Techpoint, Inc. - Quarter Report: 2017 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2017

OR

For the transition period from _______ to _______

Commission File Number: 000-55843

Techpoint, Inc.

(Exact Name of Registrant as Specified in its Charter)

2550 N. First Street, #550

San Jose, CA 95131 USA

(408) 324-0588

(Address, including zip code, and telephone number,

including area code, of registrant’s principal executive offices)

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  ☐    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, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of November 10, 2017, the registrant had 17,021,905 shares of common stock, $0.0001 par value per share, outstanding.

Table of Contents

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

Techpoint, Inc.

Condensed Consolidated Balance Sheets

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

See accompanying notes to condensed consolidated financial statements.

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Techpoint, Inc.

Condensed Consolidated Statements of Operations

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

See accompanying notes to condensed consolidated financial statements.

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Techpoint, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands, unaudited)

See accompanying notes to condensed consolidated financial statements.

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Techpoint, Inc.

Notes to Condensed Consolidated Financial Statements

(unaudited)

1. Organization and Summary of Significant Accounting Policies

Organization

Techpoint, Inc. and its wholly-owned subsidiaries (the “Company”) was originally incorporated in California in April 2012 and reincorporated into Delaware in July 2017. The Company is a fabless semiconductor company that designs, markets and sells mixed-signal integrated circuits for multiple video applications in the security surveillance and automotive markets. The Company is headquartered in San Jose, California.

Initial Public Offering

On September 29, 2017, the Company completed its initial public offering (“IPO”) of Japanese depositary shares (“JDS”).  In connection with the IPO, the Company sold 1,520,000 JDSs, represented by 1,520,000 shares of the Company’s common stock at a price to the public of $5.85 per share for net proceeds of $8.1 million, after deducting underwriting discounts and commissions of $0.7 million. Additionally, offering costs incurred by the Company totaled $3.0 million. Proceeds from the IPO were received and maintained in Japanese yen as of September 30, 2017, and were subject to foreign currency revaluation.  Prior to the closing of the Company’s IPO, all outstanding shares of its preferred stock converted to common stock on a one-to-one basis.

On October 25, 2017, the managing underwriter of our IPO elected to purchase an additional 228,000 shares of JDSs, represented by 228,000 shares of common stock, pursuant to the underwriters’ over-allotment option.  We subsequently completed the sale at the IPO price of $5.85 per share and received net proceeds of $1.2 million, after deducting underwriter discounts and commissions of $0.1 million.  The accompanying unaudited condensed financial statements, including share and per share amounts, do not give effect to the exercise of the over-allotment option by the underwriters in the IPO.

Basis of Consolidation and Significant Accounting Policies

The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, and have been prepared in conformity with generally accepted accounting principles in the United States (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”). All intercompany balances and transactions have been eliminated. The functional currency of each of the Company’s subsidiaries is the U.S. dollar. Foreign currency gains or losses are recorded as other income (expense) in the Consolidated Statements of Operations.

The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes for the year ended December 31, 2016 contained in our prospectus filed pursuant to Rule 424(b) under the Securities Act of 1933 with the SEC on September 20, 2017.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, which only include normal recurring adjustments, necessary to present fairly the Company’s financial position, results of operations and cash flows for the interim periods and are not necessarily indicative of the results to be expected for the full fiscal year or for any other future annual or interim periods.

Use of Management’s Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenue and expenses during the reporting period. Significant estimates included in the consolidated financial statements include inventory valuation, valuation allowance for recorded deferred tax assets, and stock based compensation. These estimates are based upon information available as of the date of the consolidated financial statements. Actual results could differ materially from those estimates.

Concentration of Customer and Credit Risk

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and trade receivables. Risks associated with cash and cash equivalents are mitigated by banking with creditworthy institutions. The Company generally requires advance payments from customers. The Company also performs credit evaluations of its

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customers and provides credit to certain customers in the normal course of business. The Company has not incurred bad debt write-offs during any of the periods presented.

For the nine months ended September 30, 2017 and 2016, one customer, a distributor, accounted for 73% and 86% of revenue, respectively. Additionally, for the nine months ended September 30, 2017 and 2016, one of our end-customers accounted for 60% and 65% of revenue, respectively, which primarily occurred through this distributor. No other customers accounted for 10% or greater of our revenue in the nine months ended September 30, 2017 or 2016, respectively.

