2007 to $109.9 million in 2008. We also experienced substantial revenue decline in the first half of 2009, which was largely offset by significant revenue growth in the second half of the year. Our revenue in 2009 was $105.1 million, which was 4.4% less than 2008. Our revenue in 2010 was $346.3 million, which was 229.6% higher than 2009. Our revenue growth in 2010 reflected a substantial increase in our shipments of baseband and radio frequency bundle semiconductors, or Bundle Semiconductors. We have been facing fiercer price pressure from our competitors since the second half year of 2010.  In future periods, we do not expect to achieve similar rates of revenue growth as in our historical periods and our current improvement in revenue may not continue.





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




We incurred net losses of $11.4 million and $11.7 million in 2004 and 2005, respectively. We were profitable in 2006, 2007 and first two quarters in 2008. In the third and fourth quarters of 2008, we incurred net losses of $31.3 million and $52.8 million, respectively. In the first and second quarters of 2009, we incurred net losses of $8.3 million and $13.1 million, respectively. We returned to profitability in the third quarter of 2009 and recorded net income of $0.6 million and $1.4 million in the third and fourth quarter of 2009, respectively.  We recorded net income of $67.2 million in 2010. However, we may not be able to maintain profitability in the future.  In order to be continuously profitable, we need to increase revenue while reducing our cost of revenue and operating expenses. In addition, our competitors’ behavior and strategies may affect our margins. If our revenue does not increase substantially or if we do not succeed in reducing our operating costs, we may not be continuously profitable in the future. If we do not increase profitability on a quarterly and annual basis or if we otherwise fail to meet the expectations of securities analysts or investors, the market price of our ADSs will likely decline.




We may not be able to compete effectively and increase or maintain revenue and market share.




We may not be able to compete successfully against current or potential competitors. If we do not compete successfully, our market share and revenue may decline. We currently sell substantially all of our products directly or via distributors to brand manufacturers, independent design houses, or IDHs, vendors who specialize exclusively in the design of wireless terminals based on customer specifications, and original design manufacturers, or ODMs, contract manufacturers who use their own designs and intellectual property to develop and manufacture wireless terminals for customers. We primarily compete in China with 2G baseband processor solutions providers, such as Intel Mobile Communications GmbH, or IMC, MediaTek, Inc., or MediaTek, ST-Ericsson and MStar Semiconductor Inc., or MStar. We may also compete in the Chinese 3G market with baseband processor solutions providers such as ST-Ericsson, Leadcore Technology Co., Ltd., Marvell Technologies and MediaTek. As we expand our business, we may compete in the future with additional baseband processor solutions providers, such as Broadcom Corporation, or Broadcom.  For our radio frequency transceivers, we may see competition from emerging Chinese companies such as RDA Microelectronics, Inc.  Most of our current and potential competitors have longer operating histories, significantly greater resources, brand recognition and a larger base of customers than we do. This provides them with competitive advantages and their significantly greater resources may enable them to invest substantially more resources than us to respond to the adoption of new or emerging technologies or wireless industry standards or changes in customer requirements. In addition, these competitors may have greater credibility with our existing or potential customers. Moreover, many of our competitors have been doing business with customers for a longer period of time and have established relationships, which may provide them with information regarding future trends and requirements that may not be available to us. Additionally, some of our larger competitors may be able to provide greater incentives to customers through rebates and marketing development funds and similar programs. Some of our competitors with multiple product lines may bundle their products to offer a broader product portfolio or integrate wireless functionality into other products that we do not sell, which may make it difficult for us to gain or maintain market share.


8




We do not have long-term purchase commitments from our customers, and our ability to accurately forecast demand for and sales of our products is limited, which may result in excess or insufficient inventory and significant uncertainty and volatility with respect to our revenue from period to period.




We sell a portion of our products to IDHs, ODMs and brand manufacturers directly or via distributors, who integrate our baseband semiconductors into wireless handsets and other forms of wireless terminals such as wireless desktop phones, data cards and other forms of TD-SCDMA products that they supply to their customers. We have limited visibility as to the volume of our products that our IDH and ODM customers are selling to their customers or carrying in their inventory. We do not have long-term purchase commitments from our customers and our sales are made on the basis of individual purchase orders. Our customers may cancel or defer purchase orders. Our customers’ purchase orders may vary significantly from period to period, and it is difficult to forecast future order quantities. The lead time required by the semiconductor manufacturing service providers we use to manufacture, assemble and test our products is typically longer than the lead time that our customers provide to us for delivery of our products to them. Therefore, to ensure availability of our products for our customers, we typically ask our semiconductor manufacturing service providers to start manufacturing, assembling and testing our products based on forecasts provided by our customers in advance of receiving purchase orders. However, these forecasts are not binding purchase commitments, and we do not recognize revenue from these products until they are shipped to and accepted by customers. Accordingly, we incur inventory and manufacturing costs in advance of anticipated revenue. We cannot assure you that any of our customers will continue to place purchase orders with us in the future at the same level as in prior periods or that the volume of our customers’ purchase orders will be consistent with our expectations when we plan our expenditures in advance of receiving purchase orders. Our anticipated demand for our products may not materialize. In addition, manufacturing based on customer forecasts exposes us to risks of high inventory carrying costs and increased product obsolescence, which may increase our costs. If we overestimate demand for our products or if purchase orders are cancelled or shipments delayed, we may incur excess inventory that we cannot sell. We expect to record inventory write-downs in the future as part of our normal course of business. Conversely, if we underestimate demand, we may not have sufficient inventory and may lose market share and damage customer relationships. Obtaining additional supply in the face of product shortages may be costly or impossible, particularly in the short term, which could prevent us from fulfilling orders. As a consequence, our results of operations may fluctuate significantly from period to period in the future.




Our quarterly and annual operating results may fluctuate and are difficult to predict, and if we do not meet financial expectations of securities analysts or investors, the price of our ADSs will likely decline.




Our quarterly and annual operating results may fluctuate as a result of a number of factors, many of which are beyond our control. For these reasons, comparing our operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance. Our quarterly and annual revenues and profit margins may be significantly different from our historical or projected figures. Our quarterly and annual operating results in future periods may fall below expectations. Any of these events could cause the market price of our ADSs to decline. Any of the risks described in this “Risk Factors” section, and in particular, the following factors, could cause our quarterly and annual operating results to fluctuate from period to period:




•
our ability to increase revenue and operating efficiency and reduce unit cost of sales;




•
our ability to successfully develop, introduce and sell new or enhanced products in a timely manner;




•
the adoption of new wireless industry standards or changes in our regulatory environment;




•
the announcement or introduction of new or enhanced products by us or our competitors;




•
the pricing strategies of our competitors;




•
the unpredictable volume and timing of customer orders, and subsequent delays and cancellations of customer orders;




•
our ability to stabilize revenue and costs by entering into long term agreements with customers and suppliers;




•
the amount and timing of operating costs and capital expenditures related to the maintenance and expansion of our businesses, operations and infrastructure;


•
the results of our acquisitions of, or investments in, other businesses or assets;




•
changes in the relative mix in the unit shipments of our products, which have different average selling prices and profit margins;




•
changes in the availability of capacity of our semiconductor manufacturing service providers;




•
changes in the government policies relating to our target market, which may influence the introduction of our new products; and


9




•
the overall cyclicality of the semiconductor industry and seasonality in sales of wireless handsets and fixed wireless terminals into which our products are incorporated.




In addition, we base our planned operating expenses, including research and development expenses, hiring of additional personnel and investments in inventory, in part on our expectations of future revenue, and our expenses are relatively fixed in the short term. If revenue for a particular quarter is lower than we expect, we may be unable to proportionately reduce our operating expenses for that quarter, which would harm our operating results for that quarter. If our operating results in future quarters fall below the expectations of securities analysts or investors, the market price of our ADSs will likely decline significantly. Because of our limited operating history and the fluctuations in our operating results, our historical operating results may not be useful in predicting our future operating results.





Our future growth depends in part on building relationships and achieving additional design wins with leading international and Chinese customers. If we cannot establish these relationships and achieve future design wins, our ability to grow may be limited.




We intend to pursue relationships with leading international and Chinese customers. We anticipate that these relationships will require us to make modifications to our products that involve significant technological challenges, as well as participate in lengthy field trials and extensive qualification programs. We cannot assure you that these efforts would result in a design win, where our product is incorporated into a customer’s initial product design, or that any such design win would lead to production orders. We also expect that these types of customers would place considerable pressure on us to meet their tight development schedules. In addition, these types of customers often require extensive, localized customer support, which will require us to significantly expand our customer support organization. We may have to devote a substantial amount of our limited resources to these relationships, which could detract from or delay our completion of other important development projects and may not generate a meaningful return on investment. Delays in development of these projects could impair our relationships with existing customers and negatively impact sales of the products under development. If we cannot achieve design wins in the future with leading international and Chinese customers, our ability to grow may be limited.





If TD-SCDMA is not widely adopted, or if the deployment of TD-SCDMA in China is slower than we expect, our growth will be adversely affected.




We have invested substantial time and resources in developing products that support TD-SCDMA. The market for 3G wireless terminals that support TD-SCDMA is relatively new and its potential is uncertain. The development of this market depends upon many factors, including the development of 3G wireless networks that support TD-SCDMA and the commercial acceptance of 3G wireless terminals that support TD-SCDMA. In January 2009, 3G licenses were issued to the three network operators in China. China Mobile Communications Corporation, or China Mobile, received the TD-SCDMA license, China United Telecommunications, or China Unicom received the WCDMA license, and China Telecommunications, or China Telecom, received the CDMA2000 license. In order to accelerate the development of TD-SCDMA terminal industry, China Mobile provided an incentive fund of RMB 650.0 million and initiated a number of bidding invitations and procurements for TD-SCDMA terminals in 2009. In 2010, China Mobile made TD-SCDMA terminal procurements twice, one in May 2010 for fixed wireless terminals and the other in September 2010 for handsets with CMMB feature. By the year end of 2010, China Mobile’s subscribers for TD-SCDMA-backed services reached 20 million. We cannot assure you that TD-SCDMA will be adopted by other countries as their 3G standard. China is the first country that has 3G wireless networks that support TD-SCDMA, and if the market in China fails to develop successfully, the commercial acceptance and adoption of TD-SCDMA as a worldwide 3G standard likely will be affected adversely. We are unable to predict the growth rate of this market, if any, with accuracy. Our growth depends in part upon the timely development of the market for 3G wireless terminals that support TD-SCDMA, which is affected by the extent TD-SCDMA is adopted. Even if the market for 3G wireless terminals that support TD-SCDMA fully develops, our success will still depend upon the selection by existing and potential customers of our products for use in their 3G wireless products. If this market does not develop in a timely manner or our products are not selected by customers, the growth and success of our business will be adversely affected. China Mobile, currently the only TD-SCDMA operator, has the dominant power to influence the segments, volume and pricing of TD-SCDMA terminals in the market.




In the second quarter of 2009, Spreadtrum Communications (Shanghai) Co., Ltd., or Spreadtrum Shanghai, entered into two multi-party contracts with a customer to participate in the customer’s sponsored subsidized program for the promotion of TD-SCDMA products. According to the contracts, the customer will contribute certain research and development funds to Spreadtrum Shanghai to subsidize its research and development of TD-SCDMA products if Spreadtrum Shanghai achieves certain milestones and targets. If Spreadtrum Shanghai fails to achieve certain milestones and targets, it would be required to return all research and development funds received and, in addition, be subject to penalties equal to a portion of the funds received. As of December 31, 2009, Spreadtrum Shanghai had received from the customer a total of $5.7 million, representing approximately $2.9 million for each of the two contracts, from the customer, which funds were included in accrued expenses and other liabilities. Spreadtrum Shanghai did not receive any such funds in 2010.




As of December 31, 2010, Spreadtrum Shanghai has substantially fulfilled major milestones and passed critical performance tests which were required under the terms of one of the two contracts. Accordingly, Spreadtrum Shanghai recognized subsidies of approximately $2.9 million as a reduction of research and development expenses. In February 2011, Spreadtrum Shanghai received from the customer additional funds of  $7.4 million, representing $3.7 million for each of the two contracts.


10




We may not be able to increase and maintain international market demand for our products.




Most of our sales currently are derived from customers in the PRC, Hong Kong and Macau, and the penetration of markets outside of these markets will be important to our future success. Although Samsung is one of our current customers, we may not be able to increase and maintain international market demand for our products. In addition, regulations or standards adopted by, or relevant patents issued by, other countries may require us to redesign our existing products, develop new products or obtain patent licenses to sell into those countries. For example, foreign governments may impose regulations or standards with which our baseband semiconductors do not comply, or may make frequencies available in bandwidths in which our products do not operate. In addition, we or our customers may be required to obtain patent licenses, which may not be available on commercially reasonable terms or at all. Furthermore, to the extent we are unable to expand international operations in a timely and cost-effective manner in response to increased overseas demand, we may experience losses or declines in sales, which would negatively affect our revenue. If we invest substantial time and resources to expand our international operations and are unable to do so successfully and in a timely manner, our business and operating results will suffer.





Our operating results may not meet market expectations due to reduced sales, delay or loss of significant customer orders, or delays in customer payments.




In 2008, two customers each accounted for more than 10.0% of our revenue: 30.6% and 28.5%, respectively. In 2009, three customers each accounted for more than 10.0% of our revenue: 27.1%, 15.6% and 14.0%, respectively.  In 2010, four customers each accounted for more than 10.0% of our revenue: 23.0%, 14.8%, 11.6% and 10.2%, respectively.  If we fail to successfully sell our products to one or more of our significant customers in any particular period or if a large customer purchases fewer of our products, defers orders or fails to place additional orders with us, our revenue could decline and our operating results may not meet market expectations. Also, many of our current customers are smaller companies and if those customers order our products but fail to pay on time or at all, we may incur bad debts and our operating results could be adversely affected. Furthermore, as we pursue relationships with leading international brand manufacturers, we may become dependent on a small set of customers as we focus our resources on those customers. If these customers purchase fewer products, our operating results could be adversely affected.




Our lengthy sales cycle makes it difficult for us to forecast revenue and increases the variability of our operating results.




We have a lengthy sales cycle that typically begins with our receipt of an initial request from a customer and ends when our customer executes a purchase order for production quantities. Our sales cycles typically range from four to nine months, depending on the type of customer. We typically need to obtain a design win, where our product is incorporated into a customer’s wireless terminal design, to receive purchase orders. In some cases, due to the rapid growth of new wireless terminal applications and products, this process can be time-consuming and requires substantial investment of our time and resources. During the four to nine-month sales cycle, our customers may need three to six months or longer to test, evaluate and design our products into their wireless terminals. Following a design win, our customers may need an additional one to three months or more to begin volume production of the wireless terminals that incorporate our products. There can be no assurances that a design win will result in volume shipments of our products. Changes in design will also delay our normal sales cycle. Additionally, we may commit our limited resources to a customer’s wireless terminal design that does not result in volume shipments at the expense of other customers’ wireless terminals that could have resulted in volume shipments. Because of this lengthy sales cycle and the uncertainty regarding volume shipments of our products, it is difficult for us to forecast our revenue, which increases the variability of our operating results. In addition, it is possible that we may not generate sufficient, if any, revenue from these products to offset the selling and administrative costs and investment of resources in anticipation of customer orders.


11




Our success depends upon our customers’ ability to successfully sell their products.




Our baseband semiconductors and radio frequency, or RF, transceivers are incorporated into our customers’ wireless terminals. If any of our customers are unsuccessful in their wireless terminal sales, whether due to lack of market acceptance of their products, shortage of component supplies, slowdown in sales of wireless terminals, excess inventory in the sales channels into which our customers sell their wireless terminals, changes in the wireless terminals supply chain or otherwise, our sales of baseband semiconductors could be adversely affected. Accordingly, our success depends on our customers’ success in their business. Brand manufacturers, IDHs and ODMs who purchase our products directly or via distributors have historically accounted for substantially all of our revenue. We are not certain whether these customers will be able to achieve success in their business and how long they will remain competitive in their business even if initially successful.




We depend on independent foundries to manufacture our products, and any failure to obtain sufficient foundry capacity could significantly delay our ability to ship our products and damage our customer relationships.




Access to foundry capacity is critical to our business because we are a fabless semiconductor company. We currently rely on Taiwan Semiconductor Manufacturing Company Limited, or TSMC, to manufacture most of our semiconductor products.




Because we outsource our manufacturing, we face several significant risks, including:




•
lack of manufacturing capacity;




•
limited control over delivery schedules, quality assurance and control, manufacturing yields and production costs; and




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




The ability of foundries to provide us with semiconductors is limited by its available capacity. We do not have a guaranteed level of production capacity with foundries and it is difficult to accurately forecast our capacity needs. We do not have a long-term agreement with foundries and we place our orders on a purchase order basis. As a result, if foundries raise their prices or are not able to meet our required capacity for various reasons, including shortages, or delays in shipment, of semiconductor equipment or materials used by foundries to manufacture our semiconductors, or if our business relationship with any of the foundries we currently use deteriorates, we may not be able to obtain the required capacity from it and would have to seek alternative foundries, which may not be available on commercially reasonable terms, or at all, or which may expose us to risks associated with qualifying new foundries. Furthermore, the earthquake, tsunami and nuclear crisis in Japan may negatively impact the supply of materials from Japan to foundries which could result in material shortage and foundries reducing production of materials for their customers, including us. Using foundries with which we have no established relationships could expose us to potentially unfavorable pricing, unsatisfactory quality or insufficient capacity allocation. We place our orders on the basis of our customers’ purchase orders and sales forecasts; however, foundries can allocate capacity to the production of other companies’ products and reduce deliveries to us on short notice. It is possible that customers of the foundries we currently use that are larger than we are, or that have long-term agreements with the foundries we currently use, may receive preferential treatment from the foundries in terms of capacity allocation. Reallocation of capacity by foundries to its other preferred customers could impair our ability to secure the supply of semiconductors that we need, which could significantly delay our ability to ship our products, causing a loss of revenue and damage to our customer relationships. In addition, if we do not accurately forecast our capacity needs, foundries may not have available capacity to meet our immediate needs or we may be required to pay higher costs to fulfill those needs, either of which could adversely affect our business, operating results or financial condition.





The loss of the services of our independent assembly and testing service providers could significantly disrupt our shipments, harm our customer relationships and reduce our sales.




We mainly rely on two independent assembly and testing service providers, Advanced Semiconductor Engineering, Inc., or ASE, and Siliconware Precision Industries Co., Ltd., or SPIL, to assemble and test our semiconductors. As a result, we do not directly control our product delivery schedules, assembly and testing costs or quality assurance and control. We do not have a long-term agreement with ASE or SPIL that guarantees us access to capacity. We typically procure services from ASE or SPIL on a per-order basis. If ASE or SPIL experiences capacity constraints or financial difficulties, raises its prices, suffers any damage to its facilities, is acquired and restructures its business or terminates its relationship with us, or if there is any other disruption of assembly and testing capacity, we may have to seek alternative assembly and testing services, which may not be available on commercially reasonable terms, or at all, or which may expose us to risks associated with qualifying new assembly and testing service providers. We currently estimate that it would take us several months to qualify a new assembly and testing service provider. Because of the amount of time that it takes us to qualify third-party assembly and testing service providers, we could experience significant delays in product shipments if we are required to find alternative assembly and testing service providers for our products on short notice. In addition, we may be required to pay higher assembly and testing costs. Any problems that we may encounter with the delivery or quality of our products could damage our reputation and result in a loss of customers.


12




Our primary foundry and assembly and testing service providers maintain facilities that are located in a region that is subject to earthquakes, typhoons and other natural disasters, as well as geopolitical risks and social upheaval.




TSMC, the foundry upon which we currently rely to manufacture most of our semiconductors, and ASE and SPIL, the independent assembly and testing service providers upon which we currently rely to assemble and test most of our semiconductors, have substantial operations located in Taiwan. Furthermore, a substantial number of material suppliers for TSMC, ASE and SPIL, who control most of the supply of key raw materials for wafer processing and packaging in semiconductor industry, are based in Japan. Both Taiwan and Japan are susceptible to earthquakes, typhoons, flood and other natural disasters, and have experienced severe earthquakes and typhoons in recent years such as the magnitude-9.0 earthquake and resulting tsunami in Japan in March 2011 that caused substantial production disruption to those Japanese suppliers, whose recovery plan and the associated long-term impact on the semiconductor industry remain uncertain. In addition, TSMC, ASE and SPIL are subject to risks associated with uncertain political, economic and other conditions in Taiwan and elsewhere in Asia, such as political turmoil in the region, maintaining smooth relations with the PRC and the outbreak of contagious diseases, such as Severe Acute Respiratory Syndrome, or SARS, or any other epidemic such as avian flu and swine flu. The occurrence of any of the foregoing could disrupt their operations, resulting in significant delays in deliveries or substantial shortages of our products and harm to our business.




Increases to the prices charged by the foundries and assembly and testing service providers upon which we rely may adversely affect our business and operating results.




The worldwide foundry capacity for 8-inch wafers, which are required by most of our products, was heavily overbooked in 2010 and is not expected to increase in 2011 as foundries mostly invest capital in leading-edge 12-inch wafer technologies. The assembly and testing service providers are experiencing rising commodity prices such as gold, which is one of the most important input components on packaging assembly. The combination of the limitation of foundry capacity and rising commodity prices on assembly and testing could result in higher prices from our service providers. If we are unable to pass on the higher costs of manufacturing, assembly and testing to our customers, we will experience declines in our gross margins.





Our products are becoming more complex and defects in our products could result in a loss of customers, decreased revenue, unexpected expenses, loss of market share and warranty claims.




Our products are complex and must meet stringent quality requirements. Products as complex as ours may contain undetected design flaws or manufacture defects, especially when first introduced or when new versions are released. For example, our products may contain errors that are not detected until after they are shipped because we cannot test for all possible scenarios. Errors or defects can arise due to design flaws, defects in materials or components or as a result of manufacturing difficulties, which can affect both the quality and the yield of the product. As our products become more complex, we face significantly higher risk of undetected defects. In addition, as our baseband semiconductors become more complex we may be limited in the number of wireless terminals that can utilize these components. Any errors or defects in our products, or the perception that there may be errors or defects in our products, could result in customers rejecting our products, damage to our reputation, lost revenue, diversion of development resources and increases in customer service and support costs and warranty claims.




In addition, our agreements with some customers contain warranty provisions, which provide the customer with a right to damages if a defect is traced to our products or if we cannot correct errors reported during the warranty period. Our contractual limitations on our liability may be unenforceable in a particular jurisdiction. We do not have insurance coverage for any warranty or product liability claims, and a successful claim could require us to pay substantial damages.




We may experience lower than expected manufacturing yields or limitations in designing with new process technologies, which could adversely affect our business and operating results.




The manufacture of semiconductors is a highly complex process. Minute impurities in a silicon wafer can cause a substantial number of wafers to be rejected or cause numerous die on a wafer to be nonfunctional. Semiconductor companies often encounter difficulties in achieving acceptable product yields from their manufacturers. The foundries upon which we rely to manufacture our products have occasionally experienced lower than anticipated manufacturing yields, including for our products.  This often occurs during the production of new products or the installation and start-up of new process technologies. We may experience yield problems as we migrate our manufacturing processes to smaller geometries. If we do not achieve planned yields, our product costs would increase, and product availability would decrease.




In addition, limitations inherent in new process technologies may affect the design, performance and functionality of our baseband semiconductors and RF transceivers. For example, semiconductors designed with some of the current process technologies at more advanced geometries may experience power leakage, which increases power consumption and reduces battery life. As we develop baseband semiconductors on more advanced process geometries, we may not continue to fully integrate power management on a single semiconductor. The production of our baseband semiconductors using more advanced process geometries could be delayed, which could adversely affect our business and operating results.


13





Failure of suppliers to deliver on a timely basis sufficient quantities of components or materials or licensed software used in our products may result in delays or other disruptions in introducing or shipping our products, which could adversely affect our business and operating results.




Some of the components, materials and software used in our products are purchased or licensed from a single supplier and it is difficult for us to redesign our products to incorporate other components, materials or software. For example, we have incorporated digital signal processing cores licensed from CEVA Technologies Inc., or CEVA, RISC processor cores licensed from ARM Ltd., or ARM, and 3G protocol stack software that we co-developed with Sasken Communication Technologies Limited, or Sasken. Loss or termination of the licenses for the cores or protocol stack software would have a material adverse impact on the manufacture of our products, and modifying our products for new cores or software will take a significant commitment of engineering time and resources and we may not be successful in doing so. If any vendor terminates our license to use the cores or software, or is unable to deliver components or materials used in our products, in accordance with our requirements, we may not be able to find alternative sources on favorable terms and in a timely manner, or at all. Our inability to find or develop alternative sources of components, materials and software, if and as required, could result in delays or other disruptions in introducing or shipping our products. If any of these events occur, our business and operating results could be adversely affected.




Our success depends on the continuing efforts of our senior management team and other key personnel and on our ability to successfully attract, train and retain additional key personnel.




Our future success depends heavily upon the continuing services of the members of our senior management team and various engineering and other technical personnel. Our engineers and other technical personnel are critical to our future technological and product innovations. If one or more of our senior executives or other key personnel depart or are unable or unwilling to continue in their present positions, we may not be able to replace them easily or at all, and our business may be disrupted and our financial condition and results of operations may be materially and adversely affected. Any of these employees could leave our company with little or no prior notice and would be free to work for a competitor, although we do have some non-compete protection provisions with certain employees. In addition, if any member of our senior management team or any of our other key personnel joins a competitor or forms a competing company, we may lose customers, distributors, know-how and key professionals and staff members. We do not have “key person” life insurance policies covering any of our employees. The loss of any of our key personnel or our inability to attract or retain qualified personnel, including engineers and others, could delay the development and introduction of, and would have an adverse effect on our ability to sell, our products as well as our overall business and growth prospects. We may also incur increased operating expenses and be required to divert the attention of other senior executives to recruit replacement for key personnel. Our industry is characterized by high demand and intense competition for talent and the pool of qualified candidates is very limited. We cannot assure you that we will be able to retain existing, or attract and retain new, qualified personnel, including senior executives and skilled engineers, whom we will need to achieve our strategic objectives. In addition, as we are still a young company and our business has grown rapidly, our ability to train and integrate new employees into our operations may not meet the growing demands of our business.




We may not be able to manage effectively our changes in operations.




We expect to adjust the composition of our engineering team in certain areas in the near future to meet changing customer demands. As we pursue relationships with leading international brand manufacturers and maintain and expand our relationships with our existing customers, suppliers and other third parties, we expect to accommodate any growth by adjusting our sales, engineering and customer support operations. In addition, we will need to implement a variety of new and upgraded operational and financial systems, procedures and controls, including improvements to our record keeping and our accounting, contract tracking, order processing, sales tracking, customer support and other internal management systems. All of these measures will require substantial management efforts and the dedication of additional resources. We cannot assure you that we will be able to implement these measures successfully or effectively manage our growth. Any failure to do so may adversely and materially affect our business.




Third parties may claim that we are infringing their intellectual property, and we could suffer significant litigation or licensing expenses or be prevented from selling products if these claims are successful.




In the course of our business, we may receive claims of infringement or otherwise become aware of potentially relevant patents or other intellectual property rights held by other parties. The wireless communications industry is characterized by vigorous protection and pursuit of intellectual property rights and positions, which has resulted in protracted and expensive litigation for many companies, and a large number of companies that hold significant number of patents related to GSM, GPRS, CDMA and 3G standards, such as TD-SCDMA, WCDMA/UMTS and CDMA2000, and related technologies. For example, in June 2007, we received a letter from Siemens AG, or Siemens, notifying us that Siemens claims to own certain essential patents covering the GSM/GPRS standard and offering to license such patents to us, in March 2009, we received a letter from Ericsson AB, or Ericsson, notifying us that Ericsson claims to own certain essential patents covering the GSM, GPRS, EDGE and WCDMA standards and offering to license such patents to us, and, in December, 2010, we received a letter from Washington Research Foundation, or WRF, notifying us that WRF claims to own certain patents and pending patent applications relating to Low Intermediate Frequency radio receivers and offering to license such patents and pending patent applications to us. We cannot assure you that we will prevail in these matters. We or our customers may be required to obtain licenses for such patents and if we need to license any such patents, we could be required to pay royalties on certain of our products. There can be no assurances that if we are required to obtain patent licenses to develop and sell our baseband semiconductors, we will be able to obtain such patent licenses on commercially reasonable terms or at all, or if our customers are required to obtain such patent licenses, our customers’ businesses will not be adversely affected. Our inability to obtain these patent licenses on commercially reasonable terms or at all could have a material adverse impact on our business, results of operations, financial condition or prospects. We may be unaware of intellectual property rights of others that may cover some of our technology, products and services. In addition, third parties may claim that we or our customers are infringing or contributing to the infringement of their intellectual property rights. We cannot assure you that other actions alleging infringement by us of third-party patents, trademarks and copyrights, misappropriation or misuse by us of third-party trade secrets or the validity of our patents will not be asserted or prosecuted against us, or that any assertions of infringement, misappropriation or misuse or prosecutions seeking to establish the validity of our patents will not materially or adversely affect our business, financial condition and results of operations.


14




Any litigation regarding patents or other intellectual property could be costly and time consuming and could divert our management and key personnel from our business operations. Because of the complexity of the technology involved and the uncertainty of litigation generally, any intellectual property litigation involves significant risks. Moreover, patent litigation has increased in recent years due to the increased numbers of cases asserted by intellectual property licensing entities and increasing competition and overlap of product functionality in our markets. If there is a successful claim of intellectual property infringement against us, we might be required to pay substantial damages to the party claiming infringement, refrain from further sale of our products, develop non-infringing technology or enter into costly royalty or license agreements on an on-going basis or indemnify our customers. However, we may not be able to obtain royalty or license agreements on terms acceptable to us or at all. Parties asserting infringement claims may also be able to obtain an injunction against development and sale of our products that contain the allegedly infringing intellectual property. Any intellectual property litigation or successful claim could have a material adverse effect on our business, operating results or financial condition.




We may not be able to prevent others from unauthorized use of our intellectual property, which could harm our business and competitive position.




We rely on a combination of patent, copyright, trademark and trade secret laws, as well as nondisclosure agreements and other methods to protect our intellectual property rights, which may not be sufficient to protect our intellectual property. As of April 5, 2011, we owned 141 patents and had 342 pending patent applications in China, we owned 39 patents and had 27 pending patent applications in the United States and we had 7 pending patent applications in Europe. We acquired co-ownership of 36 patents and 3 pending patent applications in China. Enforcement of PRC intellectual property-related laws has historically been ineffective, primarily because of ambiguities in the PRC laws and difficulties in enforcement. Accordingly, intellectual property rights and confidentiality protections in China may not be as effective as in the United States or other countries. Policing any unauthorized use of our intellectual property is difficult and costly and the steps we have taken may be inadequate to prevent the misappropriation of our technology. Reverse engineering, unauthorized copying or other misappropriation of our technologies could enable third parties to benefit from our technologies without paying us.





In addition, others independently may develop similar proprietary information and techniques, gain access to our intellectual property rights, disclose such technology or design around our patents. A large number of third parties hold patents or have patent applications pending that relate to core technologies used in wireless communication standards, including CDMA, FDMA, OFDM, and TDMA. Additionally, we cannot assure you that any patent or registered trademark owned by us will be enforceable or will not be invalidated, circumvented or otherwise challenged in the PRC, the United States or other countries or that the rights granted thereunder will provide competitive advantages to us or that any of our pending or future patent applications will be issued with the scope of the claims sought by us, if at all. Furthermore, litigation may be necessary to enforce our patents and other intellectual property rights, protect our trade secrets, determine the validity of and scope of the proprietary rights of others, or defend against claims of infringement or invalidity. Litigation could result in substantial costs and diversion of resources which could harm our business, could ultimately be unsuccessful in protecting our intellectual property rights, and may result in our intellectual property rights being held invalid or unenforceable. Moreover, foreign intellectual property laws may not protect our intellectual property rights.




Our participation in standards setting organizations and industry alliances may also require us to license some of our patents to our competitors and other third parties on a royalty-free basis or otherwise on fair, reasonable and nondiscriminatory terms. We may be unable to limit to whom we license some of our technologies, and may be unable to restrict many terms of the license. In addition, our control over the application and quality of our technologies that are included in patent pools or otherwise necessary for implementing industry standards may be limited.




Our intellectual property indemnification practices may adversely impact our business.




We have agreed to indemnify some customers and parties from whom we license intellectual property for costs and damages of intellectual property infringement in some circumstances. This practice may subject us to significant indemnification claims by our customers or others. In addition to indemnification claims by our customers, we may also have to defend related third-party infringement claims made directly against us. Our semiconductors and turnkey solutions are designed for use in wireless handsets and other types of wireless devices used by potentially millions of consumers, which could subject us to considerable exposure should an infringement claim occur. We cannot assure you that such claims will not be pursued.


15




We may undertake acquisitions or investments to expand our business that may pose risks to our business and dilute the ownership of our existing shareholders, and we may not realize the anticipated benefits of these acquisitions or investments.




As part of our growth strategy, we will continue to evaluate opportunities to acquire or invest in other businesses, intellectual property or technologies that would complement our current offerings, expand the breadth of markets we can address or enhance our technical capabilities. Acquisitions or investments that we may potentially make in the future entail a number of risks that could materially and adversely affect our business, operating and financial results, including:




•
problems integrating the acquired operations, technologies or products into our existing business and products;




•
diversion of management’s time and attention from our core business;




•
adverse effects on existing business relationships with customers;




•
need for financial resources above our planned investment levels;




•
failures in realizing anticipated synergies;




•
difficulties in retaining business relationships with suppliers and customers of the acquired company;




•
risks associated with entering markets in which we lack experience;




•
potential loss of key employees of the acquired company;




•
potential future impairment of our acquisitions or investments;




•
potential full or partial write-offs of acquired assets or investments and associated goodwill; and




•
potential expenses related to the amortization of intangible assets.




Our failure to address these risks may have a material adverse effect on our financial condition and results of operations. Any such acquisition or investment may require a significant amount of capital investment, which would decrease the amount of cash available for working capital or capital expenditures. In addition, if we use our equity securities to pay for acquisitions, our shareholders may experience dilution. If we borrow funds to finance acquisitions, such debt instruments may contain restrictive covenants that can, among other things, restrict us from distributing dividends.




We do not have product liability, business disruption or other business insurance coverage.




We do not have product liability, business disruption or other business insurance coverage for our operations in China or elsewhere. The insurance industry in China is still at an early stage of development and insurance companies in China currently offer limited business insurance products. In addition, we have limited business insurance coverage for our operations to cover losses that may be caused by litigation or natural disasters. Any business disruption, product liability or warranty claim, litigation or natural disaster may result in our incurring substantial costs and diversion of resources.




Our corporate actions are substantially controlled by our principal shareholders and affiliated entities.




As of February 28, 2011, our directors, executive officers, principal shareholders and their affiliated entities owned approximately 44.6% of our outstanding ordinary shares. These shareholders, acting individually or as a group, can exert substantial influence over matters such as electing directors and approving mergers or other business combination transactions. This concentration of ownership may also discourage, delay or prevent a change in control of our company, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the trading price of our ADSs. These actions may be taken even if they are opposed by our other shareholders.





Risks Related to Our Industry




Changes in industry standards, technology, customer requirements and government regulation could impair our acquired intangible assets and limit our ability to sell our products.




The wireless terminal market is characterized by changing end-user preferences and demand for new and advanced functions and applications on wireless terminals, rapid product obsolescence and price erosion, intense competition, evolving industry standards and wide fluctuations in product supply and demand. This requires us to continuously develop new products and enhance our existing products to keep pace with evolving industry standards and rapidly changing customer requirements. In order to encourage widespread market adoption of 2G and 3G technologies, efforts have been made to develop industry standards, and we have designed our products to comply with these standards. Changes in industry standards, or the development of new industry standards, may make our products obsolete or negate the cost advantages we believe we have in our products.  In addition, due to changes in industry standards and the development of new industry standards, our acquired intangible assets, including software license and technology, may become obsolete and we may have to record related impairment provisions.


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To date, most of our revenue has been derived from the sale of products that support 2G and 2.5G wireless standards such as GSM and GPRS although our revenue from 3G products is increasing as China expands its 3G product offerings and services. Continued market acceptance of these products and diversification of our product portfolio will be critical to our future success. As a result, our business, operating results, financial condition and cash flows could be adversely affected by any decline in demand for our existing products, the introduction of products and technologies by our competitors that serve as a replacement or substitute for, or represent an improvement over, our existing products, technological innovations or new standards that our existing products do not address, or our inability to release enhanced versions of our existing products on a timely basis. We offer baseband semiconductors that support TD-SCDMA, an international 3G standard promoted by the PRC government, and are focusing a significant portion of our product design and sales and marketing efforts on products that comply with such standard. We also are devoting resources to the development of mobile television solutions. If the wireless standards for which we are developing products are not widely adopted by the market, we may not be able to sell these 2.5G and 3G solutions and our revenue could decline. Because it is not practicable to develop products that comply with all current standards and standards that may be adopted in the future, our ability to compete effectively will depend on our ability to accurately select industry standards that will be widely adopted by the market and to design our products to support those relevant industry standards. We may be required to invest significant effort and to incur significant expense to redesign our products to address relevant standards. We may not have the financial resources to fund future innovations. If our products do not meet relevant industry standards that are widely adopted for a significant period of time, our revenue would decline, adversely affecting our operating results, business and prospects.




The average selling prices of products in our markets have historically decreased rapidly and will likely do so in the future, which could harm our revenue and gross margins.




As is typical in the semiconductor industry, the average selling price of a product historically declines significantly over the life of the product. In the past, we have reduced the average selling prices of our products in anticipation of future competitive pricing pressures, new product introductions by us or our competitors and other factors. We expect that we will have to similarly reduce prices in the future for our mature products. Reductions in our average selling prices to one customer could also impact our average selling prices to all customers. A decline in average selling prices would harm our gross margins. Moreover, semiconductors have short product life cycles. Our financial results will suffer if we are unable to offset any reductions in our average selling prices by increasing our sales volumes, reducing our costs, adding new features to our existing products or developing new or enhanced products on a timely basis with higher selling prices or gross margins.





We may be adversely affected by the cyclicality of the semiconductor industry.




Our industry is highly cyclical and is characterized by constant and rapid technological change, product obsolescence and price erosion, evolving standards, short product life cycles and wide fluctuations in product supply and demand. The industry has, from time to time, experienced significant downturns, often connected with, or in anticipation of, maturing product cycles of both semiconductor companies’ and their customers’ products and declines in general economic conditions. These downturns have been characterized by diminished product demand, production overcapacity, high inventory levels and accelerated erosion of average selling prices. Any future downturns may reduce our revenue and result in us having excess inventory. Furthermore, any upturn in the semiconductor industry could result in increased competition for access to limited third-party foundry, assembly and testing capacity.




Actual or perceived health risks associated with the use of wireless terminals, and the lawsuits and publicity relating to them, regardless of merit, could affect our operations negatively by leading consumers to reduce their use of wireless terminals.




There has been public speculation about possible health risks to individuals from exposure to electromagnetic fields from base stations, the two-way radio installations that are used to communicate with wireless terminals, and from the use of wireless terminals. While a substantial amount of scientific research conducted to date by various independent research bodies has shown that radio signals, at levels within the limits prescribed by public health authority safety standards and recommendations, present no adverse effect to human health, we cannot be certain that future studies, irrespective of their relative reliability or trustworthiness, will not impute a link between electromagnetic fields and adverse health effects. Research into these issues is ongoing by governmental agencies, international health organizations and other scientific bodies in order to develop a better scientific understanding and public awareness of these issues. In addition, several wireless terminal industry participants have become the targets of lawsuits alleging various health consequences as a result of wireless terminal usage or seeking protective measures. While we are not aware of any scientific studies or objective evidence which substantiates these alleged health risks, we cannot assure you that the actual, or perceived, risks associated with radio wave transmission will not reduce wireless terminal usage or cause us to allocate monetary and personnel resources to keep track of and manage these issues.


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Risks Related to Doing Business in China




Adverse changes in economic and political policies of the PRC government or laws or regulations of the PRC could have a material adverse effect on the overall economic growth of China, which could adversely affect our business.




Most of our business operations are conducted in China. Accordingly, our results of operations, financial condition and prospects are subject to a significant degree to economic, political and legal developments in China. China’s economy differs from the economies of most developed countries in many respects, including with respect to the amount of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. While the PRC economy has experienced significant growth in the past years, growth has been uneven across different regions and among various economic sectors of China. The PRC government has implemented various economic and political policies and laws and regulations to encourage economic development and guide the allocation of resources. Any adverse changes to these policies of the PRC government or the laws and regulations of the PRC could have a material adverse effect on the overall economic growth of China, which could adversely affect our business.





Our business benefits from certain government incentives and grants. Expiration of, or changes to, these incentives, reductions of these grants could have a material adverse effect on our results of operations.




The PRC government has provided various incentives to companies incorporated in the PRC in the semiconductor industry, including our company, in order to encourage development of the industry. We have received government incentives in the forms of reduced tax rates, exemption from certain taxes, favorable lending policies, research grants and other measures. Our research and development expenses have been partially offset by subsidies, including grants we have received from PRC government authorities. The aggregate cash amounts of the subsidies we received were approximately $3.7 million, $5.2 million and $13.4 million, respectively, in 2008, 2009 and 2010. For the years ended December 31, 2008, 2009 and 2010, $2.2 million, $1.5 million and $5.0 million, respectively, were recorded as offsets to research and development expenses incurred. For the years ended December 31, 2008, 2009 and 2010, $0.9 million, $1.0 million and $0.3 million, respectively, were received as subsidies for the acquisition of specific equipment in the form of a reduction of the cost of that equipment.  For the years ended December 31, 2008, 2009 and 2010, subsidies of nil, $0.7 million and $1.5 million, respectively, related to our interest expenses on the long-term bank loan we borrowed in 2009 and were recorded as offsets to our interest expenses. As of December 31, 2008, 2009 and 2010, approximately $1.0 million, $2.6 million and $7.2 million, respectively, of government subsidies had not been earned, since the requirements for those specific research and development projects had not been fulfilled. We expect to meet all these requirements in later periods before the deadlines set by the government. There can be no assurances that we will receive any subsidies in the future.




If changes in the tax laws of the PRC reduce the tax benefits available to us or our subsidiaries, our results of operations could be adversely affected.




Since China joined the World Trade Organization, or WTO, in November 2001, some of its preferential tax treatments have been criticized as not being WTO-compliant. On March 16, 2007, the National People’s Congress, the PRC legislature, approved and promulgated a tax law named “Corporate Income Tax Law,” or CIT Law, which took effect beginning January 1, 2008. Under the CIT Law, foreign-invested enterprises, or FIEs, and domestic companies are subject to a uniform tax rate of 25%. The CIT Law provides a five-year transition period starting from its effective date for those companies which were established before the promulgation date of the CIT Law and which were entitled to a preferential lower tax rate under the then effective tax laws or regulations. In accordance with regulations issued by the State Council, the tax rate of such companies may gradually transit to the uniform tax rate within the transition period. For those companies which are enjoying tax holidays, such tax holidays may continue until their expiration in accordance with the regulations issued by the State Council, but where the tax holiday has not yet started because of losses, such tax holiday shall be deemed to commence from the first effective year of the CIT Law. While the CIT Law equalizes the tax rates for FIEs and domestic companies, preferential tax treatment would continue to be given to companies in certain encouraged sectors and to entities classified as high-technology companies supported by the PRC government, whether FIEs or domestic companies. According to the CIT Law, entities that qualify as high-technology companies supported by the PRC government are expected to benefit from a tax rate of 15% as compared to the uniform tax rate of 25%. For more information regarding the Corporate Income Tax Law and the Administrative Measures for Determination of High-Technology Companies, see “Item 5.A Operating and Financial Review and Prospects—Taxation—PRC Tax.”





Additionally, our wholly-owned PRC subsidiary, Spreadtrum Shanghai, as a PRC integrated circuit design enterprise, or ICDE, is exempt from corporate income tax for two years starting from 2007, the year in which it first had positive accumulated earnings, and is entitled to a 50% reduction in the corporate income tax for the succeeding three years. Since the CIT law permits companies to continue to enjoy their existing preferential tax treatments until such treatments expire in accordance with their current terms, Spreadtrum Shanghai was exempt from income taxes in 2008. For the three years of 2009, 2010 and 2011, its income tax rate will increase from 10% to 11% to 12%, respectively, because Spreadtrum Shanghai qualifies for a 50% reduction on the standard transitional tax rate of 20%, 22%, and 24%, respectively. Spreadtrum Shanghai received the preferential income tax rate of 15% as a “new and high technology enterprise supported by the state” from the relevant tax authorities in December 2008. Based on Circular 39—Circular on the Implementation of the Preferential Policies for Corporate Income Tax During the Transition Period, which was issued by the PRC State Council, Spreadtrum Shanghai may apply the transitional tax rate during the transitional period and enjoy a 15% preferential tax rate after the transition period expires in 2012 if it continues to qualify as a “new and high technology enterprise strongly supported by the state”.  Spreadtrum Communications Technology (Shanghai) Co., Ltd., or Spreadtrum Technology, as an FIE incorporated in the Shanghai Waigaoqiao Free Trade Zone, enjoyed a preferential corporate income tax of 15% in 2007. Under the CIT Law, Spreadtrum Technology is no longer entitled to this preferential tax rate, and is therefore subject to a 18%, 20%, 22%, 24% tax rate from years 2008 through 2011, respectively, and a 25% uniform tax rate starting in 2012. Beijing Spreadtrum Hi-Tech Communications Technology Co., Ltd., or Spreadtrum Beijing, is no longer entitled to any preferential tax rate, and is therefore subject to a 25% uniform tax rate starting in 2008. Under our current tax structure, this change will increase our effective tax rate in future years.


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There can be no assurances that any of our PRC subsidiaries will continue to qualify as high-technology companies supported by the PRC government in the future, and benefit from such preferential tax rate. Following the effectiveness of the CIT Law, our effective tax rate may increase, unless we are otherwise eligible for preferential treatment. In addition, under the newly revised PRC Land Use Tax Tentative Regulations, since January 1, 2007, Spreadtrum Shanghai is subject to land use tax, levied on a yearly basis. Any increase in our tax rate in the future could have a material adverse effect on our financial condition and results of operations.





On October 18, 2010, the State Council promulgated the Circular on Extending the Urban Maintenance and Construction Tax and Educational Surcharges from Chinese to Foreign-funded Enterprises and Citizens. Under this circular, FIEs shall pay the urban maintenance and construction tax and educational surcharges starting from December 1, 2010, which FIEs and foreign citizens were exempted from paying in the past. Both urban maintenance and construction tax and educational surcharges are calculated on the basis of product tax, value-added tax and business tax paid by a company. The applicable rate of the urban maintenance and construction tax is 7% and the applicable rate of educational surcharges is 3%. These taxes will have an adverse effect on our financial results, but we do not believe the effect will be material because Spreadtrum Shanghai is entitled to certain preferential treatment for value-added taxes and business taxes and the total amount of product tax, value-added tax and business tax paid by our PRC subsidiaries is not material.




We may be treated as a resident enterprise for PRC tax purposes under the CIT Law which became effective on January 1, 2008, which may subject us to PRC income tax for any dividends we receive from our non-PRC resident subsidiaries and PRC income tax withholding for any dividends we pay to our non-PRC shareholders and ADS holders.




Under the CIT Law, enterprises established under the laws of non-PRC jurisdictions, but whose “de facto management body” is located in the PRC are treated as resident enterprises for PRC tax purposes. According to the Implementing Rules for the CIT Law, “de facto management bodies” refer to “establishments that carry out substantial and overall management and control over the manufacturing and business operations, personnel, accounting, properties, etc. of an enterprise.” Further, on April 22, 2009, the PRC State Administration of Tax issued a Notice on Certain Issues regarding the Determination of Offshore Companies Controlled by PRC Companies as Resident Enterprises pursuant to “De Facto Management Bodies” Standard, or the April Notice, which took effect retrospectively on January 1, 2008. According to the April Notice, any company established pursuant to laws and regulations other than PRC laws but that is controlled by companies or company groups within China shall be deemed as a resident enterprise for PRC tax purposes if all the following conditions are met: (i) the senior management in charge of the daily operation and management of the company is based within China or the premises where the senior management performs its duties are located within China; (ii) the financial matters (such as raising funds, financing or financial risk management) and human resources matters (such as appointment and dismissal of employees or their payrolls) are decided by companies or individuals within China or require approval from companies or individuals within China; (iii) material assets, books and accounts, company seal and minutes of board meetings or shareholder meetings are kept or placed within China; and (iv) half or more of the directors with voting rights or senior management habitually reside within China. According to this Notice, in determining the location of de facto management, “substance over form” principle should be followed. Since this Notice is issued to regulate PRC tax resident judgment of companies established overseas and controlled by PRC companies, which is not applicable in our case, the criteria in the Notice can only be used for reference purposes. The PRC tax authorities can determine whether or not certain offshore companies shall be deemed as resident enterprises for PRC tax purposes.





