- Annual and Transition Report (foreign private issuer) (20-F)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 20-F

(Mark One)

¨	REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2009

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

¨	SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Date of event requiring this shell company report

Commission file number: 000-51606

VIMICRO INTERNATIONAL CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

N/A

(Translation of Registrant’s Name into English)

Cayman Islands

(Jurisdiction of Incorporation or Organization)

15/F Shining Tower

No. 35 Xueyuan Road, Haidian District

Beijing 100191, People’s Republic of China

(Address of Principal Executive Offices)

David Wei Tang

Vimicro International Corporation

15/F Shining Tower

No. 35 Xueyuan Road, Haidian District

Beijing 100191, People’s Republic of China

Phone: (8610) 6894-8888

Facsimile: (8610) 6894-4075

(Name, Telephone, Email and/or Facsimile number and Address of Company Contact Person)

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

Title of Each Class

Name of Each Exchange on which Registered

American depositary shares, each

representing four ordinary shares, par value

$0.0001 per share

The NASDAQ Stock Market LLC

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

None

(Title of Class)

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

None

(Title of Class)

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report:

As of December 31, 2009, 147,643,168 ordinary shares were outstanding.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

¨ Yes x No

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

¨ Yes x No

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.

x 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 such shorter period that the registrant was required to submit and post such files).

¨ Yes ¨ No

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

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨

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


US GAAP x		International Financial Reporting Standards as issued by the International Accounting Standards Board ¨		Other ¨

If “Other” has been checked in response to the previous question indicate by check mark which financial statement item the registrant has elected to follow.

¨ Item 17 ¨ Item 18

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No

(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. ¨ Yes ¨ No

TABLE OF CONTENTS


		Page
INTRODUCTION		1

PART I		3

ITEM 1.	IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS	3

ITEM 2.	OFFER STATISTICS AND EXPECTED TIMETABLE	3

ITEM 3.	KEY INFORMATION	4

ITEM 4.	INFORMATION ON THE COMPANY	24

ITEM 4A.	UNRESOLVED STAFF COMMENTS	44

ITEM 5.	OPERATING AND FINANCIAL REVIEW AND PROSPECTS	44

ITEM 6.	DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES	59

ITEM 7.	MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS	71

ITEM 8.	FINANCIAL INFORMATION	72

ITEM 9.	THE OFFER AND LISTING	73

ITEM 10.	ADDITIONAL INFORMATION	74

ITEM 11.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	85

ITEM 12.	DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES	86

PART II		87

ITEM 13.	DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES	87

ITEM 14.	MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS	87

ITEM 15.	CONTROLS AND PROCEDURES	88

ITEM 16A.	AUDIT COMMITTEE FINANCIAL EXPERT	90

ITEM 16B.	CODE OF ETHICS	90

ITEM 16C.	PRINCIPAL ACCOUNTANT FEES AND SERVICES	90

ITEM 16D.	EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES	91

ITEM 16E.	PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS	91

ITEM 16F.	CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT	91

ITEM 16G.	CORPORATE GOVERNANCE	91

PART III		92

ITEM 17.	FINANCIAL STATEMENTS	92

ITEM 18.	FINANCIAL STATEMENTS	92

ITEM 19.	EXHIBITS	92

INTRODUCTION

Unless otherwise indicated, “we,” “us,” “our company,” “our,” and “Vimicro” refer to Vimicro International Corporation, its predecessor entities and subsidiaries. Unless otherwise indicated, references in this annual report on Form 20-F to,

•

“Vimicro China” are to Vimicro Corporation, our wholly owned subsidiary in China;

•

“Vimicro Shenzhen” are to Vimicro Technology Corporation, our wholly owned subsidiary in Shenzhen, China;

•

“Vimicro Hong Kong” are to Vimicro Electronics International Limited, Vimicro China’s wholly owned subsidiary in Hong Kong;

•

“Vimicro Shanghai” are to Vimicro High-Tech Corporation, our wholly owned subsidiary in Shanghai, China;

•

“Vimicro Beijing” are to Vimicro Electronic Technology Corporation, Vimicro China’s wholly owned subsidiary in Beijing, China;

•

“Vimicro Jiangsu” are to Jiangsu Vimicro Electronics Corporation, a wholly owned subsidiary of Vimicro Beijing;

•

“Vimicro Tianjin” are to Vimicro Electronics Corporation, a company incorporated in Tianjin, China, in which Vimicro China holds a 49.99% equity interest;

•

“Vimicro Wuxi” are to Wuxi Vimicro Corporation, our wholly owned subsidiary in Wuxi, China;

•

“Visiondigi” are to Shanghai Visiondigi Technology Co. Ltd., a newly formed entity in Shanghai, China, in which Vimicro China holds a 61.5% equity interest as of December 31, 2009; and

•

“Vimicro Sky-Vision” are to Vimicro Sky-Vision Technology Corporation, a company incorporated in Beijing, China, as our variable interest entity, or VIE.

In addition, references in this annual report on Form 20-F to,

•

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

•

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

•

“China” or the “PRC” are to the People’s Republic of China, excluding, for the purpose of this annual report on Form 20-F only, Hong Kong, Macau and Taiwan;

•

“ordinary shares” are to our ordinary shares, par value $0.0001 per share;

•

“RMB” are to the legal currency of China; and

•

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

This annual report on Form 20-F includes our audited consolidated financial statements for the years ended December 31, 2007, 2008 and 2009, and as of December 31, 2008 and 2009.

We and certain shareholders of our company completed the initial public offering of 8,697,063 ADSs, each representing four of our ordinary shares on November 18, 2005. On November 15, 2005, we listed our ADSs on the NASDAQ Global Market under the symbol “VIMC.”

GLOSSARY OF TECHNICAL TERMS


3G		third generation wireless networks.

AAC		Advanced Audio Coding, a standardized lossy compression and encoding scheme for digital audio.

AAC plus		High-Efficiency Advanced Audio Coding

AMR codec		Adaptive Multi Rate, a audio recording file format for certain mobile phones. The AMR codec encodes narrowband (200-3400 Hz) signals at variable bit rates ranging from 4.75 to 12.2 kbps with toll quality speech starting at 7.4 kbps.


ARM926EJ		a processor enables single processor solutions for microcontroller, DSP and Java applications.

CCIR656		the standard-definition TV frames.

CMMB		China Mobile Multimedia Broadcasting, a mobile television and multimedia standard developed and specified in China by the State Administration of Radio, Film, and Television (SARFT)

CMOS		Complementary Metal Oxide Semiconductor, a technology for constructing integrated circuits,

fab or foundry		a semiconductor fabrication facility.

fabless		a semiconductor company that uses third-party foundries for all of its wafer fabrication requirements.

FAT		file allocation table, a file system used for MS-DOS and consumer versions of Microsoft Windows.

firmware		software stored in read-only memory (ROM) or programmable ROM (PROM). Firmware is easier to modify than hardware but more difficult to modify than software stored on disk. Firmware is often responsible for the behavior of a system when it is first switched on. A typical example of firmware would be a “monitor” program in a microcomputer that loads the full operating system from disk or from a network and then passes control to it.

GPS		the Global Positioning System (GPS), a navigation and precise-positioning tool.

I2C		I2C (“eye-squared-see”) bus, a control bus that provides the communications link between integrated circuits in a system.

ISDB-T		Integrated Services Digital Broadcasting-Terrestrial (ISDB-T), a Japanese standard for digital television (DTV) and digital radio used by the country’s radio and television stations.

MCU		microcontroller unit, an electronic micro chip that can be programmed to control appliances.

memory		a device that can store information for later retrieval.

micron		a term for micrometer, which is a unit of linear measure that equals one one-millionth (1/1,000,000) of a meter; there are 25.4 microns in one one-thousandth of an inch.

MIDI		Musical Instrument Digital Interface, an industry-standard protocol that enables electronic musical instruments, such as keyboard controllers, computers, and other electronic equipment, to communicate, control and synchronize with each other.

MDTV		mobile digital television, a type of television broadcasting that is received on a small handheld device.

MPEG2		a standard for the generic coding of moving pictures and associated audio information.

NAND		Not AND, a binary operation in logic.

OSD		On Screen Display, a term describing the menu that pops up on many newer generation monitors to give digital control functions.

QFN		Quad Flat No leads, a type of chip package with a lead frame and wire bonding.

QVGA		quarter video graphics array.

PAL/DTSC		Phase Alternate Line, is an analogue television encoding system used in broadcast television systems.

RGB/YcbCr		Red, Green and Blue, a family of color spaces used as a part of the color image pipeline in video and digital photography systems.

RISC		reduced instruction set computer.

SD/MMC		secure digital, or SD, is a non-volatile memory card format developed by Matsushita, SanDisk, and Toshiba; multimedia card, or MMC, is a format developed jointly by Sandisk and Siemens.


SDHC		Secure Digital High Capacity, a type of flash memory card based on the SDA (Secure Digital Association) 2.00 specification. SDHC provides removable memory storage for compatible digital devices, including cameras, camcorders, PDAs, MP3 players and more.

SMIA		Standard Mobile Imaging Architecture, an imaging architecture especially suitable for mobile application use.

SPI/UART		serial peripheral interface and universal asynchronous receiver/transmitter.

SVAC		Surveillance Digital Video Audio Coding, a Chinese standard under development for security and surveillance market employing advanced audio video coding technology. Vimicro China is a co-founder of the SVAC Working Group with Ministry of Public Security.

system-on-chip or SoC		a chip that incorporates functions usually performed by several different devices and therefore generally offers better performance and lower cost.

T-DMB		Terrestrial Digital Multimedia Broadcasting, a digital radio transmission technology that operates via terrestrial transmission.

TD-SCDMA		Time Division-Synchronous Code Division Multiple Access, formally announced by Ministry of Information Industry of China as the country’s standard of 3G mobile telecommunication.

UAC		Universal Audio Class, Universal Serial Bus Device Class, a definition for Audio Devices..

UART		Universal Asynchronous Receiver/Transmitter, a type of microchip with programming.

UVC		Universal Video Class, short-wave ultraviolet radiation, in the “C” band (200 to 280 nanometers), mainly support Windows XP (with Service Pack 2) and Vista.

VGA		video graphics array.

ViSS		Video Surveillance System, a security and surveillance solution originally developed by Alcatel-Lucent Shanghai Bell Co., Ltd., or ASB, addressing the needs of telecom operators and local governments in China.

wafer		a thin, round, flat piece of silicon on which integrated circuits are etched.

WiFi		wireless fidelity, a globally used wireless networking technology that uses the 802.11 standard. .

WMV		Windows Media Video, a video format developed by Microsoft Corporation.

PART I

I TEM 1.

I DENTITY O F D IRECTORS , S ENIOR M ANAGEMENT A ND A DVISERS

Not Applicable.

I TEM 2.

O FFER S TATISTICS A ND E XPECTED T IMETABLE

Not Applicable.

I TEM 3.

K EY I NFORMATION

A.	Selected Financial Data

Selected Consolidated Financial Data

The following selected consolidated statements of operations data for the three years ended December 31, 2007, 2008 and 2009 and the selected consolidated balance sheet data as of December 31, 2008 and 2009 have been derived from our audited consolidated financial statements, which are included in “Item 18. Financial Statements” in this annual report on Form 20-F. The selected consolidated financial data should be read in conjunction with our audited consolidated financial statements and related notes and “Item 5. Operating and Financial Review and Prospects” in this annual report on Form 20-F. Our consolidated financial statements are prepared and presented in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”).

Our selected consolidated statement of operations data for the years ended December 31, 2005 and 2006 and our consolidated balance sheet data as of December 31, 2005, 2006 and 2007 have been derived from our audited consolidated financial statements, which are not included in this annual report on Form 20-F.


	As of or for the Year Ended December 31,
	2005			2006			2007			2008			2009
	(in thousands, except per share and per ADS data)
Consolidated Statement of Operations Data

Net revenue	$	95,277		$	126,564		$	92,753		$	86,497		$	72,971

Cost of revenue		(58,943	)		(86,183	)		(64,290	)		(61,814	)		(51,898	)

Gross profit		36,334			40,381			28,463			24,683			21,073

Operating expenses		(19,296	)		(33,548	)		(35,138	)		(41,919	)		(46,514	)

—Research and development, net		(8,102	)		(17,320	)		(20,039	)		(24,585	)		(26,364	)

—Sales and marketing		(5,118	)		(5,365	)		(4,668	)		(5,049	)		(5,311	)

—General and administrative		(6,076	)		(10,863	)		(10,431	)		(12,285	)		(14,839	)

(Loss) income from operations		17,038			6,833			(6,675	)		(17,236	)		(25,441	)


Net (loss) income		16,390			9,672			(2,004	)		(13,640	)		(20,681	)


(Loss) earnings per ordinary share

—Basic		0.16			0.07			(0.01	)		(0.10	)		(0.13	)

—Diluted		0.13			0.07			(0.01	)		(0.10	)		(0.13	)

(Loss) earnings per ADS

—Basic		0.63			0.28			(0.06	)		(0.39	)		(0.52	)

—Diluted		0.54			0.26			(0.06	)		(0.39	)		(0.52	)

Weighted -average number of shares used in earnings (loss) per share calculations

—Basic		89,639			137,593			139,710			140,261			143,182

—Diluted		105,412			146,962			139,710			140,261			143,182


	As of or for the Year Ended December 31,
	2005		2006		2007		2008		2009
	(in thousands, except per share and per ADS data)

Consolidated Balance Sheet Data

Cash and cash equivalents	$	100,610	$	114,834	$	116,958	$	58,215	$	84,510
Total assets		137,383		148,350		154,031		187,198		178,275

Total liabilities		18,218		13,493		12,829		14,376		16,451

Number of ordinary shares		138,606		139,783		140,301		137,778		147,643

Additional paid-in capital		127,502		131,449		136,418		142,681		151,672

Total shareholders’ equity		119,165		134,857		141,202		136,243		161,824

B.	Capitalization and Indebtedness

Not Applicable.

C.	Reasons for the Offer and Use of Proceeds

Not Applicable.

D.	Risk Factors

Risks Related to Our Business

We are exposed to risks associated with the recent global economic and financial crisis.

Many of the world’s largest economies continue to be impacted by the recent global economic and financial crisis. The turmoil in the financial markets and the weak global economy has contributed to slowdowns in the semiconductor industry in 2009. It is uncertain how long these effects will last, or whether economic and financial trends will worsen or improve. The markets for semiconductor products in particular depend largely on consumer spending. Economic uncertainty exacerbates negative trends in consumer spending and may cause certain customers to push out, cancel, or refrain from placing orders, which may affect our revenues and operating results. In addition, recent government tightening of liquidity might also deter the expansion and hold up the market recovery.

Difficulties in obtaining capital and uncertainty of market conditions may also lead to the inability of some customers to obtain affordable financing, resulting in lower sales for us. Customers with liquidity issues may lead to additional bad debt expense for us. These conditions may also similarly affect key suppliers, which could affect their ability to deliver parts and result in delays in our production. Further, these conditions and uncertainty about future economic conditions make it challenging for us to forecast our operating results, make business decisions, and identify the risks that may affect our business, financial condition and results of operations. If we are not able to timely and appropriately adapt to changes resulting from the uncertain macroeconomic environment, our business, financial condition or results of operations may be materially and adversely affected.

We face significant volatility in supply and demand conditions for our products, and this volatility, as well as any failure by us to accurately forecast future supply and demand conditions, could materially and negatively impact our business.

The semiconductor industry has historically been characterized by wide fluctuations in the demand for, and supply of, semiconductors. Demand for our products depends in large part on the continued growth of various electronics industries that use our products, including, but not limited to:

•

wireless telecommunications equipment;

•

mobile phone multimedia processors;

•

PC and computer-related peripherals; and

•

security processor and surveillance products.

Any downturn or reduction in the growth of these industries could seriously harm our business, financial condition and results of operations.

We order materials and build our products based primarily on our internal forecasts, customer and distributor forecasts and secondarily on existing orders, which may be cancelled under many circumstances. Because our markets are volatile and subject to rapid technological and price changes, our forecasts may be wrong causing us to make too many or too few of certain products.

We may continue to incur net losses in the future.

We have experienced significant growth in net revenue and gross profit since 2002, but our operating results have been affected by weakening global economic conditions and intense industry competition in recent years. Our net revenue decreased from $92.8 million in 2007 to $86.5 million in 2008, and decreased further to $73.0 million in 2009. Our gross profit decreased from $28.5 million in 2007 to $24.7 million in 2008, and decreased further to $21.1 million in 2009. In 2007 and 2008, we experienced a decrease in shipments and decline of the average selling price of our products, which resulted in the decrease in our revenue and gross profit. In 2008, we were also adversely affected by the global economic crisis. We cannot assure you that we can return to the rate of growth in net revenue and gross profit that we experienced prior to 2007 as our results of operations could fluctuate due to changes in our product mix and the industry environment.

We incurred net loss of $2.0 million, $13.6 million, $20.7 million in 2007, 2008 and 2009 respectively. We may continue to incur net losses in the future. Any decrease or delay in generating additional sales volume and revenue could materially and adversely affect our results of operations and could result in substantial losses. We might continue to grant options to employees and consultants in the future and will therefore continue to incur share-based compensation expenses as a result of share-based awards.

We are substantially dependent on sales of our PC camera multimedia processors and embedded notebook camera multimedia processors. A reduction in the volume of PC camera multimedia processors and embedded notebook camera multimedia processors that we sell or the average prices of which we sell them would cause our overall revenue to decline and could materially harm our business.

We have derived a substantial portion of our revenue to date from sales of our PC camera multimedia processors, embedded notebook camera multimedia processors and the third-party sensors we bundled with them. In 2007, 2008 and 2009, we generated approximately 62.8%, 61.8%, and 67.0%, respectively, of our net revenue from sales of PC camera multimedia processors, embedded notebook camera multimedia processors and the third-party sensors we bundled with them. We expect sales of our PC camera multimedia processors and embedded notebook camera multimedia processors will continue to comprise a significant portion of our revenue in the future. Accordingly, any decrease in the demand for our PC camera multimedia processors and embedded notebook camera multimedia processors resulting from the success of competing products, slower than expected growth of the PC camera market or other adverse developments relating to PC cameras and notebook cameras may materially and adversely affect our business.

We may not succeed in developing and selling our mobile phone multimedia processors.

We have invested significant resources in the development and sale of mobile phone multimedia processors and our ability to achieve significant growth in revenue and gross profit in the near future will depend on the continuation of our successful development and sales of these products. We face significant challenges in the mobile phone multimedia processor business that differs from those we have faced in the PC camera multimedia processor business, including the following:

•

technologies, designs and consumer preferences for mobile phones change more rapidly, and product life cycles are shorter, than those for PC cameras;

•

mobile phone multimedia processors have more complex product specifications than PC camera multimedia processors;

•

mobile phone multimedia processors have more stringent integration, size and power consumption requirements than PC camera multimedia processors;

•

the customer base for mobile phone multimedia processors is more fragmented than that for PC camera multimedia processors;

•

the mobile phone multimedia processor market is characterized by longer design and sales cycles than the PC camera multimedia processor market; and

•

the potential manufacturing volume requirements for mobile phone multimedia processors will be larger than those for PC camera multimedia processors.

We may not be able to successfully address these new challenges in the mobile phone multimedia processor business. Any failure by us to successfully develop and sell mobile phone multimedia processors would have a material adverse effect on our business and prospects.

The growth and success of our business depend on our ability to respond in a timely manner to the evolving multimedia mobile phone market and changing consumer preferences and industry standards.

Our future growth and success depend significantly on the development of the multimedia mobile phone market, which is evolving rapidly. The development of the multimedia mobile phone market depends on several factors, including changes in end user preferences, demand for multimedia functions and applications on mobile phones, the development of wireless networks to carry increased data traffic, the availability of multimedia-capable mobile phones and the continued provision of subsidies by mobile phone services operators to promote mobile phone upgrades and purchases. In addition, the multimedia mobile phone market is characterized by evolving industry standards, which are difficult for us to predict. If we do not respond to the evolving market, changing consumer preferences and industry standards in a timely manner, the growth and success of our business could be materially and adversely affected.

The expansion of our operations to the security and surveillance market involves risks and our failure to manage such risks may delay or preclude our ability to generate anticipated revenues and may impede our overall growth strategy.

Our growth strategy contemplates the expansion of our operations in the security and surveillance market. In December 2008, we formed the Vimicro Electronics Corporation, or Vimicro Tianjin, to focus on the design, manufacture and sale of security and surveillance products. In September 2009, we acquired, through Vimicro Tianjin, the ViSS business from ASB, to further penetrate the fast growing surveillance market in China. There are risks associated with expanding in a new business field and there is no assurance of success of our new security and surveillance products at this stage. The success of the expansion of our business and the sale of our products in the security and surveillance market will be dependent, in part, upon our ability to

•

successfully design security and surveillance products that meet customer expectations;

•

engage in effective sales and distribution;

•

respond to rapid changes in the security and surveillance industry; and

•

successfully integrate the acquired ViSS business into our operations.

The challenges and risks involved in expanding our business in the security and surveillance market may delay or preclude our ability to generate anticipated revenues and may impede our overall growth strategy.

We have depended on sales of third-party image sensors for a substantial portion of our revenue.

To meet the demand of China-based PC camera manufacturers for more comprehensive system solutions enabling greater ease-of-use and shortened time-to-market for their products, we frequently order image sensors based on our specifications from third-party sensor manufacturers and sell them together with our mixed-signal PC camera multimedia processors. In 2007, 2008 and 2009, we bundled 52%, 45%, and 33%, respectively, of our PC camera multimedia processors with third-party sensors. In the same periods, we generated 21%, 20%, and 17%, respectively, of our net revenue from the sales of these third-party sensors. At present, there is a limited supply of image sensors for PC camera applications as most of the sensor manufacturers focus on the larger market for mobile phone image sensors. If we are unable to secure an adequate supply of image sensors, our revenue growth may be adversely affected. In addition, to the extent suppliers of sensors develop PC camera multimedia processors on their own and bundle their processors with sensors, we will face competition from these suppliers and our sales of PC camera multimedia processors could be materially and adversely affected.

Our lengthy time-to-market makes it difficult for us to forecast revenue and increases the variability of our quarterly results.

Our multimedia processor products are characterized by lengthy intervals between product development and initial volume sales. This interval, commonly referred to as time-to-market, typically ranges from three to six months for our PC camera multimedia processors and six to nine months for our mobile phone multimedia processors, and may be significantly longer for first-time customers. A number of factors contribute to the length of our time-to-market. After initially developing a product, we must convince a customer to incorporate it into the design of the customer’s end product, which is referred to as a “design win.” Following the design win, we must complete our product development and deliver our product to the customer, and the customers will then test and evaluate our product before completing the design of its own end product. Our customers may need one to two months or longer to test and evaluate our products and an additional three months or more to commence volume production of end products. Our lengthy time-to-market makes it difficult for us to forecast revenue and increases the variability of our quarterly results. It also results in a lengthy interval from the time we incur research and development and other operating expenses in connection with a new product to the time that we can first generate revenue from that product. In addition, a design win may never result in volume production or sales of our product. It is possible that we may not generate sufficient, if any, revenue from a new product to offset the increased operating expenses for the development and sale of that product.

We may be unable to accurately predict demand for our products, which may result in product shortages or excess inventory or obsolete inventory.

The lead time required by the foundries that we use to fabricate wafers and manufacture our multimedia processors is often longer than the lead time our customers provide to us for delivery of our products to them. These foundries require us to provide forecasts of our anticipated manufacturing needs and place binding manufacturing orders before we receive purchase orders from our customers. This may result in product shortages or excess product inventory because we cannot easily adjust our forecasts and commitments. Obtaining additional supply in the face of product shortages may be costly or impossible, particularly in a short time frame, which could prevent us from fulfilling orders. In line with industry-wide increases in foundry lead times, the lead times the foundries require to manufacture our new multimedia processors have recently grown longer, which has led to an increase in our inventory levels. These lead times may increase further, which may in turn cause us to increase our inventory levels. In addition, like most semiconductor products, our multimedia processors are often susceptible to rapidly declining average selling prices and rapid obsolescence. Excess inventory levels, whether due to our incorrect forecasts, lengthening foundry lead times or other reasons, could result in higher levels of obsolete inventory, unprofitable sales or write-offs of excess or obsolete inventory. Consequently, if we fail to accurately forecast demand for our products, or if longer foundry lead times result in excess inventory levels that result in unprofitable sales or write-offs of inventory, our operating results could fluctuate and the price of our ADSs could decline.

Failure to obtain design wins could have a material adverse effect on our business.

Our success depends on our ability to obtain design wins where PC camera or mobile phone designers decide to incorporate our multimedia processors into their new product designs. Once a multimedia processor designed by a supplier has been incorporated into a PC camera or mobile phone design, the PC camera or mobile phone designer tends to keep the same supplier for the life of the product due to the significant costs associated with qualifying a new supplier. This reluctance to change incumbent suppliers may be an entry barrier for new suppliers such as us. On the other hand, PC camera and mobile phone designers constantly develop and introduce new products to the market, which requires suppliers such as us to continue to create innovative, highly integrated, low-power and cost-effective products and solutions in order to continue to achieve design wins from our existing customers. Our failure to achieve design wins could have a material adverse effect on our business.

Our success depends on our customers’ ability to successfully sell their products incorporating our multimedia processors.

Even if a PC camera or mobile phone designer decides to incorporate our multimedia processors into its product or design, the designer may not be able to market and sell its product or design successfully. Even though the designer does not have the right to return the multimedia processors purchased from us, the designer’s inability to market and sell its products, whether from lack of market acceptance or otherwise, could adversely affect our business since, for example, the designer may not order new products from us or we may suffer harm to our reputation. Accordingly, our success depends on our customers’ ability to successfully sell their products incorporating our multimedia processors. Most of our mobile phone multimedia processors are incorporated into mobile phones designed and produced by companies based in China. If these China-based mobile phone designers and manufacturers fail to sell their products successfully or, in the event they are successful initially, if their products fail to remain competitive in the market, our sales of mobile phone multimedia processors may be adversely and materially affected, and as a result, our operating results may suffer.

One of the principal foundries and one of the assembly and testing houses that we use are both located in a region that is subject to earthquakes, typhoons and other natural disasters, as well as geopolitical risks and social upheaval.

Taiwan Semiconductor Manufacturing Company, or TSMC, one of the principal foundries upon which we currently rely to manufacture the majority of our multimedia processors, and Advanced Semiconductor Engineering, Inc., or ASE, one of the assembly and testing houses that we use, are both located in Taiwan. Taiwan is susceptible to earthquakes, typhoons, floods and other natural disasters, and has experienced severe earthquakes in recent years that caused significant property damage and loss of life. In addition, TSMC and ASE are subject to risks associated with uncertain political, economic and other conditions in Taiwan and elsewhere in Asia, such as political turmoil in the region and the outbreak of Severe Acute Respiratory Syndrome, or SARS, or another epidemic. The occurrence of any of the foregoing could disrupt their operations, resulting in significant delays in deliveries or substantial shortages of our products and harm to our business.

We depend on third-party foundries to manufacture our multimedia processors. Failure to obtain sufficient foundry capacity could significantly delay our ability to ship our products, cause us to lose revenue and damage our customer relationships.

We do not manufacture our own products. TSMC historically manufactured substantially all of our multimedia processors. To diversify our wafer suppliers and reduce our significant dependence on a single foundry, we began to use Semiconductor Manufacturing International Corporation, or SMIC, to manufacture some of our products in 2004. In 2007, 2008 and 2009, third-party foundries other than TSMC manufactured 57%, 39%, and 19%, respectively, of our multimedia processors. Due to our dependence on third-party foundries, we face several significant risks, including:

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failure to secure sufficient manufacturing capacity, or failure to secure sufficient manufacturing capacity at a reasonable cost;

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

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

The ability of a foundry to manufacture our multimedia processors is limited by its available production capacity. None of these third-party foundries has allocated a fixed level of production capacity to us. It is difficult for us to accurately forecast our capacity needs. We do not have any long-term agreement with any foundry and we typically place orders with them on a purchase order basis, depending on our own customers’ purchase orders and sales forecasts. These foundries can allocate their production capacities to their other customers and reduce deliveries to us on short notice. It is possible that other customers of these foundries are larger and better financed than we are, or have long-term agreements with these foundries, and they may allocate their production capacities to these customers during times of production capacity shortages. Any shortfall in available foundry capacity could significantly delay our ability to ship our products, cause us to lose revenue and damage our customer relationships.

Each of our products is manufactured at only one foundry and if any of these foundries is unable to provide the capacity we need, we may experience delays in shipping our products, which could damage our customer relationships and result in reduced revenue and increased expenses.

Each of our products is manufactured at only one foundry. If any of these foundries is unable to provide us with capacity we need, we could experience significant delays in delivering the product manufactured by that foundry to our own customers. In addition, if any of these foundries experience financial difficulties, suffer damage to its facilities, or experience other disruption to their operations, we may not be able to qualify an alternative foundry in a timely manner, as the qualification process may result in a delay of several months before we can begin to ship our products. Such a delay could damage our customer relationships and have a material adverse effect on our business, financial condition and results of operations.

If the foundries that we use do not achieve expected manufacturing yields, our product costs could increase and product availability could decrease.

The manufacture of semiconductors is a highly complex process. Minute impurities in a silicon wafer can cause a substantial number of wafers to be rejected or cause numerous die on a wafer to be nonfunctional. Foundries encounter difficulties from time to time in achieving acceptable manufacturing yields, which are measured by the percentage of dies produced on a fab line that pass all visual and process control monitoring tests. This often occurs during the production of new products or the installation and start-up of new process technologies. The foundries that we use may not be able to achieve acceptable manufacturing yields as we migrate our designs to smaller geometries. If these foundries do not achieve expected manufacturing yields, our product costs could increase and product availability could decrease.

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

We rely on independent assembly and testing houses to assemble and test substantially all of our current multimedia processors either for the foundry or directly for us. As a result, we do not directly control our product delivery schedules, assembly and testing costs or quality assurance and control. Currently, we engage ASE and Siliconware Precision Industries Co., Ltd., or SPIL for our assembly and testing requirements. If either of these assembly and testing houses experiences capacity constraints or financial difficulties or suffers any damage to its facilities, or if there is any other disruption of assembly and testing capacity, we may not be able to obtain alternative assembly and testing services in a timely manner. We do not have long-term agreements with either of our independent assembly and testing houses. We typically procure services from them on a per-order basis. In 2006, we replaced ASAT Holdings Limited, or ASAT, with SPIL to better serve our clients. It took us approximately six months to locate and qualify SPIL as our assembly and testing house before we terminated our relationship with ASAT in accordance with contractual terms. Because of the amount of time that it takes us to qualify third-party assembly and testing houses, we could experience significant delays in product shipments if we are required to find alternative assembly and testing houses for our products on short notice. Any problems that we may encounter with the delivery, quality or cost of our products could damage our reputation and result in a loss of customers.

We are dependent on a limited number of customers for a significant portion of our revenue and this dependence is likely to continue.

We have been dependent on a small number of customers for a significant portion of our revenue. Our top ten customers collectively accounted for approximately 69%, 71%, and 70% of our revenue in 2007, 2008 and 2009, respectively. Sales to our largest customers have varied significantly from period to period. Tuoye Company Ltd., or Tuoye (formerly Shenzhen Hongtaili Technology Co., Ltd.), one of our major China-based distributors, accounted for over 10% of our net revenue in 2007, 2008 and 2009. Hanvision Electronic Co., Ltd., or Hanvision, and Tomen Electronics Corporation, or Tomen, were our major customers in 2009 and sales to each of Hanvision and Tomen accounted for over 10% of our net revenue in 2009. We expect that a significant portion of our sales will continue to be generated by a small number of China-based customers. Our largest customers may change from year-to-year as we continue our expansion in the mobile phone multimedia processor market and security and surveillance market. Our ability to maintain close relationships with these customers is essential to the growth and profitability of our business. If we fail to sell our products to one or more of our major customers in any particular period, or if a large customer purchases fewer of our products, defers orders or fails to place additional orders with us, or if we fail to develop additional major customers, our revenue could decline, and our operating results could be adversely affected.

We rely on third-party distributors for a significant portion of our revenue.

A significant portion of our revenue is derived from sales to distributors who resell our products to manufacturers of modules or end products, such as PC cameras and mobile phones, into which our products are incorporated. Sales to distributors accounted for 77%, 82% and 81% of our net revenue in 2007, 2008 and 2009, respectively. As of December 31, 2009, there were nine distributors among our top ten customers. As a result, our ability to maintain good relationships with these distributors is important to the growth of our business and our results from operations. If our major distributors defer orders or fail to place additional orders with us, our revenue could decline and our operating results could be materially and adversely affected.

We do not have long-term purchase commitments from our customers, which may result in significant uncertainty and volatility with respect to our revenue from period to period.

We do not have long-term purchase commitments from our customers and our sales are made on the basis of individual purchase orders. Our customers may cancel or defer purchase orders. Our customers’ purchase orders may vary significantly from period to period, and it is difficult to forecast future order quantities. We cannot assure you that any of our customers will continue to place purchase orders with us in the future at the same level as in prior periods. We also cannot assure you that the volume of our customers’ purchase orders will be consistent with our expectations when we plan our expenditures. As a result, our results of operations may vary from period to period and may fluctuate significantly in the future.

Defects in our products could result in a loss of customers and decrease in revenue, unexpected expenses and a reduction in market share.

Our products are complex and must meet stringent quality requirements. Complex products such as our highly integrated single-chip products may contain defects, errors or viruses when they are first introduced or as new versions are released. If any of our products have reliability, quality or compatibility problems, we may not be able to correct these problems on a timely basis. Consequently, our reputation may be damaged and we may fail to obtain design wins, which could harm our ability to retain existing customers and attract new customers. In addition, these defects, errors or viruses could interrupt or delay sales to our customers. Because we cannot test for all possible scenarios, our products may contain errors which are not discovered until after they are shipped. If any of these problems are not found until after we have delivered our products to our customers, we may be required to incur additional development costs and costs associated with product recalls, repairs or replacements. Product defects may also result in product liability claims against us.

Our operating results have fluctuated in the past and we expect our operating results to continue to fluctuate.

Our revenue and operating results are difficult to predict, and have in the past and may in the future fluctuate from period to period. We expect that our revenue will continue to vary from period to period, making it difficult to predict our future operating results. In particular, we experience seasonality and variability in demand for our products as our customers manage their inventories. Our customers tend to increase their inventories of our products in anticipation of the peak fourth quarter buying season for PCs and mobile devices into which our products are incorporated, which often leads to sequentially lower sales of our products in the first and fourth quarters. In addition, business activities in China generally slow down during the Chinese New Year period in the first quarter of each year, which may adversely affect our sales and results of operations during the period. We based our planned operating expenses in part on our expectations of future revenue. If our revenue for a particular quarter is lower than we expect, we may be unable to proportionately reduce our operating expenses for that quarter, which could harm our operating results for that quarter.

Additional factors that could cause our quarterly results of operations to fluctuate include:

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the timing and volume of purchase orders and cancellations from our customers;

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changes in manufacturing costs, including wafer, testing and assembly costs, and manufacturing yields, product quality and reliability;

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the timing and availability of adequate manufacturing capacity of the foundries we use;

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our ability to successfully design and introduce new products, including security and surveillance products, in a timely manner that meet our customers’ needs;

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the timing, performance and pricing of new products introduced by us and our competitors;

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the timing and amount of operating expenses incurred by us, including cash bonuses to senior management;

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the liquidity and cash flow of our company and our customers; and

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changes in exchange rates, interest rates, tax rates and tax withholding.

Any fluctuations in our quarterly results of operations may affect the price of our ADSs. In future periods, the market price of our ADSs could decline if our revenue and results of operations are below the expectations of analysts and investors.

Any changes in government policies on surveillance and safety system installation and operation may cause our revenues and profits to decrease.

We depend substantially on national, state and local government policies mandating and funding surveillance and safety system installation and operation in China. For instance, our security and surveillance business benefits from the government’s support of Safe City Projects in China, which promote installation of urban surveillance and monitoring networks to improve safety monitoring and alarming systems in cities. We expect that our security and surveillance business will continue to rely on government policies in the foreseeable future. If such policies change, whether due to tightening budgets, shifting policy, or otherwise, initiatives such as the Safe City Projects may be abandoned or cut back, and our financial condition and results of operations may suffer material adverse effects.

Our security and surveillance products often are subject to delivery acceptance, testing and approval.

We normally supply security and surveillance products and services pursuant to agreements with general contractors or government agencies. The successful completion of our obligations under these contracts is often subject to delivery acceptance, satisfactory testing and approval of such products and services. Although we endeavor to satisfy the requirements of each of these contracts to which we are a party, no assurance can be given that the necessary approval of our products and services will be granted on a timely basis or at all, and that we will receive any payments due to us. In some cases, we may depend on others to complete these projects which may also delay payments to us. Any failure to obtain these approvals and payments may have a material adverse effect on our business and future financial performance.

We sometimes extend credit to our customers in security and surveillance business. Failure to collect the trade receivables or untimely collection of them could affect our liquidity.

We extend credit to some of our customers in security and surveillance business, without requiring collateral in most cases. Generally, our customers in security and surveillance business pay in installments, with a portion of upfront payment upon signing of contracts, a portion of the payment upon receipt of our products by our customers and before the installation, and a portion of the payment after the installation of our products and upon satisfaction of our customer. Sometimes, a small portion of the payment may not be paid until after a certain period following the installation. We will perform ongoing credit evaluations of our customers’ financial condition and generally have no difficulties in collecting our payments. However, if we encounter future problems with or delay in collecting amounts due from our clients, our liquidity could be negatively affected.

If our subcontractors fail to perform their contractual obligations, our ability to provide services and products to our customers, as well as our ability to obtain future security and surveillance business, may be harmed.

We sometimes may enter into contracts with subcontractors who perform a portion of the security and surveillance services that we provide to our customers. We may have disputes with our subcontractors, including disputes regarding quality and timeliness of the work performed by those subcontractors. Failure by one of more of our subcontractors to satisfactorily perform the agreed-upon services may materially and adversely impact our ability to fulfill our obligations to our customers, expose us to liability and cause a material adverse effect on our ability to compete for future business.

If we are unable to obtain additional capital in future years, we may be unable to grow at the expected pace or proceed with our long-term business plan, and we may be forced to curtail or cease some of our projects.

We will require additional working capital to support our long-term business plan, which includes identifying suitable targets for horizontal or vertical mergers or acquisitions, fulfilling the agreements with general contractors or government agencies to provide the products and services for security and surveillance projects, constructing our office buildings with co-developers, in order to enhance our overall productivity and benefit from economies of scale. Our working capital requirements and the cash flow provided by future operating activities, if any, will vary greatly from quarter to quarter, depending on the volume of business during the period and payment terms with our customers. We may not be able to obtain adequate levels of additional financing, whether through equity financing, debt financing or other sources. Additional equity financings could result in significant dilution to our shares and debt financings could adversely affect our earnings. In addition, we may grant registration rights to investors purchasing our equity or debt securities in the future. If we are unable to raise additional capital, we may be unable to implement our long-term business plan, develop or enhance our products and services, take advantage of future opportunities or respond to competition on a timely basis, if at all. In addition, lack of financing could force us to substantially curtail or cease some of our projects.

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

We rely on a combination of patent, copyright, trademark and trade secret laws, as well as nondisclosure agreements and other methods to protect our intellectual property rights. As of December 31, 2009, we owned 687 patents in China and had 1,135 pending patent applications in China, owned 13 patents and had 67 pending patent applications in the United States, owned one patent and had seven pending patent applications in Taiwan, three pending patent applications in Japan and three pending patent applications in Korea. We cannot assure you that any patent will be issued as a result of our applications or, if issued, that it will sufficiently protect our intellectual property rights. Implementation of PRC intellectual property-related laws has historically been lacking, primarily because of ambiguities in the PRC laws and difficulties in enforcement. Accordingly, intellectual property rights and confidentiality protections in China may not be as effective as in the United States or other countries. Policing unauthorized use of proprietary technology is difficult and expensive. The steps we have taken may be inadequate to prevent the misappropriation of our proprietary technology. Reverse engineering, unauthorized copying or other misappropriation of our proprietary technologies could enable third parties to benefit from our technologies without paying us for doing so, which could harm our business and competitive position. Though we are not currently involved in any litigation with respect to intellectual property, we may need to enforce our intellectual property rights through litigation. Litigation relating to our intellectual property might result in substantial costs and diversion of resources and management attention. See “—Risks Related to Doing Business in China—Uncertainties with respect to the PRC legal system could adversely affect us.”

We may face intellectual property infringement claims that could be time-consuming and costly to defend and, if successful, result in our loss of significant rights and inability to continue providing our existing products.

Our success also depends in large part on our ability to use and develop our technology and know-how without infringing the intellectual property rights of third parties. Intellectual property litigation is expensive and time-consuming and could divert management’s attention from our business. If there is a successful claim of infringement against us, we may be required to pay substantial damages to the party claiming infringement, develop non-infringing technology or enter into royalty or license agreements that may not be available on acceptable terms, if at all. Our failure to develop non-infringing technologies or license the proprietary rights on a timely basis would harm our business. Protracted litigation could also result in our customers or potential customers deferring or limiting their purchase or use of our products until resolution of such litigation. Also, we may be unaware of filed patent applications that relate to our products. Parties making infringement claims may be able to obtain an injunction, which could prevent us from selling our products or using technology that contains the allegedly infringing intellectual property. Any intellectual property litigation could have a material adverse effect on our business, operating results or financial condition.

Our business depends substantially on the continuing efforts of our senior executives and other key personnel, and our business may be severely disrupted if we lose their services.

Our future success depends heavily upon the continued services of our senior executives and other key employees. We rely on their expertise in multimedia processor design, business operations, sales and marketing and on their relationships with our shareholders, distributors and customers and relevant government authorities. We also rely on a number of experienced mixed-signal semiconductor designers who are difficult to find since it often requires years of experience to fully master mixed-signal design. We do not maintain key-man life insurance for any of our senior executives or other key employees. If one or more of our senior executives or key employees were unable or unwilling to continue in their present positions, we might not be able to replace them easily or at all. Our business may be severely disrupted, our financial conditions and results of operations may be materially and adversely affected, and we may incur additional expenses to recruit, train and retain personnel. Since our industry is characterized by high demand and intense competition for talent, we also may not be able to attract or retain additional highly skilled employees or other key personnel that we will need to achieve our strategic objectives. As we are still a relatively young company and our business has grown rapidly, our ability to train and integrate new employees into our operations may not meet the growing demands of our business.

If any of our senior executives or key employees joins a competitor or forms a competing company, we may lose customers, suppliers, know-how and key professionals and staff members. Each of our executive officers has entered into an employment agreement with us, which contains non-competition provisions. However, if any dispute arises between our executive officers and us, we cannot assure you the extent to which any of these agreements could be enforced in China, where these executive officers reside, in light of the uncertainties with China’s legal system. See “—Risks Related to Doing Business in China—Uncertainties with respect to the PRC legal system could adversely affect us.”

Our initial option grants to many of our key employees are substantially vested. Therefore, these employees may not have sufficient financial incentives to continue to work for our company, and our ability to successfully operate our business and to execute our business strategy could be impaired if we cannot replace departing key employees in a timely manner.

The share options that we initially granted to many of our key employees have become, or will soon become, substantially vested. While we periodically grant additional share options to key employees after their hire dates, the numbers of options that we initially grant are usually much larger than in subsequent grants. Employees may be more likely to leave us after the share options that we initially granted to them fully vest, especially if the shares underlying the options have significantly appreciated in value relative to the option exercise price. If any member of our management team or any of our other key personnel leaves our company, our ability to successfully operate our business and execute our business strategy could be impaired. We may also incur significant costs in identifying, hiring, training and retaining replacements for departing employees.

If we fail to effectively manage the changes to our business brought about by growth, seasonality, and economic conditions, our business may be adversely affected.

Since 2005, we have experienced a period of rapid growth followed by a period of fluctuation that have placed, and continue to place, significant strain on our management personnel, systems and resources. To accommodate our changing needs, we anticipate that we will need to implement a variety of new and upgraded operational and financial systems, procedures and controls, including the improvement of our accounting and other internal management systems, all of which require substantial management efforts. Since 2007, we have spent, and will continue to spend, a significant amount of resources on helping our company succeed in the midst of an industry-wide downturn and uncertain market conditions. All of these endeavors will require substantial management effort and skill and incurrence of additional expenditures. We cannot assure you that we will be able to manage these adjustments effectively, and any failure to do so may have a material adverse effect on our business.

Future acquisitions may have an adverse effect on our ability to manage our business.

If we are presented with appropriate opportunities, we may acquire complementary technologies, businesses or assets. Future acquisitions would expose us to potential risks, including risks associated with the assimilation of new technologies, businesses and personnel, unforeseen or hidden liabilities, the diversion of management attention and resources from our existing business and the inability to generate sufficient revenue to offset the costs and expenses of acquisitions. Any difficulties encountered in the acquisition and integration process may have an adverse effect on our ability to manage our business.

There are unknown risks associated with our recent acquisition of the ViSS business from ASB.

Selective acquisitions, such as our recent acquisition of the ViSS business from ASB, form part of our strategic expansion plan. Failure to successfully integrate the acquired ViSS business may affect the expected synergies from this acquisition and impede our overall growth strategy. Although we have conducted due diligence in connection with this acquisition, we may not be aware of all of the risks associated with the ViSS business. Discovery of adverse information concerning the acquired ViSS business could have a material adverse effect on our business, financial condition and results of operations. Although we are entitled to claiming indemnification in certain circumstances, asserting indemnification or enforcing such indemnification could be costly and time-consuming and may not be successful at all.

We are involved in significant joint ventures and are exposed to problems inherent to companies under joint management.

We have two significant joint venture companies, Vimicro Tianjin and Visiondigi. Currently we consolidate both Vimicro Tianjin and Visiondigi as we are entitled to majority economic benefits as well as majority voting interests at the board level in both Vimicro Tianjin and Visiondigi. The joint venture agreements of Vimicro Tianjin and Visiondigi require an affirmative vote of a qualified majority of the shareholders to take certain actions, which could have the consequence of slowing down the decision-making process for the joint ventures. Futhermore, as of March 31, 2010, our holding in Visiondigi had decreased to 50.95%. We cannot assure you that we will maintain majority economic benefits and majority voting interests in both entities in the future, and that we shall continue to be able to consolidate their financial results. Failure to consolidate their financial results may have a material adverse effect on our financial condition and results of operations.

