OMNIVISION TECHNOLOGIES INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Edgar Glimpses |

The following information should be read in conjunction with our audited consolidated financial statements and the notes thereto included in Item 8 of this Annual Report on Form 10-K.

Overview

We design, develop and market high performance, highly integrated and cost-efficient semiconductor image-sensor devices. Our main products, image-sensing devices which we refer to as CameraChip™ image sensors, capture an image electronically and are used in a number of consumer and commercial mass-market applications. Our CameraChip image sensors are manufactured using the complementary metal oxide semiconductor, or CMOS fabrication process and are predominantly single-chip solutions that integrate several distinct functions including image capture, image processing, color processing, signal conversion and output of a fully processed image or video stream. We have also integrated our CameraChip image sensors with wafer-level optics, which we refer to as CameraCubeChip imaging devices. Our CameraCubeChip™ imaging device is a small footprint, total camera solution that we believe will enable the further miniaturization of camera products. We believe that our highly integrated image sensors and imaging devices enable camera device manufacturers to build high quality camera products that are smaller, less complex, more reliable, more cost-effective and more power-efficient than cameras using traditional charge-coupled devices, or CCDs.

Current Economic Environment

We operate in a challenging economic environment that has undergone significant changes in technology and in patterns of global trade. We remain a leader in the development and marketing of image sensing devices based on the CMOS fabrication process and have benefited from the growing market demand for and acceptance of this technology.

Since the latter part of fiscal 2009, we have experienced fluctuations in our financial results due in part to changing macroeconomic conditions. As macroeconomic conditions have improved, our sales have also tended to improve and when macroeconomic uncertainties have returned, our sales have tended to be negatively impacted. In fiscal 2014, macroeconomic conditions appeared to continue to improve, and our annual sales increased slightly when compared to fiscal 2013. However, for the second half of fiscal 2014, we actually experienced a decline in sales when compared to the similar prior year period. Given the continuing uncertainties in current economic environment and the volatility in our business, we remain cautious and we expect our customers to be cautious as well, which could affect our future results. If the economic recovery slows down or even dissipates, our business, financial condition, results of operations and cash flows could be materially and adversely affected.

Market Environment

We sell our products worldwide directly to OEMs which include branded customers and contract manufacturers, and VARs and indirectly through distributors. In order to ensure that we address all available markets for our image sensors, we organize our marketing efforts into end-use market groups, each of which concentrates on a particular product or, in some cases, customers within a product group. Thus, we have marketing teams that address the mobile phone market, the entertainment market, the notebook and webcam market, the DSC market, the security and surveillance market, and the automotive and medical markets.

In the mobile phone market in particular, future revenues depend to a large extent on an extensive design win process where a particular mobile phone maker determines which image sensor to design into one or more specific models. The time lag between design win and volume shipments varies from

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as little as three months to as much as 12 months, which could cause an unexpected delay in generating revenues, especially during periods of product transitions. Design wins are also an important driver in the many other markets that we address. In some markets, such as automotive or medical applications, the time lag between a particular design win and revenue generation can be longer than one year.

The overwhelming majority of our sales depend on decisions by the engineering designers for manufacturers of products that incorporate image sensors to specify one of our products rather than one made by a competitor. In most cases, the decision to specify a particular image sensor requires conforming other specifications of the product to the chosen image sensor and makes subsequent changes both difficult and expensive. Accordingly, the ability to produce and deliver reliable products in large quantities and in a timely manner is a key competitive differentiator. Since our inception, we have shipped more than 4.8 billion image sensors, including approximately 861 million in fiscal 2014. We believe that these quantities demonstrate the capabilities of our production system, including our sources of offshore fabrication.

We outsource the wafer fabrication and packaging of our image-sensor products to third parties. We outsource the color filter and micro-lens phases of production to VisEra, our joint venture with the TSMC. This approach allows us to focus our resources on the design, development, marketing and testing of our products and to significantly reduce our capital requirements.

To increase and enhance our production capabilities, we work closely with TSMC, our principal wafer supplier and one of the largest wafer fabrication companies in the world, to increase, as necessary, the number of its fabrication facilities at which our products can be produced. We also outsource some of our wafer fabrication needs to PTC. Our investments in VisEra and two other key back-end packaging suppliers are part of a broad strategy to ensure that we have sufficient back-end capacity for the processing of our image sensors in the various formats required by our customers. To enhance our CameraCubeChip production capabilities, we acquired from VisEra in October 2011 its CameraCubeChip production and assembly operations, which we had previously outsourced to them.

We currently perform the final testing of the majority of our products at our own facility in China. As necessary, we will make further investments to expand our testing and production capacity, as well as our overall capability to design additional custom products for our customers.

Since our customers' end-user customers market and sell their products worldwide, our revenues by geographic location are not necessarily indicative of the geographic distribution of end-user sales, but rather indicate where the products and/or their components are manufactured or sourced. The revenues we report by geography are based on the country or region in which our customers issue their purchase orders to us.

Many of the products using our image sensors, such as mobile phones, entertainment applications such as tablets notebooks and webcams, and DSCs are consumer electronics goods. These mass-market camera devices generally have seasonal cycles which historically have caused the sales of our customers to fluctuate quarter-to-quarter. In addition, since a very large number of the manufacturers who use our products are located in China and Taiwan, the pattern of demand for our image sensors has been increasingly influenced by the timing of the extended lunar or Chinese New Year holiday, a period in which the factories which use our image sensors generally close. Consequently, demand for our image sensors has historically been stronger in the second and third quarters of our fiscal year and weaker in the first and fourth quarters of our fiscal year. Due to the macroeconomic uncertainties that have existed during the past several years, the seasonal cycle of our business has been less predictable. Beginning in fiscal 2013, our business started to recover and the seasonal cycle in our business became

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very pronounced. However, in fiscal 2014, we experienced a decline in sales of products that were used in mobile phones made by end-user customers located in North America, which was partially offset by an increase in the sale of products that were used in mobile phones made by end-user customers located in China. As a result, the seasonal sales pattern from fiscal 2013 did not recur in fiscal 2014. Given the current economic environment, we remain cautious toward our near-term business prospects and the return of the historical seasonal cycle of our business.

We anticipate that sales of our products used in mobile phones made by end-user customers located in China will be a primary contributor to our revenues in fiscal 2015. However, we recognize that the China market is highly volatile, extremely competitive and has intense pricing pressures. While we believe that the market opportunities represented by mobile phones and entertainment applications such as tablets remain very large, the opportunities presented could be deferred because of the uncertainty surrounding the sustainability of the current global economic recovery or the volatility, competition and pricing pressure that exist in the markets in which we operate.

We believe that, like the DSC markets, mobile phone, tablet, notebook and webcam demand will not only continue to shift toward higher resolutions, but also will increasingly fragment into multiple market segments with differing product attributes. For example, we see the further expansion of the smartphone segment within the mobile phone market. In addition, there is increased demand for customization, and several different interface standards are coming to maturity. All of these trends will require the development of broader variety of products.

As the markets for image sensors have grown, we have experienced competition from manufacturers of CMOS and CCD image sensors. Our principal competitors in the market for CMOS image sensors include Aptina Imaging, Samsung, Sharp, Sony, STMicroelectronics and Toshiba. We expect to see continued price competition in the image-sensor market for mobile phones, entertainment devices, notebooks and webcams, security and surveillance systems, digital still and video cameras, automotive and medical imaging systems as those markets continue to grow. Although we believe that we currently compete effectively in those markets, our competitive position could be impaired by companies that have greater financial, technical, marketing, manufacturing and distribution resources, broader product lines, better access to large customer bases, greater name recognition, longer operating histories and more established strategic and financial relationships than we do. Such companies may be able to adapt more quickly to new or emerging technologies and customer requirements or devote greater resources to the promotion and sale of their products. Many of these competitors own and operate their own fabrication facilities, which in certain circumstances may give them the ability to price their products more aggressively than we can or may allow them to respond more rapidly than we can to changing market opportunities.