Most of our major board decisions are made outside of the PRC, and relevant documentation such as dual employment contracts of certain high-level management persons have been adopted. As such, we believe that the risk of being deemed as a PRC tax resident should be low. If we are treated as a resident enterprise for PRC tax purposes, we will be subject to PRC tax on our worldwide income, which will include any dividend income we receive from our non-PRC resident subsidiaries, at the 25% uniform tax rate, which would have an impact on our effective tax rate and a material adverse effect on our net income and results of operations, but the dividends distributed from our PRC subsidiaries should be tax-exempt income. Since we intend to reinvest our earnings to further expand our businesses in mainland China, our FIEs do not intend to declare dividends to their immediate Hong Kong holding companies in the foreseeable future. Accordingly, as of December 31, 2010, we have not recorded any withholding tax on the retained earnings of our FIEs in China.


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Furthermore, unlike the Income Tax Law for Enterprises with Foreign Investment and Foreign Enterprise previously in effect, which specifically exempted withholding tax on any dividends payable to non-PRC investors, the CIT Law provides that dividends generated after January 1, 2008 and payable by an FIE to its foreign investors will be subject to a 10% withholding tax if the foreign investors are considered as non-resident enterprises without any establishment or place within China or if the dividends payable have no connection with the establishment or place of the foreign investors within China, unless any such foreign investor’s jurisdiction of incorporation has a tax treaty with China that provides for a different withholding arrangement. Our subsidiaries in China are FIEs directly held by our subsidiaries in Hong Kong. According to the Mainland and Hong Kong Special Administrative Region Arrangement on Avoiding Double Taxation or Evasion of Taxation on Income agreed between China and Hong Kong in August 2006, dividends payable by an FIE in China to a company in Hong Kong which directly holds at least 25% of the equity interests in the FIE will be subject to a withholding tax of 5%. However, on February 20, 2009, the State Administration of Taxation promulgated the Notice on Relevant Issues of Implementing Dividend Clauses under Tax Treaties, or the 2009 February Notice, clarifying that no enterprise is entitled to the preferential treatment on dividend withholding tax rates pursuant to any tax treaties if such enterprise becomes qualified for such preferential tax rates through any transaction or arrangement whose major purpose is to obtain such preferential tax treatment. The tax authority in charge has the right to make adjustments to the applicable tax rates if it determines that any taxpayer has enjoyed preferential treatment under tax treaties as a result of such transaction or arrangement. Furthermore, on August 24, 2009, the State Administration of Taxation promulgated the Administrative Measures on Treatment of Non-residents under Tax Treaties (Trial Implementation), or 2009 August Notice, which became effective on October 1, 2009. According to the 2009 August Notice, any non-resident wishing to enjoy tax treaty treatment under the following sections in the relevant tax treaties shall apply to the tax authorities with competent jurisdiction for approval: (i) dividend; (ii) interest; (iii) royalty; and (iv) property income. The relevant tax authorities shall have 20 to 50 working days after an application is accepted to decide whether to approve such application. If the relevant tax authorities do not notify the applicant of its decision in writing within the above time frame, the relevant application shall be deemed to have been approved. We have not applied to the relevant tax authorities for enjoyment of the withholding tax rate under the tax treaty between Mainland and Hong Kong. It remains unclear how the PRC tax authorities will implement the 2009 February Notice and the 2009 August Notice in practice and to what extent they will affect the dividend withholding tax rates for dividends distributed by our subsidiaries in China to our Hong Kong subsidiary. If the relevant tax authority determines that our Hong Kong subsidiary was set up to take advantage of the preferential tax rates on dividends, or our application for enjoyment of the withholding tax rate under the tax treaty between Mainland and Hong Kong cannot be approved by the competent tax authorities, the higher 10% withholding tax rate may apply to such dividends.





If we are considered a PRC “resident enterprise”, the dividends from our Cayman Islands company to our ultimate non-PRC shareholders, and the capital gains realized by our non-PRC shareholders from the transfer of our ordinary shares or ADSs, may be regarded as income derived from sources within the PRC and may be subject to PRC withholding tax. If such dividends or capital gains are taxable in the PRC, the applicable income tax rate would be 10% for non-PRC institutional shareholders and 20% for non-PRC individual shareholders, unless they are able to claim a lower tax rate pursuant to applicable tax treaties.  If we are required under the CIT Law to withhold PRC income tax on our dividends payable to our non-PRC shareholders and ADS holders that are “non-resident enterprises,” or if you are required to pay PRC income tax on the transfer of our ordinary shares or ADSs, your investment in us may be materially and adversely affected.




We face uncertainty from PRC’s Circular on Strengthening the Management of Enterprise Income Tax Collection of Income Derived by Non-resident Enterprises from Equity Transfers.




The State Administration of Taxation of PRC issued the Circular on Strengthening the Management of Enterprise Income Tax Collection of Income Derived by Non-resident Enterprises from Equity Transfers, or Circular 698, on December 10, 2009, which addresses the transfer of equity by non-PRC resident enterprises. Under this Circular, the overseas controlling party that effectively controls a PRC resident enterprise through an overseas intermediate holding company, and “indirectly transfers” the equity interests in such PRC resident enterprise by selling shares of the intermediate holding company, is required to report such transfer to the PRC tax authority if the intermediate holding company is located in a foreign jurisdiction that has an effective tax rate of less than 12.5% or does not levy tax on such foreign-sourced capital gains of its residents. If the intermediate holding company mainly serves as tax avoidance vehicle and does not have any reasonable business purpose, the PRC in-charge tax authority may, upon verification of the State Administration of Taxation, disregard the intermediate holding company and re-characterize the equity transfer by referring to its economic essence, and as a result, the overseas controlling party may be subject to a 10% PRC withholding tax for the capital gains realized from the equity transfer.





We do not believe that the transfer of our ordinary shares or ADSs by our non-PRC shareholders should be treated as an indirect transfer of equity interests in our PRC subsidiaries subject to Circular 698, as the share transfer is not carried out for the main purposes of avoiding PRC taxes. However, Circular 698 is relatively new and there is uncertainty as to the interpretation and application of Circular 698 by the PRC tax authorities in practice. If you are required to pay PRC withholding tax on the transfer of our ordinary shares or ADSs, your investment in us may be materially and adversely affected. In addition, we cannot predict how Circular 698 will affect our financial conditions or operations. For example, we may be required to expend valuable resources on complying with Circular 698 or establishing that we should not be taxed under Circular 698, any of which could have an adverse effect on our financial condition and results of operations.





Our subsidiaries in China are subject to restrictions on dividend payments, making other payments to us or any other affiliated company and borrowing or allocating tax losses among our subsidiaries.




We are a holding company incorporated in the Cayman Islands and we conduct substantially all of our operations through our subsidiaries in China. Current PRC regulations permit our subsidiaries in China to pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, our subsidiaries in China are required to set aside at least 10% of their respective accumulated profits each year, if any, to fund certain reserve funds until such reserves have reached at least 50% of their respective registered capital. These reserves are not distributable as cash dividends. In addition, current PRC regulations prohibit inter-company borrowings or allocation of tax losses among subsidiaries in China. Further, if our subsidiaries in China incur debt on their own behalf in the future, the instruments governing the debt may restrict their ability to pay dividends or make other payments to us.


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Restrictions on currency exchange may limit our ability to receive and use our revenue effectively.




Because certain portion of our revenue is denominated in RMB, any restrictions on currency exchange may limit our ability to use revenue generated in RMB to fund any business activities we may have outside China or to make dividend payments in U.S. dollars. The principal regulation governing foreign currency exchange in China is the Foreign Currency Administration Rules (1996), as amended. Under these rules, RMB are freely convertible for trade and service-related foreign exchange transactions, but not for direct investment, loan or investment in securities outside China unless the prior approval of the State Administration of Foreign Exchange, or SAFE, is obtained. Although the PRC government regulations now allow greater convertibility of RMB for current account transactions, significant restrictions still remain. For example, foreign exchange transactions under our subsidiary’s capital account, including principal payments in respect of foreign currency-denominated obligations, remain subject to significant foreign exchange controls and the approval of SAFE. These limitations could affect our ability to obtain foreign exchange for capital expenditures. We cannot be certain that the PRC regulatory authorities will not impose more stringent restrictions on the convertibility of RMB, especially with respect to foreign exchange transactions.





Uncertainties with respect to the PRC legal system could adversely affect us.




Our operations in China are governed by PRC laws and regulations. Our subsidiaries in China are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to wholly foreign-owned enterprises. The PRC legal system is based on written statutes. Prior court decisions may be cited for reference but have limited precedential value.




Since 1979, PRC legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, China has not developed a fully integrated legal system and recently-enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. In particular, because these laws and regulations are relatively new, and because of the limited volume of published decisions and their nonbinding nature, the interpretation and enforcement of these laws and regulations involve uncertainties. In addition, the PRC legal system is based in part on government policies and internal rules (some of which are not published on a timely basis or at all) that may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until some time after the violation. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.




PRC regulations relating to offshore investment activities by PRC residents and employee stock options granted by overseas-listed companies may increase our administrative burden, restrict our overseas and cross-border investment activity or otherwise adversely affect the implementation of our acquisition strategy. If our shareholders who are PRC residents, or our PRC employees who are granted or exercise stock options, fail to make any required registrations or filings under such regulations, we may be unable to distribute profits and may become subject to liability under PRC laws.




SAFE promulgated regulations in October 2005 that require PRC residents and PRC corporate entities to register with local branches of SAFE in connection with their direct or indirect offshore investment activities. These regulations apply to our shareholders who are PRC residents and may apply to any offshore acquisitions that we make in the future.




Under the SAFE regulations, PRC residents who make, or have previously made, direct or indirect investments in offshore companies, will be required to register with local branches of SAFE in connection with their establishment or control of the offshore company established for the purpose of overseas equity financing involving a roundtrip investment whereby the offshore company acquires or controls onshore assets or equity interests held by the PRC residents. In addition, such PRC residents are required to file or update the registration with the local branch of SAFE, with respect to that offshore company, any material change involving its round-trip investment, capital variation, such as an increase or decrease in capital, transfer or swap of shares, merger, division, long-term equity or debt investment or creation of any security interest. If any PRC shareholder fails to make the required SAFE registration or file or update the registration, the PRC subsidiaries of that offshore parent company may be prohibited from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation, to their offshore parent company, and the offshore parent company may also be prohibited from injecting additional capital into their PRC subsidiaries. Moreover, failure to comply with the various SAFE registration requirements described above could result in liability under PRC laws for evasion of applicable foreign exchange restrictions.




We cannot provide any assurances that all of our shareholders who are PRC residents will make or obtain any applicable registrations or approvals required by these SAFE regulations. The failure or inability of our PRC resident shareholders to comply with the registration procedures set forth therein may subject us to fines and legal sanctions, restrict our cross-border investment activities, or limit our PRC subsidiaries’ ability to distribute dividends or obtain foreign-exchange-denominated loans to our company.


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As it is uncertain how the SAFE regulations will be interpreted or implemented, we cannot predict how these regulations will affect our business operations or future strategy. For example, we may be subject to more stringent review and approval process with respect to our foreign exchange activities, such as remittance of dividends and foreign-currency-denominated borrowings, which may adversely affect our results of operations and financial condition. In addition, if we decide to acquire a PRC domestic company, we cannot assure you that we or the owners of such company, as the case may be, will be able to obtain the necessary approvals or complete the necessary filings and registrations required by the SAFE regulations. This may restrict our ability to implement our acquisition strategy and could adversely affect our business and prospects.




On March 28, 2007, SAFE promulgated the Application Procedure of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Holding Plan or Stock Option Plan of Overseas-Listed Company, or the Stock Option Rule. Under the Stock Option Rule, PRC citizens who are granted stock options by an overseas publicly-listed company are required, through a PRC agent or PRC subsidiary of such overseas publicly-listed company, to register with SAFE and complete certain other procedures. We and our PRC employees who have been granted stock options are subject to the Stock Option Rule. If we or our PRC optionees fail to comply with these regulations, we or our PRC optionees may be subject to fines and legal sanctions.




Several of our PRC employees exercised their stock options prior to our becoming an overseas publicly-listed company. Since there is not yet a clear regulation on how and whether PRC employees can exercise their stock options granted by overseas private companies, it is unclear whether such exercises are permissible by PRC laws and it is uncertain how SAFE or other government authorities will interpret or administrate such regulations. Therefore, we cannot predict how such exercises will affect our business or operations. For example, we may be subject to more stringent review and approval processes with respect to our foreign exchange activities, such as remittance of dividends and foreign-currency-denominated borrowings, which may affect our results of operations and financial condition.




PRC regulations establish more complex procedures for acquisitions conducted by foreign investors which could make it more difficult for us to pursue growth through acquisitions.




On August 8, 2006, six PRC regulatory agencies, namely, the PRC Ministry of Commerce, the State Assets Supervision and Administration Commission, or SASAC, the State Administration for Taxation, the State Administration for Industry and Commerce, the CSRC, and SAFE, jointly adopted the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rule, which became effective on September 8, 2006. The M&A Rule established new procedures and requirements that could make merger and acquisition activities by foreign investors more time-consuming and complex, including requirements in some instances that the Ministry of Commerce be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise. On February 3, 2011, the General Office of the State Council promulgated the Notice on Launching the Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Security Review Notice, which became effective on March 6, 2011. The M&A Security Review Notice provides for certain circumstances under which foreign investors’ acquisition of domestic enterprises shall be subject to the security review of the PRC governments. The security review assesses such acquisition’s impact on national security, stable operation of national economy, basic living of the people, and research and development capacity for key technologies related to the national security. In the future, we may grow our business in part by acquiring complementary businesses. Complying with the requirements of the M&A Rule and the M&A Security Review Notice to complete such transactions could be time-consuming, and any required approval processes, including obtaining approval from the Ministry of Commerce, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.




Fluctuations in the value of RMB may have a material adverse effect on your investment.




The value of the RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and economic conditions. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the RMB to the U.S. dollar. Under the new policy, the RMB is permitted to fluctuate within a managed band based on market supply and demand and by reference to a basket of certain foreign currencies. This change in policy has resulted in a 25% appreciation of the RMB against the U.S. dollar between July 21, 2005 and December 31, 2010. While the international reaction to the RMB revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which may result in a further and more significant appreciation of the RMB against the U.S. Dollar. Although the majority of our revenue is denominated in U.S. dollars, a large portion of our revenue and most of our expenses are denominated in RMB. We use the U.S. dollar as the reporting currency for our financial statements. Any significant revaluation of the RMB may materially and adversely affect our cash flows, revenue, earnings and financial position, and the value of, and any dividends payable on, our ADSs in U.S. dollars. For example, to the extent that we need to convert U.S. dollars into RMB for our operations, appreciation of the RMB against the U.S. dollar would have an adverse effect on the RMB amount we receive from the conversion. Conversely, if we decide to convert our RMB into U.S. dollars for the purpose of making payments for dividends on our ordinary shares or ADSs or for other business purposes, appreciation of the U.S. dollar against the RMB would have a negative effect on the U.S. dollar amount available to us.


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If the PRC government determines that we failed to obtain requisite PRC governmental approvals for, or register with the PRC government, our current and past import and export of technologies, we could be subject to sanctions.




China imposes controls on technology import and export. The term “technology import and export” is broadly defined to include, without limitation, the transfer or license of patents, software and know-how, and the provision of services in relation to technology. Depending on the nature of the relevant technology, the import and export of technology require either approval by, or registration with, the relevant PRC governmental authorities. Spreadtrum Shanghai has licensed, or transferred, certain of its technologies to us, or other third parties outside of China, which license or transfer would constitute technology export under PRC laws. In addition, Spreadtrum Shanghai has entered into licenses with us and other third parties outside of China for certain technologies, which licenses would constitute the import of technology under PRC laws. Spreadtrum Shanghai has not obtained the approval of, or completed the applicable registration with, the relevant PRC governmental authorities for all of its import and export of these technologies.




If Spreadtrum Shanghai is found to be, or has been, in violation of PRC laws or regulations, the relevant regulatory authorities have broad discretion in dealing with such violation, including, but not limited to, issuing a warning, levying fines, restricting us from remitting royalties or any other fees, if any, relating to these technologies outside of China, confiscating our earnings generated from the import or export of such technology or even restricting our future export and import of any technology. If the PRC government determines that our past import and export of technology were inconsistent with, or insufficient for, the proper operation of our business, we could be subject to similar sanctions. Any of these or similar sanctions could cause significant disruption to our business operations or render us unable to conduct a substantial portion of our business operations and may adversely affect our business and result of operations.




We are obligated to withhold and pay PRC individual income tax on behalf of our employees who are subject to PRC individual income tax. If we fail to withhold or pay such individual income tax in accordance with applicable PRC regulations, we may be subject to certain sanctions and other penalties and may become subject to liability under PRC laws.




Under PRC laws, we are obligated to withhold and pay individual income tax on behalf of our employees who are subject to PRC individual income tax. We have paid such amounts. Although the relevant tax authority has verbally advised us that it will not impose any sanctions on us for the delay in withholding and paying individual income tax, we cannot assure you that the tax authority will not act otherwise, we will not be subject to sanctions imposed on us by the tax authority or other governmental authorities or we will not be subject to other penalties.





In addition, the State Administration of Taxation has issued several circulars concerning employee stock options. Under these circulars, our employees working in China (which could include both PRC employees and expatriate employees subject to PRC individual income tax) who exercise stock options will be subject to PRC individual income tax. Our PRC subsidiaries have obligations to file documents related to employee stock options with relevant tax authorities and withhold and pay individual income taxes for those employees who exercise their stock options. However, due to the difficulty in determining the fair market value of our shares prior to our initial public offering, and based on verbal advice we received from the relevant PRC tax authority, we did not withhold and pay the individual income tax for such exercises until after the closing of our initial public offering. We cannot assure you that the tax authority will not act contrary to its previous advice and impose sanctions on us.




We face risks related to health epidemics and outbreaks of contagious diseases, including swine influenza, avian influenza and SARS.




In 2009, there were outbreaks of the H1N1 swine flu in North America, Europe and Asia, which caused governments around the world to take measures to prevent the spread of the virus. An outbreak of swine flu or avian flu in the human population could result in a widespread health crisis that could adversely affect the economies and financial markets of many countries, particularly in Asia. Additionally, a recurrence of SARS, similar to the occurrence in 2003, which affected PRC, Hong Kong, Taiwan, Singapore, Vietnam and certain other countries, would also have similar adverse effects. Since substantially all of our operations and substantially all of our customers and suppliers are currently based in Asia (mainly the PRC), an outbreak of swine flu, avian flu, SARS or other contagious diseases in Asia or elsewhere, or the perception that such outbreak could occur, and the measures taken by the governments of countries affected, including the PRC, would adversely affect our business, financial condition or results of operations. If any of our employees are identified as a possible source of spreading the H1N1 virus, the avian flu or any other similar epidemic, we may be required to quarantine employees that are suspected of being infected, as well as others that have come into contact with those employees. We may also be required to disinfect our affected premises, which could adversely affect our operations.




Risks Related to Our ADSs




The market price for our ADSs may be volatile.




The market price for our ADSs may be volatile and subject to wide fluctuations in response to factors including the following:




•
actual or anticipated fluctuations in our quarterly operating results;




•
changes in financial estimates by securities research analysts;




•
conditions in the wireless communications industry;




•
changes in the economic performance or market valuations of other companies in the wireless communications industry;


23




•
announcements by us or our competitors of new products, acquisitions, strategic partnerships, joint ventures or capital commitments;




•
addition or departure of key personnel;




•
fluctuations of exchange rates between the RMB and the U.S. dollar;




•
intellectual property litigation;




•
release of lock-up or other transfer restrictions on our outstanding ADSs or sales of additional ADSs;




•
general economic or political conditions in China; and




•
global economic and financial crisis.




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




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




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




We may need additional capital, and the sale of additional ADSs or other equity securities could result in additional dilution to our shareholders.




We believe that our current cash and cash equivalents, anticipated cash flow from operations, the net proceeds from our initial public offering and the RMB 300 million bank loan Spreadtrum Shanghai obtained in April 2009 will be sufficient to meet our anticipated cash needs for the near future. We may, however, require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If our resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain a credit facility. The sale of additional equity securities could result in additional dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations. We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all.




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




Additional sales of our ADSs or ordinary shares in the public market, or the perception that these sales could occur, could cause the market price of our ADSs to decline. If our shareholders sell substantial amounts of our ADSs, including those issued upon the exercise of outstanding options, in the public market, the market price of our ADSs could fall. Such sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate. If any existing shareholder or shareholders sell a substantial amount of ordinary shares, the prevailing market price for our ADSs could be adversely affected.





In addition, we may issue additional ordinary shares or ADSs for future acquisitions. If we pay for our future acquisitions in whole or in part with additionally issued ordinary shares or ADSs, your ownership interests in our company would be diluted and this, in turn, could have a material adverse effect on the price of our ADSs.




Holders of our ADSs may not have the same voting rights as the holders of our ordinary shares and may not receive voting materials in time to be able to exercise your right to vote.




Holders of our ADSs will not be able to exercise voting rights attaching to the ordinary shares evidenced by our ADSs on an individual basis. Holders of our ADSs will appoint the depositary or its nominee as their representative to exercise the voting rights attaching to the ordinary shares represented by the ADSs. You may not receive voting materials in time to instruct the depositary to vote, and it is possible that you, or persons who hold their ADSs through brokers, dealers or other third parties, will not have the opportunity to exercise a right to vote. Upon our written request, the depositary will provide you with a shareholder meeting notice which contains, among other things, a statement as to the manner in which your voting instructions may be given, including an express indication that such instructions may be given or deemed given to the depositary to give a discretionary proxy to a person designated by us if no instructions are received by the depositary from you on or before the response date established by the depositary. However, no voting instruction shall be deemed given and no such discretionary proxy shall be given with respect to any matter as to which we inform the depositary that we do not wish such proxy given, substantial opposition exists, or such matter materially and adversely affects the rights of shareholders.


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You may not be able to participate in rights offerings and may experience dilution of your holdings as a result.




We may from time to time distribute rights to our shareholders, including rights to acquire our securities. Under the deposit agreement for the ADSs, the depositary will not offer those rights to ADS holders unless both the rights and the underlying securities to be distributed to ADS holders are either registered under the Securities Act, or exempt from registration under the Securities Act with respect to all holders of ADSs. We are under no obligation to file a registration statement with respect to any such rights or underlying securities or to endeavor to cause such a registration statement to be declared effective. In addition, we may not be able to take advantage of any exemptions from registration under the Securities Act. Accordingly, holders of our ADSs may be unable to participate in our rights offerings and may experience dilution in their holdings as a result.




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




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




Your ability to bring an action against us or against our directors and officers, or to enforce a judgment against us or them, will be limited, because we are incorporated under Cayman Islands law, conduct substantially all of our operations in China and a majority of our directors and officers reside outside the United States.





We are incorporated in the Cayman Islands, and conduct substantially all of our operations in China through Spreadtrum Shanghai. A majority of our directors and officers reside outside the United States and a substantial portion of their assets are located outside of the United States. As a result, it may be difficult or impossible for you to bring an action against us or these directors and officers in the Cayman Islands or in China in the event that you believe that your rights have been infringed under the securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands and of China may render it impossible for you to enforce a judgment against our assets or the assets of our directors and officers.




You may face difficulties in protecting your interests, and in protecting your rights through the United States federal courts, because we are incorporated in the Cayman Islands law.




Our corporate affairs are governed by our memorandum and articles of association and by the Companies Law (2010 Revision) and common law of the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in the United States. In particular, the Cayman Islands have a less developed body of securities laws as compared to the United States, and provide significantly less protection to investors. Therefore, our public shareholders may have more difficulties protecting their interests in the face of actions by our management, directors or controlling shareholders than would shareholders of a corporation incorporated in the United States. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action before the United States federal courts. As a result of all of the above, you may not be able to protect your interests if you are harmed in a manner that would otherwise enable you to sue in a United States federal court.


25




If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results or prevent fraud.




We are subject to reporting obligations under the United States securities laws. 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, has adopted rules requiring every public company to include a management report on such company’s internal control over financial reporting in its annual report, which contains the 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 management’s assessment of the effectiveness of the company’s internal controls over financial reporting. These requirements applied to us for the first time in connection with our Annual Report on Form 20-F filed with the SEC on June 30, 2009.




Our management has concluded that we have maintained effective internal control over financial reporting in 2010. We had identified a material weakness in our internal control over financial reporting in 2008 related to the ineffective operation of controls designed to ensure that significant non-routine transactions, accounting estimates and other adjustments were properly reviewed, analyzed and monitored. The management has concluded that the material weakness identified in 2008 has been remediated as a result of management internal control improvement. A material weakness in our internal control over financial reporting, could adversely affect our ability to record, process, summarize and report financial data consistent with the assertions of our management in our consolidated financial statements.





If we fail to maintain effective internal control, we may not be able to rely on our financial reporting. Even if we conclude that our internal control over financial reporting is effective, our independent registered public accounting firm may still issue a report that is qualified if it is not satisfied with our internal control or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us. Moreover, effective internal control over financial reporting is necessary for us to produce reliable financial reports and is important to help us manage the company effectively and prevent fraud. As a result, our failure to achieve and maintain effective internal control over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the trading price of our ADSs. Furthermore, we have incurred and anticipate that we will continue to incur considerable costs and use significant management time and other resources in an effort to comply with Section 404 of the Sarbanes-Oxley Act.




Our articles of association contain anti-takeover provisions that could adversely affect the rights of holders of our ordinary shares and ADSs.




Our articles of association contain provisions that could limit the ability of others to acquire control of our company. These provisions could deprive our shareholders of the opportunity to sell their shares at a premium over the prevailing market price by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transactions.




Our articles include the following provisions that may have the effect of delaying or preventing a change of control of our company:




•
Our board of directors has the authority, without approval by the shareholders, to issue up to a total of 15,000,000 preference shares in one or more series. Our board of directors may establish the number of shares to be included in each such series and may fix the designations, preferences, powers and other rights of the shares of a series of preference shares, which may be greater than the preferences, powers and other rights of the ordinary shares represented by our ADSs.




•
Our board of directors has the right to elect directors to fill a vacancy on the board or as an addition to the existing Board, which prevents shareholders from having the sole right to fill vacancies on our board of directors.




We may be classified as a passive foreign investment company, which could result in adverse United States federal income tax consequence to United States holders.




A non-United States corporation will be considered a “passive foreign investment company,” or PFIC, for any taxable year if either (1) at least 75% of its gross income is passive income or (2) at least 50% of the value of its assets (generally based on an average of the quarterly values of the assets during a taxable year) is attributable to assets that produce or are held for the production of passive income. PFIC status depends on the composition of our assets and income and the value of our assets (including, among others, a pro rata portion of the income and assets of each subsidiary in which we own, directly or indirectly, at least 25% (by value) of the equity interest) from time to time. Because we currently hold, and expect to continue to hold, a substantial amount of cash or cash equivalents, and, because the calculation of the value of our assets may be based in part on the value of our ADSs, which is likely to fluctuate (and may fluctuate considerably given that market prices of technology companies historically have been especially volatile), we may be a PFIC for any taxable year. If we were treated as a PFIC for any taxable year during which a United States holder held an ADS or an ordinary share, certain adverse United States federal income tax consequences could apply to the United States holder.


26





We do not believe we were a PFIC for the taxable year ended December 31, 2010. Based on the current price of our ADSs, and the composition of our income and assets, we do not expect to be considered a PFIC for United States federal income tax purposes for our current taxable year ending December 31, 2011. However, we must make a separate determination each year as to whether we are a PFIC (after the close of each taxable year) and we cannot assure you that we will not be a PFIC for our current taxable year ending December 31, 2011 or any future taxable year.




Item  4.
Information on the Company




A.
History and Development of the Company




We were incorporated as an exempted company under the laws of the Cayman Islands on April 11, 2001. Our legal name is Spreadtrum Communications, Inc. Since our inception, we have conducted our operations principally through our wholly-owned subsidiaries in China and the United States. Our principal executive offices are located at Spreadtrum Center, Building No. 1, Lane 2288, Zuchongzhi Road, Zhangjiang, Shanghai 201203, People’s Republic of China. Our telephone number at this address is +86 (21) 5080-2727. Our registered office in the Cayman Islands is located at the offices of Maples Corporate Services Limited, PO Box 309, Ugland House, Grand Cayman, KY1-1104, Cayman Islands. Our telephone number at this address is +1 (345) 949 8066. We also have branch offices in Beijing and Shenzhen, People’s Republic of China, a representative office in Suwon, Republic of Korea, and subsidiaries in San Diego, California, United States of America. Our agent for service of process in the United States is National Corporate Research, Ltd., located at 10 East 40th Street, 10th Floor, New York, New York 10016.




We are a holding company and conduct our operations primarily through our indirect wholly-owned PRC subsidiary, Spreadtrum Shanghai. Spreadtrum Shanghai is the entity that employs the majority of our employees in China and through which we sell our products to our customers. We have another indirect wholly-owned PRC subsidiary, Spreadtrum Technology, which has administrative and sales functions.




Spreadtrum Shanghai and Spreadtrum Technology were initially established as our direct wholly-owned subsidiaries. In November 2007, we established two wholly-owned Hong Kong subsidiaries, Spreadtrum Hong Kong Limited and Spreadtrum International Limited. In December 2007, we transferred 100% of the equity interest in each of Spreadtrum Shanghai and Spreadtrum Technology to Spreadtrum Hong Kong Limited and Spreadtrum International Limited, respectively.




In December 2010, Spreadtrum Shanghai established Spreadtrum Communications (Tianjin) Co., Ltd., or Spreadtrum Tianjin and Spreadtrum Communications (Chongqing) Co., Ltd., or Spreadtrum Chongqing.  Both Spreadtrum Tianjin and Spreadtrum Chongqing are wholly-owned PRC subsidiaries of Spreadtrum Shanghai and conduct research and development work and administrative work.




We also have two wholly-owned subsidiaries in the United States, SPRD LLC, a Delaware limited liability company, and Spreadtrum Communications USA Inc., or Spreadtrum USA, a Delaware corporation based in San Diego, California. In December 2008, we formed SPRD LLC and merged Spreadtrum Communications Corp., a California corporation and our wholly-owned subsidiary, into SPRD LLC. Subsequently, we contributed 100% of our member interest in SPRD LLC to Spreadtrum USA. We do not conduct any sales through SPRD LLC. On January 15, 2008, we acquired Spreadtrum USA (formerly known as Quorum Systems, Inc.), a fabless semiconductor company that specializes in the design of highly integrated CMOS RF transceivers, for $55.0 million in cash, all of which was paid as of December 31, 2008, and 3,822,199 ordinary shares of our share capital at a fair value of $12.5 million, or approximately $3.26 per ordinary share. The fair value of the ordinary shares was based on the average market price of our ordinary shares over a reasonable period before and after the date the terms of the acquisition were agreed to and announced.The difference between Spreadtrum USA’s assumed assets and assumed liabilities was $2,457,128, which resulted in additional purchase price consideration that we were required to pay to Spreadtrum USA’s shareholders as part of the cash component of the transaction. We were also required to pay up to an additional $6 million of earn-out payments in cash to the former shareholders of Spreadtrum USA, contingent on Spreadtrum USA meeting certain performance targets on or prior to January 15, 2010. In the second quarter of 2009, we decided to terminate the project related to one performance target and accordingly $1 million penalty was accrued and recorded as general and administration expense in the second quarter of 2009 and the amount was paid out to the former shareholders of Spreadtrum USA in January 2010. In the third quarter of 2009, Spreadtrum USA achieved another performance target and, as a result, we paid an earn-out payment of $1,996,453 to the former shareholders of Spreadtrum USA in 2009 and the remaining $3,547 was paid in 2010. The total $2 million earn-out payment was recorded as goodwill. On the expiration date, the last performance target was not met. In addition, we approved grants of restricted share units, or RSUs, worth $7 million to employees of Spreadtrum USA. On January 16, 2008, 2,140,434 of the approved RSUs were granted. These RSUs vest over a three-year period, with 50% vesting when and if the earn-out performance targets are met on or prior to January 15, 2010 and the remaining 50% vesting ratably at the end of each month thereafter over the next twelve months. In December 2009, we modified the milestone of one performance based RSU grant and extended the vesting deadline of the RSUs from January 15, 2010 to July 15, 2010. In September 2008, Spreadtrum Technology established a wholly-owned subsidiary in the PRC, Shanghai Han & Qin Investment Co., Ltd., through which we intend to invest in certain PRC companies and through which we had previously made an investment in Xi’an Chuang Xin Science and Technology Co., Ltd., or Xi’an Chuang Xin, in September 2008. Our investment amount in Xi’an Chuang Xin was RMB5 million. In March 2010, we entered into an equity transfer agreement with a third party to dispose our investment in Xi’an Chuang Xin. Pursuant to such agreement, we have received payment of RMB5 million, constituting the total consideration for such disposition, and we are currently in the process of completing requisite legal procedures relating to the transfer of our equity interest in Xi’an Chuang Xin to the third party. In September 2008, we established a wholly-owned subsidiary in the British Virgin Islands, Han & Qin International (BVI) Limited, or Han & Qin BVI. In December 2008, Han & Qin BVI established a wholly-owned subsidiary in Hong Kong, Han & Qin Investments (HK) Limited. In March 2009, Han & Qin Investments (HK) Limited was restructured to become directly and wholly-owned by us, and its name was changed to Quorum Technology (H.K.) Limited, or Quorum HK. We intend to use Han & Qin BVI and Quorum HK as our international investment vehicles. There was no accounting for this restructuring as it was among entities under common control.


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Spreadtrum Beijing was established for the purpose of performing research and development activities on behalf of Spreadtrum Shanghai and qualifying for government research grants that are restricted to PRC domestic companies. Spreadtrum Beijing, a PRC domestic company, was formed in March 2005 under the names of three PRC nationals who are family members of our co-founders. In May 2005, we entered into a loan agreement with the three PRC nationals who are nominee shareholders of Spreadtrum Beijing, pursuant to which we provided them with a loan in an aggregate principal amount of $1.0 million solely for the establishment of Spreadtrum Beijing. Spreadtrum Shanghai also entered into various agreements with Spreadtrum Beijing, including a research and development agreement pursuant to which Spreadtrum Beijing would perform research and development work for Spreadtrum Shanghai and the work products would be owned exclusively by Spreadtrum Shanghai. In return, Spreadtrum Shanghai reimburses Spreadtrum Beijing for all necessary and reasonable direct and indirect costs incurred for the research and development work. Because of these contractual arrangements, the relationships between the nominee shareholders of Spreadtrum Beijing and our co-founders, and the fact that one of the members of our management is the legal representative of Spreadtrum Beijing, we have the power to direct Spreadtrum Beijing’s operational and financial affairs, appoint its senior executives, and approve all matters requiring shareholder approval. As a result, Spreadtrum Beijing is deemed a variable interest entity and we are the primary beneficiary. Accordingly, we have consolidated the financial statements of Spreadtrum Beijing since its inception. In May 2008, Spreadtrum Shanghai injected approximately $0.7 million into Spreadtrum Beijing to increase its registered capital for the purpose of reducing its debt-to-equity ratio to a level that would enable it to qualify for certain government research grants. Consequently, Spreadtrum Shanghai now owns approximately 37.9% of the equity interest in Spreadtrum Beijing, and each of the three PRC national nominee shareholders owns approximately 20.7% of the equity interest in Spreadtrum Beijing. The transfer of ownership interests between Spreadtrum Shanghai and the three PRC national shareholders was determined to have no impact on the variable interest entity, or VIE, analysis because the three PRC national shareholders are nominees and do not share risks and rewards of equity ownership with us.





We have grown significantly since our inception. Our revenue increased sequentially from $12.9 million in 2004 to $38.3 million in 2005, $107.1 million in 2006, and $145.5 million in 2007, but subsequently decreased to $109.9 million in 2008 and $105.1 million in 2009. In 2010, our revenue increased to $346.3 million. We derive substantially all of our revenue from the sale of Bundle Semiconductors.




We first became profitable in the first quarter of 2006, and we recorded net income of $14.4 million in 2006 and $21.1 million in 2007. However, we recorded a net loss of $78.7 million in 2008 and $19.3 million in 2009. We recorded a net income of $67.2 million in 2010. For a discussion of our principal capital expenditures, please see “Item 5.B Operating and Financial Review and Prospects—Liquidity and Capital Resources—Capital Expenditures.”




B.
Business Overview




We are a fabless semiconductor company that designs, develops and markets baseband processor and RF transceiver for the wireless communications and mobile television market. We combine our semiconductor design expertise in parallel with our software development capabilities to deliver highly integrated baseband processors with rich multimedia functionality and power management. We have developed our solutions based on our proprietary as well as an open development platform, enabling our customers to develop customized wireless products that are feature-rich and meet their cost and time-to-market requirements.


28


We offer a comprehensive portfolio of integrated baseband processor solutions that support a broad range of wireless communications standards, including GSM, GPRS, EDGE, TD-SCDMA and HSPA. Our solutions also offer a wide array of multimedia capabilities such as MP3 digital audio playback, touch screen, JAVA acceleration, digital camera support with up to 5 mega-pixels, Motion JPEG, MPEG4, AVS and H.264 digital video playback and 64-channel polyphonic ringtone playback.




As a result of our acquisition of Spreadtrum USA in January 2008, we started to design, develop and market RF transceivers. Our single-chip CMOS multi-mode RF transceiver designs perform across multiple standards, covering GSM/GPRS, EDGE, WCDMA, TD-SCDMA and HSDPA/HSUPA needs, while enabling low power consumption.




In addition, we also design, develop and market a CMMB-based channel demodulator and audio/video decoder processor solution for the mobile television market.





Industry Background




Changing Wireless Technology Landscape




The wireless communications market is highly dynamic. Wireless technologies have evolved through successive generations of wireless protocols, driven by the need for more efficient networks with greater bandwidth capacity to enable increased usage of wireless data services by subscribers. Most wireless terminals are currently based on 2G technologies, such as GSM and CDMA. 2G networks utilize a relatively low bandwidth which only permits voice and basic data communications. Evolution into 2.5G technologies, such as GPRS/EDGE and CDMA 1x, enables faster wireless data communication that allows wireless terminals to offer slightly more advanced features, such as Internet access and multimedia messaging. 3G networks enable significantly higher data transmission speeds, up to a maximum of 14 Mbps compared to a maximum of a few hundred Kbps for 2.5G networks, which facilitates an enhanced user experience through advanced applications such as music downloads, interactive mobile gaming and video calls. Current international standards for 3G include WCDMA/UMTS, TD-SCDMA and CDMA2000 1xEV-DO. 3G technologies currently are seeing rapid deployment and adoption throughout the world. Multimedia capabilities also are becoming standard features on today’s terminals, transforming them from pure communication tools to personal computing and entertainment devices. Furthermore, the proliferation of data usage has expanded the number of devices that interact with the wireless network, such as personal computers and laptops.




China’s evolution into 3G is expected to be in large part based on the TD-SCDMA standard. In January 2006, the Ministry of Information Industry approved TD-SCDMA as one of the national 3G technology standards for the wireless communications industry in China. The TD-SCDMA standard has been developed through the collaboration among China’s wireless network operators and a number of technology providers, including semiconductor, equipment and software companies, and has received tremendous support from the Chinese government. In January 2009, MIIT issued 3G licenses as follows: CDMA2000 license for China Telecom, WCDMA license for China Unicom and TD-SCDMA license for China Mobile. Since then, China Mobile has sought to deploy the TD-SCDMA network nationwide and promote TD-SCDMA in the market. In 2009, China Mobile provided an incentive fund of RMB 650.0 million and initiated a number of bidding invitations and procurements for TD-SCDMA terminals. By the year end of 2010, as voluntarily reported by China Mobile, its subscribers for TD-SCDMA reached 20.7 million.




The wireless communications market continues to be highly dynamic and new changes and developments may occur from time to time and at times unexpectedly.




Wireless Baseband Market—Key Component of Wireless Semiconductor Market




The baseband semiconductor is the most critical semiconductor component in the wireless terminal. It is commonly referred to as the engine of a wireless terminal, equivalent to the central processing unit of a computer. The baseband semiconductor is responsible for encoding and decoding the wireless communications standards, and in some cases serving as a platform for the terminal’s operating system and multimedia applications, managing storage and directing short range connectivity such as Bluetooth traffic.




Baseband semiconductors are increasingly incorporating additional functions, such as multimedia capabilities. Further, baseband semiconductor suppliers have several advantages over other terminal component suppliers, including greater control over the selection of integrated complementary functionality. In some cases, baseband semiconductor suppliers can influence the selection of the peripherals that will be supported and included in the terminal.





Products




We offer a broad range of integrated baseband processor solutions and RF transceivers for the wireless communications market. We also offer a CMMB-based channel demodulator and audio/video decoder processor solution for the mobile television market.


29




I.
Baseband Semiconductors
  We have developed a family of baseband semiconductor solutions designed specifically for wireless handsets that support 2G to 3G wireless technology standards, such as GSM, GPRS and TD-SCDMA. Within our family of baseband semiconductors, we offer different models that support various wireless communications standards and incorporate different multimedia feature sets.
  As part of our total baseband processor solution, we offer software, such as protocol stacks, user interface, file systems and device driver software, for our open platform that is integrated into our baseband semiconductors. In addition, we have integrated other third-party operating systems and application software, such as text input, Internet browsing, electronic mail, wireless application protocol, Java and multimedia messaging service into our baseband products. Also, we have developed our own software development tools to assist our customers in developing software applications for our baseband semiconductors.
  When requested, we also provide certain customers with reference designs that incorporate our baseband semiconductors. These reference designs comprise a large library of complete, pre-tested, mass manufacturing ready handset designs for specific market segments.
  The following table summarizes the key features of our current baseband semiconductor solutions.
 Product Series

Wireless

Standard

Model

Number

Date of

Initial

Commercial

Release

Target Wireless

Handset

Key Features of

Series(1)SC6600 Series of Baseband Semiconductor Solutions

2G/2.5G standards of GSM/GPRS

SC6600D

June 2005

•  Value multimedia handsets

•  ARM7TDMI® core

•  GSM/GPRS standards (release V8.2.0 12/1999), Quad-band

•  GPRS Multi-Slot Class 12

•  Dual/Tri/Quad SIM support

•  Up to 3 mega- pixel digital  camera

•  Motion JPEG Record

•  MPEG4/H.263 player

•  MP3/AAC/AAC+ and other format music players

•  USB1.1

•  SD card

•  Polyphonic ringtones

•  Built-in LCD Controller, up to WQVGA resolutionSC6600I

May 2007

•Mid-range multimedia handsetsSC6600R

October 2007

•   Mid-range high quality multimedia handsetsSC6600H

December 2007

•   Low-range high quality multimedia handsets
  30
  Product Series

Wireless

Standard

Model

Number

Date of

Initial

Commercial

Release

Target Wireless

Handset

Key Features of

Series(1)SC6600L

June 2009

•  Low-end multimedia handset

•  Integrated power management

•  Build in Touch Panel Controller

•  Build in Backlight driver

•  Support ATV/BT/WiFi
  31
  Product Series

Wireless

Standard

Model

Number

Date of

Initial

Commercial

Release

Target Wireless

Handset

Key Features of

Series(1)SC6800 Series ofBasebandSemiconductorSolutions

2G/2.5G standards of GSM/GPRS

SC6800D

October 2006

•  Mid-range tohigh-endmultimedia handsets

•  ARM9EJ-S®  core

•  GSM/GPRS standards Quad-band

•  GPRS Multi-Slot Class 12

•  Up to 5 mega-pixel digitalcameraSC6800H

November 2010

•  Mid-end multimedia handsets

•  TV-out

•  Motion JPEG Record

•  MPEG4/H.263 player

•  MP3/AAC/AAC+ and other format music players

•  2D Graphics

•  64-channel polyphonic ringtones

•  USB1.1

•  Built-in LCD Controller, up to HVGA resolution

•  Integrated powermanagementSC8800 Series ofBasebandSemiconductorSolutions

3G standard of TD-SCDMA, 2G/2.5G standards of GSM/GPRS

SC8800D

October 2005

•  Value TD-SCDMA
handsets

•  GSM/GPRS Class12,TD- SCDMA Downlink 384kbps

•  ARM926EJ core.

•  16K I-Cache,16K D-Cache

•  AMR-NB/Midi/ ADPCM/AAC

•  Integrated with SDIO I/F

•  Integrated touch panel driverSC8800S

September 2009

•  Multimedia handsets

•  GSM/GPRS Class12,Edge class10 Quad-band; TD-SCDMA/ HSDPA 1.6Mbps Dual-band

•  ARM926EJ 160MHz

•  AMR-NB/Midi/ ADPCM/AAC/AAC+

•  MPEG4/H.263 QVGA Decoding 25fps

•  2M YUV I/F, 5M  JPEG I/F



•  Integrated touch panel driver
  32
  Product Series

Wireless

Standard

Model

Number

Date of

Initial

Commercial

Release

Target Wireless

Handset

Key Features of

Series(1)SC8800H

February 2010

• Videophone handsets

•  GSM/GPRS Class12,Edge class10 Quad-band; TD-SCDMA/ HSDPA 1.6Mbps Dual-band

•  ARM926EJ 200MHz

•  MPEG4/H.263 QCIF Codec 15fps

•  2M YUV I/F, 5M JPEG I/F

•  Integrated touch panel driverSC8800G

December 2010

•  CMMBhandsets

•  GSM/GPRS Class12,Edge class10 Quad-band; TD-SCDMA/HSDPA 2.8Mbps/HSUPA2.2Mbps Dual-band

•  ARM926EJ 400MHz

•  AMR-NB/Midi/ ADPCM/AAC/AAC+

•  MPEG4/H.263CIF Decoding 30fps

•   H.264 QVGA Decoding 30fps

•  2M YUV I/F, 5M JPEG I/F

•  Integrated touch panel driverSC8801G

December 2010

•  Ultra Low-costhandsets

•  GSM/GPRS Class12,Edge class10 Quad-band; TD-SCDMA/HSDPA 2.8Mbps Dual-band

•  ARM926EJ 256MHz

•  AMR-NB/Midi/ ADPCM/AAC/AAC+

•  MPEG4/H.263CIF Decoding 30fps

•  MPEG4/H.263 QCIF Codec 15fps

•  2M YUV I/F

•   Integrated touch panel driverSC8802G

December 2010

•  TD Modem

•  GSM/GPRS Class12,Edge class10 Quad-band; TD-SCDMA/HSDPA 2.8Mbps/HSUPA2.2Mbps Dual-band

•  ARM926EJ 192MHz 16K I-Cache,16K D-Cache

•  AMR-NB/Midi/ ADPCMCMMB Solutions

CMMB

SC6600V

May 2008

•  Mobile TV

•  CMMB demodulator

•  ARM7 core

•  MPEG audio layer1/2/3, AAC LC, AAC +(LP)

•  H.264 QVGA Decoding 30fps
 
 (1)
Each of the key features of a particular product series may not be applicable to each of the models included in such product series.
 