Recently Adopted Accounting Pronouncements

Stock Compensation Guidance. In March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-09 (ASC Topic 718), Stock Compensation — Improvements to Employee Share-Based Payment Accounting, which simplifies the accounting for share based payment transactions, including the income tax consequences, forfeitures, and statutory tax withholding requirements, as well as classification on the statement of cash flows. ASU 2016-09 is effective for the Company beginning the first quarter of fiscal 2017. The Company adopted the guidance in the first quarter of fiscal 2017, which resulted in no material impacts on its financial position, results of operations, or cash flows, and expects the primary impact of this standard to be the income tax effects of awards recognized in the income statement when the awards are vested or settled. The potential tax impacts remain unknown until the award vest or settlement date.

Inventory Measurement Guidance. In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory, amending ASC 330. Upon adoption, this topic supersedes the existing guidance under ASC 330 and aims to simplify the subsequent measurement of inventory. Currently, inventory can be measured at the lower of cost or market, which could result in several potential outcomes, as market could be replacement cost, net realizable value or net realizable value less an approximately normal profit margin. The major amendments would be as follows: 1. Inventory should be measured at the lower of cost or net realizable value. 2. Net realizable value is the estimated selling price in the ordinary course of business less reasonably predictable costs of completion, disposal and transportation. 3. The amendment does not apply to inventory measured under LIFO or the retail inventory method. 4. The amendment does apply to all other inventory, which includes inventory measured via FIFO or average cost. ASU 2015-11 became effective for periods beginning after December 15, 2016 (including interim reporting periods within those fiscal years), or the first quarter of fiscal 2017. The Company adopted this guidance in the first quarter of fiscal 2017, which resulted in no material impact on its consolidated financial statements.

Recently Issued Accounting Pronouncements Not Yet Adopted

Lease Guidance. In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 requires lessees to recognize all leases with terms in excess of one year on their balance sheet as a right-of-use asset and a lease liability at the commencement date. The new standard also simplifies the accounting for sale and leaseback transactions. The amendments in this update are effective for annual periods beginning after December 15, 2018, and interim periods therein and must be adopted using a modified retrospective method for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. Early adoption is permitted. The Company does not expect that the adoption of this amendment will have a material impact on its consolidated financial statements.

Revenue Recognition Guidance. In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, creating ASC Topic 606. Upon adoption, this topic supersedes the existing guidance under ASC 605 and aims to simplify the number of requirements to follow for revenue recognition and make revenue recognition more comparable across various entities, industries, jurisdictions and capital markets. There are 5 core principles: 1. Identify the contract(s) with a customer. 2. Identify the performance obligations in the contract. 3. Determine the transaction price. 4. Allocate the transaction price to performance obligations in the contract. 5. Recognize revenue when (or as) the entity satisfies a performance obligation. Additional considerations under this update include: accounting for costs to obtain or fulfill a contract with a customer and additional quantitative and qualitative disclosures. ASU 2014-09 will become effective for periods beginning after December 15, 2017 (including interim reporting periods within those periods), or the first quarter 2018, and allows for retrospective or modified retrospective application.

The Company has preliminarily completed its evaluation of the effect of the standard on the Company’s financial statements. The Company’s evaluation focused on the review of significant customer contracts as well as business processes, systems and controls required to support appropriate recognition and disclosure under the new standard. Based on the Company’s preliminary evaluation, the Company has not yet identified any expected material impact on the financial statements from the review of its existing customer contracts.  The Company will evaluate new contracts with customers as they are obtained and will adopt the standard using the modified retrospective approach in the first quarter of 2018.

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2. Balance Sheet Components

Inventory

Inventory consists of the following (in thousands):

Property and Equipment - Net

Property and equipment - net consists of the following (in thousands):

The Company recorded $53,000 and $44,000 of depreciation expense for the three months ended September 30, 2017 and 2016, respectively, and $0.2 million and $0.1 million nine months ended September 30, 2017 and 2016, respectively.

Accrued Liabilities

Accured liabilities consist of the following (in thousands):

Customer Deposits

Customer deposits represent payments received in advance of shipments of $0.1 million and $0.7 million as of September 30, 2017 and December 31, 2016, respectively.