If we fail to achieve and maintain effective internal control over financial reporting in accordance with the Sarbanes-Oxley Act, we could suffer a loss of investor confidence in the reliability of our financial statements.

We are subject to reporting obligations under the U.S. securities laws. The Securities and Exchange Commission, or the SEC, as required by Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, adopted rules requiring every public company to include a management report on such company’s internal control over financial reporting in its annual report, which must also contain management’s assessment of the effectiveness of its internal control over financial reporting. Our management has conducted an evaluation of our internal control over financial reporting, and concludes that our internal control over financial reporting as of December 31, 2009 is effective.

We are continuously improving our internal control over financial reporting in line with the development of our business, including the recent expansion of our operations in the security and surveillance market. However, we cannot assure you that our efforts on the development of our internal control over financial reporting will be effective or any significant deficiencies or material weaknesses in our internal control over financial reporting will not be identified in the future. If we fail to maintain effective internal control over financial reporting in accordance with the Sarbanes-Oxley Act, we could suffer a loss of investor confidence in the reliability of our financial statements, which in turn could negatively impact the trading price of our ADSs, result in lawsuits being filed against us by our shareholders or otherwise harm our reputation. Furthermore, we have incurred and anticipate that we will continue to incur considerable costs and use significant management time and other resources in an effort to continue to comply with Section 404 and other requirements of the Sarbanes-Oxley Act.

Contractual arrangements between Vimicro China and Vimicro Hong Kong may be subject to scrutiny by the Hong Kong tax authorities and a finding that Vimicro Hong Kong owes additional taxes could substantially reduce our consolidated net income and the value of your investment.

We use Vimicro Hong Kong, a wholly owned subsidiary of Vimicro China incorporated in Hong Kong, to facilitate a substantial portion of our sales activities primarily due to Vimicro Hong Kong’s close proximity to foundries and assembly and testing houses located in Taiwan and Hong Kong. Vimicro Hong Kong and Vimicro China have entered into certain contractual arrangements pursuant to which Vimicro Hong Kong makes royalty payments to Vimicro China for certain technologies licensed from Vimicro China. We could face material and adverse tax consequences if the Hong Kong tax authorities determine that the contractual arrangements between Vimicro China and Vimicro Hong Kong were not entered into based on arm’s-length negotiations and adjust Vimicro Hong Kong’s income and expenses for Hong Kong tax purposes in the form of a transfer pricing adjustment. In addition, the Hong Kong tax authorities may impose late payment fees and other penalties on Vimicro Hong Kong for under-paid taxes. Our consolidated net income may be materially and adversely affected if Vimicro Hong Kong’s tax liabilities increase or if it is found to be subject to late payment fees or other penalties.

Vimicro Hong Kong’s application for claims may not be successful and as a result, the penalties to those underpaid taxes might be invoked and the royalty payments to Vimicro China could be subject to withholding tax.

Vimicro Hong Kong applied for reopening of its profits tax returns with the Hong Kong Inland Revenue Department in September, 2006 to lodge offshore claims for all years since the commencement of its operations in 2002 and filed amended tax returns. Based on the territorial source principle of taxation in Hong Kong, it is considered that Vimicro Hong Kong has a reasonable technical basis to lodge the offshore claim. The offshore position claim of Vimicro Hong Kong was being examined by the Hong Kong Inland Revenue Department as of December 31, 2009. In connection with the offshore claim of Vimicro Hong Kong, all of Vimicro Hong Kong’s trading income is not taxable and the related royalty fee expenditure would not be tax deductible and should be exempted from withholding tax in Hong Kong. However, we cannot assure you that the offshore position claim of Vimicro Hong Kong would be successful. If Hong Kong Inland Revenue Department declines the offshore claim, Vimicro Hong Kong could be required to pay up all the uncharged taxes and penalties, as well as the withholding tax with the rate of 5.25% on royalty income derived (or deemed to be) from Vimicro Hong Kong.

Construction delay and other risks associated with our construction projects may require higher capital expenditure and have an adverse impact on our business and results of operation.

We have five construction projects in Beijing, Tianjin, Shenzhen, Shanghai and Nanjing, respectively, to build new offices, research and development centers and production facilities. For a description of each construction project, see “Item 4. Information on the Company—D. Property, Plant and Equipment.” We have already made pre-payments for the land use rights for some of the sites, and plan to make similar pre-payments in the future, which may require large sums of cash expenditure.

We are required to obtain various governmental approvals at the different stages of these construction projects, which are not entirely under our control. In addition, the relevant governmental authorities may require us to make substantive changes to our initial designs as conditions to issue certain approvals, which may significantly increase our construction costs. The relevant government authorities could also impose penalties or fines for construction delays and other potential violations. We rely on independent contractors for the construction of these projects. The contractors may experience financial or other difficulties which may affect their ability to carry out construction work and thus delay the completion of the projects or resulting in additional costs for us. In addition, construction delays and specific site conditions at any site could affect the final cost and completion date of the projects, which may in turn disrupt our growth strategy and materially and adversely affect our operating results. An increase in the estimated or actual construction costs may require a higher capital expenditure than we had anticipated.

Risks Relating to Our Industry

The markets in which we operate are highly competitive, and we cannot assure you that we will be able to compete successfully against our competitors.

The market for multimedia processors is intensely competitive and is characterized by frequent technological change and evolving industry standards. We expect competition to increase, especially in the mobile phone multimedia processor market. Increased competition may result in price reductions, reduced margins and inability to gain or hold market share.

In the PC camera multimedia processor market, we face competition primarily from ALi Corporation, EMPIA Technology, Sonix Technology and Sunplus Technology. We also face competition from large, diversified semiconductor vendors such as Realtek and Ricoh.

In the mobile phone multimedia processor market, we face intense competition from vendors of audio processors such as NEC Electronics, Oki Electric, Rohm, Sunplus Technology, Winbond Electronics Corp. and Yamaha, and vendors of image, video and graphics processors, such as ATI Technologies, CoreLogic, MtekVision, Nvidia, Sanyo, Seiko Epson and Sunplus Technology. In addition, we may face actual or potential competition from established suppliers of semiconductor solutions to mobile phone manufacturers which may attempt to enter our market through, among other means, bundling or integrating multimedia processing functionality with their existing offerings. These suppliers include Analog Devices, Broadcom, Freescale, Infineon, Intel, Mediatek, Spreadtrum, NEC Electronics, Philips, QUALCOMM, STMicroelectronics and Texas Instruments.

In the security and surveillance market, we face competitions from companies as Sony, Samsung, Texas Instruments, NXP, H3C and STMicroelectronics.

Many of our competitors have significantly greater financial, technical, manufacturing, marketing, sales and other resources than we do. We cannot assure you that we will be able to compete effectively and increase or maintain our revenue and market share in the PC camera multimedia processor market, or compete successfully against our current or future competitors in the mobile phone multimedia processor market.

We are subject to rapidly declining average selling prices, which may harm our revenue and gross profit.

Semiconductor products and electronics products into which they are incorporated are typically sold in high volumes and are subject to rapid declines in average selling prices. We have reduced the prices of many of our products in the past to meet market demand, and expect that we will continue to face market driven pricing pressures on our products in the short term, as a result of the industry downturn and the uncertain market condition. Our financial results will suffer if we are unable to offset any reductions in our average selling prices by developing new or enhanced products on a timely basis with higher selling prices or gross profit margins, increasing our sales volumes or reducing our costs.

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

Our industry is highly cyclical and is characterized by constant and rapid technological change, product obsolescence and price erosion, evolving standards, short product life cycles and wide fluctuations in product supply and demand. The semiconductor industry and our operations are characterized by high costs, such as those related to facility construction and equipment, research and development, and employment and training of a highly skilled workforce, that are either fixed or difficult to reduce in the short term. The industry has, from time to time, experienced significant downturns, often connected with, or in anticipation of, maturing product cycles of both semiconductor companies’ and their customers’ products and declines in general economic conditions. In addition, during these downturns some competitors may become more aggressive in their pricing practices, which would adversely impact our gross margin. Any downturns in the semiconductor industry may be severe and prolonged, and any failure of the industry to fully recover from downturns could seriously impact our revenue and harm our business, financial condition and results of operations in the short and long term. The semiconductor industry also periodically experiences increased demand and production capacity constraints, which may affect our ability to ship products.

The recent global economic crisis has significantly impacted our industry and the downturn may occur again in the near to medium term. The recent downturn on our industry has led to sharply diminished product demand, production overcapacity, high inventory levels and accelerated erosion of average selling prices. Any future downturns may result in consolidations in our industry and changes in our competitive landscape. They may also reduce our revenue, cause excessive inventory, and result in material and adverse changes in our operating results.

Our business could be materially and adversely affected if we fail to anticipate changes in evolving industry standards and to develop and introduce new and enhanced products.

Our products are generally based on industry standards, which are continually evolving. The emergence of new industry standards could render our products or those of our customers unmarketable or obsolete and may require us to incur substantial unanticipated costs to comply with any such new standards. Moreover, our past sales and profitability have resulted, to a significant extent, from our ability to anticipate changes in technology and industry standards and to develop and introduce new and enhanced products. Our continued ability to adapt to such changes and anticipate future standards will be a significant factor in maintaining or improving our competitive position and our prospects for growth. We cannot assure you that we will be able to anticipate the evolving industry standards or that we will be able to successfully develop and introduce new products to meet the new standards. If we fail to anticipate technological change and introduce new products that achieve market acceptance, our business and results of operations could be materially and adversely affected.

If we are unable to respond to the rapid changes to the digital surveillance industry, our business, financial condition and results of operations could be adversely affected.

The security and surveillance industry in China is characterized by rapid technological change. Sudden changes in customer requirements and preferences, the frequent introduction of new products and services embodying new technologies and the emergence of new industry standards and practices could render our products, services and systems obsolete. The emerging nature of products and services in the security and surveillance industry and their rapid evolution will require us to respond to changes on a timely and cost-effectively basis.

The entry into the security and surveillance market involves significant technological and business risks and requires substantial expenditures and lead time. If we fail to introduce products with new technologies in a timely manner, or adapt our products to these new technologies, our business, financial condition and results of operations could be adversely affected. We cannot assure you that even if we are able to introduce new products or adapt our products to new technologies that our products will gain acceptance among our customers.

Risks Related To Doing Business in China

Adverse changes in political and economic policies of the PRC government could have a material adverse effect on the overall economic growth of China, which could reduce the demand for our products and have a material adverse effect on our competitive position.

Most of our business operations are conducted in China and we believe that a significant portion of devices that our products are incorporated into are ultimately sold to end users in China. Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. The Chinese economy differs from the economies of most developed countries in many respects, including the amount of government involvement, the level of development, the growth rate, the control of foreign exchange and the allocation of resources.

While the Chinese economy has experienced significant growth in the past 20 years, growth has been uneven, both geographically and among various sectors of the economy. The PRC government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures benefit the overall Chinese economy, but may also have a negative effect on us. We cannot predict the future direction of economic reforms or the effects such measures may have on our business, financial position or results of operations. Any adverse change in the economic conditions in China, in policies of the PRC government or in laws and regulations in China, could have a material adverse effect on the overall economic growth of China or on the investment in the semiconductor industry. Such developments could lead to reduction in demand for our products and consequently materially and adversely affect our competitive position.

Because our business depends in part on the continuing expansion of the electronics supply chain in China, any slowdown in this expansion or a disruption of the supply chain could have a material adverse effect on our business and operating results.

Our continuing growth is based upon, among other factors, the continuing expansion of design, manufacturing and other elements of the electronics supply chain in China. This expansion depends on many factors, such as the sustained global demand for electronics products, China’s ability to continue to attract foreign investment, maintain low costs of operations and supply a well-educated labor force, as well as compete successfully against other countries which desire to establish themselves as preferred supply centers. The recent global downturn has put severe pressure on global demand for electronics product, and significant realignment may take place in the electronics supply chain in China as a result. Any slowdown in the expansion of the electronics supply chain in China or a disruption of the supply chain due to industry realignment could have a material adverse effect on our business and operating results.

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

We conduct our business primarily through Vimicro China, which is subject to PRC laws and regulations applicable to foreign investment in China and, in particular, laws applicable to wholly foreign owned companies. The PRC legal system is based on written statutes. Prior court decisions may be cited for reference but have limited precedential value. Since 1979, PRC legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since these laws and regulations are relatively new and the PRC legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involve uncertainties, which may limit the legal protections available to us. In addition, any litigation in China may be protracted and result in substantial costs and the diversion of resources and management attention.

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

The PRC government has provided various tax incentives to domestic companies in the semiconductor industry, including Vimicro China, in order to encourage development of the industry. Vimicro China has benefited from tax incentives provided by the PRC tax authorities in the form of preferential tax treatment, reduced tax rates and tax credit, and has also received government research grants and other incentive measures. However, the PRC tax authorities could reduce or eliminate any or all of these tax incentives at any time in the future.

On March 8, 2004, Vimicro China was granted the status of a “Foreign Investment Advanced Technology Enterprise” by the Ministry of Commerce of China, and is therefore entitled to a preferential tax rate at 10% for three years starting from 2006. In March 2007, the National People’s Congress adopted the New Enterprise Income Tax Law (“New EIT Law”), which became effective as of January 1, 2008. The 10% preferential tax rate no long applied to Vimicro China after the New EIT Law became effective.

Under the New EIT Law, the enterprise income tax rate for domestic and foreign enterprises is unified at 25%, and enterprises established prior to March 16, 2007 that were eligible for preferential tax treatment according to the then effective PRC EIT Law for Foreign Investment Enterprise and Foreign Enterprise, administrative regulations and circulars with equivalent effect shall be subject to transitional rules to gradually change their rates to 25%. Certain qualified “high and new technology companies” may be entitled to a 15% preferential tax rate if they meet the definition of “high and new technology enterprises “ set out in the Implementation Rules of the New EIT Law. The Implementation Rules of the New EIT Law as well as a series of clarification rules were promulgated by the State Council and its competent authorities. In accordance with the Implementation Rules of the New EIT Law, the preferential tax rates granted to PRC entities that previously qualified as “high and new technology enterprises” will not be automatically applicable under the new tax regime unless they qualify as “high and new technology enterprises” pursuant to the New EIT Law, its Implementation Rules, and relevant working guidance promulgated by the authorities. Vimicro China was recognized as a “high and new technology enterprise” under the New EIT Law by the relevant authorities and effective in 2008, which entitled Vimicro China to a preferential tax rate of 15% for three years starting from January 1, 2008. The relevant tax authorities will evaluate Vimicro China’s qualification as a “high and new technology enterprise” again after three years. We cannot assure you that Vimicro China will continue to qualify for such status under governmental evaluations in the future. In the event the preferential tax treatment for Vimicro China is discontinued, it will become subject to the standard PRC enterprise income tax rate, which could materially increase our tax obligations.

In addition, under the New EIT Law, the worldwide income of a resident enterprise, which includes an enterprise established outside of China with effective management located in China, will be subject to PRC income tax. If the PRC tax authorities determine that our company or any of our subsidiaries registered outside the PRC is a resident enterprise, its worldwide income will be subject to PRC income tax at a tax rate of 25%. Furthermore, under the New EIT Law, dividends payable by a foreign investment enterprise to its foreign non-resident enterprise investors that were derived from income after January 1, 2008 are subject to a 10% withholding tax, unless such foreign investor’s jurisdiction of incorporation has signed a tax treaty or arrangement for the avoidance of double taxation and the prevention of tax evasion with China that provides for a reduced rate of withholding tax. The Cayman Islands, where we are incorporated, does not have such a tax treaty with the PRC. If we are considered a non-resident enterprise, the 10% withholding tax imposed on our dividend income received from Vimicro China, our PRC subsidiary, would reduce our net income and have an adverse effect on our operating results. The New EIT Law also provides that, if a resident enterprise directly invests in another resident enterprise, the dividends received by the investing resident enterprise from the invested enterprise are exempted from income tax, subject to certain conditions. Therefore, if we are classified as a resident enterprise, the dividends that we receive from Vimicro China may be exempted from income tax. However, it remains unclear how the PRC tax authorities will interpret the PRC tax resident treatment of an offshore company, like us.

The discontinuation of preferential tax treatment, the increase of the enterprise income tax rate applicable to Vimicro China, or the imposition of PRC income tax on our worldwide income could have a material adverse effect on our financial condition and results of operations.

Foreign holders of our ADSs or ordinary shares may be subject to PRC withholding tax on dividends payable by us and on gains realized on the sale of our ADSs or ordinary shares, if we are classified as a PRC “resident enterprise.”

Under the New EIT Law, withholding tax at a rate of 10% is applicable to dividends payable to investors that are “non-resident enterprises,” which do not have an establishment or place of business in the PRC, or which have such establishment or place of business but the relevant income is not effectively connected with the establishment or place of business, to the extent such interest or dividends have their sources within the PRC unless such non-resident enterprise can claim treaty protection. Similarly, any gain realized on the transfer of ADSs or ordinary shares by such investors is also subject to a 10% withholding tax if such gain is regarded as income derived from sources within the PRC. Since the New EIT Law is relatively new and ambiguous in certain aspects, there is uncertainty as to whether the dividends we pay with respect to our ADSs or ordinary shares, or the gain you may realize from the transfer of our ADSs or ordinary shares, would be treated as income derived from sources within the PRC and be subject to PRC withholding tax. If we are required under the New EIT Law to withhold PRC income tax on such dividends or your gains realized on the sales of our ADSs or ordinary shares, your investment in our ADSs or ordinary shares may be materially and adversely affected.

Vimicro China is subject to restrictions on paying dividends or making other distributions to us.

We are a holding company and we rely on dividends paid by our subsidiaries, including Vimicro China, for our cash needs, such as the funds necessary to pay dividends and other cash distributions to our shareholders, to service any debt we may incur and to pay our operating expenses. Regulations in the PRC currently permit payment of dividends only out of accumulated profits as determined in accordance with accounting standards and regulations in China. Vimicro China is required to set aside at least 10% of its accumulated profits each year, if any, to fund certain reserve funds, until the accumulated reserve fund exceeds 50% of its registered capital. These reserve funds are not distributable as cash dividends. If our subsidiary in China incurs debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other distributions to us.

Fluctuations in exchange rates may have a material adverse effect on your investment.

The value of the RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in China’s political and economic conditions and China’s foreign exchange policies. The conversion of RMB into foreign currencies, including U.S. dollars, has been based on rates set by the People’s Bank of China. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the RMB to the U.S. dollar. Under the new policy, the RMB is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in an approximately 21.2% appreciation of the RMB against the U.S. dollar over the following three years. On May 19, 2007, the People’s Bank of China announced a policy to expand the maximum daily floating range of RMB trading prices against the U.S. dollar in the inter-bank spot foreign exchange market from 0.3% to 0.5%. With this increased floating range, the RMB’s value may appreciate or depreciate significantly against the U.S. dollar in the long term. While the international reactions to the RMB revaluation and widening of the RMB’s daily trading band have generally been positive, with increased floating range of the RMB’s value against foreign currencies, the RMB may appreciate or depreciate significantly in value against the U.S. dollar or other foreign currencies in the long-term, depending on the fluctuation of the basket of currencies against which it is currently valued. It is difficult to predict how long the current situation may last and when and how it may change again.

A portion of our revenue and most of our operating expenses are denominated in RMB, while most of our revenue, cost of revenue and non-operating expenses are denominated in U.S. dollars and Hong Kong dollars, which are pegged to the U.S. dollar. We use the U.S. dollar as the reporting currency for our financial statements. Fluctuations in exchange rates, primarily those involving the U.S. dollar, may affect our costs and operating margins as well as our net income and comprehensive income reported in U.S. dollars. Conversely, if we decide to convert our RMB into U.S. dollars for the purpose of making payments for dividends on our ordinary shares or ADSs or for other business purposes, appreciation of the U.S. dollar against the RMB would have a negative effect on the U.S. dollar amount available to us.

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

The PRC government imposes controls on the convertibility of RMB into foreign currencies and, in certain cases, the remittance of currency out of China. We receive a portion of our revenue in RMB, which is currently not a freely convertible currency. Under our current structure, our income will be primarily derived from dividend payments from Vimicro China. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from the transaction, can be made in foreign currencies without prior approval from the PRC State Administration of Foreign Exchange, or SAFE, by complying with certain procedural requirements. However, approval from appropriate governmental authorities is required where RMB is to be converted into foreign currency and remitted outside of China to pay capital expenses such as the repayment of bank loans denominated in foreign currencies. The PRC government may also, at its discretion, restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able to pay dividends in foreign currencies to our shareholders, including holders of our ADSs. In addition, we cannot be certain that the PRC regulatory authorities will not impose more stringent restrictions on RMB foreign exchange transactions.

PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident shareholders to personal liability and limit our ability to inject capital into our PRC subsidiary, limit our subsidiary’s ability to distribute profits to us, or otherwise adversely affect us.

SAFE issued a public notice known as “Circular 75” in October 2005 requiring PRC residents to register with the local SAFE branch before establishing or controlling any company outside of China for the purpose of capital financing, referred to in Circular 75 as a “special purpose offshore company.” Circular 75 became effective on November 1, 2005. On May 29, 2007, SAFE promulgated Circular 106, which serves as the implementing rules of Circular 75. Under Circular 106, PRC subsidiaries of an offshore enterprise governed by Circular 75 are required to coordinate and supervise the filing of SAFE registrations in a timely manner by the offshore holding company’s shareholders who are PRC residents. If these shareholders fail to comply, the PRC subsidiaries are required to report to the local SAFE branch.

We have notified beneficial owners of our company who are PRC residents to register with the local SAFE branch as required under Circular 75. We understand that members of our senior management who are PRC residents have registered with the local SAFE branch. However, we may not at all times be fully aware or informed of the identities of all our beneficial owners who are PRC residents, and we may not always be able to compel our beneficial owners to comply with the Circular 75 requirements. As a result, we cannot assure you that all of our shareholders or beneficial owners who are PRC residents will at all times comply with, or in the future make or obtain any applicable registrations or approvals required by, Circular 75 or other related regulations. The failure or inability of beneficial owners of our company resident in the PRC to comply with the registration procedures set forth under Circular 75 could subject such beneficial owners to fines and legal sanctions and may also limit our ability to contribute additional capital into our PRC subsidiary, limit our PRC subsidiary’s ability to distribute profits to our company or otherwise adversely affect our business.

If the PRC government determines that the contractual arrangements that establish the structure for operating our wireless value-added telecommunications business do not comply with applicable PRC laws and regulations, we could be subject to penalties.

We are a Cayman Islands company and, as such, we are classified as a foreign enterprise under PRC laws, and our PRC subsidiaries, including Vimicro China, are foreign-invested enterprises. Various regulations in China restrict or prevent foreign-invested entities from holding certain licenses required to operate value-added telecommunications business, including wireless value-added telecommunications business. In light of these restrictions, we rely on Vimicro Sky-Vision to hold and maintain the permits and licenses necessary to operate our wireless value-added telecommunications business in China. We do not possess any equity interest in Vimicro Sky-Vision, but we receive certain economic benefits from it through various contractual arrangements, certain corporate governance and shareholder rights arrangements. In addition, we have entered into agreements with each of Vimicro Sky-Vision’s shareholders, which provide us with substantial control over Vimicro Sky-Vision. For a description of these contractual arrangements with Vimicro Sky-Vision and its shareholders, see “Item 7. Major Shareholders and Related Party Transactions—B. Related Party Transactions— Contractual Arrangements with Vimicro Sky-Vision and its Shareholders.”

The Circular on Strengthening the Administration of Foreign Investment in and Operation of Value-added Telecommunications Business, or the Circular, issued in July 2006 by the Ministry of Industry and Information Technology, or the MIIT, reiterated the regulations on foreign investment in telecommunications businesses, which requires foreign investors to set up foreign-invested enterprises and obtain a business operating license, or VT license, for conducting any value-added telecommunications business in China. Under the Circular, a domestic company that holds a VT license is prohibited from leasing, transferring or selling the license to foreign investors in any form. They are also prohibited from providing any assistance, including providing resources, sites or facilities, to foreign investors that conduct value-added telecommunications business illegally in China. Furthermore, the relevant trademarks and domain names that are used in the value-added telecommunications business must be owned by a VT license holder or its shareholder(s). The Circular further requires each VT license holder to have the necessary facilities for its approved business operations and to maintain such facilities in the regions covered by its license. In addition, all value-added telecommunications service providers are required to maintain network and information security in accordance with the standards set forth under relevant PRC regulations. Due to a lack of interpretative materials from the regulator, it is unclear what impact the Circular will have on us or other domestic providers of value-added telecommunications services that have adopted the same or similar corporate and contractual structures as ours.

If we are found to be in violation of any existing or future PRC laws or regulations, including the Circular, or if we fail to obtain or maintain any of the required permits or approvals, the relevant regulatory authorities would have broad discretion in dealing with such violation, including but not limited to imposing fines, issuing rectification orders, confiscating our income, revoking Vimicro China’s or Vimicro Sky-Vision’s business and operating licenses, requiring us to restructure the relevant ownership structure or operations and requiring us to discontinue all or any portion of our wireless value-added telecommunication business. We did not derive any revenues from our wireless value-added telecommunications business in 2009. However, any of the foregoing actions undertaken by relevant regulatory authorities could cause significant disruption to our wireless value-added telecommunications business operations.

Our contractual arrangements with Vimicro Sky-Vision and its shareholders, respectively, may not be as effective in providing control over Vimicro Sky-Vision as direct ownership.

We conduct our wireless value-added telecommunication business in China through Vimicro Sky-Vision, which was set up in March 2010. Our contractual arrangements with Vimicro Sky-Vision and its shareholders provide us with effective control over Vimicro Sky-Vision. See “Item 7. Major Shareholders and Related Party Transactions—B. Related Party Transactions— Contractual Arrangements with Vimicro Sky-Vision and its Shareholders”. As a result of these contractual arrangements, we are considered to be the primary beneficiary of Vimicro Sky-Vision and Vimicro Sky-Vision becomes our VIE. Accordingly, we consolidate the results of operations, assets and liabilities of Vimicro Sky-Vision in our financial statements.

These contractual arrangements may not be as effective in providing us with control over Vimicro Sky-Vision as direct ownership. In addition, Vimicro Sky-Vision or its shareholders may breach the contractual arrangements. We cannot assure you that when conflicts of interest arise, Vimicro Sky-Vision and its shareholders will act completely in our interests or that conflicts of interest will be resolved in our favor. In any such event, we would have to rely on legal remedies under PRC law. These remedies may not always be effective, particularly in light of uncertainties in the PRC legal system. See “—Risks Related to Doing Business in China—Uncertainties with respect to the PRC legal system could adversely effect us.”

Contractual arrangements we have entered into may be subject to scrutiny by the PRC tax authorities, and a finding that we or Vimicro Sky-Vision owe additional taxes could reduce our net income and the value of your investment.

As required by applicable PRC laws and regulations, arrangements and transactions among related parties may be subject to audit or challenge by the PRC tax authorities. On January 8, 2009, the State Administration of Taxation issued the Implementation Measures of Special Tax Adjustments (Provisional), which reinforces its supervision on transfer pricing. We could face adverse tax consequences if the PRC tax authorities determine that the contractual arrangements between Vimicro China and Vimicro Sky-Vision do not represent an arm’s-length price, and adjust Vimicro Sky-Vision’s income in the form of a transfer pricing adjustment. A transfer pricing adjustment could, among other things, result in a reduction, for PRC tax purposes, of expense deductions recorded by Vimicro Sky-Vision, which could in turn increase its tax liabilities. In addition, the PRC tax authorities may impose late payment fees, fines, or revocation of business licenses and other penalties on Vimicro Sky-Vision for underpaid taxes. Our net income may be adversely affected if tax liabilities of Vimicro Sky-Vision increase or if Vimicro Sky-Vision is found to be subject to late payment fees or other penalties.

We face risks related to health epidemics and other outbreaks.

Our business could be adversely affected by the effect of H1N1, or swine flu, avian flu, SARS or another epidemic or outbreak on the economic and business climate. In 2009, an outbreak of swine flu occurred in various countries, including China. Any outbreak of swine flu, avian flu, or another epidemic or any prolonged recurrence of SARS in China may have a material adverse effect on our business operations, financial condition and results of operations. For instance, health or other government regulations may require temporary closure of our offices, which will severely disrupt our business operations.

Risks Related to the Shares and ADSs

We were a passive foreign investment company for the taxable year ended December 31, 2009, which could result in adverse United States federal income tax consequences to U.S. holders of our ADSs or ordinary shares.

Based on the market price of our ADSs and the value and composition of our assets, we believe we were a “passive foreign investment company,” or PFIC, for U.S. federal income tax purposes for the taxable year ended December 31, 2009. In addition, it is likely that one or more of our subsidiaries were also PFICs for such year. In addition, we believe there is a significant risk that we will be PFIC for the taxable year ending December 31, 2010 and for future taxable years, unless the market price of our ADSs increases or we reduce the amount of cash and other passive assets we hold sufficiently from current levels. A non-U.S. corporation will be a PFIC for any taxable year if either (1) at least 75% of its gross income for such year is passive income or (2) at least 50% of the value of its assets (based on an average of the quarterly values of the assets) during such year is attributable to assets that produce passive income or are held for the production of passive income. We must make a separate determination after the close of each taxable year as to whether we were a PFIC for that year. Because the value of our assets for purposes of the PFIC test will generally be determined by reference to the market price of our ADSs or ordinary shares, our PFIC status will depend in large part on the market price of the ADSs or ordinary shares, which may fluctuate significantly. Because we believe we were a PFIC for the taxable year ended December 31, 2009, certain adverse U.S. federal income tax consequences could apply to U.S. holders (as defined in “Item 10. Additional Information—E. Taxation—United States Federal Income Taxation”) of our ADSs or ordinary shares with respect to any “excess distribution” received from us and any gain from a sale or other disposition of the ADSs or ordinary shares. See “Item 10. Additional Information—E. Taxation—United States Federal Income Taxation—Passive Foreign Investment Company.”

The market price for our ADSs may be volatile.

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

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actual or anticipated fluctuations in our quarterly operating results and changes or revisions of our expected results;

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changes in financial estimates by securities research analysts;

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conditions in the PC camera, multimedia mobile phone and security and surveillance markets;

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changes in the economic performance or market valuations of other semiconductor companies;

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

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addition or departure of our key personnel;

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fluctuations of exchange rates between the RMB, the U.S. dollar and the Hong Kong dollar;

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litigation related to our intellectual property;

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release or expiry of lock-up or other transfer restrictions on our outstanding ordinary shares or ADSs; and

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sales or perceived potential sales of additional ordinary shares or ADSs.

In addition, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also have a material adverse effect on the market price of our ADSs.

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

We have a strong cash balance currently, however, we may require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue, the performance of security and surveillance projects and construction of office buildings. If our resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain a credit facility. The sale of additional equity securities could result in additional dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations. We cannot assure our existing shareholders that financing will be available in amounts or on terms acceptable to us, if at all.

Substantial future sales of our ADSs or ordinary shares in the public market, or the perception that these sales could occur, could cause the price of our ADSs to decline.

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

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

Except as described in this annual report on Form 20-F and in the deposit agreement, holders of our ADSs will not be able to exercise voting rights attaching to the shares evidenced by our ADSs on an individual basis. Holders of our ADSs will appoint the depositary or its nominee as their representative to exercise the voting rights attaching to the shares represented by the ADSs. You may not receive voting materials in time to instruct the depositary to vote, and it is possible that you, or persons who hold their ADSs through brokers, dealers or other third parties, will not have the opportunity to exercise a right to vote.

Your right to participate in any future rights offerings may be limited, which may cause dilution to your holdings and you may not receive cash dividends if it is impractical to make them available to you.

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

The depositary of our ADSs has agreed to pay to you the cash dividends or other distributions it or the custodian receives on our ordinary shares or other deposited securities after deducting its fees and expenses. You will receive these distributions in proportion to the number of ordinary shares your ADSs represent. However, the depositary may, at its discretion, decide that it is inequitable or impractical to make a distribution available to any holders of ADSs. For example, the depositary may determine that it is not practicable to distribute certain property through the mail, or that the value of certain distributions may be less than the cost of mailing them. In these cases, the depositary may decide not to distribute such property and you will not receive such distribution.

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

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

Your ability to protect your rights through the U.S. federal courts may be limited, because we are incorporated under Cayman Islands law, conduct a substantial portion of our operations in China and the majority of our directors and officers reside outside of the United States.

We are incorporated in the Cayman Islands, and conduct a substantial portion of our operations in China through Vimicro China. A majority of our directors and officers reside outside of the United States and a substantial portion of their assets are located outside of the United States. As a result, it may be difficult for you to effect service of process within the United States upon these persons. It may also be difficult for you to enforce in U.S. courts judgments obtained in U.S. courts based on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors, most of whom are not residents in the United States and the substantial majority of whose assets are located outside of the United States. In addition, there is uncertainty as to whether the courts of the Cayman Islands or the PRC would recognize or enforce judgments of U.S. courts against us or such persons predicated upon the civil liability provisions of the securities laws of the United States or any state and it is uncertain whether such Cayman Islands or PRC courts would be competent to hear original actions brought in the Cayman Islands or the PRC against us or such persons predicated upon the securities laws of the United States or any state.

You may face difficulties in protecting your interests as a shareholder, as Cayman Islands law provides significantly less protection to shareholders when compared to the laws of the U.S.

Our corporate affairs are governed by our memorandum and articles of association, as amended and restated from time to time, and by the Companies Law (2009 Revision, as amended) and common law of the Cayman Islands. The rights of shareholders to take legal action against our directors, actions by minority shareholders and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from English common law, which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in the United States. In particular, the Cayman Islands has a less developed body of securities laws as compared to the United States, and provides significantly less protection to investors. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action before the federal courts of the United States. As a result, our public shareholders may have more difficulty in protecting their interests in actions against the management, directors or our major shareholders than would shareholders of a corporation incorporated in a jurisdiction in the United States, and our ability to protect our interests if we are harmed in a manner that would otherwise enable us to sue in a United States federal court may be limited.

Provisions of our stockholder rights plan could delay or prevent an acquisition of our company, even if the acquisition would be beneficial to our shareholders, and could make it more difficult for shareholders to change management.

In December 2008, we adopted a shareholder rights plan. Although the rights plan will not prevent a takeover, it is intended to encourage anyone seeking to acquire our company to negotiate with our board of directors prior to attempting a takeover by potentially diluting an acquirer’s ownership interest significantly in our outstanding capital stock. The existence of the rights plan may also discourage transactions that otherwise could involve payment of a premium over prevailing market prices for our ADSs.

We have incurred and will continue to incur increased costs as a result of being a public company.

As a public company, we have incurred and will continue to incur a significantly higher level of legal, accounting and other expenses than we did as a private company. We have incurred and will continue to incur costs associated with our public company reporting requirements. In addition, the Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by the SEC and the Nasdaq, have required changes in corporate governance practices of public companies. We expect these new rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly. We are currently evaluating and monitoring developments with respect to these new rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.

I TEM 4.

I NFORMATION ON THE C OMPANY

A.	History and development of the Company

Our legal and commercial name is Vimicro International Corporation. We commenced operations in 1999 through Vimicro China, a company established in China. In February 2004, we incorporated Vimicro International Corporation in the Cayman Islands as an exempted company with limited liability under the Cayman Islands Company Law (2009 Revision, as amended). In May 2004, we underwent a corporate reorganization whereby all former owners of Vimicro China transferred their ownership interests in Vimicro China to Vimicro International Corporation, and Vimicro China became a wholly owned subsidiary of Vimicro International Corporation. Following the share transfer, each former owner of Vimicro China and/or its designated nominee subscribed for the shares of Vimicro International Corporation based on such former owner’s pro rata ownership interest in Vimicro China prior to the reorganization.

Vimicro China has four directly wholly owned subsidiaries, two joint ventures and one affiliated entity:

Wholly owned subsidiaries

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Viewtel Corporation, which was incorporated in California in June 1999 to keep abreast with the latest technology developments in the U.S. and to maintain a small team of engineers to conduct advanced research and development activities;

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Vimicro Hong Kong, which was established in Hong Kong in May 2002 to facilitate our sales activities and utilization of third-party foundries and assembly and testing houses located in China, Taiwan and Hong Kong;

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Vimicro Beijing, which was established in Beijing in April 2007 as a limited liability company with an approved operating period of 20 years. In December 2007, Vimicro Jiangsu, Vimicro Beijing’s wholly owned subsidiary in China was incorporated as a limited liability company with an approved operating period of 20 years. The main business activities of Vimicro Beijing and Vimicro Jiangsu are to engage in research and development; and

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Vimicro Wuxi, which was formed in Wuxi in July 2009 as a limited liability company. Vimicro Wuxi is our regional headquarter in respect of research and development and design and sales of RF/Bluetooth and other chips.

Joint ventures

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Vimicro Tianjin, which was formed in Tianjin in December 2008 as limited stock corporation by Vimicro China, the State-owned Asset Management Corporation of Tianjin Economic-Technological Development Area, or Tianjin SAMC, and a venture capital fund managed by certain members of our management, or the Management Fund. Tianjin SAMC and Vimicro China each contributed RMB250 million in cash to Vimicro Tianjin as initial registered capital and each holds approximately 49.99% ownership interest in the company. The Management Fund holds a nominal ownership interest. Pursuant to the agreement among Vimicro Tianjin’s shareholders, the Management Fund has the option to purchase all of Tianjin SAMC’s ownership interest in Vimicro Tianjin for RMB250 million plus interests calculated based on the one-year short-term bank lending rate published by the People’s Bank of China. This option can be exercised at any time after one year of the establishment of Vimicro Tianjin. Pursuant to agreements between Vimicro China and the Management Fund, we obtained the voting rights and economic interests associated with the Management Fund’s current share ownership in Vimicro Tianjin, which provides us control of Vimicro Tianjin. The Management Fund also granted us an exclusive right to acquire from the Management Fund the beneficial ownership of Tianjin SAMC’s interest in Vimicro Tianjin for the same amount of consideration paid by the Management Fund. It is necessary for the Management Fund to receive our consent before it can exercise the option to acquire Tianjin SAMC’s interest in Vimicro Tianjin. If we exercise this exclusive right, approximately 15% of Vimicro Tianjin’s ownership interest will be reserved for an equity award scheme whereby we may make grants of equity awards at our discretion. In August 2009, Vimicro Tianjin entered into a series of definitive agreements with ASB, pursuant to which, in a total consideration of RMB55,978,000 ($8.2 million), Vimicro Tianjin acquired the complete ViSS business from ASB, including all equipments, inventories, business contracts, intellectual property and employees in China. In addition, Vimicro and ASB agreed to continue the cooperation on solution and market development in the future. This acquisition was completed in September 2009. Vimicro Tianjin focuses on the design, manufacture and sale of security and surveillance products; and

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Visiondigi, which was formed in Shanghai in July 2009 as a limited liability company by Vimicro China and three DSP experts, with an approved operating period of 20 years. In January 2010, Ningbo Sunny Optoelectronic Information Co., Ltd., or Ningbo Sunny, a wholly owned subsidiary of Sunny Optical Technology Co., Ltd., a company listed on the Hong Kong Stock Exchange, acquired a 30% equity interest in Visiondigi with a consideration of RMB20 million ($2.9 million). In March 2010, Vimicro China exercised its options to increase its shareholding in Visiondigi to 51% with a consideration of RMB9.85 million ($1.4 million). As of the date of this report, Vimicro China, Ningbo Sunny and the three DSP experts as a group held 50.95%, 26.16% and 22.89% of the equity interest in Visiondigi, respectively. Visiondigi specializes in research and development, production and sales of network video surveillance products and solutions.

Affiliated entity

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Vimicro Sky-Vision was established in March 2010 as a limited liability company with an approved operating period of 20 years. Zhonghan (John) Deng, our Chairman and Chief Executive Officer, and Zhaowei (Kevin) Jin, our President and Chief Operating Officer, hold 67% and 33% of the equity interest in Vimicro Sky-Vision, respectively. We entered into a series of contractual arrangements with Vimicro Sky-Vision and its shareholders. As a result of these contractual arrangements, Vimicro Sky-Vision becomes a VIE of our company, and we are considered to be the primary beneficiary of Vimicro Sky-Vision. Accordingly, we consolidated the results of operations, assets and liabilities of Vimicro Sky-Vision in our financial statements. To comply with the PRC regulations that restrict foreign ownership in value-added telecommunications business in China, we conduct our wireless value-added telecommunication operations, particularly the mobile surveillance business, through Vimicro Sky-Vision.

In November 2006, Vimicro Shenzhen, our wholly owned subsidiary in China was incorporated as a limited liability company with an approved operating period of 20 years. The main business activity of Vimicro Shenzhen is to facilitate domestic sales and perform research and development.

In September 2007, Vimicro Shanghai, our wholly owned subsidiary in Shanghai, China was incorporated as a limited liability company with an approved operating period of 30 years. The main business activity of Vimicro Shanghai is to facilitate domestic sales and perform research and development.

Our principal executive offices are located at 15/F Shining Tower, No. 35 Xueyuan Road, Haidian District, Beijing 100191, People’s Republic of China. Our telephone number at this address is (8610) 6894-8888 and our fax number is (8610) 6874-4075. Our registered office in the Cayman Islands is located at the offices of Maples Corporate Services Limited, PO Box 309, Ugland House, Grand Cayman, KY1-1104 Cayman Islands. Our telephone number at this address is (1-345) 949-8066. In addition, we have regional offices in Shanghai, Shenzhen, Nanjing, Hong Kong, Taiwan and Silicon Valley, California.

Recent Developments

In January 2010, Ningbo Sunny invested RMB 20 million ($2.9 million) in Visiondigi. Vimicro China increased its shareholding for the consideration of RMB 9.85 million ($1.4 million). As of the end of March 2010, Vimicro China, Ningbo Sunny and the three individuals as a group held 50.95%, 26.16% and 22.89% of equity interests in Visiondigi, respectively.

In February 2010, Vimicro China entered into an agreement with Beijing Municipal Bureau of Land and Resources to acquire the land use right for approximately 5,046.524 square meters of land from Beijing local government. For a description of this agreement, please see “Item 4. Information on the Company—D. Property, Plant and Equipment.”

In March 2010, Vimicro Sky-Vision was established and became our VIE through a series of contractual arrangements. We rely on Vimicro Sky-Vision to hold and maintain the permits and licenses necessary to operate our wireless value-added telecommunications business in China. For a description of the contractual arrangements with Vimicro Sky-Vision and its shareholders, see “Item 7. Major Shareholders and Related Party Transactions—B. Related Party Transactions—Contractual Arrangements with Vimicro Sky-Vision and its Shareholders.”

B.	Business Overview

Overview

We are a multimedia semiconductor and solution provider. We design, develop and market mixed-signal semiconductor products and system-level solutions that enable multimedia capabilities in a variety of products for the consumer electronics, communications and surveillance markets. Combining our multimedia systems experience with our skills in high performance, low-power, mixed-signal SoC design, we provide customers with comprehensive, system-level solutions that include highly integrated semiconductors, customizable firmware and software, software development tools, reference designs and applications support. We conduct most of our operations in China. Although there are uncertainties with respect to China’s legal and regulatory environment, including its regulations and policies governing dividend distributions, taxes and foreign currency exchange, we believe that we benefit from our access to the high-quality design talent, competitive cost structure, growing electronics design and manufacturing industry and increasingly significant domestic electronics markets in China.

We are one of the leading suppliers of PC and embedded notebook camera multimedia processors in terms of the number of peripheral PC and embedded notebook cameras shipped worldwide in 2009. Our multimedia processors are incorporated into the products of the largest PC and embedded notebook camera vendors, such as Logitech, as well as well-known notebook computer vendors, such as the largest notebook vendor in the world, a U.S. based innovative and cross-platform consumer electronics producer, and the largest personal computer maker in China.

We seek to establish a leading position in the mobile phone multimedia processor market by leveraging our core multimedia technology capabilities. Our mobile phone multimedia processors have been used by leading international and China-based mobile phone brand owners on 2G and increasingly 3G platforms, and leading mobile phone design houses based in China.

We are expanding our business into the surveillance market with system-level solutions and semiconductor products including surveillance cameras, system and management software, digital video decoders, recorders and servers, among other things. We intend to continue to identify and actively pursue additional markets which we believe have the potential for high volume sales of multimedia semiconductor products, such as digital home and personal entertainment systems.

Founded in 1999, we began volume shipments of our mixed-signal PC and embedded notebook camera multimedia processors, mobile phone multimedia processors and security multimedia processors in September 2001, January 2003 and June 2006, respectively. We have grown significantly since we introduced our first mixed-signal multimedia products in September 2001. However, our net revenue decreased from $92.8 million in 2007 to $86.5 million in 2008, and decreased further to $73.0 million in 2009. We incurred net losses of $2.0 million in 2007, $13.6 million in 2008 and $20.7 million in 2009.

Our Solutions and Competitive Strengths

Our solutions consist of semiconductors, software and system-level reference designs. We have designed our solutions to support a broad range of standards, baseband platforms and components in order to facilitate our customers’ designs, assembly and supply chain management processes. We believe that our products and solutions, our location in China and our team of experienced managers and engineers provide us with a number of significant competitive strengths, including:

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Expertise in Mixed-Signal, System-on-Chip Design. Integrating analog and digital circuits in a single semiconductor product is inherently difficult due to noise interference and other technical challenges. Our experienced teams of mixed-signal design engineers are skilled in integrating a variety of multi-voltage, analog and digital functional building blocks in our SoC designs. Our analog circuits include analog to digital conversion, or ADC, digital to analog conversion, or DAC, power supply management, power amplification RF transceiver and high speed bus physical interfaces. Our digital circuits include embedded memory, micro-controller, embedded RISC CPU, DSP and dynamic power management. The high level of integration of our single-chip products delivers several benefits to our customers, including low power consumption, small size and cost effectiveness. All of our products are implemented in standard CMOS processes and manufactured using leading-edge process technologies.

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Leading Design Capabilities in Audio, Imaging, Video and Communications Algorithms and Related Technologies. Our teams of designers have experience in multimedia systems and a variety of audio, imaging and video technologies, including leading industry standards and compression technologies such as WMA, AAC Plus, MIDI, MP3, MPEG2, MPEG4, H.264, WMV, real audio (RM), AVS and JPEG. This enables us to integrate multiple multimedia functions in a single semiconductor product. We have created sophisticated high performance signal processing algorithms for many stages of multimedia processing, including sampling, filtering, coding, decoding, synthesis, compression, storage, playback, transmission and receiving (modulation/demodulation). Using these algorithms, our multimedia SoC solutions are able to perform image, video and audio DSP functions such as data recovery, signal quality enhancement, noise reduction, sample rate conversion, auto exposure, white-balance and focus control, and video and audio signal reconstruction.