 33
  A.
2G and 2.5G Baseband Semiconductors
  We offer two series of baseband semiconductor solutions that are designed for wireless terminals supporting the 2G and 2.5G technologies of GSM and GPRS. The SC6600 series of baseband semiconductors was first commercially released in April 2004. All of the models within the SC6600 series perform analog and digital signal processing and integrated power management, while more advanced models incorporate multimedia functionality. Integrated power management efficiently directs power to different components of a wireless terminal, which can extend battery life. Additionally, the SC6600 series includes quad-band functionality. Quad-band functionality allows the wireless terminal to support all four major GSM frequency bands, including the 850 and 1900 MHz bands that are used in the Americas and the 900 and 1800 MHz bands that are used in most other parts of the world, making it compatible with most major GSM networks worldwide. The additional key features supported by the SC6600 series are multimedia, USB devices, SD card, backlight driver, SIM cards controllers, connectivity to Bluetooth, FM and TV. The multimedia functionality of the SC6600 series includes a digital still camera with a resolution of up to 3 mega-pixels, MP3/AAC/AAC+ digital audio playback that supports digital audio record, Motion JPEG/ MPEG4 digital video playback, Motion JPEG video record and 64-channel polyphonic ringtone playback. The models within the SC6600 series are designed for low-end handsets.
  The SC6800 series of baseband semiconductors, which was first commercially released in October 2006, is designed for mid-end multimedia handsets and smart phones, which incorporate advanced multimedia functionality. In addition to standard baseband functionality and integrated power management, our SC6800 series support a digital still camera up to 5mega-pixels, USB devices, Bluetooth/Wi-Fi connectivity and Java and integrate advanced multimedia functionality.
  Both the SC6600 series and the SC6800 series allow multiple GSM SIM cards simultaneously running on standby mode with one set of baseband and RF. This capability is highly welcomed in regions such as South Asia, Africa, and South America.
  B.
3G Baseband Semiconductors
  The SC8800 series of baseband semiconductors was first commercially released in October 2005 and is designed for value multimedia and mid-range multimedia wireless terminals that support TD-SCDMA/HSPA and GSM/GPRS/EDGE. The SC8800 baseband semiconductors support dual mode functionality, which enables wireless terminals to support 2G, 2.5G, 2.75G, 3G and 3.5G technologies, and incorporate integrated power management. The SC8800 series supports up to 2.8Mbps HSDPA and 2.2Mbps HSUPA features. Additionally, the SC8800 series supports a digital still camera with a resolution of up to 5 mega-pixels. The SC8800 series incorporates multimedia functionality, which includes streaming video, video telephony, digital audio playback that supports MP3 and other music formats such as AAC and AAC+ and MPEG4 digital video playback, and 64-channel polyphonic ringtone playback.
  II. RF Transceivers
  We offer three series of RF transceivers supporting 2G, 2.5G, 2.75G and 3G technologies. These RF transceivers feature, among other things, ultra low power consumption, which is made possible by our integrated radio technology.
  Our SR500 and SR1000 series of RF transceivers are single-chip radio transceivers for GSM/GPRS, and GSM/GPRS/EDGE, respectively. Our SR3200 is the most highly integrated single-chip radio transceiver for combined TD-SCDMA , HSDPA/HSUPA and GSM/GPRS/EDGE (HEDGE) applications.  For both Chinese domestic and tier one global third party RF markets, we provide the SR3100, a single-chip transceiver for WCDMA/HSDPA/HSUPA multi-mode/multi-band terminals.
  III. Mobile Television Solutions
  We offer CMMB-based mobile television solution, the SC6600V. The SC6600V, released in May 2008, is a demodulator/decoder semiconductor for CMMB-based mobile television and is also a single chip solution that supports both AVS and H.264 video decoding standards.
  Our Technologies
  We have extensive experience in designing GSM, GPRS, EDGE, TD-SCDMA and HSPA baseband semiconductors and RF transceivers with integrated multimedia functionality and have developed expertise in the following areas:
  •
Semiconductor Hardware Design. Integrating analog and digital circuits in a single semiconductor is inherently difficult due to noise interference and other problems. We have expertise in designing complicated mixed-signal and RF system-on-chip semiconductors using 0.18-micron, 0.152-micron, or 40-nanometer CMOS process technologies. Our single-chip baseband semiconductors incorporate a number of functional blocks, such as an ARM-based RISC processor, an analog and digital signal processor and power management unit. This enables us to utilize compact packages that take up less board space in our customers’ terminals, facilitating design efforts and lowering the total cost for those customers.
  34
  •
Wireless Software. We have expertise in developing wireless software for baseband processor solutions. We have internally developed our own protocol stack software for our 2G/2.5G baseband semiconductors, user interface software, file systems and device driver software, capabilities we believe are unique and help differentiate us from our competitors. We have co-developed our protocol stack software for our 3G baseband semiconductors. A protocol stack is software that enables communication by wireless terminals. In addition, we have expertise in porting other third-party operating systems and applications to our open development platform. Also, we have developed certain application software for our baseband processor solutions, such as phonebook software, and simulation tools.
  •
Wireless Terminal Platform. We have expertise in developing wireless terminal platforms that combine voice, video and data, including advanced multimedia and mobile Internet functionality. In developing our platforms, we define the interfaces and software used by the baseband processor solution, establish the interoperability of peripherals incorporated into the wireless terminal to ensure optimized designs, define the power budgets of the baseband semiconductor and the wireless terminal. We also develop and maintain roadmaps in various disciplines, including wireless communications standards, video compression techniques, wireless protocol development and wireless terminal multimedia. In addition, we have extensive multimedia design experience with TV-out, embedded digital camera controllers for up to 5 mega-pixel resolution, JAVA accelerator, digital audio playback standards, such as MP3, AAC and AAC+, digital video playback standards, such as Motion JPEG, MPEG4, AVS and H.264 and 64-channel polyphonic ringtones.
  Through our acquisition of Spreadtrum USA in January 2008 and internally developed expertise, we have RF technology in advanced CMOS for single-chip, multi-mode RF transceivers offering high performance with low power dissipation, a small footprint and a high level of integration for multiple markets. Our RF expertise has enabled us to generate chips covering GSM/GPRS, EDGE, WCDMA, TD-SCDMA and HSPA transmission standards. Combined with our baseband and software technology, we have unique technology expertise that ranges from the RF level to baseband and from physical layer software to protocol and applications.
 
 We also have expertise in developing and marketing a CMMB-based channel demodulator and audio/video decoder processor solution for the mobile television market. This expertise enabled the industry’s first single-chip demodulator/decoder semiconductor for CMMB-based mobile television that can work as either a stand-alone solution or in conjuncture with a host processor.
  Customers
  We currently sell our products directly to brand manufacturers, IDHs and ODMs, many of whom are primarily located in China, Hong Kong and Macau, and partially via our distributors. Our customers integrate our products into their wireless products. Brand manufacturers develop wireless terminals or desktop phones under their own brand name. IDHs design wireless terminals for brand manufacturers, and, in some cases, coordinate testing and assembly services of those wireless terminals for those brand manufacturers. ODMs provide end-to-end wireless terminal design and system integration services to their customers.
  With respect to our sales to IDHs and ODMs, we ship our products to and receive payments directly from them and sometimes via our distributors. As a result, we do not always have the ability to confirm directly with brand manufacturers who purchase wireless terminals from our IDH and ODM customers that our baseband semiconductors are incorporated into their wireless terminals. However, we believe our IDH and ODM customers sell their wireless terminals that incorporate our baseband semiconductors to many of the leading PRC wireless terminal brands.
  35
  The following table summarizes information regarding the regions where we derived revenues from our direct customers for the periods indicated:
 
 Years ended December 31,2008


2009


2010(in thousands)Revenue distribution:Mainland China, excluding Hong Kong and Macau

$
62,064,315


$
9,232,369


$
27,730,120Hong Kong and Macau


37,492,230



89,175,527



310,317,223Others


10,380,396



6,661,794



8,291,399Total net revenue

$
109,936,941


$
105,069,690


$
346,338,742
  In 2008, two customers each accounted for more than 10.0% of our revenue: 30.6% and 28.5%, respectively. In 2009, three customers each accounted for more than 10.0% of our revenue: 27.1%, 15.6% and 14.0%, respectively. In 2010, four customers each accounted for more than 10.0% of our revenue: 23.0%, 14.8%, 11.6% and 10.2%, respectively.
  We do not have long-term purchase commitments from our customers and our sales are made primarily pursuant to standard individual purchase orders. Before we accept a customer’s order, we often require that our customer agree to pay the total purchase price prior to our shipment of our products to the customer. However, we also accept payments through letters of credit, generally with terms of 30 to 60 days, or bank drafts to attract and retain large customers, a trend that we expect to continue. We also extend credits to certain preferred customers. We do not maintain product liability insurance against warranty claims, and a successful warranty or indemnification claim could require us to pay substantial damages.
 
 Based upon discussions with our customers with respect to anticipated purchase orders, we prepare monthly rolling forecasts in order to place orders to manufacture our products and maintain sufficient levels of inventory.
  Sales and Marketing
  We sell our products through our direct sales force in China, which consists of sales managers who are divided into teams to support major accounts in Northern China, Eastern China, Southern China and international sales. Our trained field applications engineers assist our customers in designing, testing and qualifying their products that incorporate our products. Our field applications engineers are deployed such that our customers have localized support. As of December 31, 2010, we employed 152 field application engineers. In addition, we work with a network of distributors to also promote and market our products.
  Our sales cycle typically begins with the receipt of an initial request from a customer and ends when our customer executes a purchase order for production quantities. The length of our sales cycles varies substantially, typically from four months to nine months, and depends on a number of factors, including the technical capabilities of our customer, the customer’s need for customization and the customer’s auditing and qualification process.
  The Bundle Semiconductors industry generally is affected by seasonality. As we gain market share for our Bundle Semiconductors, we expect to experience more seasonality. Our customers tend to increase their orders of our products (i) during the third quarter in anticipation of China’s National Day holiday, which takes place in early October, and (ii) during the fourth quarter in anticipation of the Chinese New Year holiday which generally takes place in late January or early February of the following year. In addition, business activities in China generally slow down in the first quarter of each year during the Chinese New Year period, which adversely affects our sales and results of operations during that period. Because of our limited operating history, the above-described seasonal trends that we have experienced in the past may not apply to, or be indicative of, our future operating results.
  For our wireless terminal brand manufacturer customers, the sales cycle typically takes from five to nine months depending on whether our customer begins with our reference design or our open platform. Customers that begin with our reference designs are able to develop their wireless terminal quicker and place an order in a shorter amount of time than a customer that begins with our open platform. A customer that begins with our open platform usually is designing a terminal that incorporates more features and functionality and, therefore, is required to invest greater engineering resources to complete and qualify the terminal design. Such a customer requires greater engineering support throughout the design and qualification cycle. Accordingly, the sales cycle for those customers is longer.
  For our IDH customers using our reference designs, the sales cycle typically takes four to eight months. Our IDH customers are skilled at designing terminals for their customers and complete the terminal designs relatively quickly. For ODM customers, the sales cycle typically takes up to six months. Our ODM customers are skilled and experienced in designing terminals, but these terminals usually do not include as many features and functions as the terminals that are developed by brand manufacturers.
 
 36
 
 We continue to expand our sales and marketing staff, focused on leading international brand manufacturers, and develop product sales teams organized along specific product lines. In addition, we are building a distribution network by actively qualifying distributors.
  We engage in marketing activities, such as advertising in industry publications, participating in promotional activities with our brand manufacturer customers, attending trade shows, conferences and exhibitions, holding technical seminars. We believe that these activities have been instrumental in promoting our products and brand name among key industry participants.
  Manufacturing
  As a fabless semiconductor company, we do not own or operate wafer fabrication or assembly and testing facilities. Instead, we develop our proprietary designs and provide them to third-party foundries to produce silicon wafers for our semiconductors. By utilizing third-party foundries to produce silicon wafers for our semiconductors and outsourcing our assembly and testing requirements, we are able to focus more of our resources on product design and software development, and eliminate the high cost of building and operating advanced semiconductor fabrication, assembly and testing facilities. All of our current semiconductors are developed and manufactured with 0.18-micron, 0.152-micron, and 40-nanometer CMOS process technologies.
  We have outsourced all of our wafer production to foundries, most of which has been outsourced to TSMC, the world’s largest foundry and our primary foundry service provider since our inception. Our in-house engineering staff designs our products with standard cells from foundries or third-party library providers, and provides the designs to foundries for manufacturing. We periodically work with foundries to review pricing, capacity, cycle time and other terms, and we work closely with foundries in order to achieve high manufacturing yields during the wafer fabrication process, which is an important aspect of our cost-reduction efforts. However, we do not have a guaranteed level of production capacity with foundries. For further discussion of risks associated with TSMC, please see “Item 3.D – Risk Factors – Risks Related to Our Business – We depend on independent foundries to manufacture our products, and any failure to obtain sufficient foundry capacity could significantly delay our ability to ship our products and damage our customer relationships”, “Item 3.D – Risk Factors – Risks Related to Our Business—Our primary foundry and assembly and testing service providers maintain facilities that are located in a region that is subject to earthquakes, typhoons and other natural disasters, as well as geopolitical risks and social upheaval” and “Item 3.D – Risk Factors – Risks Related to Our Business—We may experience lower than expected manufacturing yields or limitations in designing with new process technologies, which could adversely affect our business and operating results”.
  Once our semiconductors have been manufactured, we have them packaged and tested. We have developed our own automatic testing program for semiconductors and outsource all of our assembly and testing requirements to ASE, SPIL and other sub-contractors. While we attempt to minimize the risks in capacity constraint, disaster recovery, and financial difficulties by commissioning most of our assembly and testing requirements to ASE and SPIL, which are two industry leaders in providing assembly and testing service, we cannot be certain that our business will not be affected by any of these risks. We use standard, readily available packages for all of our products.
  We focus on product quality through all stages of the design and manufacturing process. Our designs are subject to extensive circuit simulation before being committed to test manufacturing. In an effort to control production cost, we commit a new product to volume production only after semiconductors are successfully sampled.
 
 37
 
 Intellectual Property
  We design substantially all of our baseband semiconductors in-house and rely on a combination of patents, trademarks, and employee and third-party nondisclosure agreements to protect our intellectual property. As of April 5, 2011, we owned 141 patents and had 342 pending patent applications in China, we owned 39 patents and had 27 pending patent applications in the United States and we had 7 pending patent applications in Europe. We also acquired co-ownership of 36 patents and 3 pending patent applications in China. Our issued patents and pending patent applications relate primarily to technology we developed for our baseband semiconductors, including TD-SCDMA, HSDPA, HSUPA, WCDMA and GSM/GPRS technologies, and RF transceivers.
  Quality Assurance
  We qualify foundries and assembly and testing service providers through a series of industry standard functionality and reliability tests, as well as an audit and an analysis of their quality assurance system and, in the case of the foundry, its manufacturing capabilities and CMOS process technology roadmap. We also monitor quality and reliability throughout the production cycle by reviewing electrical parametric data from our foundries and assembly and testing service providers. We closely monitor foundry production for consistent quality and reliability.
  Our semiconductors are integrated into wireless terminals that operate within mobile operators’ networks. Before a wireless terminal vendor can release a wireless terminal into production, it must conduct rigorous field testing and obtain a certification that the wireless terminal meets certain quality and interoperability standards. For example, GSM wireless terminals must obtain FTA certification. Accordingly, our semiconductors undergo rigorous field testing in mobile operators’ networks and are certified prior to being designed into a wireless terminal. We have field tested our semiconductors in operating wireless terminals within mobile operators’ networks pursuant to comprehensive test cases that we have developed. We also subject our semiconductors to a battery of tests, including protocol stacks and interoperability testing, in order to obtain certification. We have obtained PTCRB/GCF/ FTA certification for our 2.5G baseband chipset and PRC type approval, also known as Network Access Licenses issued by MIIT for our TD-SCDMA baseband semiconductors. In addition to the tests mentioned above, our TD-SCDMA baseband semiconductor products are subject to testing by China Telecommunication Technology Labs of MIIT and an Acceptance Test by China Mobile before they can be sold in China.
  Competition
  The baseband semiconductor industry is highly competitive and dynamic and is characterized by rapid technological changes, evolving industry standards, price reductions and rapid product obsolescence. Our ability to compete effectively depends on defining, designing and regularly introducing new products that meet or anticipate the design needs of our customers’ next generation products and applications. We currently sell a substantial portion of our products to brand manufacturers, IDHs and ODMs, directly or via distributors, and we primarily compete in China with baseband processor solutions providers, such as IMC, MediaTek, ST-Ericsson and MStar. As we expand our business, we may compete in the future with additional baseband processor solutions providers, such as Broadcom.
  The most significant factors that affect our competitiveness are:
  •
our ability to provide a total systems solution approach;
  •
our ability to offer an open development platform;
  •
our ability to rapidly introduce new products to market to meet customer demand;
  •
the functionality, performance and cost effectiveness of our products relative to those of our competitors’ products;
  •
our product roadmap that meets industry trends and requirements;
  •
the wireless standards that our products support;
  •
the quality and reliability of our products;
  •
our ability to deliver products in required volumes, on a timely basis and at a competitive price; and
  •
our customer support capabilities, which include technical support.
  Many of our existing and potential competitors have significantly greater financial, technical, manufacturing, marketing, sales and other resources than we do. We cannot assure you that we will be able to compete successfully against our current or future competitors.
  Regulation
  The semiconductor industry in China is subject to substantial regulation. This section summarizes the material effects of PRC regulations on our business in China.
  38
  Regulations and Policies that Encourage the Development of Semiconductor Design Companies
  On June 24, 2000, the General Office of the State Council promulgated the Several Policies to Encourage the Development of the Software and Integrated Circuit Industry, or the IC Policies. The IC Policies set forth preferential policies on investment, financing, tax, industrial process, technology, income distribution and export-related matters concerning ICDEs. On January 28, 2011, the State Council promulgated the Several Policies to Further Encourage the Development of the Software and Integrated Circuit Industry, or the New IC Policies. The New IC Policies set forth preferential policies on tax, investment and financing, research and development, import and export, talent, intellectual property protection and market environment matters concerning ICDEs.
  Accreditation of ICDEs
  Only duly accredited ICDEs may qualify for preferential industrial policies. Pursuant to the Regulations on Administration of the Accreditation of Integrated Circuit Design Enterprises and Products jointly issued by the MIIT, and the State Administration of Taxation, or SAT, on March 7, 2002 and the Notice Concerning Adjustment of Accreditation Organization and Administration Manner of Integrated Circuit Design Enterprises and Products jointly issued by the MIIT and the SAT on June 30, 2004, in order to obtain accreditation, an ICDE must:
  •
be a legally established enterprise whose principal business is semiconductor design;
  •
possess adequate production and quality assurance capabilities; and
  •
generate more than 30% of its total annual revenue from the self-design of semiconductor products and integrated circuit design services.
 
 The MIIT is the authorized examination and approval administration for accreditation of ICDEs and has designated the China Semiconductor Industry Association and two other agencies to conduct the accreditation of ICDEs.
  We conduct our integrated circuit design in China through Spreadtrum Shanghai, which was accredited as an ICDE by the Shanghai Information Office in 2001 and has passed the annual review of such accreditation for 2006, 2007, 2008,2009 and 2010, and therefore, is eligible for preferential tax treatment under PRC laws relating to ICDEs as briefly described below.
  Encouragement of Foreign Investment in ICDEs
  Pursuant to the IC Policies and the Guideline Catalogue of Foreign Investment Industries jointly promulgated by the National Development and Reform Commission and the Ministry of Commerce on November 30, 2004, as amended on October 31, 2007, foreign investment in integrated circuit design is encouraged and may be eligible for certain types of preferential treatment.
  Preferential Taxation Policies
  Under the IC Policies and the New IC Policies, ICDEs are entitled to certain preferential tax treatment.
  Exemption of Customs Duties. Under the IC Policies, an ICDE does not need to pay customs duty on any imported equipment necessary for its own use or any technology, ancillary parts and spare parts that are included in the contract for the equipment. The exemptions from customs duty do not apply to equipment, technology and parts that are listed on the Catalogue of Imported Commodities for Foreign Investment Projects Not Subject to Tax Exemptions and the Catalogue of Imported Commodities for Domestic Investment Projects Not Subject to Tax Exemptions. Spreadtrum Shanghai has in the past applied for and successfully obtained exemptions from customs duty and will continue to apply for such exemptions in accordance with relevant regulations in the future.
  An ICDE may have semiconductors, which are designed by the ICDE itself with independent intellectual property rights, manufactured or processed overseas if such semiconductors could not be manufactured in China. Pursuant to a notice jointly issued by the Ministry of Finance and the SAT on August 31, 2004, effective October 1, 2004, the input value-added tax levied on these semiconductors imported shall be set at 17%. Spreadtrum Shanghai is subject to the 17% input value-added tax for semiconductors processed overseas and imported into China.
  Corporate Income Tax. Under the IC Policies and the New IC Policies, an accredited ICDE is entitled to take advantage of the preferential policies for corporate income tax. From the year in which an ICDE first has positive accumulated earnings, the ICDE is exempted from corporate income tax for two years and is entitled to a 50% reduction in the corporate income tax for the succeeding three years. Spreadtrum Shanghai has been accredited as an ICDE and is entitled to such tax preferential treatment.
  On March 16, 2007, the National People’s Congress approved and promulgated the CIT Law, which took effect beginning January 1, 2008. Under the CIT Law, FIEs and domestic companies are subject to a uniform tax rate of 25%. The CIT Law provides a five-year transition period starting from its effective date for those enterprises which were established before the promulgation date of the CIT Law and which were entitled to a preferential lower tax rate under the then effective tax laws or regulations. In accordance with regulations issued by the State Council, tax rate of such companies may gradually transit to the uniform tax rate within such transition period. For those companies which are enjoying tax holidays, such tax holidays may continue until its expiration in accordance with the regulations issued by the State Council, but where the tax holiday has not yet started because of losses, such tax holiday shall be deemed to commence from the first effective year of the CIT Law, i.e., 2008. While the CIT Law equalizes the tax rates for FIEs and domestic companies, preferential tax treatment would continue to be given to companies in certain encouraged sectors and to entities classified as high-technology companies supported by the PRC government, whether FIEs or domestic companies.
  39
 
 For the potential effects of the CIT Law on our preferential tax treatment, see “Risk Factors—Risks Related to Doing Business in China—If changes in the tax laws of the PRC reduce the tax benefits available to us or our subsidiaries, our results of operations could be adversely affected.”
 
 Business Tax. Under the New IC Policies, qualified ICDEs may enjoy the emption of business tax for the businesses including software development and test, information system integration, consultation and operational maintenance, and the design of IC products, in accordance with the rules to be made by the Ministry of Finance, the State Administration of Taxation and other relevant governmental authorities.
 
 Intellectual Property Protection for Semiconductors
  China has adopted legislation related to intellectual property rights, including trademarks, patents and copyrights. China is a signatory to the main international conventions on intellectual property rights and became a member of the Agreement on Trade Related Aspects of Intellectual Property Rights upon its accession to the WTO in December 2001. Set forth below are major PRC laws and international treaties effective in China protecting intellectual property rights in semiconductors:
  •
the Paris Convention for the Protection of Industrial Property of the World Intellectual Property Organization, of which China became a member state on March 19, 1985;
  •
the Patent Cooperation Treaty of the World Intellectual Property Organization, of which China became a member state on January 1, 1994;
  •
the World Intellectual Property Organization’s Washington Treaty on Intellectual Property in Respect of ICs, of which China was among the first signatory states in 1990;
  •
the General Principles of the Civil Law of the People’s Republic of China adopted at the fourth session of the Sixth National People’s Congress on April 12, 1986, effective January 1, 1987. In this legislation, intellectual property rights were defined in China’s basic civil law for the first time as the civil rights of citizens and legal persons;
  •
the Patent Law of the People’s Republic of China, adopted at the fourth meeting of the Standing Committee of the Sixth National People’s Congress on March 12, 1984, effective as of April 1, 1985, as amended, and the Implementing Regulations issued by the State Council on June 15, 2001, effective as of July 1, 2001, as amended;
  •
the Trademark Law of the People’s Republic of China, adopted at the twenty-fourth meeting of the Standing Committee of Fifth National People’s Congress on August 23, 1982 and effective as of March 1, 1983, as amended, , and its Implementing Measures issued by the State Council on August 3, 2002, effective as of September 15, 2002;
  •
the Copyright Law of the People’s Republic of China, adopted at the fifteenth meeting of the Standing Committee of the Seventh National People’s Congress on September 7, 1990, effective as of June 1, 1991, as amended, and its Implementing Measures issued by the State Council on August 2, 2002, effective as of September 15, 2002;
  •
the Regulations for the Protection of the Layout Design of Integrated Circuits, or the Layout Design Regulations, adopted March 28, 2001 at the thirty-sixth session of the executive meeting of the State Council, effective October 1, 2001, and the Implementing Rules issued by the State Intellectual Property Office on September 18, 2001, effective October 1, 2001; and
  •
the Regulations on the Protection of Computer Software, issued by the State Council on December 20, 2001, effective January 1, 2002.
  We have adopted a combination of patent, trademarks, copyright, employee and third-party nondisclosure agreements to protect our intellectual property in China. As of April 5, 2011, we owned 141 patents and had 342 pending patent applications in China. We acquired co-ownership of 36 patents and 3 pending patent applications in China.
  Protection of Integrated Circuit Layout Design
  Under the Layout Design Regulations, an integrated circuit layout design is defined as a three-dimensional configuration in a semiconductor that has two or more components, at least one of which is an active component, and part or all of the interconnected circuitry or the three-dimensional configuration has been prepared for the production of semiconductors.
  The following persons and entities can hold proprietary rights in the layout designs that they create: (i) PRC natural persons, legal persons or other organizations; (ii) foreign persons or companies whom are creators of an integrated circuit layout design and whose layout designs are first commercially used in China; and (iii) foreign persons or companies from a country that either has an agreement with China concerning the protection of layout designs or is a signatory to an international treaty concerning the protection of layout designs to which China is also a signatory.
  40
  A holder of proprietary rights in a layout design may:
  •
duplicate the entire protected layout design or any part of the original design; and
  •
use the protected layout design, the integrated circuit containing the layout design, or commodities containing the integrated circuit commercially.
  The proprietary rights are valid after the layout design is registered with the State Intellectual Property Office of the PRC.
  Proprietary rights in a layout design are granted for ten years, commencing from the earlier of the date of the application for registration of the layout design or the first date of its commercial use anywhere in the world. However, a layout design is not entitled to any protection beyond 15 years from the time of its creation, regardless of when the layout design is registered or put into commercial use. The holder of the proprietary rights may transfer those rights to another party or grant permission for use of the design.
  Registration of a Layout Design
  The State Intellectual Property Office of the PRC decides on applications for registration of layout designs. An application must be made within two years of the design being put in commercial use anywhere in the world, or the application will be rejected.
  We may register any layout design that we may have in the future.
 
 Compulsory Licenses for Exploitation of Patents in Respect of Semiconductor Technology
  Under the Patent Law and the Implementing Regulations of the Patent Law, a company may request the State Intellectual Property Office to grant a compulsory license to use the patent if: (i) three years have passed from the date of granting an invention patent or a utility model patent and four years have passed from the date of submitting the application for registration of the patent but the corresponding patent has not been implemented or fully implemented without proper reasons; and the company has been unsuccessful in obtaining a license from the holder of the rights within a reasonable period of time despite good faith attempts to obtain the license; or (ii) the way the patent rights holder exercises its rights is deemed as anti-competitive pursuant to relevant laws and regulations and for purposes of eliminating or minimizing corresponding adverse effects on competition. Further, the State Intellectual Property Office has the right to grant a compulsory license in the event of a national emergency or for public interests. A compulsory license for the use of a semiconductor technology patent is restricted to public and non-commercial uses, or to uses that counter anti-competitive actions, as determined pursuant to relevant laws and regulations.
  Under the Layout Design Regulations, the Intellectual Property Administration Department of the State Counsel may grant a non-voluntary license to use a layout design in the event of a national emergency or any extraordinary state of affairs, where public interest so requires, or where the holder is engaging in unfair competition, which requires remedy, as determined by a court or the Department of Supervision and Inspection against Unfair Competition. The scope and duration of the license will be determined in accordance with the reasons justifying the grant. The scope shall be limited to non-commercial use for public purposes, or to remedy the holder’s unfair competitive actions as determined by a court or the Department of Supervision and Inspection against Unfair Competition.
  Our PRC patents and the layout designs may be subject to the compulsory license in accordance with the relevant regulations.
  Regulations on Foreign Exchange
  Foreign exchange regulation in China is primarily governed by the following rules:
  •
Foreign Currency Administration Rules (1996), as amended, or the Exchange Rules; and
  •
Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996), or the Administration Rules.
  Under the Exchange Rules, the RMB is convertible for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions. Conversion of RMB for capital account items, such as direct investment, loan, security investment and repatriation of investment, however, is still subject to the approval of the SAFE or its competent local branches.
  Under the Administration Rules, enterprises may only buy, sell or remit foreign currencies at those banks authorized to conduct foreign exchange business after providing valid commercial documents and relevant supporting documents and, in the case of capital account item transactions, obtaining approval from the SAFE or its competent local branches. Capital investments by enterprises outside of China are also subject to limitations, which include approvals by the Ministry of Commerce, the SAFE and the State Development and Reform Commission, or their respective competent local branches.
 
 41
 
 Spreadtrum Shanghai, Spreadtrum Technology and Spreadtrum Beijing are required to handle their respective foreign exchange matters in accordance with the applicable regulations.
  Regulations on Dividend Distribution
  The principal regulations governing dividend distributions of wholly foreign-owned companies include:
  •
Wholly Foreign-Owned Enterprise Law (1986), as amended;
  •
Wholly Foreign-Owned Enterprise Law Implementing Rules (1990), as amended;
  •
PRC Corporate Income Tax Law (2007); and
  •
Implementation Rules of the PRC Corporate Income Tax Law (2007).
  Under these regulations, wholly foreign-owned companies in the PRC may pay dividends only out of their accumulated profits as determined in accordance with PRC accounting standards. Remitting dividends by a wholly foreign-owned enterprise out of China shall be subject to examination by the banks designated by SAFE. In addition, these wholly foreign-owned companies are required to maintain one statutory reserve, or PRC statutory reserve: a general reserve fund. Our PRC subsidiaries are required to transfer 10% of their profit after taxation, as reported in their PRC statutory financial statements, to the general reserve fund until the balance reaches 50% of their registered capital. The PRC statutory reserve is not distributable as cash dividends.
  Dividend distribution of Spreadtrum Shanghai and Spreadtrum Technology is subject to the requirements as discussed above.
  SAFE Regulations on Mergers and Acquisitions, Offshore Investments and Employee Stock Options
  SAFE issued a public notice in January 2005 concerning foreign exchange regulations on mergers and acquisitions in China. The public notice stated that if an offshore company controlled by PRC residents intends to acquire a PRC domestic company, such acquisition will be subject to strict examination by the relevant foreign exchange authorities. The public notice also stated that the approval of the relevant foreign exchange authorities is required for any sale or transfer by PRC residents of a PRC domestic company’s assets or equity interests to foreign entities, such as us, for equity interests or assets of the foreign entities. In April 2005, SAFE issued another public notice. In accordance with the April notice, if an acquisition of a PRC company by an offshore company controlled by PRC residents has been confirmed by a Foreign Investment Enterprise Certificate prior to the promulgation of the January notice, the PRC residents must each submit a registration form to the local SAFE branch with respect to their respective ownership interests in the offshore company, and must also file an amendment to such registration if the offshore company experiences material events, such as changes in the share capital, share transfer, mergers and acquisitions, spin-off transaction or use of assets in China to guarantee offshore obligations. The April notice also provided that failure to comply with the registration procedures set forth in the April notice may result in a restriction on the PRC company’s ability to distribute profits to its offshore parent company and to increase its registered capital. On October 21, 2005, SAFE issued a public notice which became effective on November 1, 2005. This notice repealed the January and April 2005 SAFE notices, effective from November 1, 2005. The notice also required every PRC resident to register with the local SAFE branch before setting up a special purpose company outside of China. PRC residents who had set up or controlled such special purpose offshore companies before November 1, 2005 are required to register with the local SAFE branch before March 31, 2006. Failure to register with SAFE will subject such PRC residents to personal liability, and may also limit our ability to contribute additional capital into our PRC subsidiary or our subsidiary’s ability to distribute dividends to us, or otherwise adversely affect our business.
 
 On March 28, 2007, SAFE promulgated the Application Procedure of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Holding Plan or Stock Option Plan of Overseas Listed Company, or the Stock Option Rule. The purpose of the Stock Option Rule is to regulate foreign exchange administration of PRC domestic individuals who participate in employee stock holding plans and stock option plans of overseas listed companies. According to the Stock Option Rule, if a PRC domestic individual participates in any employee stock holding plan or stock option plan of an overseas listed company, a PRC domestic agent or the PRC subsidiary of such overseas listed company shall, among others things, file, on behalf of such individual, an application with SAFE to obtain approval for an annual allowance with respect to the purchase of foreign exchange in connection with stock holding or stock option exercises as PRC domestic individuals may not directly use overseas funds to purchase stock or exercise stock options. Concurrent with the filing of such application with SAFE, the PRC subsidiary shall obtain approval from SAFE to open a special foreign exchange account at a PRC domestic bank to hold the funds required in connection with the stock purchase or option exercise, any returned principal or profits upon sales of stock, any dividends issued upon the stock and any other income or expenditures approved by SAFE. The PRC subsidiary also is required to obtain approval from SAFE to open an overseas special foreign exchange account at an overseas trust bank to hold overseas funds used in connection with any stock purchase.
  All proceeds obtained by PRC domestic individuals from sales of stock shall be fully remitted back to China after relevant overseas expenses are deducted. The foreign exchange proceeds from these sales can be converted into RMB or transferred to such individuals’ foreign exchange savings account after the proceeds have been remitted back to the special foreign exchange account opened at the PRC domestic bank. If the stock option is exercised in a cashless exercise, the PRC domestic individuals are required to remit the proceeds to the special foreign exchange account.
  42
  Although the Stock Option Rule was promulgated relatively recently and many issues require further interpretation, we and our PRC employees who have been granted stock options became subject to the Stock Option Rule commencing from the date on which we became an overseas listed company. If we or our PRC employees fail to comply with the Stock Option Rule, we and/or our PRC employees may face sanctions imposed by foreign exchange authority or any other PRC government authorities.
  In addition, the General Administration of Taxation recently has issued a few circulars concerning employee stock options. Under these circulars, our employees working in China who exercise stock options will be subject to PRC individual income tax. Our PRC subsidiaries have obligations to file documents related to employee stock options with relevant tax authorities and withhold individual income taxes of those employees who exercise their stock options. If our employees fail to pay and we fail to withhold their income taxes, we may face sanctions imposed by tax authorities or any other PRC government authorities.
  Mergers and Acquisitions Rules
  On August 8, 2006, the Ministry of Commerce, the CSRC and four other PRC authorities at the state level promulgated the M&A Rules, which came into effect on September 8, 2006.
  Under the M&A Rules, equity or assets merger and acquisition of PRC enterprises by foreign investors shall be subject to the approval from the Ministry of Commerce or its competent local branches. In particular, a share swap between a foreign investor and a PRC enterprise shall be subject to the approval of the Ministry of Commerce, and the share swap would not be approved unless such foreign investor is a listed company or an offshore SPV. As defined in the M&A Rules, an SPV is an offshore company that is directly or indirectly, established or controlled by PRC entities or individuals for the purposes of an overseas listing. In addition, the listing of the SPV shall be completed within one year after the issuing date of the business license of the PRC enterprise acquired by the SPV.
 
 Under the M&A Rules, the listing of an SPV is subject to prior approval of the CSRC. On September 21, 2006, the CSRC promulgated Guidelines on Domestic Enterprises Indirectly Issuing or Listing and Trading Their Stocks on Overseas Stock Exchanges, which emphasize that the listing of SPVs referred to in the M&A Rules are subject to CSRC approval.
 
 On February 3, 2011, the General Office of the State Council promulgated the Notice on Launching the Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Security Review Notice, which became effective on March 6, 2011. The M&A Security Review Notice provides for certain circumstances under which foreign investors’ acquisition of domestic enterprises shall be subject to security review of the PRC governments. The security review assesses the impact of the acquisition on national security, stable operation of national economy, basic living of the people, and research and development capacity for key technologies related to the national security.
  PRC Land Use Tax Tentative Regulations
  Under the newly revised PRC Land Use Tax Tentative Regulations, since January 1, 2007, foreign-invested enterprises are subject to land use tax, levied on a yearly basis. Such regulations authorize provincial governments to enact local implementing rules. On November 12, 2007, the Shanghai government issued the Shanghai Rural Land Use Tax Implementation Rules, or the Shanghai Implementation Rules, which took effect since the tax year of 2007. According to the Shanghai Implementation Rules, the land use tax levied for the rural area of Shanghai is divided into six tiers, i.e., from RMB 1.5 per square meter per year to RMB 30.0 per square meter per year.
  PRC Technology Import and Export
  According to the Regulation of PRC on Administration of Technology Import and Export effective as of January 1, 2002, technology import and export is broadly defined to include, without limitation, the transfer or license of patents, software and know-how, and the provision of services in relation to technology.
  Technology falling into the Catalogue of Prohibited Import or Export Technology, which is promulgated by the PRC government from time to time, shall not be imported or exported. Technology falling into the Catalogue of Restricted Import or Export Technology can only be imported or exported upon the approval of the Ministry of Commerce of China. Technology, which does not fall into the above two catalogues, can be imported or exported upon the registration with competent commercial administration authority. Spreadtrum Shanghai has licensed, or transferred, certain of its technologies to us, or other third parties outside of China, which licenses or transfer would constitute technology export under PRC laws. In addition, Spreadtrum Shanghai has entered into license agreements with us, or other third parties outside of China, which license agreements would constitute the import of technology under PRC laws. Spreadtrum Shanghai may from time to time need to obtain the approval of, or complete the applicable registration with, the relevant PRC governmental authorities for its import and export of these technologies, and may be subject to certain risks.
 43
  PRC Regulations on Labor
  On June 29, 2007, the National People’s Congress of China enacted the Labor Contract Law, which became effective on January 1, 2008. The Labor Contract Law imposes greater liabilities on employers and significantly affects the cost of an employer’s decision to reduce its workforce. The regulations include specific provisions related to fixed-term employment contracts, temporary employment, probation, consultation with the labor union and employee assembly, employment without a contract, dismissal of employees, compensation upon termination and overtime work, and collective bargaining. According to the Labor Contract Law, an employer is obliged to sign labor contract with unlimited term with an employee if the employer continues to hire the employee after the expiration of two consecutive fixed-term labor contracts. The employer has to compensate the employee upon the expiration of a fixed-term labor contract, unless the employee refuses to renew such contract on terms the same as or better than those contained in the expired contract. The employer also has to indemnify an employee if the employer terminates a labor contract without a cause permitted by law. In addition, under the Regulations on Paid Annual Leave for Employees, which became effective on January 1, 2008, employees who have served more than one year for an employer are entitled to a paid vacation ranging from 5 to 15 days, depending on their length of service. Employees who waive such vacation time at the request of employers shall be compensated for three times their regular salaries for each waived vacation day.
  On October 28, 2010, the National People’s Congress of China promulgated the Social Insurance Law, which will become effective on July 1, 2011. The Social Insurance Law envisions that the PRC establishes a social insurance system including basic pension insurance, basic medical insurance, work-related injury insurance, unemployment insurance, and maternity insurance. An employer shall pay the social insurance premium for its employees in accordance with the rates provided under the relevant regulations and shall withhold and pay the relevant social insurance premium that should be contributed by the employees. The authorities in charge of social insurance may impose sanctions if such employer fails to pay and withhold social insurance in a timely manner.
  C.
Organizational Structure
  We are a holding company incorporated in the Cayman Islands. The chart below sets forth our primary subsidiaries including their jurisdictions and dates of incorporation or establishment, our ownership interest in each subsidiary or affiliate, and their principal activities:
 
 Name of company

Place and date of

incorporation/establishment

Attributable equity

interest held

Principal activitiesSpreadtrum Communications

(Shanghai) Co., Ltd.

PRC

July 18, 2001

100%

(indirect)

Research and development, marketing, finance and administrative activitiesBeijing Spreadtrum Hi-TechCommunications TechnologyCo., Ltd. (1)

PRC

March 30, 2005

37.9%

(indirect)

Research and development and administrative activitiesSpreadtrum Communications

Technology (Shanghai) Co., Ltd., formerly Spreadtrum International Trading (Shanghai) Co., Ltd.

PRC

November 16, 2005

100%

(indirect)

Administrative and sales activitiesSpreadtrum Hong Kong Limited

Hong Kong

November 29, 2007

100%

(direct)

Holding companySpreadtrum International Limited

Hong Kong

November 29, 2007

100%

(direct)

Holding companySpreadtrum Communications

USA Inc., formerly QuorumSystems, Inc.

Delaware, USA

March 4, 2003;

became a subsidiary of the

Company on January 15,

2008

100%

(direct)

Research and development, sales and administrative activitiesShanghai Han & Qin Investment

Co. Ltd.

PRC

September 5, 2008

100%

(indirect)

Investment activitiesHan & Qin International (BVI)

Limited

British Virgin Islands

September 24, 2008

100%

(direct)

Investment activities
  44
  Name of company

Place and date of

incorporation/establishment

Attributableequity

interest held

Principal activitiesSpreadtrum Communications  (Tianjin) Co., Ltd.

PRC

December 8, 2010

100%

(indirect)

Research and development and administrative activitiesSpreadtrum Communications (Chongqing) Co., Ltd.

PRC

December 31, 2010

100%

(indirect)

Research and development and administrative activitiesQuorum Technology (H.K.) Limited

Hong Kong

December 12, 2008

100%

(direct)

Investment activitiesSPRD LLC (successor toSpreadtrum CommunicationsCorp.)

Delaware

December 22, 2008

100%

(indirect)

Administrative activities
 
 (1)
Spreadtrum Beijing was established for the purpose of performing research and development activities on behalf of Spreadtrum Shanghai and qualifying for government research grants that are restricted to PRC domestic companies. Spreadtrum Beijing, a PRC domestic company, was formed in March 2005 under the names of three PRC nationals who are family members of our co-founders. In May 2005, we entered into a loan agreement with the three PRC nationals who are nominee shareholders of Spreadtrum Beijing, pursuant to which we provided them with a loan in an aggregate principal amount of $1.0 million solely for the establishment of Spreadtrum Beijing. Spreadtrum Shanghai also entered into a research and development agreement with Spreadtrum Beijing pursuant to which Spreadtrum Beijing would perform research and development work for Spreadtrum Shanghai and the work products would be owned exclusively by Spreadtrum Shanghai. In return, Spreadtrum Shanghai reimburses Spreadtrum Beijing for all necessary and reasonable direct and indirect costs incurred for the research and development work. Because of these contractual arrangements, the relationships between the nominee shareholders of Spreadtrum Beijing and our co-founders, and the fact that one of the members of our management is the legal representative of Spreadtrum Beijing, we have the power to direct Spreadtrum Beijing’s operational and financial affairs, appoint its senior executives, and approve all matters requiring shareholder approval. As a result, Spreadtrum Beijing is deemed a variable interest entity and we are the primary beneficiary. Accordingly, we have consolidated the financial statements of Spreadtrum Beijing since its inception.
  In May 2008, Spreadtrum Shanghai injected approximately $0.7 million into Spreadtrum Beijing to increase its registered capital for the purpose of reducing its debt-to-equity ratio to a level that would enable it to qualify for certain government research grants. Consequently, Spreadtrum Shanghai now owns approximately 37.9% of the equity interest in Spreadtrum Beijing, and each of the three PRC national nominee shareholders owns approximately 20.7% of the equity interest in Spreadtrum Beijing. The transfer of ownership interests between Spreadtrum Shanghai and the three PRC national shareholders was determined to have no impact on the VIE analysis because the three PRC national shareholders are nominees and do not share risks and rewards of equity ownership with us.
  45
 
 
 
 
 (1)
100% owned by Spreadtrum Communications, Inc.
 
 (2)
100% owned by Spreadtrum Communications USA Inc.
 
 (3)
100% owned by Spreadtrum Hong Kong Limited
 
 (4)
100% owned by Spreadtrum International Limited
 
 (5)
37.9% owned by Spreadtrum Communications (Shanghai) Co., Ltd. and 62.1% owned by 3 PRC nationals. 100% of Beijing Spreadtrum Hi-Tech Communications Technology Co., Ltd. is consolidated into Spreadtrum Communications, Inc.
 
 (6)
100% owned by Spreadtrum Communications Technology (Shanghai) Co., Ltd.
 
 (7)
24% owned by Spreadtrum Communications (Shanghai) Co., Ltd.
 
 (8)
100% owned by Spreadtrum Communications (Shanghai) Co., Ltd.
  D.
Property, Plants and Equipment
  Our principal offices are located on premises comprising approximately 12,814 square meters in Shanghai, China. On December 26, 2006, our wholly-owned PRC subsidiary, Spreadtrum Shanghai, entered into a contract to purchase the office building where our principal offices are located. We have obtained the related ownership certificate for the office building where our principal offices are located. We own 47 residential units next to our principal offices. We also have leased offices in Beijing and Shenzhen, China, Suwon, Republic of Korea, and San Diego, California, United States of America.
  46
  On January 31, 2007, Spreadtrum Shanghai entered into a contract to purchase the land use rights to a parcel of undeveloped land of approximately 23,000 square meters and adjacent to our principal offices. We paid a deposit under such contract equal to the aggregate purchase price of $6.8 million for the land use rights. In December 2009, Spreadtrum Shanghai entered into a joint venture agreement with three other parties to form a joint venture named Shanghai Zhanxiang Electronics Technology Co., Ltd., or Zhanxiang, for the purpose of developing the land. The registered capital of Zhanxiang is $28.3 million and Spreadtrum Shanghai would inject capital of $6.8 million. In the same month, Spreadtrum Shanghai injected $0.3 million in cash into Zhanxiang. Under a series of agreements entered into by Spreadtrum Shanghai with other investors of Zhanxiang in 2009, Spreadtrum Shanghai agreed to exchange, in substance, the deposit it had paid for the land use rights as its capital contribution into Zhanxiang.In February 2010, Spreadtrum Shanghai received a refund of its deposit for the land use rights of $6.8 million. Thereafter, Spreadtrum Shanghai injected approximately $6.5 million into Zhanxiang to complete the capital contribution for its 24% equity interest in Zhanxiang (See Notes 9 and 11 to the Consolidated Financial Statements for details).
 
 We believe that we will be able to obtain adequate facilities to accommodate our future expansion plans.
  The following table sets forth the location, approximate size and primary use of our offices:
 
 Location

Type of

Ownership

Approximate Size

of Office Space in

Square Meters

Primary UseSpreadtrum Center, Building 1

Lane 2288, Zuchongzhi Road

Zhangjiang, Shanghai 201203

China

Own

12,814

Administration; research and development; sales.15th Floor B, Building No.1

Minrun Industry Community

1388 Yishan Road

Xuhui District

Shanghai 200233

China

Lease

1,000

Research and development.B701, B709, C701, C702, C703, C705, 7th Floor B

Building 1

12 Yumin Road

Chaoyang District

Beijing 100029

China

Lease

1,479.19

Administration; research and development; sales; government relations.B702, 7th Floor

China International Hi-tech Convention and  Exhibition Center

12 Yumin Road

Chaoyang District

Beijing 100029

China

Lease

165.46

Administration; research and development; sales; government relations.101, 1F, Beida Jade Bird

Building, South Area

Hi- Tech Industrial Park, Shenzhen

518057, China

Lease

450

Research and development; customer support.7th Floor, IBIS building, 1132-12,

Ingye-dong Paldal-gu, Suwon, Korea

(ZIP: 442-835)

Lease

99.6

Liaison office.A2-408, Building No.1, Tongda Plaza

Tianjin Free Trade Zone

Tianjin

China

Lease

5,430.21

Administration; research and development.No. 4, 4F, Rongying Building,

Technology Innovation Center,

8 Yuma Road, Nan’an District

Chongqing

China

Lease

2,000

Administration; research and development.5960 Cornerstone Court, Suite 200

San Diego, California 92121

United States of America

Lease

1301

Administration; research and development.
  47
  Item  4A.
Unresolved Staff Comments
  Not applicable.
  Item  5.
Operating and Financial Review and Prospects
  The following discussion and analysis of financial condition and results of operations should be read in conjunction with our consolidated financial statements for the periods specified including the notes thereto included elsewhere in this Annual Report on Form 20-F as well as “Item 3.A Key Information—Selected Consolidated Financial Data.” We undertake no obligation to update publicly any forward-looking statements in this Annual Report on Form 20-F.
 
 A.
Operating Results
  Overview
  We are a fabless semiconductor company that designs, develops and markets baseband and radio frequency processor solutions for the wireless communications market. Our baseband processor solutions include several series of baseband semiconductors to meet the demands of various market segments. Our SC6600 and SC6800 series of baseband semiconductors are designed for wireless handsets and other devices that support GSM/GPRS. Our SC8800 series of baseband semiconductors are designed for wireless terminals that support TD-SCDMA/GSM/GPRS. As a result of our acquisition of Spreadtrum USA in January 2008, we started to design, develop and market RF transceivers. Our single-chip CMOS multi-mode RF transceivers are designed to perform across multiple standards, covering GSM/GPRS, EDGE, WCDMA, TD-SCDMA, and HSDPA/HSUPA needs. Our SR500 and SR1000 series of RF transceivers are designed for wireless handsets and other devices to support GMS/GPRS. Our SR3100 and SR3200 series of RF transceivers are designed to support GSM/GPRS, EDGE, WCDMA, and TD-SCDMA. In addition, we design, develop and market a CMMB-based channel demodulator and audio/video decoder processor solution for the mobile television market.
  Revenue
  Since we began to ship our baseband semiconductors in volume in the third quarter of 2005, revenue from our baseband semiconductors has increased substantially, both in absolute dollar terms and as a percentage of total revenue. Our shipments of baseband semiconductors increased 195.5% in 2007 from 2006 and decreased 18.8% in 2008. In 2009, our sales volume of baseband semiconductors increased 10.9% from the prior year. As a result of our acquisition of Spreadtrum USA in January 2008, we started to design, develop and market RF transceivers. Revenue from our RF transceivers has increased significantly, both in absolute dollar terms and as a percentage of total revenue. Starting from 2009, we have primarily been generating our revenues from sales of Bundle Semiconductors. In 2010, our sales volume of 2.5G/2G and 3G Bundle Semiconductors increased by 253.6% and 907.5% from 2009, respectively.
 