In addition, from time to time, other companies enter the CMOS image-sensor market by using obsolete and available manufacturing equipment. While these efforts have rarely had any long-term success, the new entrants do sometimes manage to gain market share in the short-term by pricing their products significantly below current market levels which may put additional downward pressure on the prices we can obtain for our products.

In common with many other semiconductor products and as a response to competitive pressures, the average selling prices, or ASPs of image-sensor products have declined steadily since their introduction, and we expect ASPs to continue to decline in the future, especially if sales of mobile phones that use our products continue to shift from those made by end-user customers located in North America to those made by end-user customers located in Asia. Some of this ASP decline may be offset by the adoption of some of our newer and higher resolution products such as our

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CameraCubeChip products, which carry a higher ASP because of the added value from the attachment of wafer-level optics to our image sensors. Depending on the adoption rate and unit volume, we believe these products could help to mitigate the rate of ASP decline. In order to maintain or grow our revenues, we need to increase the number of units we sell by a large enough amount to offset the effect of declining ASPs.

Separately, in order to maintain our gross margins, we and our suppliers must work continuously to lower our manufacturing costs and increase our production yields. In fiscal 2013, we requested our suppliers to invest in additional equipment in connection with the production of our OmniBSI-2 products. Such investment resulted in higher product costs for these products. Because we experienced increased sales of our OmniBSI-2 products in fiscal 2013 and 2014, and expect these products to continue to constitute a significant percentage of our total sales in fiscal 2015, we anticipate that our gross margins will remain at lower levels than we have experienced historically, before our introduction of OmniBSI-2. If we are unable to spread such added cost over larger unit sales, successfully negotiate lower prices with our suppliers, or improve our gross margin through better product mix, our gross margin may continue to stay at these lower levels for future periods as well. In addition, if we are unable to timely develop and introduce new products that can take advantage of smaller process geometries or new products that incorporate more advanced technology and include more advanced features that can be sold at higher ASPs, our gross margin may decline.

Having the ability to forecast customer demand correctly and to prepare the appropriate level of inventory to meet this demand is also important in the semiconductor industry. In fiscal 2011, the entire semiconductor industry, including us, experienced supply constraints. Due to supply constraints, semiconductor companies were unable to meet the product demands of their customers and had to take certain actions such as allocating available products among their customers or, in some cases, increasing the prices of their products. This resulted in harm to customer relations, the loss of sales to customers and, in some cases, the loss of future business with those customers. We faced these same challenges as we sought to meet our customers' demand for our products. Despite these challenges, through careful strategic planning relating to our products and the technologies that we delivered to market, we were able to achieve revenue growth and unit growth. If supply constraints were to happen again and we were unable to manage our products appropriately, our relations with our customers and their end-user customers may be harmed and we may be unable to achieve future sales growth, which could result in our revenues, gross margins and other financial results being materially and adversely affected. Conversely, an excess in inventory supply can also adversely affect our performance. During the second quarter of fiscal 2012, certain of our key customers unexpectedly cutback their orders. In addition to reducing our unit sales of our OmniBSI and OmniPixel-3HS based products and adversely affecting our revenues for the second and third quarters of fiscal 2012, the cutback also resulted in our inventories at the end of the second and third quarters of fiscal 2012 being higher than we intended them to be. During the fourth quarter of fiscal 2012 and during fiscal 2013, we significantly increased our OmniBSI-2 inventories as we prepared for anticipated increases in the sales of these products. Since our production capacity ramp is slower than our customers' production ramp schedule, we must build inventory to ensure we can meet our obligations to customers. However, since customer demand can be volatile, we may be unable to sell inventories that were built in excess of demand, or we may have to sell at lower prices to eliminate excess inventories. Under such circumstances, we may be required to record significant provisions for excess and obsolete inventories. This could materially and adversely affect our results of operations and financial condition. We expect the business environment to remain volatile in fiscal 2015, especially in the consumer-oriented product markets, which could continue to affect our ability to accurately forecast customer demand.

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Given the rapidly changing nature of our technology, there can be no assurance that we will not encounter delays or other unexpected production yield issues with future products. In general, during the early stages of production, production yields and gross margins for new products are typically lower than those of established products. During production, we can also encounter unexpected manufacturing issues, such as unexpected back-end yield problems.

In addition, in preparation for new product introductions, we gradually decrease production of established products. Due to our 12-14 week production cycle, it is extremely difficult to predict precisely how many units of established products we will need. It is also difficult to accurately predict the speed of the ramp of new products. Given the current economic uncertainty, the visibility of our business outlook is extremely limited and forecasting is even more difficult than under normal market conditions. As a result, it is possible that we could suffer from shortages of certain products and build inventories in excess of demand for other products. We carefully consider the risk that our inventories may be in excess of expected future demand and record appropriate reserves. If, as sometimes happens, we are subsequently able to sell these reserved products, the sales have little or no associated cost and consequently, they have a favorable impact on gross margins.

Strategy

Our strategic goal is to provide and deliver improved image-centric technologies and solutions to our customers, and to develop and make available a full range of innovative and cross-functional imaging products to all the markets. The most important elements of our strategy are the following:

Maintain Technology Leadership. We intend to maintain our position as a leader in CMOS image-sensor technology by continuing to develop our expertise in mixed-signal implementation, advanced pixel design, feature integration, and manufacturing processes and controls, including automated testing. Our image sensor integrates both the image sensor and the signal processor into a single chip, often eliminating the requirement for a separate DSP. As a result, our CameraChip image sensors offer camera device manufacturers advantages in terms of size, power consumption, cost and ease of design.

For example, in May 2008, we announced our OmniBSI architecture, which is the enabling technology behind our current 1.4 µm pixel. In February 2010, we announced our OmniBSI-2 architecture, which forms the basis of our even smaller and more advanced 1.1 µm pixel. In November 2013, we launched our PureCel sensors, which, when compared to our OmniBSI-2 products, offer increased unit area light sensitivity and lower power consumption. In fact, ever since the announcement of our first BSI technology in May 2008, our BSI-based product portfolio has grown tremendously. We believe our continued effort in the development of BSI technology has given us the ability to design image sensors with better sensitivity and greater functionality. Our BSI products also contribute to the reduction of camera module heights, facilitating the miniaturization of camera modules in many consumer applications.

We are continuing to develop products using still narrower geometries. We have successfully developed image sensor technology from 100,000 pixels to 16 megapixels, underscoring our ability to deliver a wide range of solutions to address changing market demands. We are committed to improving image quality and to reducing the overall size of the image sensor's array.

Our introduction of wafer-level optics to our product offerings is another example of our intention to continue to develop new and innovative technologies. Our CameraCubeChip technology is a three-dimensional, reflowable, total camera solution that combines the full functionality of our image sensors with wafer-level optics in one compact, small-footprint package.

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Our commitment to maintaining our technology leadership is also reflected in our acquisition of a CMOS sensor patent portfolio from Kodak in March 2011. We effectively doubled the size of our patent portfolio from 842 in fiscal 2010 to 1,861 in fiscal 2011. Since then, our patent portfolio has continued to increase in size. As of April 30, 2014, we have been issued 655 United States patents and 982 foreign patents. As of April 30, 2014, we have 251 additional United States patent applications pending, of which 28 have been allowed, and we have 866 foreign patent applications pending, of which 33 have been allowed.

Leverage Expertise Across Multiple Mass-Market Applications. We intend to continue to focus on developing our image sensors for multiple mass-market applications. To date we have shipped more than 4.8 billion image sensors. As the demand for camera functionality increases in our principal markets and becomes a standard feature in a wider variety of consumer, commercial and industrial applications, we expect that additional markets will emerge. In the past, we have leveraged our expertise in certain of our target markets to expand into emerging mass-market applications for our image sensors. For example, we used the expertise we developed in mobile phone markets to develop image sensors for notebook computers. Other markets and applications we are focusing on include security and surveillance, entertainment devices, and the multiple opportunities in automotive and medical applications.