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Proprietary Technologies Enabling High Performance Signal Processing Capabilities. Our mixed-signal multimedia processors enable high performance real-time processing of large volumes of audio, image and video signal data. Our adaptable processor architecture incorporates circuitry that can be modified by software commands to permit different types of tasks to be performed by the same processor. We believe that this architecture allows our products to achieve processing speed, signal quality and power consumption performance comparable to that obtained from competing fixed function hardware. However, unlike fixed function hardware, which is suitable for single applications such as video processing, our products can support a variety of multimedia applications such as audio, video and imaging using a single processor. This allows us to achieve levels of integration comparable to those offered by general-purpose semiconductor devices such as CPUs and baseband processors. Since our processors are designed solely for multimedia applications, rather than a broad spectrum of computing tasks, our processors avoid the need for the complex control software used by CPUs and baseband processors, and can therefore offer significantly better processing speed, signal quality and power consumption performance.

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Application-Level Software Development Capabilities . We seek to differentiate our products and speed our customers’ time-to-market through developing application-level software capabilities. We work closely with other technology leaders to enable innovative multimedia applications through the integration of value-added software features.

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Extensive Network of Sales, Marketing and Customer Support Resources . We have an extensive network of sales, marketing and customer support resources, including offices in Mountain View, Hong Kong, Taipei, Beijing, Shanghai, Shenzhen and Nanjing. We have entered into distribution and support agreements with partners whom we have trained to support our products to cover additional areas such as Japan and specific large customers in Korea and elsewhere. We maintain an extensive technical support team in Beijing and in other cities in China to provide high-quality, low-cost support services for our global sales force.

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Proximity to the Growing Electronics Design and Manufacturing Industry and Electronics Markets in China. We market and sell our products and solutions to an increasing number of companies in the electronics industry that have established design, manufacturing and assembly facilities in China. Our close proximity to these facilitates provides opportunities for efficient cooperation, marketing, manufacturing improvements and after-sales support. In addition, domestic consumer demand for electronic devices has increased significantly in the past years as a result of the rapid growth in the Chinese economy, which in turn further boosts demand for semiconductor products. We believe that we are well positioned to take advantage of the growth of the electronics design and manufacturing industry and electronics markets in China.

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Ability to Enter Local Public Purchase Programs and to Penetrate Certain Vertical Domestic Markets. We have won various awards and endorsements from local governments in China for technological innovation and self-developed intellectual properties. Our position as a leading multimedia solution provider and our extensive industry know-how allow us to enter public projects, government procurement programs and vertical industries that are dominated by state-owned enterprises. We collaborate closely with various national research institutions and leading domestic enterprises in China to develop products and solutions that are tailored to specific local requirements, in areas of security, surveillance and other multimedia applications.

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Ability to Benefit from Worldwide Sourcing of Semiconductor and System Design Talent . Our management and engineering team leaders have significant international experience that they have leveraged in guiding us to our current position. We believe that this has enabled us to attract skilled and experienced engineers in Silicon Valley and elsewhere with expertise in mixed-signal design to support our growth and continued technology innovation. In addition, we believe this position gives us a competitive advantage in recruiting candidates from China’s top universities. China has established a significant educational system for advanced semiconductor design, and graduates a large number of advanced degree holders in engineering each year, creating a large pool of motivated and qualified candidates. As a result, we have been consistently able to hire qualified engineering graduates at a competitive cost. Recruiting and retaining research and development talent comprises one of the most significant expenses for semiconductor design companies. Our access to high-quality, low-cost design talent in China provides us with a significant competitive advantage relative to semiconductor designers based in higher-cost areas.

Products

We primarily design, develop and market mixed-signal multimedia processors for PC and embedded notebook cameras, as well as for mobile phones. We provide our customers with comprehensive, system-level solutions that include highly integrated semiconductors, customizable firmware and software, software development tools, reference designs and applications support. Our products support a broad range of standards, platforms and components in order to facilitate our customers’ designs and their assembly and supply chain management processes. To meet demand from China-based PC and embedded notebook camera manufacturers for more comprehensive system solutions to enable greater ease-of-use and shortened time-to-market for their products, we frequently order image sensors based on our specifications from third-party sensor manufacturers and sell them together with our mixed-signal PC and embedded notebook camera multimedia processors. Leveraging our multimedia technologies, we have expanded our business into the security and surveillance market and launched several products in the security and surveillance business. The security and surveillance market primarily consists of video capturing, compression, transmission, storage, processing, display and video analysis products.

PC and Embedded Notebook Camera Multimedia

We design different models of PC and embedded notebook camera multimedia processors based on the same core technology platform with modifications in successive models with improved performance and functionality. Our PC and embedded notebook camera multimedia processors are fully compatible with sensors that are based on CMOS technology, the primary type of technology for sensors. All of our PC and embedded notebook camera multimedia processors are single-chip processors manufactured under our own brand name using our proprietary intellectual property. While our principal focus is on providing our customers with proprietary, high performance products, we also develop and sell a range of basic, complementary semiconductor products in order to provide more comprehensive solutions for our customers.

The following table sets forth major PC and embedded notebook camera multimedia processors we have developed and shipped in volume from 2006 to the first quarter of 2010.


Product	Features	Month Introduced(1)
VC0338	Controller chip for USB 2.0 stand-alone or notebook PC embedded cameras with high resolution (up to 5mega pixel); supports UVC and UAC; advanced ISP; small footprint QFN package and low power design; best fitted to embedded camera applications.	September 2009

VC0347	Controller chip for USB 2.0 stand-alone or notebook PC embedded cameras with HD resolution (up to 720P or 1080P); supports UVC and UAC; supports MJPG compression; small footprint QFN package and low power design; best fitted to embedded camera applications.	July 2009

VC0345	Controller chip for USB 2.0 notebook PC embedded cameras with high resolution (up to 2mega pixel); supports UVC; small footprint QFN package and low power design; best fitted to embedded camera applications.	January 2009

VC0361	Controller chip for USB 2.0 notebook PC embedded cameras capable of producing images of 1.3mega pixel at 15 frames per second in the Moving Picture Experts Group, or MPEG format; supports UVC; small footprint QFN package and low power design best fit to embedded camera applications.	September 2008

VC0343	Controller chip for USB 2.0 notebook PC embedded cameras with high resolution (up to 2mega pixel); supports UVC and UAC; small footprint QFN package and low power design best fit to embedded camera applications.	March 2008

VC0342	Controller chip for USB 2.0 PC cameras with high resolution up to 2mega pixel; supports mono Audio ADC for high-quality audio recording; supports UVC and UAC; small footprint QFN package and low power design best fit to embedded camera applications.	January 2008

VC0341	Controller chip for USB 2.0 PC cameras with high resolution up to 2mega pixel; supports UVC; small footprint QFN package and low power design best fit to embedded camera applications.	January 2008

VC0301HUVC	Controller chip for USB 1.1/2.0 PC cameras with high resolution up to 2mega pixel; supports UVC.	December 2007

VC0334	Controller chip for USB 2.0 PC cameras with high resolution up to 2mega pixel; supports UVC; supports digital microphone input; small footprint QFN package best fit to embedded camera applications.	September 2007

VC0333	Controller chip for USB 2.0 PC cameras with high resolution up to 2mega pixel; supports UVC; small footprint QFN package best fit to embedded camera applications.	September 2007

VC0336	Controller chip for USB 1.1/2.0 PC cameras with high resolution up to 5mega pixel; supports 2-channel audio ADC or 2-channel digital microphones for high-quality audio recording; supports UVC, UAC and one Parallel and one SMIA sensor interface; supports Microsoft Microphone Array (dual Mic); supports video and audio synchronization, special HW compression for 2mega to 5mega high speed capture.	April 2007

VC0301V	Controller chip for USB 1.1/2.0 PC cameras with high resolution up to 2mega pixel; supports UVC.	March 2007

VC0332	Controller chip for USB 1.1/2.0 PC cameras with high resolution up to 2mega pixel; supports mono audio ADC for high-quality audio recording; supports UVC and UAC.	February 2007

VC0331	Controller chip for USB 1.1/2.0 PC cameras with high resolution up to 2mega pixel; supports UVC; small footprint QFN package best fit to embedded camera applications.	February 2007


ZS0211	Cost-effective single-chip solution with an integrated USB controller and transceiver, eliminates the need for external DRAM and reduces PC and embedded notebook camera bill of materials costs.	September 2006

VC0326	High-speed imaging processor with 0.18µm technology for PC and embedded notebook cameras, supports a 1.3mega pixel CMOS sensor with a frame rate of up to 30 frames per second at VGA resolution; integrates noise cancellation features, a USB 2.0 controller and transceiver, a JPEG codec, two channel audio ADC and an AC97 interface; supports human face tracking applications.	March 2006

VC0325	High-speed imaging processor with 0.18µm technology for PC and embedded notebook cameras; supports a 1.3mega pixel CMOS sensor with a frame rate of up to 30 frames per second at VGA resolution; integrates a USB 2.0 controller and transceiver, a JPEG codec and an AC97 interface; supports human face tracking applications.	March 2006

VC0323	High-speed imaging processor with 0.18µm technology for PC and embedded notebook cameras; supports a 1.3mega pixel CMOS sensor with a frame rate of up to 30 frames per second at VGA resolution; integrates a USB 2.0 controller and transceiver.	January 2006

(1)	“Month introduced” means the month during which we began shipments of the product.

In 2007, 2008 and 2009, we shipped 31.4 million, 29.9 million and 36.7 million units, respectively, of PC and embedded notebook camera multimedia processors. Our PC and embedded notebook camera multimedia processors have been incorporated into PC and embedded notebook cameras sold by leading PC and embedded notebook camera vendors, including Logitech and other major global brands.

Mobile Phone Multimedia

Our mobile phone multimedia processors are specifically designed to address the need for quality, low-power and cost-effective solutions for embedded cameras and video and audio functions in mobile phones. All of our mobile phone multimedia processors are sold under our own brand name.

The following table sets forth major mobile phone multimedia processors which we have developed and shipped in volume from 2006 to the first quarter of 2010.


Product	Features	Month Introduced(1)
VC0836	ARM926EJ based 333MHz applications processor; supports total solution for Windows Mobile Operating System and Android Operating System; supports high-quality D1 RealVideo decoder and H.264/MPEG4 decoder; integrated high-quality 90dB+ stereo audio codec; supports rich connectivity features including high-speed USB, high-speed SPI, NAND Flash, SD-card/SDHC-card/MMC/Mini-SD/TransFlash, UART, I2C as well as KeyPad, Touch Panel, Bluetooth, WiFi and GPS; supports Multi-touch; supports MP3, AAC, WMA, 3mega pixel camera sensor interface, LCD display and interfaces for Bluetooth, GPS, WiFi, analog TV out.	August 2009

VC0898	ARM926 based media player processor; supports high-quality D1 RealVideo decoder and H.264/MPEG4 decoder; integrates high-quality 90dB+ stereo audio codec; integrates rich connectivity features including high-speed USB, high-speed SPI, SD-card/SDHC-card/MMC/Mini-SD/TransFlash, UART, I2C as well as Bluetooth, WiFi and GPS solutions; supports various MDTV systems such as DVB-H, ISDB-T, T-DMB and CMMB; supports MP3, AAC, WMA, 3mega pixel camera sensor interface, LCD display and interfaces for Bluetooth, GPS, WiFi, analog TV out.	July 2009


Product	Features	Month Introduced(1)
VC0578	Mobile camera processor with 0.13µm technology; integrates hardware JPEG codec, 5mega pixel camera processor, hardware MPEG4 codec, LCD controller, display scaler, power management unit; provides a high-end camera solution for the feature-rich 2.5G and 3G handset market.	May 2008

VC0988	Mixed-signal single-chip mobile audio processor with 0.18µm technology; integrates hardwired MP3 decoder, 64-channel MIDI synthesizer, 10-band equalizer, stereo audio DAC, stereo headphone amplifier, 8-bit MCU, FAT 12/16/32 file system, NAND flash controller and a SD/MMC card controller; provides a competitive solution for 2.5G and 3G music phones.	March 2008

Vinno III	ARM926EJ based applications processor; supports hardware video codec, hardware JPEG codec, MP3, AAC, WMA. 3mega pixel camera sensor interface, QVGA LCD display, USB 2.0, NAND flash interface, SD/MMC/T-flash, built-in high performance stereo ADC and DAC, interfaces for Bluetooth, GPS, WiFi, analog TV out.	February 2008

VC0978	Mixed-signal single-chip mobile audio processor with 0.18µm technology; embedded with hardwired MP3 decoder, 64-channel MIDI synthesizer, 10-band equalizer, stereo audio DAC, stereo headphone amplifier, mono speaker amplifier, 8-bit MCU, FAT 12/16/32 file system, NAND flash controller and a SD/MMC card controller; provides a competitive solution for 2.5G and 3G music phones.	March 2007

VC0548	Single-chip mobile camera processor with 0.13µm technology; integrates hardwired JPEG codec, 1.3mega pixel camera processor, LCD controller, scaler and power management unit; provides a competitive camera solution for the feature-rich 2.5G handset market.	January 2007

VC0528	Single-chip mobile camera processor with 0.13µm technology; integrates hardwired JPEG codec, 0.3mega pixel camera processor, LCD controller, scaler and power management unit; provides a competitive camera solution for the feature-rich 2.5G handset market.	January 2007

Vinno II	Single-chip mobile multimedia processor with 0.13µm technology; supports a FAT 12/16/32 file system; powered by an embedded microprocessor core with low-power consumption; integrates a MPEG4 codec, a H.264 codec, a 2mega pixel camera processor, an AMR codec, an MP3 decoder, an AAC/AAC+ decoder, a WMA decoder, a MIDI synthesizer and a game engine; provides a complete solution for the feature-rich 2.5G handset market; also supports video conferencing for 3G phones.	March 2006

Vinno I	Mixed-signal single-chip mobile multimedia processor with 0.18µm technology; embedded with 1.3mega pixel camera processor; integrates a JPEG codec, an ISP (Image Signal Processor), a LCD controller, an MP3 decoder, a 64-channel MIDI synthesizer, a 3D-sound processor, a 10-band equalizer, a stereo audio speaker/headphone amplifier, a stereo voice ADC, an 8-bit MCU, a FAT 12/16 file system, a flash controller and a SD/MMC card controller; provides a competitive solution for 2.5G and 3G phones.	March 2006

(1)	“Month introduced” means the month during which we began shipments of the product.

In 2007, 2008 and 2009, we shipped approximately 18.2 million, 19.7 million and 11.0 million units, respectively, of mobile phone multimedia processors. Our mobile phone multimedia processors have been used by leading international and China-based mobile phone brand owners, such as Samsung, LG, Bird, Lenovo, Pantech, UTStarcom, ZTE and Huawei, as well as leading mobile phone design houses based in China, including China Techfaith Wireless Communication Technology Limited, CEC Wireless R&D Ltd., and Yuhua Teltech (Shanghai) Co., Ltd.

Security and Surveillance

The following table sets forth the features of our security processors from 2006 to the first quarter of 2010.


Product	Features	Month Introduced(1)
VC0705	High performance camera processor with enhanced image processing functions and JPEG compression and transfer interface. As a SoC chip, it has CMOS sensor interface and digital video input interface and it can capture video stream from CMOS sensor or external TV decoder, implement video enhancement, OSD interface overlay and motion detection, and compress the video to JPEG format before output it through the SPI or UART interface.	November 2009

VC0706	High performance camera processor with enhanced image processing functions. As a SoC chip it has CMOS sensor interface and digital video input interface, can capture the video stream from CMOS sensor or external TV decoder, implement video enhancement, OSD interface overlay and motion detection, before output the digital video through the CCIR656 output interface. External host processors can control the VC0706 processor through the flexible SPI/UART interface.	April 2008

VC0703	High performance video camera processor designed for applications that require high frame rate, low image noise, small package, low voltage and low power consumption; supports various video outputs, such as interlaced/progressive PAL/NTSC composite video output, RGB/YCbCr component video output and S-Video output; supports OSD.	September 2007

VC0702	High performance video camera processor designed for applications that require small package, low voltage and low power consumption; supports various video outputs, such as interlaced/progressive PAL/NTSC composite video output, RGB/YCbCr component video output and S-Video output.	June 2006

(1)	“Month introduced” means the month during which we began shipments of the product.

In 2007, 2008 and 2009, we shipped approximately 1.5 million, 3.5 million and 2.9 million units, respectively, of security processors.

The following table sets forth the features of our security platform from 2009 to the first quarter of 2010.


Product	Features	Month Introduced(1)
VISS R2.10	a carrier-grade security platform that provides remote collection, transferring, storage, processing of images, sounds and other alarming signs for users based on Broad Band Network. R2.10 has scalable, redundancy architecture and can be used to construct key security applications. It also receives certifications from China Telecom and China Unicom for deployment in the Safe-City project.	November 2009

(1)	“Month introduced” means the month during which we began shipments of the product.

In 2009, we derived approximately $1.3 million in revenue from sales of our security platform, representing approximately 99.7% of the total revenue of Vimicro Electronics Corporation. Our security platform has been mainly used by affiliates of China Telecom, China Unicom and China Mobile, the three major telecommunications network operators in China.

We have introduced other surveillance products, including digital surveillance cameras, surveillance system and management software, network cameras, network speed domes, digital video encoders, recorders and servers and software applications. In 2009, we shipped approximately 0.1 million of our other surveillance products.

Other Products

In order to meet demand from many of our China-based PC and embedded notebook camera multimedia processor customers for more comprehensive solutions, we frequently order image sensors based on our specifications from third-party sensor manufacturers and bundle them together with our mixed-signal PC and embedded notebook camera multimedia processors. Historically, we developed and sold proprietary VXP solutions to affiliates of China Telecom and China Unicom to help them promote broadband services to end users. We are also developing and selling mixed-signal power management chips as part of our SoC and system solutions. In 2007, 2008 and 2009, we shipped 191.2 million, 162.6 million and 129.6 million units of our power management chips, respectively.

Technology

We have developed a broad portfolio of technologies to support multiple functions that are required for multimedia semiconductor solutions. Our products integrate multiple multimedia applications, numerous industry-standard formats, advanced input/output capabilities, analog functions, on-chip memory, complex algorithms to provide high-quality still picture, video and audio and are architected to provide efficient use of silicon. Although many functions in multimedia are standards-based, we provide multimedia signal processing that exceeds quality levels required by several important standards to differentiate our customers’ products in the market. We have established a rigorous design process to support the integration of numerous functional blocks into a low-cost single-chip product on a rapid time-to-market schedule. This process enables us to support advanced standards and quickly improve feature-sets to support our customers’ rapid product release cycles. The following paragraphs outline our portfolio of core technologies and describe our mixed-signal design methodology.

Multimedia SoC Design and Video, Imaging, Audio, Graphic, and Communications Technologies

Our teams of designers have experience in multimedia systems and a variety of audio, imaging and video technologies, including leading industry standards and compression technologies such as MIDI, MP3, MPEG, H.264 and JPEG. This enables us to integrate multiple multimedia functions in a single semiconductor product. We have created sophisticated high performance signal processing algorithms for many stages of multimedia processing, including sampling, filtering, coding and decoding, synthesis, compression, storage, playback, transmission and receiving (modulation/demodulation).

•

Video. We possess a broad portfolio of video technologies to support leading industry standards and compression technologies, such as JPEG, MPEG2, MPEG4, AVS and H.264. In addition, we have developed a variety of technologies to provide high video quality and differentiated features, including interlaced to progressive and progressive to interlaced, audio video synchronization, noise reduction, resolution enhancement, sample rate conversion, scaling, auto focus, face tracking algorithms and signal reconstruction.

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Imaging. We have developed a number of image processing algorithm technologies to provide high-quality imaging capabilities in our products. Such technologies include color interpolation, color space conversion and correction, white balance, noise reduction, auto exposure, focus control, resolution enhancement, signal quality enhancement, contrast enhancement and dead pixel detection and correction technologies.

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Audio. We have developed a broad portfolio of audio technologies to support leading industry standards and compression technologies such as MIDI, MP3, WMA, AAC, AMR and our proprietary versatile multimedia data (VMD). We have developed several audio processing algorithms and other capabilities to provide a superior aural experience to end users and differentiate our customers’ products in the market, including wave engine, wave engine codec, surround sound audio, 3D audio, noise cancellation, echo cancellation and all-digital amplifier technologies.

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Graphics. To support graphics capabilities for gaming and other applications in mobile devices, we have developed a number of graphics signal processing capabilities, including support for low power 2D and 3D graphics such as drawing polygons, mobile flash and java.

Analog and Digital Integration

Integrating analog and digital circuits in a single semiconductor product is inherently difficult due to noise interference and other problems. We are experienced in the design of high performance analog and mixed-signal circuitry using CMOS standard process technology, allowing integration of analog and digital functions in our single-chip solutions to achieve lower power, lower cost and more compact products. Our analog and power management circuits include ADC, DAC, power supply management, power amplification RF transceiver and high speed bus physical interfaces.

Embedded DSP and Multimedia Signal Processing Algorithms

To support the development of highly integrated multimedia SoC’s incorporating multiple multimedia capabilities, we have developed adaptable processor architecture. The processor can be modified by software commands to reconfigure it in an optimal manner for the processing of different types of tasks such as audio, video, imaging and graphics processing. We believe that this architecture allows our products to achieve processing speed, signal quality and power consumption performance comparable to that obtained from competing fixed function hardware that is suitable for a single application such as video processing. Since our processors are designed solely for multimedia applications, rather than a broad spectrum of computing tasks, our processors avoid the need for the complex and power inefficient control and processing software used by general purpose CPUs and baseband processors, and can therefore offer significantly better processing speed, signal quality and power consumption performance than those general-purpose processors.

Design Methodology

Multimedia SoC design usually requires integration of each of the aforementioned technological capabilities into a single chip on a rapid product design cycle. We use a number of industry leading standard and proprietary CAD and design methodologies to accomplish this. Our design methodologies in algorithms, software and hardware co-design enables integration of multimedia signal processing algorithms with mixed-signal design to ensure that our algorithms are optimized for efficient silicon implementation and high yield manufacturing. To meet stringent time-to-market requirements and rapid product cycles of multimedia semiconductor design, we have developed a methodology based on software simulation, hardware simulation, single and multi-FPGA emulation, software-hardware co-simulation, processor based software-hardware co-emulation and digital and analog co-simulation. In addition, we have developed proprietary multimedia mixed-signal development platforms for system-level integration at the customer site.

Scene-based Image Processing Technology

We have launched a scene-based, high-fidelity image processing technology for the surveillance market. This new technology has been adopted by the Chinese National Standard for Technical Specification of Surveillance Video and Audio Coding (SVAC). Our SVAC-enabled digital multimedia processor is designed with low-power, configurable multi-core architecture that substantially boosts the performance of video surveillance systems and improves security.

Customers and Distributors

Many of the leading brand owners in our target markets use ODMs, which are companies that specialize in the design and manufacture of products for brand owners. Accordingly, a significant portion of our revenue is derived from our sales to ODMs, who incorporate our multimedia processors into end products that they supply to brand owners. Our major ODM customers include Akkord and Namuga Co. Ltd. We also sell our products to distributors, to original equipment manufacturers, or OEMs, who incorporate our multimedia processors in their end products, and to design houses and module manufacturers. In most cases, we ship products to and receive payments directly from distributors and ODMs rather than brand owners for whom the ODMs design and manufacture products. As a result, we do not always have the ability to confirm directly with brand owners that our multimedia processors are incorporated in their end products.

The following is a list of our representative customers and distributors in the PC and embedded notebook camera and mobile phone multimedia processor markets during 2009.


Market		Customers and Distributors
PC and embedded notebook camera multimedia processors		HanVision Electronics Co., Ltd. Tomen Electronics Corporation Tuoye Co., Ltd. Logitech Technology (Suzhou) Co., Ltd. Polar Star International Co., Ltd. Fuwei Technology Co., Ltd. Di An Jie Technology Co., Ltd.

Mobile phone multimedia processors		Di An Jie Technology Co., Ltd. Polar Star International Co., Ltd. Shanghai Huaqin Telecom Technology Co., Ltd. LG Electronics (MC Division) Wintech Group Incorporation Limited

A small number of customers and distributors have historically accounted for a substantial portion of our net revenue. In 2009, sales to our top five and top ten customers and distributors collectively accounted for approximately 52% and 70%, respectively, of our net revenue for the year. Sales to HanVision, Tomen and Tuoye, our major distributors, contributed 15%, 11% and 11%, respectively, of our net revenue in 2009. As we expand our mobile phone multimedia processor business, our overall customer composition as well as the identity and concentration of our top customers are expected to change from period to period.

Sales and Marketing

Our marketing staff works closely with our research and development staff and our customers to develop demand for our products. In designing products, we aim to anticipate our customers’ needs and to meet their increasingly complex and specific design requirements. We also strive to design products that will achieve broad market acceptance and generate widespread end user demand, including demand for follow-on and derivative products using our solutions. Our time-to-market typically ranges from three to six months for our PC and embedded notebook camera multimedia processors and six to nine months for our mobile phone multimedia processors, and may be significantly longer for first-time customers.

We sell our products through both our direct sales force and distributors. Our direct sales staff is located in Beijing, Shanghai, Shenzhen, Tianjin and Taipei, covering major regional markets in mainland China, Taiwan, Japan and Korea. Our direct sales staff includes trained field application engineers who assist our customers in designing, testing and qualifying their devices that incorporate our products. Our network of authorized distributors and representatives also play important roles in our sales, in particular in the Taiwanese, South Korean and Japanese markets, where many of our principal customers are located. We intend to expand our sales and marketing network to develop new customers in Asia. Our sales are made primarily pursuant to individual purchase orders rather than long-term commitments. Because industry practice allows customers to reschedule or cancel orders on relatively short notice, we believe that our backlog is not a good indicator of our future sales.

The revenue presented below is attributed by country of domicile of the entity that recorded the revenue:


	Years ended December 31,
	2007	2008	2009
	(in $ thousands)
Revenue distribution:

Mainland China	2,423	1,622	3,392

Hong Kong	90,330	84,875	69,579


Total net revenue	92,753	86,497	72,971

Substantially all of our customers are based in Asia. We anticipate that most of our revenues will continue to be derived from sales to our customers in Asia. However, we believe that a significant number of PC and embedded notebook cameras and mobile phones designed and manufactured by our customers are sold to end users outside of the Asia-Pacific region. We offer credit terms to attract and retain large customers.

We engage in marketing activities such as attending conferences and exhibitions and participating in industry specific organizations to promote our products and brand name. We were a founding member of MultiMedia Telecommunications Association, or MMTA, which was established in October 2004 by leading participants in China’s telecommunications industry, such as China Mobile, China Unicom, China Telecom, China Netcom, Huawei and ZTE, to promote domestic and international technical innovation and standards and to promote 3G applications in China. MMTA has established a number of key working groups focusing on developing and promoting industry standards in areas such as streaming technology, mobile TV, DRM and mobile surveillance.

In 2007, we became a communication member of National Technical Committee 100 on Security and Protection Alarm Systems of Standardization Administration of China, or SAC/TC100. SAC/TC100 was established and authorized by Standardization Administration of the People’s Republic of China in 1987 and charged with the responsibilities of formulating and modifying the unified national and industry standards in the fields of security and protection, and interfacing with International Electrotechnical Commission Technical Committee 79.

We are a co-founder of the Surveillance Digital Video Audio Coding Standard Working Group, or SVAC Working Group. The goals of SVAC Working Group are to develop standards for advanced audio video coding and safety system, to improve synchronization among various safety and alarm systems.

We believe that these activities have been instrumental in promoting our products and brand name among key industry participants.

Manufacturing

We develop our proprietary designs and provide them to third-party foundries to produce silicon wafers for our multimedia processors. By utilizing third-party foundries to produce silicon wafers for our multimedia processors, we are able to focus more of our resources on product design and eliminate the high cost of building and operating advanced semiconductor fabrication facilities. The bulk of our multimedia processors are manufactured with 0.18 micron and 0.13 micron CMOS process technologies. We are developing new products that will be manufactured using more advanced 90 nanometer and 65 nanometer CMOS process technology. We periodically negotiate with these third-party foundries to establish price, volume, timing and other terms.

We have historically purchased substantially all of silicon wafers from TSMC in Taiwan, and SMIC, in China, both leading foundries in the world. We usually order sufficient processors each quarter in advance to ensure that we have sufficient supply to support our current and planned sales growth. As the price of our raw materials has been stable in recent years and due to our long-term relationship with these foundries, we have enjoyed consistent pricing in the past. We have the ability to negotiate our price each quarter or every half year when we order our products for the subsequent quarter. We work closely with these foundries in order to achieve high manufacturing yields in the fabrication process, which is an important aspect of our cost containment efforts.

We have developed our own automatic testing process for mixed-signal semiconductors and outsource most of our assembly and testing requirements to independent assembly and testing houses. Currently, we engage ASE and SPIL for our assembly and testing requirements. We have also designed and incorporated on-chip test circuits into some of our multimedia processor products. We use standard, readily available packages for all of our products. We currently meet our entire mixed-signal semiconductor testing requirements through the use of logic testing equipment. For cost reduction purposes, we continue to evaluate the relative costs and benefits of outsourcing the testing of our mixed-signal semiconductors.

Quality Assurance

We focus on product quality through all stages of the design and manufacturing process. Our designs are subject to extensive circuit simulation before being committed to test manufacture. In an effort to reduce production cost, we commit a new product to volume production only after sample wafers are fabricated and sample processors are manufactured, packaged and tested. We qualify each of the foundries and assembly and testing companies we use through a series of industry standard product stress tests, as well as an audit and an analysis of their quality assurance system and, in the case of foundries, their manufacturing capability. We also monitor quality and reliability throughout the production cycle by reviewing electrical parametric data from these foundries and assembly and testing companies. We closely monitor foundry production for consistent quality and reliability. We have been certified with ISO 9001 for quality system.

Intellectual Property

We design substantially all of our multimedia processors in-house and rely on a combination of patents, trademarks, employee and third-party nondisclosure agreements and licensing arrangements to protect our intellectual property. As of December 31, 2009, we owned 687 patents and had 1,135 pending patent applications in China, owned 13 patents and had 67 pending patent applications in the United States, owned one patent and had seven pending patent applications in Taiwan, three pending patent applications in Japan and three pending patent applications in Korea. Our issued patents and pending patent applications relate primarily to technology we developed for our multimedia processors.

As of December 31, 2009, we registered 35 trademarks in China, including a trademark that incorporates our English name “Vimicro.” We have registered our domain name www.vimicro.com with ChinaDNS.

Competition

The multimedia processor semiconductor industry is highly competitive and dynamic and is characterized by rapid technological changes, evolving industry standards, price reductions and rapid product obsolescence. Our ability to compete effectively depends on defining, designing and regularly introducing new products that meet or anticipate the design needs of our customers’ next generation products and applications. We face competition from various companies, including certain of our customers.

In the mobile phone multimedia processor market, we compete with vendors of audio processors such as NEC Electronics, Oki Electric, Rohm, Sunplus Technology, Winbond Electronics Corp. and Yamaha, and vendors of image, video and graphics processors such as ATI Technologies, CoreLogic, MtechVision, Nvidia, Sanyo, Seiko Epson and Sunplus Technology. In addition, we also compete with established suppliers of semiconductor solutions to mobile phone manufacturers, which may be in a position to bundle or integrate multimedia processing functionality with their existing offerings. These suppliers include Analog Devices, Broadcom, Freescale, Infineon, Intel, Mediatek Corporation, Spreadtrum, NEC Electronics, Philips, QUALCOMM, STMicroelectronics and Texas Instruments.

A significant part of security and surveillance market involves video capturing, compression, transmission, storage, processing, display and video analysis. Leveraging our multimedia technologies, we have expanded our business into the security and surveillance market, where we face competition mainly from companies such as Sony, Samsung, Texas Instruments, NXP, Hikvision, H3C and STMicroelectronics.

The most significant factors that affect our competitiveness are:

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the performance and cost effectiveness of our products relative to those of our competitors’ products;

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the level of integration and power efficiency of our products;

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the quality and reliability of our products;

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our ability to deliver products in required volumes, on a timely basis and at competitive prices;

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our ability to rapidly introduce new products to market; and

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our customer support capabilities.

We believe we compete favorably on the basis of these factors. However, many of our existing and potential competitors have significantly greater financial, technical, manufacturing, marketing, sales and other resources than we do. We cannot assure you that we will be able to compete successfully against our current or future competitors.

REGULATION

The semiconductor industry in China is subject to substantial regulation. This section summarizes the most significant PRC regulations governing our business in China.

Regulations and Policies that Encourage the Development of Semiconductor Design Companies

On June 24, 2000, the State Council promulgated the Several Policies to Encourage the Development of the Software and Integrated Circuit Industry, or the IC Policies. The IC Policies set forth preferential policies on investment, financing, tax, industrial process, technology, income distribution and export-related matters concerning integrated circuit design enterprises, or ICDEs. On the basis of the IC Polices, on October 10, 2002, the Ministry of Finance and the State Administration of Taxation, or the SAT, jointly issued the Notice on Relevant Taxation Policy Issues Concerning the Further Development of the Software and the Integrated Circuit Industries, or the IC Notice, which further specifies the tax treatment afforded to ICDEs. To apply for the preferential policies, an integrated circuit enterprise must have complied with relevant tax regulations and must meet certain other qualifications.

We conduct our integrated circuit design in China through Vimicro China, which holds an ICDE approval from MIIT, and is eligible for preferential tax treatment under PRC laws relating to ICDEs as described below.

Accreditation of ICDEs

Only duly accredited ICDEs may qualify for preferential industrial policies. Pursuant to a policy entitled Administration of the Accreditation of Integrated Circuit Design Enterprises and Products Procedures, jointly issued by MIIT and the SAT, on March 27, 2002, in order to obtain accreditation, an ICDE must (i) be a legally established enterprise whose principal business is semiconductor design; (ii) possess adequate production and quality assurance capabilities; and (iii) generate at least 30% of its total annual revenue from the design of semiconductor products. MIIT has designated China Semiconductor Industry Association as one of the qualified institutions to conduct the accreditation of ICDEs. On June 30, 2004, MIIT and the SAT jointly issued a notice to modify the accreditation procedure. According to notice, an ICDE should file an application with the certification institution for review, and then submit the opinion issued by the certification institution to MITT for final approval.

Encouragement of Foreign Investment in ICDEs

Pursuant to the IC Policies and the Guideline Catalogue of Foreign Investment Industries (amended in 2007) jointly promulgated by the National Development and Reform Commission, which became effective on December 1, 2007, semiconductor design is among the industries in which foreign investment is encouraged by the Chinese government.

Preferential Taxation Policies

Under the IC Policies and the IC Notice, ICDEs are treated as software enterprises for purposes of tax treatment.

Exemption of Customs Duties and Import-related Value-added Tax. Under the IC Policies, an ICDE does not need to pay customs duty or import-related VAT on any imported equipment necessary for its own use or any technology, ancillary parts and spare parts that are included in the contract for the equipment. The exemptions from customs duty and import-related VAT do not apply to equipment, technology and parts that are listed on the Catalogue of Imported Commodities for Foreign Investment Projects Not Subject to Tax Exemptions and the Catalogue of Imported Commodities for Domestic Investment Projects Not Subject to Tax Exemptions. Effective from January 1, 2009, the exemption from import-related VAT for ICDE is discontinued pursuant to relevant tax regulation.

An ICDE may manufacture its self-designed semiconductors overseas if it is not able to manufacture them in China. Pursuant to a notice jointly issued by the Ministry of Finance and the SAT on August 31, 2004, effective October 1, 2004, the import-linked VAT levied on these semiconductors is set at 17%.

Promulgation of PRC New Income Tax Law. In March 2007, the National People’s Congress adopted the New Enterprise Income Tax Law, or the New EIT Law, which became effective as of January 1, 2008. Under the New EIT Law, the enterprise income tax rate for domestic and foreign enterprises is unified at 25%, and enterprises established prior to March 16, 2007 that were eligible for preferential tax treatment according to the then effective PRC EIT Law for Foreign Investment Enterprise and Foreign Enterprise, administrative regulations, and circulars with equivalent effect shall be subject to transitional rules to gradually change their rates to 25%. Certain qualified “high and new technology companies” may be entitled to a 15% preferential tax rate if they meet the definition of “high and new technology enterprise” set out in the Implementation Rules of the New EIT Law. The Implementation Rules of the New EIT Law as well as a series of clarification rules were promulgated by the State Council and the taxation authorities in December 2007 and early 2008. On April 14, 2008, the Measures on the Qualification of High and New Technology Enterprises were promulgated. In accordance with these laws and rules, the preferential tax rates granted to PRC entities that previously qualified as “high and new technology enterprises” will not automatically be applicable under the new tax regime unless they qualify as “high and new technology enterprises” pursuant to the New EIT Law, its Implementation Rules, and relevant working guidance promulgated by the authorities. Vimicro China was recognized as a “high and new technology enterprise” under the New EIT Law by the relevant authorities and effective in 2008, which entitled Vimicro China to a preferential tax rate of 15% for three years from January 1, 2008.

Restriction on Foreign Investment in Value-Added Telecommunications Business

In July 2006, the MIIT issued the Circular on Strengthening the Administration of Foreign Investment in and Operation of Value-added Telecommunications Business, or the Circular. The Circular reiterated the regulations on foreign investment in telecommunications businesses, which requires foreign investors to set up foreign-invested enterprises and obtain a business operating license, or VT license, for conducting any value-added telecommunications business in China. Under the Circular, a domestic company that holds a VT license is prohibited from leasing, transferring or selling the license to foreign investors in any form, and from providing any assistance, including providing resources, sites or facilities, to foreign investors that conduct value-added telecommunications business illegally in China. Furthermore, the relevant trademarks and domain names that are used in the value-added telecommunications business must be owned by a VT license holder or its shareholder(s). The Circular further requires each VT license holder to have the necessary facilities for its approved business operations and to maintain such facilities in the regions covered by its license. In addition, all value-added telecommunications service providers are required to maintain network and information security in accordance with the standards set forth under relevant PRC regulations. Due to a lack of interpretative materials from the regulator, it is unclear what impact the Circular will have on us or other domestic providers of value-added telecommunications services that have adopted the same or similar corporate and contractual structures as ours.

Intellectual Property Protection for Semiconductors

China has adopted legislation related to intellectual property rights, including trademarks, patents and copyrights. China is a signatory to the main international conventions on intellectual property rights and became a member of the Agreement on Trade Related Aspects of Intellectual Property Rights upon its accession to the World Trade Organization, in December 2001. Set forth below are major PRC laws and international treaties effective in China protecting intellectual property rights in semiconductors:

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the Patent Law of the People’s Republic of China , revised at the seventh meeting of the Standing Committee of the Ninth National People’s Congress of the People’s Republic of China on August 25, 2000 and the revised implementing regulation of the Patent Law issued by the State Council on June 15, 2001, effective July 1, 2001; the third amendment of the Patent Law was adopted by the People’s Congress on December 27, 2008 and became effective on October 1, 2009 and the amended implementing regulation of the Patent Law was issued by the State Council on January 9, 2010, effective on February 1, 2010.

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the Paris Convention for the Protection of Industrial Property of the World Intellectual Property Organization, of which China became a member state on March 19, 1985;

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the Patent Cooperation Treaty , of which China became a member state on January 1, 1994;

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the General Principles of the Civil Law of the People’s Republic of China adopted at the fourth session of the Sixth National People’s Congress of the People’s Republic of China on April 12, 1986, effective January 1, 1987. In this legislation, intellectual property rights were defined in China’s basic civil law for the first time as a civil right of citizens and legal persons;

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the Regulations for the Protection of the Layout Design of Integrated Circuits , or the Layout Design Regulations, adopted March 28, 2001 at the 36th session of the executive meeting of the State Council, effective October 1, 2001;

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the Washington Treaty on Intellectual Property in Respect of ICs of the World Intellectual Property Organization, of which China was among the first signatory states in 1990;

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the Law of the People’s Republic of China on Scientific and Technological Progress amended and adopted at the 31st session of the Standing Committee of the Tenth National People’s Congress of the People’s Republic of China on December 29, 2007. The amended Law of the People’s Republic of China on Scientific and Technological Progress became effective on July 1, 2008;

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the Property Law of the People’s Republic of China, which was adopted at the fifth session of the Tenth National People’s Congress of the People’s Republic of China on March 16, 2007 and became effective on October 1, 2007; and

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the Opinions of the Supreme People’s Court on Comprehensively Strengthening the Trial System Involving Intellectual Property Rights Litigation to Provide Judicial Protection for the Construction of an Innovative Country , which was circulated in January 11, 2007. The Supreme Court sought to provide powerful judicial protection of intellectual property rights such as patents, and integrated circuit lay-out designs in this circulation.

Protection of Semiconductors under the Patent Law of the People’s Republic of China

In China, the semiconductor is the patentable subject matter and protected under Chinese patent laws.

Under the Patent Law of the People’s Republic of China, or the Patent Law, the holder of a patent has an exclusive right to the invention. The holder of a patent has the right to prevent a third party from infringement, including making, manufacturing, using, or selling the invention for the duration of the patent. The term of a patent on an invention is valid for 20 years from the day on which the application is filed under the Patent Law.

The State Intellectual Property Office in China accepts applications for the protections of invention, carries out examination of patent applications and grants patents.

Protection of Integrated Circuit Layout Design

Under the Layout Design Regulations, an integrated circuit layout design is defined as a three-dimensional configuration of a semiconductor circuit that has two or more components, at least one of which is an active component, and part or all of the interconnected circuitry or the three-dimensional configuration has been prepared for the production of semiconductor circuits.

The following persons and entities can hold proprietary rights in the layout designs that they create: (i) PRC natural persons, legal persons or other organizations; (ii) foreign persons or companies who are creators of integrated circuit layout design, and whose layout designs are first commercially used in China; and (iii) foreign persons or companies from a country that either has an agreement with China concerning the protection of layout designs or is a signatory to an international treaty concerning the protection of layout designs to which China is also a signatory.

A holder of proprietary rights in a layout design may:

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duplicate the entire protected layout design or any part of the original design; and

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use the protected layout design, the integrated circuit containing the layout design or products containing the integrated circuit commercially.

The proprietary rights are valid after the layout design is registered with the State Intellectual Property Office in China.

Proprietary rights in a layout design are granted for ten years, commencing from the earlier of the date of the application for registration of the layout design or the first date of its commercial use anywhere in the world. However, a layout design is not entitled to any protection beyond 15 years from the time of its creation, regardless of when the layout design is registered or put into commercial use. The holder of the proprietary rights may transfer those rights to another party or grant permission for use of the design.

Registration of a Layout Design

The State Intellectual Property Office in China decides on applications for registration of layout designs. An application must be made within two years of the design being put in commercial use anywhere in the world, or the application will be rejected.

Compulsory Licenses for Exploitation of Patents in Respect of Semiconductor Technology

Under the third amendment of the Patent Law, which became effective on October 1, 2009, an individual or a company may request the patent regulatory body under the State Council to grant a compulsory license to use an invention patent or a utility model patent if: (i) three years has passed from the patent grant date and four years has passed from the patent application date by a patent applicant, and the patentee or the patent applicant has not used the patent or has not adequately used the patent without a good reason; or (ii) the patentee’s use of the patent has been recognized as monopolization under applicable laws and the grant of a compulsory license can eliminate or reduce the adverse effect on competition caused by the patentee’s use.

A compulsory license for the use of a semiconductor technology patent is restricted to public uses, or to uses that prevent anti-competitive actions, as determined by judicial or administrative procedures.

Under the Layout Design Regulations, the intellectual property administration department of the State Counsel may grant a non-voluntary license to use a layout design in the event of a national emergency or any extraordinary state of affairs, where public interest so requires, or where the holder is engaging in unfair competition, as determined by a court or the supervision and inspection against unfair competition department of the State Council. The scope and duration of the license will be determined in accordance with the reasons justifying the grant. The scope shall be limited to non-commercial use for public purposes, or to remedy the holder’s unfair competitive actions as determined by a court or the supervision and inspection against unfair competition department.

Regulations on Foreign Exchange

Foreign exchange regulation in China is primarily governed by the following rules:

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Foreign Currency Administration Rules (1996), which was amended on August 5, 2008, or the Exchange Rules; and

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Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996), or the Administration Rules.

Under the Exchange Rules, the RMB is convertible for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions. Conversion of RMB for capital account items, such as direct investment, loan, security investment and repatriation of investment, however, is still subject to the approval of the SAFE or its local branch.

The amendments to the Exchange Rules, which was adopted on August 5, 2008, provided for the following: (i) domestic entities are no longer required to remit foreign currencies back to the PRC; (ii) international payment or remittance under current accounts is not restricted, and proceeds in foreign currencies are not required to be exchanged into RMB and (iii) the requirement that foreign currencies under capital accounts shall be deposited into designated banks was abolished. Instead, unless the laws provide otherwise, foreign currencies under capital accounts may be retained or exchanged into RMB upon approval by relevant authority, which approval may be waived under certain circumstances; (iv) the foreign currencies under capital accounts may in principle be purchased after the relevant transaction documents are submitted to the relevant financial institutions that sell foreign currencies; and (v) a simplified registration regime is adopted for direct offshore investment by domestic entities.

Under the Administration Rules, foreign-invested enterprises may only buy, sell or remit foreign currencies at those banks authorized to conduct foreign exchange business after providing valid commercial documents and, in the case of capital account item transactions, obtaining approval from the SAFE. Capital investments by foreign-invested enterprises outside of China are also subject to limitations, which include approvals by the Ministry of Commerce, the SAFE and the State Development and Reform Commission.

Regulations on Dividend Distribution

The principal regulations governing dividend distributions of wholly foreign-owned companies include:

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Wholly Foreign-Owned Enterprise Law (1986), as amended;

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Wholly Foreign-Owned Enterprise Law Implementing Rules (1990), as amended; and

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Company Law of the PRC (2005).