 Cost of Revenue
  Our cost of revenue primarily consists of costs associated with the outsourcing of the manufacturing of our products, including the fabrication, assembly and testing of our semiconductors, royalty expenses, sales rebates (in the form of free products), shipping and handling costs relating to inventory purchase, the salary and other related compensation costs attributable to operations and procurement, personnel, warranties, and the procurement of third-party components and other materials that are bundled into our products. Our relationships with third-party foundry and assembly and testing companies do not provide for guaranteed levels of production capacity at pre-determined prices. As a result, our outsourcing costs related to wafer fabrication, assembly and testing are susceptible to changes based on conditions in the global semiconductor market and available capacity. Our cost of revenue also includes share-based compensation expense and inventory write-down.
 
 48
 
 Operating Expenses
  Our operating expenses primarily consist of research and development expenses and selling, general and administrative expenses, each of which includes share-based compensation expenses. Our operating expenses also include in-process research and development, or IPR&D, expense acquired in connection with our acquisition of Spreadtrum USA, impairment loss of goodwill and long-lived assets, provision for loss commitment.
  Research and Development Expenses. Research and development expenses consist primarily of salaries, bonuses and benefits for research and development personnel, expenses associated with prototype masks, lease payments associated with space allocated to research and development personnel, travel expenses, fees for engineering services provided by outside contractors and consultants, amortization of software and design tools, depreciation of equipment and share-based compensation expense. Our research and development expenses have been partially offset by subsidies, including grants we have received from PRC government authorities. The aggregate cash amounts of the subsidies we received were $3.7 million, $5.2 million and $13.4 million in 2008, 2009 and 2010, respectively. For the years ended December 31, 2008, 2009 and 2010, $2.2 million, $1.5 million and $5.0 million were recorded as offsets to research and development expenses incurred, respectively. As of December 31, 2009 and 2010, we had total unearned subsidies of $2.6 million and $7.2 million, respectively, since the requirements for those specific research and development projects had not been fulfilled. In addition to the government subsidies, we recognized $2.9 million subsidy as a reduction of research and development expenses, related to a customer sponsored subsidized program for the promotion of TD-SCDMA products. We expect to meet all these requirements in later periods before the deadlines set by the government. There can be no assurances that we will receive any subsidies in the future. We expect that our total research and development expenses will increase as we continue to develop new baseband or other semiconductors.
  Selling, General and Administrative Expenses. Selling expenses consist primarily of salaries, bonuses and benefits for sales and marketing, field application engineering and customer support personnel, travel and  other expenses related to sales and marketing activities, product promotion sample costs, expenses related to public relations activities, such as attendance at conferences, exhibitions and media relations events, and share-based compensation expense. We expect that our total selling expenses will increase as we hire additional sales and marketing personnel, expand our sales and marketing network in China and globally, and engage in additional marketing and promotional activities. General and administrative expenses consist primarily of salaries, bonuses and benefits for administrative personnel, travel, lease and other expenses for general administrative functions, share-based compensation expense as well as costs for outside professional services, including legal, tax and accounting services. We expect that our general and administrative expenses will increase as we hire additional personnel and incur costs related to the anticipated growth of our business.
  Impairment Loss of Goodwill and Long-lived Assets. Pursuant to our accounting policy, we evaluate our goodwill and long-lived assets for impairment each year. We determine the fair value of goodwill and long-lived assets using the income approach.
  In 2008, we recorded $32.3 million impairment loss on goodwill based on the decline of implied fair value of goodwill. The decline was primarily caused by our lower projected future cash flows compared to the forecasts at the time we completed our acquisition of Spreadtrum USA. As of December 31, 2009 and 2010, the implied fair value of goodwill was higher than the carrying value of goodwill due to the profit growth and the improvement of economic environment. As a result, there was no impairment charge on goodwill recognized in 2009 and 2010.
 
 We recorded a $17.4 million impairment loss on intangible assets in 2008 to write down the book value of these assets to their fair values. The impairment of 2008 mainly consisted of the impairment on intangible assets acquired from Spreadtrum USA. We conducted our evaluation based on a weighted average of multiple discounted cash flow scenarios. The impairment of 2008 was primarily driven by our updated long-term financial forecast, which indicated lower estimated future cash flows compared to the estimates at the time we completed our acquisition of Spreadtrum USA due to the downturn in the economy. When the market began to improve in the second half of 2009, we updated our impairment assessment and believed no further impairment for intangible assets would be necessary. In 2010, except for the impairment provision for the obsolete technology described as follows, we did not provide any impairment provisions for other intangible assets.
  We also recorded $3.0 million provision for loss commitment and $0.5 million impairment charge on other long-term assets in connection with an agreement with a third party vendor for acquiring certain technology in 2008.  In 2009, we capitalized such technology upon the receipt of the intangible asset and recorded cost of $4.8 million, after netting off the prior year’s provisions of $3.5 million for this intangible asset.  In 2010, the Company noticed that the technology was rapidly losing market acceptance to competing technology and believed that continuing to market products using this technology would not be commercially viable. Accordingly, we concluded that this technology had become obsolete and the remaining carrying amount of $4.5 million was fully impaired in 2010. Accordingly, we recorded a $4.5 million impairment loss on intangible assets during 2010.
  We recorded an impairment loss of $56,045 in 2008 for obsolete property and equipment, and property and equipment to be disposed. There was no such impairment charge recognized in 2009 and 2010.
  49
  IPR&D expense acquired per Spreadtrum USA Acquisition. IPR&D expense incurred in connection with our acquisition of Spreadtrum USA in 2008 was $6.6 million. This IPR&D expense was recorded at its estimated fair value on the acquisition date which was determined by management based on a number of factors including a valuation report provided by a third party valuation firm. The valuation report utilized and considered generally accepted valuation methodologies such as the income, market and cost approach. We have incorporated certain assumptions which include projected cash flows and replacement costs. See note 3 of the Notes to the Consolidated Financial Statements for the details. There was no such IPR&D expense recorded in 2009 and 2010.
  Provision for Loss Commitment. In January 2008, we signed an agreement with a third party vendor to acquire certain technology. In the agreement we committed to pay $10.0 million over the next seven years including licensing fees and guaranteed royalty payments even if no products were sold using the acquired technology. Due to deteriorating global economic conditions, the related mobile phone market did not materialize as projected by us when the agreement was signed. We evaluated the commitment for impairment at the end of 2008. We determined the fair value of the project and related intangible asset using the income approach. The income approach includes the use of a weighted average of multiple discounted cash flow scenarios, which requires the use of unobservable inputs, including assumptions of projected revenues, expenses, capital spending, and other costs, as well as a discount rate calculated based on the risk profile of the semiconductor industry. As a result of the analysis, we recorded a $3.5 million write-off in the fourth quarter of 2008, of which $3.0 million was accrued as provision for loss commitment and $0.5 million was charged against the other long-term assets as of December 31, 2008. In 2009, we received the related technology and recorded intangible asset of $4.8 million, its estimated fair value, which is net off this provision. In 2010, we wrote off the carrying amount of this technology with an amount of $4.5 million.
  In 2009, we recorded $52,449 provision for loss commitment related to open purchase orders for its old version of baseband semiconductors. In 2010, we did not record any provisions for loss commitment.
  Share-based Compensation Expense. In accordance with the provisions of Accounting Standards Codification 718 Compensation—Stock Compensation, or ASC 718, we record share-based compensation expense for options issued to employees based on the fair value of the options as estimated on the date of grant using the Black-Scholes-Merton option pricing model. For our employees, we amortize share-based compensation expense over the corresponding vesting periods, which are generally four years. We account for restricted share units (RSUs) in accordance with ASC 718, and record the fair value of unvested shares equal to the market price on the date of grant with related compensation expense recognized over the vesting period.
 
 We recorded share-based compensation expense of $8.3 million, $9.7 million and $10.3 million in 2008, 2009 and 2010, respectively. Our share-based compensation expenses are included in our operating expenses as well as cost of revenue. As of December 31, 2010, we had $16.5 million of unrecognized deferred share-based compensation expense.
  Taxation
  Cayman Islands Tax
  Under the current laws of the Cayman Islands, we are not subject to tax on our income or capital gains. In addition, our payment of dividends, if any, is not subject to withholding tax in the Cayman Islands.
  PRC Tax
  Corporate Income Tax. On January 1, 2008, the CIT Law in China took effect. The CIT Law applies a uniform 25% corporate income tax rate to both foreign invested companies and domestic companies. Under the prior tax regime, foreign-invested companies were generally subject to a 30% state tax rate plus a 3% local tax rate for a total tax rate of 33%. The CIT Law provides a five-year transition period from its effective date for those companies which were established before the promulgation date of the CIT Law and which were entitled to a preferential tax treatment such as a reduced tax rate or a tax holiday. Under the CIT Law, preferential income tax rate of 15% will continue to be granted to companies that qualify as “new and high technology companies strongly supported by the state”. In addition, on December 26, 2007, the State Council issued the Notice of the State Council Concerning Implementation of Transitional Rules for Corporate Income Tax Incentives, or Circular 39. Based on Circular 39, certain specifically listed categories of companies which enjoyed a preferential tax rate of 15% are eligible for a graduated rate increase to 25% over the 5-year period beginning from January 1, 2008. Where transitional rules overlap with preferential policies provided by the CIT Law, a company may choose to implement the more favorable policy, and shall not enjoy both simultaneously. Also the policy cannot be changed once determined.
  Before 2008, Foreign-invested Integrated Circuit, or IC, design companies were entitled to income tax exemption for the first two profitable years of operation, after taking into account any tax losses brought forward from prior years, and a 50% tax rate reduction for the succeeding three years thereafter. As a qualified Foreign-invested IC design company, Spreadtrum Shanghai was cumulatively profitable in 2007 and started its tax holiday accordingly. It was exempt from income tax for 2007 and 2008, and entitled to a 50% tax rate reduction for the succeeding three years from 2009 to 2011. Being located in Shanghai Pudong New District, Spreadtrum Shanghai was also entitled to a 15% preferential tax rate before 2008. In addition, Spreadtrum Shanghai was qualified as a “new and high technology companies strongly supported by the state” from the relevant tax authorities in December 2008. Since the CIT Law permits companies to continue to enjoy their existing preferential tax treatments until such treatments expire in accordance with their current terms, its income tax rate will increase from 10% to 12% (i.e. 50% of transitional tax rate of 20%, 22%, and 24%, respectively) from 2009 to 2011. Based on Circular 39, Spreadtrum Shanghai chooses to enjoy 15% preferential tax rate after the transition period expires in 2011 if it continually qualifies as “new and high technology companies strongly supported by the state”.
  50
 
 Before 2008, as a high-technology company incorporated in the Zhongguancun Hi-Tech Park, Spreadtrum Beijing was subject to PRC income tax at a preferential tax rate of 15%, and was entitled to an income tax exemption from 2005 to 2007 and a 50% tax rate reduction for the succeeding three years from 2008 to 2010 based on the approval obtained from the tax authority. Pursuant to the CIT Law, Spreadtrum Beijing was subject to 25% tax rate starting from 2008 since it did not qualify as “new and high technology companies strongly supported by the state”. It has entered its first year of accumulated profit making and started to pay income tax in 2009.
  Shanghai Technology was established in Shanghai Waigaoqiao Free Trade Zone and was subject to PRC income tax at a preferential rate of 15% in 2007. It has entered its first year of accumulated profit making and started to pay income tax in 2007. Because Shanghai Technology is located in Shanghai Pudong New District, it was subject to a transitional income tax rate of 18% in 2008, 20% in 2009 and 22% in 2010 and will be subject to graduated increase of income tax rate to 25% by 2012.
  Value-added Tax. Value-added tax is imposed on sales or imports of goods and on the provision of processing, repair or replacement labor services. A 17% value-added tax applies to integrated circuit products sold to PRC domestic customers.
  Business Tax. Revenue generated from services provided by Spreadtrum Shanghai, Spreadtrum Technology and Spreadtrum Beijing, including from technical, consulting and other services and royalties, are subject to a 5% PRC business tax. Revenue from technical services related to technology development and transfer can be exempted from this business tax, subject to government approval. We have been successful in obtaining approvals for such exemptions for services revenue in the past.
  Land-Use Tax. Under the newly revised PRC Land Use Tax Tentative Regulations, beginning January 1, 2007, Spreadtrum Shanghai is subject to land use tax, levied on a yearly basis.
  Individual Income Tax. Under the PRC regulations, a foreign individual is required to pay individual income tax on his/her income if the length of his/her work period in the PRC in any given calendar year exceeds certain number of days as provided under tax regulations or he/she serves as a director or senior officer in a company incorporated in the PRC. It is our responsibility to pay, on behalf of our expatriate employees, their individual income taxes to the local tax authority. We account for the individual income tax as part of employee compensation with the corresponding liability properly recorded in our books.
  United States Tax
  Spreadtrum USA is subject to federal and state income taxes at the applicable statutory rates, subject to the potential deductibility of state income tax paid for federal income tax purposes.
  Variable Interest Entity
  Spreadtrum Beijing was established for the purpose of performing research and development activities on behalf of Spreadtrum Shanghai and qualifying for government research grants that are restricted to PRC domestic companies. Spreadtrum Beijing, a PRC domestic company, was formed in March 2005 under the names of three PRC nationals who are family members of our co-founders. In May 2005, we entered into a loan agreement with the three PRC nationals who are nominee shareholders of Spreadtrum Beijing, pursuant to which we provided them with a loan in an aggregate principal amount of $1.0 million solely for the establishment of Spreadtrum Beijing. Spreadtrum Shanghai also entered into various agreements with Spreadtrum Beijing, including an agreement for the use of trademarks of Spreadtrum, and a research and development agreement, pursuant to which Spreadtrum Beijing would perform research and development work for Spreadtrum Shanghai and the work products would be owned exclusively by Spreadtrum Shanghai. In return, Spreadtrum Shanghai reimburses Spreadtrum Beijing for all necessary and reasonable direct and indirect costs incurred for the research and development work. Because of these contractual arrangements, the relationships between the nominee shareholders of Spreadtrum Beijing and our co-founders, and the fact that one of the members of our management is the legal representative of Spreadtrum Beijing, we have the power to direct Spreadtrum Beijing’s operational and financial affairs, appoint its senior executives, and approve all matters requiring shareholder approval. As a result, Spreadtrum Beijing is deemed a variable interest entity and we are the primary beneficiary. Accordingly, we have consolidated the financial statements of Spreadtrum Beijing since its inception.
 
 In May 2008, Spreadtrum Shanghai injected $0.7 million into Spreadtrum Beijing to increase its registered capital for the purpose of reducing its debt-to-equity ratio to a level that would enable it to qualify for certain government research grants. Consequently, Spreadtrum Shanghai now owns approximately 37.9% of the equity interest in Spreadtrum Beijing, and each of the three PRC national nominee shareholders owns approximately 20.7% of the equity interest in Spreadtrum Beijing. The transfer of ownership interests between Spreadtrum Shanghai and the three PRC national shareholders was determined to have no impact on the VIE analysis because the three PRC national shareholders are nominees and do not share risks and rewards of equity ownership with us.
  51
 
 In June 2009, the FASB issued FAS 167: Amendments to FASB Interpretation No. 46(R), codified primarily in the Consolidation Topic of the FASB ASC 810. This guidance modifies the method for determining whether an entity is a variable interest entity as well as the methods permitted for determining the primary beneficiary of a variable interest entity. In addition, this guidance requires ongoing reassessments of whether a company is the primary beneficiary of a variable interest entity and enhanced disclosures related to a company’s involvement with a variable interest entity. We adopted this guidance on January 1, 2010.  In accordance with the new guidance, we are deemed to have a controlling financial interest and are the primary beneficiary of the VIEs as we have both the power to direct the activities of the VIE that most significantly impact the VIE's economic performance and an obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. As a result, we continued to consolidate the same VIE that was consolidated prior to January 1, 2010 and the adoption did not have any impact on our consolidated financial statements.
  Critical Accounting Policies
  We prepare our financial statements in conformity with U.S. GAAP, which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities on the date of the financial statements and the reported amounts of net revenues and expenses during the financial reporting period. We continually evaluate these estimates and assumptions based on the most recently available information, our own historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from those estimates. Some of our accounting policies require higher degrees of judgment than others in their application. We consider the policies discussed below to be critical to an understanding of our financial statements as their application places the most significant demands on our management’s judgment.
  Revenue Recognition
  Revenue is generated from the sale of products, including baseband semiconductors and radio frequency transceivers, and the rendering of engineering services, including design services according to customer’s specification, product prototyping, testing services, training and support services.
 
 We recognize revenue from sales of products, including primarily baseband semiconductors and radio frequency transceivers, when persuasive evidence of an arrangement exists, the sales price is fixed and determinable, delivery has occurred and collectability is reasonably assured. To evidence an arrangement, we (i) enter into a master agreement with our customers, which specifies general terms and conditions, or (ii) obtain purchase orders, which specify the key terms of individual orders, such as quantity and price. Most of our arrangements do not include rights of return, price protection or other similar privileges. Accordingly, we record revenue when products are delivered to and accepted by the customers as there are no future remaining obligations. Delivery occurs when title and risk of loss transfer to customers, which is generally at the customers’ designated location.
 
 Certain contracts have specified acceptance provisions and for such contracts we defer the revenue recognition until the acceptance is obtained. In the event that neither acceptance note nor denial note is received, revenue and cost of sales are recognized when the contractual quality inspection period expires. Any payments received prior to revenue recognition are recorded as advance from customers. We grant rebates to certain customers depending on the volume of business the customers bring in. The rebates granted are either goods rebates or cash rebates. Goods rebates are “free” products offered to customers and are recorded as cost of sales when revenue is recognized. Cash rebates are recorded as reduction of revenue when granted to customers and when revenue is recognized.
 
 We recognize revenue from service contracts upon completion of all services. Service contracts are short term in nature (generally one to three months) and are insignificant for all periods presented.
  Warranty
  In general, we offer a one-year warranty on all of our products. We accrue the estimated cost of product warranty at the time revenue is recognized, and adjust the warranty accrual periodically based on historical experience and expected warranty claims. Although we engage in extensive product quality programs and processes, including actively monitoring and evaluating the quality of component suppliers, the warranty obligation is affected by actual warranty costs, including but not limited to usage of material and labor and service delivery costs incurred in connection with a product failure.
  52
  Share-Based Compensation
  The costs of share based payments are recognized in our consolidated financial statements based on their grant-date fair value over the required period, which is generally the period from the date of grant to the date when the share compensation is no longer contingent upon additional service, or the vesting period. We determine fair value of our share options as of the grant date using the Black-Scholes-Merton option pricing model. Under this model, we make a number of assumptions regarding fair value including the maturity of the options, the expected volatility of our future ordinary share price, the risk free interest rate and the expected dividend rate. Determining the value of our share-based compensation expense in future periods also requires the input of highly subjective assumptions around estimated forfeitures of the underlying shares. We estimate our forfeitures based on past employee retention rates, our expectations of future retention rates, and we will prospectively revise our forfeiture rates based on actual history. Our compensation charges may change based on changes to our assumptions.
  Income Taxes
  As required by ASC 740 “Accounting for Income Taxes”, we periodically evaluate the likelihood of the realization of deferred tax assets, and reduce the carrying amount of these deferred tax assets by a valuation allowance to the extent we believe a portion will not be realized. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent cumulative earnings experience by taxing jurisdiction, expectations of future taxable income, the carry-forward periods available to us for tax reporting purposes, and other relevant factors. Deferred income taxes are recognized for temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, net operating loss carry forwards and credits by applying enacted statutory tax rates applicable to future years. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Current income taxes are provided for in accordance with the laws of the relevant taxing authorities. The components of the deferred tax assets and liabilities are individually classified as current and non-current based on the characteristics of the underlying assets and liabilities, or the expected timing of their use when they do not relate to a specific asset or liability.
  We adopted the provisions of ASC 740-10-25 effective January 1, 2007. Based on the analysis performed, we have made our assessment of the relevant level of tax authority for each tax position (including the potential application of interest and penalties) based on the technical merits, and have measured the unrecognized tax benefits associated with the tax positions. The adoption of ASC 740-10-25 did not have any material impact on our financial position or results of operations.
 
 Goodwill and Other Intangible Assets
  We account for goodwill and intangible assets with indefinite lives in accordance with ASC 350 “Goodwill and Other Intangible Assets”. Goodwill and intangible assets with indefinite lives are not amortized, but are instead reviewed for impairment annually (or more frequently if impairment indicators arise).  We perform a goodwill impairment test annually on December 31 or more frequently if an event occurs or circumstances change that could more likely than not reduce the fair value of the goodwill to below its carrying amount, and determine whether there is a goodwill impairment.
  The application of the impairment test requires judgment, including the identification of reporting units, assignments of assets and liabilities to reporting units and the determination of the fair value of each reporting unit. Further, the impairment test involves the use of accounting estimates and assumptions related to future operating results. Consistent with the requirements of ASC 350-20-35, the fair values of our reporting units are generally based on discounted cash flow projections that are believed to be reasonable under current and forecasted circumstances, the results of which form the basis for making judgments about carrying values of the reported net assets of our reporting units. There was no impairment loss on goodwill recognized in 2010.
  We complete a two-step goodwill impairment test on an annual basis. The first step compares the fair value of each reporting unit to its carrying amount, including goodwill. If the fair value of each reporting unit exceeds its carrying amount, goodwill is not considered to be impaired and the second step will not be required. If the carrying amount of a reporting unit exceeds its fair value, the second step compares the implied fair value of goodwill to the carrying value of a reporting unit’s goodwill. The fair value of each reporting unit is estimated using the expected present value of future cash flows. The implied fair value of goodwill is determined in a manner similar to accounting for a business combination with the allocation of the assessed fair value determined in the first step to the assets and liabilities of the reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to the assets and liabilities is the implied fair value of goodwill. An impairment loss is recognized for any excess in the carrying value of goodwill over the implied fair value of goodwill.
  We will continue to closely monitor the 2011 results and projections for our reporting units and the economic conditions of the product end-markets. Any significant change in market conditions and estimates or judgments could give rise to impairment in the period that the change becomes known.
  Prior to performing the goodwill impairment testing process for a reporting unit under U.S. GAAP, if there is reason to believe that other non-goodwill related intangible assets may be impaired, these other intangible assets must first be tested for impairment under guidance of “Accounting for the Impairment or Disposal of Long-Lived Assets,”. Assets governed by U.S. GAAP require a recoverability test for impairment whereby the gross undiscounted cash flows are determined specific to the asset. For non-goodwill related intangible assets with indefinite lives, a fair value determination is made. If the carrying value of the asset exceeds the fair value, then impairment occurs. Any impairment on these assets is recorded first to provide the appropriate carrying value for the goodwill impairment calculation.
  53
 
 These impairment tests also involve the use of accounting estimates and assumptions management believed to be reasonable, the results of which form the basis for our conclusions. Significant changes to these estimates and assumptions could adversely impact our conclusion to these impairment tests.
  Impairment of Long-lived Assets
  We evaluate our long-lived assets and definite life intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When these events occur, we measure impairment by comparing the carrying amount of the assets to future undiscounted net cash flows expected to result from the use of the assets and their eventual disposition. If the sum of the expected undiscounted cash flow is less than the carrying amount of the assets, we recognize an impairment loss based on the fair value of the assets. The determination of fair value of the intangible and long-lived assets involves certain judgments and estimates. These judgments can include, but are not limited to, the cash flows that an asset is expected to generate in the future. This analysis also relies on a number of factors, including changes in strategic direction, business plans, regulatory developments, economic and budget projections, technological improvements, and operating results. Any write-downs would be treated as permanent reductions in the carrying amounts of the assets and an operating loss would be recognized.
 
 In 2010 we recorded $4.5 million non-cash reserve charges on acquired intangible assets that became obsolete in connection with rapid technology advancement and evolvement. In 2011, if actual future demand or market conditions are less favorable than those projected by our management, additional impairments on long-lived assets and write-downs may be required.
  Valuation of Inventories
  Our inventories are stated at the lower of cost or net realizable value. Cost is comprised of direct material and, where applicable, direct labor costs and overhead incurred in bringing the inventories to their present location and condition. We estimate excess and slow moving inventory based upon assumptions of future demands and market conditions. If actual market conditions are less favorable than projected by management, additional inventory write-downs may be required.
  As of December 31, 2010, the balance of inventory written-down was $4.3 million, of which $1.7 million was related to deferred cost.  During second half year of 2010, we sold certain older types of products as market demands arose due to the quick recovery of the semiconductor industry and our business. In connection with sales of the previously written-down inventories, we recognized increased gross profit in an amount of $19,838, $14,320 and $5,143,448 for the years ended December 31, 2008 and 2009 and 2010, respectively (see note 4 of our Consolidated Financial Statements for details).  As of December 31, 2010, the written-down inventories with original cost of $1.7 million were shipped to customers where the rights and obligations of ownership were passed to the customers but revenue had not yet been recognized due to pending customer acceptance. We expect to recognize related revenue in the first quarter of 2011 and will then reverse the written-down inventories. We expect to recognize revenue and gross profit in the amount of $1.1 million in 2011 which represent the sales proceeds on the written-down inventories. We are seeking to dispose of the remaining written-down inventory items as of December 31, 2010 in 2011 as scrapped chips and wafers to third party trading companies engaged in the scrapped material recovery business.  If actual future demand or market conditions are less favorable than those projected by our management, additional inventory write-downs may be required.
  Allowance for Doubtful Accounts, Prepayment and Loan Receivables
  We maintain allowances for doubtful accounts, prepayment and loan receivables primarily based on the age of receivables or prepayments and factors surrounding the credit risk of specific customers or suppliers. If there is a deterioration of a major customer or supplier’s creditworthiness or actual defaults are higher than our historical experience, we may need to record additional allowances.
 
 We make most of the prepayments without receiving collateral for such payments. As a result, our claims for such prepayments would rank only as an unsecured claim, which exposes us to the credit risks of our suppliers in the event of their insolvency or bankruptcy.
  54


Fair Value Measurements




On January 1, 2008, we adopted ASC 820, Fair Value Measurements and Disclosures, for financial assets and liabilities and non-financial assets and liabilities measured or disclosed at fair value on a recovering basis. On January 1, 2009, we also adopted the statement for all non-financial assets and non-financial liabilities. FASB ASC 820 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions the guidance establishes a three-tier value hierarchy, which prioritizes the inputs used in measuring fair value as follows: (Level 1) observable inputs such as quoted prices (unadjusted) in active markets; (Level 2) inputs other than the quoted prices in active markets that are observable either directly or indirectly, or quoted prices in less active markets; and (Level 3) unobservable inputs with respect to which there is little or no market data, which require us to develop our own assumptions. This hierarchy requires us to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value.




Long-term Investments




We review our long-term investments for impairment based on our determination of whether the decline in market value of the investment below our carrying value is other than temporary. In making this determination, we considered ASC 320 “The Equity Method of Accounting for Investments in Common Stock” and related interpretations, which set forth factors to be evaluated in determining whether a loss in value should be recognized, including our ability to hold our investment, the market price and market price fluctuations of the investment’s publicly traded shares and ability of the investee to sustain an earnings capacity, which would justify the carrying amount of the investment.




Acquisitions




For acquisition made before December 31, 2008, the acquired assets and liabilities are recorded at their fair value at the date of acquisition. Any excess of acquisition cost over the fair value of the acquired assets and liabilities, including identifiable intangible assets, is recorded as goodwill. Acquisition of Spreadtrum USA was accounted for using such method.




On January 1, 2009, we adopted ASC 805 (formerly referred to as SFAS No. 141 (revised 2007), “Business combinations”. Following the adoption, the consideration transferred in a business combination is measured at fair value, which is calculated as the sum of the acquisition-date fair values of the assets transferred by the acquirer, liabilities incurred by the acquirer to former owners of the acquiree, and equity instruments issued by acquirer. The costs directly attributable to the acquisition are expensed as incurred. Identifiable assets, liabilities and contingent liabilities acquired or assumed are measured separately at their fair value as of the acquisition date, irrespective of the extent of any non controlling interests. The excess of the (i) the total of cost of acquisition, fair value of the non controlling interests and acquisition date fair value of any previously held equity interest in the acquiree over (ii) the fair value of the identifiable net assets of the acquiree is recorded as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is recognized directly in the income statement.





The determination and allocation of fair values to the identifiable assets acquired and liabilities assumed is based on various assumptions and valuation methodologies requiring considerable management judgment. The most significant variables in these valuations are discount rates, terminal values, the number of years on which to base the cash flow projections, as well as the assumptions and estimates used to determine the cash inflows and outflows. Management determines discount rates to be used based on the risk inherent in the related activity’s current business model and industry comparisons. Terminal values are based on the expected life of products and forecasted life cycle and forecasted cash flows over that period




Determining the useful life of an intangible asset also requires judgment, as different types of intangible assets will have different useful lives.




Inflation




Since our inception, inflation in China has not materially impacted our results of operations. According to the National Bureau of Statistics of China, the change in the consumer price index in China was 5.9%, -0.7% and 3.3% in 2008, 2009 and 2010, respectively.




Foreign Currency Risk




See “Item 11. Quantitative and Qualitative Disclosures About Market Risk— Foreign Exchange Risk” for information regarding the impact of foreign currency fluctuations on the company.


55





Government Policies




For information regarding governmental economic, fiscal, monetary or political policies or factors that have materially affected, or could materially affect, our operations or our shareholders’ investments, see “Item 3.D Risk Factors—Risks Related to Doing Business in China,” “Item 4.B Information on the Company—Business Overview—Regulation,” “Item 5.A Operating and Financial Review and Prospects–Taxation—PRC Tax” and “Item 10.E Additional Information—Taxation.”




Results of Operations




The following table sets forth a summary of our consolidated statements of operations. Our business has evolved rapidly since we commenced operations in 2001. Our limited operating history makes it difficult to predict future operating results. We believe that period-to-period comparisons of operating results should not be relied upon as indicative of future performance.





For the Year Ended December 31,2008


2009


2010(in thousands)Selected Consolidated Statement of Operations Data:Revenue

$
109,937


$
105,070


$
346,338Cost of revenue(1)


68,033



66,876



193,873Gross profit


41,904



38,194



152,465Operating expenses:(1)Research and development


42,877



37,039



58,687Selling, general and administrative


21,998



20,539



20,188In-process research and development expense per Spreadtrum USA acquisition


6,612



—



—Impairment loss of goodwill


32,345



—



—Impairment loss of long-lived assets


17,984



—



4,486Provision for loss commitment


3,013



—



—Total operating expenses


124,829



57,578



83,361Income (loss) from operations


(82,925
)


(19,384
)


69,104Other income, net


4,448



1,092



6,220Income tax expense


201



1,024



8,130Net income (loss)

$
(78,678
)

$
(19,316
)

$
67,194





Note: (1) Share-based compensation expense is included in the following financial statements line items:


For the Year Ended December 31,2008


2009


2010(in thousands)Cost of revenue

$
405


$
278


$
437Research and development


3,933



2,871



5,718Selling, general and administrative


4,010



6,550



4,131Total

$
8,348


$
9,699


$
10,286


56




The following table sets forth a summary of our consolidated statements of operations as a percentage of revenue for the periods indicated.





For the Year Ended December 31,2008


2009


2010(in percentage)Revenue


100.0
%


100.0
%


100
%Cost of revenue(1)


61.9
%


63.6
%


56.0
%Gross profit


38.1
%


36.4
%


44.0
%Operating expenses:(1)Research and development


39.0
%


35.3
%


16.9
%Selling, general and administrative


20.0
%


19.5
%


5.8
%In-process research and development expense per Spreadtrum USA acquisition


6.0
%


—



—Impairment loss of goodwill


29.4
%


—



—Impairment loss of long-lived assets


16.4
%


—



1.3
%Provision for loss commitment


2.7
%


—



—Total operating expenses


113.5
%


54.8
%


24.0
%Income (loss) from operations


(75.4
)%


(18.4
)%


20.0
%Other income, net


4.0
%


1.0
%


1.7
%Income taxes expense


0.2
%


1.0
%


2.3
%Net income (loss)


(71.6
)%


(18.4
)%


19.4
%





Note: (1) Share-based compensation is included in cost of revenue and operating expenses.





Year Ended December 31, 2010 Compared with Year Ended December 31, 2009




Revenue. Our revenue increased by 229.6% to $346.3 million in 2010 from $105.1 million in 2009. The increase in revenue was due to significant increase in sales volume, partially offset by decrease in average selling price. In 2010, sales volume of our 2G/2.5G and 3G Bundle Semiconductors increased by 253.6% and 907.5% from 2009, respectively. The increase in sales volume was a result of growing market share for both our 2G/2.5G and 3G semiconductors, introduction of our innovative new products of superior quality, and the overall expansion of our customer base. In 2010, the average selling price of our 2G/2.5G and 3G Bundle Semiconductors decreased by 20.9% and 33.3%, respectively. The decrease in average selling price was primarily due to our decision to reduce the prices of our products in response to the fierce competition and the downward pricing trend in the wireless communication market.





Cost of Revenue. Our cost of revenue increased by 189.8% to $193.9 million in 2010 from $66.9 million in 2009. The increase was primarily attributable to the significant increase in our sales volume which led to an increase in our semiconductor production cost, sales rebates, royalties and other expenses, partially offset by a decrease in inventory write-down and a decrease in unit semiconductor production cost as a result of reduced average purchase price in connection with our increased purchase volume.  The amount of inventory write-down was $1.9 million, a decline of $3.5 million from $5.4 million in 2009.





Gross Profit. Our gross profit increased by 299.2% to $152.5 million in 2010 from $38.2  million in 2009, and our gross margin increased to 44.0% in 2010 as compared to 36.4% in 2009. The increase in gross margin was primarily attributable to the increased sales volume of higher gross margin products such as our SC6600L series Bundle Semiconductors as well as unit cost reduction in our products as a result of economies of scale. In addition, in connection with sales of the previously written-down inventories in 2009 and 2010, we recognized increased gross profit in the amount of $14,320 and $5,143,448 for the years ended December 31, 2009 and 2010, respectively, and the increase in gross margin for the years ended December 31, 2009 and 2010 was 0.01% and 1.5%, respectively. The increase in gross margin was partially offset by the decrease in the average selling price of our products in 2010 due to market competition and downward pricing trend in the wireless communications market.





Operating Expenses. Our operating expenses increased by 44.8% to $83.4 million in 2010 from $57.6 million in 2009, primarily due to an overall increase in our research and development expenses in line with our substantial expansion and growth during 2010. Our research and development expenses increased by 58.6% to $58.7 million in 2010 from $37.0 million in 2009 reflecting our significantly increased research and development efforts in line with our launch of innovative new products, in particular, an increase in engineering expenses related to the development of new products of $11.7 million, an increase in employee compensation of $9.6 million, an increase in stock-based compensation of $2.9 million and an increase in depreciation and amortization expenses of $2.6 million, partially offset by an increase in government subsidies in the amount of $3.5 million and a first-time recognition of subsidies in the amount of $2.9 million from a customer in connection with TD-SCDMA product development. Our selling, general and administrative expenses decreased slightly by 1.7% to $20.2 million in 2010 from $20.5 million in 2009 and the fluctuation was primarily due to decrease in stock-based compensation expenses of $2.7 million, partially offset by increase in employee compensation of $1.7 million and a contingent loss of $0.8 million accrued in connection with a pending arbitration.  In 2009, we recognized a one-off share-based compensation charge of approximately $4 million in connection with the resignation of our former Chief Executive Officer.


57




Impairment Loss of Long-lived Assets. There were no impairment charges recognized in 2009. We assessed that a technology had become obsolete and the remaining carrying amount of $4.5 million was fully impaired in 2010. Accordingly, we recorded a $4.5 million impairment loss on intangible assets during 2010.




Provision for Loss Commitment. We did not record any provision for loss commitment in 2010 and recorded $52,449 provision for loss commitment in 2009 which was related to open purchase orders for our old version of baseband semiconductors.





Income From Operations. As a result of the factors mentioned above, we recorded income from operations of $69.1 million in 2010, as compared to loss from operations of $19.3 million in 2009.




Other Income, net. We recorded other income of $6.2 million in 2010 as compared to other income of $1.1 million in 2009. Our other income primarily consisted of exchange gains and interest income, net of interest expenses.  Our interest expenses are presented net of the government subsidies we received, which amounted to $0.7 million and $1.5 million, respectively, in 2009 and 2010.  Our exchange gains increased from $0.7 million to $3.8 million, as a result of RMB appreciation against US dollar. Our interest income increased from $1.6 million to $3.6 million, as a result of investing a higher balance of cash and increase in bank deposits saving rate. Our interest expense, net of reimbursement from local government for bank loan interest incurred, remained stable.




Income Tax Expense. We recorded income tax expense of $8.1 million in 2010 as compared to an income tax expense of $1.0 million in 2009. The increase mainly resulted from current income tax expenses of Spreadtrum Shanghai and an increase in withholding income tax on royalty payments received by us from Spreadtrum Shanghai in connection with a license of certain intellectual property related to RF transceivers owned by us.  The change in effective tax rate from -5.6% in 2009 to 10.8% in 2010 was mainly due to the effect of different tax rates applicable to us and our subsidiaries in different jurisdictions, partially offset by change in valuation allowance on deferred tax assets (refer to Note 16 to Consolidated Financial Statements for detailed reconciliation from PRC statutory income tax rate to effective tax rate).




Net Income. As a result of factors mentioned above, we reported net income of $67.2 million in 2010 as compared to a net loss of $19.3 million in 2009.




Year Ended December 31, 2009 Compared to Year Ended December 31, 2008




Revenue. Our revenue decreased by 4.4% to $105.1 million in 2009 from $109.9 million in 2008. Revenue from baseband semiconductors decreased by 20.6% to $77.0 million in 2009 compared to $97.0 million in 2008. Although unit shipments of baseband semiconductors increased 10.9% in 2009 due to improved quality of our products and customer service, the average selling price of baseband semiconductors decreased 28% from 2008 in connection with the downward pricing trend in the wireless communications market resulting in the decrease in revenue in 2009 of $20 million. Revenue from RF transceivers increased more than four times to $27.5 million in 2009 compared to $5.3 million in 2008. The sequential increase in unit shipments of RF transceivers was primarily the result of bundle sales of RF transceivers and baseband product shipments in 2009.




Cost of Revenue. Our cost of revenue decreased by 1.6% to $66.9 million in 2009 from $68.0 million in 2008. The decrease was primarily due to lower inventory write-downs in 2009, partially offset by an increase in the cost due to more sales rebates in 2009. The amount of inventory write-down was $5.5 million, a decline of $3.6 million from $9.1 million in 2008.




Gross Profit. Our gross profit decreased by 8.9% to $38.2 million in 2009 from $41.9 million in 2008, and our gross margin decreased to 36.4% in 2009 as compared to 38.1% in 2008. The decline in our gross margin was mainly due to the lower average selling price of baseband semiconductors. Although revenue from sales of our RF transceivers increased substantially during this period, revenue from sales of RF transceivers accounted for a small portion of our total revenue in 2009, so the impact of such sales to gross profit is immaterial compared to the impact of sales of our baseband semiconductors.




Operating Expenses. Our operating expenses decreased by 53.8% to $57.6 million in 2009 from $124.8 million in 2008. This significant decline was primarily attributable to the fact that certain expenses were incurred in 2008 but not in the year 2009, mainly a $32.3 million impairment loss of goodwill (See note 9 to the Consolidated Financial Statements for details), a $3.0 million provision for loss commitment (See note 13 to the Consolidated Financial Statements for details), a $1.6 million provision for bad debt related to other receivables and a $1.2 million provision for bad debt in accounts receivable from customers, a $18.0 million impairment loss of long-lived assets (See note 5 and note 7 to the Consolidated Financial Statements for details) and a $6.6 million IPR&D expense as a result of the Spreadtrum USA acquisition (See note 3 to the Consolidated Financial Statements for details). A decrease of $2.0 million in employee compensation expenses also contributed to the decline.


58




Research and Development. Our research and development expenses decreased by 13.8% to $37.0 million in 2009 from $42.9 million in 2008. This decrease was primarily due to decreases of $2.2 million in amortization of acquired intangible assets, $1.7 million in salary and other employee compensation expenses related to research and development and $1.1 million share-based compensation expenses attributable to research and development.




Selling, General and Administrative. Our selling, general and administrative expenses decreased by 6.8% to $20.5 million in 2009 from $22.0 million in 2008. This decrease was primarily due to decreases of $2.8 million in bad debt expenses and $0.3 million in salary and other employee compensation expenses related to selling, general and administrative, partially offset by an increase of $1.0 million in share-based compensation expenses attributable to selling, general and administrative.




Impairment Loss of Goodwill and Long-lived Assets. We recognized impairment loss of $32.3 million (See note 9 to the Consolidated Financial Statements for details), $17.4 million (See note 7 to the Consolidated Financial Statements for details), $0.06 million (See note 5 to the Consolidated Financial Statements for details) and $0.5 million (See note 7 to the Consolidated Financial Statements for details) on goodwill, acquired intangible assets, property and equipment and other long-term assets, respectively, in 2008. There were no impairment charges recognized for the year ended December 31, 2009.




IPR&D expense acquired in connection with the Spreadtrum USA Acquisition. We recorded $6.6 million in-process research and development expense acquired in connection with the acquisition of Spreadtrum USA in 2008. There was no such expense recorded in 2009.




Provision for Loss Commitment. We recorded $52,449 provision for loss commitment related to open purchase orders for our old version of baseband semiconductors in 2009 and $3.0 million provision for loss commitment in 2008 which was related to an unconditional purchase obligation.





Loss From Operations. As a result of the factors mentioned above, we recorded loss from operations of $19.4 million in 2009, as compared to loss from operations of $82.9 million in 2008.




Other Income, net. We recorded other income of $1.1 million in 2009 as compared to other income of $4.4 million in 2008. The decrease was primarily due to a decline in foreign exchange gain.




Income Tax Expense. We recorded income tax expense of $1.0 million in 2009 as compared to an income tax expense of $0.2 million in 2008. The increase mainly resulted from an increase in withholding income tax expense on royalty payments received by Spreadtrum Communications, Inc. from Spreadtrum USA in connection with a license of certain intellectual property related to RF transceivers owned by Spreadtrum Communications, Inc. The change in effective tax rate from -0.3% in 2008 to -5.6% in 2009 is mainly due to impairment losses of goodwill and intangible assets in 2008, which are not tax deductible, and utilization of certain deferred tax assets in 2009 where valuation allowance were made in prior years.




Net Loss. As a result of factors mentioned above, we reported net loss of $19.3 million in 2009 as compared to a net loss of $78.7 million in 2008.




B.
Liquidity and Capital Resources




Prior to June 27, 2007, the date of our initial public offering, we have financed our operations primarily through private sales of equity interests to investors, as well as through cash generated from our operating activities. We have also received government subsidies in the form of interest reimbursement of bank loans and grants to fund our research and development projects. At the initial public offering, we obtained net proceeds of $100.2 million through the issuance of ADSs, with each ADS representing three ordinary shares. Our principal uses of cash for the years ended December 31, 2008, 2009 and 2010 were for operating and investing activities, primarily research and development and capital expenditures. As of December 31, 2010, the total balance of cash and cash equivalents, short-term deposit with maturity dates over three months but less than one year, long-term deposit with maturity dates over one year and restricted cash which is available for use when related expenses occur and appropriate obligations need to be satisfied amounted to $272.3 million.




As of December 31, 2010, we had no short-term bank borrowings. In April 2009, Spreadtrum Shanghai borrowed a long-term unsecured loan from a Chinese bank in the amount of $45.3 million. The loan is for a term of three years. The bank loan bears interest at 5.40% per annum initially which will be reset annually at the then benchmark applicable rate as set by the People’s Bank of China. As of December 31, 2010, applicable interest rate was 5.85% per annum. The local government has agreed to reimburse a portion of the interest expense on the bank loan. In 2009 and 2010, we received $0.7 million and $1.5 million, respectively, from the local government as a reimbursement of the bank loan interests incurred, which was recorded as reduction of interest expenses.





The following table sets forth a summary of our cash flows for the periods indicated:




59





For the Year Ended December 31,2008


2009


2010(in thousands)Net cash provided by (used in) operating activities

$
(18,973
)

$
19,723


$
166,185Net cash used in investing activities


(69,692
)


(82,740
)


(129,584
)Net cash provided by (used in) financing activities


(11,391
)


43,027



4,576Effect of exchange rate change


780



37



2,200Net increase(decrease) in cash and cash equivalents


(99,276
)


(19,953
)


43,377Cash and cash equivalents at beginning of period


157,038



57,762



37,809Cash and cash equivalents at end of period

$
57,762


$
37,809


$
81,186




Operating activities




Net cash provided by operating activities for the year ended December 31, 2010 was $166.2 million, which is primarily derived from our net income of $67.2 million, adjusted for non-cash inventory write-down of $1.9 million, depreciation and amortization of $10.5 million and share-based compensation of $10.3 million, and was further adjusted by (i) increase in advance from customers of $88.0 million, (ii) increase in accounts payable of $73.3 million, (iii) increase in accrued expenses and other liabilities of $21.5 million; (iv) increase in tax payable of $10.0 million, partially offset by (i) increase in inventories of $108.7 million, (ii) increase in prepayment, other receivables and other current assets of $13.5 million.  The increase in advance from customers, accounts payables, accrued expenses and other liabilities and tax payable, and increase in inventories, prepayment, other receivables and other current assets are in line with the expansion of our business and increase of our revenue and cost of revenue in 2010.




Net cash provided by operating activities for the year ended December 31, 2009 was $19.7 million, which was primarily attributable to a $14.4 million increase in advances from customers, $9.7 million share-based compensation, $7.9 million depreciation and amortization and $7.2 million accrued expenses and other liabilities.




Net cash used in operating activities for the year ended December 31, 2008 was $19.0 million, which was primarily attributable to our net loss of $78.7 million, impairment loss of goodwill and long-lived assets of $50.3 million, IPR&D expensed per our acquisition of Spreadtrum USA of $6.6 million, depreciation and amortization of $9.9 million, share-base compensation of $8.3 million, increase in provision for loss commitment of $3.0 million, a decrease in accounts payable of $14.2 million and an increase in accounts receivable of $7.9 million, partially offset by an increase in inventory of $11.4 million. The decrease in inventories was due to an increase of $9.1 million inventory reserve while the increase in accounts receivable was primarily due to timing of cash receipts from our customers. The decreases in accounts payable were primarily due to lower purchases in 2008.




Investing activities




Net cash used in investing activities was $129.6 million in 2010, consisting primarily of (i) increase in term deposit of $104.2 million, (ii) increase in restricted cash of $8.0 million, (iii) acquisition of intangible asset of $9.9 million, (iv) acquisition of equity investment of $9.3 million, (v) acquisition of property and equipment of $5.7 million, partially offset by the refund of a deposit for land use rights (recorded under other long-term assets) in the amount of $6.8 million.




Net cash used in investing activities was $82.7 million in 2009, primarily due to $59.2 million changes in term deposit, $11.5 million increase in restricted cash, $4.0 million acquisition of property and equipment, and $7.7 million acquisition of intangible assets and goodwill.




Net cash used in investing activities was $69.7 million in 2008, primarily due to our acquisition of Spreadtrum USA of $53.7 million, our purchases of intangible assets, property and equipment of $10.0 million, a decrease in term deposit of $5.2 million, and an increase in equity investment of $0.7 million.




Financing activities




Net cash provided by financing activities was the proceeds from issuance of shares upon exercise of employee stock options of $4.6 million.




Net cash provided by financing activities amounted to $43.0 million in 2009, primarily due to the borrowings from debt of $43.9 million we received in April 2009, partially offset by repayment of debts which were borrowed in prior years.




Net cash used in financing activities amounted to $11.4 million in 2008, primarily due to share repurchase of $14.9 million, repayment of long term debt of $0.7 million, partially offset by proceeds of $4.2 million from issuance of ordinary shares upon exercise of stock options.




60





We believe that our current cash and cash flow from operations will be sufficient to meet our anticipated cash needs, including working capital requirements and capital expenditures for at least the next 12 months. Our future cash requirements will depend on many factors, including our level of operating income, the timing of our new product introductions, the timing and size of our new office building, the costs to secure access to adequate manufacturing capacity, the continuing market acceptance of our products, or other changing business conditions and future developments, including any investments or acquisitions we may decide to pursue. In the next 12 months or in the long term, if our existing cash is insufficient to meet our requirements, we may seek to sell additional equity securities, debt securities or borrow from banks. We cannot assure you that financing will be available in the amounts we need or on terms acceptable to us, if at all. The sale of additional equity securities, including convertible debt securities, would be dilutive to our shareholders. The incurrence of indebtedness would divert cash for working capital requirements and capital expenditures to service debt and could result in operating and financial covenants that restrict our operations and our ability to pay dividends to our shareholders. If we are unable to obtain additional equity or debt financing as required, our business, operations and prospects may suffer.