Increase Our Market Presence. We intend to increase our visibility and penetration into new product designs by collaborating with OEMs, VARs and distributors and by entering into partnerships with other companies that offer complementary and supporting technologies. In certain instances we will provide design services to our contract manufacturing partners, enabling them to increase their overall value added through the production of highly tailored end products, which we believe will increase the likelihood that they will recommend the use of our products to branded manufacturers. In addition, we will partner with companies that offer complementary and supporting technologies to integrate our products with theirs for use in the reference designs that they promote to manufacturers. As a result, we believe that we are able to provide our customers with valuable design and marketing references. We also see a developing trend for video-centric applications in the consumer markets. Consequently, we acquired Aurora and its advanced image projection technology, which we believe we can leverage to offer innovative and comprehensive imaging solutions to OEMs as they design their next generation products.

Further Develop Close Customer Relationships. We intend to enhance our customer relationships by continuing to collaborate with our customers on the design and specification of their products. We work with customers during various stages of their product development cycles, including strategic decision-making, new product design and replacement design to help them develop a logical technology migration path and to ensure that our products meet their future design needs. By working closely with our customers, we believe we can better anticipate their future design needs and increase the likelihood that they will incorporate our image sensors into their products.

Our Solution

We specifically design our highly integrated image sensors to be cost-effective and to provide high image quality. By integrating a number of distinct functions onto a single CMOS chip, including image capture, image processing, color processing, signal conversion and output of images for either digital or

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analog equipment, our image sensors offer camera device manufacturers a number of benefits, including:

High Image Quality and Resolution. We have developed a number of proprietary methods for enhancing image quality by increasing our image sensors' sensitivity to light and significantly improving their signal to noise ratio. These methods allow us to reduce the size of each individual pixel and thereby increase the number of pixels in an image sensor of a given size. The result is a current portfolio of several high resolution image sensors ranging up to a 16-megapixel product. In addition, we are able to produce image sensors at lower resolutions with smaller pixel arrays, which serve to reduce the overall cost of the image sensor and its supporting components, such as lenses.

Lower Cost. The highly integrated design of our image sensors enables us to deliver image sensors to our customers at a cost which makes the cameras that they are part of increasingly less expensive. This cost saving is driven, in large part, by our ability to achieve a high level of functionality in a single chip while continually reducing the overall size of the device. Similarly, we believe our CameraCubeChip imaging devices, as compact total camera solutions that can be reflowed onto circuit boards directly, can streamline the camera device manufacturers process, yielding further cost savings to our customers.

Accelerated Time to Market. The highly integrated nature of our image sensors simplifies the design of cameras and allows our customers to shorten their product design cycles. We believe our CameraCubeChip devices further shorten the design cycle by offering a complete imaging solution from the very beginning. These factors provide our mobile phone and consumer electronics customers with critical competitive advantages, as time to market is typically a major determinant of product success and longevity. We also work closely with our customers to accelerate product development cycles by providing camera reference designs, engineering design review services and customer product evaluation, testing and debugging services. In addition, we have designed our manufacturing and production processes to allow us to quickly ramp production volumes to meet increased customer demand, which is particularly important in the high volume markets in which we participate.

Streamlined Manufacturing and Production. Our image sensors are well suited for production using the relatively simple, low cost and large-scale wafer fabrication processes developed for other semiconductor products that use the CMOS process. We work closely with our foundry partners and with all the other providers of the manufacturing services we require to produce our final products to refine their processes in order to optimize our image-sensor performance and yields.

Ease of Use. Our single-chip CMOS design generates video outputs in industry standard formats directly from the chip. These formats include the National Television System Committee, or NTSC, format and/or the Phase Alternating Line, or PAL, format for analog video. For digital video, our sensors generate unprocessed data called RGB and/or a standard signal color encoding system known as YUV. As a result, our image sensors can be quickly and easily integrated into products targeted at numerous markets.

Capital Resources

As of April 30, 2014, we held approximately $298.0 million in cash and cash equivalents and approximately $153.0 million in short-term investments. To mitigate market risk related to short-term investments, we have an investment policy designed to preserve the value of capital and to generate interest income from these investments without material exposure to market fluctuations. Market risk is the potential loss due to the change in value of a financial instrument as a result of changes in interest

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rates or bond prices, and changes in market liquidity and in the pricing of risk. Our policy is to invest in financial instruments with short maturities, limiting interest rate exposure, and to measure performance against comparable benchmarks. We maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including both government and corporate obligations with ratings of "A" or better and money market funds. We do not believe that the value of our cash and short-term investments will be significantly affected by current instability in the global financial markets.

Sources of Revenues

We generate almost all our revenues by selling our products directly to OEMs and VARs and indirectly through distributors. For accounting purposes, we treat sales to OEMs and VARs as one source of revenue, and sales to distributors as another and our revenue recognition policies for the two groups are different. See "Critical Accounting Policies and Estimates-Revenue Recognition" below for additional information regarding recognition of revenue.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates 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 the reported amounts of revenues and expenses during the reporting period. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty. On an ongoing basis we re-evaluate our judgments and estimates including those related to product returns, bad debts, inventories, long-lived assets, income taxes, stock based compensation, litigation and contingencies. We base our estimates and judgments on our historical experience, knowledge of current conditions and our beliefs of what could occur in the future considering available information. Actual results could differ from those estimates, and material effects on our operating results and financial position may result. Our significant accounting policies are more fully described in Note 2-"Summary of Significant Accounting Policies" to the consolidated financial statements included in this Annual Report on Form 10-K. Our estimates reflect the following critical accounting policies:

Revenue Recognition

For shipments to customers without agreements that allow for returns or credits, principally OEMs and VARs, we recognize revenue using the "sell-in" method. Under this method, we recognize revenue when title passes to the customer provided that we have received a signed purchase order, the price is fixed or determinable, title and risk of loss has transferred to the customer, collection of resulting receivables is considered reasonably assured, product returns are reasonably estimable, there are no customer acceptance requirements and there are no remaining material obligations. We provide for future returns of potentially defective products based on historical experience at the time we recognize revenue. For cash consideration given to customers that is primarily in the form of rebates, and for which we do not receive a separately identifiable benefit or cannot reasonably estimate fair value, we record the amounts as reductions of revenue.

For shipment of products sold to distributors under agreements allowing for returns or credits, title and the risk of ownership to the products transfer to the distributor upon shipment, and the distributor is obligated to pay for the products whether or not the distributor has sold them at the time payment is due. Under the terms of our agreements with such distributors and subject to our prior approval,

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distributors are entitled to reclaim from us as price adjustments the difference, if any, between the prices at which we sold the product to the distributors and the prices at which the product is subsequently sold by the distributor. In addition, distributors have limited rights to return inventory that they determine is in excess of their requirements, and accordingly, in determining the appropriate level of provision for excess and obsolete inventory, we take into account the inventories held by our distributors. For these reasons, prices and revenues are not fixed or determinable until the distributor resells the products to our end-user customers and the distributor notifies us in writing of the details of such sales transactions. Accordingly, we recognize revenue using the "sell-through" method. Under the "sell-through" method, we defer the revenue, adjustments to revenue and the related costs of revenue until the final resale of such products to end customers. The amounts billed to these distributors and adjustments to revenue and the cost of inventory shipped to, but not yet sold by, the distributors are shown net on the Consolidated Balance Sheets as "Deferred revenues, less cost of revenues."

In order to determine whether collection is probable, we assess a number of factors, including our past transaction history with the customer and the creditworthiness of the customer. If we determine that collection is not reasonably assured, we defer the recognition of revenue until collection becomes reasonably assured or upon receipt of payment.

Allowance for Doubtful Accounts

We undertake credit evaluations for all major sale transactions before we release product for shipment. Normal payment terms apply upon transfer of risk of loss. On an ongoing basis, we analyze the payment history of customer accounts, including recent customer purchases. We evaluate aged items in accounts receivable and provide allowances for doubtful accounts. Customer creditworthiness and economic conditions may change and increase the risk of collectability and may require additional allowances, which would negatively impact our operating results. Our allowance for doubtful accounts represented approximately 0.6\% and 0.5\%of total accounts receivable as of April 30, 2014 and 2013, respectively.