Under these regulations, wholly foreign-owned companies in the PRC may pay dividends only out of their accumulated profits as determined in accordance with PRC accounting standards. In addition, these wholly foreign-owned companies are required to set aside at least 10% of their respective accumulated profits each year, if any, to fund certain reserve funds, until the accumulative amount of such fund reaches 50% of its registered capital. At the discretion of these wholly foreign-owned companies, they may allocate a portion of their after-tax profits based on PRC accounting standards to staff welfare and bonus funds. These reserve funds and staff welfare and bonus funds are not distributable as cash dividends.

In addition, under SAFE’s Circular 75, which became effective on November 1, 2005, PRC subsidiaries of offshore parent companies may be prohibited from making distributions of profits to their offshore parent companies or paying the offshore parent companies proceeds from any reduction in capital, share transfer or liquidation, unless PRC shareholders with a direct or indirect stake in such offshore parent companies make the required SAFE registrations.

SAFE Registration Relating to the Establishment of Offshore Special Purpose Companies and Round-trip Investment by PRC Residents

On October 21, 2005, SAFE issued the Notice on Issues Relating to the Administration of Foreign Exchange in Fund-raising and Reverse Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies, or Circular 75, which became effective as of November 1, 2005.

According to Circular 75, prior to establishing or assuming control of an offshore company for the purpose of financing that offshore company with assets or equity interests in an onshore enterprise in the PRC, each PRC resident, whether a natural or legal person, must complete the overseas investment foreign exchange registration procedures with the relevant local SAFE branch. Moreover, such PRC residents must also amend such registration form if there is a material event affecting the offshore company, such as, among other things, a change to the company’s share capital, a transfer of shares or if the company is involved in a merger, an acquisition or a spin-off transaction or provides guarantees to other entities.

On May 29, 2007, SAFE promulgated Circular 106, which serves as the implementing rules of Circular 75. Under Circular 106, PRC subsidiaries of an offshore enterprise governed by Circular 75 are required to coordinate and supervise the filing of SAFE registrations in a timely manner by the offshore holding company’s shareholders who are PRC residents. If these shareholders fail to comply, the PRC subsidiaries are required to report to the local SAFE authorities. If our shareholders who are PRC citizens or residents do not complete their registration with the local SAFE authorities, our PRC subsidiaries will be prohibited from distributing their profits and proceeds from any reduction in capital, share transfer or liquidation to us, and we may be restricted in our ability to contribute additional capital to our PRC subsidiaries.

C.	Organizational Structure

The following table sets out the details of our subsidiaries and affiliated entity:


Name	Country of Incorporation	Ownership Interest
Vimicro Corporation (Vimicro China)	People’s Republic of China	100%

Viewtel Corporation (Viewtel)	California, U.S.A.	100%

Vimicro Electronics International Limited (Vimicro Hong Kong)	Hong Kong Special Administrative Region	100%

Vimicro Electronic Technology Corporation (Vimicro Beijing)	People’s Republic of China	100%

Vimicro High-Tech Corporation (Vimicro Shanghai)	People’s Republic of China	100%

Vimicro Technology Corporation (Vimicro Shenzhen)	People’s Republic of China	100%

Jiangsu Vimicro Electronics Corporation (Vimicro Jiangsu)	People’s Republic of China	100%

Wuxi Vimicro Corporation (Vimicro Wuxi)	People’s Republic of China	100%

Vimicro Electronics Corporation (Vimicro Tianjin)	People’s Republic of China	49.99%

Shanghai Visiondigi Technology Co. Ltd. (Visiondigi)	People’s Republic of China	50.95%

Vimicro Sky-Vision Technology Corporation (Vimicro Sky-Vision) ⁽¹⁾	People’s Republic of China	0%

Notes:

(1)	Vimicro Sky-Vision was established in March 2010. Through a series of contractual arrangements, we are considered to be the primary beneficiary of Vimicro Sky-Vision and Vimicro Sky-Vision became our VIE.

We conduct substantially all of our business through our subsidiaries and affiliated companies. Vimicro China primarily conducts our research and development, marketing, finance and administrative activities. It currently has four directly wholly owned subsidiaries: Viewtel Corporation, Vimicro Hong Kong, Vimicro Beijing and Vimicro Wuxi. Vimicro Shenzhen was incorporated in Shenzhen, PRC in November 2006 as a limited liability company with an approved operating period of 20 years. The main business activity of Vimicro Shenzhen is to facilitate domestic sales and perform research and development. In September 2007, Vimicro Shanghai, our wholly owned subsidiary in China was incorporated as a limited liability company with an approved operating period of 30 years. The main business activity of Vimicro Shanghai is to facilitate domestic sales and perform research and development. Vimicro Beijing was established in Beijing in April 2007 as a limited liability company with an approved operating period of 20 years. In December 2007, Vimicro Jiangsu, Vimicro Beijing’s wholly owned subsidiary in China, was incorporated as a limited liability company with an approved operating period of 20 years. The main business activities of Vimicro Beijing and Vimicro Jiangsu are to facilitate external cooperation and to enhance development of system-level solution and exploitation in other development technology. Vimicro Wuxi was incorporated in Wuxi, PRC in July 2009 as a limited liability company. The main business activity of Vimicro Wuxi is to carry out research and development, design and sales of RF/Bluetooth and other chips.

Vimicro Tianjin was formed on December 29, 2008 as a limited stock corporation by Vimicro China, Tianjin SAMC and the Management Fund. Vimicro China and Tianjin SAMC each holds approximately 49.99% ownership interest in Vimicro Tianjin, and the Management Fund holds a nominal ownership interest. Vimicro Tianjin focuses on the design, manufacture and sale of security and surveillance products and solutions.

In July 2009, Visiondigi was formed in Shanghai as a limited liability company by Vimicro China and three DSP experts with an approved operating period of 20 years. Vimicro China and the same three individuals as a group contributed cash and intangible assets, for a 61.5% and 38.5% equity interest in Visiondigi, respectively. In January 2010, Ningbo Sunny invested RMB20 million ($2.9 million) in Visiondigi. Vimicro China increased its shareholding for the consideration of RMB 9.85 million ($1.4 million). As of the end of March 2010, Vimicro China, Ningbo Sunny and the three individuals as a group held 50.95%, 26.16% and 22.89% of equity interest in Visiondigi, respectively. Visiondigi specializes in the research and development, production and sales of network video surveillance products and solutions.

In March 2010, Vimicro Sky-Vision was established as a limited liability company with an approved operating period of 20 years. Zhonghan (John) Deng, our Chairman and Chief Executive Officer, and Zhaowei (Kevin) Jin, our President and Chief Operating Officer, hold 67% and 33% of the equity interest in Vimicro Sky-Vision, respectively. We entered into a series of contractual arrangements with Vimicro Sky-Vision and its shareholders. As a result of these contractual arrangements, Vimicro Sky-Vision becomes a VIE of our company, and we are considered to be the primary beneficiary of Vimicro Sky-Vision. To comply with the PRC regulations that restrict foreign-invested companies from carrying out certain value-added telecommunications business in China, we conduct our wireless value-added telecommunication operations, particularly the mobile surveillance business, through Vimicro Sky-Vision.

D.	Property, Plant and Equipment

We are a multimedia semiconductor and solution provider. We develop our proprietary designs and provide them to third-party foundries to produce silicon wafers for our multimedia processors. Therefore, we do not have manufacturing facilities of our own.

Our principal executive offices are located on premises comprising approximately 8,026 square meters in Beijing, China. We have regional offices in Shanghai, Shenzhen, Nanjing, Tianjin, Wuxi, Hong Kong, Taiwan, San Diego and Silicon Valley, California. We lease substantially all of our premises from unrelated third parties. We believe that we will be able to obtain adequate facilities, either at research and development centers that are currently planned for construction and will be available for future use or leasing of appropriate properties, to accommodate our future expansion plans.

In February 2010, Vimicro China entered into an agreement with Beijing Municipal Bureau of Land and Resources to acquire the land use right for approximately 5,046.524 square meters of land from Beijing local government. Upon acquisition of the land, Vimicro China shall be responsible at its own cost for the land grounding work (including the relevant removal and relocation work) and infrastructure construction work (including the relevant construction of access to road, water, electricity, telecommunication, gas, etc.). The land will be the site of a new office building, which will become Vimicro China’s new headquarters and accommodate a research and development center. The aggregate consideration for the acquisition of the land-use right is RMB39.1 million ($5.73 million). Pursuant to an agreement entered into in December 2006 between Vimicro China and Xinhua Agricultural Industrial & Commercial Co., or Xinhua Agricultural, the former holder of this land use right, Vimicro China shall transfer 35% of the total construction area of the same developed property to Xinhua Agricultural as compensation in kind for the expropriation of the land upon completion of the construction of the office building. The proposed project is subject to governmental approval. Should the governmental authorities request us to modify the project, the land and construction site areas, as well as the total cost for the project, may change. It is estimated that the construction of this new building will be completed by 2012.

In June 2007, Vimicro Shenzhen entered into an agreement with Shenzhen Municipal Bureau of Land Resources and Housing Management, pursuant to which, in consideration of approximately RMB6.7 million ($1.0 million), we acquired the land use right for approximately 3,947 square meters of land in Shenzhen High-Tech Industrial Park. The land will be the site of a new building, which will become Vimicro Shenzhen’s office building and accommodate a research and development center. According to the land use right transfer agreement, we had until June 22, 2009 to complete construction on this site. The relevant government agencies received our construction extension application in June 2009 and we believe the application will likely be approved. However, the relevant government agencies could deny our application for extension and forfeit this land as idle land, in which case we will receive a refund in the amount equal to the consideration we paid for the land use right minus any applicable monetary penalty. If we receive the approval for the extension, governmental authorities may require us to obtain other necessary approvals for the proposed project. Construction on this site is expected to start in the first half of 2010. We are in discussions with the potential developers of this site for an estimated completion date.

In November 2007, Vimicro Shanghai entered into an agreement with Zhangjiang Semiconductor Industry Park Co., Ltd. pursuant to which, in consideration of approximately RMB42.2 million ($6.2 million), Vimicro Shanghai would acquire the land use right for approximately 21,123 square meters of land in Zhangjiang Hi-Tech Park, Shanghai. We have planned to use this property as the site of a new building, which will become Vimicro Shanghai’s office building and accommodate a research and development center. Governmental authorities require us to obtain necessary governmental approvals for the proposed project. Construction on this site is expected to start in the first half of 2010. We are in discussions with the potential developers of this site for an estimated completion date.

In December 2007, Vimicro Jiangsu entered into an agreement with Xuzhuang Committee and the Xuanwu SAMC, pursuant to which, in consideration of approximately RMB39.6 million ($5.8 million) to be paid in installments, Vimicro Jiangsu would acquire the land use right for approximately 80,000 square meters of land in Nanjing Xuzhuang Software Industrial Park. We had acquired such rights through the Xuzhuang Committee and Xuanwu SAMC, both of which are government-affiliated entities. In June 2009, Vimicro Jiangsu entered into a supplementary agreement with Xuzhuang Committee and the Xuanwu SAMC pursuant to which the size of the plot stipulated in the original agreement was reduced to approximately 68,224 square meters from 80,000 square meters, and the payment for the transfer was reduced to RMB33.8 million ($4.9 million). Furthermore, pursuant to a supplementary agreement signed in July 2009 among Vimicro Jiangsu, Nanjing SAMC and the Nanjing Municipal Bureau of Land Resources, Vimicro Jiangsu became the direct transferee of the land use right of the plot and the owner of the land use right. The last installment of the transfer cost of RMB9.2 million ($1.3 million) may be offset by the taxes we pay to Xuanwu District according to a pre-set, seven-year schedule, or offset by any local government subsidies to us. This land will be used as the site of Vimicro Jiangsu’s office building and a research and development, IC design and industrial center. Governmental authorities require us to obtain necessary governmental approvals for the proposed project. According to the foregoing agreements, the construction of the proposed project on this land should be commenced prior to December 31, 2009. We expect to commence construction of this project in the first half of 2010, after we obtain the land use right certificate for this land. We are also in discussion with the relevant authorities on possible extension of construction and amendment of the relevant agreements. However, the relevant government authorities may deny our request and impose penalties or fines on us for the construction delay. Please see “Item 3. Key Information—D. Risk Factors—Risks Related to Our Business—Construction delay and other risks associated with our construction projects may require higher capital expenditure and have an adverse impact on our business and results of operation.”

In May 2009, Vimicro Tianjin entered into a transfer agreement for land use rights with Tianjin Municipal Bureau of Land Resources and Housing Management, pursuant to which, in consideration of approximately RMB13.8 million ($2 million), Vimicro Tianjin acquired the land use right for approximately 34,418 square meters of land in Tianjin Economic Technology Development Area. The land will be the site of Vimicro Tianjin’s office building and production facilities. Governmental authorities require us to obtain necessary governmental approvals for the proposed project. We plan to start construction of this project in the first half of 2010 and expect to complete the construction of the first building by the end of 2011.

I TEM 4 A .

U NRESOLVED S TAFF C OMMENTS

There are no unresolved Staff comments.

I TEM 5.

O PERATING AND F INANCIAL R EVIEW AND P ROSPECTS

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included elsewhere in this annual report on Form 20-F. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Item 3. Key Information—D. Risk Factors” or in other parts of this annual report on Form 20-F.

A.	Operating Results

Overview

We have grown significantly since we introduced our mixed-signal multimedia products in September 2001. However, affected by the slowdowns in semiconductor industry since 2007 and worldwide financial crisis since late 2008, our net revenue decreased from $92.8 million in 2007 to $86.5 million in 2008, and decreased further to $73.0 million in 2009. The decrease in net revenue of $13.5 million from 2008 to 2009 was mainly attributable to decreased shipment of mobile phone multimedia processors and third-party sensors, as well as a decline of the average selling price of PC, embedded notebook camera multimedia processors and third-party sensors, as a result of severe competition in the market and a weakening global economy. Our gross profit decreased from $28.5 million in 2007 to $24.7 million in 2008 and $21.1 million in 2009. The decrease in gross profit by $3.6 million from 2008 to 2009 was mainly due to the decrease in revenue discussed above. We had a net loss of $2.0 million in 2007 and a net loss of $13.6 million in 2008 as a result of the decrease in gross profit. Our net loss amounted to $20.7 million in 2009, mainly due to the further decrease in gross profit and an increase in operating expenses. Our limited operating history makes the prediction of future operating results very difficult. We believe that period to period comparisons of operating results should not be relied upon as predictive of future performance.

We currently derive a significant portion of our revenue from sales of mixed-signal PC and embedded notebook camera multimedia processors, as well as mobile phone multimedia processors and other new mixed signal products. In the future, we intend to sell less third-party image sensors and to derive an increasing percentage of our revenue from security and surveillance products and solutions abased on certain core technologies we develop to address the needs of additional markets which we believe have the potential for high volume sales of multimedia products. Our security and surveillance business contributed $2.2 million in 2009 since it started generating revenue in the fourth quarter of 2009.

In December 2008, Vimicro China established Vimicro Tianjin to focus on the design, manufacture and sale of security and surveillance products. In August 2009, Vimicro Tianjin acquired from ASB the ViSS business, a leading security and surveillance solution for telecommunication networks. In July 2009, Vimicro China established Visiondigi in Shanghai to focus on network video surveillance products and solutions. Vimicro Tianjin and Visiondigi constituted another reportable segment in 2009 for security and surveillance products, in addition to the multimedia processor segment.

In reviewing our performance, we focus on the following non-financial factors: our market penetration, the features and performance of our products, our number of design wins, the length of our product sales cycles and shipment volumes of our products. We evaluate our performance with respect of these non-financial factors against our operating plans. We also focus on the following key financial factors: revenue, gross profit margins and operating expenses.

While our business is influenced by factors affecting the semiconductor industry generally and by conditions in each of the markets we serve, we believe our business will be influenced by company-specific factors such as our ability to continually improve our product development capabilities, increase our sales and improve our operations. We expect that our ability to grow our business will depend on our success in penetrating our target markets.

Our gross profit margins have historically fluctuated and are expected to continue to fluctuate due to several factors, including changes in the relative mix of our products, the per-unit costs for our products, and the average selling prices for our products. We expect to continue to face price pressure for our products as average selling prices for semiconductor products generally decline over time. However, the average selling price decline may be mitigated by our developing and marketing successive generations of products with lower unit costs than prior generations. In order to maintain or improve our gross profit margins, we need to continue to introduce new, lower cost products, increase sales volumes and reduce unit costs.

We expect that the total amount of our operating expenses will generally grow over time. Our research and development expenses are expected to increase as we continue to develop new multimedia products and security and surveillance products and increase our headcount. Our sales and marketing expenses are expected to grow as we expand our sales and marketing network, especially in the new business of security and surveillance and engage in additional marketing and promotional activities. Our general and administrative expenses are expected to increase, reflecting the hiring of additional personnel and other costs related to the anticipated growth of our business, as well as the higher costs of operating as a publicly-traded company.

Furthermore, as most of our operating expenses are denominated in RMB, we also expect our operating expenses will continue to increase if there is continued appreciation of the RMB against the U.S. dollar, which is our reporting currency.

We use a limited number of third-party foundries to manufacture our multimedia products, and we rely on a limited number of independent assembly and testing houses to assemble and test substantially all of our multimedia processors. We believe that this business model enables us to reduce our capital expenditures and fixed costs relative to semiconductor companies that manufacture, assemble and test their own products, while focusing our engineering and design resources on our core strengths. We do not have any long-term agreement with any foundry or assembly and testing house and we typically place orders with them on a purchase order basis, depending on our customers’ purchase orders and sales forecasts.

Multimedia processors are characterized by a lengthy time-to-market, which is the interval between product development and initial volume sales. The time-to-market typically ranges from three to six months for our PC and embedded notebook camera multimedia processors and six to nine months for our mobile phone multimedia processors, and may be significantly longer for first-time customers. Our lengthy time-to-market makes it difficult for us to forecast our revenue and increases the variability of our quarterly results. It also results in a lengthy interval from the time we incur research and development and other operating expenses in connection with a new product to the time that we can first generate revenue from that product.

Discussion of Segment Operations

Historically, we managed our business as a single operating segment engaged in providing multimedia semiconductors and solutions. In order to better manage and measure the performance of different lines of businesses, we grouped our subsidiaries and joint ventures into the following two operating segments:

•

multimedia processors segment, which refers to entities that have been primarily engaged in the design, manufacture and sale of multimedia processors; and

•

Security and surveillance segment, which refers to entities that have been primarily engaged in the design, manufacture and sale of security and surveillance.

We established Vimicro Tianjin to focus on the design, manufacture and sale of security and surveillance products in December 2008. In September 2009, Vimicro Tianjin acquired from ASB the ViSS business, a leading security and surveillance solution over telecommunication networks. In July 2009, Vimicro China established Visiondigi in Shanghai to focus on network video surveillance products and solutions. As a result of the above, we have two reportable segments beginning in 2009. In 2009, we had net revenue, cost of revenue and gross profit from sales of security and surveillance products of $2.2 million, $1.3 million and $0.9 million, respectively, compared to $70.8 million, $50.6 million and $20.2 million, respectively, from sales of multimedia processors. We believe that sales of security and surveillance products will constitute a greater portion of our revenue, cost of goods sold and gross profit in the future. Due to that we only commenced segmentation reporting in 2009, we are unable to present period to period comparison for the historical periods. The two segments are evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assessing performance. We do not allocate operating expenses among our products and no measure of assets by segment is used by chief operating decision maker.

Overview of Financial Results

We evaluate our business using a variety of key financial measures.

Net Revenue

We generate revenue from sales of a variety of mixed-signal multimedia processors for PC and embedded notebook cameras, as well as mobile phones and other related products. Our net revenue reflects a deduction for business taxes and related surcharges incurred in connection with our operations in China. The following table sets forth our net revenue derived from PC and embedded notebook camera multimedia processors, image sensors, mobile phone multimedia processors, security and surveillance products and other products, respectively, in amounts and as percentages of total net revenue for the periods indicated.


	For the Year Ended December 31,
	2007		2008		2009
	Amount	% of Total Net Revenue	Amount	% of Total Net Revenue	Amount	% of Total Net Revenue
	(In $ thousands, except percentages)
Net revenue:

PC and embedded notebook camera multimedia processors	38,869	41.9	36,334	42.0	36,802	50.4

Image sensors	19,422	20.9	17,166	19.8	12,101	16.6

Mobile phone multimedia processors	24,003	25.9	20,284	23.5	12,836	17.6

Security and surveillance products (1)	—	—	—	—	2,146	2.9

Other products	10,459	11.3	12,713	14.7	9,086	12.5


Total net revenue	92,753	100.0	86,497	100.0	72,971	100.0

(1) Revenue generated from sales of security and surveillance products by Vimicro Tianjin and Visiondigi in 2009 is reported in a separate reportable segment of business.

Cost of Revenue and Gross Profit

Our cost of revenue primarily consists of costs associated with fabrication of wafers, assembly, testing and shipping of our multimedia processors, amortization of costs associated with production masks and tooling and costs of third-party products that we sell to our customers, the cost of hardware and software, installation and other services and warranty cost . As we do not have long-term, fixed supply agreements with third-party foundries and assembly and testing companies, our costs for wafer fabrication, assembly and testing are susceptible to changes based on conditions in the global semiconductor market.

Cost of revenue was $64.3 million, $61.8 million and $51.9 million in 2007, 2008 and 2009, respectively. Gross profit margin was 30.7%, 28.5% and 28.9% for the years ended December 31, 2007, 2008 and 2009, respectively.

Semiconductor products and electronic devices into which they are incorporated are typically sold in high volumes and are subject to rapid declines in average selling prices. We have reduced the prices of many of our products in the past to meet market demand, and expect that we will continue to face market driven pricing pressures on our products in the future. Therefore, there is no assurance that we will be able to maintain our gross profit margins in the future.

Operating Expenses

Our operating expenses primarily consist of research and development expenses, sales and marketing expenses and general and administrative expenses, each of which includes share-based employee compensation expenses.

Share-based Employee Compensation

In 2007, 2008 and 2009, we recognized a total of $4.6 million, $6.1 million and $8.9 million, respectively, of share-based employee compensation expenses.

We adopted a 2004 share option plan, or the 2004 Plan, and granted a total of 2,701,200 options to our employees under the 2004 Plan in 2005. Our board of directors and shareholders also adopted a 2005 Share Incentive Plan, or the 2005 Plan. For a description of the 2004 Plan and 2005 Plan, see “Item 6. Directors, Senior Management and Employees—B. Compensation of Directors and Executive Officers—Share Options.” As of December 31, 2007, 2008 and 2009, 15,685,200, 16,248,600 and 17,099,152 options, respectively, were granted under the 2005 Plan.

We have adopted Accounting Standards Codification (“ASC”) 718 “Compensation-Stock Compensation,” or ASC 718, with effect from January 1, 2006, under which share-based compensation expense is determined based on the fair value of the share option as of the option grant date. Our share-based compensation expense increased in 2009 as compared to 2008 and 2007 due primarily to the $4.7 million share-based compensation expenses resulting from the grant of approximately 9.8 million ordinary shares to certain members of our management on June 30, 2009. We also granted restricted shares and recognized the resulting share-based compensation expenses under ASC 718. We might continue to issue share-based awards in the future.

As of December 31, 2009, there was approximately $4.3 million in unrecognized share-based compensation expenses related to share options, of which $13,000 is under the accelerated method and approximately $4.3 million is under the straight-line method. The unrecognized share-based compensation expense is expected to be recognized over a weighted-average vesting period of 0.65 and 1.83 years under the accelerated method and the straight-line method, respectively. As of December 31, 2009, there was $325,000 in unrecognized share-based compensation expense related to restricted shares. The unrecognized share-based compensation expense is expected to be recognized over a weighted-average vesting period of 2.59 years. To the extent the actual forfeiture rate is different from original estimates, actual share-based compensation related to these awards may be different from the expectation.

Research and Development

We received grants from various PRC government authorities from 2007 through 2009. The aggregate amounts of the grants we received were $3.6 million, $1.5 million and $6.2 million in 2007, 2008 and 2009, respectively. As of December 31, 2009, we had unused grants of $3.8 million in connection with establishment and business operation of Vimicro Wuxi.

Research and development expenses consist primarily of salaries, bonuses and benefits for research and development personnel, lease expenses for occupancy associated with research and development, costs of engineering services from contractors and consultants, purchase cost of intellectual property, depreciation of engineering equipment and share-based compensation expenses. Our research and development expenses have been offset by the government grant associated with particular research and development projects that we have undertaken. When we apply any portion of a grant to the related project for which qualified expenses have been incurred, our research and development expenses for the period are offset by the amount applied. We applied a total of $3.8 million, $1.5 million and $1.7 million of these grants to research and development projects in 2007, 2008 and 2009, respectively. There is no assurance that we will continue to receive grants from PRC government authorities or any other party in the future. We expect that our total research and development expenses, including, among other things, costs incurred in connection with hiring additional research and development staff and purchase of intellectual property, will increase as we continue to develop new multimedia products.

Sales and Marketing

Sales and marketing expenses consist primarily of salaries, bonuses, benefits, advertising, promotion and related costs for sales and marketing personnel, travel and other expenses related to sales and marketing activities, and sales commissions to our distributors in Asia. We expect that our total sales and marketing expenses will increase as we hire additional sales and marketing personnel, expand our sales and marketing network globally to promote and sell our multimedia processor products, and engage in additional marketing and promotional activities.

General and Administrative

General and administrative expenses consist primarily of salaries, bonuses, benefits and related costs for administrative personnel, travel, lease and other expenses for general and administrative purposes, share-based compensation expenses, as well as costs for outside services, including legal and accounting services. We expect that our total general and administrative expenses will increase as we hire additional personnel and incur costs related to the anticipated growth of our business and our operations.

Taxation

Cayman Islands

Under the current laws of the Cayman Islands, we are not subject to tax on our income or capital gains. In addition, no Cayman Islands withholding tax will be imposed on payments of dividends by the Company to its shareholders.

PRC

Enterprise Income Tax . PRC enterprise income tax is calculated based on taxable income determined under PRC accounting principles. Prior to March 2007, in accordance with the then-applicable “Income Tax of China for Enterprises with Foreign Investment and Foreign Enterprises,” or the old Income Tax Law, and the related Implementing Rules, foreign-invested enterprises, or FIEs, are generally subject to an enterprise income tax rate of 33%.

On March 8, 2006, Vimicro China received qualification from the Ministry of Commerce as an “Advanced Technology Enterprise with Foreign Investment.” According to the regulations of the Beijing Municipal Office of State Administration of Taxation, an enterprise with this qualification is entitled to a preferential enterprise income tax rate for the three years following the receipt of this qualification, equal to the higher of 10% or half of the applicable tax rate. As a result, on April 4, 2006, Vimicro China received approval from Beijing Municipal Office of State Administration of Taxation and was entitled to a 10% preferential income tax rate starting from 2006 to 2008. In March 2007, the National People’s Congress adopted the New EIT Law, which became effective as of January 1, 2008. The preferential tax treatment described above was discontinued under the New EIT Law, and the 10% preferential income tax rate was no longer applicable to Vimicro China starting from 2008.

Under the New EIT Law, an enterprise established outside of the PRC with effective management located in the PRC, is considered a resident enterprise and will normally be subject to the enterprise income tax at the rate of 25% on its global income. If the PRC tax authorities subsequently determine that any of the entities in the group registered outside the PRC should be deemed a resident enterprise, they will be subject to PRC income tax at a rate of 25%.

Furthermore, under the New EIT Law, dividends payable by a foreign investment enterprise to its foreign non-resident enterprise investors that were derived from income after January 1, 2008, are subject to a 10% withholding tax, unless such foreign investor’s jurisdiction of incorporation has signed a tax treaty or arrangement for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income with China that provides for a reduced rate of withholding tax. The Cayman Islands, where we are incorporated, does not have such a tax treaty with the PRC. If we are considered a non-resident enterprise, the 10% withholding tax imposed on our dividend income received from Vimicro China, our PRC subsidiary, would reduce our net income and have an adverse effect on our operating results. The New EIT Law also provides that, if a resident enterprise directly invests in another resident enterprise, the dividends received by the investing resident enterprise from the invested enterprise are exempted from income tax, subject to certain conditions. Therefore, if we are classified as a resident enterprise, the dividends that we receive from Vimicro China may be exempted from income tax. However, it remains unclear how the PRC tax authorities will interpret the PRC tax resident treatment of an offshore company, like us.

The amount of income tax payable by Vimicro China in the future will depend on various factors, including, among other things, its results of operations, taxable income, the amount of its deductible research and development expenses, and the statutory tax rate applicable to it. Our effective tax rate depends partially on the extent of each of our subsidiaries’ relative contribution to our consolidated taxable income.

Value-added Tax According to PRC value-added tax policy, Vimicro China is subject to an output Value-added Tax, or VAT, at 17% of selling price of products sold to customers in China, while the purchase of products by Vimicro China is subject to an input VAT at the rate of 17%. VAT payable is the net difference between periodic output VAT and deductible input VAT. On November 5, 2008, the PRC State Council passed The Provisional Regulations of the People’s Republic of China on Value-Added Tax (“New VAT Law”). In accordance with the New VAT Law and its Implementation Rules, which became effective as of January 1, 2009, input VAT on fixed asset purchases are included in the input VAT for VAT payable purposes.

Business Tax . According to PRC business tax policy, service income generally is subject to business tax at 5%. Vimicro China is entitled to business tax exemption on income arising from or related to technology transfers, provided these technology transfer agreements are registered with the relevant government agencies. In accordance with the Implementation Rules for the PRC Tentative Regulations on Business Tax, promulgated on December 15, 2008 and effective as of January 1, 2009, service income is subject to PRC business tax when either the service provider or the service recipient is located in China. We incurred additional business tax primarily in connection with our procurement of overseas intellectual properties and the purchase of the research and development services from Viewtel by Vimicro China beginning January 1, 2009.

United States

Income Tax . Viewtel, our subsidiary in the United States, is subject to state income tax and federal income tax in the United States at varying tax brackets, depending upon taxable income levels. Viewtel incurred income tax expenses of approximately $2,000, $5,000 and $11,000 for the years of 2007, 2008 and 2009, respectively.

Hong Kong

Profits Tax . Corporations carrying on any trade or business in Hong Kong are subject to profits tax on their assessable profits arising or derived from Hong Kong from such trade or business.

Vimicro Hong Kong, the Hong Kong subsidiary of Vimicro China, has filed Hong Kong profits tax returns for the years of 2003/04 to 2005/06. However, Vimicro Hong Kong applied for reopening of its profits tax returns with the Hong Kong Inland Revenue Department in September, 2006 to lodge offshore claims for all years since the commencement of its operations in 2002 and filed amended tax returns. Based on the territorial source principle of taxation in Hong Kong, it is considered that Vimicro Hong Kong has a reasonable technical basis to lodge the offshore claim. An adjustment was made in 2006 to reflect the accumulative changes as a result of the change in filing status. The offshore position claim of Vimicro Hong Kong was being examined by the Hong Kong Inland Revenue Department as of December 31, 2009.

Pursuant to relevant PRC tax rules, Vimicro Hong Kong is probably deemed to create a permanent establishment in Mainland China because Vimicro China conducted certain trading activities on behalf of Vimicro Hong Kong in China. Consequently, the profits of Vimicro Hong Kong attributable to its permanent establishment in China are probably subject to PRC income taxes. Furthermore pursuant to the New EIT Law and related implementation rules effective from January 1, 2008, if Vimicro Hong Kong is deemed to be a PRC tax resident, it will be subject to the PRC enterprise income tax at a rate of 25% on its worldwide income. In order to be prudent, Vimicro Hong Kong accrued PRC income tax expenses of $131,000 for the year ended December 31, 2009. In PRC, tax authorities are empowered to assess the net taxable income of a taxpayer. The tax authorities shall adopt methods other than actual profits method if the taxpayer is deemed unable to correctly compute taxable income due to inaccurate or incomplete accounts or other reasons. If the tax authority assess taxable income using the deemed profits method, material difference could result in the amount of income tax expense provided for Vimicro Hong Kong.

Withholding Tax. Under the current Hong Kong tax laws, an entity established outside of Hong Kong is subject to a 5.25% withholding tax on royalty income derived (or deemed to be) from Hong Kong. Vimicro Hong Kong makes royalty payments to Vimicro China for certain technologies licensed from Vimicro China. Vimicro China was previously subject to a 5.25% withholding tax on royalties received from Vimicro Hong Kong, which Vimicro Hong Kong had withheld and used to settle the tax liabilities on behalf of Vimicro China. Upon approval by the relevant PRC tax authorities, the amount of Hong Kong withholding tax paid on the royalty income could be allowed as a foreign tax credit against Vimicro China’s PRC income tax liabilities.

In connection with the offshore claim of Vimicro Hong Kong, all of Vimicro Hong Kong’s trading income is not taxable and the related royalty fee expenditure would not be tax deductible and should be exempted from withholding tax in Hong Kong.

Critical Accounting Policies

We prepare financial statements in accordance with U.S. GAAP, which requires us to make judgments, estimates and assumptions that affect the reported amounts of our assets and liabilities and the disclosure of our contingent assets and liabilities at the end of each fiscal period and the reported amounts of revenues and expenses during each fiscal period. We continually evaluate these judgments and estimates based on our own historical experience, knowledge and assessment of current business and other conditions, our expectations regarding the future based on available information and assumptions that we believe to be reasonable, which together form our basis for making judgments about matters that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, our actual results could differ from those estimates. Some of our accounting policies require a higher degree of judgment than others in their application.

Our critical accounting policies, the judgments and other uncertainties affecting application of those policies and the sensitivity of reported results to changes in conditions and assumptions are factors that should be considered when reviewing our financial statements. We believe the following accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements.

Revenue Recognition

We recognize revenue from the sales of products and rendering of services on a gross basis when the earnings process has been completed, as evidenced by agreement with the customer, delivery of products and transfer of title have occurred, the fees are fixed or determinable and collectability is reasonably assured, as prescribed by ASC 605 “Revenue recognition”.

Multimedia processors

Multimedia processor revenue derives from PC and embedded notebook camera multimedia processors, mobile phone multimedia processors, image sensors, and other products. Multimedia processors revenues are generally recorded net of business taxes and related surcharges, provided all revenue recognition criteria have been met.

The cost of multimedia processor revenue primarily consists of costs unconsolidated affiliated with the fabrication of wafers, assembly, testing and shipping of our multimedia processors, amortization of costs unconsolidated affiliated with production masks and tooling and costs of third-party image sensors that we sell to our customers.

Security and surveillance products

Surveillance and security products arrangements generally comprise of hardware, software and installation. These arrangements are considered multiple accounting units in accordance with Accounting Standards Update (“ASU”) No. 2009-13. “Revenue recognition (Topic 605): Multiple-Deliverable Recognition Arrangement”. The total arrangement consideration is allocated to the individual deliverables on the basis of their relative selling price. Relative selling price method is based on vendor-specific objective evidence (“VSOE”) of selling price if available, third-party evidence (“TPE”) if VSOE is not available, or management’s best estimate the selling price (“ESP”) if neither VSOE nor TPE is available. The Company uses the ESP for each deliverable in 2009 as neither VSOE nor TPE is available. The objective of ESP is to determine the price at which the Company would transact a sale if the deliverable were sold on a stand-alone basis. The Company determines ESP for a deliverable by considering multiple factors including, but not limited to, market conditions, competitive landscape, cost, gross margin objectives and pricing practices.

The Group recognizes revenue of delivered hardware and software components after obtaining the shipping acceptance from customers and recognizes revenue of installation service after obtaining the final acceptance from customers.

The cost of security and surveillance product revenue include the cost of hardware and software, third-party hardware and software products, installation and other services and warranty cost.

Mostly the installation service will be provided within several months after delivering the hardware and software and warranty period is within one to three years after shipping acceptance. Warranty obligation is provided based on estimated warranty payment when the underlying revenue is recognized.

Payments received from customers in advance of shipment are recorded as advances from customers.

We extend credit terms only to a limited number of customers. For customers to which we provide credit, we have assessed a number of factors to determine whether collection from them is probable, including past transaction history with them and their creditworthiness. If we determine that collection is not reasonably assured, we defer the recognition of revenue until collection becomes reasonably assured, which is generally upon receipt of payment.

Inventories

We state inventories at the lower of cost, on a weighted-average basis, or market. Market value is equal to current replacement cost to the extent that it does not exceed net realizable value. We record adjustments to write-down the cost of obsolete or excess inventory to the estimated net realizable value based on historical and forecasted demand. Determination of net realizable value of inventories involves numerous judgments, including projecting average selling prices and sales volumes for future periods and costs to complete products in work in process inventories. To project average selling prices and sales volumes, we review recent sales volumes, existing customer orders, current contract prices, industry analysis of supply and demand, seasonal factors, general economic trends and other information. When these analyses reflect estimated market values below our manufacturing costs or the carrying value reflected in the balance sheet, we record a charge to cost of revenue in advance of when the inventory is actually sold. Differences in forecasted average selling prices used in calculating lower of cost or market adjustments can result in significant changes in the estimated net realizable value of product inventories and accordingly the amount of write-down recorded.

Goodwill

Goodwill represents the excess of the purchase price over the fair value of the identifiable net assets acquired in a business combination. Goodwill is tested for impairment at the reporting unit level on an annual basis, or more frequently if events or changes in circumstances indicate that it might be impaired. Goodwill from the acquisition of ViSS business is allocated to security and surveillance products segment.

Intangible Assets

Intangible assets with finite useful lives are amortized over their estimated useful lives using the straight-line method and carried at cost less accumulated amortization with no residual value. The estimated useful lives of intangible assets are reviewed at least annually.

An intangible asset that is subject to amortization shall be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. The Group evaluates recoverability of an intangible asset by comparing the carrying amount of the intangible asset to its fair value. An intangible asset is considered to be impaired if its carrying amount is greater than its fair value and the impairment loss is measured as the amount by which the carrying amount of the intangible asset exceeds the fair value of the intangible asset.

Share-based Compensation

Our share-based compensation plan is described in more detail under “Item 6. Directors, Senior Management and Employees.” We adopted ASC 718 using the modified prospective transition approach from January 1, 2006. Prior to January 1, 2006, we accounted for share-based compensation arrangements with employees in accordance with the provisions of APB 25 “Accounting for Stocks Issued to Employees,” and related interpretations thereof. Pursuant to ASC 718, we recognized share-based compensation over the requisite service periods for any share option and restricted share granted after December 31, 2005 based on the fair value of the share option and restricted share on the date of grant. We continue to account for share options that had been granted prior to the initial public filing of our registration statement on Form F-1 with the SEC on October 24, 2005 and that remained unvested at December 31, 2005 under APB 25. For share-based awards granted after the initial public filing of our registration statement on Form F-1 but prior to January 1, 2006, the unvested compensation cost at the effective date of adoption of ASC 718 is computed based on the grant date fair values of those awards. For the options that were repriced during the year ended December 31, 2008, in accordance with ASC 718, we recognized additional compensation cost for the excess of fair value of the modified share options issued over the fair value of the original share options at the date of the modification for all the original share options vested as of the modification date. The compensation cost due to the incremental fair value of the modified awards and the remaining balance of the unrecognized compensation cost for the unvested share options are recognized over the remaining requisite service periods of the modified awards.

We recognize share-based compensation using the accelerated method for all share-based awards issued prior to January 1, 2006. We have elected to recognize share-based compensation after the date of adoption of ASC 718 using the straight-line method for all share-based awards issued or modified after January 1, 2006, which results in the recognition of less share-based compensation in the first several years during the vesting period compared to that which would have been recognized had we used the accelerated method. Forfeitures were estimated based on historical experience and are periodically reviewed.

We account for share awards issued to non-employees in accordance with the provisions of ASC 718 and ASC 505-50 “Equity-Based Payments to Non-Employees” or ASC 505-50. Under ASC 718 and ASC 505-50, we use the Black-Scholes option pricing model method to measure the value of options granted to non-employees at each reporting date to determine the appropriate charge to share-based compensation.

Depreciation of Property and Equipment

We depreciate our property and equipment at rates sufficient to write off their costs less accumulated impairment losses and estimated residual values over their estimated useful lives on a straight-line basis. We review the useful lives periodically to ensure that the method and rates of depreciation are consistent with the expected pattern of economic benefits from fixed assets. We estimate the useful lives and the residual values of the fixed assets based on our historical experience with similar assets, taking into account anticipated technological changes. The depreciation expense in future periods will change if there are significant changes from previous estimates.

Impairment of Long-lived Assets

We assess the impairment of long-lived assets when events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. Recoverability of assets to be held and used is measured by comparing the carrying amount of the assets to the estimated future undiscounted cash flows to be produced by the assets. If the total of the estimated future undiscounted cash flow is less than the carrying value, impairment is present and a loss is recognized in the statement of income based on the excess of the carrying value over the fair value of the asset or asset group. The future undiscounted cash flow is based on management’s estimates and assumptions with respect to future revenues, cost of revenues and operating expenses. We cannot provide you with any assurances that actual results will be equal to our estimates. During the three years ended December 31, 2009, we did not record impairment charges. If we make different judgments or adopt different assumptions, material differences could result in the amount and timing of any impairment charge that is recorded.

Deferred Tax Valuation Allowance

We record a valuation allowance to reduce our deferred tax assets if, based on an estimate of our future taxable income and prudent and feasible tax planning strategies, it is more likely than not that we will not be able to utilize our deferred tax asset amounts. Our estimated realization of our deferred tax assets is dependent on many factors, including our ability to generate taxable income within the period during which temporary differences reverse or before our tax loss carry-forwards expire, the outlook for the Chinese economy and overall outlook for our industry. If we make different judgments or adopt different assumptions, material differences could result in the amount and timing of any valuation allowance that is recorded.

Results of Operations

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


	For the Year Ended December 31,
	2007		2008		2009
Net revenue	100.0	%	100.0	%	100.0	%

Cost of revenue	(69.3	)%	(71.5	)%	(71.1	)%

Gross profit	30.7	%	28.5	%	28.9	%

Operating expenses:

Research and development, net	(21.6	)%	(28.4	)%	(36.1	)%

Sales and marketing	(5.0	)%	(5.8	)%	(7.3	)%

General and administrative	(11.3	)%	(14.3	)%	(20.3	)%

Total operating expenses	(37.9	)%	(48.5	)%	(63.7	)%

Other income	4.9	%	4.5	%	6.6	%

Income tax benefit/(expense)	0.1	%	(0.4	)%	(0.1	)%


Net loss	(2.2	)%	(15.8	)%	(28.3	)%

Comparison of the Year Ended December 31, 2009 and 2008

Net Revenue . Our net revenue decreased by $13.5 million, or 15.6%, to $73.0 million in 2009 from $86.5 million in 2008. This decrease was primarily due to (i) a decrease in revenue from the sales of mobile phone multimedia processors from $20.3 million in 2008 to $12.8 million in 2009, mainly caused by a 44.2% decrease in unit shipment in 2009, as one telecom operator temporarily suspended the purchase of our mobile phone multimedia processors in connection with their CDMA business, which resumed at the end of 2009 and (ii) a decrease in revenue from the sales of image sensors from $17.2 million in 2008 to $12.1 million in 2009, mainly caused by a decrease in unit shipments by 9.7% and a reduction in unit price by 21.9%, as a result of our strategic decision to focus on the sales of our proprietary products in response to the global pressure on the pricing and supply of sensors. The decrease in revenue was partially offset by (i) the increase of revenue from the sales of notebook camera processors from $28.0 million in 2008 to $29.8 million in 2009, due primarily to an increase in unit shipments by 35% in 2009, and (ii) $2.2 million revenue generated from sales of security and surveillance products in the fourth quarter of 2009.

Cost of Revenue and Gross Profit . Cost of revenue decreased by $9.9 million, or 16.0%, to $51.9 million in 2009 from $61.8 million in 2008. The decrease was primarily due to a 16.1% decrease in our sales volume. Our gross profit decreased by $3.6 million, or 14.6%, to $21.1 million in 2009 from $24.7 million in 2008. Our gross profit margin kept stable at 28.9% in 2009, compared with 28.5% in 2008, primarily due to (i) the increase of sales of relatively higher gross profit margin embedded notebook camera multimedia processors in our product mix, which increased 35% from 19.7 million units in 2008 to 26.6 million units in 2009 and offset by (ii) the gross profit margin of image sensor declined to -3.8% in 2009 from 5.8% in 2008 due to our destocking of sensors in 2009.

Operating Expenses . Operating expenses increased by $4.6 million, or 11.0%, to $46.5 million in 2009 from $41.9 million in 2008. This increase was primarily due to (i) a $2.7 million increase in share-based compensation expenses, mainly attributable to the $4.7 million share-based compensation expense in connection with the grant of ordinary shares to certain members of the management in June 2009, partially offset by full vesting in 2009 of options granted in prior years and the decrease in option grants to employees in 2009 and (ii) an increase of $3.0 million in salary and welfare, $2.2 million of which was for research and development staff . However the increase of operating expenses was partially offset by a decrease of $1.0 million in purchase of intellectual properties.

•

Research and Development. Research and development expenses increased by $1.8 million, or 7.3%, to $26.4 million in 2009 from $24.6 million in 2008. Our gross research and development expenditures before government grant deduction increased by $2.0 million, or 7.7%, from $26.1 million in 2008 to $28.1 million in 2009. The increase was mainly due to (i) an increase of approximately $2.2 million in payroll and welfare expenses, including payroll and welfare expenses incurred for the new surveillance business conducted by Vimicro Tianjin and Visiondigi and (ii) an increase of $0.5 million for share-based compensation expenses, and partially offset by a decrease of $1.0 million in purchase of intellectual properties. We expect our total research and development expenses, including costs incurred in connection with hiring additional research and development staff and purchasing intellectual properties, to increase as we continue to expand our portfolio of multimedia products.

•

Sales and Marketing . Sales and marketing expenses increased by $0.3 million, or 6.0%, to $5.3 million in 2009 from $5.0 million in 2008. The change mainly reflected a $0.4 million increase in commission fee and a $0.2 million increase in salary and compensation for our sales staff, which was partially offset by a $0.6 million decrease in share-based compensation expenses.

•

General and Administrative. General and administrative expenses increased by $2.5 million, or 20.3%, to $14.8 million in 2009 from $12.3 million in 2008, which is mainly attributable to an increase of $2.8 million in share-based compensation expenses and $0.6 million in payroll and welfare expenses.

Income Tax Expense/Benefit. Income tax expense was approximately $91,000 in 2009 compared to approximately $305,000 in 2008, the fluctuation was mainly due to increase in valuation allowance in 2008 arising from the realizability of $281,000 of China deferred tax assets recorded as December 31, 2007 as a result of the Company’s pre-tax losses incurred in 2008.