Capital Expenditures




(a)
Our capital expenditures amounted to $10.0 million, $9.7 million and $15.6 million in 2008, 2009 and 2010, respectively. Our capital expenditures consisted principally of purchases of software and licensed technologies, development tools, computer equipment, field test equipment, lab equipment, test vehicles, other items related to our product development activities, office building, leasehold improvements and office furniture and equipment. We expect our capital expenditures for 2011 to be approximately $33.4 million, of which $31.2 million is for additional software and licensed technologies, development tools, computer equipment, field test equipment, lab equipment and other items for our product development activities. We entered into an agreement on January 22, 2008 to access certain technology and committed to pay $10.0 million, of which $3.5 million was paid as of December 31, 2010 with the remaining to be paid over six years for both licensing the technology and guaranteed royalty payments even if no related products were sold using the acquired technology. We recorded a $3.0 million provision for loss commitment and $0.5 million impairment charge on other long-term assets in connection with this agreement in 2008. In 2009, we received the related technology and recorded intangible assets of $4.8 million, which is its estimated fair value after netting off the provision. In 2010, we assessed that the technology had become obsolete and the remaining carrying amount of $4.5 million was fully impaired accordingly recorded a $4.5 million impairment loss on intangible assets (See note 8 to the Consolidated Financial Statements for details). In the fourth quarter of 2009, we established a joint venture with three partners for the purpose of developing a piece of land we acquired in Shanghai, next to the offices of Spreadtrum Shanghai. In 2010, the Company completed the capital contribution for its 24% equity investment in Zhanxiang (See note 9 to the Consolidated Financial Statements for details).




We believe that the cash on hand and operating cash flow will be sufficient to meet our anticipated cash needs, including our cash needs for working capital and capital expenditures for the next 12 months. We may, however, require additional cash due to changing business conditions or other future developments, including any investments or acquisitions we have decided or may decide to pursue. If our existing cash is insufficient to meet our requirements, we may seek to sell additional equity securities, debt securities or borrow from lending institutions.


61




Recent Accounting Pronouncements




In October 2009, the Financial Accounting Standards Board, or FASB, issued new guidance on “revenue recognition for arrangements with multiple deliverables and certain revenue arrangements that include software elements.” By providing another alternative for determining the selling price of deliverables, the guidance for arrangements with multiple deliverables allows companies to allocate consideration in multiple deliverable arrangements in a manner that better reflects the transaction’s economics and will often result in earlier revenue recognition. The new guidance modifies the fair value requirements of previous guidance by allowing “best estimate of selling price” in addition to vendor-specific objective evidence, or VSOE, and other vendor objective evidence, which is now referred to as TPE, standing for third-party evidence, for determining the selling price of a deliverable. A vendor is now required to use its best estimate of the selling price when VSOE or TPE of the selling price cannot be determined. In addition, the residual method of allocating arrangement consideration is no longer permitted under the new guidance. The new guidance for certain revenue arrangements that include software elements removes non-software components of tangible products and certain software components of tangible products from the scope of existing software revenue guidance, resulting in the recognition of revenue similar to that for other tangible products. The new guidance is effective for fiscal years beginning on or after June 15, 2010. However, companies may adopt the guidance as early as interim periods ended September 30, 2009. The guidance may be applied either prospectively from the beginning of the fiscal year for new or materially modified arrangements or retrospectively. We have not early adopted the new guidance and are currently evaluating the impact on our consolidated financial statements.




In January 2010, the FASB issued an accounting standard update on improving disclosures about fair value measurements. The updated guidance amends existing disclosure requirements by adding required disclosures about items transferring into and out of Levels 1 and 2 in the fair value hierarchy; adding separate disclosures about purchase, sales, issuances, and settlements relative to Level 3 measurements; and clarifying, among other things, the existing fair value disclosures about the level of disaggregation. This update is effective for fiscal years beginning after December 15, 2009, except for the requirement to provide Level 3 activity of purchases, sales, issuances, and settlements on a gross basis, which is effective beginning the first quarter of 2011. We currently do not have any assets or liabilities that are measured at fair value on a recurring basis subsequent to initial recognition.





In April 2010, FASB issued amendments to Topic 718 to clarify that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. The amendments in this update are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. The amendments in this update should be applied by recording a cumulative-effect adjustment to the opening balance of retained earnings. Earlier application is permitted. We do not expect any impact from adoption of this update.





In December 2010, FASB issued amendments Topic 350 to modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with the existing guidance and examples in paragraph 350-20-35-30, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. For public entities, the amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. We will adopt this accounting standard upon its effective date for periods ending on or after December 15, 2010, and do not anticipate that this adoption will have a significant impact on our financial position or results of operations.





In December 2010, FASB issued revised guidance on the “Disclosure of Supplementary Pro Forma Information for Business Combinations.” The revised guidance specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The revised guidance also expands the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The revised guidance is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. We have not adopted the new guidance and are currently evaluating the impact on our consolidated financial statements.





C.
Research and Development, Patents and Licenses




We design substantially all of our semiconductors in-house and rely on a combination of patents, trademarks, and employee and third-party nondisclosure agreements to protect our intellectual property. We have invested substantial resources in research and development. Of our 917 employees as of December 31, 2010, 704 were engineers, approximately 55% of whom hold a Master’s degree or Ph.D. Through our significant investment in research and development, we have developed a large and growing portfolio of patents. As of December 31, 2010, we owned 117 patents and had 358 pending patent applications in China, we owned 38 patents and had 28 pending patent applications in the United States and we had 7 pending patent applications in Europe.


62




Our issued patents and pending patent applications relate primarily to technology we developed for our baseband semiconductors, including TD-SCDMA and GSM/GPRS technologies. We cannot assure you that any patent will be issued as a result of our applications or, if issued, that it will sufficiently protect our intellectual property rights. Our 117 PRC patents expire between March 2023 and April 2028, and our 38 United States patents expire between April 2022 and January 2027.




In addition to our in-house development efforts, we have entered into patent transfer agreements with several leading PRC universities, such as Beijing University of Posts and Telecommunications and Tsinghua University, pursuant to which we acquired co-ownership of 36 patents and 3 pending patent applications in China, and joint development agreements with leading PRC universities, such as Beijing University of Posts and Telecommunications, and other technology companies. These agreements relate to 2G, 2.5G and 3G technologies. In certain of the patent transfer agreements, we made a one-time payment and acquired joint ownership of the patents. Under the majority of our joint development agreements, we jointly own any developed technology and our partners generally cannot license the developed technology without our consent.




We rely on third-party licenses for some of our key technologies, as well as other technologies that are utilized in our products. For example, we have incorporated into our baseband semiconductors digital signal processing cores licensed from CEVA, RISC processor cores licensed from ARM, 3G protocol stack software that we co-developed with Sasken. From time to time, we may be required to license additional technology from third-parties to develop new products or enhance our existing products. Third-party licenses may not continue to be available to us on commercially reasonable terms or at all. Our inability to maintain any third-party licenses required in our current products, or obtain third-party licenses necessary to develop new products and product enhancements, could result in delays or other disruptions in introducing or shipping our baseband semiconductors or require us to obtain substitute technology at greater cost or of lower quality or performance standards.




We require our customers to enter into confidentiality and nondisclosure agreements before we disclose any sensitive aspects of our platforms, technology or business plans. Despite our efforts to protect our proprietary rights through confidentiality and licensing agreements, unauthorized parties may attempt to copy or otherwise obtain and use our platforms or technology. It is difficult to monitor unauthorized use of technology, particularly in China and other developing countries where the laws may not protect our proprietary rights as fully as the laws in the United States. In addition, our competitors may independently develop technology similar to ours. Our precautions may not prevent misappropriation or infringement of our intellectual property.




As of December 31, 2010, we had 8 registered trademarks in China, including 2 trademarks that incorporate our English name “Spreadtrum” and 2 trademarks that incorporate our open platform name “Mocor”. We also had 25 registered trademarks in countries other than China. Additionally, we have registered the copyright for our 2.5G/GPRS terminal software V1.0 in China. We also have registered 39 domain names, including the following: www.spreadtrum.com, spreadtrum.net and spreadtrum.com.cn.





See “Item 5.A Operating and Financial Review and Prospects—Operating Results—Results of Operations” for an information regarding the amount spent by us on research and development activities during the last three fiscal years.




D.
Trend Information




For a discussion of significant recent trends in our financial condition and results of operations, please see Item 5.A “Operating and Financial Review and Prospects—Operating Results” and 5.B “Operating and Financial Review and Prospects—Liquidity and Capital Resources”.




E.
Off-Balance Sheet Arrangements




We have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholders’ equity, or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.




F.
Tabular Disclosure of Contractual Obligations




The following table sets forth our contractual obligations as of December 31, 2010:


63





Total


Less Than

1 Year


1 to 3

Years


3 to 5

Years


More than

5 Years(in thousands)Contractual obligation:Debt

$
45,299


$
—


$
45,299


$
—


$
—Interest on debt(1)


3,533



2,650



883



—



—Lease


1,964



748



857



287



72License Fees (including minimum royalties)


9,887



3,187



1,200



3,000



2,500Commitment to purchase technology


1,200



1,200



—



—



—Total

$
61,883


$
7,785


$
48,239


$
3,287


$
2,572





(1)
Debt is unsecured and bears interest at 5.40% per annum initially which will be reset annually at the then benchmark applicable rate as set by the People’s Bank of China. Interest rate of 5.85% per annum, the applicable interest rate as of December 31, 2010, has been utilized to estimate the interest obligation. A portion of the interest will be reimbursed by the Chinese government.








The above table excludes income tax liabilities of $2.9 million recorded in accordance with ASC 740-10-25, because we are unable to reasonably estimate the timing of future payments of these liabilities due to uncertainties in the timing of the effective settlement of tax positions. For additional information on ASC 740-10-25, see Note 16 to our Consolidated Financial Statements, included in this Annual Report on Form 20-F.




Item  6.
Directors, Senior Management and Employees




A.
Directors and Senior Management




The following table sets forth certain information relating to our directors and executive officers as of February 28, 2011. Unless otherwise indicated, the business address of each of our directors and executive officers is Spreadtrum Center, Building No. 1, Lane 2288, Zuchongzhi Road, Zhangjiang, Shanghai 201203, People’s Republic of China.





Name

Age

PositionLeo Li

53

Chairman of the Board of Directors, President and Chief Executive OfficerDatong Chen

56

DirectorHao Chen(1)

45

DirectorScott Sandell(2)

46

Lead DirectorZhongrui Xia(1)

61

DirectorCarol Yu(1)(2)

48

DirectorXiaoning (Shannon) Gao

41

Chief Financial OfficerQiang Cao

49

Vice President of ProductsBrian Chen

36

Vice President of Operations





(1)
Member of Audit Committee.


(2)
Member of Compensation Committee.




Leo Li, a director since August 2009 and the Chairman of our Board since August 2010, has served as our President since October 2008 and Chief Executive Officer since February 2009. Dr. Li has more than 21 years of experience in the wireless communications industry. Before joining us, Dr. Li served as Chief Executive Officer of Magicomm Technology Inc., a cell phone product development company from 2005 to 2007. He was Senior Business Development Director at Broadcom responsible for baseband business from 2002 to 2005. From 1998 to 2002, Dr. Li served as General Manager of Mobile Phone Product and Vice President of Mobilink Telecom Inc., a GSM baseband start-up company that was sold to Broadcom in 2002. Prior to 1998, Dr. Li held various senior engineering and program management positions at Rockwell Semiconductors and Ericsson. Dr. Li holds 10 patents in wireless communication systems, RF IC system and circuit designs, and RFID applications. Dr. Li received a bachelor of science degree from the University of Science and Technology of China in Hefei, China; a master of science degree from the Institute of Electronics, Chinese Academy of Sciences in Beijing, China; a Ph.D. degree in electrical engineering from the University of Maryland in College Park, Maryland, USA; and a master of business administration degree from the National University in La Jolla, California, USA.





Datong Chen, one of our founders, has been a director since April 2004. He served as our Chief Technology Officer from April 2001 to January 2008. Dr. Chen has over 20 years of experience in the semiconductor industry and holds over 34 patents. Prior to co-founding our company, Dr. Chen co-founded OmniVision Technologies, Inc. and served as Vice President of Technology from 1995 to 2000. Dr. Chen served as a post-doctoral researcher at both the University of Illinois and Stanford University. Dr. Chen holds a bachelor of science degree, master degree and Ph.D. degree in electrical engineering from Tsinghua University.


64




Hao Chen has been a director since March 2007. He has been a member of the investment committee of Legend Capital since 2001. He served as a General Manager and Vice President of Legend Advanced System Ltd. from 1992 to 2001. Mr. Chen has over 15 years of experience in the IT industry, specifically in business management and operations, and IT applications/services. He serves on the Boards of numerous portfolio companies, including Berkana (acquired by Qualcomm), Photonic Bridges (acquired by Siemens), AutoNavi, Crystal Media, Cub Digital, Eyang, Kaitone, Rock Mobile, and Worksoft. Mr. Chen holds a bachelor degree in computer science from Huazhong University of Science and Technology




Scott Sandell has been a director since April 2004 and the Lead Director of our Board since August 2010. He joined NEA in 1996 and became a General Partner in 2000. Mr. Sandell focuses on investments in information technology and alternative energy, and is responsible for NEA’s activities in China. His present board memberships include Bloom Energy, DreamFactory, Fusion-io, HelioVolt, Lianlian Pay, Playdom, SolFocus, Spreadtrum Communications, SugarCRM, Tableau Software, Telegent and Workday. Mr. Sandell has sponsored investments in 3ware (acquired by Applied Micro Circuits Corporation), Amplitude Software (acquired by Critical Path), Fineground Networks (acquired by Cisco), Neoteris (acquired by Juniper Networks) NetIQ, Salesforce.com and WebEx. Mr. Sandell started his career at the Boston Consulting Group and later joined C-ATS Software as the company’s first salesman. He founded and ran the European Subsidiary before attending Stanford Business School. During and after business school, Mr. Sandell was a Product Manager at Microsoft, where he worked on Windows 95. In addition to an MBA from Stanford, he holds an AB in Engineering Sciences from Dartmouth College.




Zhongrui Xia has served as a director since 2009. He has been President of Hua Hong International Inc. which focuses on international venture capital business since 2001. He also served as Chairman of Shanghai Xin Hong Investment Corporation with focus on venture capital investments in 2000. Mr. Xia was President of Shanghai Hua Hong Corporation in 1998 and Director of Information Office of Shanghai Municipal Government in 1995. Mr. Xia has more than 30 years experience in the IT industry. He earned both undergraduate and graduate degrees from Fudan University and holds an EMBA degree from Madonna University in the USA.




Carol Yu has served as a director since December 2006. Since March 2004, Ms. Yu has served as the Chief Financial Officer of Sohu.com Inc. Ms. Yu has previously served as Senior Vice-President Investment Banking of Donaldson Lufkin & Jenrette Securities Corporation, and has also worked with Arthur Andersen Hong Kong and Beijing for ten years and was a partner of the Audit Division, holding the position of General Manager of Arthur Andersen-Hua Qiang, the joint venture accounting firm formed between Arthur Andersen and the Ministry of Finance in China.




Xiaoning (Shannon) Gao is our Chief Financial Officer. Prior to assuming this position in March 2010, she had served as our Vice President of Finance and Corporate Controller since 2009. Ms. Gao has been with us since our inception in 2001. Before joining us, Ms. Gao held management roles in various CPA firms in the USA. She is a Certified Public Accountant in the State of California. Ms. Gao received a Bachelor of Science degree in Engineering Economics from Harbin Institute of Technology in China and a Master Degree in Accounting from the University of Toledo in the United States.





Qiang Cao has served as our Vice President of Products since January 2008 and previously served as our Vice President of Marketing from December 2006 until January 2008. From September 2004 until December 2006, Dr. Cao served as Vice President of Marketing of the Mobility Division of ZTE Corporation. From March 1997 until September 2004, Dr. Cao worked for Lucent Technologies (UK) and was awarded Distinguished Member of Technical Staff and appointed as Technical Director for the China Market. Dr. Cao holds a bachelor’s of science degree and a master’s of science degree in communications engineering from Beijing Polytechnic University and a Ph.D. degree in communications engineering from the Imperial College, University of London.




Brian Chen has served as our Vice President of Operations since February 2009. In this role, he is responsible for operations activities including procurement, logistics, manufacturing, quality assurance, and information technology. Mr. Chen joined us in January 2007 as Director of Operations and was appointed Senior Director of Operations in May 2008. Before joining us, from 2002 to 2007 Mr. Chen worked at TSMC North America in positions including Member of Technical Staff, Technical Manager and Account Manager. Prior to joining TSMC North America, Mr. Chen served device engineering positions at Mosel Vitelic Corporation and Altera Corporation. Mr. Chen holds a bachelor’s of science degree in materials science & engineering from National Tsinghua University and a master’s of science degree in materials science & engineering from Stanford University.




There are no family relationships among any of the persons listed above. There are also no arrangements or understandings with any person pursuant to which any of our directors or executive officers were selected.




The term of service of Dr. Ping Wu as a director expired on June 29, 2010.




B.
Compensation




The aggregate cash compensation that we paid to all of our current executive officers and directors for services rendered to us and our subsidiaries during the year ended December 31, 2010 was approximately $1,500,506, which includes bonuses, salaries and consulting fees that were earned in 2010 and paid in 2011. We did not pay any cash compensation to the ex-executive officers and directors in office as of December 31, 2010 for services rendered to us and our subsidiaries during the year ended December 31, 2010.


65




In 2010, we did not provide cash compensation to directors solely for their service as directors of our company. Other than life insurance for certain of our executive officers, we do not provide pension, retirement or similar benefits to our executive officers and directors. None of our non-executive directors has any employment or service contract with us.




In 2010, options to purchase 2,501,663 ordinary shares were granted under our 2007 Equity Incentive Plan to our current directors and executive officers. The per share exercise prices of the options granted to our directors and executive officers during 2010 range from $2.03 to $2.76, and the expiration dates of such options range from March 19, 2020 to May 14, 2020. In addition, in 2010, restricted share units to receive 350,000 ordinary shares were granted under our 2007 Equity Incentive Plan to our current directors and executive officers.





Equity Compensation Plans




Second Amended and Restated 2001 Stock Plan




Our Second Amended and Restated 2001 Stock Plan, or 2001 Stock Plan, was adopted by our board of directors and our shareholders in April and May 2007, respectively. Our 2001 Stock Plan provides for the grant of incentive stock options, or ISOs, within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended, to our employees and any parent and subsidiary corporations’ employees, and for the grant of nonstatutory stock options, or NSOs to our employees, directors and consultants and any parent and subsidiary corporations’ employees and consultants. We have not issued any awards under our 2001 Stock Plan since the completion of our initial public offering and we do not intend to do so in the future. Instead we have granted options under our 2007 Equity Incentive Plan. However, our 2001 Stock Plan will continue to govern the terms and conditions of outstanding awards granted thereunder.




As part of our ongoing efforts to retain and motivate our service providers, in 2009 we implemented an option exchange program for our non-U.S. resident employees, pursuant to which such non-U.S. resident employees could elect to exchange out-of-money options granted under the 2001 Stock Plan for new options under our 2007 Equity Incentive Plan.




To avoid incurring additional compensation expenses as a result of our option exchange program, we structured the program as a “value-for-value” exchange, such that the total fair value of out-of-money options offered for exchange was equal to the fair value of the modified options granted in the exchange. Accordingly, participants in the option exchange program received modified options at lower exercisable for fewer numbers of shares relative to the out-of-money options surrendered for exchange. The number of shares exercise price under each new option was determined by applying an exchange ratio that was calculated with the purpose of achieving a “value-for-value” exchange as described above. In addition, service providers participating in the option exchange program forfeited all vesting credit under their surrendered options, because all new options granted under the program were 100% unvested on the date of grant and scheduled to vest monthly over the four-year period commencing on the date of modification.




As of December 31, 2010, as a result of our option exchange program, options to purchase 140,000 of our ordinary shares in the aggregate were exchanged and cancelled under the 2001 Stock Plan, and options to purchase 62,190 of our ordinary shares in the aggregate were granted under the 2007 Equity Incentive Plan. We compared the fair value of the modified options against the original awards as of the modification date and concluded that there was no incremental compensation cost to be recognized during the modification.




Share Reserve. As of December 31, 2010, options to purchase 3,326,477 ordinary shares were outstanding, options to purchase 20,695,099 ordinary shares have been exercised and such shares were outstanding. No ordinary shares were available for future grant under this plan.




Administration . Our board of directors or a committee appointed by our board administers our 2001 Stock Plan. Under our 2001 Stock Plan, the administrator has the power to determine the terms of the awards, including the fair market value, the service providers who will receive awards, the number of shares subject to each such award, the exercise price, the vesting schedule and exercisability of awards and the form of consideration payable upon exercise.





Options. With respect to all ISOs, the exercise price must at least be equal to the fair market value of our ordinary shares on the date of grant. With respect to all NSOs, the exercise price must at least be equal to 85% of the fair market value of our ordinary shares on the date of grant. The term of an option may not exceed ten years, except that with respect to any participant who owns 10% of the voting power of all classes of our outstanding shares as of the grant date, in which case, the term must not exceed five years and the exercise price must equal at least 110% of the fair market value on the grant date. The administrator determines the term of all options, subject to the above limitations.





After termination of an employee, director or consultant, he or she may exercise his or her vested options for the period of time stated in the option agreement. If termination is due to death or disability, the option will remain exercisable for at least six months. In all other cases, the option will remain exercisable for at least thirty days. However, an option generally may not be exercised later than the expiration of its term.


66




Transferability . Unless the administrator provides otherwise, our 2001 Stock Plan does not allow for the transfer of awards other than by will or the laws of descent and distribution and only the recipient of an award may exercise an award during his or her lifetime.




Change in Control Transactions. Our 2001 Stock Plan provides that in the event of our merger with or into another corporation or our change in control, the successor corporation or its parent or subsidiary will assume or substitute an equivalent award for each outstanding award. If there is no assumption or substitution of outstanding awards, the awards will terminate as of the date of the closing of the merger or change in control.




Amendment and Termination. Our 2001 Stock Plan terminated on June 26, 2007. However, the termination of the 2001 Stock Plan did not affect any awards outstanding under the plan on the date of termination.




2007 Equity Incentive Plan




Our board of directors adopted our 2007 Equity Incentive Plan in December 2006 and our shareholders approved such plan in June 2007.




Our 2007 Equity Incentive Plan provides for the grant of ISOs to our employees and any parent and subsidiary corporations’ employees, and for the grant of NSOs, restricted shares, restricted share units, share appreciation rights, performance units and performance shares are provided to our employees, directors and consultants and our parent and subsidiary corporations’ employees and consultants.




Share Reserve. As of December 31, 2010, the maximum aggregate number of our ordinary shares that may be issued under the 2007 Equity Incentive Plan is 3,923,646. In addition, our 2007 Equity Incentive Plan provides for annual increases in the number of shares available for issuance thereunder on the first day of each fiscal year, beginning with our 2008 fiscal year, equal to the least of:




•
4% of our outstanding ordinary shares on the last day of the immediately preceding fiscal year;




•
10 million ordinary shares; or




•
such other amount as our board of directors may determine.





As a result of the turnover in our senior management team and other personnel during the first half of 2009, we granted equity awards for large numbers of shares under the 2007 Equity Incentive Plan. Taking into consideration these extraordinary circumstances, in June 2009, our board of directors authorized an increase in the total number of shares reserved for issuance under the 2007 Equity Incentive Plan by 1,432,359 ordinary shares, which represents a special one-time increase beyond the automatic annual increase described above.




Administration . Our board of directors or a committee of our board administers our 2007 Equity Incentive Plan. Different committees with respect to different groups of service providers may administer our 2007 Equity Incentive Plan. In the case of options intended to qualify as “performance based compensation” within the meaning of Section 162(m) of the Internal Revenue Code of 1986, as amended, the committee will consist of two or more “outside directors” within the meaning of Section 162(m). The administrator has the power to determine the terms of the awards, including the exercise price, the number of shares subject to each such award, the exercisability of the awards and the form of consideration payable upon exercise. The administrator also has the authority to institute an exchange program whereby the exercise prices of outstanding awards may be reduced, outstanding awards may be surrendered in exchange for awards with a lower exercise price, or outstanding awards may be transferred to a third party.




Options . The exercise price of options granted under our 2007 Equity Incentive Plan must at least be equal to the fair market value of our ordinary shares on the date of grant. The term of an ISO may not exceed ten years, except that with respect to any participant who owns 10% of the voting power of all classes of our outstanding shares as of the grant date, in which case, the term must not exceed five years and the exercise price must equal at least 110% of the fair market value on the grant date. The administrator determines the term of all other options.




After termination of an employee, director or consultant, he or she may exercise his or her vested options for the period of time stated in the option agreement. Generally, if termination is due to death or disability, the option will remain exercisable for twelve months. In all other cases, the option will generally remain exercisable for three months. However, an option generally may not be exercised later than the expiration of its term.




Share Appreciation Rights. Share appreciation rights may be granted under our 2007 Equity Incentive Plan. Share appreciation rights allow the recipient to receive the appreciation in the fair market value of our ordinary shares between the exercise date and the date of grant. The exercise price of share appreciation rights granted under our 2007 Equity Incentive Plan must at least be equal to the fair market value of our ordinary shares on the date of grant. The administrator determines the terms of share appreciation rights, including when such rights become exercisable and whether to pay the increased appreciation in cash or with our ordinary shares, or a combination thereof. Share appreciation rights expire under the same rules that apply to options.


67




Restricted Shares. Restricted shares may be granted under our 2007 Equity Incentive Plan. Restricted share awards are ordinary shares that vest in accordance with terms and conditions established by the administrator. The administrator will determine the number of restricted shares granted to any employee. The administrator may impose whatever conditions to vesting it determines to be appropriate. For example, the administrator may set restrictions based on the achievement of specific performance goals. Restricted shares that do not vest are subject to our right of repurchase or forfeiture.




Restricted Share Units. Restricted share units may be granted under our 2007 Equity Incentive Plan. Restricted share units are similar to awards of restricted shares, but are not settled unless the award vests. The awards may be settled in shares, cash, or a combination of both, as the administrator may determine. The administrator determines the terms and conditions of restricted share units including the vesting criteria and the form and timing of payment.





Performance Units and Performance Shares. Performance units and performance shares may be granted under our 2007 Equity Incentive Plan. Performance units and performance shares are awards that will result in a payment to a participant only if performance goals established by the administrator are achieved or the awards otherwise vest. The administrator will establish organizational or individual performance goals in its discretion, which, depending on the extent to which they are met, will determine the number and/or the value of performance units and performance shares to be paid out to participants. Performance units will have an initial dollar value established by the administrator prior to the grant date. Performance shares will have an initial value equal to the fair market value of our ordinary shares on the grant date. Payment for performance units and performance shares may be made in cash or in our ordinary shares with equivalent value, or in some combination, as determined by the administrator.




Transferability . Unless the administrator provides otherwise, our 2007 Equity Incentive Plan does not allow for the transfer of awards other than by will or the laws of descent and distribution and only the recipient of an award may exercise an award during his or her lifetime.




Change in Control Transactions. Our 2007 Equity Incentive Plan provides that in the event of our change in control, as defined in the 2007 Equity Incentive Plan, each outstanding award will be treated as the administrator determines, including that the successor corporation or its parent or subsidiary will assume or substitute an equivalent award for each outstanding award. The administrator is not required to treat all awards similarly. If there is no assumption or substitution of outstanding awards, the awards will fully vest, all restrictions will lapse, and the awards will become fully exercisable. The administrator will provide notice to the recipient that he or she has the right to exercise the option and share appreciation right as to all of the ordinary shares subject to the award, all restrictions on restricted shares will lapse, and all performance goals or other vesting requirements for performance shares and units will be deemed achieved at target levels, and all other terms and conditions met. The option or share appreciation right will terminate upon the expiration of the period of time the administrator provides in the notice.




Amendment and Termination. Our 2007 Equity Incentive Plan will automatically terminate in 2016, unless we terminate it sooner. Our board of directors has the authority to amend, suspend or terminate the 2007 Equity Incentive Plan provided such action does not impair the rights of any participant with respect to any outstanding awards.




C.
Board Practices




Our board of directors currently consists of six directors plus three vacancies, which may be filled by our board of directors.




We believe that each of the current members of our board of directors and members of our board of directors in the past fiscal year, except for Dr. Wu, our former director, President and Chief Executive Officer, Dr. Chen, our former Chief Technology Officer, and Dr. Li, our President and Chief Executive Officer, is or was an “independent director” as that term is used in the NASDAQ corporate governance rules.




Currently, no shareholder or other person or entity has the contractual right to designate persons to be elected to our board of directors, and our memorandum and articles of association provides that directors will be elected upon a resolution passed at a duly convened shareholder meeting by holders of a majority of our outstanding shares entitled to vote in person or by proxy at such meeting to hold office until the expiration of their respective terms. There is no minimum shareholding or age limit requirement for qualification to serve as a member of our board of directors.




We have a staggered board that is divided into three classes, designated as Class I, consisting of three directors (two of which are currently vacant), Class II, consisting of three directors, and Class III, consisting of three directors (one of which is currently vacant), with no more than one class eligible for reelection at any annual shareholder meeting. The terms of our Class I directors will expire on the date of our 2011 annual shareholder meeting. The terms of our Class II directors will expire on the date of our 2012 annual shareholder meeting. The terms of our Class III directors will expire on the date of our 2013 annual shareholder meeting. Starting with the Class I directors who were re-elected at our 2008 annual shareholder meeting, each class of directors will be elected to serve terms of three years. The division of our board of directors into three classes with staggered three year terms may delay or prevent a change of our management or a change in control. For information regarding when each of our current directors became a member of our board of directors, please see “Item 6.A Directors, Senior Management and Employees – Directors and Senior Management.”


68




The following table sets forth the names and classes of our current directors:





Class I

Class II

Class IIIHao Chen

Leo Li

Datong ChenCarol Yu

Scott SandellZhongrui Xia




Dr. Wu was a Class III director until his term of service on our board of directors concluded on June 29, 2010.




Directors may be removed for negligence or other reasonable cause by a resolution passed at a duly convened shareholder meeting by holders of two-thirds of our outstanding shares entitled to vote in person or by proxy at such meeting. Vacancies on our board of directors created by such a removal or by resignation may be filled by resolution passed at a duly convened shareholder meeting by holders of a majority of our outstanding shares entitled to vote in person or by proxy at such meeting or by a majority vote of the directors in office. A director so elected shall hold office until the next succeeding annual shareholder meeting. Such director is eligible for reelection at that time.




Under our memorandum and articles of association, a director may vote on a contract or transaction in which the director is interested, provided that such director has disclosed the nature of his interest in such matter to the board of directors at a meeting of the board of directors.




Our board of directors may exercise all the powers of the company to borrow money, mortgage or charge its undertaking, property and uncalled capital, and issue debentures, debenture stock and other securities whenever money is borrowed or as security for any debt, liability or obligation of the company or of any third-party.




None of our directors has any service contract with our company or our subsidiaries providing for benefits upon termination of their service as directors of our company.




Committees of Our Board of Directors




We have established two committees under the board of directors—the audit committee and the compensation committee. We have adopted a charter for each of these committees. Each committee’s members and functions are described below.





Audit Committee




Our audit committee consists of Hao Chen, Zhongrui Xia and Carol Yu, each of whom meets the independence standards of NASDAQ and the SEC. Carol Yu is the Chairperson of our audit committee. The audit committee oversees our accounting and financial reporting processes and the audits of the financial statements of our company. The audit committee is responsible for, among other things:




•
appointing and overseeing the work of the independent auditors, approving the compensation of the independent auditors, and reviewing, and, if appropriate, discharging the independent auditors;




•
pre-approving engagements of the independent auditors to render audit services and/or establishing pre-approval policies and procedures for such engagements and pre-approving any non-audit services proposed to be provided to us by the independent auditors;




•
discussing with management and the independent auditors significant financial reporting issues raised and judgments made in connection with the preparation of our financial statements;




•
receiving, reviewing and discussing reports from the independent auditors on (i) the major critical accounting policies to be used, (ii) significant alternative treatments of financial information within GAAP that have been discussed with management, (iii) ramifications of the use of such alternative disclosures and treatments, (iv) any treatments preferred by the independent auditors, and (v) other material written communications between the independent auditors and management;




•
resolving any disagreements between management and the independent auditors regarding financial reporting;




•
establishing procedures for receiving, retaining and treating any complaints we receive regarding accounting, internal accounting controls or auditing matters and procedures for the confidential, anonymous submission by employees of concerns regarding questionable accounting or auditing matters; and




•
reporting regularly to the full board of directors.


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Compensation Committee




Our compensation committee consists of Scott Sandell and Carol Yu, each of whom is an “independent director” as that term is used in the NASDAQ corporate governance rules. Scott Sandell is the Chairperson of our compensation committee. Our compensation committee assists the board in reviewing and approving the compensation structure of our directors and executive officers, including all forms of compensation to be provided to our directors and executive officers. The responsibilities of our compensation committee include, among other things:




•
reviewing and recommending to the board with respect to the total compensation package for our executive officers;




•
reviewing and recommending to the board with respect to the compensation of our directors; and





•
reviewing periodically and recommending to the board with respect to any long-term incentive compensation or equity plans, programs or similar arrangements, annual bonuses, employee pension and welfare benefit plans.




D.
Employees




As of December 31, 2010, our workforce consisted of 917 employees, of which 877 were located in China and 36 were located in the United States and 4 were located in Korea. Of our employees, 130 were in sales and marketing, 61 were in general and administration, 699 were in research and development and 27 were in operations and procurement and information technology. We had 674, 682 and 917 employees as of December 31, 2008, 2009 and 2010, respectively. We do not have a significant number of temporary employees. None of our employees is covered by any collective bargaining agreement. We believe that our relations with our employees are good.




E.
Share Ownership




The table below sets forth the ordinary shares beneficially owned by each of our directors and executive officers as of February 28, 2011, the most recent practicable date.





Ordinary Shares

Beneficially Owned(1)Name

Number


Percent(2)Datong Chen(3)


3,613,301



2.5
%Hao Chen


*Scott Sandell(4)


21,048,456



14.4
%Zhongrui Xia


—



*Carol Yu


*



*Leo Li(5)


2,272,139



1.5
%Xiaoning (Shannon) Gao


*



*Qiang Cao


*



*Brian Chen


*



*All directors and executive officers as a group(6)


28,566,688



19.2
%





*
Represents less than 1% of our ordinary shares.


(1)
Beneficial ownership is determined in accordance with the rules of the SEC and generally includes voting power or investment power with respect to securities. The number of ordinary shares beneficially owned includes options and warrants currently exercisable into ordinary shares and restricted share units that will vest within 60 days after February 28, 2011 for the purpose of computing the number of shares beneficially owned by such shareholder. They are not, however, deemed to be outstanding and beneficially owned for the purpose of computing the percentage ownership of any other shareholder.


(2)
Percentage of ordinary shares is based on 145,521,685 ordinary shares outstanding as of February 28, 2011.


(3)
Includes 3,389,184 ordinary shares and 31,900 ADSs held by Dr. Chen and 128,417 ordinary shares issuable upon exercise of options held by Dr. Chen that are or will become exercisable within 60 days of February 28, 2011.


(4)
Includes 378,417 ordinary shares issuable upon exercise of options held by Mr. Sandell that are exercisable or will become exercisable within 60 days of February 28, 2011. Also includes 20,659,926 ordinary shares owned by New Enterprise Associates 11, Limited Partnership; 7,449 ordinary shares owned by New Enterprise Associates, LLC; and 2,664 ordinary shares owned by The Sandell Family Trust, u/d/t March 30, 2001, Scott D. Sandell and Jennifer Ayer Sandell, Trustees. The general partner for New Enterprise Associates 11, Limited Partnership is NEA Partners 11, Limited Partnership. The general partner for NEA Partners 11, Limited Partnership is NEA 11 GP, LLC. The individual managers of NEA 11 GP, LLC are M. James Barrett, Peter J. Barris, Forest Baskett, Ryan D. Drant, Krishna “Kittu” Kolluri, C. Richard Kramlich, Charles W. Newhall, III, Mark W. Perry and Scott D. Sandell. Each of the individual managers may be deemed to have voting and dispositive power with respect to the ordinary shares held by New Enterprise Associates 11, Limited Partnership. The individual managers disclaim beneficial ownership of all such shares, except to the extent of their respective proportionate pecuniary interest therein. The individual members of New Enterprise Associates, LLC are M. James Barrett, Peter J. Barris, Forest Baskett, Ryan D. Drant, C. Richard Kramlich, Charles W. Newhall, III, Mark W. Perry and Scott D. Sandell, each of whom may be deemed to have voting and dispositive power with respect to the ordinary shares held by New Enterprise Associates, LLC. The individual managers disclaim beneficial ownership of all such shares, except to the extent of their respective proportionate pecuniary interest therein. Mr. Sandell is a trustee of The Sandell Family Trust, u/d/t March 30, 2001, Scott D. Sandell and Jennifer Ayer Sandell, Trustees and may be deemed to have voting and dispositive power with respect to the ordinary shares held by The Sandell Family Trust, u/d/t March 30, 2001, Scott D. Sandell and Jennifer Ayer Sandell, Trustees. Mr. Sandell disclaims beneficial ownership of all such shares, except to the extent of his pecuniary interest therein.


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(5)
Includes 865,089 ordinary shares held by Dr. Li and 1,342,155 ordinary shares issuable upon exercise of options held by Dr. Li that are or will become exercisable within 60 days of February 28, 2011 and 64,895 ordinary shares underlying restricted share units held by our directors and executive officers that will vest within 60 days after February 28, 2011.


(6)
Includes 25,436,220 ordinary shares and 31,900 ADSs held by our directors and executive officers. Also includes 2,946,116 ordinary shares issuable upon exercise of options held by our directors and executive officers that are exercisable or will become exercisable within 60 days of February 28, 2011 and 88,652 ordinary shares underlying restricted share units held by our directors and executive officers that will vest within 60 days after February 28, 2011.




As of February 28, 2011, our directors and executive officers held options to purchase an aggregate of 7,347,752 ordinary shares under our 2001 Stock Plan and our 2007 Equity Incentive Plan. The per share exercise prices of these options held by our directors and executive officers range from $0.30 to $2.76, and the expiration dates of such options range from February 2, 2015 to May 14, 2020. In addition, as of February 28, 2011, our directors and executive officers hold restricted share units representing 1,260,946 ordinary shares issuable upon vesting of restricted share units under our 2007 Equity Incentive Plan.




Item  7. Major Shareholders and Related Party Transactions




A.
Major Shareholders




The following table sets forth information regarding the beneficial ownership as of February 28, 2011, the most recent practicable date, of our ordinary shares, by each shareholder who is known by us to beneficially own 5% or more of our outstanding shares as of such date.





Ordinary Shares

Beneficially Owned(1)Name

Number


Percent(2)Scott Sandell(3)


21,048,456



14.4
%Entities affiliated with New Enterprise Associates 11, Limited Partnership(4)


20,684,206



14.2
%Entities affiliated with Silver Lake Partners(5)


8,484,630



5.8
%FMR LLC and Edward C. Johnson 3d (6)


7,697,220



5.3
%





Note 1:


(1)
Beneficial ownership is determined in accordance with the rules of the SEC and generally includes voting power or investment power with respect to securities. The number of ordinary shares beneficially owned includes options and warrants exercisable into ordinary shares within 60 days after February 28, 2011 for the purpose of computing the number of shares beneficially owned by such shareholder. They are not, however, deemed to be outstanding and beneficially owned for the purpose of computing the percentage ownership of any other shareholder.


(2)
Percentage of ordinary shares is based on 145,521,685 ordinary shares outstanding as of February 28, 2011.


(3)
Includes 378,417 ordinary shares issuable upon exercise of options held by Mr. Sandell that are exercisable or will become exercisable within 60 days of February 28, 2011 held by Mr. Sandell. Also includes 20,659,926 ordinary shares owned by New Enterprise Associates 11, Limited Partnership; 7,449 ordinary shares owned by New Enterprise Associates, LLC; and 2,664 ordinary shares owned by The Sandell Family Trust, u/d/t 3/30/01, Scott D. Sandell and Jennifer Ayer Sandell, Trustees. The entities and individuals having voting and dispositive power with respect to the ordinary shares owned by New Enterprise Associates 11, Limited Partnership and New Enterprise Associates, LLC are described in footnote 4 below. Mr. Sandell is a trustee of The Sandell Family Trust, u/d/t 3/30/01, Scott D. Sandell and Jennifer Ayer Sandell, Trustees and may be deemed to have voting and dispositive power with respect to the ordinary shares held by The Sandell Family Trust, u/d/t 3/30/01, Scott D. Sandell and Jennifer Ayer Sandell, Trustees. Mr. Sandell disclaims beneficial ownership of all such shares, except to the extent of his pecuniary interest therein.


(4)
Includes 20,659,926 ordinary shares owned by New Enterprise Associates 11, Limited Partnership; 16,831 ordinary shares owned by NEA Ventures 2004, Limited Partnership; and 7,449 ordinary shares owned by New Enterprise Associates, LLC. The general partner for New Enterprise Associates 11, Limited Partnership is NEA Partners 11, Limited Partnership. The general partner for NEA Partners 11, Limited Partnership is NEA 11 GP, LLC. The individual managers of NEA 11 GP, LLC are M. James Barrett, Peter J. Barris, Forest Baskett, Ryan D. Drant, Krishna “Kittu” Kolluri, C. Richard Kramlich, Charles W. Newhall, III, Mark W. Perry and Scott D. Sandell. Each of the individual managers may be deemed to have voting and dispositive power with respect to our ordinary shares held by New Enterprise Associates 11, Limited Partnership. The individual managers disclaim beneficial ownership of all such shares, except to the extent of their respective proportionate pecuniary interest therein. J. Daniel Moore is the general partner of NEA Ventures 2004, Limited Partnership and may be deemed to have voting and dispositive power with respect to the ordinary shares held by NEA Ventures 2004, Limited Partnership. Mr. Moore disclaims beneficial ownership of all such shares, except to the extent of his pecuniary interest therein. The individual members of New Enterprise Associates, LLC are M. James Barrett, Peter J. Barris, Forest Baskett, Ryan D. Drant, C. Richard Kramlich, Charles W. Newhall, III, Mark W. Perry and Scott D. Sandell, each of whom may be deemed to have voting and dispositive power with respect to our ordinary shares held by New Enterprise Associates, LLC. The individual managers disclaim beneficial ownership of all such shares, except to the extent of their respective proportionate pecuniary interest therein. The address for New Enterprise Associates 11, Limited Partnership is 2490 Sand Hill Road, Menlo Park, CA 94025.


71





(5)
Includes 3,000,000 ordinary shares and 1,828,210 ADSs held by SLP Cathay Holdings Ltd., or SLP Cathay. Silver Lake Partners III Cayman (AIV), L.P., or SLP III Cayman, and Silver Lake Technology Investors III Cayman, L.P., or SLTI III Cayman, are shareholders of SLP Cathay. Silver Lake Technology Associates III Cayman, L.P., or SLTA III Cayman, is the general partner of each of SLP III Cayman and SLTI III Cayman. Silver Lake (Offshore) AIV GP III, Ltd., or SLA GP III, is the general partner of SLTA III Cayman. Each of (i) SLP III Cayman, as a shareholder of SLP Cathay, (ii) SLTI III Cayman, as a shareholder of SLP Cathay, (iii) SLTA III Cayman, as a general partner of each of SLP III Cayman and SLTI III Cayman, and (iv) SLA GP III, as the general partner of SLTA III Cayman, may be deemed to share voting and/or investment power over the shares owned by SLP Cathay. Each of SLP III Cayman, SLTI III Cayman, SLTA III Cayman and SLA GP III, however, disclaims beneficial ownership of such shares, except to the extent of its pecuniary interest therein.


(6)
Information based on Schedule 13G filed with the SEC on February 14, 2011 by FMR LLC and Edward C. Johnson 3d. Includes 7,673,820 ordinary shares beneficially owned by Fidelity Management & Research Company, or Fidelity, and 23,400 ordinary shares beneficially owned by Pyramis Global Advisors Trust Company, or PGATC. Fidelity, located at 82 Devonshire Street, Boston, Massachusetts 02109, is a wholly- owned subsidiary of FMR LLC and an investment adviser registered under Section 203 of the Investment Advisers Act of 1940, or the 1940 Act. Fidelity owns the 7,673,820 ordinary shares as a result of acting as an investment adviser to various investment companies registered under Section 8 of the 1940 Act. PGATC, located at 900 Salem Street, Smithfield, Rhode Island, 02917, is an indirect wholly-owned subsidiary of FMR LLC and a bank as defined in Section 3(a)(6) of the Securities Exchange Act of 1934. PGATC owns the 23,400 ordinary shares as a result of its serving as an investment manager of institutional accounts owning such shares.


Edward C. Johnson 3d, or Johnson, is the Chairman of FMR LLC.  Johnson and FMR LLC, through its control of Fidelity, each has sole power to dispose of the 7,673,820 ordinary shares. Neither FMR LLC nor Johnson has the sole power to vote or direct the voting of the shares owned directly by Fidelity, which power resides with Fidelity' Boards of Trustees. Fidelity carries out the voting of the shares under written guidelines established by its Boards of Trustees. Johnson and FMR LLC, through its control of PGATC, each has sole dispositive power over 23,400 shares and sole power to vote or to direct the voting of 0 shares owned by the institutional accounts managed by PGATC as reported above.


Members of the family of Johnson are the predominant owners, directly or through trusts, of Series B voting common shares of FMR LLC, representing 49% of the voting power of FMR LLC. The Johnson family group and all other Series B shareholders have entered into a shareholders' voting agreement under which all Series B voting common shares will be voted in accordance with the majority vote of Series B voting common shares.  Accordingly, through their ownership of voting common shares and the execution of the shareholders' voting agreement, members of the Johnson family may be deemed, under the 1940 Act, to form a controlling group with respect to FMR LLC.





The group of entities affiliated with New Enterprise Associates 11, Limited Partnership, or NEA, significantly increased their ownership of our shares in September and October 2006 in connection with our private placement of Series D preference shares at a per share price of $2.74. Such price was determined based on arm’s-length negotiations between us, NEA and other investors in the private placement and was approved by our board of directors. NEA purchased 1,901,501 Series D preference shares in the private placement. Since our initial public offering, NEA has significantly decreased its ownership of our shares through distributions to NEA’s limited partners. According to the Amendment No.2 to Schedule 13G filed with the SEC on March 10, 2011, as of the most recent practicable date, the Bank of New York Mellon Corporation and its subsidiary, the Dreyfus Corporation, previously among our list of major shareholders, decreased their holding of our shares and cease to be our major shareholders. None of the shareholders known by us to beneficially own 5% or more of our outstanding shares as of February 28, 2011 have voting rights that are different from the voting rights of our other shareholders.





B.
Related Party Transactions




Equity Issuances




We have granted options and restricted share unit awards to some of our directors and executive officers pursuant to our 2001 Stock Plan and 2007 Equity Incentive Plan. See “Item 6.B Directors, Senior Management and Employees—Compensation.”




Indemnification Agreements




We have entered into indemnification agreements with each of our directors and executive officers that will provide our directors and executive officers with additional protection regarding the scope of the indemnification set forth in our post-offering memorandum and articles of association. Pursuant to these agreements, we will indemnify each of our directors and executive officers (to the fullest extent permitted by applicable law) against all expenses, including damages, settlements and costs, which such person incurs or becomes obligated to incur in connection with any proceeding. Under the indemnification agreement, a proceeding includes any threatened, pending, or completed action, suit or proceeding, in which the indemnified person may be or may have been involved as a party or otherwise by reason of any event or occurrence related to the fact that such person is or was our director or officer or a director or officer of any of our subsidiaries, or is or was serving at our request as a director or officer of another corporation, partnership, joint venture or other entity, or related to anything done or not done by such person in any such capacity, including, without limitation, any threatened, pending, or completed action, suit or proceeding by or in our right. However, we will not be obligated to indemnify any such person for certain matters, which include:


72




•
any judgment, fine or penalty which we are prohibited by applicable law from paying as indemnity;




•
in connection with any proceeding initiated by such person against us, any of our directors or officer or any other party, and not by way of defense, unless we have joined in or the reviewing party has consented to the initiation of such proceeding, or the proceeding is one to enforce indemnification rights under the indemnification agreement or any applicable law;




•
any matter brought about by the dishonesty or fraud of such person seeking payment under the indemnification agreement; provided, however, that such person shall be protected under the indemnification agreement as to any claims upon which suit may be brought against such person by reason of any alleged dishonesty on such person’s part, unless a judgment or other final adjudication thereof adverse to such person establishes that such person committed acts of active and deliberate dishonesty, with actual dishonest purpose and intent, and which acts were material to the cause of action so adjudicated; or




•
any matter arising out of such person’s personal tax matters.