Allowance for Sales Returns and Warranties

Based on historical sales returns and other known factors, we provide for estimated sales returns in the same period we record the related revenues. To estimate our allowance for sales returns, we analyze potential customer-specific product application issues, potential quality and reliability issues and historical returns. We evaluate quarterly the adequacy of the allowance for sales returns. This allowance is reflected as a reduction to accounts receivable in our consolidated balance sheets. Increases to the allowance are recorded as a reduction to net revenues. Because the allowance for sales returns is based on our judgments and estimates, particularly as to product application, quality and reliability issues, our allowances may not be adequate to cover actual sales returns and other allowances. If our allowances are not adequate, our net revenues could be adversely affected. We warrant to our customers that our products will work in accordance with each product's specifications. Due to the cost and other complexities associated with rectifying any product defects, we do not repair any defective products. If a product is defective, the customer notifies us and, with our approval, returns the defective product. We then send replacement products to the customer. Accordingly, we account for any exposure related to defective products as a portion of our allowance for sales returns. The net change in our allowance for sales returns balance in fiscal 2014 was approximately 0.2\% of revenues, and the allowance was approximately 1.8\% of total accounts receivable at April 30, 2014.

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RESULTS OF OPERATIONS-(Continued) Excess and Obsolete Inventory and Effect on Gross Margin

We regularly monitor inventory quantities on hand and record provisions for excess and obsolete inventories based primarily on historical usage rates and our forecast of future demand for our products. We record provisions for the cost of inventories when the number of units on hand exceeds the number of units that we forecast will be sold over a certain period of time, generally 12 months. When we recognize the provisions, a new, lower-cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration of or increase in that newly established cost basis.

We may subsequently sell some of these excess and obsolete inventories. Even though we may sell these products at a price that was less than our original cost, sales of these products improve our current period gross margins because the inventory was previously written down.

We attempt to control our inventory levels so that we do not hold inventories in excess of demand at the end of each of fiscal quarter. However, because we need to place non-cancelable orders with significant lead time and because it is difficult to estimate product demand, it is possible that we will build inventories in excess of demand for future periods. If we have inventories in excess of estimated product demand, we will record a provision, which could have a material adverse effect on our reported results of operations and financial position. In preparation for new product introductions, we gradually decrease production of established products, while preparing for production of newer products. Given our 12-14 week production cycle, it is extremely difficult to predict precisely how many units of established products we need. It is also difficult to accurately predict the speed of the ramp of new products or the projected life cycles of new products which have continued to shorten in duration. Under these circumstances, it is possible that we could suffer from shortages of certain products and also build inventories in excess of demand for other products.

Stock-Based Compensation Expense

The authoritative guidance for stock-based compensation requires all share-based payments to employees, including grants of employee stock options and employee stock purchases under our employee stock purchase plan, to be recognized in our financial statements based on their respective measurement date fair values. We use the Black-Scholes option pricing model to estimate the fair value of our share-based payment awards. The Black-Scholes option pricing model requires the use of highly subjective and complex assumptions, including our stock price, expected volatility, expected term, risk-free interest rate and expected dividend yield. For expected volatility, we use an average between the historical volatility of our common stock, and the implied volatility of traded options on our common stock. The expected term of the awards is based on historical data regarding our employees' option exercise behaviors. The risk-free interest rate assumption is based on observed interest rates appropriate for the terms of our awards. The dividend yield assumption is based on our history and expectation of dividend payouts. In addition to the requirement for fair value estimates, authoritative guidance for stock-based compensation also requires the recording of expense that is net of an anticipated forfeiture rate. Only expenses associated with awards that are ultimately expected to vest are included in our financial statements. Our forfeiture rate is determined based on our historical option cancellation experience.

We evaluate the Black-Scholes assumptions that we use to value our awards on a quarterly basis. With respect to the forfeiture rate, we will revise the rate, if necessary, in subsequent periods if actual forfeitures differ from our estimates. If factors change and we employ different assumptions, stock-

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based compensation expense related to future stock-based payments may differ significantly from estimates recorded in prior periods.

We elected to use the long-form method to establish the beginning balance of, and to determine the subsequent impact on, the additional paid-in capital pool. For the tax effects of share-based payment awards, we use the "with and without" approach in determining the order in which tax attributes are utilized. As a result, we will recognize a tax benefit from stock-based awards in additional paid-in capital only if an incremental tax benefit is realized after all other tax attributes currently available to us have been utilized. In addition, we account for the indirect effects of stock-based awards on other tax attributes, such as research and development tax credits, through the Consolidated Statements of Income.

In September 2007, our stockholders approved the 2007 Equity Incentive Plan, or the 2007 Plan. See Note 13-"Employee Stock Purchase, Equity Incentive and Stock Option Plans" to our consolidated financial statements. The 2007 Plan, as amended, allows the grant of, among other things, performance share awards to employees. Under the authoritative guidance for stock-based compensation, when we record the stock-based compensation expense for such awards that carry performance contingencies, we have to estimate the probable outcome at the end of the performance period. Furthermore, we have to adjust the cumulative compensation expense recorded when probable outcome for the performance-based shares is subsequently updated for changes in facts and circumstances.

Valuation of Long-Lived Assets

Whenever events or changes in circumstances indicate that the carrying value of identifiable intangibles and long-lived assets, including property, plant and equipment and prepaid wafer credits, may not be recoverable, we assess whether the value of such asset or asset group has been impaired. Impairment evaluations involve management estimates of assets' useful lives and future cash flows. If such events occur, we would estimate the undiscounted future cash flows expected to result from the use of the asset and its eventual disposition. If the undiscounted expected future cash flows were less than the carrying amount of the asset, we would recognize an impairment loss. Actual useful lives and cash flows could be different from those estimated by our management. This could have a material effect on our operating results and financial position. Factors we consider important that could trigger an impairment review include the following:

º • º operating losses; º • º significant negative industry trends; º • º significant underutilization of the assets; and º • º significant changes in how we use the assets or our plans for their use. Valuation of Financial Instruments

The authoritative guidance for fair value measurements specifies a hierarchy of valuation techniques based upon whether the inputs to those valuation techniques reflect assumptions other market participants would use based upon market data obtained from independent sources (observable inputs) or reflect our own assumption of market participant valuation (unobservable inputs).

We use inputs such as quoted prices in active markets, broker/dealer quotes and other similar data from independent sources to determine the fair value of our financial assets and liabilities. For quoted prices from active markets, we do not make any material adjustments. For quoted prices in markets

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that are not active, or other observable and market-corroborated inputs, we review the inputs for reasonableness, and may further adjust the fair value based on market indices or other information that management deems material to the fair value estimates.

As of April 30, 2014, the fair value of our financial instruments measured at fair value on a recurring basis included $255.8 million of assets, and $3.0 million of liabilities. Of the $255.8 million of assets, $57.2 million were classified as Level 1, which included investments in money market funds. The remaining $198.6 million of investments were classified as Level 2, representing investments in debt securities issued by the U.S. government and its agencies, and other corporate securities. The $3.0 million of liabilities were classified as Level 2, and consisted of an interest rate swap that we entered into in conjunction with a mortgage loan. The fair value of the interest rate swap included the effect of our credit risk. We did not classify any financial instruments as Level 3 under the fair value hierarchy.

Accounting for Income Taxes

In accordance with the authoritative guidance for income taxes, we make certain estimates and judgments in determining the income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of tax credits, benefits, and deductions, and in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes, as well as the interest and penalties relating to these uncertain tax positions. Significant changes to these estimates may increase or decrease our tax provision in a subsequent period. Similarly, for tax liabilities denominated in a currency other than the U.S. dollar, changes in the value of the denominated currency will increase or decrease our tax provision in a subsequent period.

In addition, the calculation of our tax liabilities involves the assessment of uncertainties in the application of complex tax regulations. We recognize liabilities for uncertain tax positions based on a two-step process. In the first step, recognition, we determine whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The second step addresses measurement of a tax position that meets the more-likely-than-not criterion. The tax position is measured at the largest amount of benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement. Because we are required to determine the probability of various possible outcomes, such estimates are inherently difficult and subjective. We reevaluate these uncertain tax positions on a quarterly basis. This re-evaluation is based on factors including, but not limited to, changes in facts or circumstances, and changes in tax law. A change in recognition or measurement would result either in the recognition of a tax benefit or in an additional charge to the tax provision for the period.