Other Income . Other income was $4.8 million in 2009 compared to $3.9 million in 2008 mainly due to increase in gain on disposal of marketable equity securities of $2.5 million and government grants of $0.5 million, partially offset by decrease in interest income from $2.4 million in 2008 to $1.4 million in 2009, and foreign exchange gain of $1.1 million due to RMB continuous appreciation against US dollar in 2008.

Net Income. We had a net loss of $20.7 million in 2009, compared to a net loss of $13.6 million in 2008, mainly due to the decrease of revenue from the sales of multimedia processors and the expenses related to our new security and surveillance business.

Comparison of the Years Ended December 31, 2008 and 2007

Net Revenue . Our net revenue decreased by $6.3 million, or 6.8%, to $86.5 million in 2008 from $92.8 million in 2007. This change was primarily due to (i) a decrease in unit shipments of our PC multimedia processors from 24 million units in 2007 to 10.2 million units in 2008, however the decrease in net revenue was mainly offset by an increase in the unit shipments of our embedded notebook camera multimedia processors from 7.4 million units in 2007 to 19.7 million units in 2008, (ii) a decrease in unit shipments of image sensors from 16.3 million units in 2007 to 13.6 million units in 2008, due to our strategic decision to focus on the sales of our proprietary products as a result of the global pressure on the pricing and supply of sensors, and (iii) the decline in the average selling price of our products, particularly the average selling price for mobile processors, which dropped by more than 20% in 2008.

Cost of Revenue and Gross Profit . Cost of revenue decreased by $2.5 million, or 3.9%, to $61.8 million in 2008 from $64.3 million in 2007. This change was primarily due to a decrease in our sales volume. Our gross profit decreased by $3.8 million, or 13.3%, to $24.7 million in 2008 from $28.5 million in 2007. The gross profit margin decreased by 2.2% from 30.7% in 2007 to 28.5% in 2008, primarily due to (i) a decrease of the average selling price of major products, including PC camera multimedia processors, embedded notebook camera multimedia processors and mobile multimedia processors, (ii) the decrease of sales of our relatively higher gross profit margin PC camera multimedia processors in our products mix, and the gross profit margin of PC camera multimedia processors declined from 59.9% in 2007 to 42.7% in 2008, and (iii) the gross profit margin of third-party sensors declined from 11.6% in 2007 to 5.8% in 2008. However the decrease in gross profit margin was partially offset by (i) a decrease in average unit cost of embedded notebook camera processors and mobile multimedia processors, and (ii) an increase in the sales of our relatively higher gross profit margin embedded notebook camera multimedia processors. Our sales of embedded notebook camera multimedia processors increased from 14.5 million in 2007 to 28.0 million in 2008, and our embedded notebook camera multimedia processors business accounted for 32.4% of revenues in 2008, an increase from 15.7% in 2007.

Operating Expenses . Operating expenses increased by $6.8 million, or 19.4%, to $41.9 million in 2008 from $35.1 million in 2007. This increase was primarily due to (i) a decrease of approximately $2.3 million in governmental grants to our research and development projects, (ii) an increase of $1.9 million in salary and welfare, in which $1.5 million was for research and development staff; (iii) a total increase of $1.3 million in share-based compensation expenses, (iv) a total increase of $0.6 million in business entertainment expenses and (v) a total increase of $0.4 million in purchase of intellectual properties.

•

Research and Development. Research and development expenses increased by $4.6 million, or 23.0%, to $24.6 million in 2008 from $20.0 million in 2007. Our gross research and development expenditures before government grant deduction increased by $2.2 million or 9.2% from $23.9 million in 2007 to $26.1 million in 2008. The increase was mainly due to (i) an increase of approximately $1.5 million payroll and welfare expenses and (ii) an increase of $0.3 million for the share-based compensation expenses. We expect our total research and development expenses, including costs incurred in connection with hiring additional research and development staff and purchase of intellectual property, to increase as we continue to expand our portfolio of new multimedia products.

•

Sales and Marketing . Sales and marketing expenses increased by $0.3 million, or 6.4%, to $5.0 million in 2008 from $4.7 million in 2007. The change mainly reflected a $0.2 million increase in share-based compensation expenses and a $0.1 million increase in salary and compensation for our sales staff.

•

General and Administrative. General and administrative expenses increased by $1.9 million, or 18.3%, to $12.3 million in 2008 from $10.4 million in 2007. The increase mainly reflected (i) an increase of $0.8 million in share-based compensation expenses, (ii) an increase of approximately $0.5 million in entertainment expenses, (iii) an increase in consulting fees of $0.3 million.

Other Income Other income was $3.9 million in 2008 compared to $4.6 million in 2007 mainly because interest income decreased to $2.4 million by $1.6 million in 2008 compared to 2007, partially offset by foreign exchange gain of $1.1 million in 2008 due to RMB continuous appreciation against U.S dollar in 2008.

Income Tax Expense/Benefit. Income tax expense was approximately $305,000 in 2008 compared to income tax benefit of approximately $99,000 in 2007, mainly because we provided full valuation allowance for deferred tax assets for all of our subsidiaries in the PRC as there is significant uncertainty about the realization of the deferred tax assets before expiration or reversal.

Net Income. We had a net loss of $13.6 million in 2008, as compared to a net loss of $2.0 million in 2007, mainly due to a decrease in revenue and gross profit margin, and an increase in operating expenses.

B.	Liquidity and Capital Resources

In the past, we financed our operations primarily through sales of our equity interests to private investors, the proceeds from our initial public offering, as well as through cash generated from our operating activities. We have also received government grants to fund our research and development projects. Our principal use of cash for the three years ended December 31, 2009 was to fund our working capital requirements and investments. As of December 31, 2008 and 2009, we had $58.2 million and $84.5 million in cash and cash equivalents, respectively.

We expect that our net working capital requirements will increase as we offer longer payment terms to attract and retain large customers, including customers for our mobile phone multimedia processors and security and surveillance products. We plan to fund the increase in working capital requirements from our operating cash inflow and existing cash reserve.

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


	Year Ended December 31,
	2007		2008		2009
	(in $ thousands)
Net cash provided by/(used in) operating activities	8,403		(2,759	)	(5,788	)

Net cash (used in) provided by investing activities	(9,415	)	(94,038	)	32,961

Net cash provided by/ (used in) financing activities	22		34,922		(949	)

Effect of exchange rate changes on cash and cash equivalent	3,114		3,132		71


Net increase/(decrease) in cash and cash equivalent	2,124		(58,743	)	26,295

Cash and cash equivalent at beginning of year	114,834		116,958		58,215


Cash and cash equivalent at end of year	116,958		58,215		84,510

Net cash used in operating activities in 2009 and 2008 was $5.8 million and $2.8 million respectively, primarily as a result of our operating loss. Net cash provided by operating activities amounted to $8.4 million in 2007, primarily as a result of our operating profit excluding non-cash share-based compensation expenses and depreciation.

Net cash provided by investing activities was $33.0 million in 2009, primarily due to the release of approximately $73.2 million from restricted cash account into cash and cash equivalents account of Vimicro Tianjin , partially offset by cash consideration of $8.2 million paid for ViSS business acquisition and the increase of $29.0 million in short-term deposits. Net cash used in investing activities was $94.0 million in 2008, primarily due to the investment of approximately $73.2 million for the establishment of Vimicro Tianjin and $14.7 million in short-term time deposits. Net cash used in investing activities was $9.4 million in 2007, primarily due to an approximately $4.5 million purchase of fixed assets and $4.9 million payments towards land use rights.

Net cash used in financing activities was $0.9 million in 2009, primarily due to our repurchase of 286,000 ADSs. Net cash provided by financing activities amounted to $34.9 million in 2008, primarily due to capital contributions from non-controlling interests of Vimicro Tianjin, offset in part by the amount we used to repurchase shares. Net cash provided by financing activities amounted to $22,000 in 2007, primarily due to proceeds from the exercise of share options,

Our future cash requirements will depend on many factors, including our level of operating income, the timing of our new product introductions, the costs to secure access to adequate manufacturing capacity, the continuing market acceptance of our products, or other changing business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If our existing cash is insufficient to meet our requirements, we may require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue, the performance of security and surveillance projects or construction of office buildings. If these resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain a credit facility.

Regulations in the PRC permit payments of dividends by our PRC subsidiaries only out of their retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. Subject to certain cumulative limits, a statutory reserve fund requires annual appropriations of at least 10% of after-tax profit, if any, of the relevant PRC subsidiary. The statutory reserve funds are not distributable as cash dividends. Foreign exchange and other regulation in the PRC may further restrict our PRC subsidiaries from transferring funds to our company in the form of dividends, loans and advances. In addition, the registered capital of our PRC subsidiaries is also restricted. We have cash and bank deposits of approximately $112.0 million and $97.5 million in PRC as of December 31, 2008 and 2009, respectively, of which approximately $104.7 million and $89.7 million, respectively, are denominated in RMB.

Capital Expenditures

Our capital expenditures amounted to $4.5 million, $3.4 million and $2.7 million, in 2007, 2008 and 2009, respectively. In the past, our capital expenditures consisted principally of purchases of software, development tools, computer equipment and other items related to our product development activities. We estimate that we will make capital expenditures of approximately $1.8 million in 2010 (excluding land use rights premium, property development expenditure and capital injection into new companies), for purchases of software, development tools and other items related to our product development activities, of which we spent approximately $0.6 million in the three months ended March 31, 2010.

Vimicro China has executed an agreement in December 2006 with Beijing Haidian Xinhua Agricultural Industrial & Commercial Co., providing that Vimicro China, upon completion of the construction of the office building, shall transfer 35% of the total construction area of the same developed property to the original land users as compensation in kind for expropriation of the land.

In December 2007, Vimicro Jiangsu entered into an agreement with the Administrative Committee of Nanjing Xuzhuang Software Industry Base (“Xuzhuang Committee”) and Nanjing Xuanwu District Management and Investment of State-Owned Assets Holdings (Group) Co., Ltd (“Xuanwu SAMC”). Under the agreement, Vimicro Jiangsu would acquire land use rights for approximately 80,000 square meters of land in Nanjing Xuzhuang Software Industrial Park in consideration of RMB 39.6 million ($5.8 million). On June 18, 2009, Vimicro Jiangsu entered into a supplementary agreement, pursuant to which the size of the plot stipulated in the original agreement was reduced to approximately 68,224 square meters, and the payment for the transfer was reduced to RMB33.8 million ($4.9 million). Pursuant to the original agreement, the last installment of the transfer cost of RMB 9.2 million ($1.3 million) may be offset by the taxes Vimicro Jiangsu pays to Xuanwu District according to a pre-set, seven-year schedule or offset by any local government subsidies to Vimicro Jiangsu. Total consideration of RMB 24.6 million ($3.6 million) was paid for the land use right as of December 31, 2009. This land will be the site of a new building, which will become Vimicro Jiangsu’s office building and accommodate a research and development center.

In addition, we have incurred the following land use right and investment expenditures for the four months ended April 30, 2010.

In February 2010, Vimicro China entered into an agreement with Beijing Municipal Bureau of Land and Resources to officially acquire the construction land use rights for 5,046.524 square meters located in Haidian, Beijing. The aggregate consideration for the acquisition of the land use right is RMB39.1 million ($5.7 million) and was fully paid in March 2010.

In April 2010 Vimicro Shanghai obtained the land use right certificate for the land located in Shanghai, PRC after payment of the last consideration of RMB12.9 million ($1.9 million). The total consideration for the land amounted to approximately RMB 42.2 million ($6.2 million).

As various regulations in China restrict or prevent foreign-invested entities, such as us, to operate value-added telecommunications business, including wireless value-added telecommunications business, we rely on Vimicro Sky-Vision to hold and maintain the permits and licenses necessary to operate our wireless value-added telecommunications business in China through various contractual arrangements and certain corporate governance and shareholder rights arrangements. We have, through Vimicro China, extended loans of RMB 10 million ($1.5 million) in February 2010 to Zhonghan Deng (RMB6.7 million) and Zhaowei Jin (RMB3.3 million), each a member of the Company’s management to finance their capital contribution in Vimicro Sky-Vision. As a result of these contractual arrangements, we are considered to be the primary beneficiary of Vimicro Sky-Vision and accordingly, we consolidated the results of operations, assets and liabilities of Vimicro Sky-Vision in our financial statements.

C.	Research and Development

We maintain a team of experienced engineers who are involved in our research and development efforts. As of December 31, 2009, our research and development staff consisted of 585 employees, representing approximately 81% of the total number of our employees. Many of our senior engineers have work experience in research institutions or technology companies in Silicon Valley. Going forward, we intend to recruit most of our engineers in China. We have established various recruiting and training programs with leading universities in China. In addition, we will also selectively recruit experienced engineers from Silicon Valley. Our research and development staff is divided into four teams: semiconductor development, software/firmware development, system design, and management and support. Our engineers work with our customers’ system design, engineering and procurement groups to identify future product needs. Through these efforts, we seek to introduce new products to address new market opportunities, to continue to reduce our design cost and to improve the cost effectiveness and performance of our products and solutions.

Our gross expenditures on research and development before offsetting research grants amounted to $23.9 million, $26.1 million and $28.1 million in 2007, 2008 and 2009 respectively.

D.	Trend Information

Other than as disclosed elsewhere in this annual report, we are not aware of any operational trends, uncertainties, demands, commitments or events for the period from January 1, 2009 to December 31, 2009 that are reasonably likely to have a material effect on our net revenue, income, profitability, liquidity or capital resources, or that caused the disclosed financial information to be not necessarily indicative of future operating results or financial conditions.

E.	Off-Balance Sheet Arrangements

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

F.	Contractual Obligations

The following table sets forth our contractual obligations as of December 31, 2009:


	Payment Due by Period
Contractual Obligations	Total	Less than 1 year	1-3 years	More than 3 years
	(in $ thousands)

Operating lease obligations	2,549	2,389	160	—

Product purchase obligations	5,112	5,112	—	—

Property, equipment and software purchase obligation	198	198	—	—


Total	7,859	7,699	160	—

In addition to the contractual obligations in the table above, we have contractual obligations under certain land use rights acquisition agreements which are described in the section entitled “Item 5 Operating and Financial Review and Prospects- B. Liquidity and Capital Resources”.

Other than the contractual obligations set forth above, we do not have any long-term commitments.

We do not have any contractual obligations outside our normal course of business.

G.	Safe Harbor

This annual report on Form 20-F contains forward-looking statements that relate to future events, including our future operating results and conditions, our prospects and our future financial performance and condition, all of which are largely based on our current expectations and projections. The forward-looking statements are contained principally in the sections entitled “Item 3. Key Information—D. Risk Factors,” “Item 4. Information on the Company” and “Item 5. Operating and Financial Review and Prospects.” These statements are made under the “safe harbor” provisions of the U.S. Private Securities Litigation Reform Act of 1995. You can identify these forward-looking statements by terminology such as “may,” “will,” “expect,” “anticipate,” “future,” “intend,” “plan,” “believe,” “estimate,” “is/are likely to” or other similar expressions. The accuracy of these statements may be impacted by a number of known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements, including the following risks and uncertainties:

•

our ability to develop and sell new mobile multimedia products;

•

the expected growth of the mobile multimedia market;

•

our ability to increase our sales of PC and notebook camera multimedia processors;

•

our ability to retain existing customers and acquire new customers and respond to competitive market conditions;

•

our ability to respond in a timely manner to the evolving multimedia market and changing consumer preferences and industry standards and to stay abreast of technological changes;

•

our ability to secure sufficient foundry capacity in a timely manner;

•

our ability to effectively protect our intellectual property and the risk that we may infringe on the intellectual property of others; and

•

cyclicality of the semiconductor industry.

We would like to caution you not to place undue reliance on these statements and you should read these statements in conjunction with the risk factors disclosed in the section entitled “Item 3. Key Information—D. Risk Factors.” Except as required by law, we undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, after the date on which the statements are made or to reflect the occurrence of unanticipated events.

I TEM 6.

D IRECTORS , S ENIOR M ANAGEMENT AND E MPLOYEES

A.	Directors and Senior Management

The following table sets forth information regarding our directors and executive officers as of the date of this annual report on Form 20-F.


Directors and Executive Officers		Position/Title
Zhonghan (John) Deng		Chairman of the Board and Chief Executive Officer

Xiaodong (Dave) Yang		Director, Chief Technology Officer

Zhaowei (Kevin) Jin		Director, President and Chief Operating Officer

Yundong (Raymond) Zhang		Senior Vice President and Head of Product and Marketing

Jun Zhu		Vice President and Head of IC Engineering

David Wei Tang		Chief Financial Officer and Vice President of Finance

Changyong (Robert) Chen (2)(3)		Independent Director

Donald L. Lucas (1)(3)		Independent Director

Theodore Van Duzer (1)(2)		Independent Director

Zhijie (Jeffrey) Zeng (3)		Independent Director

(1)	Member of the Corporate Governance and Nominating Committee.

(2)	Member of the Compensation Committee.

(3)	Member of the Audit Committee.

Dr. Zhonghan (John) Deng is a co-founder of our company. He currently serves as the chairman of our board of directors and chief executive officer of our company. Dr. Deng was elected as the youngest member of Chinese Academy of Engineering in December 2009 and a member of the National People’s Congress of the People’s Republic of China for a five-year term from March 2008. He also serves as a board member and audit committee member of Sohu.com Inc. (Nasdaq: SOHU). Dr. Deng has received numerous awards for his achievements, including the National First Class Award for Science and Technology in 2005, which was presented by the President of China, Hu Jintao. Dr. Deng graduated from the University of California at Berkeley with a Ph.D. degree in Electrical Engineering and Computer Science, a M.S. degree in Economics and a M.S. degree in Physics. Dr. Deng worked as a research scientist for IBM at the T.J. Watson Research Center in Yorktown Heights, New York.

Dr. Xiaodong (Dave) Yang is a co-founder of our company. He currently is a member of our board of directors and also serves as our chief technology officer. Dr. Yang is responsible for leading all research and development activities and setting product and technology directions for our company. Dr. Yang graduated from Stanford University with Ph.D., M.S. and B.S. degrees in Electrical Engineering. Dr. Yang began his research on mixed-signal imaging chips in Silicon Valley in 1993. He won research and development awards at both Hewlett-Packard Co. and Intel Corporation. He has published many technical papers and holds numerous patents.

Zhaowei (Kevin) Jin is a co-founder of our company. He currently is a member of our board of directors and also serves as our president and chief operating officer. From 1996 to 1999, Mr. Jin served as the founder and president of Jin Ye Company where he led the establishment of an electronics sales and distribution network in China. Mr. Jin was the co-founder of Mitech Corporation, one of the largest providers of medical electronic image manipulation equipment in China. Mr. Jin received his B.S. degree in Electrical Engineering from the University of Electronics Science and Technology of China.

Yundong (Raymond) Zhang joined our company in 2001 and currently serves as our senior vice president and head of the product and marketing. From 1996 to 2001, Mr. Zhang was the co-founder and director of research and development for T Square Design, Inc. in Santa Clara, California, where he gained experience in PC audio IC, 32-bit RISC CPU, game console SoC and DVD SoC. From 1991 to 1996, Mr. Zhang served as a semiconductor design manager for Realtek, where he gained experience in PC graphics IC, MPEG2 decoder, 3D graphics engine, ethernet controller and 16- bit game processor. Mr. Zhang received his B.S. and M.S. degrees in Electrical Engineering from Fudan University.

Jun Zhu joined our company in 2000 as an engineering director and currently serves as our vice president and head of IC engineering. From 2001 to 2007 Mr. Zhu served as president and as a member of the board of directors of Silicon Rain Technology, a business focused on the development of IC products in the United States. From 1996 to 2000, Mr. Zhu served as a design manager of Intel Corporation in Santa Clara, California. From 1989 to 1996, Mr. Zhu served as a chip design architect, senior ASIC (Application Specific IC) design engineer and ASIC design engineer at the Application Specific Standard Product group of Toshiba America Electronics Components Inc. in San Jose, California. Mr. Zhu received his M.S. degree in Computer Engineering from Syracuse University.

David Wei Tang joined our company as our chief financial officer and vice president in July 2008. Prior to joining our company, Mr. Tang served as the Chief Financial Officer of CNinsure Inc. a NASDAQ listed company operating in China. Prior to CNinsure, Tang has also served as the Chief Financial Officer in two other companies, including: IRICO Group, a Hong Kong and China listed company, and Chinasoft International, a Hong Kong listed company. Prior to those positions, he was an equity research analyst at Merrill Lynch & Co. in New York. Mr. Tang received his MBA degree from Stern School of Business, New York University.

Changyong (Robert) Chen has served as a member of our board of directors since July 2004. Mr. Chen is a successful serial entrepreneur. Mr. Chen was a founder of Monolithic Power System and OPTI, the fabless semiconductor companies, which were listed on the NASDAQ Global Market. Mr. Chen also founded TMC in Taiwan, a PC motherboard manufacturer which was later acquired by a German public company. Mr. Chen also served as investment advisor of Fortune Investment, a Taiwan-based venture capital company from 1996 to 2000. Mr. Chen received his M.S. degree in Electrical Engineering from the University of California at Berkeley.

Donald L. Lucas has served as a member of our board of directors since July 2004. Since 1967, Mr. Lucas has been actively engaged in venture capital activities as a private individual. Mr. Lucas currently serves as a board member of Cadence Design Systems, Inc., DexCom, Inc., Oracle Corporation and Spansion, Inc. Mr. Lucas also serves as a director for several privately held companies. Mr. Lucas received his B.A. degree from Stanford University and his M.B.A. degree from the Stanford Graduate School of Business.

Dr. Theodore Van Duzer has served as a member of our board of directors since July 2004. He is professor emeritus in the Department of Electrical Engineering and Computer Science at University of California at Berkeley. Dr. Van Duzer received his Ph.D. degree from the University of California at Berkeley in 1960 and has served as a member of its faculty since 1961. Dr. Van Duzer is the founding editor-in-chief of IEEE Transactions. He is also the co-author of two textbooks, “Principles of Superconductive Devices and Circuits” and “Fields and Waves in Communication Electronics” and has published over 200 papers in the research literature on superconductor electronics. He was elected to the U.S. National Academy of Engineering and is an IEEE Life Fellow.

Zhijie (Jeffrey) Zeng has served as a member of our board of directors since July 31, 2009. He is currently the managing partner of Kaixin Investment, a venture capital fund founded by China Development Bank Corporation and CITIC Capital (formerly known as the China International Trust and Investment Company). Prior to joining Kaixin Investment, he served as a managing director of Walden International since 2001, an established global venture capital firm, for which he was mainly responsible for venture investments in China and other Asia countries. At present, Mr. Zeng also serves on the boards of directors of several listed companies, including the E-House (China) Holdings Limited listed on the New York Stock Exchange. He also serves as an executive director of the China Branch of the Asia America MultiTechnology Association (AAMA) and a board member of China Western Returned Scholars Association, Chamber of Commerce (WRSACC) 2005 Committee. Mr. Zeng received his B.S. degree in Economics from the University of Nagasaki, Japan and his Master’s degree in Management from Stanford University.

B.	Compensation of Directors and Executive Officers

Cash Compensation

In 2009, the aggregate cash compensation we paid to our executive officers was approximately $1 million and the aggregate cash compensation we paid to our non-executive directors was $60,000.

Share Options

Historical Option Grants . During the period from 1999 to February 2004, Vimicro China promised to grant options to certain employees, directors, consultants and other individuals based on terms and conditions mutually agreed upon by Vimicro China and each such individual. In connection with our reorganization, we issued options pursuant to Vimicro China’s prior commitments. The following table summarizes, as of March 31, 2010, the outstanding historical options granted to our directors and executive officers named below and to other individuals including our employees, consultants and advisors.


	Ordinary Shares Underlying Options Granted	Exercise Price ($ per share)	Date of Grant	Date of Expiration

Xiaodong (Dave) Yang	1,200,000	0.60	March 17, 2004	March 17, 2014

Jun Zhu	75,000	0.60	March 17, 2004	March 17, 2014

Changyong (Robert) Chen	300,000	0.12	March 17, 2004	March 17, 2014

Other individuals as a group	2,063,936	From 0.01 to 0.60	March 17, 2004	March 17, 2014

The vesting schedule of the options we granted in March 2004 was determined based on the optionee’s length of employment with or services to us and the date on which Vimicro China initially promised to grant options to such optionee.

2004 Share Option Plan . Our board of directors adopted a 2004 share option plan, or the 2004 Plan, which is intended to attract and retain the best available personnel for positions of substantial responsibility, provide additional incentive to employees, directors and consultants and promote the success of our business. We have reserved 12,541,080 of our ordinary shares for issuance under the 2004 Plan. The 2004 Plan was terminated in October 2005, and the remaining options available for grant were transferred to the 2005 Share Incentive Plan, or the 2005 Plan. The following paragraphs describe the principal terms of the 2004 Plan.

Termination of Options . Where the option agreement permits the exercise or purchase of the options granted for a certain period of time following the recipient’s termination of service with us, or the recipient’s disability or death, the options will terminate to the extent not exercised or purchased on the last day of the specified period or the last day of the original term of the options, whichever occurs first.

Administration . The 2004 Plan is administered by our board of directors or a committee designated by our board of directors. In each case, our board of directors or the committee it designates will determine the provisions, terms and conditions of each option grant, including, but not limited to, the option vesting schedule, repurchase provisions, rights of first refusal, forfeiture provisions, form of payment upon settlement of the award, payment contingencies and satisfaction of any performance criteria.

Vesting Schedule . In general, options granted under the 2004 Plan vest over a five-year period following a specified vesting commencement date. 20% of the options granted vest at the end of the first anniversary of the vesting commencement date, and 10% of the options vest semi-annually thereafter over the next four years, subject to the optionee continuing to be an employee or a service provider on each vesting date.

Option Agreement . Options granted under the 2004 Plan are evidenced by an option agreement that contains, among other things, provisions concerning exercisability and forfeiture upon termination of employment or consulting arrangement, as determined by our board. In addition, the option agreement also provides that options granted under the 2004 Plan are subject to a 180-day lock-up period following the effective date of a registration statement filed by us under the Securities Act, if so requested by us or any representative of the underwriters in connection with any registration of the offering of any of our securities.

Option Exercise . The term of options granted under the 2004 Plan may not exceed ten years from the date of grant. The consideration to be paid for our shares upon exercise of an option or purchase of shares underlying the option will be determined by the share option plan administrator and may include cash, check, ordinary shares, a promissory note, consideration received by us under a cashless exercise program implemented by us in connection with the 2004 Plan, or any combination of the foregoing methods of payment.

Third-Party Acquisition . If a third-party acquires us through the purchase of all or substantially all of our assets, a merger or other business combination, all outstanding options or share purchase rights will be assumed or equivalent options or rights will be substituted by the successor corporation or parent or subsidiary of successor corporation. In the event that the successor corporation refuses to assume or substitute for the options or share purchase rights, all options or share purchase rights will become fully vested and exercisable immediately prior to such transaction.

Termination of Plan . Unless terminated earlier, the 2004 Plan will expire in 2009. Our board of directors has the authority to amend or terminate the 2004 Plan subject to shareholder approval to the extent necessary to comply with applicable law and regulations. However, no such action may (i) impair the rights of any optionee unless agreed by the optionee and the share option plan administrator, or (ii) affect the share option plan administrator’s ability to exercise the powers granted to it under our share option plan.

Option Repricing. On March 27, 2008, our compensation committee acted to reprice certain outstanding options that it had previously granted to our senior management. The options, all of which had been previously issued pursuant to the 2004 Plan and 2005 Plan, were repriced based on the closing price on March 27, 2008 which was $0.70 per ordinary share.

The repriced options had originally been issued with $1.60 to $3.00 per ordinary share option exercise prices. As a result of the recent sharp reduction in our stock price, we believed that such options no longer would properly incentivize our senior management who held such options to work in the best interest of our company and shareholders. Moreover, we believed that if these options were repriced, that such options would provide better incentives to senior management.

The following table summarizes, as of March 31, 2010, the outstanding options and restricted shares granted pursuant to the 2004 Plan.


	Ordinary Shares Underlying Options Granted	Exercise Price ($ per share)	Date of Grant	Date of Expiration

Zhaowei (Kevin) Jin	1,601,600	0.70	October 14, 2004	October 14, 2014

Yundong (Raymond) Zhang	460,000	0.70	October 14, 2004	October 14, 2014

Donald L. Lucas	400,000	1.60	October 14, 2004	October 14, 2014

Jun Zhu	150,000	0.70	October 14, 2004	October 14, 2014
	200,000	0.70	October 28, 2005	October 28, 2015

Changyong (Robert) Chen	100,000	1.60	October 14, 2004	October 14, 2014

Theodore Van Duzer	100,000	1.60	October 14, 2004	October 14, 2014

Zhijie (Jeffrey) Zeng	30,000	2.10	May 2, 2005	May 2, 2015

Other individuals as a group	2,298,013	From 0.70 to 3.0	From October 14, 2004 to October 28, 2005	From October 14, 2014 to October 28, 2015

Notes:

(1)	In connection with Mr. Xiaosong Zhang’s resignation on January 31, 2007, his unvested options to purchase 820,000 ordinary shares were forfeited.

(2)	In connection with Mr. Qing Yu’s resignation on December 5, 2008, his unvested options to purchase 12,000 ordinary shares were forfeited and his vested options to purchase 48,000 ordinary shares were cancelled.

2005 Share Incentive Plan . In October 2005, our board of directors and shareholders adopted the 2005 Plan. In December 2006, our board of directors and shareholders amended the 2005 Plan to increase the maximum aggregate number of awards to 21,065,505 ordinary shares. We have reserved for issuance 21,065,505 ordinary shares upon exercise of awards granted under our 2005 Plan. In March 2008, our board of directors and compensation committee amended the 2005 Plan to provide for a provision permitting our compensation committee to reprice share options. In December 2008, the 2005 Plan was further amended at our annual general meeting to increase the maximum aggregate number of shares which may be issued pursuant to all awards granted under the 2005 Plan by ten million ordinary shares (equivalent to 2.5 million American depositary shares).

Types of Awards . We may grant the following types of awards under the 2005 Plan:

•

our ordinary shares;

•

options to purchase our ordinary shares;

•

restricted shares, which are non-transferable ordinary shares, that may be subject to forfeiture;

•

restricted share units, which represent the right to receive our ordinary shares at a specified date in the future, which may be subject to forfeiture;

•

share appreciation rights, which provide for payment to the grantee based upon increases in the price of our ordinary shares over a set base price; and

•

dividend equivalent rights, which represent the value of the dividends per share that we pay.

Awards may be designated in the form of ADSs instead of ordinary shares. If we designate an award in the form of ADSs, the number of shares issuable under the 2005 Plan will be adjusted to reflect a ratio of one ADS to four ordinary shares.

Eligibility . We may grant awards to employees, directors and consultants of our company or any of our related entities, which include our subsidiaries or any entities in which we hold a substantial ownership interest. However, we may grant options that are intended to qualify as incentive stock options, or ISOs, only to our employees and employees of our majority owned subsidiaries.

Plan Administration . Our board of directors, or a committee designated by our board of directors, will administer the 2005 Plan. However, with respect to awards made to our non-employee directors and executive officers, the entire board of directors will administer the 2005 Plan. The committee or the full board of directors, as appropriate, will determine the individuals who will receive grants, the types of awards to be granted and terms and conditions of each award grant, including any vesting or forfeiture restrictions.

Award Agreement . Awards granted under the 2005 Plan are evidenced by an award agreement that sets forth the terms, conditions and limitations for each award. In addition, in the case of options, the award agreement also specifies whether the option constitutes an ISO or a non-qualifying stock option.

Acceleration of Awards upon Corporate Transactions. The outstanding awards will accelerate upon occurrence of a change of control corporate transaction where the successor entity does not assume our outstanding awards under the 2005 Plan. In such event, each outstanding award will become fully vested and immediately exercisable, and the transfer restrictions on the awards will be released and any forfeiture provisions will terminate immediately before the date of the change of control transaction. If the successor entity assumes our outstanding awards and later terminates the grantee’s service without cause within 12 months of the change of control transaction, the outstanding awards automatically become fully vested and exercisable.

Exercise Price and Term of Awards . In general, the plan administrator determines the exercise price of an option and sets forth the price in the award agreement. The exercise price may be a fixed or variable price related to the fair market value of our ordinary shares. However, ISOs may not be granted at an exercise price which is less than the fair market value of our ordinary shares on the date of grant. Also, if we grant an ISO to an employee, who, at the time of that grant, owns shares representing more than 10% of the voting power of all classes of our share capital, the exercise price cannot be less than 110% of the fair market value of our ordinary shares on the date of that grant.

The term of each award shall be stated in the award agreement. The term of an award shall not exceed ten years from the date of the grant, except that five years is the maximum term of an ISO granted to an employee who holds more than 10% of the voting power of our share capital.

Amendment and Termination . Our board of directors may at any time amend, suspend or terminate the 2005 Plan. Amendments to the 2005 Plan are subject to shareholder approval to the extent required by law, or stock exchange rules or regulations. Additionally, shareholder approval will be specifically required to increase the number of shares available for issuance under the 2005 Plan or to extend the term of an option beyond ten years. Unless terminated earlier, the 2005 Plan will expire and no further awards may be granted after the tenth anniversary of the shareholder approval of the 2005 Plan. We followed home country practice with respect to an amendment to the 2005 Plan on repricing the outstanding options. Based on home country practice, we are not required to seek shareholder approval for repricing our outstanding options.

Grant of Restricted Shares. We granted 3,640,600 restricted shares under the 2005 Plan. Key terms in the award agreements are summarized as follow:

•

The restricted shares will vest approximately according to the following schedules:

40% of the restricted shares will vest two years after the grant date, and 10% of the shares will vest semi-annually thereafter over the next three years.

20% of the restricted shares will vest one year after the grant date, and 10% of the shares will vest semi-annually thereafter over the next four years.

100% of the restricted shares will vest one year after the grant date.

50% of the restricted shares will vest on the first anniversary of the grant date, 25% of the shares will vest semi-annually thereafter over the next year.

25% of the restricted shares will vest on the first anniversary of the grant date, 12.5% of the shares will vest semi-annually thereafter over the next three years.

100% of the restricted shares will vest on the second anniversary of the grant date.

The unvested portion of the restricted shares is subject to forfeiture upon the termination of the holder’s employment with or service to us. Until vested, the restricted shares are not transferable and may not be sold, pledged or otherwise transferred.

Option Repricing. On March 27, 2008, our compensation committee acted to reprice 10,072,100 outstanding options that it had previously granted to our senior management. The options, all of which had been previously issued pursuant to the 2004 Plan and 2005 Plan, were repriced based on the closing price on March 27, 2008 which was $0.70 per ordinary share.

The repriced options had originally been issued with $1.25 to $4.55 per ordinary share option exercise prices reflected the then current market prices of our stock on the dates of original grant. As a result of the reduction in our stock price in the first quarter of 2008, we believed that such options no longer would properly incentivize our senior management who held such options to work in the best interest of our company and shareholders. Moreover, we believed that if these options were repriced, that such options would provide better incentives to senior management.

December 2008 Amendment. On December 11, 2008, our shareholders approved an amendment to the 2005 Plan at the annual general meeting. The amendment increased the maximum aggregate number of shares which may be issued pursuant to all awards granted under the 2005 Plan by ten million ordinary shares (equivalent to 2.5 million American depositary shares).

The following table summarizes, as of March 31, 2010, the outstanding options and restricted shares granted pursuant to the 2005 Plan.


	Ordinary Shares Underlying Options Granted	Exercise Price ($ per share)	Date of Grant	Date of Expiration

Zhonghan (John) Deng	3,500,000	0.70	August 9, 2006	August 9, 2016

Zhaowei (Kevin) Jin	1,200,000	0.70	August 9, 2006	August 9, 2016

Jun Zhu	200,000	0.70	August 13, 2007	August 13, 2017

Xiaodong (Dave) Yang	1,200,000	0.70	August 9, 2006	August 9, 2016

David Wei Tang	700,000	1.06	March 6, 2010	March 6, 2020

Zhijie (Jeffrey) Zeng	100,000	0.63	August 1, 2009	August 1, 2019

Other individuals as a group	5,395,052	From 0.48 to 4.55	From December 26, 2005 to March 6, 2010	From December 26, 2015 to March 6, 2020

Notes:

(1)	Dr. Hui (Tom) Zhang resigned as our advisor and consultant on January 1, 2009. His unvested options to purchase 155,556 ordinary shares were forfeited and his vested options to purchase 644,444 ordinary shares were cancelled.

(2)	In connection with Mr. Quincy Tang’s resignation on July 31, 2008, his unvested options to purchase 160,000 ordinary shares were forfeited and vested options to purchase 80,000 ordinary shares were cancelled.

(3)	Mr. Yingyi Qian resigned from our board on June 30, 2008, and he continues to serve as our advisor and consultant. His options and restricted shares agreements remain in effect.

(4)	In connection with Mr. Qing Yu’s resignation on December 5, 2008, his unvested options to purchase 120,000 ordinary shares were forfeited and vested options to purchase 80,000 ordinary shares were cancelled.


	Ordinary Shares Underlying Restricted Shares Granted	Exercise Price ($ per share)	Date of Grant	Date of Expiration

David Wei Tang	300,000	0.00	July 28, 2008	July 28, 2018

Other individuals as a group	497,500	0.00	From March 3, 2006 to January 1, 2010	From March 3, 2016 to January 1, 2020

Notes:

(1)	In connection with Mr. Qing Yu’s resignation on December 5, 2008, his 80,000 unvested restricted shares were forfeited.

(2)	Dr. Hui (Tom) Zhang resigned as our advisor and consultant on January 1, 2009. His unvested 38,892 restricted shares held on such date were forfeited.

C.	Board Practices

Our board of directors consists of seven directors. A director is not required to hold any of our shares by way of qualification. A director may vote with respect to any contract, proposed contract or arrangement in which he is materially interested. The directors may exercise all the powers of the company to borrow money, mortgage its undertaking, property and uncalled capital and issue debentures or other securities whenever money is borrowed or as security for any obligation of the company or of any third-party.

Committees of the Board of Directors

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

Audit Committee. Our audit committee consists of Messrs. Donald L. Lucas, Changyong (Robert) Chen and Jeffrey Zeng. Messrs. Lucas, Chen and Zeng satisfy the “independence” requirements of the NASDAQ Marketplace Rules. The audit committee oversees our accounting and financial reporting processes and the audits of the financial statements of our company. The audit committee is responsible for, among other things:

•

selecting the independent auditors and pre-approving all auditing and non-auditing services permitted to be performed by the independent auditors;

•

reviewing with the independent auditors any audit problems or difficulties and management’s response;

•

reviewing and approving all proposed related-party transactions, as defined in Item 404 of Regulation S-K;

•

discussing the annual audited financial statements with management and the independent auditors;

•

reviewing major issues as to the adequacy of our internal controls and any special audit steps adopted in light of material control deficiencies;

•

annually reviewing and reassessing the adequacy of our audit committee charter;

•

such other matters that are specifically delegated to our audit committee by our board of directors from time to time;

•

meeting separately and periodically with management and the independent auditors; and

•

reporting regularly to the full board of directors.

In 2009, our audit committee held meetings or passed resolutions by unanimous written consent eight times.

Compensation Committee . Our compensation committee consists of Messrs. Changyong (Robert) Chen and Theodore Van Duzer. Messrs. Chen and Van Duzer satisfy the “independence” requirements of the NASDAQ corporate governance rules. Our compensation committee assists the board in reviewing and approving the compensation structure of our directors and executive officers, including all forms of compensation to be provided to our directors and executive officers. Our chief executive officer may not be present at any committee meeting during which his compensation is deliberated. The compensation committee is responsible for, among other things:

•

reviewing and recommending to the board with respect to the total compensation package for our four most senior executives;

•

approving and overseeing the total compensation package for our executives other than the four most senior executives;

•

reviewing and making recommendations to the board with respect to the compensation of our directors; and

•

reviewing periodically and approving any long-term incentive compensation or equity plans, programs or similar arrangements, annual bonuses, employee pension and welfare benefit plans.

In 2009, our compensation committee held meetings or passed resolutions by unanimous written consent two times.

Corporate Governance and Nominating Committee . Our corporate governance and nominating committee consists of Messrs. Donald L. Lucas and Theodore Van Duzer. Messrs. Lucas and Van Duzer satisfy the “independence” requirements of the NASDAQ corporate governance rules. The corporate governance and nominating committee assists the board of directors in identifying individuals qualified to become our directors and in determining the composition of the board and its committees. The corporate governance and nominating committee is responsible for, among other things:

•

identifying and recommending to the board nominees for election or re-election to the board, or for appointment to fill any vacancy;

•

reviewing annually with the board the current composition of the board in light of the characteristics of independence, age, skills, experience and availability of service to us;

•

identifying and recommending to the board the names of directors to serve as members of the audit committee and the compensation committee, as well as the corporate governance and nominating committee itself;

•

advising the board periodically with respect to significant developments in the law and practice of corporate governance as well as our compliance with applicable laws and regulations, and making recommendations to the board on all matters of corporate governance and on any corrective action to be taken; and

•

monitoring compliance with our code of business conduct and ethics, including reviewing the adequacy and effectiveness of our procedures to ensure proper compliance.

In 2009, our corporate governance and nominating committee held meetings or passed resolutions by unanimous written consent two times.

Duties of Directors

Under Cayman Islands law, our directors have a duty of loyalty to act honestly in good faith with a view to our best interests. Our directors also have a duty to exercise the skill they actually possess and such care and diligence that a reasonably prudent person would exercise in comparable circumstances. In fulfilling their duty of care to us, our directors must ensure compliance with our memorandum and articles of association. Our articles of association govern the way our company is operated and the powers granted to the directors to manage the daily affairs of our company.

Terms of Directors and Officers

All directors hold office until their successors have been duly elected and qualified. Our shareholders may remove any director by special resolution before the expiration of his or her term and may by ordinary resolution appoint another person to fill the vacancy. A valid ordinary resolution requires the votes of a majority of shareholders attending the shareholder meeting that is duly constituted and meets the quorum requirement. Officers are elected by and serve at the discretion of the board of directors.

Home Country Practice Exemption

Nasdaq Marketplace Rule 4350(a)(1) permits foreign private issuers like us to follow “home country practice” in certain corporate governance matters. Maples and Calder, our Cayman Islands counsel, has provided letters to the Nasdaq certifying that under Cayman Islands law and under our articles of association, (1) we are not required to hold annual shareholder meetings every year, and (2) we are not required to seek shareholder approval for any material amendments to our equity compensation plans.

Pursuant to the “home country practice” exemptions above that we applied and obtained, we did not hold an annual shareholder meeting in 2009. We may, however, hold annual shareholder meetings in the future if there are significant issues that require shareholders’ approvals.

Additionally, in March 2008, our compensation committee repriced 10,072,100 of our outstanding share options by reducing their exercise prices based on the closing price on March 27, 2008 which was $0.70 per ordinary share. The rationale for the repricing is that our share options no longer provided a meaningful incentive to the option holders to remain in our employment, and that a repricing of the share options with a lower exercise price for our existing options would once again provide an incentive to the option holders to continue to provide services to us and to maximize shareholder value.

Nasdaq Marketplace Rule 4350(i)(1) requires each issuer to seek shareholder approval for any material amendments to the issuer’s equity compensation plans, including a repricing of outstanding share options. Pursuant to the “home country practice” exemptions above that we applied and obtained, the amendments to our 2005 Share Incentive Plan to permit the option repricing in March 2008 were approved and ratified by only our board of directors and such amendments have not been, and will not be sought by us to be, approved or ratified by our shareholders.

Employees

We had 568, 663 and 724 employees as of December 31, 2007, 2008 and 2009, respectively. As of December 31, 2009, we had 78 employees in management and administration, 585 employees in research and development and 61 employees in sales and marketing.

We have a workers’ union that protects employees’ rights and welfare benefits. We have not had any strikes or other material labor disputes that have interfered with our operations. We believe that we have maintained a good relationship with our workers’ union and our employees.

E.	Share Ownership

As of March 31, 2010, the most recent practicable date, 147,673,168 of our ordinary shares were outstanding, excluding shares issuable upon exercise of outstanding options and 797,500 restricted shares. On that date, a total of 21,512,887 of our ADSs were outstanding. Our shareholders are entitled to vote together as a single class on all matters submitted to shareholders vote. Except for holders of 797,500 restricted shares, no shareholder has different voting rights from other shareholders. We are not aware of any arrangement that may, at a subsequent date, result in a change of control of our company.

The following table sets forth information with respect to the beneficial ownership of our ordinary shares, as of March 31, 2010, assuming the exercise of all of our outstanding share options, by:

(1)

each of our directors and executive officers; and

(2)

each person known to us to own beneficially more than 5.0% of our ordinary shares.


	Ordinary Shares Beneficially Owned (1)
	Number	%

Directors and Executive Officers:

Zhonghan (John) Deng (2)	19,203,192	12.8

Xiaodong (Dave) Yang (3)	11,093,961	7.4

Zhaowei (Kevin) Jin (4)	6,233,451	4.2

Yundong (Raymond) Zhang (5)	1,563,472	1.1


	Ordinary Shares Beneficially Owned (1)
	Number	%

Jun Zhu (6)	705,000	0.5

Donald L. Lucas (7)	693,808	0.5

Changyong (Robert) Chen (8)	420,000	0.3

Theodore Van Duzer (9)	170,000	0.1

Zhijie (Jeffrey) Zeng (10)	32,000	0.0

David Wei Tang	—	—

All Directors and Executive Officers as a Group (11)	40,114,884	26.8

Principal Shareholders:

Investment entities affiliated with General Atlantic LLC (12)	24,535,522	16.6

Power Pacific (Mauritius) Limited (13)	11,250,000	7.6

Sparta Asset Management, LLC (14)	10,148,652	6.9

Columbia Pacific Opportunity Fund, L.P. (14)	7,921,768	5.4

(1)

Beneficial ownership of each listed person in the table is determined assuming the exercise of all share options held by such person within 60 days after March 31, 2010. Percentage ownership of each listed person is based on 147,673,168 shares outstanding as of March 31, 2010 (excluding 797,500 restricted shares) and the number of shares underlying options and restricted shares held by such person.