Relationship with Spreadtrum Beijing




Spreadtrum Beijing assembled a staff of engineers with expertise in wireless communications technologies, particularly in TD-SCDMA, AVS and 2G/2.5G standards. Accordingly, Spreadtrum Shanghai entered into a Research and Development Agreement dated as of December 27, 2006 with Spreadtrum Beijing to utilize this engineering talent. Under the agreement, Spreadtrum Shanghai hired and retained Spreadtrum Beijing to perform ongoing research and development relating to wireless telecommunications systems. In consideration for performing this research and development, Spreadtrum Shanghai agreed to reimburse Spreadtrum Beijing for all necessary and reasonable direct and indirect costs incurred by Spreadtrum Beijing in connection with the performance of the agreed upon scope of work, plus an additional percentage of those costs. From the execution of the agreement until February 28, 2011, Spreadtrum Shanghai paid to Spreadtrum Beijing an aggregate of approximately $3.3 million. Spreadtrum Shanghai owns all rights, title and interest in the results of such research and development. Spreadtrum Beijing agreed that its employees, agents and subcontractors who work on specified research and development work for Spreadtrum Shanghai will execute confidential information agreements acceptable to Spreadtrum Shanghai. The term of the Research and Development Agreement is 10 years, unless terminated earlier by Spreadtrum Shanghai. At the end of the initial term, the agreement will renew automatically for additional one-year terms, unless either party elects to terminate the agreement.





In connection with the Research and Development Agreement, our employees worked closely with their counterparts at Spreadtrum Beijing. Under the Research and Development Agreement, Spreadtrum Shanghai and Spreadtrum Beijing must agree on the type of research and development projects that Spreadtrum Beijing will undertake for Spreadtrum Shanghai and the related milestones. In addition, Ms. Qian Dong, our Vice President of Administration and Human Resources, is the PRC legal representative, executive director and manager of Spreadtrum Beijing.




On March 27, 2007, Spreadtrum Shanghai established a branch office in Beijing. In an effort to reduce our costs under the Research and Development Agreement, in May 2007, Spreadtrum Shanghai’s Beijing branch office accepted the transfer of 77 of Spreadtrum Beijing’s employees. As of April 5, 2011, Spreadtrum Beijing’s workforce consisted of  44 employees.




Additionally, we have entered into a Loan Agreement with Shujun Zhang, Dichen Li and Yuer Zhang, three of the shareholders of Spreadtrum Beijing, pursuant to which we loaned them an aggregate amount of $1,000,000. Shujun Zhang is the mother of Datong Chen, one of our directors and co-founders and our former Chief Technology Officer, Yuer Zhang is the mother of Renyong Fan, one of our co-founders and our former Vice President of Operations, and Dichen Li is the mother of Jin Ji, one of our co-founders and employees. Pursuant to the Loan Agreement, each of Shujun Zhang, Dichen Li and Yuer Zhang agrees to use the principal amount of the loan to establish and operate Spreadtrum Beijing. Each is restricted from assigning, transferring or causing a security interest to be created with respect to the equity interests of Spreadtrum Beijing without our prior written consent. We may cause the loan, which does not accrue interest, to be repaid with prior written notice to the shareholders of Spreadtrum Beijing.




Relationship with Xi’an Chuang Xin




In September 2008, Shanghai Han & Qin Investment Co., Ltd., one of our wholly-owned indirect subsidiaries, invested $0.7 million in Xi’an Chuang Xin, for a 39.06% equity interest ownership. Ping Wu, one of our co-founders and our former Chairman of the board of directors, President and Chief Executive Officer, is the Chairman of the board of directors of Xi’an Chuang Xin. The principal activities of Xi’an Chuang Xin are the research and development, marketing and sales activities of chips for multimedia products such as digital TV. In March 2010, we entered into an equity transfer agreement with a third party to dispose of our investment in Xi’an Chuang Xin. Pursuant to such agreement, we have received payment of $0.7 million, constituting the total consideration for such disposition, and we are currently in the process of completing requisite legal procedures relating to the transfer of our equity interest in Xi’an Chuang Xin to the third party.


73




Employment and Consulting Agreements




Each of our executive officers has entered into a confidential information and invention assignment agreement with us. We require all of our employees to execute the same confidential information and invention assignment agreement or an agreement on substantially similar terms. Under the terms of the agreement, each executive officer has agreed to hold, both during and after such executive officer’s term of employment, in strictest confidence and not to use, except for our benefit, or to disclose to any person, firm or corporation without written authorization, any confidential information. Confidential information does not include any information which has become publicly known and made generally available through no wrongful act of our executive officers. Each executive officer also has agreed during such executive officer’s term of employment to not improperly use or disclose any proprietary information or trade secrets of any former or current employer or other person or entity unless consented to in writing by such employer, person or entity. In addition, each executive officer has agreed to disclose to us, hold in trust for the sole right and benefit of us and assign to us all right, title and interest in and to any and all inventions, original works of authorship, developments, concepts, improvements or trade secrets, whether or not patentable or registrable under copyright or similar laws, which such executive officer may solely or jointly conceive, develop or reduce to practice, or cause to be conceived, developed or reduced to practice, during the period of employment. Furthermore, each executive officer has agreed to not directly or indirectly solicit, induce, recruit or encourage any employees to leave their employment during the 12-month period immediately following such executive officer’s termination of employment.




In June 2007, we entered into employment agreements with each of (i) Ping Wu, our former Chairman of our board of directors, President and Chief Executive Officer, and (ii) Datong Chen, one of our current directors and our former Chief Technology Officer.




In connection with Dr. Chen’s resignation as our Chief Technology Officer in January 2008, the employment agreement with Dr. Chen terminated. In March 2008, we entered into a consulting agreement with Dr. Chen, pursuant to which Dr. Chen agreed to advise us with respect to our strategy, business development and internal management system and identify, meet with and negotiate with our potential strategic partners to develop and establish relationships between us and such potential strategic partners.




In October 2008, we appointed Leo Li as our President. In February 2009, we promoted Dr. Li from his position as our President to become our President and Chief Executive Officer, with Dr. Wu retaining his role as Chairman of our board of directors until his term of service as our director concluded in June 2010.In connection with Dr. Li’s promotion, Dr. Wu’s employment agreement terminated, and we entered into a separation agreement with Dr. Wu and an employment agreement with Dr. Li.




In addition, in June 2009, we entered into an employment agreement with David S. Wu, our former Chief Financial Officer, which employment agreement terminated in connection with Mr. Wu’s resignation in October 2009. In March 2010, we promoted Ms. Shannon Gao from her position as our Vice President of Finance and Corporate Controller to become our Chief Financial Officer, and we entered into an employment agreement with Ms. Shannon Gao.




The employment agreement with each of Dr. Li and Ms. Gao provides that we may terminate his/her employment at any time, with or without cause, and the executive officer may also terminate his/her employment at any time, for any reason or no reason at all. In the event that we terminate the employment of the executive officer for cause, or if the executive officer resigns without good reason, such departing executive officer will not be entitled to receive any severance benefits. In the case of a termination without cause or a resignation for good reason, the executive officer will be entitled to certain severance benefits. For Dr. Li, these severance benefits include (i) severance pay at a rate equal to his then current monthly base salary until the earlier of twelve months from the date of termination or such time Dr. Li becomes employed by another company, and (ii) accelerated vesting of all outstanding equity awards as to 50% of the then unvested portion of any such award, provided, however, that in the event such a termination occurs within twelve months following a change in control, Dr. Li would be entitled to 100% accelerated vesting of all outstanding equity awards. For Ms. Gao, the severance benefits include severance pay for six months at her then current base salary and accelerated vesting of all outstanding equity awards as to the lesser of (i) 50% of the then unvested portion of any such award, or (ii) 25% of any such award.





Cause is defined as (i) an act of dishonesty made by the executive officer in connection with his responsibilities as our employee which is intended to result in substantial personal enrichment of the executive officer, (ii) a conviction or no contest plea to a felony or any crime involving fraud, embezzlement or any other act of moral turpitude, (iii) gross misconduct, (iv) unauthorized use or disclosure of any of our proprietary information or trade secrets, (v) willful breach of any obligations under any written agreement or covenant with us, (vi) failure to perform employment duties after notice and an opportunity to cure the failure, and (vii) failure to cooperate in an investigation initiated by our board of directors.




Good reason means, without the executive officer’s consent, (i) a material reduction of authorities, duties or responsibilities, or the removal from such authorities, duties or and responsibilities, unless the executive officer is provided with a comparable position, excluding a reduction in authorities, duties or responsibilities solely by virtue of us being acquired and made part of a larger entity, or (ii) a material reduction of the executive officer’s aggregate base salary and target bonus opportunity below the base compensation immediately prior to such reduction, unless we also similarly reduce the base compensation of all our other executives officers.


74




A change in control is defined as (i) a change in the ownership of our shares that results from any one person, or more than one person acting as a group, acquiring ownership of our shares that, together with the shares held by such person or persons, constitutes more than 50% of the total voting power of our shares, or (ii) a change in the ownership of a substantial portion of our assets that results from any person acquiring (or having acquired during the 12-month period ending on the date of the most recent acquisition by such person) assets from us that have a total gross fair market value equal to or greater than 85% of the total gross fair market value of all our assets immediately prior to such acquisition or acquisitions; provided, however, that asset transfers to the following persons or entities would not constitute a change in the ownership of a substantial portion of our assets: (a) an entity that is controlled by our shareholders immediately after the transfer, (b) one of our shareholders in exchange for or with respect to our shares, (c) an entity, 50% or more of the total value or voting power of which is owned, directly or indirectly, by us, (d) a person that owns, directly or indirectly, 50% or more of the total value or voting power of all our outstanding shares, or (e) an entity, at least 50% of the total value or voting power of which is owned, directly or indirectly by a person described in clause (d).




Pursuant to these employment agreements, each of these executive officers has also agreed to not, until the date one year after the termination of such executive officer’s employment with us, either directly or indirectly, solicit, induce, attempt to hire, recruit, encourage, take away, hire any employee of us or our subsidiaries or cause any such employee to leave his employment for any other entity or person.




C. Interests of Experts and Counsel




Not required.




Item  8.
Financial Information




A.
Consolidated Financial Statements and other Financial Information




Please see “Item 18. Financial Statements” and pages F-1 through F-36 for our Consolidated Financial Statements. In addition, for more information regarding the percentages and amounts of our revenues from customers located in the United States and outside the United States, please see “Item 5. Operating and Financial Review and Prospects” and the Notes to the Consolidated Financial Statements.





Legal Proceedings




We are not involved in any legal matters that management believes will have a material adverse effect on our business. Many companies in the semiconductor, networking and software industries have a significant number of patents and have demonstrated a willingness to instigate litigation based on allegations of patent, trademark, copyright and other claims of infringement. From time to time, we have received, and expect to continue to receive, notices of claims of patent and software copyright infringement, misappropriation or misuse of other parties’ proprietary rights. For example, in June 2007, we received a letter from Siemens notifying us that Siemens claims to own certain essential patents covering the GSM/GPRS standard and offering to license such patents to us. After reviewing their list of essential GSM/GPRS patents and the corresponding claims chart, we requested to receive more information from Siemens and we have not received Siemens’ feedback since June, 2008. Also, we received a letter in March 2009 from Ericsson notifying us that Ericsson claims to own certain essential patents covering the GSM/GPRS, EDGE and WCDMA standards and offering to license such patents to us. We requested to receive more information from Ericsson. In December 2010, we received a letter from WRF notifying us that WRF claims to own certain patents and pending patent applications relating to Low Intermediate Frequency radio receivers and offering to license such patents and pending patent applications to us. We cannot reasonably estimate the potential losses we may experience in connection with the claims from Siemens and Ericsson. Although we believe that the likelihood of losses arising from these matters is remote, we cannot assure you that we will prevail in such matters. If we need to license any such patents, there can be no assurances that we will be able to do so on commercially reasonable terms or at all and our failure to do so could have a material adverse impact on our business, results of operations, financial condition or prospects.




Some of these claims may lead to litigation. We cannot assure you that we will prevail in these actions, or that other actions alleging infringement by us of third-party patents, trademarks and copyrights, misappropriation or misuse by us of third-party trade secrets or the validity of our patents will not be asserted or prosecuted against us, or that any assertions of infringement, misappropriation or misuse or prosecutions seeking to establish the validity of our patents will not materially or adversely affect our business, financial condition and results of operations. In 2010, we accrued a contingent loss of approximately $0.8 million in connection with one arbitration case.


75




Dividends




Since our inception, we have not declared or paid any cash dividends on our ordinary shares. We intend to retain any earnings for use in our business and do not currently intend to pay cash dividends on our ordinary shares. Dividends, if any, on our outstanding ordinary shares will be declared by and subject to the discretion of our board of directors. Even if our board of directors decides 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.




Our ability to pay cash dividends will also depend upon the amount of distributions, if any, received by us from our subsidiaries in China, which must comply with PRC laws and regulations and the respective articles of association of such subsidiaries in declaring and paying dividends to us. Under applicable requirements of PRC law, our subsidiaries in China may only distribute dividends after they have made allowances for:




•
recovery of losses, if any;




•
allocation to statutory common reserve funds; and




•
allocation to staff and workers’ bonus and welfare funds.





More specifically, these subsidiaries may pay dividends only after at least 10% of their net profit has been set aside as reserve funds and a discretionary percentage of their net profit has been set aside for staff and workers’ bonus and welfare funds. These PRC subsidiaries are not required to set aside any of their net profit as reserve funds if such reserves are at least 50% of their respective registered capital. Furthermore, if they record no net income for a year as determined in accordance with generally accepted accounting principles in the PRC, they generally may not distribute dividends for that year.





Any 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.




B.
Significant Changes




None.




Item  9.
The Offer and Listing




A.
Offer and Listing Details




Our ADSs have been quoted on the NASDAQ Global Market under the symbol SPRD since June 27, 2007. Each ADS represents three ordinary shares. On April 5, 2011, the last reported sale price of our ADSs on the NASDAQ Market was $18.34. Citibank, N.A., the depositary, has advised us that, as of December 31, 2010, 37,860,583 ADSs, representing 113,581,749 underlying shares, were held of record by DTC, under the nominee name of CEDE & CO, on behalf of DTC participants. We have no further information as to ADSs held, or beneficially owned, by U.S. persons.




The table below sets forth, for the periods indicated, the highest and lowest sale prices on the NASDAQ Global Market for our ADSs.




Trading

PriceHigh


LowUS$


US$Annual:Fiscal year 2010


19.20



5.34Fiscal year 2009


6.30



0.70Fiscal year 2008


12.55



0.63Fiscal year 2007(1)


17.00



9.30Quarterly:First quarter 2009


2.50



0.70Second quarter 2009


3.18



1.14Third quarter 2009


4.67



2.35Fourth quarter 2009


6.30



4.21First Quarter 2010


7.04



5.34Second quarter 2010


10.29



5.54Third quarter 2010


14.20



7.60Fourth quarter 2010


19.20



11.49First Quarter 2011


24.20



17.42


76
  Trading

PriceHigh


LowUS$


US$Monthly:October 2010


14.68



11.49November 2010


16.99



14.16December 2010


19.20



16.15January 2011


21.75



17.92February 2011


24.19



19.29March 2011


24.20



17.42April 1 – 5, 2011


18.99



18.15


(1)
Our ADSs commenced trading on the NASDAQ Global Market on June 27, 2007.





B.
Plan of Distribution


Not applicable.




C.
Markets on which the Company’s Shares Trade




Our ADSs are listed and principally traded on the NASDAQ Global Market under the symbol SPRD, where the prices are expressed in U.S. dollars. The ADSs are represented by American Depositary Receipts, or ADRs, which are issued by the Depositary, Citibank, N.A.




D.           Selling Shareholders




Not applicable.




E.
Dilution




Not applicable.




F.
Expenses of the Issue




Not applicable.




Item  10.
Additional Information




A.
Share Capital




Not applicable.




B.
Memorandum and Articles of Association




Our Memorandum of Association and Articles of Association, as amended, are filed as Exhibit 3.1 to our registration statement on Form F-1 (File No. 333-143555), as amended, which exhibit is incorporated by reference herein. Each ADR represents ownership interests in, or the right to receive, three ordinary shares, which have been deposited with Citibank, N.A., as the custodian. A summary of the other rights of the ordinary shares and ADSs is included in our registration statement on Form F-1 (File No. 333-143555), as amended, which summary is incorporated by reference herein.




C.
Material Contracts




On August 27, 2009, we signed a Seventh Amendment to License Agreement with CEVA Technologies Inc. and CEVA DSP Ltd., which amends the License Agreement dated September 30, 2001 among us, CEVA Technologies Inc. and CEVA DSP Ltd., as amended and which is filed as an exhibit to this Annual Report.




In December 2009, Spreadtrum Shanghai signed an agreement with Shanghai Zhangjiang Semiconductor Industry Park Co., Ltd. regarding the refunding of the payment made by Spreadtrum Shanghai in connection with the transfer of land use rights pursuant to certain contract for the Transfer of the State-owned Land Use rights between Shanghai Zhangjiang Semiconductor Industry Park Co., Ltd. and Spreadtrum Shanghai, dated January 2007. A summary of this agreement is filed as an exhibit to this Annual Report.


77





On December 1, 2009, Zhanxiang, a company in which we own a 24% equity interest, signed an agreement for the Transfer of State-owned Land Use Rights with Shanghai Zhangjiang Semiconductor Industry Park Co., Ltd. A summary of this agreement is filed as an exhibit to this Annual Report.




On December 2, 2009, Spreadtrum Shanghai signed a Shareholder Agreement with Shanghai Spreadtrum Real Estate Development Co., Ltd., Shanghai Zhangjiang Semiconductor Industry Park Co., Ltd. and Shanghai Wingtech Electronics Co., Ltd. A summary of this agreement is filed as an exhibit to this Annual Report.




We have not entered into any other material contracts other than in the ordinary course of business and other than those disclosed in Item 4 “Information on the Company”.




D.
Exchange Controls




China’s government imposes control over the convertibility of RMB into foreign currencies. The conversion of RMB into foreign currencies, including U.S. dollars, has been based on rates announced by the People’s Bank of China. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the Renminbi to the U.S. dollar. Under the new policy, the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in an approximately 25% appreciation of the RMB against the U.S. dollar by the end of 2010. While the international reaction to the RMB revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a further and more significant appreciation of the RMB against the U.S. dollar.




Pursuant to the Foreign Exchange Administration Rules issued by the State Council on January 29, 1996, and effective as of April 1, 1996 (and amended on January 14, 1997 and further amended on August 1, 2008) and the Administration of Settlement, Sale and Payment of Foreign Exchange Regulations which came into effect on July 1, 1996 regarding foreign exchange control, or the Regulations, conversion of RMB into foreign exchange by foreign investment enterprises for current account items, including the distribution of dividends and profits to foreign investors of joint ventures, is permissible. Foreign investment enterprises are permitted to remit foreign exchange from their foreign exchange bank account in China on the basis of, inter alia, the terms of the relevant joint venture contracts and the board resolutions declaring the distribution of the dividend and payment of profits. On January 14, 1997, the State Council amended the Foreign Exchange Control Regulations and added, among other things, an important provision, as Article 5 provides that the State shall not impose restrictions on recurring international current account payments and transfers. Conversion of RMB into foreign currencies and remittance of foreign currencies for capital account items, including direct investment, loans, security investment, is still subject to the approval of the SAFE, in each such transaction.




Under the Regulations, foreign investment enterprises are required to open and maintain separate foreign exchange accounts for capital account items (but not for other items). In addition, foreign investment enterprises may only buy, sell and/or remit foreign currencies at those banks authorized to conduct foreign exchange business upon the production of valid commercial documents and, in the case of capital account item transactions, document approval from the SAFE.




Currently, foreign investment enterprises are required to apply to the SAFE for “foreign exchange registration certificates for foreign investment enterprises” (which are currently in the form of IC cards and are granted to foreign investment enterprises, upon fulfilling specified conditions and which are subject to review and renewal by the SAFE on an annual basis). With such foreign exchange registration certificates and required underlying transaction documents, or with approval documents from the SAFE if the transactions are under capital account (which are obtained on a transaction-by-transaction basis), foreign-invested enterprises may enter into foreign exchange transactions at banks authorized to conduct foreign exchange business to obtain foreign exchange for their needs.





E.
Taxation




Cayman Islands Tax




Under the current laws of the Cayman Islands, we are not subject to tax on our income or capital gains. In addition, our payment of dividends, if any, is not subject to withholding tax in the Cayman Islands.




PRC Tax




If we declare dividends to our shareholders and ADS holders from income originating from Spreadtrum Shanghai or Spreadtrum Technology, it is unclear whether such dividends will be deemed to be derived from sources within the PRC under the CIT Law and be subject to a 10% withholding tax. Accordingly, we may be required under the CIT Law to withhold PRC income tax on our dividends payable to our non-PRC shareholders and ADS holders. Please see “Item 3.D Risk Factors—Risks Related to Doing Business in China—We may be treated as a resident enterprise for PRC tax purposes under the CIT Law which became effective on January 1, 2008, which may subject us to PRC income tax for any dividends we receive from our subsidiaries and PRC income tax withholding for any dividends we pay to our non-PRC shareholders and ADS holders.”


78




United States Tax




Except where noted, the following summary deals only with the ownership and disposition of the ADSs and ordinary shares that are held as capital assets by U.S. holders of our ADSs and ordinary shares, referred to herein as U.S. Holders. This summary does not represent a detailed description of the U.S. federal income tax consequences applicable to U.S. Holders that are subject to special treatment under the U.S. federal income tax laws, including:




•
banks;




•
dealers in securities or currencies;




•
financial institutions;




•
real estate investment trusts;




•
insurance companies;




•
tax-exempt organizations;




•
persons holding ADSs or ordinary shares as part of a hedging, integrated or conversion transaction, constructive sale or straddle;




•
traders in securities that have elected the mark-to-market method of accounting;




•
persons liable for the alternative minimum tax;




•
persons who have ceased to be U.S. citizens or to be taxed as resident aliens;




•
persons who own or who are deemed to own more than 10% of our voting shares; or




•
U.S. persons whose “functional currency” is not the U.S. dollar.




This summary 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, or the Code, and U.S. Treasury Regulations, rulings and judicial decisions thereunder as of the date hereof, and such authorities may be replaced, revoked or modified, possibly on a retroactive basis, so as to result in U.S. federal income tax consequences different from those discussed below.




A U.S. Holder that holds ADSs or ordinary shares is urged to consult its own tax advisor concerning the U.S. federal income tax consequences of acquiring, owning or disposing of our ADSs or ordinary shares as well as any consequences arising under the laws of any other taxing jurisdiction in light of the particular circumstances of the U.S. Holder.




A U.S. Holder is a beneficial owner of ADSs or ordinary shares that is a U.S. person. A U.S. person is:




•
a citizen or resident of the United States;




•
a corporation or other entity taxable as a corporation created or organized, or treated under U.S. tax law as created or organized, in or under the laws of the United States, any state thereof, or the District of Columbia;




•
an estate the income of which is subject to United States 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 United States Treasury regulations to be treated as a U.S. person.




If a partnership holds ADSs or ordinary shares, the tax treatment of a partner will generally depend on the status of the partner and the activities of the partnership. A U.S. Holder that is a partner of a partnership holding ADSs or ordinary shares is urged to consult its own tax advisors.




ADSs or Ordinary Shares. 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. Subject to the discussion under “—Passive Foreign Investment Company Rules” below, the gross amount of the cash distributions on the ADSs or ordinary shares will be taxable to a U.S. Holder as dividends to the extent of our current and accumulated earnings and profits, as determined under U.S. federal income tax principles. Subject to certain limitations, under current law, dividends paid to noncorporate 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.  A qualified foreign corporation includes:




•
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; and


79




•
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 with respect to dividends paid on such stock or ADSs,




but does not include an otherwise qualified corporation that is a PFIC. We believe that we will be a qualified foreign corporation for so long as we are not a PFIC and the ordinary shares or ADSs are considered to be readily tradable on an established securities market within the United States. 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 readily tradable on an established securities market within the United States. Our status as a qualified foreign corporation, however, may change.




Dividends will be includable in a U.S. Holder’s gross income on the date actually or constructively received by such U.S. Holder, in the case of ordinary shares, or by the depositary, in the case of ADSs. 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 that the amount of any cash 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 (thereby increasing the amount of gain, or decreasing the amount of loss, a U.S. Holder would recognize on a subsequent disposition of the ADSs or ordinary shares), and the balance in excess of adjusted basis will be subject to tax as capital gain. We do not intend to calculate our earnings and profits for U.S. federal income tax purposes.  Therefore, a U.S. Holder should expect that a distribution with respect to our ADSs or ordinary shares will be reported as a dividend.




Dividends paid on the ADSs or ordinary shares will generally be income from sources outside of the United States for U.S. foreign tax credit limitation purposes.




If we are treated as a resident enterprise for PRC tax purposes, we may be required under the CIT Law to withhold PRC income taxes on any dividends paid to U.S. Holders of our ADSs or ordinary shares. For more information regarding the CIT Law, see “— PRC Tax.” U.S. Holders should consult their own tax advisors regarding the availability of, and limitations on, foreign tax credits with respect to any PRC withholding taxes on dividends received on our ADSs or ordinary shares.




Sale, Exchange or Other Disposition of ADSs or Ordinary Shares. Subject to the discussion under “—Passive Foreign Investment Company Rules” below, 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. A U.S. Holder’s adjusted tax basis in an ADS or an ordinary share will initially be, in general, the price it paid for that ADS or ordinary share. 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 currently eligible for reduced rates of taxation. The deductibility of capital loss is subject to limitations. Any gain or loss that a U.S. Holder recognizes may be treated as gain or loss from sources within the United States for U.S. foreign tax credit limitation purposes.





Passive Foreign Investment Company Rules. We believe that we were not a PFIC for 2010. Based on the projected composition of our income, the timing of our anticipated capital expenditures and the valuation of our assets, we do not expect to be a PFIC for 2011, although this may change.




In general, we will be deemed to be a PFIC for any taxable year in which either (i) at least 75% of our gross income is passive income or (ii) 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 are a PFIC in any taxable year, unless a mark-to-market election described below is made, U.S. Holders will generally be subject to additional taxes and interest charges on certain “excess” distribution we make and on any gain realized on the disposition or deemed disposition of ADSs or ordinary shares regardless of whether we continue to be a PFIC in the year of the “excess” distribution or disposition. Distributions in respect of a U.S. Holder’s ADSs or ordinary shares during the taxable year will generally constitute “excess” distributions if, in the aggregate, they exceed 125% of the average amount of distributions in respect of the U.S. Holder’s ADSs or ordinary shares over the three preceding taxable years or, if shorter, the portion of the U.S. Holder’s holding period before such taxable year.




To compute the tax on “excess” distributions or any gain, (i) the “excess” distribution or the gain will be allocated ratably to each day in the holding period; (ii) the amount allocated to the current year and any tax year before we became a PFIC will be taxed as ordinary income in the current year; (iii) the amount allocated to other taxable years will be taxable at the highest applicable marginal rate in effect for that year; and (iv) an interest charge at the rate for underpayment of taxes will be imposed with respect to any portion of the “excess” distribution or gain described under (iii) above that is allocated to such other taxable years. In addition, if we are a PFIC or were a PFIC in the taxable year prior to the distribution, no distribution will qualify for taxation at the preferential rate for non-corporate holders discussed in “—Distributions on ADSs or Ordinary Shares” above.




80




If we are a PFIC in any year in which our ADSs or ordinary shares are “marketable”, a U.S. Holder will be able to avoid the “excess” distribution rules described above if such U.S. Holder makes a timely “mark-to-market” election with respect to its ADSs or ordinary shares. The ADSs or ordinary shares will be “marketable” as long as they remain regularly traded on a national securities exchange, such as the NASDAQ. If this election is made in a timely fashion, the U.S. Holder will generally recognize as ordinary income or ordinary loss the difference between the fair market value of the ADSs or ordinary shares on the last day of any taxable year and the U.S. Holder’s adjusted tax basis in the ADSs or ordinary shares. Any ordinary income resulting from this election will generally be taxed at ordinary income rates. Any ordinary losses will be deductible only to the extent of the net amount of previously included income as a result of the mark-to-market election, if any. The U.S. Holder’s adjusted tax basis in the ADSs or ordinary shares will be adjusted to reflect any such income or loss.




Alternatively, the “excess distribution” rules described above may generally be avoided by electing to treat us as a “Qualified Electing Fund,” or QEF, under Section 1295 of the Code. A QEF election is available only if the U.S. Holder receives an annual information statement from the PFIC setting forth its ordinary earnings and net capital gains, as calculated for U.S. federal income tax purposes. We will not provide our U.S. Holders with the information statement necessary to make a QEF election. Accordingly, U.S. Holders will not be able to make or maintain such an election.





A U.S. Holder is urged to consult its own tax advisors concerning the availability of making a mark-to-market election or a qualified electing fund election and the U.S. federal income tax consequences of holding the ADSs or ordinary shares if we are deemed to be a PFIC in any taxable year.




Information Reporting and Backup Withholding. In general, unless a U.S. Holder belongs to a category of certain exempt recipients, information reporting requirements will apply to distributions on ADSs or ordinary shares made within the United States and to the proceeds of sales of ADSs or ordinary shares that are effected through the U.S. office of a broker or the non-U.S. office of a broker that has certain connections with the United States. Backup withholding (currently imposed at a rate of 28%) may apply to these payments if a U.S. Holder fails to provide a correct taxpayer identification number or certification of exempt status, fails to report in full dividend and interest income or, in certain circumstances, fails to comply with applicable certification requirements.




Any amounts withheld under the backup withholding rules may generally be allowed as a refund or a credit against a U.S. Holder’s U.S. federal income tax, provided the U.S. Holder furnishes the required information to the Internal Revenue Service in a timely manner.




F.
Dividends and Paying Agents




Not applicable.




G.
Statements by Experts





Not applicable.




H.
Documents on Display





The documents concerning our company referred to in this document and required to be made available to the public are available at the offices of Spreadtrum Shanghai at Spreadtrum Center, Building No. 1 Lane 2288, Zuchongzhi Road, Zhangjiang, Shanghai 201203, People’s Republic of China.




In addition, we previously filed with the SEC our registration statement on Form F-1 (Registration No. 333-143555, as amended) and prospectus under the Securities Act of 1933, with respect to our ordinary shares. We have also filed with the SEC a related registration statement on F-6 (Registration No. 333-143705) to register the ADSs.




We are subject to the periodic reporting and other informational requirements of the Securities Exchange Act of 1934, as amended, or 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 six months after the close of each fiscal year, which is December 31. 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 100 F Street, N.E., Room 1580, Washington, D.C. 20549. The public may obtain information regarding the Washington, D.C. Public Reference Room by calling the Commission at 1-800-SEC-0330. The SEC also maintains a web site 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. 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 officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions contained in Section 16 of the Exchange Act.




81





I.
Subsidiary Information





See “Item 4.C Information on the Company—Organizational Structure” for information about our subsidiaries.




Item  11.
Quantitative and Qualitative Disclosures About Market Risk




Interest Rate Risk. Currently, our exposure to interest rate risk primarily relates to the interest income generated by excess cash invested in demand and time deposits. We have not historically used and do not expect to use in the future any derivative financial instruments to manage our interest risk exposure. Interest-earning instruments carry a degree of interest rate risk, and we expect our future income will change, subject to changes in market interest rate and our cash balance.




Credit Risk. Financial instruments that potentially subject us to concentration of credit risk consist of cash and cash equivalents, restricted cash, term deposit, note receivable and accounts receivable. We deposit our cash and cash equivalents, restricted cash and term deposit with financial institutions located in jurisdictions where the subsidiaries are located. We conduct credit evaluations of customers and generally do not require collateral or other security from our customers. We establish an allowance for doubtful accounts primarily based on the age of the receivables and factors surrounding the credit risk of specific customers. Substantially all revenue was derived from customers located in China, including Hong Kong and Macau.





Foreign Exchange Risk. The value of the RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in China’s political and economic conditions. The conversion of RMB into foreign currencies, including U.S. dollars, has been based on rates set by the People’s Bank of China. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the RMB to the U.S. dollar. Under this new policy, the RMB is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. While the international reaction to the RMB revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a further and more significant appreciation of the RMB against the U.S. dollar. Although a majority of our revenue and payments are denominated in U.S. dollars, a large portion of our revenue and payments are denominated in RMB. We use the U.S. dollar as the reporting currency for our financial statements. Fluctuations in exchange rates, primarily those involving the U.S. dollar, may affect our costs and operating margins as well as our net income reported in U.S. dollars. For example, to the extent that we need to convert U.S. dollars we receive into RMB for our operations, appreciation of the RMB against the U.S. dollar would have an adverse effect on the RMB amount we receive from the conversion. Conversely, if we decide to convert our RMB into U.S. dollars for the purpose of making payments for dividends on our ordinary shares or ADSs or for other business purposes, appreciation of the U.S. dollar against the RMB would have a negative effect on the U.S. dollar amount available to us. We have not used any forward contracts or currency borrowings to hedge our exposure to foreign currency exchange risk.





Item 12.
Description of Securities Other Than Equity Securities




Fees and Charges Our ADS Holders May Have to Pay




Under the terms of the deposit agreement for our American Depositary Shares (ADSs), an ADS holder may have to pay the following services fees to Citibank, N.A., our depositary bank:




•
Issuance of ADSs: $5.00 (or less) per 100 ADSs (or portion of 100 ADSs) issued




•
Cancellation of ADSs: $5.00 (or less) per 100 ADSs (or portion of 100 ADSs) canceled




•
Distribution of cash dividends or other cash distributions (i.e., sale of rights and other entitlements): $5.00 (or less) per 100 ADSs (or portion of 100 ADSs) held




•
Distribution of ADSs pursuant to stock dividends, free stock distributions or exercises of rights: $5.00 (or less) per 100 ADSs (or portion of 100 ADSs) issued




•
Distribution of securities other than ADSs or rights to purchase additional ADSs: $5.00 (or less) per 100 ADSs (or portion of 100 ADSs) issued




•
Depositary Services: $5.00 (or less) per 100 ADSs (or portion of 100 ADSs) held on the applicable record date(s) established by the depositary, charged on an annual basis.




The depositary fees payable for cash distributions are generally deducted from the cash being distributed.




An ADS holder will also be responsible to pay certain fees and expenses incurred by the depositary bank and certain taxes and governmental charges such as:




•
taxes (including applicable interest and penalties) and other governmental charges;




•
such registration fees as may from time to time be in effect for the registration of shares or other deposited securities on the share register and applicable to transfers of shares or other deposited securities to or from the name of the custodian, the depositary or any nominees upon the making of deposits and withdrawals, respectively;




82




•
such cable, telex and facsimile transmission and delivery expenses as are expressly provided in the deposit agreement;




•
the expenses and charges incurred by the depositary in the conversion of foreign currency;




•
such fees and expenses as are incurred by the depositary in connection with compliance with exchange control regulations and other regulatory requirements applicable to shares, deposited securities, ADSs and ADRs; and




•
the fees and expenses incurred by the depositary, the custodian, or any nominee in connection with the servicing or delivery of deposited securities.




Fees and Payments from the Depositary to Us




In 2010, we received from our depositary a reimbursement of $542,752 for our expenses incurred in connection with the advancement of our ADR and investor relations programs, including legal fees, investor relations expenses, shareholder meetings, and other expenses related to our ongoing compliance with NASDAQ and SEC rules and regulations in the amounts of:




•
Reimbursement of legal fees (including DTC feeds): $1,518




•
Reimbursement of settlement infrastructure fees: $3,307




•
Reimbursement of proxy process expenses (printing, postage and distribution): $9,655




•
Contributions towards our investor relations efforts: $528,272





In addition, the depositary waived costs payable by us of $50,000 related to the maintenance of the ADR program, database subscription fees and other services.




The depositary has agreed to reimburse us for our expenses incurred in connection with our ADR and investor relations programs in the future. There are limits on the amount of expenses for which the depositary will reimburse us, but the amount of reimbursement is not related to the amount of fees the depositary collects from ADS holders.




PART II




Item  13.
Defaults, Dividend Arrearages and Delinquencies




Not applicable.




Item  14.
Material Modifications to the Rights of Security Holders and Use of Proceeds




See “Item 10. Additional Information” for a description of the rights of securities holders, which remain unchanged.




We completed our initial public offering of 26,978,100 ordinary shares, in the form of ADSs, at $14.00 per ADS in June 2007, after our ordinary shares and ADRs were registered under the Securities Act. In the initial public offering, we offered 8,000,000 ADSs and certain of our shareholders offered 992,700 ADSs. The aggregate price of the offering amount registered and sold was $125,897,800, of which we received $104,160,000. The effective date of our registration statement on Form F-1 (File number: 333-143555) was June 26, 2007. Morgan Stanley & Co. International plc and Lehman Brothers Inc. were the joint book-running managers of our initial public offering.




The amount of expenses incurred by us in connection with the issuance and distribution of the registered securities in our initial public offering totaled $13.2 million, including $8.8 million for underwriting discounts and commissions and approximately $4.4 million for other expenses. None of the payments were direct or indirect payments to our directors, officers, general partners of our associates, persons owning 10% or more of any class of our shares, or any of our affiliates.




We received net proceeds of $100.2 million from our initial public offering, of which we have used approximately $60.0 million for our acquisition of Spreadtrum USA and approximately $14.9 million for the repurchase of our ADSs, including commissions paid to Morgan Stanley & Co. Incorporated, or Morgan Stanley. We have applied the remainder of net proceeds to working capital.




Item  15.
Controls and Procedures




Disclosure Controls and Procedures




As of December 31, 2010, the end of the period covered by this Annual Report on Form 20-F, management performed, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Disclosure controls and procedures are those controls and procedures designed to provide reasonable assurance that the information required to be disclosed in our Exchange Act filings is (1) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) accumulated and communicated to the management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2010, our disclosure controls and procedures were effective.




83





Management’s Report on Internal Control over Financial Reporting




Management is responsible for establishing and maintaining adequate internal control over financial reporting. 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 generally accepted accounting principles. 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 our management or our Board of Directors; 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 interim or annual consolidated financial statements.




Management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system cannot provide absolute assurance due to its inherent limitations; it is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. A control system also can be circumvented by collusion or improper management override. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of such limitations, disclosure controls and internal control over financial reporting cannot prevent or detect all misstatements, whether unintentional errors or fraud. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, but not eliminate, this risk.




Under the supervision of our Chief Executive Officer and Chief Financial Officer, management conducted an assessment of the effectiveness of our internal control over financial reporting as of December 31, 2010, using the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO.




Based on this assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2010 based on the criteria established in Internal Control — Integrated Framework issued by COSO.




The effectiveness of internal control over financial reporting as of December 31, 2010 has been audited by PricewaterhouseCoopers Zhong Tian CPAs Limited Company, or PwC, our independent registered public accounting firm, as stated in its report on pages F-2 of this Annual Report.




Item  16A.
Audit Committee Financial Expert




The Board of Directors has determined that Carol Yu is an Audit Committee Financial Expert as defined by the applicable rules and regulations of the SEC and is independent under the NASDAQ Marketplace Rules.




Item  16B.
Code of Ethics




Our Code of Business Conduct and Ethics, or Code, summarizes the ethical standards and key policies that guide our business conduct and applies to our directors, executive officers and employees. The purpose of the Code is to promote ethical conduct and deter wrongdoing. The policies outlined in the Code are designed to ensure that our directors, executive officers and employees act in accordance with not only the letter but also the spirit of the laws and regulations that apply to our business. We expect our directors, executive officers and employees to exercise good judgment, to uphold these standards in their day-to-day activities, and to comply with all applicable policies and procedures in the course of their relationship with the company. A copy of our Code is posted on our website at www.spreadtrum.com.




Any amendment to or waivers of the Code for members of our board of directors and our executive officers will be disclosed on our website at www.spreadtrum.com within five business days following the amendment or waiver, and we will also disclose such amendment or waiver on a Form 6-K or Form 20-F. During fiscal year 2010, no amendments to or waivers from the Code were made or given for any of our executive officers.





Item 16C.
Principal Accountant Fees and Services




Fees Billed for Services Rendered by Principal Auditors




PwC, our independent auditors for fiscal year 2010 and 2009, and Deloitte Touche Tohmatsu CPA Ltd., or DTT, our independent auditors for fiscal year 2009, billed us the fees set forth below for services rendered during years ended December 31, 2010 and 2009. The Audit Committee has considered whether, and concluded that, the non-audit services provided by PwC and DTT are compatible with maintaining its independence.




84




An analysis of principal accountant fees and services, for the last two fiscal years, is included below




Accountant Fees and Services





For the year ended December 31,2009


2010(U.S. dollars in thousands)Audit fees(1)

$
1,014


$
834Total fees

$
1,014


$
834




(1)
“Audit fees” means the aggregate fees billed in each of the fiscal years listed for professional services rendered by our principal auditors for the audit of our annual financial statements.





Policies and Procedures




The Audit Committee has adopted a policy and procedures for the approval of audit and non-audit services rendered by our independent auditors, PricewaterhouseCoopers. The policy generally requires the Audit Committee’s approval of the scope of the engagement of our independent auditor on an individual basis. The policy prohibits retention of the independent auditors to perform the prohibited non-audit functions defined in Section 201 of the Sarbanes-Oxley Act of 2002 or the rules of the SEC, and also considers whether proposed services are compatible with the independence of the public auditors. Our Audit Committee has approved 100% of the audit fees, audit-related fees, tax fees and all other fees listed in the table above.




Item  16D.
Exemptions from the Listing Standards for Audit Committees




Not applicable.




Item  16E.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers




In June 2010, we cancelled 1,784,848 ADSs representing 5,354,544 ordinary shares that we had repurchased in 2008.




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 Market, we are subject to NASDAQ’s corporate governance requirements.




NASDAQ Marketplace Rule 5615(a)(3) permits a foreign private issuer like us to follow home country practices in lieu of certain requirements of Rule 5600, provided that such foreign private issuer discloses in its annual report filed with the SEC each requirement of Rule 5600 that it does not follow and describes the home country practice followed in lieu of such requirement.




In February 2009, we implemented an option exchange program, pursuant to which certain of our non-U.S. resident employees exchanged their out-of-money options to purchase our shares under our 2001 Stock Plan for modified options to purchase our shares under our 2007 Equity Incentive Plan. Because our 2001 Stock Plan does not explicitly permit option exchange programs, implementation of such a program constituted a material amendment to the plan under NASDAQ Marketplace Rule 5635(c) and IM-5635-1.




In addition, in June 2009, we increased the number of shares reserved under our 2007 Equity Incentive Plan by 1,432,359 ordinary shares, which also constituted a material amendment to the plan under NASDAQ Marketplace Rule 5635(c) and IM-5635-1.




NASDAQ Marketplace Rule 5635(c) and IM-5635-1 require us to obtain shareholder approval prior to the issuance of securities when a stock option or purchase plan or other equity compensation arrangement is materially amended. We elected to follow our home country practice in lieu of the requirements of such NASDAQ rules. The Cayman Islands Companies Law (2010 Revision) does not require us to obtain shareholder approval prior to the issuance of securities when our equity compensation plans have been materially amended, nor is doing so required under our amended and restated memorandum and articles of association. However, the implementation of our option exchange program and the increase of the number of shares reserved for issuance under the 2007 Equity Incentive Plan were authorized, approved and ratified by our board of directors and our shareholders.




85




PART III




Item  17.
Financial Statements




Please see “Item 18. Financial Statements”.




Item  18.
Financial Statements




The following Spreadtrum Communications, Inc. Consolidated Financial Statements prepared in accordance with U.S. GAAP and attached hereto on pages F-1 to F-36 are herein incorporated by reference:




Reports of Independent Registered Public Accounting Firms


Consolidated Balance Sheets


Consolidated Statements of Operations


Consolidated Statements of Changes in Shareholders’ Equity


Consolidated Statements of Cash Flows


Notes to the Consolidated Financial Statements





86


Item 19.
Exhibits





Exhibit

Number

Description1.1

Memorandum and Articles of Association of the Registrant, as currently in effect (incorporated by reference to Exhibit 3.2 of Form F-1 (File No. 333-143555) filed with the Securities and Exchange Commission on June 6, 2007)2.1

Registrant’s Form of American Depositary Receipt (included in Exhibit 2.3 below)2.2

Registrant’s Form of Certificate for Ordinary Shares (incorporated by reference to Exhibit 4.2 of Form F-1/A (File No. 333-143555) filed with the Securities and Exchange Commission on June 22, 2007)2.3

Form of Deposit Agreement among the Registrant, the depositary and holders and beneficial owners from time to time of American depositary shares issued thereunder (incorporated by reference to the Registration Statement on Form F-6 (File No. 333-143705) filed with the Securities and Exchange Commission on June 13, 2007)2.4

Letter agreement titled Provisional Deposit of Provisional Shares, dated as of May 22, 2008, between the Registrant and Citibank, N.A. (incorporated by reference to Exhibit 2.4 of Form 20-F (File No. 001-33535) filed with the Securities and Exchange Commission on June 30, 2008)2.5

Fourth Amended and Restated Members Agreement, dated as of May 9, 2007, among the Registrant and other parties therein (incorporated by reference to Exhibit 4.4 of Form F-1 (File No. 333-143555) filed with the Securities and Exchange Commission on June 6, 2007)2.6

Amended letter agreement regarding Provisional Deposit of Provisional Shares, dated as of January 22, 2009, among the Registrant, Citibank, N.A. and other parties thereto (incorporated by reference to Exhibit 2.6 of Form 20-F (File No. 001-33535) filed with the Securities and Exchange Commission on June 30, 2009)2.7

Amended letter agreement regarding Provisional Deposit of Provisional Shares, dated as of February 9, 2010, among the Registrant, Citibank, N.A. and other parties thereto(incorporated by reference to Exhibit 2.7 of Form 20-F (File No. 001-33535) filed with the Securities and Exchange Commission on May 7, 2010)4.1

Second Amended and Restated 2001 Stock Plan (incorporated by reference to Exhibit 10.1 of Form F-1 (File No. 333-143555) filed with the Securities and Exchange Commission on June 6, 2007)4.2

2007 Equity Incentive Plan (incorporated by reference to Exhibit 10.2 of Form F-1/A (File No. 333-143555) filed with the Securities and Exchange Commission on June 12, 2007)4.3

Form of Indemnification Agreement with the Registrant’s directors (incorporated by reference to Exhibit 10.3 of Form F-1 (File No. 333-143555) filed with the Securities and Exchange Commission on June 6, 2007)4.4

Form of Employment Agreement between the Registrant and certain of its executive officers (incorporated by reference to Exhibit 10.4 of Form F-1/A (File No. 333-143555) filed with the Securities and Exchange Commission on June 12, 2007)4.5

License Agreement, dated as of September 30, 2001, by and among the Registrant, CEVA Technologies Inc. and CEVA DSP Ltd., as amended (incorporated by reference to Exhibit 10.5 of Form F-1/A (File No. 333-143555) filed with the Securities and Exchange Commission on June 12, 2007)†4.6

Design License Agreement, dated as of October 15, 2001, between the Registrant and ARM Limited, as amended (incorporated by reference to Exhibit 10.6 of Form F-1/A (File No. 333-143555) filed with the Securities and Exchange Commission on June 12, 2007)†4.7

Summary of Shanghai Commercial Building Sale Contract, dated as of December 26, 2006, between Spreadtrum Communications (Shanghai) Co. Ltd. and Spreadtrum (Shanghai) Real Estate Development Co., Ltd. (incorporated by reference to Exhibit 10.7 of Form F-1 (File No. 333-143555) filed with the Securities and Exchange Commission on June 6, 2007)4.8

Summary of Contract for the Transfer of State-owned Land Use Rights, dated January 31, 2007, between Spreadtrum Communications (Shanghai) Co. Ltd. and Shanghai Zhangjiang Semiconductor Industry Park Co., Ltd. (incorporated by reference to Exhibit 10.8 of Form F-1 (File No. 333-143555) filed with the Securities and Exchange Commission on June 6, 2007)4.9

Research and Development Agreement, dated as of December 27, 2006, by and between Spreadtrum Communications (Shanghai) Co. Ltd. and Beijing Spreadtrum Hi-Tech Communications Technology Co. Ltd., as amended (incorporated by reference to Exhibit 10.9 of Form F-1 (File No. 333-143555) filed with the Securities and Exchange Commission on June 6, 2007)


87





Exhibit

Number

Description4.10

Agreement and Plan of Merger, dated as of November 16, 2007, by and among the Registrant, Breeze Acquisition Corporation, Quorum Systems, Inc., Bernard Xavier, Jarrett Malone, Lon Christensen and Enterprise Partners VI, LP as shareholder representative and U.S. Bank, National Association as escrow agent (incorporated by reference to Exhibit 4.10 of Form 20-F (File No. 001-33535) filed with the Securities and Exchange Commission on June 30, 2008)†4.11

Technology Transfer and Technology License Agreement, made on January 22, 2008, by and among InterDigital Communications, LLC, InterDigital Technology Corporation and the Registrant, on behalf of itself and its affiliates(incorporated by reference to Exhibit 4.11 of Form 20-F (File No. 001-33535) filed with the Securities and Exchange Commission on June 30, 2008)†4.12

First Amendment to Technology Transfer and Technology License Agreement and Statement of Work, dated as of April 20, 2009, by and among InterDigital Communications, LLC, InterDigital Technology Corporation and the Registrant, on behalf of itself and its affiliates (incorporated by reference to Exhibit 4.12 of Form 20-F (File No. 001-33535) filed with the Securities and Exchange Commission on June 30, 2009)†4.13

English summary of Mid-Term Working Capital Bank Loan Contract between Shanghai Pudong Development Bank Jinqiao Sub-Branch and Spreadtrum Communications (Shanghai) Co., Ltd., dated April 30, 2009 (incorporated by reference to Exhibit 4.13 of Form 20-F (File No. 001-33535) filed with the Securities and Exchange Commission on June 30, 2009)4.14

Seventh Amendment to License Agreement, dated August 27, 2009, by and between CEVA Technologies Inc. and CEVA DSP Ltd. and the Registrant, on behalf of itself, Spreadtrum Communications USA Inc. and Spreadtrum Communications (Shanghai) Co. Ltd. (incorporated by reference to Exhibit 4.14 of Form 20-F/A (File No. 001-33535) filed with the Securities and Exchange Commission on August 27, 2010)†4.15

English summary of an agreement by and between Spreadtrum Shanghai and Shanghai Zhangjiang Semiconductor Industry Park Co., Ltd. regarding the refunding of the payment made by Spreadtrum Shanghai in connection with the transfer of the land use rights pursuant to certain contract for the Transfer of the State-owned Land Use rights between Shanghai Zhangjiang Semiconductor Industry Park Co., Ltd. and Spreadtrum Shanghai, dated January 2007(incorporated by reference to Exhibit 4.15 of Form 20-F (File No. 001-33535) filed with the Securities and Exchange Commission on May 7, 2010)4.16

English summary of the Contract for the Transfer of State Owned Land Use Rights, dated December 1, 2009, by and among Shanghai Zhangjiang Semiconductor Industry Park Co., Ltd. and Shanghai Zhanxiang Electronics Technology Co., Ltd. (incorporated by reference to Exhibit 4.16 of Form 20-F (File No. 001-33535) filed with the Securities and Exchange Commission on May 7, 2010)4.17

English summary of the Shareholder Agreement, dated as of December 2, 2009, by and among Shanghai Spreadtrum Real Estate Development Co., Ltd., Shanghai Zhangjiang Semiconductor Industry Park Co., Ltd, Shanghai Wingtech Electronics Co., Ltd. and Spreadtrum Communications (Shanghai) Co., Ltd. (incorporated by reference to Exhibit 4.17 of Form 20-F (File No. 001-33535) filed with the Securities and Exchange Commission on May 7, 2010)8.1

List of Subsidiaries*12.1

CEO Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*12.2

CFO Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*13.1

CEO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*13.2

CFO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*15.1

Consent of PricewaterhouseCoopers Zhong Tian CPAs Limited Company*15.2

Consent of Deloitte Touche Tohmatsu CPA Ltd.*16.1

Letter from Deloitte Touche Tohmatsu CPA Ltd. to the Securities and Exchange Commission (incorporated by reference to Exhibit 16.1 of Form 20-F (File No. 001-33535) filed with the Securities and Exchange Commission on May 7, 2010)


*
Filed herewith.