We also have to assess the likelihood that we will be able to realize our deferred tax assets. If realization is not likely, we are required to increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate we will not ultimately realize. We believe that we will ultimately realize a majority of the deferred tax assets recorded on our Consolidated Balance Sheets. However, should there be a change in our ability to realize our deferred tax assets, our tax provision would increase in the period in which we determined that it is more-likely-than-not that the benefit of our deferred tax assets will not be realized.

As of April 30, 2014, we have recorded a valuation allowance of $17.3 million primarily to offset California research and development tax credit carryovers. We believe that it is more-likely-than-not that we will not realize these carryovers. In the future, if the credit is utilized and the valuation

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allowance is released, the release of valuation allowance will be accounted for as a reduction of the income tax expense in the period such event occurs.

For fiscal 2014, 2013 and 2012, our income tax provision reflected effective tax rates of 9.5\%, 14.5\% and 9.4\%, respectively. These rates are less than the combined U.S. federal and state statutory rate of approximately 40\% principally because we earn a significant portion of our profits in jurisdictions where tax rates are lower than the combined U.S. federal and state statutory rate.

Litigation and Contingencies

From time to time, we have been subject to legal proceedings and claims with respect to such matters as patents and other actions arising out of the normal course of business, as well as other matters identified in "Legal Proceedings" in Part I, Item 3 of this Annual Report.

It is possible that other companies might pursue litigation with respect to any claims such companies purport to have against us. The results of any litigation are inherently uncertain. In the event of an adverse result in any litigation with respect to intellectual property rights relevant to our products that could arise in the future, we could be required to obtain licenses to the infringed technology, pay substantial damages under applicable law, including treble damages if we are held to have willfully infringed, cease the manufacture, use and sale of infringing products or to expend significant resources to develop non-infringing technology. Litigation frequently involves substantial expenditures and can require significant management attention, even if we ultimately prevail.

Given the uncertainties associated with litigation, if our assessments prove to be wrong, or if additional information becomes available such that we estimate that there is a probable loss or probable range of loss associated with these contingencies, then we would record the minimum estimated liability, which could materially impact our results of operations, financial position or cash flows.

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RESULTS OF OPERATIONS-(Continued)

Results of Operations

The following table sets forth the results of our operations as a percentage of revenues for the periods indicated. Our historical operating results are not necessarily indicative of the results we can expect for any future period.

Year Ended April 30, 2014 2013 2012 Revenues 100.0 \% 100.0 \% 100.0 \% Cost of revenues 81.0 82.7 72.4 Gross margin 19.0 17.3 27.6 Operating expenses: Research, development and related 8.2 8.0 12.3 Selling, general and administrative 5.0 5.2 7.2 Amortization of acquired patent portfolio 0.7 0.6 1.0 Total operating expenses 13.9 13.8 20.5 Income from operations 5.1 3.5 7.1

Benefit from acquisition of production operations from VisEra

0.2 - 1.0 Equity in earnings of investee 0.3 0.3 0.3 Interest expense, net (0.2 ) (0.2 ) (0.2 ) Other income (expense), net 1.8 - (0.1 ) Income before income taxes 7.2 3.6 8.1 Provision for income taxes 0.7 0.5 0.8 Net income 6.5 \% 3.1 \% 7.3 \% Revenues

We derive substantially all of our revenues from the sale of our image-sensor products that are used in a wide variety of consumer and commercial mass-market applications including mobile phones, entertainment devices, notebooks and webcams, security and surveillance cameras, DSCs, automotive and medical products. Revenues increased by 3.3\% to $1.5 billion in fiscal 2014 from $1.4 billion in fiscal 2013. Revenues increased by 56.8\% to $1.4 billion in fiscal 2013 from $897.7 million in fiscal 2012.

Comparison of Fiscal 2014 and Fiscal 2013

The increase in revenues in fiscal 2014 when compared to fiscal 2013 was primarily due to a 0.7\% increase in unit sales of our image-sensor products, reflecting increased unit shipments into the mobile phone, entertainment, security and surveillance, and automotive markets. These increases were partially offset by decreased shipment into the notebook and webcam market. The increase in unit shipment in fiscal 2014, as compared to fiscal 2013, was principally attributable to an increase in shipment of our 2-megapixel and above products as more and more consumer applications migrate to higher resolution cameras. Related to this migration was a continued conversion of cameras from VGA to HD resolution, which caused an increase in our shipment of HD sensors and a corresponding decrease in our shipment of VGA sensors. The industry trend for camera resolution increases in consumer

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applications caused a favorable mix shift in our unit sales, which increased our ASPs by 3.0\% in fiscal 2014 when compared to fiscal 2013.

Comparison of Fiscal 2013 and Fiscal 2012

The increase in revenues in fiscal 2013 when compared to fiscal 2012 was primarily due to a 39.0\% increase in unit sales of our image-sensor products, reflecting increased unit shipments into the mobile phone and the entertainment markets. The increase in unit shipment in fiscal 2013, as compared to fiscal 2012, was principally attributable to an increase in shipment of HD sensors, the result of a significant and pervasive conversion from VGA to HD sensors in many mobile consumer applications. Unit sales for our 2-megapixel and above products also increased, commensurate with a general increase in demand for higher resolution sensors in consumer applications. The industry trend of converting from VGA to HD sensors, and the increase in demand for other higher resolution sensors, caused favorable mix shifts in our unit sales, which in turn increased our ASPs by 12.3\% in fiscal 2013 when compared to fiscal 2012.

Revenues from Sales to OEMs and VARs as Compared to Distributors

We sell our image-sensor products either directly to OEMs and VARs or indirectly through distributors. The percentage of revenues from sales to OEMs and VARs in fiscal 2014 remained the same as in fiscal 2013. The increase in percentage of revenue from sales to OEMs and VARs in fiscal 2013, as compared to fiscal 2012, was attributable to variations in our customer list. We expect that the percentage of revenues from sales through OEMs and VARs will vary from year to year in response to changes in the composition of our customer list, and that it may continue to represent a majority of our revenues. The gross margins that we earn on sales to OEMs and VARs or through distributors are not significantly different.

The following table shows the percentages of revenues from sales to OEMs and VARs and distributors for the periods indicated :

Year Ended April 30, 2014 2013 2012 OEMs and VARs 81.2 \% 81.2 \% 78.1 \% Distributors 18.8 18.8 21.9 Total 100.0 \% 100.0 \% 100.0 \%

OEMs and VARs. The two OEM customers that accounted for 10\% or more of our revenues in fiscal 2014 were Foxconn Technology Group and Cowell Electronics Co., Ltd., which accounted for approximately 13.8\% and 12.5\% of our revenues, respectively. The three OEM customers that accounted for 10\% or more of our revenues in fiscal 2013 were LG Innotek Co., Ltd, or LG Innotek, Foxconn Technology Group, and Cowell Electronics Co., Ltd., which accounted for approximately 18.0\%, 10.7\%, and 10.3\% of our revenues, respectively. The one OEM customer that accounted for 10\% or more of our revenues in fiscal 2012 was LG Innotek, which accounted for approximately 15.2\% of our revenues. For fiscal 2014, 2013 and 2012, no other OEM or VAR customer accounted for 10\% or more of our revenues.

Distributors. The one distributor that accounted for 10\% or more of our revenues in fiscal 2014, 2013 and 2012 was World Peace Industrial Co., Ltd., which accounted for approximately 11.0\%, 11.7\% and 13.5\% of our revenues, respectively. For fiscal 2014, 2013 and 2012, no other distributor accounted for 10\% or more of our revenues.