(2)

Includes 11,839,490 ordinary shares held by Vimicro Beijing Corporation, an entity wholly owned by Golden Hill Assets Limited, a British Virgin Islands company, which is owned by The Golden Hill International Trust, of which Mr. Deng is the settler, 4,913,702 restricted shares held by Vimicro Beijing Corporation, which are subject to the restriction on transfer, and 2,450,000 ordinary shares issuable upon exercise of options held by Mr. Deng within 60 days after March 31, 2010. The address for Mr. Deng is 15/F, Shining Tower, No. 35, Xueyuan Road, Haidian District, Beijing 100191, PRC.

(3)

Includes 6,597,110 ordinary shares and 2,456,851 restricted shares, which are subject to the restriction on transfer, held by Vimicro Tianjin Corporation, an entity wholly owned and controlled by Mr. Yang, and 2,040,000 ordinary shares issuable upon exercise of options held by Mr. Yang within 60 days after March 31, 2010. The address for Mr. Yang is 15/F, Shining Tower, No. 35, Xueyuan Road, Haidian District, Beijing 100191, PRC.

(4)

Includes 1,335,000 ordinary shares held by Vimicro Shenzhen Corporation, an entity wholly owned by Absolute Sino Group Limited, of which Mr. Jin is the sole shareholder, 2,456,851 restricted shares held by Vimicro Shenzhen Corporation, which are subject to the restriction on transfer and 2,441,600 ordinary shares issuable upon exercise of options held by Mr. Jin within 60 days after March 31, 2010. The address for Mr. Jin is 15/F, Shining Tower, No. 35, Xueyuan Road, Haidian District, Beijing 100191, PRC.

(5)	Includes 1,103,472 ordinary shares, and 460,000 ordinary shares issuable upon exercise of options held by Mr. Zhang within 60 days after March 31, 2010. The address for Mr. Zhang is 15/F, Shining Tower, No.35, Xueyuan Road, Haidian District, Beijing 100191, PRC.

(6)	Includes 200,000 ordinary shares and 505,000 ordinary shares issuable upon exercise of options held by Mr. Zhu within 60 days after March 31, 2010. The address for Mr. Zhu is 1758 N. Shoreline Blvd., Mountain View, CA 94043.

(7)

Includes 273,189 ordinary shares held by Donald L. Lucas TTEE, Donald L. Lucas & Lygia S. Lucas Trust DTD 12-3-84, 20,619 ordinary shares held by Donald L. Lucas Profit Sharing Trust DTD 1-1-84, and 400,000 ordinary shares issuable upon exercise of options held by Mr. Lucas within 60 days after March 31, 2010. The address for Mr. Lucas is 3000 Sand Hill Road #3-210, Menlo Park, CA 94025.

(8)	Includes 20,000 ordinary shares and 400,000 ordinary shares issuable upon exercise of options held by Mr. Chen within 60 days after March 31, 2010. The address for Mr. Chen is 15/F, Shining Tower, No. 35, Xueyuan Road, Haidian District, Beijing 100191, PRC.

(9)	Includes 70,000 ordinary shares held by Mr. Van Duzer and 100,000 ordinary shares issuable upon exercise of options held by Mr. Van Duzer within 60 days after March 31, 2010. The address for Mr. Van Duzer is 1240 Scott Street, El Cerrito, CA 94530.

(10)	Includes 2,000 ordinary shares and 30,000 ordinary shares issuable upon exercise of options held by Mr. Zeng within 60 days after March 31, 2010. The address for Mr. Zeng is 15/F, Shining Tower, No. 35, Xueyuan Road, Haidian District, Beijing 100191, PRC.

(11)	Includes 31,288,284 ordinary shares, ordinary shares represented by ADSs and restricted shares beneficially owned by our officers and directors, and 8,826,600 ordinary shares underlying outstanding options held by our directors and executive officers within 60 days after March 31, 2010.

(12)

Includes a total of 18,531,786 ordinary shares and 1,500,934 ADSs of which General Atlantic Partners (Bermuda), L.P. holds 12,725,792 ordinary shares and 1,060,596 ADSs, GAP-W International, L.P. holds 4,394,803 ordinary shares and 307,275 ADSs, GAP Coinvestments III, LLC holds 912,790 ordinary shares and 82,925 ADSs, GAP Coinvestments IV, LLC holds 246,877 ordinary shares and 19,650 ADSs, GapStar, LLC holds 231,647 ordinary shares and 28,142 ADSs and GAPCO GmbH & Co. KG holds 19,877 ordinary shares and 2,346 ADSs. GAP (Bermuda) Limited is the general partner of General Atlantic GenPar (Bermuda), L.P. General Atlantic GenPar (Bermuda), L.P. is the general partner of General Atlantic Partners (Bermuda), L.P.and GAP-W International, L.P. GAPCO Management GmbH is the general partner of GAPCO GmbH & Co. KG. There are 25 Managing Directors of General Atlantic LLC. The managing members of GAP Coinvestments III, LLC and GAP Coinvestments IV, LLC are Managing Directors of General Atlantic LLC. The members of GapStar, LLC are also comprised of managing directors of General Atlantic LLC. The Managing Directors of General Atlantic LLC are the executive officers and directors of GAP (Bermuda) Limited. The Managing Directors of General Atlantic LLC make voting and investment decisions with respect to GAPCO Management GmbH and GAPCO GmbH & Co. KG. General Atlantic Partners (Bermuda), L.P, GAP-W International, L.P., GapStar, LLC, GAP Coinvestments III, LLC, GAP Coinvestments IV, LLC and GAPCO GmbH & Co. KG are a “group” within the meaning of Rule 13d-5 of the Securities Exchange Act of 1934, as amended. The address of General Atlantic Partners (Bermuda), L.P., General Atlantic GenPar (Bermuda), L.P., GAP (Bermuda) Limited and GAP-W International, L.P. is Clarendon House, Church Street, Hamilton, Bermuda. The address of GAPCO GmbH & Co. KG and GAPCO Management GmbH is c/o General Atlantic GmbH, Koenigsallee 62, 40212 Duesseldorf, Germany. The address of the other General Atlantic entities is c/o General Atlantic Service Company, LLC, 3 Pickwick Plaza, Greenwich, Connecticut 06830, U.S.A.

(13)

Power Pacific (Mauritius) Limited is 100% owned by Power Pacific Corporation Limited, which is 99.9% owned by Power Corporation International Limited. Power Corporation International Limited is 100% owned by Power Corporation of Canada, a company listed on the Toronto Stock Exchange. The address for Power Pacific (Mauritius) Limited is Les Cascades, Edith Cavell Street, Port-Louis, Republic of Mauritius. The address of Power Corporation of Canada is 751 Victoria Square, Montréal, Québec, Canada H2Y 2J3.

(14)

Beneficial ownership calculation is based solely on a review of a Schedule 13G filing made with the SEC on February 9, 2010. Sparta Asset Management, LLC is an investment advisor in accordance with SS.240.13d-1(b)(1)(ii)(E). The address of Sparta Asset Management, LLC is One O’Hare Centre, 6250 N. River Road, Suite 1000, Rosemont, IL 60018, United States.

(15)	Beneficial ownership calculation is based solely on a review of a Schedule 13G filing made with the SEC on February 12, 2010. The business address of the reporting person(s) is 1910 Fairview Avenue East Suite 500, Seattle, WA 98102.

Based on 147,673,168 ordinary shares outstanding as of March 31, 2010, approximately 59.9% of our outstanding ordinary shares are held by 39 record holders in the United States, including the ordinary shares held by JPMorgan Chase Bank N.A., the depositary of our ADS program.

I TEM 7.

M AJOR S HAREHOLDERS AND R ELATED P ARTY T RANSACTIONS

A.	Major Shareholders

Please refer to “Item 6. Directors, Senior Management and Employees—E. Share Ownership.”

B.	Related Party Transactions

Option to Purchase Ownership Interest in Vimicro Tianjin

On December 29, 2008, we formed Vimicro Tianjin with Tianjin SAMC and the Management Fund. Tianjin SAMC and Vimicro China each contributed RMB250 million in cash to Vimicro Tianjin as initial registered capital and each holds approximately 49.99% ownership interest in the company. The Management Fund holds a nominal ownership interest. Pursuant to the agreement among Vimicro Tianjin’s shareholders, the Management Fund has the option to purchase all of Tianjin SAMC’s ownership interest in Vimicro Tianjin for RMB250 million plus interests calculated based on the one-year short-term bank lending rate published by the People’s Bank of China. This option can be exercised at any time after one year of the establishment of Vimicro Tianjin. Pursuant to agreements between Vimicro China and the Management Fund, we obtained the voting rights and economic interests associated with the Management Fund’s current share ownership in Vimicro Tianjin, which provides us control of Vimicro Tianjin. The Management Fund also granted us an exclusive right to acquire from the Management Fund the beneficial ownership of Tianjin SAMC’s interest in Vimicro Tianjin for the same amount of consideration paid by the Management Fund. It is necessary for the Management Fund to receive our consent before it can exercise the option to acquire Tianjin SAMC’s interest in Vimicro Tianjin. If we exercise this exclusive right, approximately 15% of Vimicro Tianjin’s ownership interest will be reserved for an equity award scheme whereby we may make grants of equity awards at our discretion. The arrangements described above were approved by our board of directors and the committees of the board of directors on June 30, 2009. Vimicro Tianjin focuses on the design, manufacture and sale of security and surveillance products.

Contractual Arrangements with Vimicro Sky-Vision and its Shareholders

In order to comply with PRC laws restricting foreign ownership in the wireless value-added telecommunication business in China, we conduct all of our wireless value-added telecommunication business through Vimicro Sky-Vision. Vimicro Sky-Vision will apply and hold the licenses and permits required to operate our wireless value-added telecommunication services. The equity interest in Vimicro Sky-Vision was owned 67% by Zhonghan (John) Deng, our Chairman and Chief Executive Officer, and 33% by Zhaowei (Kevin) Jin, our President and Chief Operating Officers, upon its establishment in March 2010. Vimicro China, Vimicro Sky-Vision and the shareholders of Vimicro Sky-Vision entered into a series of agreements that became effective on March 5, 2010, through which we exercise effective control of Vimicro Sky-Vision and receive economic benefits generated from its shareholders’ equity interests. The following is a summary of the agreements currently in effect:

•

Loan Agreement , between Vimicro China and Vimicro Sky-Vision’s shareholders. These loan agreements provide for loans in the amount of RMB6,700,000 ($982,405) to Zhonghan (John) Deng and of RMB3,300,000 ($483,871) to Zhaowei (Kevin) Jin for them to make contributions to the registered capital of Vimicro Sky-Vision in exchange for the 67% and 33% equity interest, respectively, in Vimicro Sky-Vision. The loans are interest free and are repayable on demand, but the only means by which the shareholders can repay the loans is to transfer to Vimicro China or a third party designated by Vimicro China of their respective equity interest in Vimicro Sky-Vision.

•

Equity Interests Purchase Right Agreement , among Vimicro China, Vimicro Sky-Vision and Vimicro Sky-Vision’s shareholders. Pursuant to these agreements, Vimicro China and any third party designated by Vimicro China have the right, exercisable at any time during the term of the agreements, to the extent permitted under PRC law, to purchase from Zhonghan (John) Deng or Zhaowei (Kevin) Jin, as the case may be, all or any part of his equity interest in Vimicro Sky-Vision at a purchase price equal to his initial contributions to the registered capital of Vimicro Sky-Vision or a price determined by Vimicro China. Vimicro China also has the right to determine the type of purchase price payment and the means of rendering the purchase price when exercising all or part of the option to purchase the equity interest held by the shareholders of Vimicro Sky-Vision.

•

Share Pledge Agreements , among Vimicro China, Vimicro Sky-Vision and the shareholders of Vimicro Sky- Vision. Pursuant to these agreements, Zhonghan (John) Deng and Zhaowei (Kevin) Jin pledged to Vimicro China their equity interest in Vimicro Sky-Vision to secure the performance of their respective obligations and Vimicro Sky-Vision’s obligations under the various VIE-related agreements. If any of the shareholders of Vimicro Sky-Vision breaches his or her respective obligations under any VIE-related agreements (Vimicro Sky-Vision’s breach of any of its obligations under the various VIE-related agreements will be treated as its shareholders’ breach of their respective obligations), including the Share Pledge Agreement, Vimicro China is entitled to exercise its rights as the beneficiary under the Share Pledge Agreement, including all the rights such shareholder has as a shareholder of Vimicro Sky-Vision.

•

Business Operations Agreement , among Vimicro China, Vimicro Sky-Vision and the shareholders of Vimicro Sky-Vision. This agreement sets forth the rights of Vimicro China to control the actions of the shareholders of Vimicro Sky-Vision.

•

Powers of Attorney , executed by the shareholders of Vimicro Sky-Vision in favor of Vimicro China. These powers of attorney give Vimicro China the exclusive right to appoint nominees to act on behalf of each of the Vimicro Sky-Vision shareholders, in connection with all actions to be taken by Vimicro Sky-Vision.

•

Exclusive Technical and Consulting Services Agreement , between Vimicro China and Vimicro Sky-Vision. Pursuant to this agreement, Vimicro China has the exclusive right to provide product development and application services, technology support, intellectual property rights, marketing, staffing, business operation and maintenance services to Vimicro Sky-Vision for a fee based on a predetermined operating margin of Vimicro Sky-Vision.

In the opinion of our PRC counsel, King and Wood, (i) the ownership structure and the business and operation model of Vimicro China and Vimicro Sky-Vision comply with current PRC laws and regulations; and (ii) each contract under Vimicro China’s contractual arrangements with Vimicro Sky-Vision and each of Vimicro Sky-Vision’s shareholders is valid, binding and enforceable, and will not result in any violation of PRC laws or regulations currently in effect. There are, however, substantial uncertainties regarding the interpretation and application of current or future PRC laws and regulations. Accordingly, PRC governmental authorities may ultimately take a view that is inconsistent with the opinion of King and Wood. See “Item 3. Key Information—D. Risk Factors—Risks Related To Doing Business in China—If the PRC government determines that the contractual arrangements that establish the structure for operating our wireless value-added telecommunications business do not comply with applicable PRC laws and regulations, we could be subject to severe penalties.”

Share Options

See “Item 6. Directors, Senior Management and Employees—B. Compensation of Directors and Executive Officers—Share Options.”

C.	Interests of Experts and Counsel

Not applicable.

I TEM 8.

F INANCIAL I NFORMATION

A.	Consolidated Statements and Other Financial Information

We have appended consolidated financial statements filed as part of this annual report.

Legal Proceedings

From time to time, we may be involved in litigation or other legal proceedings incidental to our business. We are not aware of any material legal proceedings currently existing or pending against us that will have a material adverse effect on our business and results of operations. Regardless of the outcome, however, any litigation or other legal proceedings can result in substantial costs and diversion of management resources and attention.

Dividend Policy

We have never declared or paid any dividends, nor do we have any present plan to pay any cash dividends on our ordinary shares in the foreseeable future. We currently intend to retain most, if not all, of our available funds and any future earnings to operate and expand our business.

Our board of directors has complete discretion as to whether to distribute dividends. Even if our board of directors decides to pay dividends, the timing, amount and form of future dividends, if any, will depend on, among other things, our future results of operations and cash flow, our capital requirements and surplus, the amount of distributions, if any, received by us from our subsidiaries, our financial condition, contractual restrictions and other factors deemed relevant by our board of directors.

If we pay any dividends, we will pay our ADS holders to the same extent as holders of our ordinary shares, subject to the terms of the deposit agreement, including the fees and expenses payable thereunder. See “Description of American Depositary Shares” from our F-1 registration statement (File No. 333-129217), as amended, initially filed with the Commission on October 24, 2005. Cash dividends on our ordinary shares, if any, will be paid in U.S. dollars.

B.	Significant Changes

We have not experienced any significant changes since the date of our audited consolidated financial statements included in this annual report.

I TEM 9.

T HE O FFER AND L ISTING

A.	Offering and Listing Details

Our ADSs, each representing four of our ordinary shares, have been listed on the NASDAQ Global Market since November 15, 2005 under the symbol “VIMC.”

In 2009 the trading price of our ADSs on the NASDAQ Global Market ranged from $1.29 to $4.89 per ADS.

The following table provides the high and low trading prices for our ADSs on the NASDAQ Global Market for (1) the years 2007, 2008 and 2009; (2) all quarters in 2008 and 2009, and the first quarter of 2010; and (3) each of the past four months.


	Share Price
	High		Low

Annual High and Low

2006	$	23.34	$	8.20
2007	$	11.00	$	3.55
2008	$	3.99	$	1.23
2009	$	4.89	$	1.29
Quarterly High and Low

First Quarter 2008	$	3.99	$	2.53
Second Quarter 2008	$	3.50	$	2.50
Third Quarter 2008	$	3.17	$	2.19
Fourth Quarter 2008	$	2.64	$	1.23
First Quarter 2009	$	2.34	$	1.29
Second Quarter 2009	$	2.25	$	1.66
Third Quarter 2009	$	3.75	$	1.95
Fourth Quarter 2009	$	4.89	$	3.38
First Quarter 2010	$	5.15	$	4.02
Monthly Highs and Lows

October 2009	$	4.00	$	3.38
November 2009	$	4.21	$	3.42
December 2009	$	4.89	$	4.10
January 2010	$	5.15	$	4.39
February 2010	$	4.82	$	4.02
March 2010	$	4.64	$	4.10
April 2010	$	4.65	$	4.26
May 2010 (through May 11)	$	4.56	$	4.25

B.	Plan of Distribution

Not applicable.

Markets

Our ADSs, each representing four of our ordinary shares, have been listed on the NASDAQ Global Market since November 15, 2005 under the symbol “VIMC.”

D.	Selling Shareholders

Not applicable.

Dilution

Not applicable.

F.	Expenses of the Issue

Not applicable.

I TEM 10.

A DDITIONAL I NFORMATION

A.	Share Capital

Not applicable.

B.	Memorandum and Articles of Association

The following are summaries of material provisions of the amended and restated memorandum and articles of association adopted on October 29, 2005, and the Companies Law insofar as they relate to the material terms of our ordinary shares.

Registered Office and Objects

The registered office of our company is located at the offices of Maples Corporate Services Limited, PO Box 309, Ugland House, Grand Cayman, KY1-1104, Cayman Islands, or at such other place as the directors may from time to time decide.

According to Article 3 of our memorandum of association, the objects for which our company is established are unrestricted and our company shall have full power and authority to carry out any object not prohibited by the Companies Law (2007 Revision) or as the same may be revised from time to time, or any other law of the Cayman Islands.

Board of Directors

See “Item 6. Directors, Senior Management and Employees—C. Board Practices.”

Ordinary Shares

General

Certificates representing the ordinary shares are issued in registered form. Our shareholders who are non-residents of the Cayman Islands may freely hold and vote their shares.

Dividend Rights

The holders of our ordinary shares are entitled to such dividends as may be declared by our board of directors subject to the Companies Law.

Voting Rights

Each ordinary share is entitled to one vote on all matters upon which the ordinary shares are entitled to vote. Voting at any meeting of shareholders is by show of hands unless a poll is demanded. A poll may be demanded by any shareholder holding at least ten percent of the shares given a right to vote at the meeting, present in person or by proxy.

A quorum required for a meeting of shareholders consists of shareholders present in person or by proxy or, if a corporation or other non-natural person, by its duly authorized representative, holding not less than an aggregate of one-third of our issued voting share capital. Shareholders’ meetings are held annually and may be convened by our board of directors on its own initiative or upon a request to the directors by shareholders holding in aggregate at least one-third of our voting share capital. Advance notice of at least 21 calendar days is required for the convening of our annual general meeting and other shareholders’ meetings.

An ordinary resolution to be passed by the shareholders requires the affirmative vote of a simple majority of the votes attaching to the ordinary shares cast in a general meeting, while a special resolution requires the affirmative vote of no less than two-thirds of the votes cast attaching to the ordinary shares. A special resolution is required for important matters such as a change of name. Holders of the ordinary shares may effect certain changes by ordinary resolution, including alter the amount of our authorized share capital, consolidate and divide all or any of our share capital into shares of larger amount than our existing share capital, and cancel any shares.

Transfer of Shares

Subject to the restrictions of our articles of association, as applicable, any of our shareholders may transfer all or any of his or her ordinary shares by an instrument of transfer in the usual or common form or any other form approved by our board.

Our board of directors may, in its absolute discretion, decline to register any transfer of any ordinary share which is not fully paid up or on which we have a lien.

Liquidation

On a return of capital on winding up or otherwise (other than on conversion, redemption or purchase of shares), assets available for distribution among the holders of ordinary shares shall be distributed among the holders of the ordinary shares on a pro rata basis. If our assets available for distribution are insufficient to repay all of the paid-up capital, the assets will be distributed so that the losses are borne by our shareholders proportionately.

Calls on Shares and Forfeiture of Shares

Our board of directors may from time to time make calls upon shareholders for any amounts unpaid on their shares in a notice served to such shareholders at least 14 calendar days prior to the specified time and place of payment. The shares that have been called upon and remain unpaid on the specified time are subject to forfeiture.

Redemption of Shares

Subject to the provisions of the Companies Law, we may issue shares on terms that are subject to redemption, at our option or at the option of the holders, on such terms and in such manner as may be determined by special resolution.

Variations of Rights of Shares

All or any of the special rights attached to any class of shares may, subject to the provisions of the Companies Law, be varied either with the written consent of the holders of a majority of the issued shares of that class or with the sanction of a resolution passed by at least a majority of the holders of the class present in person or by proxy at a separate general meeting of the holders of the shares of that class.

Inspection of Books and Records

Holders of our ordinary shares will have no general right under Cayman Islands law to inspect or obtain copies of our list of shareholders or our corporate records. However, we will provide our shareholders with annual audited financial statements. See “Item 10. Additional Information—H. Documents on Display.”

Differences in Corporate Law

The Companies Law of the Cayman Islands is modeled after that of the United Kingdom but does not follow recent United Kingdom statutory enactments. In addition, the Companies Law differs from laws applicable to United States corporations and their shareholders. Set forth below is a summary of the significant differences between the provisions of the Companies Law applicable to us and the laws applicable to companies incorporated in the United States and their shareholders.

Directors’ Fiduciary Duties

Under Delaware corporate law, a director of a Delaware corporation has a fiduciary duty to the corporation and its shareholders. This duty has two components: the duty of care and the duty of loyalty. The duty of care requires that a director act in good faith, with the care that an ordinarily prudent person would exercise under similar circumstances. Under this duty, a director must inform himself of, and disclose to shareholders, all material information reasonably available regarding a significant transaction. The duty of loyalty requires that a director act in a manner he reasonably believes to be in the best interests of the corporation. He must not use his corporate position for personal gain or advantage. This duty prohibits self-dealing by a director and mandates that the best interest of the corporation and its shareholders take precedence over any interest possessed by a director, officer or controlling shareholder and not shared by the shareholders generally. In general, actions of a director are presumed to have been made on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the corporation. However, this presumption may be rebutted by evidence of a breach of one of the fiduciary duties. Should such evidence be presented concerning a transaction by a director, a director must prove the procedural fairness of the transaction, and that the transaction was of fair value to the corporation.

As a matter of Cayman Islands law, a director of a Cayman Islands company is in the position of a fiduciary with respect to the company and therefore it is considered that he owes the following duties to the company—a duty to act bona fide in the best interests of the company, a duty not to make a profit out of his position as director (unless the company permits him to do so) and a duty not to put himself in a position where the interests of the company conflict with his personal interest or his duty to a third-party. A director of a Cayman Islands company owes to the company a duty to act with skill and care. It was previously considered that a director need not exhibit in the performance of his duties a greater degree of skill than may reasonably be expected from a person of his knowledge and experience. However, English and Commonwealth courts have moved towards an objective standard with regard to the required skill and care and these authorities are likely to be followed in the Cayman Islands.

Shareholder Action by Written Consent

Under the Delaware General Corporation Law, a corporation may eliminate the right of shareholders to act by written consent by amendment to its certificate of incorporation.

Cayman Islands law and our amended and restated articles of association provide that shareholders may approve corporate matters by way of a unanimous written resolution signed by or on behalf of each shareholder who would have been entitled to vote on such matter at a general meeting without a meeting being held.

Shareholder Proposals

Under the Delaware General Corporation Law, a shareholder has the right to put any proposal before the annual meeting of shareholders, provided it complies with the notice provisions in the corporate charter documents. A special meeting may be called by the board of directors or any other person authorized to do so in the governing documents, but shareholders may be precluded from calling special meetings.

Cayman Islands law and our amended and restated articles of association allow our shareholders holding not less than one third of our paid up voting share capital to requisition a shareholder’s meeting. As an exempted Cayman Islands company, we are not obliged by law to call shareholders’ annual general meetings. However, applicable Nasdaq corporate governance rules require us to hold annual shareholder meetings.

Removal of Directors

Under the Delaware General Corporation Law, a director of a corporation may be removed only for cause with the approval of a majority of the outstanding shares entitled to vote, unless the certificate of incorporation provides otherwise.

Under our amended and restated articles of association, directors can be removed by passing of a special resolution of our shareholders.

Transactions with Interested Shareholders

The Delaware General Corporation Law contains a business combination statute applicable to Delaware public corporations whereby, unless the corporation has specifically elected not to be governed by such statute by amendment to its certificate of incorporation, it is prohibited from engaging in certain business combinations with an “interested shareholder” for three years following the date that such person becomes an interested shareholder. An interested shareholder generally is a person or group who or which owns or owned 15% or more of the target’s outstanding voting stock within the past three years. This has the effect of limiting the ability of a potential acquirer to make a two-tiered bid for the target in which all shareholders would not be treated equally. The statute does not apply if, among other things, prior to the date on which such shareholder becomes an interested shareholder, the board of directors approves either the business combination or the transaction which resulted in the person becoming an interested shareholder. This encourages any potential acquirer of a Delaware public corporation to negotiate the terms of any acquisition transaction with the target’s board of directors.

Cayman Islands law has no comparable statute. As a result, we cannot avail ourselves of the types of protections afforded by the Delaware business combination statute. However, although Cayman Islands law does not regulate transactions between a company and its significant shareholders, it does provide that such transactions must be entered into bona fide in the best interests of the company and not with the effect of constituting a fraud on the minority shareholders.

Amendment of Governing Documents

Under the Delaware General Corporation Law, a corporation’s governing documents may be amended with the approval of a majority of the outstanding shares entitled to vote, unless the certificate of incorporation provides otherwise.

As permitted by Cayman Islands law, our amended and restated memorandum and articles of association may be amended with passing of a special resolution of our shareholders.

Indemnification of Directors and Officers and Limitation of Liability

Cayman Islands law does not limit the extent to which a company’s articles of association may provide for indemnification of officers and directors, except to the extent any such provision may be held by the Cayman Islands courts to be contrary to public policy, such as to provide indemnification against civil fraud or the consequences of committing a crime. Our amended and restated memorandum and articles of association permit indemnification of officers and directors for losses, damages, costs and expenses incurred in their capacities as such unless such losses or damages arise from the willful neglect or default of such directors or officers. This standard of conduct is generally the same as permitted under the Delaware General Corporation Law to a Delaware corporation. In addition, we intend to enter into indemnification agreements with our directors and senior executive officers that will provide such persons with additional indemnification beyond that provided in our amended and restated memorandum and articles of association.

Insofar as indemnification for liabilities arising under the Securities Act may be permitted to our directors, officers or persons controlling us under the foregoing provisions, we have been informed that in the opinion of the SEC such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable as a matter of United States law.

Inspection of Books and Records

Unlike Delaware law, holders of our ordinary shares will have no general right under Cayman Islands law to inspect or obtain copies of our list of shareholders or corporate records. However, we will provide our shareholders with annual audited consolidated financial statements.

Mergers and Similar Arrangements

The Companies Law permits mergers and consolidations between Cayman Islands companies and between Cayman Islands companies and non-Cayman Islands companies. For these purposes, (a) “merger” means the merging of two or more constituent companies and the vesting of their undertaking, property and liabilities in one of such companies as the surviving company and (b) a “consolidation” means the combination of two or more constituent companies into a consolidated company and the vesting of the undertaking, property and liabilities of such companies to the consolidated company. In order to effect such a merger or consolidation, the directors of each constituent company must approve a written plan of merger or consolidation (a “Plan”), which must then be authorised by either (a) a special resolution of the shareholders of each constituent company voting together as one class if the shares to be issued to each shareholder in the consolidated or surviving company will have the same rights and economic value as the shares held in the relevant constituent company or (b) a shareholder resolution of each constituent company passed by a majority in number representing 75% in value of the shareholders voting together as one class. The Plan must be filed with the Registrar of Companies together with a declaration as to the solvency of the consolidated or surviving company, a list of the assets and liabilities of each constituent company and an undertaking that a copy of the certificate of merger or consolidation will be given to the members and creditors of each constituent company and published in the Cayman Islands Gazette. Dissenting shareholders have the right to be paid the fair value of their shares (which, if not agreed between the parties, will be determined by the Cayman Islands court) if they follow the required procedures, subject to certain exceptions. Court approval is not required for a merger or consolidation which is effected in compliance with these statutory procedures.

In addition, there are statutory provisions that facilitate the reconstruction and amalgamation of companies, provided that the arrangement is approved by a majority in number of each class of shareholders and creditors with whom the arrangement is to be made, and who must in addition represent three-fourths in value of each such class of shareholders or creditors, as the case may be, that are present and voting either in person or by proxy at a meeting, or meetings, convened for that purpose. The convening of the meetings and subsequently the arrangement must be sanctioned by the Grand Court of the Cayman Islands. While a dissenting shareholder has the right to express to the court the view that the transaction ought not to be approved, the court can be expected to approve the arrangement if it determines that:

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the statutory provisions as to majority vote have been met;

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the shareholders have been fairly represented at the meeting in question;

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the arrangement is such that a businessman would reasonably approve; and

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the arrangement is not one that would more properly be sanctioned under some other provision of the Companies Law.

When a take-over offer is made and accepted by holders of 90.0% of the shares within four months, the offerer may, within a two month period, require the holders of the remaining shares to transfer such shares on the terms of the offer. An objection can be made to the Grand Court of the Cayman Islands but this is unlikely to succeed unless there is evidence of fraud, bad faith or collusion.

If the arrangement and reconstruction is thus approved, the dissenting shareholder would have no rights comparable to appraisal rights, which would otherwise ordinarily be available to dissenting shareholders of United States corporations, providing rights to receive payment in cash for the judicially determined value of the shares.

Shareholders’ Suits

The Cayman Islands courts can be expected to follow English case law precedents. The common law principles (namely the rule in Foss v. Harbottle and the exceptions thereto) which permit a minority shareholder to commence a class action against or derivative actions in the name of a Cayman Islands company to challenge (a) an act which is ultra vires or illegal, (b) an act which constitutes a fraud against the minority where the wrongdoers are themselves in control of the company, and (c) an action which requires a resolution with a qualified (or special) majority which has not been obtained) have been applied and followed by the courts in the Cayman Islands.

Demand Registration Rights

At any time commencing 12 months after our initial public offering, General Atlantic had the right to demand that we file a registration statement under the Securities Act covering the offer and sale of their securities, except other than pursuant to a registration statement on Form F-4, S-4 or S-8, so long as the aggregate amount of securities to be sold under the registration statement exceeds $5.0 million. However, we are not obligated to effect any such demand registration if we have, within the six month period preceding the demand, already effected a registration under the Securities Act or if General Atlantic had an opportunity to be included in a registration pursuant to their piggyback registration rights. We have the ability to delay or withdraw the filing of a registration statement for up to 90 days if our board of directors determines there is a valid business reason to delay such filing. We are not obligated to effect such demand registrations on more than two occasions.

Form F-3 Registration Rights

Upon our company becoming eligible for use of Form F-3 or S-3, General Atlantic has the right to request we file a registration statement under Form F-3 or S-3. Such requests for registrations are not counted as demand registrations.

Piggyback Registration Rights

If, at any time after our initial public offering, we propose to file a registration statement with respect to an offering for our own account, we must offer General Atlantic the opportunity to include their securities in the registration statement, other than pursuant to a registration statement on Form F-4, S-4 or S-8. We must use our reasonable best efforts to cause the underwriters in any underwritten offering to permit any such shareholder who so requests to include their securities on the same terms and conditions as the securities of our company.

Expenses of Registration

We will pay all expenses relating to any demand or piggyback registration, whether or not such registrations become effective, except that shareholders shall bear the expense of any broker’s commission or underwriter’s discount or commission relating to registration and sale of their securities, and shall bear the fees and expenses of their own counsel.

C.	Material Contracts

We have not entered into any material contracts other than in the ordinary course of business and other than those described in “Item 4. Information on the Company” or elsewhere in this annual report on Form 20-F.

D.	Exchange Controls

Foreign exchange regulation in China is primarily governed by the following rules:

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Foreign Currency Administration Rules (1996), as amended, or the Exchange Rules; and

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Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996), or the Administration Rules.

Taxation

Cayman Islands Taxation

According to Maples and Calder, our Cayman Islands counsel, the Cayman Islands currently levies no taxes on individuals or corporations based upon profits, income, gains or appreciation and there is no taxation in the nature of inheritance tax or estate duty. No Cayman Islands stamp duty will be payable unless an instrument is executed in, or brought within the jurisdiction of the Cayman Islands, or produced before a court of the Cayman Islands. The Cayman Islands is not party to any double tax treaties. There are no exchange control regulations or currency restrictions in the Cayman Islands.

United States Federal Income Taxation

The following discussion describes the material U.S. federal income tax consequences to U.S. Holders (as defined below) under present law of an investment in the ADSs or ordinary shares. This discussion applies only to U.S. Holders that hold the ADSs or ordinary shares as capital assets (generally, property held for investment) and that have the U.S. dollar as their functional currency. This discussion is based on the tax laws of the United States in effect as of the date of this annual report on Form 20-F and on U.S. Treasury regulations in effect or, in some cases, proposed, as of the date of this annual report on Form 20-F, as well as judicial and administrative interpretations thereof available on or before such date. All of the foregoing authorities are subject to change, which change could apply retroactively and could affect the tax consequences described below.

The following discussion does not deal with the tax consequences to any particular investor or to persons in special tax situations such as:

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banks;

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insurance companies;

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regulated investment companies;

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real estate investment trusts;

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broker-dealers;

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traders that elect to mark to market;

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tax-exempt entities;

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persons liable for alternative minimum tax;

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U.S. expatriates;

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Tax-exempt entities;

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Persons liable for alternative minimum tax;

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persons holding an ADS or ordinary share as part of a straddle, hedging, conversion or integrated transaction;

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persons that actually or constructively own 10% or more of the total combined voting power of all classes of our voting stock;

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partnerships or other pass-through entities, or persons holding ADSs or ordinary shares through such entities; or

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persons who acquired ADSs or ordinary shares pursuant to the exercise of any employee share option or otherwise as compensation.

Investors are urged to consult their tax advisors about the application of the U.S. federal tax rules to their particular circumstances as well as the state, local, foreign and other tax consequences to them of the purchase, ownership and disposition of ADSs or ordinary shares.

The discussion below of the U.S. federal income tax consequences to “U.S. Holders” will apply to you if you are a beneficial owner of ADSs or ordinary shares and you are, for U.S. federal income tax purposes,

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an individual who is a citizen or resident of the United States;

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a corporation (or other entity taxable as a corporation for U.S. federal income tax purposes) created or organized in the United States or under the laws of the United States, any State thereof or the District of Columbia;

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an estate, the income of which is subject to U.S. federal income taxation regardless of its source; or

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a trust that (1) is subject to the primary supervision of a court within the United States and the control of one or more U.S. persons for all substantial decisions or (2) has a valid election in effect under applicable U.S. Treasury regulations to be treated as a U.S. person.

If a partnership (or other entity taxable as a partnership for U.S. federal income tax purposes) is a beneficial owner of our ADSs or ordinary shares, the tax treatment of a partner in such partnership will depend on the status of such partner and the activities of such partnership.

The discussion below assumes that the representations contained in the deposit agreement are true and that the obligations in the deposit agreement and any related agreement have been and will be complied with in accordance with their terms. If you hold ADSs, you should be treated as the holder of the underlying ordinary shares represented by those ADSs for U.S. federal income tax purposes.

The U.S. Treasury has expressed concerns that intermediaries in the chain of ownership between the holder of an ADS and the issuer of the security underlying the ADS may be taking actions that are inconsistent with the beneficial ownership of the underlying security (for example, pre-releasing ADSs to persons that do not have the beneficial ownership of the securities underlying the ADSs). Accordingly, the availability of the reduced tax rate for dividends received by certain non-corporate U.S. Holders, including individual U.S. Holders (as discussed below), could be affected by actions taken by intermediaries in the chain of ownership between the holders of ADSs and our company if as a result of such actions the holders of ADSs are not properly treated as beneficial owners of underlying ordinary shares.

Passive Foreign Investment Company

Based on the market price of our ADSs and the value and composition of our assets, we believe we were a passive foreign investment company (“PFIC”) for U.S. federal income tax purposes for the taxable year ended December 31, 2009. A non-U.S. corporation will be a PFIC for any taxable year if either:

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at least 75% of its gross income for such year is passive income; or

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at least 50% of the value of its assets (based on an average of the quarterly values of the assets) during such year is attributable to assets that produce passive income or are held for the production of passive income (the “asset test”).

We will be treated as owning our proportionate share of the assets and earning our proportionate share of the income of any other corporation in which we own, directly or indirectly, at least 25% (by value) of the stock. In applying this rule, however, it is not clear whether the contractual arrangements between us and our affiliated entity will be treated as ownership of stock.

We must make a separate determination after the close of each taxable year as to whether we were a PFIC for that year. Because the value of our assets for purposes of the asset test will generally be determined by reference to the market price of our ADSs or ordinary shares, our PFIC status will depend in large part on the market price of the ADSs or ordinary shares, which may fluctuate significantly. Based on the market price of our ADSs and our retention of a significant amount of cash and other passive assets during the taxable year ended December 31, 2009, we believe we were a PFIC for such year. In addition, we believe there is a significant risk that we will be a PFIC for the taxable year ending December 31, 2010 and for future taxable years, unless the market price of our ADSs increases or we reduce the amount of cash and other passive assets we hold sufficiently from current levels.

If we are a PFIC for any taxable year during which you hold ADSs or ordinary shares, we will continue to be treated as a PFIC with respect to you for all succeeding years during which you hold ADSs or ordinary shares, unless we cease to be a PFIC and you make a “deemed sale” election with respect to the ADSs or ordinary shares, as applicable. If such election is made, you will be deemed to have sold the ADSs or ordinary shares you hold at their fair market value and any gain from such deemed sale would be subject to the rules described in the following two paragraphs. After the deemed sale election, so long as we do not become a PFIC in a subsequent taxable year, your ADSs or ordinary shares with respect to which such election was made will not be treated as shares in a PFIC and you will not be subject to the rules described below with respect to any “excess distribution” you receive from us or any gain from an actual sale or other disposition of the ADSs or ordinary shares. You are strongly urged to consult your tax advisors as to the possibility and consequences of making a deemed sale election if we cease to be a PFIC and such election becomes available to you.

For each taxable year that we are treated as a PFIC with respect to you, you will be subject to special tax rules with respect to any “excess distribution” you receive and any gain you recognize from a sale or other disposition (including a pledge) of the ADSs or ordinary shares, unless you make a “mark-to-market” election as discussed below. Distributions you receive in a taxable year that are greater than 125% of the average annual distributions you received during the shorter of the three preceding taxable years or your holding period for the ADSs or ordinary shares will be treated as an excess distribution. Under these special tax rules, if you receive any excess distribution or recognize any gain from a sale or other disposition of the ADSs or ordinary shares:

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the excess distribution or recognized gain will be allocated ratably over your holding period for the ADSs or ordinary shares;

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the amount allocated to the current taxable year, and any taxable years in your holding period prior to the first taxable year in which we became a PFIC, will be treated as ordinary income; and

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the amount allocated to each other taxable year will be subject to tax at the highest tax rate in effect for individuals or corporations, as applicable, for each such year, and the interest charge generally applicable to underpayments of tax will be imposed on the resulting tax attributable to each such year.

The tax liability for amounts allocated to taxable years prior to the year of disposition or excess distribution cannot be offset by any net operating losses for such years, and gains (but not losses) from the sale or other disposition of the ADSs or ordinary shares cannot be treated as capital, even if you hold the ADSs or ordinary shares as capital assets.

If we are treated as a PFIC with respect to you for any taxable year, to the extent any of our subsidiaries are also PFICs or we make direct or indirect equity investments in other entities that are PFICs, you will be deemed to own shares in such lower-tier PFICs that are directly or indirectly owned by us in that proportion that the value of the ADSs or ordinary shares you own bears to the value of all of our ADSs or ordinary shares, and you may be subject to the rules described in the preceding two paragraphs with respect to the shares of such lower-tier PFICs that you would be deemed to own. It is likely that one or more of our subsidiaries were PFICs for the taxable year ended December 31, 2009. You should consult your tax advisors regarding the application of the PFIC rules to any of our subsidiaries.

A U.S. Holder of “marketable stock” (as defined below) of a PFIC may make a mark-to-market election for such stock to elect out of the PFIC rules described above regarding excess distributions and recognized gains. If you make a mark-to-market election for the ADSs or ordinary shares, you will include in income for each year that we are a PFIC an amount equal to the excess, if any, of the fair market value of the ADSs or ordinary shares as of the close of your taxable year over your adjusted basis in such ADSs or ordinary shares. You will be allowed a deduction for the excess, if any, of the adjusted basis of the ADSs or ordinary shares over their fair market value as of the close of the taxable year. However, deductions will be allowable only to the extent of any net mark-to-market gains on the ADSs or ordinary shares included in your income for prior taxable years. Amounts included in your income under a mark-to-market election, as well as gain on the actual sale or other disposition of the ADSs or ordinary shares, will be treated as ordinary income. Ordinary loss treatment will apply to the deductible portion of any mark-to-market loss on the ADSs or ordinary shares, as well as to any loss from the actual sale or other disposition of the ADSs or ordinary shares, to the extent that the amount of such loss does not exceed the net mark-to-market gains previously included for such ADSs or ordinary shares. Your basis in the ADSs or ordinary shares will be adjusted to reflect any such income or loss amounts. If you make a mark-to-market election, the tax rules that apply to distributions by corporations that are not PFICs would apply to distributions by us, except that the lower capital gains rate applicable to qualified dividend income (discussed below in “—Taxation of Dividends and Other Distributions on the ADSs or Ordinary Shares”) would not apply.

The mark-to-market election is available only for “marketable stock,” which is stock that is traded in greater than de minimis quantities on at least 15 days during each calendar quarter (“regularly traded”) on a qualified exchange or other market, as defined in applicable U.S. Treasury regulations. The ADSs are currently listed on the NASDAQ Global Market, which is a qualified exchange or other market for these purposes. Consequently, if the ADSs remain listed on the NASDAQ Global Market and are regularly traded, and you are a holder of ADSs, we expect the mark-to-market election would be available to you if we are a PFIC (as we believe we were for 2009). Because a mark-to-market election cannot be made for equity interests in any lower-tier PFICs that we own, a U.S. Holder may continue to be subject to the PFIC rules described above regarding excess distributions and recognized gains with respect to its indirect interest in any investments held by us that are treated as an equity interest in a PFIC for U.S. federal income tax purposes. You should consult your tax advisors as to the availability and desirability of a mark-to-market election, as well as the impact of such election on interests in any lower-tier PFICs.

Alternatively, a U.S. Holder of stock in a PFIC may make a “qualified electing fund” election with respect to such corporation to elect out of the PFIC rules described above regarding excess distributions and recognized gains. A U.S. Holder that makes a qualified electing fund election with respect to a PFIC will generally include in income such holder’s pro rata share of the corporation’s income on a current basis. However, you may make a qualified electing fund election with respect to your ADSs or ordinary shares only if we furnish you annually with certain tax information, and we currently do not intend to prepare or provide such information.

Under newly enacted legislation, unless otherwise provided by the U.S. Treasury, each U.S. shareholder of a PFIC is required to file an annual report containing such information as the U.S. Treasury may require. Prior to such legislation, a U.S. shareholder of a PFIC was required to file Internal Revenue Service Form 8621 only for each taxable year in which such shareholder received distributions from the PFIC, recognized gain on a disposition of the PFIC stock, or made a “reportable election.” If we are a PFIC (as we believe we were for 2009), you should consult your tax advisors regarding any reporting requirements that may apply to you.

YOU ARE STRONGLY URGED TO CONSULT YOUR TAX ADVISORS REGARDING THE IMPACT OF OUR BEING A PFIC FOR 2009 ON YOUR INVESTMENT IN OUR ADSs AND ORDINARY SHARES AS WELL AS THE APPLICATION OF THE PFIC RULES AND THE POSSIBILITY OF MAKING A MARK-TO-MARKET ELECTION.

Taxation of Dividends and Other Distributions on the ADSs or Ordinary Shares

Subject to the PFIC rules discussed above, the gross amount of any distributions we make to you with respect to the ADSs or ordinary shares will be includible in your gross income as dividend income on the date of receipt by the depositary, in the case of ADSs, or by you, in the case of ordinary shares, but only to the extent that the distribution is paid out of our current or accumulated earnings and profits (as determined under U.S. federal income tax principles). To the extent that the amount of the distribution exceeds our current and accumulated earnings and profits, such excess amount will be treated first as a tax-free return of your tax basis in your ADSs or ordinary shares, and then, to the extent that such excess amount exceeds your tax basis, as capital gain. We currently do not, and we do not intend to, calculate our earnings and profits under U.S. federal income tax principles. Therefore, a U.S. Holder should expect that any distribution we make will be reported as a dividend even if that distribution would otherwise be treated as a non-taxable return of capital or as capital gain under the rules described above. Any dividends we pay to you will not be eligible for the dividends-received deduction allowed to corporations in respect of dividends received from other U.S. corporations.