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3. Fair Value Measurements

Fair value is defined as the exchange price that would be received from selling an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company measures financial assets and liabilities at fair value at each reporting period using a fair value hierarchy which requires us to maximize the use of observable inputs and minimize the use of unobservable inputs. A financial instrument’s classification within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Three levels of inputs may be used to measure fair value:

Level 1. Quoted prices in active markets for identical assets or liabilities.

Level 2. Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3. Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities, including pricing models, discounted cash flow methodologies and similar techniques.

Financial assets measured at fair value on a recurring basis were as follows:

As of September 30, 2017 and December 31, 2016, money market funds are classified as Level 1 because they are valued using quoted market prices and are included in cash and cash equivalents.

4. Segment Information

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or group, in deciding how to allocate resources and in assessing performance.

The Company’s chief operating decision maker, the chief executive officer, reviews financial information presented on a consolidated basis for purposes of regularly making operating decisions and assessing financial performance. Accordingly, the Company considers itself to be in one reportable segment, which is comprised of one operating segment, the designing, marketing and selling of mixed-signal integrated circuits for the security surveillance and automotive markets.

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Product revenue from customers is designated based on the geographic region to which the product is delivered. Revenue by geographic region was as follows (in thousands):

Revenue by principal product lines were as follows (in thousands):

Long-lived assets are attributed to the geographic region where they are located. Net long-lived assets by geographic region were as follows (in thousands):

5. Commitments and Contingencies

Operating leases

The Company leases facilities under non-cancellable lease agreements expiring through fiscal year 2020.

As of September 30, 2017, the aggregate future minimum lease payments under operating leases consist of the following (in thousands):

Rent expense under operating leases was $0.1 million and $0.1 million for the three months ended September 30, 2017 and 2016, respectively, and $0.4 million and $0.3 million for the nine months ended September 30, 2017 and 2016, respectively.

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Purchase Commitments

As of September 30, 2017, the Company had purchase commitments with its third-party suppliers through fiscal year 2018. Future minimum payments under purchase commitments are $45,000 and $63,000 for the years ending December 31, 2017 and 2018, respectively.

Litigation

Although the Company is not currently subject to any litigation, and no litigation is currently threatened against it, the Company may be subject to legal proceedings, claims and litigation, including intellectual property litigation, arising in the ordinary course of business. Such matters are subject to many uncertainties and outcomes and are not predictable with assurance. The Company accrues amounts that it believes are adequate to address any liabilities related to legal proceedings and other loss contingencies that the Company believes will result in a probable loss that is reasonably estimable.

Indemnification

During the normal course of business, the Company may make certain indemnities, commitments and guarantees which may include intellectual property indemnities to certain of the Company’s customers in connection with the sales of the Company’s products and indemnities for liabilities associated with the infringement of other parties’ technology based upon the Company’s products. The Company’s exposure under these indemnification provisions is generally limited to the total amount paid by a customer under the agreement. However, certain agreements include indemnification provisions that could potentially expose us to losses in excess of the amount received under the agreement. In addition, the Company indemnifies its officers, directors and certain key employees while they are serving in good faith in such capacities.

The Company has not recorded any liability for these indemnities, commitments and guarantees in the accompanying consolidated balance sheets. Where necessary, the Company accrues for losses for any known contingent liabilities, including those that may arise from indemnification provisions, when future payment is probable.

6. Stockholders’ Equity

Convertbile Preferred Stock

The Company had authorized and issued Series Seed Preferred Stock (“Series Seed”), Series A preferred stock (“Series A”), and Series B preferred stock (“Series B”). Preferred stock outstanding as of December 31, 2016 consisted of the following (in thousands, except share and per share data):

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Prior to the closing of the Company’s IPO, all shares of the then-outstanding convertible preferred stock, as shown in the table above, converted on a one-for-one basis into common stock.

Common Stock

The Company was authorized to issue 75,000,000 shares of common stock with $0.0001 par value per share as of September 30, 2017. The shares of common stock issued and outstanding were 16,365,738 excluding 330,167 legally issued shares subject to repurchase related to the early exercise of options to purchase common stock as of September 30, 2017.