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RESULTS OF OPERATIONS-(Continued) Revenues from Domestic Sales as Compared to Foreign Sales

The following table shows the percentages of our revenues derived from sales of our image-sensor products to domestic customers, as compared to foreign customers for the periods indicated:

Year Ended April 30, 2014 2013 2012 Domestic sales 0.3 \% 0.3 \% 6.9 \% Foreign sales 99.7 99.7 93.1 Total 100.0 \% 100.0 \% 100.0 \%

We derive the majority of our foreign sales from customers in Asia and, to a lesser extent, in Europe. Our sales to Asia-Pacific customers remain significant primarily due to the continuing trend of outsourcing the production of consumer electronics products to Asia-Pacific manufacturers and facilities and as a result of the increasing markets in Asia for consumer products. The revenues we report by geography are based on the country or region in which our customers issue their purchase orders to us. Because of the preponderance of Asia-Pacific manufacturers and the fact that virtually all products incorporating our image-sensor products are sold globally, we believe that the geographic distribution of our sales does not accurately reflect the geographic distribution of sales into end-user markets of products which incorporate our image sensors. Over time, our domestic and foreign sales mix may fluctuate as a result of changes in the composition of our customer list that we experience in our business.

Gross Profit

Comparison of Fiscal 2014 and Fiscal 2013

Our gross margin in fiscal 2014 increased to 19.0\% from 17.3\% for fiscal 2013. The year-over-year increase in gross margin reflected a reduction in the production cost of our OmniBSI-2 products, which constitute a significant percentage of our total product shipments. The incremental improvement in OmniBSI-2 production cost was partially offset by unfavorable net effects from the sale of previously written-down products and write-down of inventories. We had an increase in the write-down of inventories, which totaled approximately $33.2 million in fiscal 2014, as compared to $23.1 million in fiscal 2013. The increase in the write-down of inventories in fiscal 2014 reflected a reduction in demand for certain products that we had designed specifically for the mobile phone market. Partially offsetting the increase in write-down of inventories was an increase in the amount of sales from previously written down products, which totaled $8.2 million in fiscal 2014, as compared to $6.3 million in the prior fiscal year. We recorded approximately $4.0 million in stock-based compensation expense to cost of revenues during fiscal 2014, as compared to $3.8 million in the prior fiscal year. We currently expect our OmniBSI-2 devices to continue to constitute a significant portion of our unit shipments in the first quarter of fiscal 2015. As a consequence, although we are working with our supply chain vendors to further reduce production costs, we expect that our gross margins for the first quarter of fiscal 2015 will also remain at lower levels than we have experienced historically before our introduction of OmniBSI-2.

Comparison of Fiscal 2013 and Fiscal 2012

Our gross margin in fiscal 2013 decreased to 17.3\% from 27.6\% for fiscal 2012. The year-over-year decrease in gross margin reflected an increase in unit shipments of our OmniBSI-2 products, which

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carried higher per-unit production costs when compared to products we shipped during fiscal 2012, because of additional assembly and manufacturing costs incurred by our supply chain vendors in connection with capacity expansion. Price erosion experienced by our older products also contributed to the decrease in gross margin. In addition, we experienced a decrease in the sales of previously written-down products in fiscal 2013, which totaled $6.3 million, as compared to $12.1 million during the same period in the prior fiscal year. We also recorded an increase in the write-down of inventories which totaled approximately $23.1 million during fiscal 2013, as compared to $17.1 million in the similar prior year period. We recorded approximately $3.8 million in stock-based compensation expense to cost of revenues during fiscal 2013, as compared to $2.9 million in the similar prior year period.

Research, Development and Related

Research, development and related expenses consist primarily of compensation and personnel-related expenses, non-recurring engineering costs related principally to the costs of the masks we buy when we release new product designs to the manufacturing foundries, costs for purchased materials, designs, tooling, depreciation of computers and workstations, and amortization of acquired intangible intellectual property and computer aided design software. Research, development and related expenses may fluctuate significantly as the number of new designs we release to the foundries can fluctuate from period to period. Research, development and related expenses for fiscal 2014, 2013 and 2012 were approximately $119.2 million, $113.2 million and $110.7 million, respectively. As a percentage of revenues, research, development and related expenses for fiscal 2014, 2013 and 2012 represented 8.2\%, 8.0\% and 12.3\%, respectively.

Comparison of Fiscal 2014 and Fiscal 2013

The increase in research, development and related expenses of approximately $6.1 million, or 5.3\%, in fiscal 2014, as compared to fiscal 2013 resulted primarily from: a $8.5 million increase in salary and payroll-related expenses resulting primarily from a headcount increase; a $0.9 million increase in legal expenses primarily related to patent registration activities; a $0.8 million increase in expenditures for design software tools; a $419,000 increase in office and facility expenses; and a $292,000 increase in stock-based compensation expense. These increases were partially offset by: a $3.9 million decrease in non-recurring engineering expenses related to new product development; and a $1.5 million decrease in amortization and depreciation expenses. We anticipate that research, development and related expenses will increase for our first quarter of fiscal 2015, reflecting anticipated increases in non-recurring engineering expenses.

Comparison of Fiscal 2013 and Fiscal 2012

The increase in research, development and related expenses of approximately $2.5 million, or 2.2\%, in fiscal 2013, as compared to fiscal 2012 resulted primarily from: a $7.8 million increase in salary and payroll-related expenses resulting primarily from a headcount increase; a $2.8 million increase in stock-based compensation expense; a $0.9 million increase in expenditures for design software tools; and a $444,000 increase in office and facility expenses. These increases were partially offset by a $9.5 million decrease in non-recurring engineering expenses related to new product development.

Selling, General and Administrative

Selling, general and administrative expenses consist primarily of compensation and personnel related expenses, commissions paid to distributors and manufacturers' representatives and insurance

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and legal expenses. Commission payments, in particular, can vary from period to period as our overall revenues change. Selling, general and administrative expenses for fiscal 2014, 2013 and 2012 were approximately $73.3 million, $73.0 million and $63.9 million, respectively. As a percentage of revenues, selling, general and administrative expenses for fiscal 2014, 2013 and 2012 represented 5.0\%, 5.2\% and 7.2\%, respectively.

Comparison of Fiscal 2014 and Fiscal 2013

The increase in selling, general and administrative expenses of approximately $334,000, or 0.5\%, for fiscal 2014 from fiscal 2013 resulted primarily from: a $3.8 million increase in salary and payroll-related expenses resulting primarily from a headcount increase; and a $1.1 million increase in stock-based compensation expense. These increases were partially offset by: a $1.8 million decrease in legal expenses primarily related to patent defense; a $1.6 million decrease in commission expenses paid primarily to distributors and sales representatives; a $0.5 million decrease in outsourcing and other expenses; a $382,000 decrease in bad debt expense; and a $261,000 decrease in depreciation expenses. We anticipate that our selling, general and administrative expenses will increase for the first quarter of fiscal 2015, due to an anticipated increase in commission payments.

Comparison of Fiscal 2013 and Fiscal 2012

The increase in selling, general and administrative expenses of approximately $9.1 million, or 14.2\%, for fiscal 2013 from fiscal 2012 resulted primarily from: a $2.5 million increase in stock-based compensation expense; a $2.2 million increase in salary and payroll-related expenses resulting primarily from a headcount increase; a $1.8 million increase in commission expenses paid primarily to distributors and sales representatives; and a $1.4 million increase in legal expenses, primarily related to patent defense; and a $0.6 million increase in bad debt expense. These increases were partially offset by a $467,000 decrease in facility expenses.

Amortization of Acquired Patent Portfolio

In March 2011, we purchased certain image sensor-related patents and patent applications from Kodak in a cash transaction. As a result, we recorded $65.0 million in additions to intangible assets, which we began amortizing during the three months ended April 30, 2011. Consequently, amortization of acquired patent portfolio totaled approximately $9.3 million for fiscal 2014, 2013 and 2012, respectively.

Benefit from Acquisition of Production Operations from VisEra

In October 2011, we acquired the CameraCubeChip production operations from VisEra, for a total consideration of $42.9 million, to be paid in fiscal 2012 and 2013. We recorded a one-time benefit of $8.6 million in "Benefit from acquisition of production operations from VisEra," representing the difference between the acquisition-date fair value and the original carrying value of our previously held investment in the production operations.

Subsequently, in April 2014, due to the lack of commercial viability for certain milestone deliverables, we agreed with VisEra to reduce our final installment of cash consideration for the acquisition from $9.0 million to $4.5 million. This resulted in a net post-acquisition gain of approximately $3.1 million, representing the $4.5 million reduction in the final installment payment, net of a $1.4 million equity method elimination for the corresponding write-off recorded by VisEra.