†
Confidential treatment has been requested for portions of this document. The omitted portions of this document have been filed with the Securities and Exchange Commission.





88


SIGNATURE




The registrant hereby certifies that it meets all of 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.





SPREADTRUM COMMUNICATIONS, INC.(Registrant)By:
/s/ Leo LiLeo LiPresident and Chief Executive Officer




Date: April 6, 2011





89


SPREADTRUM COMMUNICATIONS, INC.





INDEX TO CONSOLIDATED FINANCIAL STATEMENTS





PageReport of Independent Registered Public Accounting Firms
F-2 – F-3Consolidated Balance Sheets as of December 31, 2009 and 2010
F-4Consolidated Statements of Operations for the years ended December 31, 2008, 2009 and 2010
F-5Consolidated Statements of Shareholders’ Equity and Comprehensive Income (Loss) for the years ended December 31, 2008, 2009 and 2010
F-6Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2009 and 2010
F-7- F-8Notes to Consolidated Financial Statements
F-9 - F-36








Report of Independent Register Public Accounting Firm





To the Board of Directors and Shareholders of


Spreadtrum Communications, Inc.:





In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of shareholders’ equity and comprehensive income (loss), and of cash flows present fairly, in all material respects, the financial position of Spreadtrum Communications Inc. (the “Company”) and its subsidiaries at December 31, 2009 and 2010, and the results of their operations and their cash flows for the years ended December 31, 2009 and 2010 in conformity with accounting principles generally accepted in United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 15. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.





A company’s 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 generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) 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 (iii) 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 its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.





/s/ PricewaterhouseCoopers Zhong Tian CPAs Limited Company





Shanghai, the People’s Republic of China





April 6, 2011




F-2


Report of Independent Registered Public Accounting Firm





To the Board of Directors and Shareholders of


Spreadtrum Communications, Inc.:





We have audited the accompanying consolidated statements of operations, shareholders' equity and comprehensive income (loss), and cash flows of Spreadtrum Communications, Inc., its subsidiaries, and its variable interest entity (collectively the “Company”) for the year ended December 31, 2008. 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 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 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 audit provides a reasonable basis for our opinion.




In our opinion, such consolidated financial statements present fairly, in all material respects, the results of operations and cash flows of Spreadtrum Communications, Inc., its subsidiaries, and its variable interest entity for the year ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.





/s/ Deloitte Touche Tohmatsu CPA Ltd.





Shanghai, China





June 30, 2009





F-3


SPREADTRUM COMMUNICATIONS, INC.


CONSOLIDATED BALANCE SHEETS


(Expressed In U.S. dollars unless otherwise stated)





December 31Note


2009


2010ASSETSCurrent assetsCash and cash equivalents




$
37,809,364


$
81,185,639Restricted cash





11,495,588



20,496,230Short-term deposit





20,503,207



125,340,724Note receivable





1,383,343



—Accounts receivable, net of allowance for doubtful accounts of $1,016,101 and nil, respectively as of December 31, 2009 and 2010





7,008,297



6,073,855Inventories

4



25,541,268



133,096,138Deferred tax assets

16



1,346,985



1,669,670Prepayment, other receivables and other current assets, net of allowance of $1,611,000 for the other receivable from the 3rd party of $1,673,677 as of December 31, 2009 and 2010

5



5,562,499



16,957,153Total current assets





110,650,551



384,819,409Property and equipment, net

6



27,090,012



28,597,363Acquired intangible assets, net

8



26,620,989



36,447,954Long-term investments

9



1,000,614



9,467,299Deferred tax assets

16



569,745



794,138Long-term deposit





43,935,444



45,298,746Goodwill

10



2,000,000



2,000,000Other long-term assets

11



7,226,571



792,466Total assets




$
219,093,926


$
508,217,375LIABILITIES AND SHAREHOLDERS’ EQUITYCurrent liabilitiesAccounts payable




$
19,498,093


$
103,110,448Advances from customers





14,667,459



103,068,451Accrued expenses and other current liabilities

14



17,887,158



39,647,375Income tax payable





3,071,350



13,026,333Total current liabilities





55,124,060



258,852,607Long-term loan

12



43,935,444



45,298,746Other long-term obligations

13



5,463,373



5,482,804Total liabilities





104,522,877



309,634,157Commitments and contingencies

22Shareholders’ equityOrdinary shares, $0.0001 par value, 550,000,000 shares authorized, 138,091,420 and 144,819,613 shares issued and outstanding as of December 31, 2009 and 2010, respectively





13,809



14,482Additional paid-in capital





214,063,782



228,924,701Statutory reserve





1,069,848



7,230,475Accumulated other comprehensive income





2,688,700



4,644,839Accumulated deficit





(103,265,090
)


(42,231,279
)Total shareholders’ equity





114,571,049



198,583,218TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY




$
219,093,926


$
508,217,375




The accompanying notes are an integrated part of the consolidated financial statements.




F-4


SPREADTRUM COMMUNICATIONS, INC.


CONSOLIDATED STATEMENTS OF OPERATIONS


(Expressed In U.S. dollars unless otherwise stated)





Year ended December 312008


2009


2010Revenue

$
109,936,941


$
105,069,690


$
346,338,742Cost of revenue


68,033,246



66,876,249



193,873,323Gross profit


41,903,695



38,193,441



152,465,419Operating expensesResearch and development


42,876,901



37,039,253



58,686,993Selling, general and administrative


21,997,292



20,538,521



20,188,234In-process research and development (IPR&D) expensed per Spreadtrum USA acquisition


6,612,000



—



—Impairment loss of goodwill


32,344,959



—



—Impairment loss of long-lived assets


17,984,494



—



4,486,474Provision for loss commitment


3,013,000



—



—Total operating expenses


124,828,646



57,577,774



83,361,701Income (loss) from operations


(82,924,951
)


(19,384,333
)


69,103,718Other income (expenses)Interest income


2,348,419



1,553,114



3,600,898Interest expense


(230,805
)


(1,172,516
)


(1,145,432
)Other income, net


2,330,200



711,959



3,764,849Total other income


4,447,814



1,092,557



6,220,315Income (loss) before income taxes


(78,477,137
)


(18,291,776
)


75,324,033Income tax expense


201,013



1,024,693



8,129,595Net income (loss)

$
(78,678,150
)

$
(19,316,469
)

$
67,194,438Income (loss) per share – basis

$
(0.60
)

$
(0.14
)

$
0.47Income (loss) per share – diluted

$
(0.60
)

$
(0.14
)

$
0.43Shares used in calculating income (loss) per shareBasic


131,510,359



134,431,135



141,739,261Diluted


131,510,359



134,431,135



157,342,529




The accompanying notes are an integrated part of the consolidated financial statements.





F-5


SPREADTRUM COMMUNICATIONS, INC.


CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)


(Expressed In U.S. dollars unless otherwise stated)




Ordinary shares


Additional

paid-in


Statutory


Accumulated

other

comprehensive


Accumulated


Total

shareholders’


ComprehensiveShares


Amount


capital


reserve fund


income


Deficit


equity


income (loss)Balance at December 31, 2007


126,914,512


$
12,691


$
191,463,691



—


$
619,775


$
(4,200,623
)

$
187,895,534Issuance of ordinary shares upon exercise of options and vesting of restricted share units


6,597,047



660



4,231,806



—



—



—



4,232,466Repurchase of ordinary shares by the Company


(5,354,544
)


(535
)


(14,890,840
)


—



—



—



(14,891,375
)Issuance of ordinary shares as acquisition for Spreadtrum USA


3,822,199



382



12,459,987



—



—



—



12,460,369Appropriation to statutory reserve funds


—



—



—



860,219



—



(860,219
)


—Share-based compensation


—



—



8,348,207



—



—



—



8,348,207Foreign currency translation


—



—



—



—



2,049,789



—



2,049,789



2,049,789Net loss


—



—



—



—



—



(78,678,150
)


(78,678,150
)


(78,678,150
)Balance at December 31, 2008


131,979,214



13,198



201,612,851



86,0219



2,669,564



(83,738,992
)


121,416,840



(76,628,361
)Issuance of ordinary shares upon exercise of options and vesting of restricted share units


6,112,206



611



2,752,192



—



—



—



2,752,803Share-based compensation


—



—



9,698,739



—



—



—



9,698,739Appropriation to statutory reserve funds


—



—



—



209,629



—



(209,629
)


—Foreign currency translation


—



—



—



—



19,136



—



19,136



19,136Net loss


—



—



—



—



—



(19,316,469
)


(19,316,469
)


(19,316,469
)Balance at December 31, 2009


138,091,420



13,809



214,063,782



1,069,848



2,688,700



(103,265,090
)


114,571,049



(19,297,333
)Issuance of ordinary shares upon exercise of options and vesting of restricted share units


6,728,193



673



4,575,358



—



—



—



4,576,031Share-based compensation


—



—



10,285,561



—



—



—



10,285,561Appropriation to statutory reserve funds


—



—



—



6,160,627



—



(6,160,627
)


—Foreign currency translation


—



—



—



—



1,956,139



—



1,956,139



1,956,139Net income


—



—



—



—



—



67,194,438



67,194,438



67,194,438Balance at December 31, 2010


144,819,613


$
14,482


$
228,924,701


$
7,230,475


$
4,644,839


$
(42,231,279
)

$
198,583,218


$
69,150,577





The accompanying notes are an integrated part of the consolidated financial statements.




F-6


SPREADTRUM COMMUNICATIONS, INC.


CONSOLIDATED STATEMENTS OF CASH FLOWS


(Expressed In U.S. dollars unless otherwise stated)


Year ended December 31,Note


2008


2009


2010CASH FLOW FROM OPERATING ACTIVITIESNet income (loss)




$
(78,678,150
)

$
(19,316,469
)

$
67,194,438Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:Loss from disposal of property and equipment





128,314



308,275



42,153Allowance for doubtful accounts and other receivables





2,789,892



—



—Inventory write-down

4



9,052,893



5,432,673



1,918,214Depreciation and amortization





9,947,509



7,908,571



10,466,170IPR&D expensed per Spreadtrum USA acquisition

3



6,612,000



—



—Share-based compensation

18



8,348,207



9,698,739



10,285,561Loss from equity investment





6,536



22,033



114,560Deferred income taxes





(414,017
)


83,011



(500,015
)Impairment loss of long-lived assets





17,984,494



—



4,486,474Impairment loss of goodwill





32,344,959



—



—Provision for loss commitment





3,013,000



—



—Changes in operating assets and liabilities, net off acquisitionAccounts receivable





(9,068,264
)


1,760,874



2,538,913Inventories





2,374,962



(17,158,015
)


(108,686,598
)Prepayment, other receivables and other current assets





(2,883,815
)


2,210,729



(13,493,771
)Accounts payable





(14,199,778
)


6,032,345



73,285,809Advances from customers





(907,039
)


14,355,732



88,046,631Project cancellation penalty related to Spreadtrum USA acquisition – increase (decrease) in accrued expenses

3



—



1,000,000



(1,000,000
)Accrued expenses and other liabilities





(5,231,311
)


7,207,443



21,531,228Income tax payable





(193,660
)


177,256



9,954,647Net cash provided (used in) by operating activities





(18,973,268
)


19,723,197



166,184,414CASH FLOW FROM INVESTING ACTIVITIESAcquisition of property and equipment





(6,814,589
)


(4,008,788
)


(5,748,133
)Acquisition of intangible assets





(3,220,504
)


(5,701,987
)


(9,865,291
)Acquisition of Spreadtrum USA, net of cash acquired

3



(53,730,433
)


(1,996,453
)


—Increase in restricted cash





—



(11,495,588
)


(7,991,240
)Net increase in term deposit





(5,190,370
)


(59,243,886
)


(104,201,311
)Acquisition of equity investment

9(b)



(736,250
)


(292,933
)


(9,328,540
)Proceeds from disposal of equity investment





—



—



747,295Refund of deposit for land use rights (recorded under other long-term assets)

9(b)



—



—



6,802,876Net cash used in investing activities





(69,692,146
)


(82,739,635
)


(129,584,344
)





F-7


SPREADTRUM COMMUNICATIONS, INC.


CONSOLIDATED STATEMENTS OF CASH FLOWS


(Expressed In U.S. dollars unless otherwise stated)





Year ended December 31,2008


2009


2010CASH FLOW FROM FINANCING ACTIVITIESBorrowings from debt

$
—


$
43,935,444


$
—Repayment of debt


(731,571
)


(3,661,287
)


—Proceeds from issuance of shares upon exercise of stock options


4,232,466



2,752,803



4,576,031Share repurchase


(14,891,375
)


—



—Net cash provided by (used in) financing activities


(11,390,480
)


43,026,960



4,576,031Effect of exchange rate changes


779,832



37,218



2,200,173NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS


(99,276,062
)


(19,952,260
)


43,376,275CASH AND CASH EQUIVALENTS - Beginning of year


157,037,686



57,761,624



37,809,364CASH AND CASH EQUIVALENTS - End of year

$
57,761,624


$
37,809,364


$
81,185,639SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATIONCash paid for interests of loan, net of subsidy received

$
—


$
816,467


$
841,674Cash paid for income taxes

$
807,923


$
817,161


$
—NON-CASH INVESTING AND FINANCING ACTIVITIESLong-term assets applied to acquisition of building

$
(2,388,857
)

$
—


$
—Accounts payable for acquisition of property and equipment

$
(634,455
)

$
(935,488
)

$
149,822Accounts payable for acquisition of intangible assets

$
(2,492,379
)

$
(4,779,775
)

$
15,473,458Other long-term obligations for acquisition of property and equipment

$
(469,206
)

$
(272,152
)


—Other long-term obligations for acquisition of intangible assets

$
(564,357
)

$
(5,191,224
)

$
5,482,804SPREADTRUM USA ACQUISITIONCash consideration (including purchase price adjustment)

$
57,457,128


$
—


$
—Additional consideration due to earn-out arrangement


—



2,000,000



—Fair value of ordinary shares issued


12,460,369



—



—Direct expenses related to the acquisition


808,911



—



—Assets acquired (including intangible assets of $28,695,000 in 2008)

$
70,726,408


$
2,000,000


$
—Purchase consideration settled in cash, and direct expenses related to the acquisition

$
58,266,039


$
1,996,453


$
—Less: cash and cash equivalents acquired


(4,535,606
)


—



—Investing cash outflow for acquisition of Spreadtrum USA

$
53,730,433


$
1,996,453


$
—




The accompanying notes are an integrated part of the consolidated financial statements.





F-8


SPREADTRUM COMMUNICATIONS, INC.




NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED DECEMBER 31, 2008, 2009 and 2010


(Amount expressed in U.S. dollars unless otherwise stated)




1. DESCRIPTION OF BUSINESS




Spreadtrum Communications, Inc. (“Holding”) is incorporated in the Cayman Islands, British West Indies. On June 27, 2007, Holding became listed on NASDAQ in the United States under the market symbol of “SPRD”.




Holding, its subsidiaries and its variable interest entity (“VIE”) (hereafter collectively referred to as the “Company”) is a fabless semiconductor company that designs, develops and markets baseband and radio frequency (“RF”) processor solutions for the wireless communications market. The Company combines its semiconductor design expertise with its software development capabilities to deliver highly-integrated baseband processors with multimedia functionality and power management. The Company has developed its solutions based on an open development platform, enabling its customers to develop customized wireless products that are feature-rich to meet their cost and time-to-market requirements.




Holding’s primary subsidiaries and VIE as of December 31, 2010 included the following:





Name of subsidiary/VIE

Place of

incorporation

Date of

incorporation/

acquisition

Percentage

of ownershipSubsidiaries:Spreadtrum Communications (Shanghai) Co., Ltd. (“Spreadtrum Shanghai”)

The People’s Republic of China (the “PRC”)

July 18, 2001

100%Spreadtrum Communications Technology Co., Ltd. (formerly known as Spreadtrum International Trading (Shanghai) Co., Ltd.) (“Shanghai Technology”)

PRC

November 16, 2005

100%Spreadtrum Communications USA Inc. (formerly known as Quorum System Inc.) (“Spreadtrum USA”)

US

January 15, 2008

100%Shanghai Han & Qin Investment Co., Ltd (“Han & Qin Shanghai”)

PRC

September 5, 2008

100%Spreadtrum Communications (Tianjin) Co., Ltd. (“Spreadtrum Tianjin”)

PRC

December 9, 2010

100%Spreadtrum Communications (Chongqing) Co., Ltd. (“Spreadtrum Chongqing”)

PRC

December 31, 2010

100%VIE:Beijing Spreadtrum Hi-Tech Communications Technology Co., Ltd (“Spreadtrum Beijing”)

PRC

March 30, 2005

37.9% equity interests held by Spreadtrum Shanghai





Spreadtrum Beijing, a PRC domestic company, was established to perform research and development activities on behalf of Spreadtrum Shanghai and qualify for government research grants that are restricted to PRC domestic companies. Spreadtrum Beijing was formed in March 2005 under the names of three PRC nationals who are family members of the Company’s co-founders. In May 2005, the Company entered into a loan agreement with the three PRC nationals who are nominee shareholders of Spreadtrum Beijing, pursuant to which the Company provided them with a loan in an aggregate principal amount of $1.0 million solely for the establishment of Spreadtrum Beijing. Spreadtrum Shanghai also entered into a research and development agreement with Spreadtrum Beijing, pursuant to which Spreadtrum Beijing would perform research and development work for Spreadtrum Shanghai and the work products would be owned exclusively by Spreadtrum Shanghai. In return, Spreadtrum Shanghai reimburses Spreadtrum Beijing for all necessary and reasonable direct and indirect costs incurred for the research and development work. Because of these contractual arrangements, the relationships between the nominee shareholders of Spreadtrum Beijing and the Company’s co-founders, and the fact that one of the members of the Company’s management is the legal representative of Spreadtrum Beijing, the Company has the power to direct Spreadtrum Beijing’s operational and financial affairs, appoint its senior executives, and approve all matters requiring shareholder approval. As a result, Spreadtrum Beijing is deemed a variable interest entity and the Company is the primary beneficiary. Accordingly, the Company consolidates the financial statements of Spreadtrum Beijing since its inception.




F-9





In May 2008, Spreadtrum Shanghai injected RMB 5 million (approximately $0.7 million) into Spreadtrum Beijing to increase its registered capital for the purpose of reducing its debt-to-equity ratio to a level that would enable it to qualify for certain government research grants available to PRC domestic companies. Consequently, Spreadtrum Shanghai now owns approximately 37.9% of the equity interest in Spreadtrum Beijing, and the three PRC national nominee shareholders, each of them, owns approximately 20.7% or, on an aggregative basis, 62.1%, of the equity interest in Spreadtrum Beijing. The transfer of ownership interests to Spreadtrum Shanghai from the three PRC national shareholders was determined to have no impact on the VIE analysis because the three PRC national shareholders are nominees, therefore do not share the Company’s risks and rewards.




In June 2009, the FASB issued FAS 167: Amendments to FASB Interpretation No. 46(R), codified primarily in the Consolidation Topic of the FASB ASC 810. This guidance modifies the method for determining whether an entity is a variable interest entity as well as the methods permitted for determining the primary beneficiary of a variable interest entity. In addition, this guidance requires ongoing reassessments of whether a company is the primary beneficiary of a variable interest entity and enhanced disclosures related to a company’s involvement with a variable interest entity. The Company adopted this guidance on January 1, 2010. In accordance with the new guidance, the Company is deemed to have a controlling financial interest and is the primary beneficiary of the VIEs as it has both the power to direct the activities of the VIE that most significantly impact the VIE's economic performance and an obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. As a result, the Company continued to consolidate the same VIE that was consolidated prior to January 1, 2010 and the adoption did not have any impact on the Company’s consolidated financial statements.




Pursuant to the contractual arrangements with the VIE, the Company has the power to direct activities of the VIE, and can have assets transferred freely out of the VIE without any restrictions. Therefore, the Company considers that there is no asset of the VIE that can be used to settle obligations of the VIE only, except for registered capital of the VIE amounting to approximately $1.7 million as of December 31, 2010. As the consolidated VIE was incorporated as a limited liability company under the PRC Company Law, creditors of the VIE do not have recourse to the general credit of the Company for any of the liabilities of the consolidated VIE, which amounted to, in aggregate, approximately $55,000 as of December 31, 2010. Currently there is no contractual arrangement that could require the Company to provide additional financial support to the VIE. In the future, the Company might provide such support on a discretionary basis.




The following balance sheet amounts of Spreadtrum Beijing were included in the Company’s consolidated balance sheets as of December 31, 2009 and 2010:





December 31,2009


2010Total assets

$
1,478,226


$
1,277,581Total liabilities

$
740,123


$
417,902





2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES




(a) Basis of presentation




The consolidated financial statements of the Company are prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”).




(b) Principles of consolidation




The consolidated financial statements include the accounts of Holding, its wholly-owned subsidiaries and its consolidated VIE. All significant inter-company transactions and balances have been eliminated upon consolidation.




(c) Use of estimates




The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ materially from such estimates. Significant accounting estimates reflected in the Company’s consolidated financial statements include inventory valuation, useful lives of fixed assets and acquired intangible assets, valuation allowance on deferred tax assets, bad debt provision, accruals for warranty and estimated loss from pending litigations, assumptions used in purchase price allocation, assumptions used to measure impairment of goodwill and long-lived assets, assumptions related to the valuation of share-based compensation and related forfeiture rates.




F-10




(d) Concentration of credit risk




Financial instruments that potentially subject the Company to concentration of credit risk consist of cash and cash equivalents, restricted cash, term deposit, note receivable and accounts receivable. The Company deposits its cash and cash equivalents, restricted cash and term deposit with financial institutions located in jurisdictions where the subsidiaries are located. The Company conducts credit evaluations of customers and generally does not require collateral or other security from its customers. The Company establishes an allowance for doubtful accounts primarily based on the age of the receivables and factors surrounding the credit risk of specific customers. Substantially all revenue was derived from customers located in China, including Hong Kong and Macau.




The following table summarizes note receivable, accounts receivable and revenue from customers which accounted for 10% or more of the note receivable, accounts receivable and/or revenue.




Note receivable

December 312009


2010Customer A


100.0
%


—





Accounts receivable

December 31,2009


2010Customer A


*



29.4
%Customer B


—



29.1
%Customer C


18.1
%


27.4
%Customer D


15.0
%


—Customer E


43.3
%


—Customer F


21.3
%


—





RevenueYear ended December 31,2008


2009


2010Customer D


*



27.1
%


23.0
%Customer E


28.5
%


15.6
%


14.8
%Customer F


*



*



10.2
%Customer G


30.6
%


14.0
%


*Customer H


*



*



11.6
%




*
Less than 10% in the year.




F-11




(e) Cash and cash equivalents




Cash and cash equivalents are cash on demand, and time deposits and highly-liquid investments with original maturities of three months or less.




(f) Restricted cash




The Company’s restricted cash represents certain cash deposits, the usage of which are limited within specified projects.




(g) Term deposit




Term deposit consists of bank deposits with an original maturity of over three months.




Term deposit with an original maturity of over three months but less than a year is classified as short-term deposit and term deposit with an original maturity of more than a year is classified as long-term deposit.





(h) Accounts Receivable and Note Receivables




Accounts receivable are recorded at the invoiced amount and do not bear interest. We make specific bad debt provisions based on (i) our specific assessment of the collectability of all significant accounts; and (ii) any specific knowledge we have acquired that might indicate that an account is uncollectible. The facts and circumstances of each account may require us to use substantial judgment in assessing its collectability.




Notes receivables are the bank acceptance notes in the normal course of business. Notes are typically non-interest bearing and have maturities of less than six months. The Company uses the allowance method to account for uncollectable amounts. There were no allowance provided for the year of 2009 and 2010.




(i) Inventories




Inventories are stated at the lower of cost (weighted average) or market. Cost is comprised of direct material and where applicable, direct labor costs and overhead incurred in bringing the inventories to their present location and condition.




The Company estimates excess and slow moving inventory based upon assumptions of future demands and market conditions. If actual market conditions are less favorable than projected by management, additional inventory write-downs may be required.




Deferred costs consist of product shipped to the customer where the rights and obligations of ownership have passed to the customer, but revenue has not yet been recognized. All deferred costs are stated at cost. The Company periodically assesses the recoverability of deferred costs and provides reserves against deferred cost balances when recovery of deferred costs is not probable. The amount of deferred costs is included in the inventories (refer to Note 4 for details). Recoverability is evaluated based on various factors including the viability of payment and status of customer acceptance.




F-12




(j) Property and equipment




Property and equipment are stated at cost less the accumulated depreciation and amortization, and are depreciated using the straight-line method over the following estimated useful lives:





Buildings

30 yearsBuilding improvements

10 yearsMachinery and equipment

5 yearsOffice furniture, equipment and vehicles

5-7 yearsComputer equipment and software

3-5 yearsLeasehold improvements

shorter of lease terms or expected useful life




Costs incurred in constructing new facilities, including capitalized interest and other costs relating to the construction are capitalized and transferred to property, plant and equipment on completion, at which time depreciation commences.





(k) Acquired intangible assets




Acquired intangible assets consist of software licenses and technology and intangible assets acquired through business acquisition (Note 3). Software license and technology are amortized using the straight-line method over their estimated useful life of two to fifteen years and intangible assets acquired through business acquisition are amortized over 15 years.




(l) Impairment of long-lived assets




The Company assesses the impairment of long-lived assets when events or changes in circumstances indicate that the carrying amount of an asset may no longer be recoverable. The Company measures impairment by comparing the carrying value of the long-lived assets to the estimated undiscounted future cash flows expected to result from the use of the assets and their eventual disposition. If the sum of the estimated undiscounted future cash flow is less than the carrying amount of the assets, the Company recognizes an impairment loss equal to the excess of the carrying value over the fair value of the assets. The determination of fair value of the intangible and long-lived assets acquired involves certain judgments and estimates. These judgments can include, but are not limited to, the cash flows that an asset is expected to generate in the future. This analysis also relies on a number of factors, including changes in strategic direction, business plans, regulatory developments, economic and budget projections, technological improvements, and operating results. Any write-downs would be treated as permanent reductions in the carrying amounts of the assets and an operating loss would be recognized.




The Company recognized impairment losses of $17.4 million (Note 8), $56,045 (Note 6) and $0.5 million (Note 8) on acquired intangible assets, property and equipment and other long-lived assets, respectively, in 2008. There was no impairment charge recognized for year ended December 31, 2009. The Company recognized impairment loss of $4.5 million (Note 8) on acquired intangible assets in 2010.




(m) Business combinations




For acquisitions made before December 31, 2008, the acquired assets and liabilities are recorded at their fair value at the date of acquisition. Any excess of acquisition cost over the fair value of the acquired assets and liabilities, including identifiable intangible assets, is recorded as goodwill. Acquisition of Spreadtrum USA (Note 3) was accounted for using such method.




F-13




On January 1, 2009, the Company adopted ASC 805 (formerly referred to as SFAS No. 141 (revised 2007), “Business combinations”). Following the adoption, the consideration transferred in a business combination is measured at fair value, which is calculated as the sum of the acquisition-date fair values of the assets transferred by the acquirer, liabilities incurred by the acquirer to former owners of the acquiree, and equity instruments issued by acquirer. The costs directly attributable to the acquisition are expensed as incurred. Identifiable assets, liabilities and contingent liabilities acquired or assumed are measured separately at their fair value as of the acquisition date, irrespective of the extent of any noncontrolling interests. The excess of (i) the total of cost of acquisition, fair value of the non controlling interests and acquisition date fair value of any previously held equity interest in the acquiree over (ii) the fair value of the identifiable net assets of the acquiree is recorded as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is recognized directly in the income statement.





The determination and allocation of fair values to the identifiable assets acquired and liabilities assumed is based on various assumptions and valuation methodologies requiring considerable management judgment. The most significant variables in these valuations are discount rates, terminal values, the number of years on which to base the cash flow projections, as well as the assumptions and estimates used to determine the cash inflows and outflows. Management determines discount rates to be used based on the risk inherent in the related activity’s current business model and industry comparisons. Terminal values are based on the expected life of products and forecasted life cycle and forecasted cash flows over that period.




(n) Impairment of goodwill




The Company completes a two-step goodwill impairment test on an annual basis, or more frequently when events or change in circumstances indicate that it might be impaired. The first step compares the fair value of each reporting unit to its carrying amount, including goodwill. If the fair value of each reporting unit exceeds its carrying amount, goodwill is not considered to be impaired and the second step will not be required. If the carrying amount of a reporting unit exceeds its fair value, the second step compares the implied fair value of goodwill to the carrying value of a reporting unit’s goodwill. The fair value of each reporting unit is estimated using the expected present value of future cash flows. The implied fair value of goodwill is determined in a manner similar to accounting for a business combination with the allocation of the assessed fair value determined in the first step to the assets and liabilities of the reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to the assets and liabilities is the implied fair value of goodwill. An impairment loss is recognized for any excess in the carrying value of goodwill over the implied fair value of goodwill.




The Company recognized impairment loss on goodwill of $32,344,959 in 2008 (Note 10). No impairment loss was recognized in 2009 and 2010.




(o) Revenue recognition




Revenue is generated from the sale of products, including baseband semiconductors and radio frequency transceivers, and the rendering of engineering services, including design services according to customer’s specification, product prototyping, testing services, training and support services.





The Company recognizes revenue from sales of products, including primarily baseband semiconductors and radio frequency transceivers, when persuasive evidence of an arrangement exists, the sales price is fixed and determinable, delivery has occurred and collectability is reasonably assured. To evidence an arrangement, the Company (i) enters into a master agreement with its customers, which specifies general terms and conditions, or (ii) obtains purchase orders, which specify the key terms of individual orders, such as quantity and price. Most of the Company’s arrangements do not include rights of return, price protection or other similar privileges. Accordingly, the Company records revenue when products are delivered to and accepted by the customers as there are no future remaining obligations. Delivery occurs when title and risk of loss transfer to customers, which is generally at the customers’ designated location.




Certain contracts have specified acceptance provisions (quality inspection) and for such contracts the Company defers the revenue recognition until the acceptance is obtained. In the event that no acceptance note or denial note is received, revenue and cost of sales are recognized when the contractual quality inspection period expires. Any payments received prior to revenue recognition are recorded as advance from customers.




The Company grants rebate to certain customers depending on the volume of business the customers bring in. The rebates granted are either goods rebate of cash rebate. Goods rebate is “free” products offered to customers and is recorded as cost of sales when revenue is recognized. Cash rebate is recorded as a reduction of revenue when being granted to customers and revenue is recognized. The Company recognizes revenue from service contracts upon completion of all services in view of the short-term nature of such arrangements (generally one to three months). Such contracts were insignificant for all periods presented.




F-14




(p) Government subsidies




Government subsidies related to expense items are recognized as a reduction of the relevant expense in the same period as those expenses are incurred.  Government subsidies related to depreciable assets are recognized as a reduction to the carrying value of the related assets.  Government subsidies are originally recorded as liabilities when received and then are recognized as reduction of expense or asset when the Company has complied with the conditions attached to the subsidies and collection of payment is probable.




(q) Shipping and handling costs




Shipping and handling costs relating to sales of $132,129, $46,364 and $133,471 were included in selling expenses for the years ended December 31, 2008, 2009 and 2010, respectively. Shipping and handling costs relating to inventory purchases of $306,928, $239,607 and $745,404 were included as a component of cost of revenue for the years ended December 31, 2008, 2009 and 2010, respectively.




(r) Research and development costs




Research and development cost are expensed as incurred.




(s) Software development costs




The Company accounts for internally generated software development costs in accordance with ASC 350. Capitalization of eligible software development costs begin upon the establishment of technological feasibility and ends when the software is available for internal use. To date, the period between achieving technological feasibility which the Company has defined as establishment of a working model and the general availability of such software is generally very short. Accordingly, the Company has not capitalized any internally generated software development costs and such costs are insignificant.





(t) Warranty




In general, the Company offers a one-year warranty on all of its products. The Company accrues the estimated cost of product warranty at the time revenue is recognized, and adjusts the warranty accrual periodically based on historical experience and expected warranty claims. Although the Company engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of component suppliers, the warranty obligation is affected by actual warranty costs, including but not limited to usage of material and labor and service delivery costs incurred in connection with a product failure.




(u) Share-based compensation




The Company adopted ASC 718, using the modified prospective basis in accounting for share-based compensation. The Company recognizes the services received in exchange for awards of equity instruments based on the grant-date fair value of the award as determined by the Black-Scholes-Merton option pricing model, net of estimated forfeitures. The estimated compensation cost is recognized ratably over the period the granter is required to provide services per the conditions of the award. See Note18, “Stock Options and Restricted Share Units” for further details.




(v) Income Taxes




Deferred income taxes are recognized for temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, net operating loss carry forwards and credits by applying enacted statutory tax rates applicable to future years. A valuation allowance is recorded to reduce deferred tax assets when it is more likely than not that the deferred tax assets will not be realized. Current income taxes are provided for in accordance with the laws of the relevant taxing authorities. The components of the deferred tax assets and liabilities are individually classified as current and non-current based on the characteristics of the underlying assets and liabilities, or the expected timing of their use when they do not relate to a specific asset or liability.




F-15




Effective January 1, 2007, the Company adopted ASC 740-10-25, pursuant to which the Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate resolution. See Note 15 for additional information including the impact of adopting ASC 740-10-25 on the Company’s consolidated financial statements.




(w) Comprehensive Income (Loss)




Comprehensive income (loss) includes net income or loss and foreign currency translation adjustment.





(x) Foreign currency translation and foreign currency risk




The functional currency of Holding and its subsidiaries and VIE, except Spreadtrum Shanghai, Spreadtrum Beijing, Spreadtrum Tianjin, Spreadtrum Chongqing and Han & Qin Shanghai, is the United States dollar (“US dollar”). Spreadtrum Shanghai, Spreadtrum Beijing, Spreadtrum Tianjin, Spreadtrum Chongqing and Han & Qin Shanghai’s functional currency is the Renminbi (“RMB”). Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency at the rates of exchange in effect at the balance sheet date. Transactions in currencies other than the functional currency during the reporting period are converted into the functional currency at the applicable rates of exchange prevailing on the day transactions occurred. Transaction gains and losses are recognized in the consolidated statement of operations.




The Company has chosen the US dollar as the reporting currency. Assets and liabilities are translated at the exchange rates at the balance sheet date, equity accounts are translated at historical exchange rates, and revenues, expenses, gains, and losses are translated using the average exchange rate for the year. Translation gains and losses are accounted for as a separate component of comprehensive income (loss) in the consolidated statements of shareholders’ equity and comprehensive income (loss). The RMB is not a freely convertible currency. The PRC State Administration for Foreign Exchange, under the authority of the PRC government, controls the conversion of RMB into foreign currencies. The value of the RMB is subject to changes in central government policies and to international economic and political developments affecting supply and demand in the China foreign exchange trading system market. The Company’s cash and cash equivalents, restricted cash and term deposit (including short-term deposit and long-term deposit) denominated in RMB amounted to $99,846,037 and $ 246,207,830 as of December 31, 2009 and 2010, respectively.




(y) Fair value measurements




On January 1, 2008, the Company adopted ASC 820, Fair Value Measurements and Disclosures, for financial assets and liabilities and non-financial assets and liabilities measured or disclosed at fair value on a recurring basis. On January 1, 2009, the Company also adopted the statement for all non-financial assets and non-financial liabilities. FASB ASC 820 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions the guidance establishes a three-tier value hierarchy, which prioritizes the inputs used in measuring fair value as follows: (Level 1) observable inputs such as quoted prices (unadjusted) in active markets; (Level 2) inputs other than the quoted prices in active markets that are observable either directly or indirectly, or quoted prices in less active markets; and (Level 3) unobservable inputs with respect to which there is little or no market data, which require the Company to develop its own assumptions. This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. See Note 7, “Fair Value Measurements”, for further details.




(z) Income (loss) per share




Basic income (loss) per share is computed by dividing net income (loss) by the weighted average number of ordinary shares outstanding during the year. Diluted income (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue ordinary shares were exercised or converted into ordinary shares. Ordinary share equivalents are excluded from the computation in periods in which loss is reported as their effects would be anti-dilutive.





(aa) Recently issued accounting standards





In January 2010, the FASB issued an accounting standard update on improving disclosures about fair value measurements. The updated guidance amends existing disclosure requirements by adding required disclosures about items transferring into and out of Levels 1 and 2 in the fair value hierarchy; adding separate disclosures about purchase, sales, issuances, and settlements relative to Level 3 measurements; and clarifying, among other things, the existing fair value disclosures about the level of disaggregation. This update is effective for fiscal years beginning after December 15, 2009, except for the requirement to provide Level 3 activity of purchases, sales, issuances, and settlements on a gross basis, which is effective beginning the first quarter of 2011. The Company currently does not have any assets or liabilities that are measured at fair value on a recurring basis subsequent to initial recognition.




F-16


In April 2010, FASB issued amendments to Topic 718 to clarify that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. The amendments in this update are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. The amendments in this update should be applied by recording a cumulative-effect adjustment to the opening balance of retained earnings. Earlier application is permitted. The Company does not expect any impact from adoption of this update.





In December 2010, FASB issued amendments Topic 350 to modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with the existing guidance and examples in paragraph 350-20-35-30, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. For public entities, the amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. The Company will adopt this accounting standard upon its effective date for periods ending on or after December 15, 2010, and does not anticipate that this adoption will have a significant impact on our financial position or results of operations.





In December 2010, FASB issued revised guidance on the “Disclosure of Supplementary Pro Forma Information for Business Combinations.” The revised guidance specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The revised guidance also expands the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The revised guidance is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The Company has not early adopted the new guidance and is currently evaluating the impact on its consolidated financial statements.





In October 2009, the Financial Accounting Standards Board (“FASB”) issued new guidance on “revenue recognition for arrangements with multiple deliverables and certain revenue arrangements that include software elements”. By providing another alternative for determining the selling price of deliverables, the guidance for arrangements with multiple deliverables will allow companies to allocate consideration in multiple deliverable arrangements in a manner that better reflects the transaction’s economics and will often result in earlier revenue recognition. The new guidance modifies the fair value requirements of previous guidance by allowing “best estimate of selling price” in addition to vendor-specific objective evidence (“VSOE”) and other vendor objective evidence (“VOE,” now referred to as “TPE,” standing for third-party evidence) for determining the selling price of a deliverable. A vendor is now required to use its best estimate of the selling price when VSOE or TPE of the selling price cannot be determined. In addition, the residual method of allocating arrangement consideration is no longer permitted under the new guidance. The new guidance for certain revenue arrangements that include software elements removes non-software components of tangible products and certain software components of tangible products from the scope of existing software revenue guidance, resulting in the recognition of revenue similar to that for other tangible products. The new guidance is effective for fiscal years beginning on or after June 15, 2010. However, companies may adopt the guidance as early as interim periods ended September 30, 2009. The guidance may be applied either prospectively from the beginning of the fiscal year for new or materially modified arrangements or retrospectively. The Company has not early adopted the new guidance and is currently evaluating the impact on our consolidated financial statements.





3. ACQUISITION




On January 15, 2008, the Company completed its acquisition of Quorum Systems, Inc. (name of which was changed to Spreadtrum Communications USA Inc. in 2009, “Spreadtrum USA”), a fabless semiconductor company that develops integrated multi-mode radio frequency transceivers in San Diego, California, USA. The combination of the Company’s leading single-chip baseband solutions with Spreadtrum USA’s complementary, low-power high-performance radio frequency designs strengthen the Company’s competitive position in the wireless market, including in 2G, 3G, physical layer software, protocol and applications. The combined entity provided a more complete wireless platform and more design flexibility.




F-17




The purchase price included cash of $55,000,000, all of which was paid as of December 31, 2008, and 3,822,199 ordinary shares of the Company at a fair value of $12,460,369, or approximately $3.26 per ordinary share. The fair value of the ordinary shares was based on the average market price of the Company’s ordinary shares over a reasonable period before and after the date the terms of the acquisition were agreed to and announced. The difference between Spreadtrum USA’s assumed assets and assumed liabilities was $2,457,128, which resulted in additional purchase price consideration that the Company was required to pay to Spreadtrum USA’s shareholders as part of the cash component of the transaction within five business days of Spreadtrum USA’s assets and liabilities being deemed final by the Company and Spreadtrum USA. The Company was also required to pay up to an additional $6 million earn-out payment in cash to the former shareholders of Spreadtrum USA, contingent on Spreadtrum USA meeting three performance targets (which are independent from each other) on or prior to January 15, 2010 (the “expiration date”), $2 million per target. In the second quarter of 2009, the Company decided to terminate the project related to one performance target and accordingly $1 million penalty was accrued (Note 14) and recorded as general and administration expense in the second quarter of 2009 and was paid out to the former shareholders of Spreadtrum USA in January 2010. In the third quarter of 2009, Spreadtrum USA achieved another performance target and, as a result, the Company paid $1,996,453 earn-out payment to the former shareholders of Spreadtrum USA in 2009 and the remaining $3,547 was paid in 2010. The total $2 million earn-out payment was recorded as goodwill. On the expiration date, the last performance target has not been met.




In addition, the Company approved grants of restricted share units (“RSU”) worth of $7 million to employees of Spreadtrum USA. On January 16, 2008, 2,140,434 shares of the approved RSUs were granted. These RSUs shall vest over a three-year period, with 50% vesting when and if any of the three earn-out performance targets are met on or prior to January 15, 2010 and the remaining 50% vesting ratably at the end of each month thereafter over the next twelve months. The RSUs are accounted for as compensation for services as the employees must fulfill employment obligations with the Company over the vesting period in order to benefit from the award. Certain of the RSUs’ vesting condition has been modified during 2009, see Note 18 for details.





The aggregate purchase price excluding earn-out payment is comprised of the following:





Cash

$
55,000,000Fair value of ordinary shares issued


12,460,369Purchase price adjustment (difference between assumed assets and liabilities)


2,457,128Direct expenses related to the acquisition


808,911Total consideration

$
70,726,408




The purchase price was allocated as follows:





Net tangible assets acquired

$
3,074,449Intangible assets:Completed technology


28,695,000In Process Research & Development (“IPR&D”) acquired and expensed


6,612,000Goodwill


32,344,959Total

$
70,726,408




The transaction was accounted using the purchase method of accounting, and accordingly, the acquired assets were recorded at their estimated fair values on the acquisition date. The results of Spreadtrum USA’s operation after the acquisition were included in the statement of operations of the Company.




The purchase price allocation and related net asset valuations were determined by management based on a number of factors including a valuation report provided by a third party valuation firm. The valuation report utilized and considered generally accepted valuation methodologies such as the income, market and cost approach. The Company has incorporated certain assumptions which include projected cash flows and replacement costs.




The fair values of the completed technology and IPR&D were established using a form of income approach known as excess earnings method. The first step to apply the excess earning method was to estimate the future debt-free net income attributable to the intangible assets. The resulting debt-free net income was then reduced by an estimated fair rate of return on contributory assets necessary to realize the projected earnings attributable to the intangible assets. These assets include property and equipment, working capital and other intangible assets. The excess earnings attributable to the intangible assets were discounted to present value based on an analysis of the market data of comparable listed companies and the risk profile of the subject intangible asset and the business taken as a whole.


F-18




The sum of the estimated debt-free excess earnings discounted to present value, plus the tax benefit of amortization, yields the indicated value of the completed technology and IPR&D.




Please see Note 16 for the income tax implication for this acquisition.





4. INVENTORIES




Inventories consisted of the following:





December 312009


2010Raw materials

$
3,014,051


$
19,340,554Work in progress


3,257,780



10,770,078Finished goods


15,125,742



43,406,115Deferred cost


4,143,695



59,579,391$
25,541,268


$
133,096,138





The inventory written-down reserve balance amounted to $14,524,416 and $4,335,613 as of December 31, 2009 and 2010, respectively, to reflect the lower of cost or market. The write-down of inventory was $9,052,893, $5,432,673 and $1,918,214 in 2008, 2009 and 2010, respectively, and included in the “Cost of Revenue”. The following table summarizes the movement of inventory write-downs for the years ended December 31, 2008, 2009 and 2010:





Movement of

inventory

written-downAs of December 31, 2007

$
1,883,295Inventory write-downs


9,052,893Removal of write-down inventory balance in connection with inventory discarded with nominal proceeds of $19,838


(1,478,088
)As of December 31, 2008


9,458,100Inventory write-downs


5,432,673Removal of write-down inventory balance in connection with inventory discarded with nominal proceeds of $14,320


(366,357
)As of December 31, 2009


14,524,416Inventory write-downs


1,918,214Removal of write-down inventory balance in connection with inventory discarded with nominal proceeds of $31,260


(6,426,808
)Removal of write-down inventory balance in connection with inventory sales with proceeds of $5,112,188


(5,680,209
)As of December 31, 2010

$
4,335,613





Inventory items previously written down mainly included earlier generation semiconductor chips and wafers relating to older types of products which were phased out during 2008 and 2009. As the Company is generally not able to reliably estimate the sales price of these older types of products and historically the Company was only been able to recover nominal value from such sales, write-downs have generally been at 100% of inventory cost. During second half of 2010, the Company sold certain older types of products as market demands arose due to the quick recovery of the semiconductor industry and the Company’s business. In connection with sales of the written-down inventories in 2008, 2009 and 2010, the Company recognized increased gross profit in amount of $19,838, $14,320 and $5,143,448 for the years ended December 31, 2008 and 2009 and 2010, respectively.