The Company has reserved the following number of shares of common stock for future issuances:

7. Stock Option Plan

Stock Incentive Plan

In April 2012, the Company adopted the 2012 Stock Option Plan (“2012 Plan”). The 2012 Plan provides for the granting of stock-based awards to employees, directors, and consultants under terms and provisions established by the Company’s board of directors. Under the terms of the 2012 Plan, options may be granted at an exercise price not less than fair market value. For employees holding more than 10% of the voting rights of all classes of stock, the exercise prices for incentive and nonstatutory stock options must be at least 110% of fair market of the common stock on the grant date, as determined by the Company’s board of directors. The terms of options granted under the 2012 Plan may not exceed ten years.

In August 2017, the Company adopted the 2017 Stock Option Plan (“2017 Plan”). The Company’s stockholders approved the 2017 Plan in September 2017 and it became effective immediately prior to the closing of the Company’s IPO. In connection with the adoption of the 2017 Plan, no additional awards and no shares of common stock remain available for future issuance under the 2012 Plan and shares reserved but not issued under the 2012 Plan as of the effective date of the 2017 Plan were included in the number of shares reserved for issuance under the 2017 Plan. The Company has reserved 3,953,649 shares of its common stock for issuance under the 2017 Plan, including 1,453,649 shares reserved but not issued under the 2012 Plan as of the effective date of the 2017 Plan. In addition, shares subject to awards under the 2012 Plan that are forfeited or terminated will be added to the 2017 Plan. The number of shares that have been authorized for issuance under the 2017 Plan will be automatically increased on the first day of each fiscal year beginning on January 1, 2018 and ending on (and including) January 1, 2027, in an amount equal to the lesser of (1) 4% of the outstanding shares of our common stock on the last day of the immediately preceding fiscal year, or (2) another amount determined by the Company’s board of directors. The 2017 Plan provides for the granting of incentive stock options, or ISOs, within the meaning of Section 422 of the Code to employees and the granting of nonstatutory stock options, or NSOs, to employees, non-employee directors, advisors and consultants. The 2017 Plan also provides for the grants of restricted stock, stock appreciation rights, or SARs, stock unit and cash-based awards to employees, non-employee directors, advisors and consultants.

The Company has various vesting agreements with employees. Options granted to employees generally vest over a five-year period with 20% vesting at the end of one year and the remaining to vest monthly thereafter. Options granted generally are exercisable up to 10 years.

Early Exercise of Stock Options

Certain employees and directors have exercised option grants prior to vesting. The unvested shares are subject to a repurchase right held by the Company at the original purchase price. The proceeds initially are recorded as liability related to early exercised stock options and reclassified to additional paid in capital as the repurchase right lapses. The Company issued 37,167 and 302,083 unvested shares of common stock upon early exercise for the nine months ended September 30, 2017 and 2016, respectively, for total exercise proceeds of $26,000 and $113,000, respectively. For the nine months ended September 30, 2017 and 2016, the Company

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repurchased 45,666 and 37,167 shares, respectively, of unvested common stock related to early exercised stock options at the original purchase price due to termination of employees. As of September 30, 2017, 330,167 shares held by employees and nonemployees were subject to repurchase at an aggregate price of $153,000.

Stock Options

The Company’s stock option activity under the stock incentive plan is summarized as follows:

The stock options outstanding and exercisable by exercise price at September 30, 2017, are as follows:

The aggregate intrinsic value of options exercised for the nine months ended September 30, 2017 and 2016 was $0.4 million and $0.8 million, respectively.

8. Stock-Based Compensation

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The following table summarizes the distribution of stock-based compensation expense (in thousands):

9. Net Income Per Share

For the periods presented prior to the Company’s IPO, basic and diluted net income per common share are presented in conformity with the two-class method required for participating securities. Prior to the closing of the Company’s IPO, all outstanding shares of its Series Seed, Series A, and Series B convertible preferred shares, which were participating securities, were converted to common stock on a one-to-one basis. The common stock issued for the conversion of 10,742,500 preferred shares were included in calculation of the weighted average shares outstanding for the three and nine months period ended September 30, 2017.  

The following table presents the calculation of basic and diluted net income per share (amounts in thousands, except per share data):

The potentially dilutive securities outstanding as of September 30, 2017 and 2016 that were excluded from the computation of diluted net income per common share for the periods presented as their effect would have been antidilutive was 2,988 and 39,860 shares, respectively, related to stock options.