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Equity in Earnings of Investee

Equity in earnings of investee for fiscal 2014, 2013 and 2012 was approximately $4.0 million, $3.8 million and $3.1 million, respectively. Equity in earnings of investee represented our portion of the net income recorded by WLCSP, and equity method investment adjustments.

Interest Expense, Net

We invest our cash, cash equivalents and short-term investments in interest-bearing accounts consisting primarily of money market funds, commercial paper, certificates of deposit, high-grade corporate securities and government bonds. Additionally, we have obtained funds under certain long-term borrowing facilities comprised of a variable rate mortgage and a construction loan. Interest expense, net, for fiscal 2014, 2013and 2012 was approximately $2.0 million, $2.7 million and $2.1 million, respectively. Between fiscal 2014 and 2013, the $0.7 million decrease in interest expense, net, resulted from: a $0.6 million decrease in interest expense, primarily associated with the accretion of interest during the prior year period, on the purchase consideration payable to VisEra that we acquired in October 2011; and a $156,000 decrease in interest expense associated with a fixed asset loan agreement that we entered into for the construction of a research center at our wholly-owned subsidiary in Shanghai, OmniVision Technologies (Shanghai) Co. Ltd. These decreases to interest expense, net were partially offset by a $119,000 increase in interest expense associated with the payment schedule of a license agreement that we entered into with the California Institute of Technology in January 2014. Between fiscal 2013 and 2012, the $0.6 million increase in interest expense, net, resulted from: a $0.8 million decrease in interest income that resulted from balance decreases on interest-bearing accounts; and a $170,000 increase in interest expense that was attributable to the accretion of more interest on the purchase consideration due VisEra for the CameraCubeChip production operations that we acquired in October 2011. These increases to interest expense, net were partially offset by a $402,000 decrease in interest expense associated with the mortgage on our complex of four buildings located in Santa Clara, California, or our Santa Clara Property.

Other Income (Expense), Net

Other income (expense), net for fiscal 2014, 2013 and 2012 was approximately $26.0 million, $356,000 and $(1.1 million), respectively. Other income (expense), net, for fiscal 2014 included: $14.1 million of change-in-interest gain associated with WLCSP's initial public offering, when it issued 37.2 million new shares at a per share price that was higher than our per share carrying value; a $9.7 million gain from the sale of 5.1 million shares of WLCSP's common stock that we owned; a $2.0 million gain from the sale of our investment in Tong Hsing; $1.4 million of income associated with the leasing out of our office space; a $1.2 million gain on the interest rate swap agreement related to the mortgage on our Santa Clara Property; offset by a $2.0 million impairment charge for our investment in Phostek, Inc., or Phostek; and a $0.7 million loss from foreign exchange.

Other income (expense), net, for fiscal 2013 included: a $0.6 million gain on the interest rate swap agreement related to the mortgage on our Santa Clara Property; $342,000 of income associated with the leasing out of our office space; partially offset by a $0.6 million loss from foreign exchange

Other income (expense), net for fiscal 2012 included: a $0.8 million loss on foreign exchange; a $0.9 million loss on the interest rate swap agreements related to the mortgage on the Santa Clara Property; partially offset by $487,000 of dividends distributed by XinTec and Tong Hsing.

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Provision for Income Taxes

We generated approximately $104.9 million, $50.2 million and $72.6 million in income before income taxes for fiscal 2014, 2013 and 2012, respectively. We recorded a provision for income taxes of approximately $9.9 million, $7.3 million and $6.8 million for fiscal 2014, 2013 and 2012, respectively. For fiscal 2014, 2013 and 2012, our effective tax rates were 9.5\%, 14.5\% and 9.4\%, respectively. These rates were less than the combined U.S. federal and state statutory rate of approximately 40.0\% because we earn a significant portion of our income in jurisdictions where tax rates are lower than the combined U.S. federal and state statutory rate. We expect that our consolidated effective tax rate in fiscal 2015 will continue to be less than the combined U.S. federal and state statutory rate. The extent of the difference is principally contingent upon the amount of non-deductible stock based compensation expenses and the proportion and geographic mix of our total pre-tax income. See Note 8-"Income Taxes" of the Notes to our consolidated financial statements for the reconciliation of how our provision for income taxes differs from the amount computed by applying the U.S. federal income tax rate of 35.0\% to income before income taxes.

Liquidity and Capital Resources

Our principal sources of liquidity at April 30, 2014 consisted of cash, cash equivalents and short-term investments of $450.9 million.

Liquidity

Our working capital increased by $125.5million to $700.0 million as of April 30, 2014, as compared to $574.5 million as of April 30, 2013. Our working capital increased as a result of: a $238.6 million increase in cash, cash equivalents and short term investments primarily due to cash provided by operating activities; a $46.2 million decrease in accounts payable resulting from the reduction in inventory purchases; a $8.3 million decrease in accrued expenses and other current liabilities; and a $6.0 million increase in accounts receivable, net. These increases in working capital were partially offset by: a $159.4 million decrease in inventories due to a reduction in inventory purchases; a $10.3 million increase in deferred revenues, less cost of revenues; and a $5.4 million decrease in prepaid expenses and other current assets.

Cash balances are held by our US headquarters and our subsidiaries throughout the world. As of April 30, 2014, the amount of cash, cash equivalents and short-term investments held by foreign subsidiaries totaled approximately $196.3 million. In the event these funds from foreign subsidiaries are needed to fund operations in the U.S., and if U.S tax has not already been previously provided, we would be required to accrue and pay additional U.S. taxes in order to repatriate these funds. However, our intent is to indefinitely reinvest these funds outside the U.S. and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations.

In March 2007, we purchased our Santa Clara Property. In connection with the purchase, we obtained from a domestic bank a mortgage loan with a principal amount of $27.9 million, or the Mortgage Loan, and a term loan with a principal amount of $12.0 million, or the Term Loan. The Term Loan was paid off in full in July 2012. As of April 30, 2014, the principal amount outstanding under the Mortgage Loan was $23.7 million. See Note 7-"Borrowing Arrangements and Related Derivative Instruments" of the Notes to our consolidated financial statements.

In August 2009, in order to finance costs associated with the construction of a research center for OTC, our wholly-owned subsidiary in Shanghai, we entered into a fixed asset loan agreement with a

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bank in China, or the Construction Loan. We completed the construction of the research center during the three months ended October 31, 2010. As of April 30, 2014, the principal amount outstanding under the Construction Loan was $12.2 million.

Cash Flows from Operating Activities

For fiscal 2014, net cash provided by operating activities totaled approximately $237.9 million, as compared to cash used in operating activities of approximately $60.6 million for fiscal 2013. The principal components of the current year amount were: net income of approximately $95.0 million for fiscal 2014; adjustments for non-cash charges of $35.0 million in stock-based compensation, $33.2 million in write-down of inventories, $32.7 million in depreciation and amortization, a $23.8 million gain associated with WLCSP's IPO, a $19.5 million in gain on equity investments, a $3.1 million post-acquisition gain in "Benefit from acquisition of production operations from VisEra," and a $2.0 million gain from the sale of our investment in Tong Hsing; a $128.8 million decrease in inventories; a $10.5 million increase in deferred revenues, less cost of revenues; a $8.3 million decrease in deferred income taxes; and a $2.8 million decrease in prepaid expenses and other assets. These increases were partially offset by: a $47.2 million decrease in accounts payable; a $6.0 million increase in accounts receivable, net; a $4.9 million decrease in income taxes payable; and a $1.1 million decrease in accrued expenses and other liabilities. The $128.8 million decrease in inventories resulted from a reduction in inventory purchases during fiscal 2014. The decrease in inventories relative to fourth quarter cost of revenues resulted in an increase in annualized inventory turns to 4.0 as of April 30, 2014 from 2.6 as of April 30, 2013. The $47.2 million decrease in accounts payable reflected the decrease in inventory purchases.