With respect to certain non-corporate U.S. Holders, including individual U.S. Holders, for taxable years beginning before January 1, 2011, dividends will be taxed at the lower capital gains rate applicable to “qualified dividend income,” provided that (1) the ADSs or ordinary shares, as applicable, are readily tradable on an established securities market in the United States, or we are eligible for the benefits of a qualifying income tax treaty with the United States that includes an exchange of information program, (2) we are neither a PFIC nor treated as such with respect to you for the taxable year in which the dividend was paid and the preceding taxable year, and (3) certain holding period requirements are met. Under published Internal Revenue Service authority, common or ordinary shares, or ADSs representing such shares, are considered for the purpose of clause (1) above to be readily tradable on an established securities market in the United States if they are listed on the NASDAQ Global Market, as are our ADSs (but not our ordinary shares). If we are treated as a “resident enterprise” for PRC tax purposes under the New EIT Law (see “Item 3. Key Information—D. Risk Factors—Risks Related To Doing Business in China—Our business benefits from certain tax incentives and government grants. Expiration or elimination of, or other adverse changes to, these tax incentives or reductions of these grants could have a material adverse effect on our results of operations”), we may be eligible for the benefits of the income tax treaty between the United States and the PRC. As discussed above in “—Passive Foreign Investment Company,” we believe that we were a PFIC for the taxable year ended December 31, 2009, and that there is a significant risk we will be a PFIC for the taxable year ending December 31, 2010 and for future taxable years. You should consult your tax advisors regarding the availability of the lower capital gains rate applicable to qualified dividend income for any dividends paid with respect to our ADSs or ordinary shares.

Newly enacted legislation requires certain U.S. Holders that are individuals, estates or trusts to pay an additional 3.8% tax on, among other things, dividends on the ADSs or ordinary shares for taxable years beginning after December 31, 2012. You should consult your tax advisors regarding the effect, if any, of this legislation on an investment in the ADSs or ordinary shares.

Dividends will constitute foreign source income for foreign tax credit limitation purposes. If the dividends are taxed as qualified dividend income (as discussed above), the amount of the dividend taken into account for purposes of calculating the foreign tax credit limitation will be limited to the gross amount of the dividend, multiplied by the reduced tax rate applicable to qualified dividend income and divided by the highest tax rate normally applicable to dividends. The limitation on foreign taxes eligible for credit is calculated separately with respect to specific classes of income. For this purpose, dividends distributed by us with respect to the ADSs or ordinary shares will generally constitute “passive category income” but could, in the case of certain U.S. Holders, constitute “general category income.”

If PRC withholding taxes apply to dividends paid to you with respect to our ADSs or ordinary shares (see “Item 3. Key Information—D. Risk Factors—Risks Related To Doing Business in China—Foreign holders of our ADSs or ordinary shares may be subject to PRC withholding tax on dividends payable by us and on gains realized on the sale of our ADSs or ordinary shares, if we are classified as a PRC ‘resident enterprise’”), subject to certain conditions and limitations, such PRC withholding taxes may be treated as foreign taxes eligible for credit against your U.S. federal income tax liability. The rules relating to the determination of the foreign tax credit are complex, and you should consult your tax advisors regarding the availability of a foreign tax credit in your particular circumstances.

Taxation of Disposition of the ADSs or Ordinary Shares

Subject to the PFIC rules discussed above, you will recognize taxable gain or loss on any sale, exchange or other taxable disposition of an ADS or ordinary share equal to the difference between the amount realized (in U.S. dollars) for the ADS or ordinary share and your tax basis (in U.S. dollars) in the ADS or ordinary share. The gain or loss will be capital gain or loss. If you are a non-corporate U.S. Holder, including an individual U.S. Holder, who has held the ADS or ordinary share for more than one year, you will be eligible for reduced tax rates. The deductibility of capital losses is subject to limitations.

Newly enacted legislation requires certain U.S. Holders that are individuals, estates or trusts to pay an additional 3.8% tax on, among other things, capital gains from the sale or other disposition of the ADSs or ordinary shares for taxable years beginning after December 31, 2012. You should consult your tax advisors regarding the effect, if any, of this legislation on an investment in the ADSs or ordinary shares.

Any gain or loss you recognize on a disposition of ADSs or ordinary shares will generally be treated as U.S. source income or loss for foreign tax credit limitation purposes, subject to exceptions and limitations. However, if we are treated as a “resident enterprise” for PRC tax purposes under the New EIT Law, we may be eligible for the benefits of the income tax treaty between the United States and the PRC. In such event, if PRC withholding tax were to be imposed on any gain from the disposition of the ADSs or ordinary shares (see “Item 3. Key Information—D. Risk Factors—Risks Related To Doing Business in China—Foreign holders of our ADSs or ordinary shares may be subject to PRC withholding tax on dividends payable by us and on gains realized on the sale of our ADSs or ordinary shares, if we are classified as a PRC ‘resident enterprise’”), a U.S. Holder that is eligible for the benefits of the treaty may elect to treat such gain as PRC source income. You should consult your tax advisors regarding the proper treatment of gain or loss in your particular circumstances.

Information Reporting and Backup Withholding

Dividend payments with respect to ADSs or ordinary shares and proceeds from the sale, exchange or redemption of ADSs or ordinary shares will generally be subject to information reporting to the Internal Revenue Service and possible U.S. backup withholding at a current rate of 28%. Backup withholding will not apply, however, to a U.S. Holder that furnishes a correct taxpayer identification number and makes any other required certification or that is otherwise exempt from backup withholding. U.S. Holders that are required to establish their exempt status must provide such certification on Internal Revenue Service Form W-9. Under newly enacted legislation, for taxable years beginning after March 18, 2010, certain individuals holding ADSs or ordinary shares other than in an account at a financial institution may be subject to additional information reporting requirements. U.S. Holders should consult their tax advisors regarding the application of the U.S. information reporting and backup withholding rules.

Backup withholding is not an additional tax. Amounts withheld as backup withholding may be credited against your U.S. federal income tax liability, and you may obtain a refund of any excess amounts withheld under the backup withholding rules by filing an appropriate claim for refund with the Internal Revenue Service and furnishing any required information in a timely manner.

F.	Dividends and Paying Agents

Not applicable.

G.	Statement by Experts

Not applicable.

H.	Documents on Display

We have previously filed with the Commission our registration statement on Form F-1, as amended and annual report on Form 20-F under the Securities Act, with respect to our ordinary shares.

We are subject to the periodic reporting and other informational requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Under the Exchange Act, we are required to file reports and other information with the Securities and Exchange Commission. Specifically, we are required to file annually a Form 20-F no later than six months after the close of each fiscal year, which is December 31. Copies of reports and other information, when so filed, may be inspected without charge and may be obtained at prescribed rates at the public reference facilities maintained by the Securities and Exchange Commission at 100 F. Street, N.E., Washington, D.C. 20549, and at the regional office of the Securities and Exchange Commission located at Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. The public may obtain information regarding the Washington, D.C. Public Reference Room by calling the Commission at 1-800-SEC-0330. The SEC also maintains a Web site at www.sec.gov that contains reports, proxy and information statements, and other information regarding registrants that make electronic filings with the SEC using its EDGAR system. As a foreign private issuer, we are exempt from the rules under the Exchange Act prescribing the furnishing and content of quarterly reports and proxy statements, and officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions contained in Section 16 of the Exchange Act.

Our financial statements have been prepared in accordance with U.S. GAAP.

We will furnish our shareholders with annual reports, which will include a review of operations and annual audited consolidated financial statements prepared in conformity with U.S. GAAP.

I.	Subsidiary Information

For a listing of our subsidiaries, see “Item 4. Information on the Company—C. Organizational Structure.”

I TEM 11.

Q UANTITATIVE AND Q UALITATIVE D ISCLOSURES A BOUT M ARKET R ISK

Interest Rate Risk

Our exposure to interest rate risk primarily relates to the interest income generated by excess cash invested in demand and time deposits. We have not historically used and do not expect to use in the foreseeable future, any derivative financial instruments to manage our interest risk exposure. Interest-earning instruments carry a degree of interest rate risk. We may be exposed to material risks due to changes in interest rates depending on our capital needs.

Foreign Exchange Risk

A portion of our revenue and most of our operating expenses are denominated in RMB, while most of our revenue, cost of revenue and non-operating expenses are denominated in U.S. dollars and Hong Kong dollars, which are pegged to the U.S. dollar. We use the U.S. dollar as the reporting currency for our financial statements. Fluctuations in exchange rates, primarily those involving the U.S. dollar, may affect our costs and operating margins as well as our net income and comprehensive income reported in U.S. dollars. For example, to the extent that we need to convert U.S. dollars we receive from our initial public offering into RMB for our operations, appreciation of the RMB against the U.S. dollar would have an adverse effect on the RMB amount we receive from the conversion.

Assuming we had converted the U.S. dollar and HK dollar denominated cash balance equivalent to $38.7 million as of December 31, 2009 into RMB at the exchange rate of $1.00 for RMB6.8282 and HKD1.00 for RMB0.88048, the respective People’s Bank of China rates as of December 31, 2009, this cash balance would have been RMB264.6 million. Assuming a further 10% appreciation of the RMB against the U.S. dollar, this cash balance would have decreased to RMB238.1 million as of December 31, 2009. Conversely, if we decide to convert our RMB into U.S. dollars for the purpose of making payments for dividends on our ordinary shares or ADSs or for other business purposes, appreciation of the U.S. dollar against the RMB would have a negative effect on the U.S. dollar amount available to us. We have not used any forward contracts or currency borrowings to hedge our exposure to foreign currency exchange risk.

Inflation

Since our inception, inflation in China has not materially impacted on our results of operations. According to the National Bureau of Statistics of China, the change in the consumer price index in China was 4.8%, 5.9% and 0.7% in 2007, 2008 and 2009, respectively.

I TEM 12.

D ESCRIPTION OF S ECURITIES O THER THAN E QUITY S ECURITIES

A.	Debt Securities

Not applicable.

B.	Warrants and Rights

Not applicable.

C.	Other Securities

Not applicable.

D.	American Depository Shares

Fees and Charges Payable by ADS Holders

According to the deposit agreement, the depositary may charge each person to whom ADSs are issued against deposits of ordinary shares and each person surrendering ADSs for withdrawal of deposited securities, U.S. $5.00 for each 100 ADSs (or portion thereof) delivered or surrendered.

The following additional charges shall be incurred by the ADS holders, by any party depositing or withdrawing shares or any party surrendering ADRs or to whom ADRs are issued (including, without limitation, issuance pursuant to a stock dividend or stock split declared by our company, an exchange of stock regarding the ADRs or the deposited securities or a distribution of ADRs), whichever is applicable:

•

a fee of $1.50 per ADR or ADRs for transfers of certificated ADRs made pursuant to the deposit agreement;

•

a fee of $0.02 or less per ADS (or portion thereof) for any cash distribution made pursuant to the deposit agreement;

•

a fee of $0.02 per ADS (or portion thereof) per calendar year for services performed by the depositary in administering our ADR program, which shall be assessed against holders of our ADSs as of the record date or dates set by the depositary not more than once each calendar year and shall be payable at the sole discretion of the depositary by billing such holders or by deducting such charge from one or more cash distributions; provided that the fee assessed under this provision shall be reduced to the extent a cash dividend fee was charged in such calendar year pursuant to the above;

•

a fee for the distribution of the deposited securities, in an amount equal to the fee for the execution and delivery of ADSs which would have been charged as a result of the deposit of such securities but which securities or the net cash proceeds from the sale thereof are instead distributed by the depositary to those ADS holders entitled thereto;

•

stock transfer or other taxes and other governmental charges, payable by ADS holders or persons depositing ordinary shares;

•

cable, telex and facsimile transmission and delivery charges incurred at the request of persons depositing or delivering shares, ADRs or deposited securities;

•

transfer or registration fees for the registration or transfer of deposited securities on any applicable register in connection with the deposit or withdrawal of deposited securities, payable by persons depositing ordinary shares or ADS holders withdrawing deposited securities;

•

expenses of the depositary in connection with the conversion of foreign currency into U.S. dollars, which are paid out of such foreign currency;

•

such fees and expenses as are incurred by the depositary (including without limitation expenses incurred on behalf of the ADS holders in connection with compliance with foreign exchange control regulations or any law or regulation relating to foreign investment) in delivery of deposited securities or otherwise in connection with the depositary’s or its custodian’s compliance with applicable laws, rules or regulations; and

•

any other charge payable by any of the depositary, any of the depositary’s agents, including, without limitation, the custodian, or the agents of the depositary’s agents, in connection with the servicing of the ordinary shares or other deposited securities, which charge shall be assessed against ADS holders as of the record date or dates set by the depositary and shall be payable at the sole discretion of the depositary by billing such holders or by deducting such charge from one or more cash dividends or other cash distributions. Such charges may at any time and from time to time be changed by agreement between the depositary and us.

We will pay all other charges and expenses of the depositary and any agent of the depositary (except the custodian) pursuant to agreements from time to time between us and the depositary. The fees described above may be amended from time to time.

Fees Payable by the Depository to Us

The depositary has agreed to, subject to certain limits, reimburse us annually for bona fide and reasonable expenses incurred by us in connection with the ADS program, including legal fees, accountants’ fees in relation to our form 20-F filings investor relations and related presentations, ADR-related advertising and public relations in those jurisdictions in which the ADRs may be listed or otherwise quoted for trading. In 2009, we received from the depositary reimbursement of US$300,000 for certain reasonable expenses related to our ADS program.

The depositary has further agreed to waive any servicing fees in connection with our routine corporate actions, such us annual general meetings and dividend distributions. We agreed to reimburse the depositary for the out-of-pocket expenses incurred in connection with servicing routine or non-routine corporate actions and paying reasonable service fees for non-routine corporation actions, including but not limited to stock splits, depository receipt ratio changes and rights issues.

PART II

I TEM 13.

D EFAULTS , D IVIDEND A RREARAGES AND D ELINQUENCIES

None of these events occurred in any of the years ended December 31, 2007, 2008 and 2009.

I TEM 14.

M ATERIAL M ODIFICATIONS TO THE R IGHTS OF S ECURITY H OLDERS AND U SE OF P ROCEEDS

Shareholder Rights Plan

On December 12, 2008, our board of directors declared a dividend of one ordinary share purchase right, or a Right, for each of our ordinary shares outstanding at the close of business on December 22, 2008. As long as the Rights are attached to the ordinary shares, we will issue one Right (subject to adjustment) with each new ordinary share so that all such ordinary shares will have attached Rights. When exercisable, each Right will entitle the registered holder to purchase from us one ordinary share at a price of $5 per ordinary share, subject to adjustment.

The Rights will expire on December 12, 2018, subject to our right to extend such date and are exercisable only if a person or group obtains ownership of or announces a tender offer for 20% or more of our voting securities (including Vimicro’s ADSs representing ordinary shares). Upon exercise, all Rights holders except the potential acquirer will be entitled to acquire our shares or the acquirer’s shares at a discount. We are entitled to redeem the Rights in whole at any time on or before the acquisition by a person or group of 20% or more of our voting securities (which for these purposes include ADSs representing ordinary shares), or exchange the Rights, in whole or in part, at an exchange ratio of one ordinary share, and of other securities, cash or other assets deemed to have the same value as one ordinary share, per Right, subject to adjustment.

The Rights were not distributed in response to any specific effort to acquire control of our company.

We completed our initial public offering of 34,788,252 ordinary shares, in the form of ADSs, at $10 per ADS in November 2005, after our ordinary shares and American Depositary Receipts were registered under the Securities Act. The aggregate price of the offering amount registered and sold was $86,970,630, of which we received $62,775,000. The effective date of our registration statement on Form F-1 (File number: 333-12917) was November 14, 2005. Morgan Stanley was the global coordinator and book runner for the global offering of our ADSs.

We received net proceeds of $59.1 million from our initial public offering, which are expected to be used for general corporate purposes, including funding our working capital needs.

I TEM 15.

C ONTROLS AND P ROCEDURES

Disclosure Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer have performed an evaluation of our disclosure controls and procedures, as that term is defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. Based on their evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of December 31, 2009, our disclosure controls and procedures were effective in ensuring that the information required to be disclosed by us in the reports that we file and furnish under the Exchange Act was recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.

Management’s Annual Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15 and 15d-15 under the Exchange Act. Our management evaluated the effectiveness of our internal control over financial reporting based on criteria established in the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2009.

Because of its inherent limitations, any system of internal controls over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation of effectiveness of our internal control over financial reporting to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.

Our independent registered public accounting firm, Ernst & Young Hua Ming, has audited the effectiveness of our internal control over financial reporting as of December 31, 2009, as stated in its attestation report included below.

Changes in Internal Control

The financial reporting and disclosure risks could increase as we enter the security and surveillance sector. New internal control procedures were established according to characteristics and risks related to this new business segment. The Company will continue to develop an effective internal control system for our security and surveillance operations, as it continues to expand in scale and in scope. Aside from this, there have been no other significant changes in our internal control over financial reporting during the year ended December 31, 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders

Vimicro International Corporation

We have audited the internal control over financial reporting of Vimicro International Corporation (the “Company”) as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Vimicro International Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the accompanying consolidated balance sheets of Vimicro International Corporation as of December 31, 2009 and 2008, and the related consolidated statements of operations and comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009 of Vimicro International Corporation and our report dated May 12, 2010 expressed an unqualified opinion thereon.

/s/ Ernst & Young Hua Ming

Beijing, People’s Republic of China

May 12, 2010

I TEM 16A.

A UDIT C OMMITTEE F INANCIAL E XPERT

Our board of directors has determined that Donald Lucas qualifies as an “audit committee financial expert” as defined in Item 16A of Form 20-F. Each of the members of our audit committee is an “independent director” as defined in the NASDAQ Marketplace Rules.

I TEM 16B.

C ODE OF E THICS

Our board of directors has adopted a code of business conduct and ethics that applies to our directors, officers, employees and agents, including certain provisions that specifically apply to our chief executive officer, chief financial officer, chief operating officer, chief technology officer, vice presidents and any other persons who perform similar functions for us. A copy of the code is posted on our website at www.vimicro.com. We hereby undertake to provide to any person without charge, a copy of our code of business conduct and ethics within ten working days after we receive such person’s written request.

I TEM 16C.

P RINCIPAL A CCOUNTANT F EES AND S ERVICES

The following table sets forth the aggregate fees by categories specified below in connection with certain professional services rendered by our principal external auditor, Ernst & Young Hua Ming for the years ended December 31, 2008 and 2009. We did not pay any other fees to our auditors during the periods indicated below other than as disclosed below.


	For the Year Ended December 31,
	2008	2009
	(in $ thousands)

Audit fees ⁽¹⁾	990	996
Audit-related fees ⁽²⁾	0	0
Tax fees ⁽³⁾	11	0

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

(2)

“Audit-related fees” means the aggregate fees billed in each of the fiscal years listed for assurance and related services by our principal auditors that are reasonably related to the performance of the audit or review of our financial statements and are not reported under “Audit fees.” Services comprising the fees disclosed, under the category of “Audit-related fees” involve principally the issue of comfort letter and rendering of listing advice, internal control advisory services rendered in connection with Section 404 of the Sarbanes-Oxley Act of 2002, additional procedures during audit committee investigation, and other audit-related services.

(3)	“Tax fees” include fees billed for tax compliance services, including the preparation of tax returns and tax consultations, such as tax advice related to employee share-based compensation.

The policy of our audit committee is to pre-approve all audit and non-audit services provided by our principal external auditors, including audit services, audit-related services, tax services and other services as described above, other than those services which are approved by the Audit Committee prior to the completion of the audit.

I TEM 16D.

E XEMPTIONS FROM THE L ISTING S TANDARDS FOR A UDIT C OMMITTEES

Not applicable.

I TEM 16E.

P URCHASES OF E QUITY S ECURITIES BY THE I SSUER AND A FFILIATED P URCHASERS


Period	Total Number of ADSs Purchased [(1)]	Average Price Paid per ADS		Total Number of ADSs Purchased as Part of Publicly Announced Plans or Programs	Approximate Dollar Value of ADSs that May Yet Be Purchased Under the Program
September 1 through September 30, 2009	225,100	$	3.4300	1,081,700	22,569,329.68
October 1 through October 31, 2009	60,900	$	3.6756	1,142,600	22,345,485.64

Note:

(1)	Our ADS to ordinary share ratio is one ADS for every 4 ordinary shares.

I TEM 16F.

C HANGE IN R EGISTRANT ’ S C ERTIFYING A CCOUNTANT

Not applicable.

I TEM 16G.

C ORPORATE G OVERNANCE

In March 2008, our compensation committee repriced 10,072,100 of our outstanding share options by reducing their exercise prices based on the closing price on March 27, 2008 which was $0.70 per ordinary share. The rationale for the repricing is that our share options no longer provided a meaningful incentive to the option holders to remain in our employment, and that a repricing of the share options with a lower exercise price for our existing options would once again provide an incentive to the option holders to continue to provide services to us and to maximize shareholder value.

Other than the home country practice described above, we are not aware of any significant ways in which our corporate governance practices differ from those followed by U.S. domestic companies under the Nasdaq Market Rules.

PART III

I TEM 17.

F INANCIAL S TATEMENTS

We have elected to provide financial statements pursuant to Item 18.

I TEM 18.

F INANCIAL S TATEMENTS

The consolidated financial statements for Vimicro International Corporation and its subsidiaries are included at the end of this annual report.

I TEM 19.

E XHIBITS

EXHIBITS INDEX


Exhibit Number		Description of Document
1.1		Amended and Restated Memorandum and Articles of Association of Vimicro International Corporation (incorporated by reference to Exhibit 3.2 from the second amendment to our F-1 registration statement (File No. 333-129217), initially filed with the Commission on November 8, 2005)

2.1		Specimen Certificate for Ordinary Shares of Vimicro International Corporation (incorporated by reference to Exhibit 4.2 from our F-1 registration statement (File No. 333-129217), as amended, initially filed with the Commission on October 24, 2005)

2.2		Specimen American Depositary Receipt of Vimicro International Corporation (incorporated by reference to Exhibit 4.1 from our F-1 registration statement (File No. 333-129217), as amended, initially filed with the Commission on October 24, 2005)

2.3		Form of Deposit Agreement among Vimicro International Corporation, the depositary and holder of the American Depositary Receipts (incorporated by reference to Exhibit 4.3 from our F-1 registration statement (File No. 333-129217), as amended, initially filed with the Commission on October 24, 2005)

4.1		Form of Shareholding Transfer Agreement, dated as of March 17, 2004, among Vimicro International Corporation and other parties therein (incorporated by reference to Exhibit 4.4 from our F-1 registration statement (File No. 333-129217), as amended, initially filed with the Commission on October 24, 2005)

4.2		Reorganization and Subscription Agreement, dated as of March 17, 2004, among Vimicro International Corporation and other parties therein (incorporated by reference to Exhibit 4.5 from our F-1 registration statement (File No. 333-129217), as amended, initially filed with the Commission on October 24, 2005)

4.3		Shareholders Agreement, dated as of October 12, 2004, among the Registrant and other parties therein (incorporated by reference to Exhibit 4.6 from our F-1 registration statement (File No. 333-129217), as amended, initially filed with the Commission on October 24, 2005)

4.4		Registration Rights Agreement, dated as of October 12, 2004, among Vimicro International Corporation and other parties therein (incorporated by reference to Exhibit 4.7 from our F-1 registration statement (File No. 333-129217), as amended, initially filed with the Commission on October 24, 2005)


Exhibit Number		Description of Document
4.5		2004 Share Option Plan (incorporated by reference to Exhibit 10.1 from our F-1 registration statement (File No. 333-129217), as amended, initially filed with the Commission on October 24, 2005)

4.6		2005 Share Incentive Plan (incorporated by reference to Exhibit 10.2 from our F-1 registration statement (File No. 333-129217), as amended, initially filed with the Commission on October 24, 2005)

4.7		Form of Indemnification Agreement with the Registrant’s directors (incorporated by reference to Exhibit 10.3 from our F-1 registration statement (File No. 333-129217), as amended, initially filed with the Commission on October 24, 2005)

4.8		Form of Employment and Confidentiality Agreement between Vimicro International Corporation and senior executive officers of Vimicro International Corporation (incorporated by reference to Exhibit 10.4 from our F-1 registration statement (File No. 333-129217), as amended, initially filed with the Commission on October 24, 2005)

4.9		Cooperation Agreement, dated December 22, 2006, between Beijing Haidian Xinhua Agricultural Industrial & Commercial Co. and Vimicro Corporation (incorporated by reference to Exhibit 4.9 from our annual report filed on Form 20-F (File No. 000-51606), initially filed with the Commission on July 16, 2007)

4.10		Supplementary Agreement, dated April 18, 2007, between Beijing Haidian Xinhua Agricultural Industrial & Commercial Co. and Vimicro Corporation (incorporated by reference to Exhibit 4.10 from our annual report filed on Form 20-F (File No. 000-51606), initially filed with the Commission on July 16, 2007)

4.11		Contract for Transfer of the Use Right of the State-owned Land in Zhangjiang Semiconductor Industry Park, Shanghai, dated November 15, 2007, between Zhangjiang Semiconductor Industry Park Co., Ltd. and Vimicro High-Tech Corporation (incorporated by reference to Exhibit 4.11 from our annual report filed on Form 20-F (File No. 000-51606), initially filed with the Commission on June 17, 2008)

4.12		Investment & Cooperation Agreement, dated December 26, 2007, between Administrative Committee of Nanjing Xuzhuang Software Industry Base and Nanjing Xuanwu District Management and Investment of State-Owned Assets Holdings (Group) Co., Ltd. and Jiangsu Vimicro Electronics Corporation (incorporated by reference to Exhibit 4.12 from our annual report filed on Form 20-F (File No. 000-51606), initially filed with the Commission on June 17, 2008)

4.13		Amended and Restated 2005 Share Incentive Plan, dated December 11, 2008 (incorporated by reference to Exhibit 4.13 from our annual report filed on Form 20-F (File No. 000-51606), initially filed with the Commission on July 9, 2009)

4.14		Cooperative Agreement, dated September 24, 2008, among Tianjin Economic Technological Development Area Administrative Committee, Vimicro Corporation and Beijing Zhongxing Tianshi Investment Center (Limited Partnership) (incorporated by reference to Exhibit 4.14 from our annual report filed on Form 20-F (File No. 000-51606), initially filed with the Commission on July 9, 2009)

4.15		Shareholders Agreement regarding the arrangement of initial share, effective from December 29, 2008, between Vimicro Corporation and Beijing Zhongxing Tianshi Investment Center (Limited Partnership) (incorporated by reference to Exhibit 4.15 from our annual report filed on Form 20-F (File No. 000-51606), initially filed with the Commission on July 9, 2009)

4.16		Lock-up Agreements, dated June 30, 2009, between the Company and each of Mr. Zhonghan (John) Deng, Mr. Xiaodong (Dave) Yang, and Mr. Zhaowei (Kevin) Jin (incorporated by reference to Exhibit 4.16 from our annual report filed on Form 20-F (File No. 000-51606), initially filed with the Commission on July 9, 2009)

4.17		Agreement for the Transfer of Land Use Right of State-owned Construction Land, dated May 18, 2009, between Tianjin Economic-Technological Development Area (TEDA) Land Administration and Vimicro Electronics Corporation (incorporated by reference to Exhibit 4.17 from our annual report filed on Form 20-F (File No. 000-51606), initially filed with the Commission on July 9, 2009)

4.18		Supplementary Agreement Regarding the Investment & Cooperation Agreement, dated June 18, 2009, between Administrative Committee of Nanjing Xuzhuang Software Industry Base and Nanjing Xuanwu District Management and Investment of State-Owned Assets Holdings (Group) Co., Ltd. and Jiangsu Vimicro Electronics Corporation (incorporated by reference to Exhibit 4.18 from our annual report filed on Form 20-F (File No. 000-51606), initially filed with the Commission on July 9, 2009)


Exhibit Number		Description of Document
4.19		Shareholders Agreement regarding the grant of an exclusive right, dated June 30, 2009, between Vimicro Corporation and Beijing Zhongxing Tianshi Investment Center (Limited Partnership) (incorporated by reference to Exhibit 4.19 from our annual report filed on Form 20-F (File No. 000-51606), initially filed with the Commission on July 9, 2009)

4.20*		Investment Frame Agreement, dated January 4, 2010, among Vimicro China, Ningbo Sunny, Bin Sheng, Weiqi Sheng and Xuewu Zhou

4.21*		Supplementary Agreement regarding the direct transfer of land use right of state-owned construction land, dated June 18, 2009, among Vimicro Jiangsu, Nanjing SAMC and the Nanjing Municipal Bureau of Land Resources

4.22*		Agreement regarding the transfer of land use right of state-owned construction land, dated February 20, 2010, between Vimicro China and Beijing Municipality Bureau of Land Resources

4.23*		Agreements regarding the acquisition of ViSS business from ASB, dated August 28, 2009, between Vimicro Tianjin and ASB

8.1*		List of Subsidiaries

11.1		Code of Business Conduct and Ethics

12.1*		CEO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

12.2*		CFO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

13.1*		CEO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

13.2*		CFO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

15.1*		Consent of Maples and Calder

15.2*		Consent of Independent Registered Public Accounting Firm

*	Filed with this Annual Report on Form 20-F

SIGNATURES

The registrant hereby certifies that it meets all of the requirements for filing its annual report on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.


VIMICRO INTERNATIONAL CORPORATION

By:		/s/ Zhonghan (John) Deng
Name:		Zhonghan (John) Deng
Title:		Chairman and Chief Executive Officer

Date: May 12, 2010

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders

Vimicro International Corporation

We have audited the accompanying consolidated balance sheets of Vimicro International Corporation (the “Company”) as of December 31, 2009 and 2008, and the related consolidated statements of operations and comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Vimicro International Corporation at December 31, 2009 and 2008, and the consolidated results of its operations and comprehensive income and its cash flows for each of the three years in the period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Vimicro International Corporation’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated May 12, 2010 expressed an unqualified opinion thereon.

/s/ Ernst & Young Hua Ming

Beijing, People’s Republic of China

May 12, 2010

F-1

VIMICRO INTERNATIONAL CORPORATION

CONSOLIDATED BALANCE SHEETS

(Amounts expressed in thousands of U.S. dollars, except number of shares data)


		December 31
	Note	2008		2009
Assets

Current assets:
Cash and cash equivalents		58,215		84,510
Short-term time deposits	4	14,885		43,935
Restricted cash	5	73,157		132
Marketable equity securities	6	731		543
Accounts receivable, net of provision for doubtful accounts of $0 as of December 31, 2008 and 2009		7,131		9,462
Inventories	7	13,430		8,804
Prepayments and other current assets	8	2,431		4,155
Deferred tax assets	17(b)	2		3

Total current assets		169,982		151,544
Investment in unconsolidated affiliate	9	168		—
Property, equipment and software, net	10	8,736		9,015
Land use rights	11	7,365		10,905
Intangible assets, net	12	—		3,819
Goodwill	12	—		2,019
Other assets		947		973


Total assets		187,198		178,275


Liabilities and Shareholders’ Equity

Current liabilities:
Accounts payable		8,074		4,958
Taxes payable		1,345		879
Advances from customers		56		649
Accrued expenses and other current liabilities	13	4,870		5,900
Deferred government grant		—		3,844


Total current liabilities		14,345		16,230

Non-current liabilities:
Deferred tax liabilities	17(b)	31		196
Product warranty		—		25


Total liabilities		14,376		16,451


Commitments and contingencies	19

Shareholders’ equity:
Ordinary shares, $0.0001 par value, 500,000,000 shares authorized, 137,778,145 and 147,643,168 shares issued and outstanding as of December 31, 2008 and 2009, respectively	14	14		15
Additional paid-in capital		142,681		151,672
Treasury stock	14	(1,650	)	(2,664	)
Accumulated other comprehensive income		9,435		9,967
Accumulated deficit		(17,019	)	(35,786	)
Statutory reserve		2,782		2,782


Total shareholders equity attributable to Vimicro International Corporation		136,243		125,986

Non-controlling interest		36,579		35,838


Total shareholders’ equity		172,822		161,824


Total liabilities and shareholders’ equity		187,198		178,275

The accompanying notes are an integral part of these consolidated financial statements.

F-2

VIMICRO INTERNATIONAL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME

(Amounts expressed in thousands of U.S. dollars, except number of shares and per share data)


		Years ended December 31
	Note	2007		2008		2009
Net revenue	18	92,753		86,497		72,971
Cost of revenue		(64,290	)	(61,814	)	(51,898	)

Gross profit		28,463		24,683		21,073

Operating expenses:
Research and development, net	16	(20,039	)	(24,585	)	(26,364	)
Selling and marketing		(4,668	)	(5,049	)	(5,311	)
General and administrative		(10,431	)	(12,285	)	(14,839	)

Total operating expenses		(35,138	)	(41,919	)	(46,514	)


Loss from operations		(6,675	)	(17,236	)	(25,441	)

Other income/(expense):
Interest income		4,001		2,371		1,437
Foreign exchange gain/(loss), net		185		1,144		(7	)
Gain on disposal of marketable equity securities		—		—		2,461
Government grant		—		—		549
Others, net		385		387		408


Loss before income taxes and share of gain/(loss) of an unconsolidated affiliate		(2,104	)	(13,334	)	(20,593	)
Income taxes benefit/(expense)	17(a)	99		(305	)	(91	)


Net loss before share of gain/(loss) of an unconsolidated affiliate		(2,005	)	(13,639	)	(20,684	)
Equity in profit /(loss) of an unconsolidated affiliate, net of tax		1		(1	)	3


Net loss		(2,004	)	(13,640	)	(20,681	)

Less: loss attributable to non-controlling interest		—		—		(1,914	)


Loss attributed to Vimicro International Corporation		(2,004	)	(13,640	)	(18,767	)


Other comprehensive income/(loss):
Foreign currency translation adjustment		3,380		4,097		93
Unrealized (loss)/ gain on marketable equity securities		—		(29	)	484


Comprehensive income/(loss)		1,376		(9,572	)	(20,104	)
Less: comprehensive (loss) attributable to non-controlling interest.		—		—		(1,869	)

Comprehensive income/(loss) attributable to Vimicro International Corporation		1,376		(9,572	)	(18,235	)


Loss per share
-Basic		(0.01	)	(0.10	)	(0.13	)
-Diluted		(0.01	)	(0.10	)	(0.13	)


Weighted-average number of ordinary shares outstanding
-Basic		139,709,890		140,261,311		143,182,200

-Diluted		139,709,890		140,261,311		143,182,200



Components of share-based compensation expenses are included in the following expense captions:

Research and development, net		(2,240	)	(2,613	)	(3,119	)
Selling and marketing		(654	)	(852	)	(261	)
General and administrative		(2,053	)	(2,811	)	(5,575	)

The accompanying notes are an integral part of these consolidated financial statements.

F-3

VIMICRO INTERNATIONAL CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Amounts expressed in thousands of U.S. dollars, except for number of shares data)


	Common Shares			Additional Paid-in Capital		Treasury Stock		Accumulated Other Comprehensive Income (loss)		Accumulated Deficit		Statutory Reserve	Non- Controlling Interest		Total Shareholders Equity
	Shares		Amount	Additional Paid-in Capital		Treasury Stock		Accumulated Other Comprehensive Income (loss)		Accumulated Deficit		Statutory Reserve	Non- Controlling Interest		Total Shareholders Equity
Balance as of December 31, 2006	139,782,585		14	131,449		—		1,987		(1,325	)	2,732	—		134,857

Exercise of share options/vested restricted shares (note 15)	533,793		—	53		—		—		—		—	—		53

Repurchase of exercised share options	(15,000	)	—	(31	)	—		—		—		—	—		(31	)

Share-based compensation expense- non-employees	—		—	350		—		—		—		—	—		350
Share-based compensation expense- employees (note 2)	—		—	4,597		—		—		—		—	—		4,597
Net loss	—		—	—		—		—		(2,004	)	—	—		(2,004	)

Appropriation to statutory reserve (note 2)	—		—	—		—		—		(50	)	50	—		—
Foreign currency translation adjustment	—		—	—		—		3,380		—		—	—		3,380


Balance as of December 31, 2007	140,301,378		14	136,418		—		5,367		(3,379	)	2,782	—		141,202

Exercise of share options/vested restricted shares (note 15)	923,167		—	25		—		—		—		—	—		25

Refund of payment for share option	(20,000	)	—	(38	)	—		—		—		—	—		(38	)
Share repurchase	(3,426,400	)	—	—		(1,650	)	—		—		—	—		(1,650	)
Share-based compensation expenses- non-employees	—		—	145		—		—		—		—	—		145
Share-based compensation expenses – employees (note 2)	—		—	6,131		—		—		—		—	—		6,131
Net loss	—		—	—		—		—		(13,640	)	—	—		(13,640	)

Foreign currency translation adjustment	—		—	—		—		4,097		—		—	—		4,097
Unrealized loss on marketable equity securities	—		—	—		—		(29	)	—		—	—		(29	)

Purchase of equity interest in Vimicro Tianjin	—		—	—		—		—		—		—	36,579		36,579

Balance as of December 31, 2008	137,778,145		14	142,681		(1,650	)	9,435		(17,019	)	2,782	36,579		172,822

Exercise of share options/vested restricted shares (note 15)	1,141,619		0	36		—		—		—		—	—		36
Issuance of ordinary shares	9,867,404		1	—		—		—		—		—	—		1
Share repurchase	(1,144,000	)	—	—		(1,014	)	—		—		—	—		(1,014	)
Share-based compensation expenses- non-employees	—		—	39		—		—		—		—	—		39
Share-based compensation expenses – employees (note 2)	—		—	8,916		—		—		—		—	—		8,916
Net loss	—		—	—		—		—		(18,767	)	—	(1,914	)	(20,681	)
Foreign currency translation adjustment	—		—	—		—		48		—		—	45		93
Unrealized gain on marketable equity security	—		—	—		—		2,945		—		—	—		2,945
Reclassification of unrealized gain on marketable equity security upon disposal	—		—	—		—		(2,461	)	—		—	—		(2,461	)
Purchase of equity interest in Visiondigi	—		—	—		—		—		—		—	1,128		1,128

Balance as of December 31, 2009	147,643,168		15	151,672		(2,664	)	9,967		(35,786	)	2,782	35,838		161,824

The accompanying notes are an integral part of these consolidated financial statements.

F-4

VIMICRO INTERNATIONAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts expressed in thousands of U.S. dollars)


	Years ended as of December 31
	2007		2008		2009
Cash flows from operating activities:
Net loss	(2,004	)	(13,640	)	(20,681	)
Adjustments to reconcile net loss to net cash provided by/ (used in) operating activities:
Depreciation	3,378		3,283		3,559
Provision for doubtful accounts	(3	)	—		—
Amortization	33		55		557
Share-based compensation expense	4,947		6,276		8,955
Loss from disposal of property and equipment	380		25		14
Gain on disposal of marketable equity securities	—		—		(2,461	)
Equity in (profit)/ loss of an unconsolidated affiliate	(1	)	1		(3	)
Changes in assets and liabilities:
Restricted cash	—		—		(132	)
Accounts receivable	564		(1,238	)	(2,335	)
Notes receivable	2,215		313		—
Inventories	(1,522	)	112		5,763
Prepayments and other current assets	1,241		559		(1,750	)
Deferred tax assets	(97	)	295		(1	)
Other assets	(342	)	37		(62	)
Accounts payable	2,495		159		(3,113	)
Taxes payable	(364	)	22		120
Advances from customers	(166	)	(100	)	593
Due to an unconsolidated affiliate	4		(63	)	—
Accrued expenses and other current liabilities	(2,135	)	1,140		1,361
Product warranty	—		—		25
Deferred government grants	(216	)	—		3,844
Deferred tax liabilities	(4	)	5		(41	)

Net cash provided by/(used in) operating activities	8,403		(2,759	)	(5,788	)


Cash flows from investing activities:
Increase in short-term time deposits	—		(14,654	)	(29,021	)
Purchase of marketable equity securities	—		(760	)	(627	)
Change in restricted cash	—		(73,157	)	73,157
Proceeds from disposal of marketable equity securities	—		—		3,759
Purchase of property, equipment and software	(4,511	)	(3,424	)	(2,697	)
Cash payment for business acquisition	—		—		(8,198	)
Land use rights payments	(4,910	)	(2,052	)	(3,584	)
Proceeds from disposal of property and equipment	6		9		1
Proceeds from disposal of an unconsolidated affiliate	—		—		171

Net cash (used in)/ provided by investing activities	(9,415	)	(94,038	)	32,961

The accompanying notes are an integral part of these consolidated financial statements.

F-5

VIMICRO INTERNATIONAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONT’D)

(Amounts expressed in thousands of U.S. dollars)


	Years ended as of December 31
	2007		2008		2009
Cash flows from financing activities:
Payment for repurchasing of exercised share options	(31	)	—		—
Refund of payment for share option	—		(38	)	—
Repurchase of shares	—		(1,650	)	(1,014	)
Proceeds from exercise of share options	53		25		36
Capital contributions from non-controlling interests	—		36,585		29

Net cash provided by/(used in) financing activities	22		34,922		(949	)


Effect of exchange rate changes on cash and cash equivalents	3,114		3,132		71


Net increase/ (decrease) in cash and cash equivalents	2,124		(58,743	)	26,295

Cash and cash equivalents at beginning of year	114,834		116,958		58,215


Cash and cash equivalents at end of year	116,958		58,215		84,510


Supplemental disclosure of cash flow information:
Cash paid during the year for income taxes	119		—		—
Software acquired in exchange for equity interests in subsidiary	—		—		1,098

The accompanying notes are an integral part of these consolidated financial statements.

F-6

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

1. ORGANIZATION AND PRINCIPAL ACTIVITIES

Vimicro International Corporation (the “Company”) was incorporated under the laws of the Cayman Islands on February 24, 2004 as an exempted company with limited liability. It holds 100% of the equity interest of Vimicro Corporation (“Vimicro China”) which was established on October 14, 1999 in the People’s Republic of China (the “PRC”) as a limited liability company with an approved operating period of thirty years. The Company also holds 100% of the equity interest of Vimicro Technology Corporation (“Vimicro Shenzhen”) and Vimicro High-Tech Corporation (“Vimicro Shanghai”). Vimicro Shenzhen was incorporated in Shenzhen, PRC in November 2006 to facilitate domestic sales and perform research and development with an approved operating period of twenty years. Vimicro Shanghai was established in Shanghai, PRC in September 2007 with an approved operating period of thirty years.

Vimicro China has five subsidiaries, Viewtel Corporation (“Viewtel”), Vimicro Electronics International Limited (“Vimicro Hong Kong”), Vimicro Electronic Technology Corporation (“Vimicro Beijing”), Wuxi Vimicro Corporation (“Vimicro Wuxi”), Visiondigi Technology Corporation (“Visiondigi”) and one joint venture, Vimicro Electronics Corporation (“Vimicro Tianjin”).

Viewtel was incorporated in California, United States of America in June 1999 to perform in-house research and development. Vimicro Hong Kong was established in Hong Kong in May 2002 to facilitate international sales. Vimicro Beijing was incorporated in Beijing, PRC in April 2007. Jiangsu Vimicro Electronics Limited (“Vimicro Jiangsu”) was established in Nanjing, PRC in December 2007. Vimicro Wuxi was established in Wuxi, PRC in July 2009 and is the regional operating center of design, research and development (“R&D”) and sales of radio frequency, bluetooth and other chips.

On December 29, 2008, Vimicro China formed Vimicro Tianjin in Tianjin, PRC as a joint venture with the State-owned Asset Management Corporation of Tianjin Economic-Technological Development Area (“Tianjin SAMC”), and a venture capital fund managed by certain members of the Company’s management (“Management Fund”). Vimicro China and Tianjin SAMC each contributed capital of RMB250 million (equivalent to $36.6 million) in cash to Vimicro Tianjin as initial registered capital and each holds approximately 49.99% ownership interest in Vimicro Tianjin. The Management Fund holds a nominal ownership interest. Pursuant to the related agreements, Vimicro China obtained the voting rights and economic interests associated with the Management Fund’s current share ownership in Vimicro Tianjin, which provides Vimicro China control over Vimicro Tianjin. Accordingly, the Company consolidated Vimicro Tianjin. Vimicro Tianjin focuses on the design, manufacture and sale of digital video surveillance products.

Pursuant to the agreement among Vimicro Tianjin’s shareholders, the Management Fund has the option to purchase all of Tianjin SAMC’s ownership interest in Vimicro Tianjin for RMB250 million plus bank rate interest. The option can be exercised at any time after one year of the establishment of Vimicro Tianjin. The Board of Directors approved this agreement on June 30, 2009.

F-7

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

1. ORGANIZATION AND PRINCIPAL ACTIVITIES (CONT’D)

The Board of Directors also approved the agreement between Vimicro China and the Management Fund on June 30, 2009, pursuant to which Vimicro China has an exclusive right to acquire the beneficial ownership up to the 250,000,000 shares held by the Management Fund for the same consideration paid by the Management Fund. If Vimicro China acquires the beneficial ownership, Vimicro China shall be entitled to the voting rights and the economic interests of the shares with the Management Fund continuing to hold the title of these shares. Vimicro China through the beneficiary ownership, receives all of economic benefits from the option.

Should Vimicro China exercise the beneficiary ownership right, it has been agreed that 15% of Vimicro Tianjin’s ownership interest will be reserved for an equity award scheme whereby the Company may make grants of equity awards at its discretion.

Effective September 16, 2009, Vimicro Tianjin acquired the video surveillance system (“ViSS”) business from Alcatel-Lucent Shanghai Bell Ltd. Co. (“ASB”). The ViSS provides a leading security and surveillance solution over telecommunication networks.

On July 27, 2009, Vimicro China formed Visiondigi in Shanghai with three individuals, Visiondigi specializes in network video surveillance products and solutions. Vimicro China and the three individuals contributed cash and intangible assets for 61.5%, 38.5% equity interest in Visiondigi, respectively.

There have been no significant operations in Vimicro Shenzhen, Vimicro Shanghai, Vimicro Beijing, Vimicro Jiangsu and Vimicro Wuxi since their incorporation.

The Company and its subsidiaries are hereinafter collectively referred to as the “Group”.

The Group designs, develops and markets semiconductor products with multimedia applications, including personal computer (“PC”) camera multimedia processors, mobile phone multimedia processors, security processors. The Group also provides video surveillance and security products solutions and services. In addition, it is also involved in the packaging, testing and reselling of third party image sensors according to the Company’s specifications. Product manufacturing, certain product packaging and testing are outsourced to third party vendors.

F-8

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of presentation

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

Principles of consolidation

The consolidated financial statements of the Group include the financial statements of the Company and its subsidiaries for all years presented.

Subsidiaries are those entities in which the Company, directly or indirectly, controls more than one half of the voting power; has the power to govern the financial and operating policies; to appoint or remove the majority of the members of the board of directors; or to cast a majority of votes at the meeting of directors.