F-19




5. PREPAYMENT, OTHER RECEIVABLES AND OTHER CURRENT ASSETS, NET





Prepayment, other receivables and other current assets, net consisted of the following:





December 312009


2010Value-added tax refundable on export sales

$
1,400,411


$
3,934,001Value-added tax recoverable


1,241,437



3,545,351Interest receivable accrued on term deposits


976,300



3,467,954Deposits for import value-added tax


—



1,774,816Prepaid income tax


—



1,313,746Other prepaid expenses and other current assets


1,944,351



2,921,285$
5,562,499


$
16,957,153




6. PROPERTY AND EQUIPMENT, NET




Property and equipment, net consisted of the following:





December 312009


2010Buildings

$
20,052,774


$
20,684,064Machinery and equipment


5,134,971



6,323,493Office furniture, equipment and vehicles


1,376,278



1,704,841Computer equipment and software


8,013,098



10,926,159Leasehold and building improvements


4,007,453



4,813,73338,584,574



44,452,290Less: accumulated depreciation, amortization and impairment


(11,937,922
)


(16,344,275
)26,646,652



28,108,015Construction in progress


443,360



489,348$
27,090,012


$
28,597,363




Depreciation and amortization expense was $3,632,702, $3,666,808 and $4,201,203 for the years ended December 31, 2008, 2009 and 2010, respectively.




As of December 31, 2009 and 2010, there was no property and equipment pledged as collateral for loans. The Company recorded an impairment loss of $56,045 in 2008. There was no impairment charge recognized in 2009 and 2010.





7. FAIR VALUE MEASUREMENTS




As of December 31, 2010, the Company does not have any financial assets or liabilities that are measured at fair value on a recurring basis subsequent to initial recognition.




Cash and cash equivalents, restricted cash, short-term deposit, accounts receivable, notes receivable, accounts payable, advances from customers, and short-term borrowings are carried at cost on the consolidated balance sheets and the carrying amount approximates their fair value because of the short-term nature of these financial instruments.




The Company’s long-term deposit includes bank deposits with original maturities of over 1 year at interest rates set by the People’s Bank of China. The carrying amount of long-term deposit was $43.9 million and $45.3 million which approximated their fair value as of December 31, 2009 and 2010, respectively.




In April 2009, the Company borrowed RMB 300 million (approximately $43.9 million) bank loan which is payable in 3 years. Interest on borrowings was initially set at 5.40% per annum and would be adjusted annually based on the then benchmark applicable rate as set by the People’s Bank of China. As of December 31, 2010, applicable interest rate was 5.85% per annum. A portion of the interest on borrowings under this bank loan will be reimbursed by local government subsidy funds. The carrying amount of long-term loan was $43.9 million and US$45.3 million as of December 31, 2009 and 2010, respectively. The estimated fair value of long-term loan approximated the carrying amount as of December 31, 2009 and 2010. The fair value is measured using the discounted cash flow technique based on the current rate for comparable loans on the respective valuation date. Significant unobservable input (Level 3) was used for measuring the fair value.


F-20




The Company’s other long-term obligations were incurred for intangible assets acquired. The face value and carrying amounts of other long-term obligations (including both current and non-current portions) as of December 31, 2009 and 2010 are disclosed in Note 13.  The estimated fair value of long-term obligations (including both current and non-current portions) amounted to approximately $7.5 million and $5.4 million, respectively, as of December 31, 2009 and 2010. The fair value is measured using the discounted cash flow technique, using the Company’s weighted-average borrowing rate of approximately 5.4% and 5.85% per annum, respectively, as of December 31, 2009 and 2010.




8. ACQUIRED INTANGIBLE ASSETS, NET




Acquired intangible assets consisted of the following:





December 312009


2010Intangible assetsCompleted technology acquired from Spreadtrum USA

$
28,695,000


$
28,695,000Software license and technology


31,846,349



52,087,37660,541,349



80,782,376Less: accumulated amortizationCompleted technology acquired from Spreadtrum USA


(2,709,570
)


(3,729,426
)Software license and technology


(13,782,341
)


(18,704,660
)(16,491,911
)


(22,434,086
)Less: accumulated impairmentCompleted technology acquired from Spreadtrum USA


(12,727,250
)


(12,727,250
)Software license and technology


(4,701,199
)


(9,173,086
)(17,428,449
)


(21,900,336
)Net book valueCompleted technology acquired from Spreadtrum USA


13,258,180



12,238,324Software license and technology


13,362,809



24,209,630$
26,620,989


$
36,447,954




In 2010, the Company acquired approximately $20 million intangible assets, which are mainly software and technology for the Company’s own use.




Acquired intangible assets are amortized over the estimated useful life, normally, two to fifteen years. The Company recorded an amortization expense of $6,314,807, $4,241,763 and $6,264,967 for the years ended December 31, 2008, 2009 and 2010, respectively.




The weighted average estimated useful life of software license and technology is 4.03 years and 3.28 years as of December 31, 2009 and 2010, respectively, while the completed technology acquired from Spreadtrum USA is estimated to be 15 years for both 2009 and 2010.




The Company estimated its amortization expenses from its existing intangible assets as of December 31, 2010 for the next five years as follows:




2011

$
9,077,0002012


8,243,0002013


6,604,0002014


2,150,0002015


1,023,000$
27,097,000




In 2008, in connection with rapidly declining market share and demand for the Company’s products, the Company evaluated its intangible assets for impairment. The impairment charge was determined by comparing their fair value with the carrying value of intangible assets as of December 31, 2008. The Company determined the fair value of its intangible assets using the income approach. The income approach includes the use of a weighted average of multiple discounted cash flow scenarios, which requires the use of unobservable inputs (Level 3), including assumptions of projected revenues, expenses, capital spending, and other costs, as well as a discount rate calculated based on the risk profile of the Company’s industry. Estimates of projected revenues, expenses, capital spending, and other costs are prepared by management. Changes in management estimates to the unobservable inputs in the Company’s valuation models would change the valuation. The estimated projected revenue is the assumption that most significantly affects the fair value determination. The Company recorded a $17.4 million impairment loss on intangible assets during 2008 to write down these balances to their fair values.


F-21




The Company also recorded $3.0 million provision for loss commitment and $0.5 million impairment charge on other long-term assets in connection with an agreement with a third party vendor for acquiring certain technology in 2008. In 2009, the Company capitalized such technology upon the receipt of the intangible asset and recorded cost of $4.8 million, after netting off the prior year’s provisions of $3.5 million for this intangible assets. In 2009, the Company assessed the fair value of the technology was in excess over its carrying amount and determined that no impairment provision was necessary. In 2010, the Company identified that the technology was rapidly losing market acceptance to competing technology and believed that continue marketing products using the technology would not be commercially viable. Accordingly, the Company believed these changes warranted the re-assessment of the recoverability of these intangible assets. As a result, the Company concluded that this technology has become obsolete and the remaining carrying amount of $4.5 million was fully impaired in 2010. Accordingly, the Company recorded a $4.5 million impairment loss on intangible assets during 2010.




9. LONG-TERM INVESTMENTS





December 312009


2010Investments accounted for under equity method:- Xi’an Chuang Xin (a)

$
707,681



—- Zhanxiang (b)


292,933



6,654,247Investment accounted for under cost method:- Shanghai Mobil (c)


-



2,813,052Total

$
1,000,614


$
9,467,299




(a)
In September 2008, Spreadtrum Technology established a wholly owned subsidiary in the PRC, Han & Qin Shanghai, through which the Company intends to invest in certain PRC companies. In 2008, Han & Qin Shanghai acquired approximate 39.1% equity interest in Xi’an Chuang Xin Science and Technology Co., Ltd. (“Xi’an Chuang Xin”) for cash of RMB 5 million (approximately $0.7 million). The main activities of Xi’an Chuang Xin are research and development, marketing and sales of chips for multimedia products such as digital TV. In 2010, Han & Qin Shanghai disposed its equity interest in Xi’an Chuang Xin to a third party at a price of RMB 5 million (approximately $0.7 million) and there was no significant gain or loss resulting from the disposal as the proceeds approximated the carrying value of the investment disposed.




(b)
In December 2009, Spreadtrum Shanghai entered into a joint venture agreement with three other parties to form a joint venture to develop a piece of land adjacent to the Company’s corporate headquarters in Shanghai, China. The joint venture is named Shanghai Zhanxiang Electronics Technology Co., Ltd. (“Zhanxiang”). The registered capital of Zhanxiang is RMB 193.5 million (approximately $28.3 million) and Spreadtrum Shanghai would inject capital of RMB 46.5 million (approximately $6.8 million) in exchange of 24% equity interest. In December 2009, Spreadtrum Shanghai injected RMB 2 million in cash (approximately $0.3 million) into Zhanxiang. As described in Note 11, Spreadtrum Shanghai paid a deposit of RMB 46.5 million (approximately $6.8 million) for land use rights to this parcel of land in 2007 and recorded such deposit in other long term assets as of December 31, 2009. Under a series of agreements entered into by Spreadtrum Shanghai with other investors of Zhanxiang in 2009, Spreadtrum Shanghai agreed to exchange, in substance, the deposit it had paid for the land use rights as its capital contribution into Zhanxiang. In February 2010, Spreadtrum Shanghai received a refund of its deposit for the land use rights in the amount of RMB 46.5 million (approximately $6.8 million). Thereafter, Spreadtrum Shanghai injected RMB 44.4 million (approximately $6.5 million) into Zhanxiang to complete the capital contribution for its 24% equity interest in Zhanxiang.





(c)
In December 2010, Spreadtrum Tianjin acquired 4.0% equity interest of Shanghai Mobil Embedded Technology Co., Ltd. (“Shanghai Mobil”) at a cash consideration of RMB23.3 million (approximately $2.8 million). The main activities of Shanghai Mobil are development of mobile phone related software platform, games and applications.




The Company accounted for investments in Xi’an Chuang Xin and Zhanxiang using the equity method of accounting due to the fact that the Company has significant influence on these two companies. The Company recorded $6,536, $22,033 and $114,560 as its share of the net loss of the equity investment under “other income, net” in 2008, 2009 and 2010, respectively. The Company accounted for investment in Shanghai Mobile using cost method as the Company does not have significant influence on this company.


F-22




10. GOODWILL




The movements of goodwill for the years ended December 31, 2008, 2009 and 2010 were as follows:





Year ended December 312008


2009


2010Goodwill

$
-


$
32,344,959


$
34,344,959Accumulated impairment losses


-



(32,344,959
)


(32,344,959
)Balance at beginning of year

$
-


$
-


$
2,000,000Balance at beginning of year

$
-


$
-


$
2,000,000Goodwill acquired during the year


32,344,959







-Adjustment to goodwill balance (Note 3)


-



2,000,000



-Impairment loss


(32,344,959
)


-



-Balance at end of year

$
-


$
2,000,000


$
2,000,000Goodwill

$
32,344,959


$
34,344,959


$
34,344,959Accumulated impairment losses


(32,344,959
)


(32,344,959
)


(32,344,959
)Balance at end of year

$
-


$
2,000,000


$
2,000,000




The adjustment to Goodwill relates to the Spreadtrum USA earn-out payment in 2009 (Note 3).





The Company conducted its annual impairment test of goodwill at each calendar year end. The Company employed an income approach in determining the implied fair value of the goodwill, which requires estimates of future operating results and cash flows of the reporting unit discounted. The estimates of future operating results and cash flows were mainly derived from an updated long-term financial forecast.





The Company recorded $32.3 million impairment loss on goodwill in 2008, mainly due to the decline in the implied fair value of goodwill. The impairment of 2008 was primarily driven by the Company’s updated long-term financial forecast, which indicated lower estimated future cash flows compared to the estimates at the time of the Company completed its acquisition of Spreadtrum USA due to the downturn in the economy.




As of December 31, 2009 and 2010, the implied fair value of goodwill was higher than the carrying value of goodwill, resulting from the profit growth over the year of 2009 and 2010 and the improvement of economic environment and the Company’s business since the second half of 2009. Accordingly, there was no impairment loss on goodwill recognized in the years ended December 31, 2009 and 2010.





11. OTHER LONG TERM ASSETS





December 312009


2010Deposit in land use rights (a)

$
6,802,876


$
—Rental deposits and others


423,695



792,466$
7,226,571


$
792,466




(a)
On January 31, 2007, Spreadtrum Shanghai signed a contract (“land purchase contract”) with Shanghai Zhangjiang Semiconductor Industry Park Co., Ltd. for the land use rights of a parcel of undeveloped land for approximately RMB 46.5 million (approximately $6.8 million). As of December 31, 2009, a deposit equal to the the total purchase price for the land use rights was fully paid and recorded as other long-term asset. In 2010 Spreadtrum Shanghai exchanged, in substance, the refunded deposit for a 24% equity interest into Zhanxiang pursuant to a series of agreements entered into in 2009 (Note 9).


F-23




12. LONG-TERM LOAN





In April 2009, the Company entered into a 3-year loan agreement for RMB 300 million (approximately $43.9 million) with a PRC financial institution, all of which was drawn down in April 2009. The bank loan is unsecured and bears interest at 5.40% per annum initially which will be reset annually at the then benchmark applicable rate as set by the People’s Bank of China. As of December 31, 2009 and 2010, applicable interest rates were 5.4% and 5.85% per annum, respectively. The local government has agreed to reimburse a portion of the interest expense on the bank loan. In 2009 and 2010, the Company received RMB5 million (approximately $0.7 million) and RMB10 million (approximately $1.5 million), respectively, from local government as a reimbursement of the bank loan interests incurred, which was recorded as reduction of interest expense. The movement in long-term loan in the year ended December 31, 2010 is a result of effect from change in exchange rate.    The payment of $3.7 million shown in the statement of cash flow in 2009 represented the Company’s repayment of a borrowing outstanding as of December 31, 2008.





13. OTHER LONG-TERM OBLIGATIONS





The Company entered into several software, license and technology agreements for acquired intangible asset which are to be settled by installment payments. Installments payable under the agreements as of December 31, 2009 and 2010 are as follows:





December 312009


2010Maturity

Face value


Carrying

amounts


Face value


Carrying

amounts2010

$
2,123,096


$
2,078,527


$
—


$
—2011


392,718



363,089



3,187,461



3,134,1132012


325,000



288,847



449,743



411,5462013


750,000



637,729



750,000



672,1662014


1,500,000



1,210,111



1,500,000



1,275,458After 2014


4,000,000



2,963,600



4,000,000



3,123,634$
9,090,814


$
7,541,903


$
9,887,204


$
8,616,917Less: Current portion of other long-term obligations


(2,123,096
)


(2,078,530
)


(3,187,461
)


(3,134,113
)Non-current portion of other long-term obligations

$
6,967,718


$
5,463,373


$
6,699,743


$
5,482,804





These other long-term obligations were interest freeand their fair value as of December 31, 2009 and 2010 is disclosed in Note 7.




The average discount rates used to determine the carrying amounts during the year ended December 31, 2009 and 2010 were 5.4% and 5.85% per annum, respectively.




The current portion of other long-term obligations is recorded as part of “accounts payable” on the balance sheet.




Accretion to the carrying amounts was amounted to $149,032, $191,210 and $346,777 for the years ended December 31, 2008, 2009 and 2010, respectively, and was recorded under interest expense.





14. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES




Accrued expenses and other current liabilities consisted of the following:





December 312009


2010Accrued employee compensation

$
2,984,915


$
8,671,334Government subsidies


2,617,678



7,211,625Accrued royalty


1,228,680



5,446,604Accrued expenses in connection with a R&D agreement


—



4,000,000Accrued goods rebate to customers


555,737



3,971,460Subsidies received from a customer for TD-SCDMA product development


5,739,386



2,959,518Employee individual income tax payable withheld


875,236



1,874,374Customer deposit and reimbursement


935,363



1,149,250Accrued professional service fee


539,770



967,704Accrued contingent loss relating to pending litigations (Note 22)


—



845,577Accrued warranty


136,239



427,581Provision for loss commitment


52,449



—Payable related to Spreadtrum USA acquisition (Note 3)


1,003,547



—Other accrued expenses and current liabilities


1,218,158



2,122,348$
17,887,158


$
39,647,375




F-24




Government subsidies




The Company received subsidies from the Chinese government to fund certain research and development activities and acquisition of equipment.




Amounts of $2,234,764, $1,510,864 and $5,000,912 of the government subsidies received has been applied to research and development activities and recorded as a reduction of research and development expenses incurred for the years ended December 31, 2008, 2009 and 2010, respectively. Refer to Note 12 for government subsidies received that has been applied to off-setting interest expenses.




Amounts of $907,149, $1,017,956 and $326,628 of the government subsidies received have been used for the acquisition of specific equipment and recorded as a reduction of the cost of that equipment for the years ended December 31, 2008, 2009 and 2010, respectively.




Included in the accrued expenses and other current liabilities of the consolidated balance sheets as of December 31, 2009 and 2010 were government subsidies relating to research and development activities of $2,617,678 and $7,211,625, respectively, as the conditions for those specific research and development projects to earn the subsidies have not been met.




Royalty




The Company has entered into certain license and technology agreements with third parties, which require the Company to pay royalty for sale of products using the relevant technology license or to pay the minimum royalty according to the term of the agreements. The Company recorded royalty expense of $3,267,360, $3,228,805 and $14,439,235 for the years ended December 31, 2008, 2009 and 2010, respectively. Royalty expense is included as part of cost of revenue upon the corresponding revenue being recognized.




Accrued expenses in connection with a R&D contract




The Company entered into a R&D contract with a third-party supplier in October 2010. According to the agreement, the Company would reimburse the R&D costs incurred by the supplier with a non-refundable amount of $7 million. The completion of the R&D project will help the supplier and the Company reduce production costs through savings in material consumption, reduction in failure rate and improvement in efficiency. The R&D project has been completed in the fourth quarter of 2010 according to the schedule specified in the agreement. Accordingly, the Company recorded $7 million as R&D expenses in 2010 and the amount would be paid in 2011. As of December 31, 2010, the Company recorded $3 million under “Accounts Payable” upon receiving of billing from the supplier and the remaining $4 million under accrued expenses and other current liabilities.




Subsidies received from a customer for TD-SCDMA product development




Spreadtrum Shanghai entered into two multi-party contracts with a customer in the second quarter of 2009 to participate in the customer’s sponsored subsidized program for the promotion of TD-SCDMA products. According to the contracts, the customer will contribute certain research and development funds to Spreadtrum Shanghai to subsidize its research and development of TD-SCDMA products if Spreadtrum Shanghai achieves certain milestones and targets. If Spreadtrum Shanghai fails to achieve certain milestones and targets, Spreadtrum Shanghai would be required to return all research and development funds received and, in addition, be subject to penalties equal to a portion of the funds received. As of December 31, 2009, Spreadtrum Shanghai has received RMB 39.2 million funds (approximately $5.7 million) for the two contracts, representing RMB19.6 million (approximately $2.9 million) for each of the two contracts, from the customer, which funds were included in accrued expenses and other liabilities. Spreadtrum Shanghai did not receive any such funds in 2010.





F-25





As of December 31, 2010, Spreadtrum Shanghai has substantially fulfilled major milestones and passed critical performance tests which were required under the terms of one of the two contracts. Accordingly, Spreadtrum Shanghai recognized subsidies of RMB19.6 million (approximately $2.9 million) as a reduction of research and development expenses. In February 2011, Spreadtrum Shanghai received from the customer additional funds of RMB49.0 million (approximately $7.4 million), representing RMB24.5 million (approximately $3.7 million) for each of the two contracts.




Warranty




The change in accrued warranty costs was summarized as follows:





December 312009


2010Beginning balance

$
537,209


$
136,239Warranty provision


636,968



1,206,018Warranty cost incurred


(1,037,938
)


(914,676
)Ending balance

$
136,239


$
427,581




The Company offers a one-year warranty on all of its products and accrues the estimated cost of product warranty at the time revenue is recognized.




15. SEGMENT AND GEOGRAPHIC INFORMATION




In accordance with guidance of “Disclosures about Segments of an Enterprise and Related Information”, the Company’s chief operating decision maker has been identified as the Chief Executive Officer, who reviews consolidated results of operations when making decisions about allocating resources and assessing performance of the Company. The Company believes it operates in one segment of baseband processor and RF solutions, and all financial segment information required can be found in the consolidated financial statements.




The following table summarizes the Company’s revenue generated from different geographic locations for the years ended December 31, 2008, 2009 and 2010:





Year ended December 312008


2009


2010Mainland China, excluding Hong Kong and Macau

$
62,064,315


$
9,232,369


$
27,730,120Hong Kong and Macau


37,492,230



89,175,527



310,317,223Others


10,380,396



6,661,794



8,291,399Total

$
109,936,941


$
105,069,690


$
346,338,742




Most of the Company’s long-lived assets were located in the PRC except intangible assets and property and equipment of Holding which were recorded under Holding’s books.





16. INCOME TAXES





(a) Income tax status




Holding is a tax-exempted company incorporated in the Cayman Islands.




On January 1, 2008, a new corporate income tax law (“new CIT law”) in China took effect. The new CIT law applies a uniform 25% corporate income tax rate to both foreign invested corporations and domestic corporations. Under the prior tax regime, foreign-invested corporations were generally subject to a 30% state tax rate plus a 3% local tax rate for a total tax rate of 33%. The new CIT law provides a five-year transition period from its effective date for those corporations which were established before the promulgation date of the new CIT law and which were entitled to a preferential tax treatment such as a reduced tax rate or a tax holiday. Under the new CIT law, the preferential income tax rate of 15% will continue to be granted to corporations that qualify as “new and high technology corporations strongly supported by the state”. In addition, on December 26, 2007, the State Council issued the Notice of the State Council Concerning Implementation of Transitional Rules for Corporate Income Tax Incentives (“Circular 39”). Based on Circular 39, certain specifically listed categories of corporations which enjoyed a preferential tax rate of 15% are eligible for a graduated rate increase to 25% over the 5-year period beginning from January 1, 2008. Where transitional rules overlap with preferential policies provided by the new CIT, a corporation may choose to implement the more favorable policy, and shall not enjoy both simultaneously. Once determined, the implemented tax policy cannot be changed.


F-26




Before 2008, Foreign-invested Integrated Circuit (“IC”) design corporations were entitled to income tax exemption for the first two profitable years of operation, after taking into account any tax losses brought forward from prior years, and a 50% tax rate reduction for the succeeding three years thereafter. As a qualified Foreign-invested IC design corporation, Spreadtrum Shanghai was cumulatively profitable in 2007 and started its tax holiday accordingly. It was exempt from income tax for 2007 and 2008, and entitled to a 50% tax rate reduction for the succeeding three years from 2009 to 2011. Being located in Shanghai Pudong New District, Spreadtrum Shanghai was also entitled to a 15% preferential tax rate before 2008. In addition, Spreadtrum Shanghai was qualified as a “new and high technology corporations strongly supported by the state” from the relevant tax authorities in December 2008. Since the new CIT law permits companies to continue to enjoy their existing preferential tax treatments until such treatments expire in accordance with their current terms, its income tax rate will increase from 10% to 12% (i.e. 50% of transitional tax rate of 20%, 22% and 24%, respectively) from 2009 to 2011. Based on Circular 39, Spreadtrum Shanghai chooses to enjoy 15% preferential tax rate after the transition period expires after 2012 if it continually qualifies as “new and high technology corporations strongly supported by the state”. Spreadtrum Shanghai’s income tax rate was 0%, 10% and 11%, respectively, in 2008, 2009 and 2010.




Before 2008, as a high-technology company incorporated in the Zhongguancun Hi-Tech Park, Spreadtrum Beijing was subject to PRC income tax at a preferential tax rate of 15%, and was entitled to an income tax exemption from 2005 to 2007 and a 50% tax rate reduction for the succeeding three years from 2008 to 2010 based on the approval obtained from the tax authority. Pursuant to the new CIT law, Spreadtrum Beijing was subject to 25% tax rate starting from 2008 since it did not qualify as “new and high technology corporations strongly supported by the state”. It has entered its first year of accumulated profit making and started to pay income tax in 2009. Spreadtrum Beijing’s income tax rate was 25%, 25% and 25%, respectively, in 2008, 2009 and 2010.




Shanghai Technology was established in Shanghai Waigaoqiao Free Trade Zone and was subject to PRC income tax at a preferential rate of 15% in 2007. It has entered its first year of accumulated profitability and started to pay income tax in 2007. Because Shanghai Technology is located in Shanghai Pudong New District, it was subject to a transitional income tax rate of 18% in 2008, 20% in 2009, 22% in 2010 and will be subject to graduated increase of income tax rate to 25% by 2012. Spreadtrum USA is subject to US federal and state income taxes of 34% and 8.84%, respectively. The state income tax paid is deductible for US federal income tax purposes and the combined US federal and state income tax rate is approximately 39.8%.




(b) Income tax expenses





The provision for income taxes, by location of the taxing jurisdiction, for the years ended December 31, 2008, 2009 and 2010 were as follows:





Year ended December 312008


2009


2010PRC Current:

$
995,202


$
945,617


$
8,619,367PRC Deferred:


(1,196,953
)


(66,989
)


(500,015
)$
(201,751
)

$
878,628


$
8,119,352US Current:


(379,372
)


(3,935
)


10,243US Deferred:


782,136



150,000



—$
402,764


$
146,065


$
10,243Total provision for income taxes

$
201,013


$
1,024,693


$
8,129,595




F-27





(c) Deferred income tax





The significant components of the Company’s deferred income tax assets and liabilities consisted of the following:





December 312009


2010Deferred tax assets:Research and development credits

$
3,978,248


$
4,336,030Reserves and accruals recognized in different periods


2,561,216



2,028,255Fixed assets basis difference


94,942



27,190Tax loss carrying forward


7,189,417



5,710,026Others


609,320



829,652$
14,433,143


$
12,931,153Less valuation allowance


(12,516,413
)


(10,467,345
)Deferred tax assets

$
1,916,730


$
2,463,808Analysis as:Current

$
1,346,985


$
1,669,670Non-current


569,745



794,138Deferred tax liabilities

$
—


$
—




The net change of the deferred tax assets and deferred tax liability in 2010 was $500,015.




In early 2008, the Company acquired Spreadtrum USA. The deferred tax liability of $14.3 million related to this acquisition was offset by the deferred tax asset related to the net operating loss and tax credits of Spreadtrum USA carryover from prior years, which was in excess of the deferred tax liability.





In December 2008, the Company formed SPRD LLC and merged Spreadtrum Communications Corporation, a California corporation and its wholly-owned subsidiary, into SPRD LLC. Subsequently, the Company contributed 100% of its interest in SPRD LLC to Spreadtrum USA. All of Spreadtrum Communications Corporation’s tax attributes, i.e. operating loss carryover, Federal and California R&D credits will be carried over into Spreadtrum USA.




As of December 31, 2010 and 2009, the Company had approximately $46.8 million and $57.5 million of tax loss carry forwards available to offset against future taxable income respectively, certain amounts of which will expire in varying amounts from 2014 to 2028 (from 2014 to 2028 for 2009).




As of December 31, 2010 and 2009, respectively, the Company had approximately $4.3 million and $4.0 million of research and development credits, certain amounts of which will expire in varying amounts from 2021 to 2030 for 2010 and from 2021 to 2029 for 2009.




A valuation allowance is provided for deferred tax assets where the recoverability of the assets is uncertain. The determination to provide a valuation allowance is dependent upon the assessment of whether it is more likely than not that sufficient future taxable income will be generated to utilize the deferred tax assets. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carry forward period are reduced.




In 2009 and 2010, based on the current profit, projected future profitability and other available evidences, the Company believes that its deferred tax assets in certain tax jurisdiction will not be fully realizable. Thus, a valuation allowance was provided for deferred tax assets.




The net changes in valuation allowance on deferred tax assets during the years ended December 31, 2008, 2009 and 2010 are as follows:





Year ended December 312008


2009


2010Balance at January 1

$
-


$
(13,495,606
)

$
(12,516,413
)Net change in valuation allowance during the year


(13,495,606
)


979,193



2,049,068Balance at December 31

$
(13,495,606
)

$
(12,516,413
)

$
(10,467,345
)





(d) Uncertain tax position




The Company adopted the provisions of ASC 740-10-25 effective January 1, 2007. Based on the analysis performed, the Company has made its assessment of the relevant level of tax authority for each tax position (including the potential application of interest and penalties) based on the technical merits, and has measured the unrecognized tax benefits associated with the tax positions. The adoption of ASC 740-10-25 did not have any material impact on the Company’s financial position or results of operations.


F-28




As of December 31, 2008, 2009 and 2010, unrecognized tax benefits were approximated $2.6 million, $2.6 million and $3.1 million, respectively. The total amount of unrecognized tax benefit if recognized that would favorably affect the effective tax rate is $1.7million, $1.9 million and $2.1 million at end of year 2008, 2009 and 2010, respectively.





The Company expects it will decrease its income tax liability by $1.9 million for unrecognized tax benefits within the next 12 months if approved by the relevant tax authority.





Unrecognized Tax Benefit—December 31, 2007

$
2,021,093Gross increases—tax positions in current period


609,704Lapse of statute of limitations


(64,592
)Unrecognized Tax Benefit—December 31, 2008

$
2,566,205Gross increases—tax positions in current period


198,966Lapse of statute of limitations


(181,190
)Unrecognized Tax Benefit—December 31, 2009

$
2,583,981Gross increases—tax positions in current period


477,996Lapse of statute of limitations


-Unrecognized Tax Benefit—December 31, 2010

$
3,061,977




The Company classifies interest and/or penalties related to income tax matters in income tax expense. As of December 31, 2007, the amount of interest and penalties related to uncertain tax positions was immaterial. In 2008, 2009 and 2010, the Company accrued interest of $0.2 million each year related to the uncertain tax positions.




According to the PRC Tax Administration and Collection Law, the statute of limitations is generally three years if the underpayment of taxes is due to computational errors made by the taxpayer or the withholding agent. The statute of limitations will be extended to five years under special circumstances, which are not clearly defined (but an underpayment of tax liability exceeding RMB 100,000 is specifically listed as a special circumstance). In the case of a related party transaction, the statute of limitations is 10 years. There is no statute of limitation in the case of tax evasion.




Spreadtrum USA’s federal income tax returns for 2007 through 2010 and California state income tax returns for 2006 through 2010 are open tax years, subject to examination by the relevant tax authorities.




(e) Effective tax rate





Reconciliation between the total income tax expense (benefit) computed by applying the applicable corporate income tax rate of 25% to the income (loss) before taxes and the actual income tax expense was as follows:





2008


2009


2010PRC statutory Income Tax Rate


25
%


25
%


25
%Effect of different tax rate of Holding and subsidiaries


1
%


-38
%


-12
%Effect of tax rates in foreign jurisdictions


—



-4
%


6
%Expense not deductible for tax purpose


-14
%


1
%


-1
%Benefit of Tax Holiday


1
%


2
%


-3
%Change in valuation allowance


-15
%


8
%


-2
%Other


2
%


—



-2
%-0
%


-6
%


11
%





The aggregate amount and per share effect of the tax holiday are as follows:





Year ended December 312008


2009


2010The aggregate dollar effect

$
(2,468,339
)

$
(312,104
)

$
(9,089,241
)Per share effect—basic

$
(0.02
)

$
(0.002
)

$
(0.06
)Per share effect—diluted

$
(0.02
)

$
(0.002
)

$
(0.06
)




F-29


(f) Withholding income tax





Under applicable accounting principles, a deferred tax liability should be recorded for taxable temporary differences attributable to the excess of financial reporting basis over tax basis in a domestic subsidiary. However, recognition is not required in situations where the tax law provides a means by which the reported amount of that investment can be recovered tax-free and the enterprise expects that it will ultimately use that means. The Company has not recorded any such deferred tax liability attributable to the undistributed earnings of its financial interests in VIE because these entities do not have any unremitted earnings to be distributed.




The new CIT Law imposes a 10% withholding income tax for dividends distributed by foreign invested enterprises to their holding companies outside mainland China. As of December 31, 2010, the Company had not recorded any withholding tax on the undistributed earnings of its PRC subsidiaries amounting to approximately $65.1 million, since the Company intends to indefinitely reinvest these earnings to further expand its business in mainland China, and there is no intention of its PRC subsidiaries to declare any dividend to the Company.




17. ORDINARY SHARES





In March 2008, the Company adopted a share repurchase program enabling it to repurchase up to an aggregate of 2,274,066 ADSs or $20,000,000 of its ADSs. The share repurchase program continued until May 27, 2008. As of December 31, 2008, the Company had repurchased an aggregate of 1,784,848 ADSs, representing 5,354,544 ordinary shares, on the open market for total cash consideration of $14,891,375. In June 2010, the Company canceled all the repurchased 1,784,848 ADSs which represent 5,354,544 ordinary shares.





18. STOCK OPTIONS AND RESTRICTED SHARE UNITS





In 2001, the Company adopted the 2001 Stock Plan (the “2001 Plan”). The Company originally reserved 5,100,000 ordinary shares for issuance to employees, directors and consultants under the Plan. Options granted under the 2001 Plan may be incentive stock options, nonqualified stock options or stock purchase rights. Options granted under the 2001 Plan generally vest over a four-year period, with 25% vesting after one year and the remaining 75% vesting ratably thereafter. The Company ceased to grant options under the 2001 Plan after June 26, 2007.  As of December 31, 2009 and 2010, 7,567,832 and 3,326,477 options, respectively, were outstanding under the 2001 Option Plan.





In 2007, the Company adopted the 2007 Equity Incentive Plan (the “2007 Plan”). The Company originally reserved 15,000,000 ordinary shares for issuance to employees, directors and consultants under the 2007 Plan. As of December 31, 2008, 2009 and 2010, the authorized number of shares issuable under the Plan was 20,076,580, 26,788,107, and 32,311,763 respectively. The 2007 Plan permits the grant of incentive stock options, nonqualified stock options, restricted shares, restricted share units (“RSUs”), share appreciation rights, performance units and performance shares, stock purchase rights. Shares options granted under 2007 Incentive Plan are generally vested over a four year period. As of December 31, 2010, 14,882,933options and 5,931,291 RSUs (December 31, 2009: 15,283,300 options and 5,833,218 RSUs) were outstanding under the 2007 Incentive Plan.





RSUs may be granted at any time and from time to time as determined by the Company. The Company will set vesting criteria in its discretion, which will determine the number of RSUs that will be paid out to the participant. Upon meeting the applicable vesting criteria, the participant will be entitled to receive a payout as determined by the Company.





The Company has not issued any restricted shares, performance units, performance shares and stock purchase rights as of December 31, 2010.





The Company adopted the provisions of ASC 718 effective January 1, 2006 and share-based compensation recorded during the years ended December 31, 2008, 2009 and 2010 are as follows:





For the Year Ended December 31,2008


2009


2010Cost of revenue

$
405,241


$
277,778


$
436,638Research and development


3,932,917



2,871,166



5,718,328Selling, general and administrative


4,010,049



6,549,795



4,130,595Total

$
8,348,207


$
9,698,739


$
10,285,561




F-30


Stock Options to Employees





The following is a summary of stock option activities under the 2001 and 2007 Plan in 2010:





Number of

options

outstanding


Weighted

average exercise

price (per share)Balance at December 31, 2009


22,851,132


$
1.14Granted (weighted average fair value of $1.72 per share)


2,596,663


$
2.51Exercised


(4,101,015
)

$
1.12Forfeited


(3,137,370
)

$
2.44Balance at December 31, 2010


18,209,410


$
1.12





Additional information regarding options outstanding as of December 31, 2010 was as follows:





Number of

options


Weighted

average

exercise

price (per

share)

Weighted

average

remaining

contractual

life

Aggregate

intrinsic

valueOptions outstanding


18,209,410


$
1.12

7.85 years

$
90,964,867Options vested and expected to vest


13,314,742


$
1.11

7.98 years

$
66,669,052Options exercisable


7,719,560


$
1.10

7.07 years

$
38,625,979





As of December 31, 2010, there was $6,900,324 in unrecognized compensation expense related to unvested stock options granted under the 2001 and 2007 Plan, which is expected to be recognized over a weighted-average period of 1.53 years.





On December 16, 2008, the Company granted 5,202,500 options to certain employees. These options vest over a four-year period, with 25% vesting after one year and the remaining 75% vesting ratably thereafter. The exercise price of these options is $0.37 per share. There is no intrinsic value associated with these options on the date of grant.





In 2009, the Company granted 12,808,229 options to certain employees. These options, except 403,000 options granted on May 26, 2009, vest over a four-year period, with 25% vesting after one year and the remaining 75% vesting ratably thereafter. The 403,000 options granted on May 26, 2009 vest over a three-year period, with 1/36 vesting per month. The weighted average exercise price of these options is $0.78 per share. There is no intrinsic value associated with these options on the date of grant.





In 2010, the Company granted total 2,596,663 options to certain employees. These options, except 300,000 options granted on May 14, 2010, vest over a four-year period, with 25% vesting after one year and the remaining 75% vesting ratably thereafter. The 300,000 options granted on May 14, 2010 vest over a four-year period, with 1/48 vesting of the total shares per month. The weighted average exercise price of these options is $2.51 per share. There is no intrinsic value associated with these options on the date of grant.




The following table summarizes information regarding options granted in the year ended December 31, 2008, 2009 and 2010, respectively:




Grant date

Number of

Options issued


Exercise Price

(per share)December 16, 2008


5,202,500


$
0.37





Grant date

Number of

Options issued


Exercise Price

(per share)February 23, 2009


407,835


$
0.32May 26, 2009


403,000


$
0.56May 26, 2009


3,568,594


$
0.56June 8, 2009


850,000


$
0.80June 19, 2009


7,049,800


$
0.86November 14, 2009


529,000


$
1.8012,808,229




F-31




Grant date

Number of

Options issued


Exercise Price

(per share)March 19, 2010


895,000


$
2.03May 14, 2010


1,701,663


$
2.762,596,663





The weighted-average grant-date fair value of options granted during the years ended December 31, 2008, 2009 and 2010 was $0.24, $0.57 and $1.72, respectively. The total intrinsic value of options exercised during the years ended December 31, 2008, 2009 and 2010, was $12,076,172, $1,840,583 and $9,427,181, respectively. The fair value of the options vested in 2009 and 2010 amounted to approximately $5.1 million and $3.4 million, respectively.





Option modification





In February 2009, the Company offered an option exchange to certain outstanding options granted under the Company’s 2001 Stock Plan, which reduced the number of options and exercise prices of these options. The offer is to exchange the eligible outstanding options, whether vested or unvested, for new options to be granted under the Company’s 2007 Equity Incentive Plan. Each new option will be subject to the terms of the 2007 plan with a new vesting period which is the first 3 months cliff vesting, monthly pro rata vesting for the remaining vesting period around 3 years of 10 years’ life period. There were total 1,468,813 shares of original options from 77 employees exchanged to 407,835 shares of new options under this program. The Company compared the fair value of the modified options against the original awards as of the modification date and concluded that there is no incremental compensation cost to be recognized as the number of awards have been reduced during the modification. The weighted average exercise price before and after the modification were $2.55 and $0.32, respectively.





The Company values options using the Black-Scholes-Merton option pricing model. The following assumptions were used in determining the fair value of the options for the years ended December 31, 2008, 2009 and 2010, respectively.





Year ended December 312008


2009


2010Risk-free rate of return


1.55
%


2.68
%


2.67
%Expected life

6.10years


6.08 years


6.08 yearsExpected volatility rate


74
%


82-85
%


77-79
%Dividend yield

Nil


Nil


Nil




The Company uses the Black-Scholes-Merton option-pricing model to estimate the fair value of each stock option grant in 2008, 2009 and 2010. The use of a valuation model requires the Company to make certain assumptions with respect to selected model inputs. Expected volatility is calculated based on the historical volatility of the Company’s stock price and four comparable companies’ stock prices. The Company has applied the provisions of ASC 718-10-S99 regarding the use of the simplified method in developing estimates of the expected lives of stock options. The risk-free interest rate is based on U.S. Treasury zero-coupon issues with a remaining term equal to the expected life assumed at the date of the grant. Expected dividend yield is determined in view of the Company’s historical dividend as well as expected future pay out rate.




In 2008, 2009 and 2010, the Company issued options to part-time employees and board members to purchase nil, 1,755,000 and 300,000 ordinary shares at exercise prices in the range of $0.56 - $2.76 per share. These options are accounted for as equity awards. The options issued have 25% cliff vesting on their first anniversary, and the remaining shares vest 1/48 per month thereafter. The options expire 10 years from the date of grant.





The Company recorded share-based compensation expense of $361,180, $335,327 and $544,111 relating to these option grants for the years ended December 31, 2008, 2009 and 2010, respectively. As of December 31, 2010, 2,273,054 and 1,340,753 options granted to part time employees and board members were outstanding and exercisable, respectively.


F-32





RSUs to Employees





The following table summarizes information regarding RSUs granted in the year ended December 31, 2008, 2009 and 2010, respectively:




Grant date

Number of

RSUs issued


Fair value per

share on grant

dateJanuary 16, 2008


2,860,434


$
3.17May 23, 2008


6,593,500


$
2.97November 15, 2008


856,000


$
0.22November 15, 2008


7,500


$
0.3710,317,434





Grant date

Number of

RSUs issued


Fair value

per share on

grant dateMay 26, 2009


707,278


$
0.56June 19, 2009


795,000


$
0.86November 14, 2009


360,000


$
1.801,862,278





Grant date

Number of

RSUs issued


Fair value

per share on

grant dateMarch 19, 2010


2,539,750


$
2.03August 5, 2010


895,240


$
3.173,434,990





The shares were granted in anticipation of services to be provided from the employee during the respective vesting periods. The Company accounts for RSUs in accordance ASC 718 and records the fair value of unvested shares equal to the market price on the date of grant with related compensation expense recognized over the vesting period. The Company granted 10,317,434, 1,862,278 and 3,434,990 RSUs, with an aggregate grant-date fair value of approximately $28.8 million, $1.73 million and $7.99 million, for the year ended December 31, 2008, 2009 and 2010, respectively. During the year ended December 31, 2008, 2009 and 2010, 49,371, 2,786,688 and 2,627,178 RSUs vested with a total grant date fair value of $0.10 million, $7.74 million and $5.97 million, respectively. The fair value at the vesting date of the RSUs vested in 2008, 2009 and 2010 are about $0.07 million, $2.63 million and $8.07 million respectively.





The following is a summary of RSU activities under the 2007 Plan in 2010:




Number of RSUs

outstanding


Weighted-average

grant-date fair

value(per share)Unvested balance at December 31, 2009


5,883,218


$
2.13Granted


3,434,990


$
2.33Vested


(2,627,178
)

$
2.27Forfeited


(759,739
)

$
2.88Unvested balance at December 31, 2010


5,931,291


$
2.09





As of December 31, 2010, there was $9,631,503 in unrecognized compensation expense related to unvested share-based compensation of RSUs granted under the 2007 Plan, which is expected to be recognized over a weighted-average period of 1.20 years.




F-33




RSU modification





In December 2009, the Company’s Board of Directors approved an RSU modification to extend the deadline from January 15, 2010 to July 15, 2010 of the performance condition for certain RSUs granted on January 16, 2008 (Note 3). Other terms of the RSUs remained unchanged. The Company compared the fair value of the modified RSUs against the original awards as of the modification date and concluded that there is incremental compensation cost of $0.55 million to be recognized over the remaining vesting period (up to July 2010). Insignificant incremental charge was recognized in 2009 due to proximity of modification date to the year end of 2009. This milestone was achieved on April 15, 2010.





Stock Reserved for Future Issuance





As of December 31, 2010, the Company reserved the following shares of authorized but unissued ordinary shares for future issuance:





Stock options outstanding


18,209,410RSUs outstanding


5,931,291Ordinary shares available for grant


3,923,64628,064,347




F-34




19. DISTRIBUTION OF PROFIT




Pursuant to the relevant laws and regulations in the PRC applicable to foreign investment enterprises and the Articles of Association of the Company’s PRC subsidiaries, the Company is required to maintain one statutory reserve (“PRC statutory reserve”): a general reserve fund, which is non-distributable. The Company’s PRC subsidiaries are required to transfer 10% of their profit after taxation, as reported in their PRC statutory financial statements, to the general reserve fund until the balance reaches 50% of their registered capital. The general reserve fund may be used to make up prior year losses incurred and, with approval from the relevant government authority, to increase capital. PRC regulations currently permit payment of dividends only out of the Company’s PRC subsidiaries’ accumulated profits as determined in accordance with PRC accounting standards and regulations. As a result of these PRC laws and regulations, the Company’s PRC subsidiaries are restricted in their ability to transfer a portion of net profit to Holding in the form of dividends. As of December 31, 2009 and 2010, total restricted net assets held by the Company’s PRC subsidiaries were $31,405,151 and $42,380,536, respectively, which were not available for distribution to the Company. These amounts are made up of the registered capital of the Company’s PRC subsidiaries and the statutory reserves.




The Company has statutory reserve balance of $1,069,848 and $7,230,475 as of December 31, 2009 and 2010.





20. RETIREMENT PLAN




The Company’s local PRC employees are entitled to a retirement benefit, based on their basic salary upon retirement and their length of service in accordance with a state-managed pension plan. The PRC government is responsible for the pension liability to these retired staff. The Company is required to make contributions to the state-managed pension plan equivalent to certain percentage of the monthly basic salary, subject to a ceiling, of current local PRC employees. Local PRC employees are required to make contributions equivalent to certain percentage of their basic salary, subject to a ceiling. The Company’s contribution to the pension plan was $1,750,311, $1,903,948 and $2,438,199 for the years ended December 31, 2008, 2009 and 2010, respectively. The retirement benefits do not apply to expatriate employees.




In August 2001, the Company adopted a 401(k) plan for its expatriate employees and employees of a US subsidiary whereby eligible employees may contribute up to 15% of their compensation, on a pretax basis, subject to the maximum amount permitted by the Internal Revenue Code. Spreadtrum USA’s 401(k) plan is subject to the same limitation. The Company is not required to, and has not contributed to, either of these two 401(k) Plans.




21. EARNINGS PER SHARE




The following table sets forth the computation of basic and diluted net income (loss) per share for the periods indicated:





Year ended December 312008


2009


2010Net income (loss) attributable to holders of ordinary shares

$
(78,678,150
)

$
(19,316,469
)

$
67,194,438Weighted average shares outstanding - basic


131,510,359



134,431,135



141,739,261Potential dilutive shares:- Stock options


—



—



12,074,708- RSUs


—



—



3,528,560Weighted average shares outstanding - diluted


131,510,359



134,431,135



157,342,529Income (loss) per share - basic

$
(0.60
)

$
(0.14
)

$
0.47Income (loss) per share - diluted

$
(0.60
)

$
(0.14
)

$
0.43




Ordinary share equivalents of stock options are calculated using the treasury stock method. Under the treasury stock method, the proceeds from the assumed conversion/exercise of options, RSUs and warrants are used to repurchase outstanding ordinary shares using the average fair value for the periods.




For the years ended December 31, 2008 and 2009, ordinary share equivalents outstanding of 28,084,683 and 28,734,350 shares of stock options and RSUs, were excluded in the computation of diluted loss per share, as their effect would have been anti-dilutive due to the net loss reported in such periods. For the year ended December 31, 2010, outstanding stock options of 466,474 shares were excluded in the computation of diluted earnings per share due to their anti-dilutive effect.




F-35




22. COMMITMENTS AND CONTINGENCIES




Operating lease as lessee




The Company has entered into operating leases for certain office space some of which contain renewal options. As of December 31, 2010, future minimum lease payments under non-cancelable operating leases were as follows:





Years EndingDecember 31, 2011

$
748,205December 31, 2012


523,733December 31, 2013


333,514December 31, 2014


143,294December 31, 2015


143,294Thereafter


71,647Total minimum lease payments

$
1,963,687





Rental expenses under operating leases amounted to $1,657,387, $1,219,194 and $1,273,525 for the years ended December 31, 2008, 2009 and 2010, respectively.




Commitment to Purchase technology




On September 30, 2009, the Company entered into an agreement with a third party vendor under which the vendor would license certain technology to the Company. As of December 31, 2010, the Company had committed to pay non-refundable and pre-paid license fee of US$1.2 million to this vendor for technology to be received in 2011.




Legal contingencies




The Company is a party to legal matters and claims that are normal in the course of its operations. The Company has received some notices of claims for infringement of certain intellectual property, but believes that the likelihood of losses arising from such claims is remote as of December 31, 2010. While the Company also believes that the ultimate outcome of these matters will not have a material adverse effect on its financial position, results of operations and cash flows, the outcome of these matters is not determinable with certainty and negative outcomes may adversely affect the Company.




In November 2010, the Company submitted an arbitration application against a customer for breaching of its purchase commitment specified in certain sales agreements. In December 2010, the customer submitted a counter claim which requests the Company to compensate its losses, expenses and costs in the approximate amount of RMB11.2 million (US$1.7 million). The Company accrued a contingent loss of RMB5.6 million (approximately $0.8million), being the amount of management’s estimated loss, for the arbitration case.




23. SUBSEQUENT EVENT





On January 4, 2011, pursuant to the resolution of the Board, the Company granted 3,004,983 RSUs to its employees, with fair value of approximately $18 million on the date of grant.


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