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10. Income Taxes

The components of income before income taxes are as follows (in thousands):

The components of the provision for income taxes are as follows (in thousands):

On April 1, 2007, the Company adopted FASB Interpretation No. 48 (FIN 48)(now codified in ASC 740), Accounting for Uncertainty in Income Taxes. FIN 48 clarifies the accounting for uncertainty in income taxes and prescribes a recognition threshold, measurement attribute for the financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return. Under FIN 48, the Company is required to recognize in the financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure. The Company policy is to record interest and penalties related to unrecognized tax benefits in income tax expense.

At September 30, 2017 there was no material increase in the liability for unrecognized tax benefits nor any accrued interest and penalties related to uncertain tax positions.

At September 30, 2017, the Company had approximately $0.2 million of unrecognized tax benefits of which $0.1 million was netted against deferred tax assets with a full valuation allowance. If these amounts are recognized, there will be a tax benefit of $0.1 million against the Company's effective tax rate due.

The Company’s Federal, state, and foreign tax returns may be subject to examination by the tax authorities for fiscal years ended from 2013 to 2016.

11. Subsequent Events

On October 25, 2017, the managing underwriter of our IPO elected to purchase an additional 228,000 shares of JDSs, represented by 228,000 shares of common stock, pursuant to the underwriters’ over-allotment option.  We subsequently completed the sale at the IPO price of $5.85 per share and received net proceeds of $1.2 million, after deducting underwriting discounts and commissions of $0.1 million.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Information Regarding Forward-Looking Statements

This Quarterly Report on Form10-Q includes forward-looking statements. All statements other than statements of historical facts contained in this Quarterly Report on Form 10-Q, including statements regarding our future results of operations and financial position, strategy and plans, and our expectations for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “design,” “plan,” “project,” “intend,” “expect” or the negative version of these words and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, strategy, short-term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in “Risk Factors” in this Quarterly Report on Form 10-Q. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this Quarterly Report on Form 10-Q may not occur, and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. Forward-looking statements include, but are not limited to, statements about:

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance or achievements. Any forward-looking statement made by us in this Quarterly Report on Form 10-Q speaks only as of the date on which it is made. We disclaim any duty to update any of these forward-looking statements after the date of this Quarterly Report on Form 10-Q, except as required by law.

General Backgound

The following discussion and analysis should be read together with our consolidated financial statements and the notes to those statements that appear in this Quarterly Report on Form 10-Q and our prospectus filed pursuant to Rule 424(b)(4), on September 20, 2017 (“Prospectus”). This discussion contains forward-looking statements based on our current expectations, assumptions, estimates and projections. These forward-looking statements involve risks and uncertainties. Our actual results could differ materially from those indicated in these forward-looking statements as a result of certain factors, as more fully described in “Risk Factors” in this Quarterly Report on Form 10-Q.

In this Quarterly Report, unless otherwise specified or the context otherwise requires, “Techpoint,” “we,” “us,” and “our” refer to Techpoint, Inc. and its consolidated subsidiaries.

Overview

We are a fabless semiconductor company that designs, markets and sells mixed-signal integrated circuits for multiple video applications in the security surveillance and automotive markets. Our integrated circuits are enabling the transition from standard definition, or SD, video to high definition, or HD, video in the security surveillance and automotive industries. We target specific video applications that receive and process high definition analog video signals, including surveillance cameras, surveillance digital video recorders, or DVRs, as well as cameras in automobiles. We design application specific products that utilize our HD analog transmission technology and perform advanced digital video processing to facilitate the display, transmission and storage of video content. We believe designing our integrated circuits for specific applications allows us to better address varying end-customer requirements, fully leverage our technological capabilities and achieve greater share within our target markets.

Our solutions take HD video signals from a camera and convert them into analog signals for reliable long distance transmission, then convert the HD analog signal into the appropriate format for video processing and display. Our HD analog technology operates at

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the same 1080p HD resolution as digital HD, but processes video in an HD analog format and transmits the video in this same analog format, thereby eliminating the need for any compression or decompression. Our integrated circuits are based on our proprietary architecture and mixed signal technologies that we believe provide high video quality, enable high levels of integration and are cost effective. Our integrated circuits are used by leading security surveillance manufacturers, such as Hikvision in China, IDIS in South Korea and AVTech in Taiwan. These three manufacturers are each a leading security surveillance manufacturer in its respective country and together accounted for 61% of our revenue in the nine months ended September 30, 2017.