For fiscal 2013, net cash used in operating activities totaled approximately $60.6 million, as compared to cash provided by operating activities of approximately $8.4 million for fiscal 2012. The principal components of the current year amount were: net income of approximately $42.9 million for fiscal 2013; a $163.5 million increase in inventories; a $58.7 million increase in accounts receivable, net; a $20.0 million gain on equity investments; and a $4.4 million increase in deferred income taxes. These decreases were partially offset by: adjustments for non-cash charges of $33.5 million in stock-based compensation, $32.5 million in depreciation and amortization, and $23.1 million in write-down of inventories; a $29.9 million increase in accounts payable; a $10.2 million decrease in prepaid expenses and other assets; a $5.3 million increase in accrued expenses and other liabilities; a $4.8 million increase in deferred revenues, less cost of revenues; and a $3.2 million increase in income taxes payable. The $163.5 million increase in inventories resulted from an increase in sales activity during fiscal 2013. The increase in inventories relative to fourth quarter cost of revenues resulted in a slight increase in annualized inventory turns to 2.6 as of April 30, 2013 from 2.4 as of April 30, 2012. The $58.7 million increase in accounts receivable, net, reflects the increased level of revenues during the fourth quarter of fiscal 2013 when compared with the fourth quarter of fiscal 2012. However, days of sales outstanding remained comparable, at 44 days as of April 30, 2013 and 2012. The $29.9 million increase in accounts payable reflected the increase in cost of sales associated with the substantial increase in sales activity.

Cash Flows from Investing Activities

For fiscal 2014, our cash used in investing activities totaled $138.0 million, as compared to cash used in investing activities of approximately $47.1 million for fiscal 2013, due primarily to: $228.2 million in purchases of short-term investments, $14.8 million in purchases of property, plant and equipment; $12.3 million in purchases of intangible and other assets; partially offset by $96.2 million in

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RESULTS OF OPERATIONS-(Continued)

net proceeds from sales or maturities of short-term investments $14.9 million in net proceeds from sales of investment in WLCSP and $6.2 million in proceeds from the sale of investment in Tong Hsing in fiscal 2014.

For fiscal 2013, our cash used in investing activities totaled $47.1 million, as compared to cash used in investing activities of approximately $13.0 million for fiscal 2012, due primarily to: $309.3 million in purchases of short-term investments, offset by $327.2 million in net proceeds from sales or maturities of short-term investments; $35.3 million in purchases of property, plant and equipment; $20.6 million in purchases of intangible and other assets; and $9.0 million in payments to VisEra for the acquisition of the CameraCubeChip production operations in fiscal 2012.

Cash Flows from Financing Activities

For fiscal 2014, net cash provided by financing activities totaled $7.9 million, as compared to net cash provided by financing activities of $7.4 million during fiscal 2013. This change was due primarily to: $13.7 million in proceeds from the exercise of stock options and employee purchases through our employee stock purchase plan; and $2.5 million in excess tax benefits from stock-based compensation; partially offset by a $4.5 million final installment payment to VisEra and $3.8 million in payments of long-term borrowings.

For fiscal 2013, net cash provided by financing activities totaled $7.4 million, as compared to net cash used in financing activities of $84.3 million during fiscal 2012. This change was due primarily to: $7.8 million in proceeds from the exercise of stock options and employee purchases through our employee stock purchase plan; and $2.7 million in excess tax benefits from stock-based compensation; partially offset by $3.1 million in payments of long-term borrowings.

Capital Commitments and Resources

During the three months ended July 31, 2013, we formed OV-Wuhan, a wholly-owned subsidiary in Wuhan, China, to support our growing research and development efforts. OV-Wuhan had an initial registered capital requirement of $1.0 million, and we increased it to $3.5 million in January 2014. As of April 30, 2014, we had contributed the entire $3.5 million to OV-Wuhan, meeting the registered capital commitment requirement.

We currently expect our available cash, cash equivalents and short-term investments, together with cash that we anticipate generating from operating activities, will be sufficient to satisfy our capital requirements over approximately the next twelve months and the foreseeable future. Other than normal working capital requirements, we expect our capital requirements totaling approximately $65.0 million over approximately the next 12 months will consist primarily of funding capital investments in our wholly-owned subsidiaries.

Our ability to generate cash from operations is subject to substantial risks described above under the caption Part I Item 1A. "Risk Factors." We encourage you to review these risks carefully.

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS-(Continued)

Contractual Obligations and Commercial Commitments

The following summarizes our contractual obligations and commercial commitments as of April 30, 2014 and the effect such obligations and commitments are expected to have on our liquidity and cash flows in future periods (in thousands): Payments Due by Period Less than More than Total 1 Year 1 - 3 Years 4 - 5 Years 5 Years Contractual Obligations and Commercial Commitments: Operating leases $ 16,400 $ 6,012 $ 7,456 $ 1,612 $ 1,320 Debt obligations(1) 35,832 3,802 32,030 - - Purchase obligations(2) 215,732 215,732 - - - Total contractual obligations $ 267,964 $ 225,546 $ 39,486 $ 1,612 1,320

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º (1) º In March 2007, we entered into the Mortgage Loan with a domestic bank in the amount of $27.9 million. In August 2009, we entered into the Construction Loan with a bank in China to finance costs associated with the construction of a research center for OTC. As of April 30, 2014, our balances outstanding under the Mortgage Loan and Construction Loan were approximately $23.7 million and $12.2 million, respectively. See Note 7-"Borrowing Arrangements and Related Derivative Instruments" to our consolidated financial statements. The amounts as disclosed in the table above do not include any associated interest payments as the loans have variable interest rates and interests will vary accordingly. º (2) º Purchase obligations represent outstanding purchase orders that we have placed with our suppliers at period-ends. The lead time for delivery is long, typically 12 to 14 weeks, and suppliers must prepare unique materials for us at the beginning of the fabrication process. Accordingly, we are precluded from cancelling our orders once placed and the production process has begun.

As of April 30, 2014, the long-term income taxes payable, including estimated interest and penalties, was $86.5 million. We are unable to make a reasonably reliable estimate of the timing of payments in individual years due to uncertainties in the timing of tax audits, if any, or their outcomes. Accordingly, we have excluded this obligation from the schedule summarizing our significant obligations to make future payments under contractual obligations as of April 30, 2014 presented above.

Off-Balance Sheet Arrangements

We did not have any material off-balance sheet arrangements during the periods covered by this Annual Report on Form 10-K.

Recent Accounting Pronouncements

In March 2013, the Financial Accounting Standards Board, or FASB, revised the authoritative guidance on accounting for cumulative translation adjustment. The revised guidance specifies that a cumulative translation adjustment should be released into earnings when an entity ceases to have a controlling financial interest in a subsidiary or a group of assets within a consolidated foreign entity and the sale or transfer results in the complete or substantially complete liquidation of the foreign entity. For sales of an equity method investment that is a foreign entity, a pro rata portion of cumulative

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translation adjustment attributable to the investment would be recognized in earnings upon sale of the investment. The guidance is effective for us beginning in the first quarter of fiscal 2015. We do not expect the adoption of this guidance to have any material impact on our financial position, results of operations or cash flows.

In July 2013, the FASB issued final guidance on the presentation of certain unrecognized tax benefits in the financial statements. Under the new guidance, a liability related to an unrecognized tax benefit would be offset against a deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryforward if such settlement is required or expected in the event the uncertain tax position is disallowed. The guidance is effective for us beginning in the first quarter of fiscal 2015. We expect that our long-term income taxes payable to decrease and our deferred tax liabilities-non-current to increase in the first quarter of fiscal 2015 as a result of the adoption of this guidance.

In April 2014, the FASB revised the authoritative guidance on reporting discontinued operations. The revised guidance specifies that a disposal of a component of an entity or a group of components of an entity is required to be reported in a discontinued operation if the disposal represents a strategic shift that has, or will have a major effect on an entity's operations and financial results. The guidance also changes the requirements for reporting discontinued operations which requires additional disclosures for discontinued operations and new disclosures for individually material disposal transactions that do not meet the definition of a discontinued operation. The guidance is effective for us beginning in the first quarter of fiscal 2016. We are currently evaluating the impact this guidance may have on our financial position, results of operations and cash flows.

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