We derive our revenue from sales of our mixed-signal integrated circuits into the security surveillance and automotive camera markets. We began shipping our products in 2013 and to date, we have sold over 56 million integrated circuits. Our revenue has increased 10% to $23.4 million for the nine months ended September 30, 2017 from $21.3 million for the nine months ended September 30, 2016. We recorded net income of $3.7 million and $3.0 million for the nine months ended September 30, 2017 and 2016, respectively. The security surveillance market accounted for a majority of our revenue in the nine months ended September 30, 2017 and 2016. We have secured design wins with major automotive equipment manufacturers to sell our solutions to them for automotive backup cameras. We recognized $2.0 million and $0.3 million of revenue on sales into the automotive market in the nine months ended September 30, 2017 and 2016, respectively.

We sell our products to distributors that fulfill third-party orders for our products. We also sell directly to original design manufacturers, or ODMs. In the nine months ended September 30, 2017 and 2016, we derived substantially all of our revenue from products sold to distributors as compared to products sold to ODMs directly.

We undertake significant product development efforts well in advance of a product’s release, and in advance of receiving purchase orders. Our product development efforts, which are focused on developing new designs with broad demand and potential for future derivative products, typically take from six to 24 months until production begins, depending on the product’s complexity. If we secure a design win, we believe the system designer is likely to continue to use the same or enhanced versions of our product across a number of their models, tending to extend the life cycles of our products. Conversely, if a competitor secures the design win, it may be difficult for us to sell into the end-customer’s application for an extended period. Our sales cycle typically ranges from three to six months for the security surveillance market and one to three years for the automotive industry. Due to the length of our product development and sales cycle, the majority of our revenue for any period is likely to be weighted toward products introduced for sale in the prior one or two years. As a result, our present revenue is not necessarily representative of future sales because our future sales are likely to be comprised of a different mix of products, some of which are now in the development stage.

We employ a fabless manufacturing strategy and use market-leading suppliers for all phases of the manufacturing process, including wafer fabrication, assembly, testing and packaging. This strategy significantly reduces the capital investment that would otherwise be required to operate manufacturing facilities of our own.

We have made significant investments in research and development in order to develop our products to attract and retain end-customers. For the nine months ended September 30, 2017 and 2016, our research and development expense was $3.8 million and $3.4 million, respectively. We expect that our research and development expenses will increase significantly in the future as we pursue additional opportunities. As of September 30, 2017, we had 63 employees, 23 of whom are in research and development. We also had 4 full-time contractors based in China and South Korea. Our headquarters are located in San Jose, California, with additional operations in Japan, Taiwan, China and South Korea.

Key Factors Affecting Our Results of Operations

The following are key factors that impact our results of operations:

Ability to attract and retain customers that make large orders. In the nine months ended September 30, 2017, three of our end-customers accounted for 71% of our revenue, one of which, Hikvision, the largest security surveillance manufacturer in China, accounted for 60%. In the nine months ended September 30, 2016, Hikvision accounted for 65% of our revenue, respectively. While we expect the composition of our end-customers to change over time, our business and operating results will depend on our ability to continually target new and retain existing end-customers that make large orders.

Design wins with new and existing customers. We believe our products provide high-quality HD video with an attractive combination of characteristics, at a lower overall cost than competing solutions. In order to get our solutions designed into our end-customer’s products, we work with our end-customers and potential end-customers to understand their product roadmaps and strategies. We consider design wins to be critical to our future success. We define a design win as the successful completion of the evaluation stage, where an end-customer has tested our product, verified that our product meets its requirements and qualified our integrated circuits for their products. We have secured design wins with major automotive manufacturers to sell our solutions to them for automotive backup cameras. The revenue that we generate, if any, from each design win can vary significantly. Our long-term sales expectations are based on

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forecasts from end-customers, internal estimates of end-customer demand factoring in expected time to market for end-customer products incorporating our solutions and associated revenue potential and internal estimates of overall demand based on historical trends.

Pricing, product cost and gross margins of our products. Our gross margin has been and will continue to be affected by a variety of factors, including the timing of changes in pricing, shipment volumes, new product introductions, changes in product mixes, changes in our purchase price of fabricated wafers and assembly and test service costs, manufacturing yields and inventory write downs, if any. In general, newly introduced products and products with higher performance and more features tend to be priced higher than older, more mature products. Average selling prices in the semiconductor industry typically decline as products mature. Consistent with this historical trend, we expect that the average selling prices of our products will decline as they mature. In the normal course of business, we will seek to offset the effect of declining average selling prices on existing products by reducing manufacturing costs and introducing new and higher value-added products. If we are unable to maintain overall average selling prices or offset any declines in average selling prices with realized savings on product costs, our gross margin will decline.

Product adoption and safety regulations in the automotive market. We have secured design wins with major automotive equipment manufacturers to sell our solutions to them for automotive backup cameras. Certain jurisdictions, including the United States, have passed laws and regulations requiring that all new cars sold after a certain date must contain back-up cameras. If these jurisdictions do not maintain and implement these rules, or if back-up cameras are not put into automobiles sold in other locations as well, or do so more slowly than we expect, our financial results could be adversely affected.

Investment in growth. We have invested, and intend to continue to invest, in expanding our operations, increasing our headcount, developing our products and differentiated technologies to support our growth and expanding our infrastructure. We expect our total operating expenses to increase significantly in the foreseeable future to meet our growth objectives. We plan to continue to invest in our sales and support operations throughout the world, with a particular focus in the near term of adding additional sales and field applications personnel in the Asia-Pacific region to further broaden our support and coverage of our existing end-customer base, in addition to developing new end-customer relationships and generating design wins. We also intend to continue to invest additional resources in research and development to support the development of our products and differentiated technologies. Any investments we make in our sales and marketing organization or research and development will occur in advance of experiencing any benefits from such investments, and the return on these investments may be lower than we expect. In addition, as we invest in expanding our operations into new areas internationally, our business and results will become further subject to the risks and challenges of operations in those locations, including potentially higher operating expenses and the impact of legal and regulatory developments.

Components of Consolidated Statements of Operations

Revenue

We derive substantially all of our revenue through the sale of our products to distributors who, in turn, sell to our end-customers, which consists of ODMs, contract manufacturers and design houses. We recognize revenue from product sales when persuasive evidence of an arrangement exists and all other revenue recognition criteria are met, which generally occurs when we ship our product to the distributors.

Cost of revenue

Cost of revenue primarily consists of costs paid to our third-party manufacturers for wafer fabrication, assembly and testing of our products. To a lesser extent, cost of revenue also includes write-downs of inventory for excess and obsolete inventory, depreciation of test equipment, and expenses relating to manufacturing support activities, including personnel-related costs, logistics and quality assurance and shipping.

Research and Development Expenses

Research and development expenses consist primarily of compensation and associated costs of employees engaged in research and development, contractor costs, tape-out costs, development testing and evaluation costs, and depreciation expense. Before releasing new products, we incur charges for mask sets, prototype wafers and mask set revisions, which we refer to as tape-out costs. Tape-out costs cause our research and development expenses to fluctuate because they are not incurred uniformly every quarter. We expect our research and development costs to increase in absolute dollars in the future as we increase our investment in developing new products and headcount to support our development efforts.

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Selling, General and Administrative Expenses

Selling expenses consist primarily of personnel-related costs for our sales, business development, marketing, and applications engineering activities, promotional and other marketing expenses, and travel expenses. We expect selling expenses to increase in absolute dollars for the foreseeable future as we continue to expand our sales teams and increase our marketing activities.

General and administrative expenses consist primarily of personnel-related costs, consulting expenses and professional fees. Professional fees principally consist of legal, audit, tax and accounting services. We expect general and administrative expenses to increase in absolute dollars for the foreseeable future as we hire additional personnel, make improvements to our infrastructure and incur significant additional costs for the compliance requirements of operating as a public company, including higher legal, insurance and accounting expenses, particularly with respect to operating as a U.S. company that is publicly traded in Japan.

Personnel-related costs, including salaries, benefits, bonuses and stock-based compensation, are the most significant component of each of selling expenses and general and administrative expenses.

Income Tax Provision

The provision for income taxes consists of our estimated federal, state and foreign income taxes based on our pre-tax income. Our provision differs from the federal statutory rate primarily due to the research tax credit and non-deductible stock-based compensation.

Results of Operations

The following table sets forth our consolidated results of operations for the periods shown:

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The following table sets forth the consolidated statements of operations data for each of the periods presented as a percentage of revenue:

Comparison of the Three and Nine Months Ended September 30, 2017 and September 30, 2016

Revenue