All significant inter-company transactions and balances, and any unrealized gains arising from inter-company transactions, are eliminated in consolidation. Unrecognized gains arising from transactions with an unconsolidated affiliate are eliminated to the extent of the Group’s interest in the unconsolidated affiliate, against the investment in the unconsolidated affiliate. Unrecognized losses are eliminated similarly but only to the extent that there is no evidence of impairment of the assets transferred.

Investment in unconsolidated affiliate

Investments in entities over which the Group holds between 20% and 50% of the equity interest, or over which the Group has significant influence, but does not control are accounted for using the equity method of accounting. Equity accounting involves recognizing in the consolidated statement of operations the Group’s share of the profit or loss for the year of the investment. Vimicro China held 50% equity interest in Shenzhen Haoxing Information Technology Corporation which was liquidated in August 2009.

F-9

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Use of estimates

The preparation of the consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the 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. Actual results could differ from those estimates.

Significant accounting estimates reflected in the Group’s consolidated financial statements mainly include useful lives of property, equipment and software and other long-lived assets, realization of deferred tax assets, provision for doubtful accounts, write-down of inventories, determining the fair value of assets and liabilities in acquisition and share-based compensation expenses.

Concentration of risk

Business and economic risks

The Group’s operating results are significantly dependent on its ability to develop and market products. The Group faces rapid technology advancement which requires the Group to continually improve the performance, feature and reliability of its products. Inability of the Group to successfully develop and market its products as a result of competition or other factors would have a material adverse effect on the Group’s business, financial condition and results of operations.

The Group operates in two segments: multimedia processors, and surveillance and security products from 2009. Revenues from multimedia processors, and surveillance and security products accounted for approximately 97% and 3% of total revenue, respectively.

The Group depends on a few key customers for the majority of its sales, and the loss of or a significant reduction in orders from any of these customers would have a material adverse impact on its operating results. For the years ended December 31, 2007, 2008 and 2009 the top ten customers accounted for approximately 69%, 71% and 70% of total product revenue, respectively. The Group cannot assure that these customers will continue to purchase products from them.

The following table summarizes the customers who accounted for more than 10% of the total revenue of the Group for the years ended December 31, 2007, 2008 and 2009. All of the customers are attributed to multimedia processors segment.


	Years ended December 31
	2007		2008		2009
Customer B	22	%	12	%	11	%
Customer R	6	%	11	%	11	%
Customer I	4	%	11	%	15	%

The Group relies on a few foundries for wafers and several companies for assembly and testing services for the existing products. The ability of each foundry to provide wafers is limited by the foundry’s available capacity. Moreover, the price of wafers may fluctuate based on the available industry capacity. The Group does not have long-term supply contracts with any of these foundries or assembly and testing houses. Therefore, the Group cannot be certain that these foundries and assembly and testing houses will allocate sufficient capacity to satisfy its requirements. If the Group is not able to obtain the necessary foundry capacity and assembly and testing capacity to produce the required volume for its customers in a timely manner, both its relationships with the customers and operating results would be adversely affected.

F-10

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Concentration of risk (cont’d)

Concentration of credit risk

Financial instruments that are potentially subject to credit risk consist of cash and cash equivalents, time deposits, temporarily restricted cash and accounts receivable. Deposits held with financial institutions were not protected by statutory or commercial insurance. In the event of bankruptcy of one of these financial institutions, the Company may be unlikely to claim its deposits back in full. The Company continues to monitor the financial strength of the financial institutions. The Company had $128.6 million in cash and cash equivalents, short-term time deposits and temporarily restricted cash as of December 31, 2009. The Group performs ongoing credit evaluations of its customers’ financial conditions and, generally, requires no collateral or third party guarantee.

The following table summarizes the customers who accounted for more than 10% of the total accounts receivables as of December 31, 2008 and 2009:


	As of December 31
	2008		2009
Customer I	24	%	12	%
Customer O	13	%	—
Customer R	17	%	10	%
Customer S	—		14	%
Customer U	3	%	27	%

Currency convertibility risks

The RMB is not a freely convertible currency. The PRC State Administration for Foreign Exchange, under the authority of the People’s Bank of China, controls the conversion of RMB into foreign currencies. The value of the RMB is subject to changes in central government policies and to international economic and political developments affecting supply and demand in the PRC foreign exchange trading system market.

Foreign currency exchange risks

The value of the RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in China’s political and economic conditions and China’s foreign exchange policies. Under the current policy, the RMB is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in an appreciation of the RMB against the U.S. dollar in prior years.

F-11

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Concentration of risk (cont’d)

Foreign currency exchange risks (cont’d)

Fair value of financial instruments

The Company adopted Accounting Standard Codification (“ASC”) 820, “Fair value measurements and Disclosures” (“ASC 820”) on January 1, 2008 except for nonfinancial assets and nonfinancial liabilities. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). The standard outlines a valuation framework and creates a fair value hierarchy. Although the adoption of ASC 820 did not impact the Group’s financial position, results of operations, or cash flow, ASC 820 requires additional disclosures to be provided on fair value measurement.

ASC 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

Level 1 — Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 — Other inputs that are directly or indirectly observable in the marketplace.

Level 3 — Unobservable inputs which are supported by little or no market activity

ASC 820 describes three main approaches to measure the fair value of assets and liabilities: (1) market approach; (2) income approach and (3) cost approach. The market approach uses prices and other relevant information generated from market transactions involving identical or comparable assets or liabilities. The income approach uses valuation techniques to convert future amounts to a single present value amount. The measurement is based on the value indicated by current market expectations about those future amounts. The cost approach is based on the amount that would currently be required to replace an asset.

The carrying amounts of the Group’s cash and cash equivalents, time deposits and restricted cash approximate their fair value due to the short maturity of those instruments. Fair values for equity securities classified as available for sale securities are based upon quoted market prices. The carrying amounts of the Group’s receivables, payables and accrued liabilities approximated their fair values as of the balance sheet dates due to their short maturities and the interest rates currently available.

F-12

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Fair value of financial instruments (cont’d)

In accordance with ASC 820, the Company measures marketable equity securities classified as available for sale at fair value on a recurring basis. These assets are classified within the Level 1 by the fair value hierarchy as they can be valued using quoted market prices.

Cash and cash equivalents

Cash and cash equivalents represent cash on hand and deposits placed with banks or other financial institutions, which are repayable on demand and have original maturities of three months or less.

Restricted cash

Restricted cash balances comprise cash in bank balances which are restricted as to withdrawal under the terms of certain contracts or under banking regulations.

Short-term time deposits

Short-term time deposits consist of deposits placed with financial institutions with original maturity terms of greater than three months, but less than one year.

Marketable equity securities

Marketable equity securities are classified as available-for-sale and carried at fair value. Unrealized gains and losses, net of tax, are recorded in accumulated other comprehensive income, a separate component of shareholders equity. Realized gains and losses and declines in value judged to be other-than-temporary, if any, on available-for-sale securities are recorded as gain/(loss) on disposal of available-for-sale securities and impairment of available-for-sale securities respectively under other income/(expense) in the consolidated statements of operations and comprehensive income. The basis on which the cost of a security sold or the amount reclassified out of accumulated other comprehensive income into earnings is determined by the first in, first out method.

Inventories

Inventories are stated at the lower of cost or market. The cost is computed on a weighted-average basis. Adjustments are made to write down excess or obsolete inventories to their estimated realizable values.

Property, equipment and software

Property, equipment and software are stated at cost less accumulated depreciation and impairment loss.

F-13

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Property, equipment and software (cont’d)

Property, equipment and software are depreciated at rates sufficient to write off their costs less estimated residual values and impairment loss, if any, over their estimated useful lives on a straight line basis. The estimated useful lives and residual values are as follows:


	Estimated useful lives	Residual value
Equipment and office furniture	5 years	10	%
Mask and tooling	2 years	—
Motor vehicles	5 years	10	%
Software	3 to 5 years	0-10	%
Leasehold improvements	Shorter of the lease term or the estimated useful lives	—

Expenditures for maintenance and repairs are expensed as incurred.

The gain or loss on the disposal of property, equipment and software is the difference between the net sales proceeds and the carrying amount of the relevant assets and is recognized in the consolidated statements of operations and comprehensive income.

Provision for doubtful accounts

Provisions are made against accounts receivable to the extent that collection is considered to be doubtful. Accounts receivable in the consolidated balance sheets are stated net of such provision, if any.

Goodwill

Goodwill represents the excess of the purchase price over the fair value of the identifiable net assets acquired in a business combination. Goodwill is tested for impairment at the reporting unit level on an annual basis, or more frequently if events or changes in circumstances indicate that it might be impaired. Goodwill from the acquisition of the ViSS business was allocated to the surveillance and security products segment.

Intangible assets


Core technologies		15.3 years
Trade name		1.3 years
Software		5-8 years

An intangible asset that is subject to amortization shall be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. The Group evaluates recoverability of an intangible asset to be held and used by comparing the carrying amount of the intangible asset to its fair value. An intangible asset is considered to be impaired if its carrying amount is greater than its fair value and the impairment loss is measured as the amount by which the carrying amount of the intangible asset exceeds the fair value of the intangible asset.

F-14

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Impairment of long-lived assets

Long-lived assets are reviewed for impairment whenever events or changes in circumstance indicate that the carrying amount of the asset may no longer be recoverable. The assessment of possible impairment is based on the Group’s ability to recover the carrying value of the asset or asset group from the expected future pre-tax cash flows, undiscounted and without interest charges, of the related operations. When these events occur, the Group measures and recognizes the impairment loss based on the excess of the carrying amount over the fair value of the asset or asset group.

Revenue recognition

The Group recognizes revenue from the sales of products and rendering of services on a gross basis when the earnings process has been completed, as evidenced by agreement with the customer, delivery of products and transfer of title have occurred, the fees are fixed or determinable and collectability is reasonably assured, as prescribed by ASC 605 “Revenue recognition”.

Multimedia processors

Multimedia processor revenue derives from PC and embedded notebook camera multimedia processors, mobile phone multimedia processors, image sensors, and other products. Multimedia processors revenues are generally recorded net of business taxes and related surcharges provided all revenue recognition criteria have been met.

The cost of multimedia processor revenue primarily consists of costs associated with the fabrication of wafers, assembly, testing and shipping of our multimedia processors, amortization of costs associated with production masks and tooling and costs of third-party image sensors that we sell to our customers.

Surveillance and security products

Surveillance and security products arrangements generally comprise of hardware, software and installation, These arrangements are considered multiple accounting units in accordance with Accounting Standards Update (“ASU”) No. 2009-13, “Revenue recognition (Topic 605): Mulitple-Deliverable Recognition Arrangement”. The total arrangement consideration is allocated to the individual deliverables on the basis of their relative selling price. Relative selling price method is based on vendor-specific objective evidence (“VSOE”) of selling price if available, third-party evidence (“TPE”) if VSOE is not available, or management’s best estimate the selling price (“ESP”) if neither VSOE nor TPE is available. The Company uses the ESP for each deliverable in 2009 as neither VSOE nor TPE is available. The objective of ESP is to determine the price at which the Company would transact a sale if the deliverable were sold on a stand-alone basis. The Company determines ESP for a deliverable by considering multiple factors including, but not limited to, market conditions, competitive landscape, cost, gross margin objectives and pricing practices.

The Group recognizes revenue from delivered hardware and software components after obtaining the shipping acceptance from customers and recognizes revenue from installation service after obtaining the final acceptance from customers.

F-15

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Revenue recognition (cont’d)

Surveillance and security products (cont’d)

The cost of surveillance and security product revenue includes the cost of hardware and software, third-party hardware and software products, installation and other services and warranty cost.

Warranty obligation is provided based on estimated warranty payment when the underlying revenue is recognized.

Payments received from customers in advance of shipment are initially recorded as advances from customers and recorded as revenue after all the revenue recognition criteria has been met.

Research and development costs

Research and development costs are charged to expense as incurred.

Government grants

Research and development grants received from PRC government agencies or enterprises are recognized as deferred grants and offset against the corresponding research and development expenses as and when they are incurred for the specific research and development projects for which these grants are received.

Other government grants are recognized as deferred government grant when received and recorded as other income over the period the attached conditions are met and the government grants are earned.

Advertising costs

Advertising costs are charged to expense as incurred. Advertising costs were approximately $172,000, $214,000 and $403,000 for the years ended December 31, 2007, 2008 and 2009, respectively.

Income taxes

Current income taxes are provided on the basis of income for financial reporting purposes, adjusted for income and expense items which are not assessable or deductible for tax purposes, in accordance with the regulations of the relevant tax jurisdictions.

Deferred income taxes are provided for using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the carrying amounts of assets and liabilities and their respective tax bases, and for the expected future tax benefits from loss carry-forwards, if any. Deferred tax assets and liabilities are measured using the enacted tax rates expected in the years of recovery or reversal and the effect from a change in tax rates is recognized in the consolidated statements of operations and comprehensive income in the period of enactment. A valuation allowance is provided to reduce the amount of deferred tax assets if it is considered more likely than not that some portion of, or all of the deferred tax assets will not be realized.

F-16

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Income taxes (cont’d)

The Company adopted a two-step approach to recognize and measure uncertain tax positions accounted for in accordance with ASC 740 “Income Taxes” on January 1, 2007. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement. The cumulative effects of applying the two-step approach is recorded as an adjustment to retained earnings as of the beginning of the period of adoption. The Company has elected to classify interest and penalties related to an uncertain tax position, if and when required, as part of income tax expense in the consolidated statements of operations and comprehensive income.

Foreign currency translation

The functional currencies of the Company and its subsidiaries are their respective local currencies. The reporting currency of the Group is the United States Dollar (“USD”). Transactions denominated in foreign currencies are translated into the functional currency at the exchange rates prevailing at the date of the transactions. Monetary assets and liabilities denominated in foreign currencies are remeasured into the functional currency using exchange rates in effect at the balance sheet dates. These exchange differences are included in the consolidated statements of operations and comprehensive income.

Those entities that use a different functional currency other than USD are translated into USD using the applicable exchange rates at balance sheet dates for assets and liabilities and average exchange rates are used for the statements of operations. Translation adjustments resulting from translation of these consolidated financial statements are reflected as foreign currency translation adjustment in accumulated other comprehensive income/(losses) in the shareholders’ equity.

Share-based compensation

The Company applies ASC 718 “Compensation-Stock Compensation” (“ASC 718”) and used the prospective transition approach from January 1, 2006, prior to which the Company accounted for share-based compensation arrangements with employees in accordance with the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related interpretations thereof. Pursuant to ASC 718, the Company recognized share-based compensation over the requisite service periods for any share option and restricted share granted after December 31, 2005 based on the fair values of share option and restricted share on the dates of grant. The Company continues to account for share options that were granted prior to the initial public offering in the United States on October 24, 2005 that remained unvested at December 31, 2005 under APB 25. For share-based awards granted after the initial public filing but prior to January 1, 2006, the unvested compensation cost at the effective date of adoption of ASC 718 is computed based on the grant date fair values of those awards. For the options that were repriced during the year ended December 31, 2008, in accordance with ASC 718, the Company recognized additional compensation cost for the excess of fair value of the modified share options issued over the fair value of the original share options at the date of the modification for all the original share options vested as of the modification date. The compensation cost due to the incremental fair value of the modified awards and the remaining balance of the unrecognized compensation cost for the unvested share options are recognized over the remaining requisite service periods of the modified awards. The Company does not receive any tax benefits or deductions from awards exercised.

F-17

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Share-based compensation (cont’d)

The Company recognizes share-based compensation using the accelerated method for all share-based awards issued prior to January 1, 2006. The Company has elected to recognize share-based compensation after the date of adoption of ASC 718 using the straight-line method for all share-based awards issued or modified after January 1, 2006, which results in the recognition of less share-based compensation in the first several years during the vesting period compared to that which would have been recognized had the Company used the accelerated method. Forfeitures are estimated based on historical experience and are periodically reviewed.

The Company accounts for share-based awards issued to non-employees in accordance with the provisions of ASC 718 and ASC 505-50 “Equity-Based Payments to Non-Employees” (“ASC 505-50”). Under ASC 505-50, the Company uses the Black-Scholes option pricing model method to measure the value of options granted to non-employees at each reporting date to determine the appropriate charge to share-based compensation.

Employee social security and welfare benefit plans

All Chinese employees of the Company’s PRC subsidiaries participate in employee social security plans, including pension, medical, housing and other welfare benefits, organized and administered by relevant government authorities. The premiums and welfare benefit contributions that are borne by these entities are calculated based on percentages of the total salary of employees, subject to certain ceilings and are paid to the respective labor and social welfare authorities. The PRC government is responsible for the welfare benefit for the retired employees. The Group has no obligation for post retirement or other welfare benefits beyond the annual contributions.

The welfare benefits expenses were approximately $2,792,000, $3,484,000 and $4,371,000 for the years ended December 31, 2007, 2008 and 2009, respectively.

Profit appropriation

The PRC subsidiaries of the Group are required to make appropriations to statutory reserve funds based on after-tax net income, after recouping prior years’ losses, determined in accordance with PRC GAAP.

F-18

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Profit appropriation (cont’d)

Vimicro China is a wholly foreign-owned enterprise established in the PRC. In accordance with the “Law of the People’s Republic of China on Enterprises Operated Exclusively with Foreign Capital”, Vimicro China should set aside at least 10% of its net profit, after recouping prior years’ losses, determined under PRC GAAP to a statutory reserve fund before distributions to investors. The appropriation of the net profit to the statutory reserve fund must be made annually until the accumulated reserve fund exceeds 50% of Vimicro China’s registered capital.

During the years ended December 31, 2007, 2008 and 2009 the PRC subsidiary appropriated approximately $50,000, $0 and $0 respectively to this statutory reserve fund, which is not available for distribution except in liquidation.

Segment reporting

In accordance with ASC 280 ‘Segment Reporting’, segment reporting is determined based on how the Group’s chief operating decision maker reviews operating results to make decisions about allocating resources and assessing performance for the Group. According to the management approach, the Group operates in two principal business segments from 2009, namely multimedia processor, surveillance and security products. The Group does not allocate any assets to the two segments as management does not use this information to measure the performance of the reportable segments.

Comprehensive income

Comprehensive income is defined as the changes in equity of the Company during a period from transactions and other events or circumstances excluding transactions resulting from investments by owners and distributions to owners. Accumulated other comprehensive income of the Company consists of foreign currency translation adjustments and unrealized gain/(loss) on available-for-sale securities as follows:


	As of December 31
	2008		2009
	*(in thousands)*
Foreign currency translation adjustment	9,464		9,512
Unrealized (loss)/ gain on marketable equity securities (less than 12 months)	(29	)	455

	9,435		9,967

Loss per share

The Group computes loss per share in accordance with ASC 260 “Earning Per share”. Basic net loss per share is computed by dividing net loss by the weighted-average number of ordinary shares outstanding during the period. Diluted net loss per share is computed by dividing net loss by the sum of the weighted-average number of ordinary shares outstanding and, if dilutive, the potential ordinary shares outstanding during the period.

F-19

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Loss per share (cont’d)

The dilutive effect of outstanding stock options and restricted shares is reflected in diluted earnings per share by application of the treasury stock method. Potentially dilutive securities have been excluded from the computation of diluted loss per share if their inclusion is anti-dilutive.

The following table sets forth the computation of basic and diluted loss attributable to ordinary shareholders per share:


	Year ended December 31
	2007		2008		2009
	*(in thousands of U.S. dollars except per share data)*
Numerator:
Net loss	(2,004	)	(13,640	)	(18,767	)

Numerator for basic loss per share	(2,004	)	(13,640	)	(18,767	)

Numerator for diluted loss per share	(2,004	)	(13,640	)	(18,767	)

Denominator (in thousands of shares):

Weighted-average ordinary shares outstanding	139,710		140,261		143,182

Denominator for diluted loss per share	139,710		140,261		143,182


Basic loss per share	(0.01	)	(0.10	)	(0.13	)


Diluted loss per share	(0.01	)	(0.10	)	(0.13	)

There were 24,237,714, 23,286,387 and 21,325,751 share options and non-vested restricted shares outstanding as of December 31, 2007, 2008 and 2009, respectively, that were excluded from the computation of loss per share because of their anti-dilutive effect.

Operating leases

Rental payments under operating leases are charged to expense based on a straight- line method over the period of the leases.

Land use rights

Land use rights include prepayments towards acquisition and land use rights acquired. Land use rights acquired are stated at cost less accumulated amortization and impairment loss. Land use rights are amortized on a straight-line basis over their useful lives.

As of December 31, 2008 and 2009, the Company had land use rights that are amortized over the useful life of 50 years.

F-20

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Recent accounting pronouncements

In May 2009, the FASB issued SFAS No. 165 “Subsequent Events” (subsequently codified by Accounting Standards Codification (“ASC”) No. 855 (“ASC 855”) names the two types of subsequent events either as recognized subsequent events or non-recognized subsequent events and modifies the definition of subsequent events as events or transactions that occur after the balance sheet date, but before the financial statements are issued (for public entities) or available to be issued (for nonpublic entities that do not widely distribute their financial statements). The statement also requires to disclose the date through which an entity has evaluated subsequent events and the basis for that date. SFAS 165 is effective on a prospective basis for interim or annual financial periods ending after June 15, 2009. The Company adopted ASC 855 from fiscal year 2009. In February 2010, Accounting Standards Update (“ASU”) 2010-09 “Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements” was issued to remove the requirement for an SEC filer to disclose a date in both issued and revised financial statements, effective from issuance of the final update. The Company does not believe that ASC 855 and related update will have a significant impact on its consolidated financial position and results of operations.

In June 2009, the FASB issued SFAS 167, (subsequently codified by ASU 2009-17), Amendments to FASB Interpretation No. 46(R), which amends guidance regarding consolidation of variable interest entities (“VIE”) to address the elimination of the concept of a qualifying special purpose entity. SFAS 167 also replaces the quantitative-based risks and rewards calculation for determining which enterprise has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of the variable interest entity, and the obligation to absorb losses of the entity or the right to receive benefits from the entity. Additionally, SFAS 167 requires any enterprise that holds a variable interest in a variable interest entity to provide enhanced disclosures that will provide users of financial statements with more transparent information about an enterprise’s involvement in a variable interest entity. SFAS 167 is effective for interim and annual reporting periods beginning after November 30, 2009. The Company is currently evaluating the impact on its consolidated financial statements of adopting this guidance.

In October 2009, the FASB issued ASU No. 2009-13 (“ASU 2009-13”), Multiple-Deliverable Revenue Arrangements. ASU 2009-13 amends ASC sub-topic 605-25 (“ASC 605-25”), Revenue Recognition: Multiple-Element Arrangements, regarding revenue arrangements with multiple deliverables. These updates address how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting, and how the arrangement consideration should be allocated among the separate units of accounting. These updates are effective for fiscal years beginning after June 15, 2010 and are to be applied retrospectively or prospectively for new or materially modified arrangements. In addition, early adoption is permitted. The Company early adopted the new guidance as of January 1, 2009. The adoption of ASU 2009-13 has no impact on the Company’s prior year financial statements as there were no multiple-element arrangements prior to 2009.

F-21

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Recent accounting pronouncements (cont’d)

In October 2009, the FASB issued ASU No. 2009-14 (“ASU 2009-14”), Certain Revenue Arrangements That Include Software Elements. ASU 2009-14 amends the scope of ASC sub-topic 985-605 (“ASC 985-605”), Software: Revenue Recognition, to exclude all tangible products containing both software and non-software components that function together to deliver the product’s essential functionality. ASU 2009-14 is effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 and is to be applied on a prospective basis. Early application is permitted as of the beginning of an entity’s fiscal year. The Company early adopted the new guidance as of January 1, 2009. The adoption of ASU 2009-14 has no impact on the Company’s prior year financial statements as there were no arrangements that include software elements prior to 2009.

In January 2010, the FASB issued ASU No. 2010-06 (“ASU 2010-06”), Fair Value Measurements and Disclosures: Improving Disclosures about Fair Value Measurements. ASU 2010-06 amends ASC 820 to require a number of additional disclosures regarding (1) the different classes of assets and liabilities measured at fair value, (2) the valuation techniques and inputs used, (3) the activity in Level 3 fair value measurements, and (4) the transfers between Levels 1, 2, and 3. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The Company does not expect that the adoption of ASU 2010-06 will have a material impact on its consolidated financial statements.

F-22

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

3. ACQUISITIONS

Business combination

Effective September 16, 2009, Vimicro Tianjin acquired the ViSS business from ASB for consideration of RMB55,978,000 (equivalent to $8,198,000), which included equipment, inventories, business contracts, intellectual property and employees in China. ViSS is a leading security and surveillance solution over telecommunication networks. The Company expects the acquisition will expand the Group’s surveillance business in China.

The acquisition has been accounted for using the purchase method of accounting. Under this method, the purchase price is allocated to the assets acquired and liabilities assumed, if any, based upon their respective fair values at the date of acquisition. The purchase price in excess of the fair value of the identifiable net asset, is recorded as goodwill. The goodwill is not deductible for tax purposes. The results of operations of ViSS business (revenue of $1,269,000 and net loss of $2,565,000) have been included in the surveillance and security product segment in the Group’s consolidated financial statements since the acquisition date of September 16, 2009.

The allocation of the purchase price is as follows:


	For the Year Ended December 31
	2009
	(in thousands)
Equipment	1,584
Inventory	1,145
Intangible assets
-Core technology	2,249
-Trade name	816
Value-added tax credit	589
Deferred tax liability	(204	)
Goodwill	2,019

Total consideration paid in cash	8,198

F-23

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

3. ACQUISITIONS (CONT’D)

Business combination (cont’d)

The professional costs associated with the acquisition of $109,000 were recognized in general and administrative expense when incurred.

Pro forma consolidated financial information (Unaudited)

The following unaudited pro forma consolidated financial information for the years ended December 31, 2007, 2008 and 2009 reflects the results of operations of the Group assuming the acquisitions of the ViSS business occurred on January 1, 2007, 2008 and 2009, respectively. These pro forma results have been prepared for information purposes only and do not purport to be indicative of what operating results would have been had the acquisitions actually taken place on January 1, 2007, 2008 and 2009 respectively, and may not be indicative of future operating results.


	For the Year Ended December 31
	2007		2008		2009
	*(in thousands)*
Pro forma revenue	103,272		103,570		80,061
Pro forma net loss	(4,865	)	(14,910	)	(21,243	)

4. SHORT-TERM TIME DEPOSITS

Short-term time deposits consist of deposits of $14,885,000 and $43,935,000 with an original maturity of six months and an interest rate of 3.78% and 1.98% per annum as of December 31, 2008 and 2009, respectively.

5. RESTRICTED CASH

Restricted cash of $73,157,000 as of December 31, 2008 represents the bank deposits in the capital registration account of Vimicro Tianjin. Upon the completion of capital registration in February 2009, the restricted cash was reclassified to cash and cash equivalents.

Restricted cash of $132, 000 represents amounts restricted as biding deposits as of December 31, 2009.

F-24

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

6. MARKETABLE EQUITY SECURITIES

In 2008 and 2009 the Company purchased marketable equity securities for consideration of $760,000 and $626,912, respectively in cash. The marketable equity securities have been classified as available-for-sale.

The Company sold certain available-for-sale securities and received the proceeds totaling $3,759,000 in 2009. The amount of gains reclassified out of accumulated other comprehensive income into earnings was $2,461,000 and the gross gains on disposal amounted to $2,461,000.

The cost of the available-for-sale securities was $760,000 and $88,000 and the aggregate fair value based on quoted market prices of the available-for-sale securities was $731,000 and $543,000 as of December 31, 2008 and 2009, respectively. The Company recorded an unrealized loss of $29,000 and an unrealized gain of $484,000 on its available-for-sale securities in other comprehensive income for the years ended December 31, 2008 and 2009, respectively.

7. INVENTORIES


	As of December 31
	2008	2009
	*(in thousands)*
Inventories
Finished goods	8,259	5,897
Work in process	5,171	2,907

	13,430	8,804

The finished goods included consigned inventory of $0 and $132,000 as of December 31, 2008 and 2009, respectively.

F-25

FVIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

8. PREPAYMENTS AND OTHER CURRENT ASSETS


	As of December 31
	2008	2009
	*(in thousands)*
Receivable from employees	73	216
Hong Kong withholding tax refundable (Note 17(a))	984	984
Prepayments to suppliers and other third parties	1,003	2,469
Other receivables	371	486

	2,431	4,155

9. INVESTMENT IN AN UNCONSOLIDATED AFFILIATE


	As of December 31
	2008		2009
	*(in thousands)*
Cost	278		278
Share of loss in unconsolidated affiliate	(110	)	(107	)
Disposal of unconsolidated affiliate	—		(171	)

	168		—

The investment in Shenzhen Haoxing Information Technology Corporation was liquidated in August 2009.

10. PROPERTY, EQUIPMENT AND SOFTWARE, NET


	As of December 31
	2008		2009
	*(in thousands)*
Equipment and office furniture	8,297		8,948
Leasehold improvements	1,638		1,757
Mask and tooling	5,231		3,929
Motor vehicles	1,090		1,176
Software	1,576		3,287
Construction in progress	645		635

	18,477		19,732
Less: accumulated depreciation	(9,741	)	(10,717	)

	8,736		9,015

Depreciation expenses for the years ended December 31, 2007, 2008 and 2009 were approximately $3,378,000, $3,283,000 and $3,559,000, respectively.

F-26

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

11. LAND USE RIGHTS


	As of December 31
	2008		2009
	*(in thousands)*
Cost:
Land use rights acquired	1,007		3,096
Prepayment for land use rights acquisition	6,388		7,882
	7,395		10,978
Less: accumulated amortization	(30	)	(73	)

	7,365		10,905

Amortization expenses for the years ended December 31, 2007, 2008 and 2009 were $9,000, $21,000 and $43,000, respectively.

Estimated amortization expense of the land use rights acquired as of December 31, 2009 for each of next five years is as follows:


		$
For the years ending December 31,		(in thousands)
2010		62
2011		62
2012		62
2013		62
2014		62

12. GOODWILL AND INTANGIBLE ASSETS

In 2009, Vimicro Tianjin completed the acquisition of ViSS business that resulted in goodwill of $2,019,000.

In 2009, the Group acquired intangible assets with a fair value of $3,065,000 and $1,098,000 in connection with the acquisition of the ViSS business and Visiondigi, respectively.


	As of December 31
	2009
	Cost	Accumulated amortization	Net
	*(in thousands)*
Core technology	2,249	49	2,200
Trade name	816	204	612
Software	1,098	91	1,007

	4,163	344	3,819

F-27

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

12. GOODWILL AND INTANGIBLE ASSETS (CONT’D)

During the years ended December 31, 2007, 2008 and 2009, the amortization expenses of intangible assets were $0, $0, and $344,000, respectively.

Estimated amortization expense of the intangible assets as of December 31, 2009 for each of next five years is as follows:


		$
For the years ending December 31,		(in thousands)
2010		978
2011		366
2012		366
2013		366
2014		275

13. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES


	As of December 31
	2008	2009
	*(in thousands)*
Accrued salary and welfare expenses	1,797	2,739
Accrued professional fees	845	1,146
Payables to IP suppliers	1,169	448
Other payables	688	1,232
Other accrued expenses	371	335

	4,870	5,900

14. SHAREHOLDERS’ EQUITY

Ordinary Shares

The Company’s Amended and Restated Memorandum and Articles of Association authorize the Company to issue 500,000,000 shares with a nominal or par value of $0.0001 each.

In October 2005, certain share option holders exercised their options for 14,241,437 shares, among which 2,715,000 options were not vested. These early exercised shares had the following features:

(a)

The Company’s right to purchase

These shares were subject to the Company’s right to repurchase during the remaining vesting periods if the optionee’s employment with the Company is terminated for any reason during the vesting periods. If the Company exercises its right of repurchase, the price to be paid shall be the lower of the exercise price per share paid by the optionees to the Company pursuant to the option agreement or the fair value of the shares at the date of repurchase.

(b)

Restriction on transfer

The optionee shall not transfer the shares acquired through early exercise of the unvested options during the vesting period.

F-28

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

14. SHAREHOLDERS’ EQUITY (CONT’D)

Early exercised Ordinary Shares are excluded from basic EPS until the shares are vested and the Company’s right to repurchase these shares has lapsed. 2,465,000 exercised Ordinary Shares became vested and treated as Ordinary Shares, and 250,000 unvested options were forfeited due to one optionee’s employment termination as of December 31, 2009.

Share repurchase program

On October 12, 2008, the Company announced a share repurchase program authorized by the Board of Directors with total share repurchase amounts up to $25,000,000.

Pursuant to the share repurchase plan approved by the Board of Directors, the Company repurchased 856,600 ADSs in 2008, representing 3,426,400 ordinary shares, with a total consideration of $1,650,000 at prices from $1.54 to $2.33 per ADS including brokerage commissions. In 2009, the Company repurchased 286,000 ADSs, representing 1,144,000 ordinary shares, with a total consideration of $1,014,000 at prices from $3.06 to $3.73 per ADS including brokerage commissions. The shares repurchased by the Company were accounted for at cost and there was no reissuance of the shares as of December 31, 2009.

15. SHARE-BASED COMPENSATION

Share-based compensation recognized in 2007, 2008 and 2009 was $4.9 million, $6.3 million and $9.0 million, respectively. No income tax benefit was recognized in the statements of operations and comprehensive income for share-based compensation arrangements for the years ended December 31, 2007, 2008 and 2009 as no tax deduction was claimed.

The Company has three share option plans to honor the contributions of employees and non-employee consultants. The first plan is a discretionary share option plan adopted in March 2004 concurrent with the reorganization of the Company (the “Discretionary Plan”). The second share option plan was adopted in March 2004 (the “2004 Plan”). In November 2005, the third plan, the 2005 Share Incentive Plan (the “2005 Plan”) was adopted to replace the 2004 Plan. Three share option plans have contractual life of 10 years from the date of grant.

Discretionary Plan:

Concurrent with the reorganization of the Company, the Company’s shareholders approved the grant of share options to certain employees and non employees to honor the Company’s promises to issue share options upon the formalization of the share capital and option structures of the Company.

F-29

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

15. SHARE-BASED COMPENSATION(CONT’D)

Majority of the options granted under the Discretionary Plan have a vesting period of five years. Under the vesting schedule, 20% of the share options will vest one year after the grant date, and 10% of the share options shall vest semi-annually over the next four years.

The Company recognized compensation expenses of approximately $77,000, $212,000 and $6,000 respectively for the years ended December 31, 2007, 2008 and 2009 in connection with the Discretionary Plan.

The share options issued under the Discretionary Plan were fully vested in 2009.

2004 Plan:

The 2004 Plan provides for the granting of share options to employees and non-employee consultants of the Company. The Company has reserved 12,541,080 ordinary shares for grant under the 2004 Plan.

Majority of the options granted under the 2004 Plan have a vesting period of 5 years. Under the vesting schedule, 20% of the share options will vest 1 year after the grant date, and 10% of the share options shall vest semi-annually over the next 4 years, or 1/60 of the shares options shall vest monthly over the next 4 years.

The 2004 Plan was terminated in November 2005, and the remaining options available for grant were transferred to the 2005 Plan.

Employee options:

Under the 2004 Plan, the Company granted total 10,006,600 share options to employees with an exercise price range of between US$1.60 to US$3.00

The Company recognized compensation expenses of approximately $77,000, $150,000 and $87,000 for the years ended December 31, 2007, 2008 and 2009.

Non-employee options:

Under the 2004 Plan, for the service of non-employee consultants, the Company granted a total of 664,800 share options to non-employees with an exercise price range of between US$1.60 to US$2.50.

The Company recorded consultancy fee expense with respect to research and development activities of approximately $62,000, $17,000 and $15,000 for the years ended December 31, 2007, 2008 and 2009, respectively.

2005 Plan:

The 2005 Plan provides for the granting of share options and restricted shares to employees and non-employee consultants of the Company. The 3,065,505 share options which were not issued under the 2004 Plan were transferred to the 2005 Plan. Subsequently, another 10,000,000 shares were authorized for future grant.

F-30

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

15. SHARE-BASED COMPENSATION (CONT’D)

Options granted thereafter are made under the 2005 Plan and no new options were granted under the 2004 Plan. The Company has reserved 13,065,505 ordinary shares for grant and authorized another 18,000,000 shares under the 2005 Plan as of December 31, 2009. The Board of Directors may terminate the 2005 Plan at any time at its discretion.

Employee options:

Options granted under the 2005 Plan have vesting periods of three years or five years. For options with three years vesting period, 1/3 of the share options will vest one year after the grant date and 1/6 shall vest semi-annually over the next two years.

For options with five years vesting period, 20% of the share options will vest one year after the grant date, and 10% of the share options shall vest semi-annually over the next four years.

Under the 2005 Plan, the Company granted 16,348,600 share options to employees prior to 2009 and 850,552 share options during 2009 with an exercise price range of between $0.48 to $4.55.

The Company recognized $3,076,000, $3,734,000 and $3,299,000 in share-based compensation expense for the years ended December 31, 2007, 2008 and 2009, respectively.

Employee restricted shares:

Under the 2005 Plan, the Company granted 3,340,600 restricted shares as of December 31, 2009 to employees with vesting period between one and five years.

The Company recognized $1,374,000, $1,048,000 and $465,000 in share-based compensation expense for the years ended December 31, 2007, 2008 and 2009, respectively.

Non-employee options:

Under the 2005 Plan, as of December 31, 2009, for services provided by non-employee consultants, the Company granted 1,134,500 share options to non-employees with an exercise price range of between $1.11 to $4.55.

The Company recorded consultancy fee expense with respect to research and development activities of approximately $191,000, $72,000 and $24,000 for the years ended December 31, 2007, 2008 and 2009, respectively.

Non-employees restricted shares:

Under the 2005 Plan, the Company granted 200,000 restricted shares with a vesting period of three years and 20,000 restricted shares with a vesting period of one year to non-employees. The vesting schedule is that 1/36 of the restricted shares will vest each month and 100% vested in one year after the grant date, respectively.

The Company recognized $90,000, $51,000 and nil in expense for the years ended December 31, 2007, 2008 and 2009, respectively.

F-31

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

15. SHARE-BASED COMPENSATION (CONT’D)

Option repricing under 2004 Plan and 2005 Plan :

On March 27, 2008, the Company repriced 10,072,100 outstanding options that it had previously granted to 13 employees in senior management under the 2004 Plan and 2005 Plan with original exercise prices ranging from $1.25 to $4.55 per share. The repriced exercise price, based on the closing price on March 27, 2008, was $0.70 per share. The Company believed that the repriced options would provide better incentives to senior management.

The Company recognized the re-pricing related share-based compensation expense of $992,000 and $341,000 for the year ended December 31, 2008 and 2009, respectively.

Ordinary shares granted

On June 30, 2009, the Company granted 9,827,404 ordinary shares to certain senior executives at the consideration of par value per share. The ordinary shares are subject to a four year transfer lock up restrictions with the release of 25% on each anniversary of the share grant date.

On July 31, 2009, the Company granted 40,000 ordinary shares at the consideration of par value of $0.0001 per share to one retired board member without any condition.

In connection with these two grants of ordinary shares, the Company recognized compensation expense of $4,718,000 for the year ended December 31, 2009.

Summary of share options granted to both employees and non-employees as of December 31, 2009 is presented below:


	Number of options		Weighted- average exercise price
Outstanding at December 31, 2008	21,883,443		1.12
Options granted	850,552		0.67
Options exercised	(175,064	)	0.20
Options forfeited/cancelled	(1,950,680	)	1.55


Outstanding at December 31, 2009	20,608,251		1.07

Vested and expected to vest at December 31, 2009	18,975,280		1.05

Total intrinsic value of options exercised for the years ended December 31, 2007, 2008 and 2009 was $103,000, $108,000 and $137,000, respectively.

The aggregate intrinsic value and weighted-average remaining contractual life for share options vested and expected to vest at December 31, 2009 was $8,507,000 and 5.83 years, respectively.

F-32

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

15. SHARE-BASED COMPENSATION (CONT’D)

The weighted-average grant date fair value of options granted for each of the years ended December 31, 2007, 2008 and 2009 was $0.96, $0.50 and $0.42, respectively.

As of December 31, 2009, total unrecognized share-based compensation expense related to share options was $4,346,000, of which $13,000 is under the accelerated method and $4,333,000 is under the straight-line method. The unrecognized share-based compensation expense is expected to be recognized over a weighted-average vesting period of 0.65 and 1.83 years under the accelerated and straight-line method, respectively. To the extent the actual forfeiture rate is different from the original estimate, actual share based compensation related to these awards may be different from the expectation.

Summary of restricted shares granted to both employees and non-employees as of December 31, 2009 is presented below:


	Number of restricted shares		Weighted average grant date fair value
Non-vested at December 31, 2008	1,402,944		0.98
Granted	320,000		0.78
Vested	(966,555	)	0.81
Forfeited/cancelled	(38,889	)	0.55

Non-vested at December 31, 2009	717,500		1.01

As of December 31, 2009, total unrecognized share-based compensation expense related to restricted shares was $325,000. The unrecognized share-based compensation expense is expected to be recognized over a weighted-average vesting period of 2.59 years. To the extent the actual forfeiture rate is different from the original estimate, actual share-based compensation related to these awards may be different from the expectation.

The total fair value of shares vested during the year ended December 31, 2007, 2008 and 2009 was $559, 000, $571,000 and $5,182, 000, respectively.

There were no capitalized share-based compensation expenses for the years ended December 31, 2007, 2008 and 2009.

F-33

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

15. SHARE-BASED COMPENSATION (CONT’D)

The following table summarizes information with respect to options outstanding as of December 31, 2009:


	Options outstanding				Options exercisable
Range of exercise price	Number of options outstanding	Weighted- Average Remaining Contractual life (years)	Weighted- average exercise price	Intrinsic value as of Dec.31, 2009	Number of options exercisable	Weighted- average remaining contractual life (years)	Weighted- Average Exercise Price	Intrinsic value as of Dec.31, 2009
0.01-0.32	2,327,236	4.07	0.13	2,525,607	2,327,236	4.07	0.13	2,525,607
0.42-0.63	1,791,700	5.54	0.58	1,149,630	1,347,700	4.23	0.60	835,210
0.68-0.97	10,461,320	6.36	0.71	5,304,302	6,802,728	5.98	0.70	3,512,752
1.10-1.39	916,700	7.42	1.28	9,492	426,800	7.36	1.28	3,857
1.47-1.60	1,640,245	5.15	1.59	—	1,523,245	4.98	1.60	—
1.73-2.10	527,550	5.82	1.92	—	423,870	5.60	1.95	—
2.27-2.59	1,404,100	6.33	2.48	—	961,860	6.24	2.47	—
2.75-2.82	847,400	6.25	2.80	—	591,140	6.24	2.80	—
3.00-3.37	401,500	6.08	3.11	—	297,800	5.98	3.10	—
4.22-4.55	290,500	6.31	4.42	—	203,350	6.31	4.42	—

	20,608,251	5.95	1.07	8,989,031	14,905,729	5.48	1.04	6,877,426

F-34

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

15. SHARE-BASED COMPENSATION (CONT’D)

The estimated grant date fair values of each option outstanding for employees and non-employees range from $0 to $3.36 and $0.64 to $4.41, respectively. The Company estimates the grant date fair value of stock options using a Black-Scholes option-pricing model.

Employee grants:

The assumptions below are for options with 5 years vesting period after grant date.


	2007	2008	2009
Risk-free interest rates (%) ⁽¹⁾	3.83-5.10	2.71-3.81	3-3.30
Expected life ⁽²⁾	6.4 years	6.4 years	6.4 years
Expected dividend yield (%) ⁽³⁾	—	—	—
Expected volatility (%) ⁽⁴⁾	65	65	65

The assumptions below are for options with 3 years vesting period after grant date.


		2007
Risk-free interest rates (%) ⁽¹⁾		4.97
Expected life ⁽²⁾		3.9 years
Expected dividend yield (%) ⁽³⁾		—
Expected volatility (%) ⁽⁴⁾		65

(1)	The risk-free interest rate is based on the United States Treasury Bill for a term of 5 or 7 years which is approximately consistent with the expected life of the awards.

(2)

The Company uses the simplified method specified in ASC subtopic 718-10 (“ASC 718-10”), Compensation-Stock Compensation: Overall to calculate the expected life of share options because the Company changed the type of employees who receive the share option grants such that its historical exercise data no longer provide a reasonable basis upon which to estimate expected term.

(3)	The Company currently has no history or expectation of paying dividends on its ordinary shares.

(4)	The Company estimated volatility based on the historical volatilities of the Company and comparable public companies for a term which approximate the expected life.

Non-employee grants:


	2007	2008	2009
Risk-free interest rates (%) ⁽¹⁾	4.19-4.78	1.55-3.34	1.47-2.95
Expected life ⁽²⁾	5 years	5 years	5 years
Expected dividend yield (%) ⁽³⁾	—	—	—
Expected volatility (%) ⁽⁴⁾	65	65	65

(1)	The risk-free interest rate is based on the United States Treasury Bill for a term of 5 years consistent with the expected life of the awards.

(2)	The Company uses the vesting term 5 years as the expected life of share options for non-employees.

(3)	The Company currently has no history or expectation of paying dividends on its ordinary shares.

(4)	The Company estimated volatility based on the historical volatilities of the Company and comparable public companies from 2007.

F-35

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

16. RESEARCH AND DEVELOPMENT EXPENSES


	Years ended December 31
	2007		2008		2009
	*(in thousands)*
Research and development	23,888		26,089		28,078
Less: research and development grants	(3,849	)	(1,504	)	(1,714	)

Research and development, net	20,039		24,585		26,364

There is no assurance that the Company will continue to receive research and development grants.

17. TAXATION

(a)

Income taxes

Income taxes of the Group are as follows:


	Years ended December 31
	2007		2008		2009
	*(in thousands)*
Current income tax expense	(5	)	(1	)	(131	)
Deferred income tax benefit /(expense)	104		(304	)	40

Income tax benefit /(expense)	99		(305	)	(91	)

The components of income/(loss) before income taxes are as follows:


	Years ended December 31
	2007		2008		2009
	*(in thousands)*
Income/(loss) arising from China operations	895		(5,731	)	(13,010	)
Loss arising from non-China operations	(2,999	)	(7,603	)	(7,583	)
- U.S.	52		31		25
- Hong Kong	(251	)	(1,298	)	522
- Cayman	(2,800	)	(6,336	)	(8,130	)

Loss before taxes and loss of an unconsolidated affiliate	(2,104	)	(13,334	)	(20,593	)

Income tax benefit/(expense) relating to
China operations	101		(300	)	51
Income tax expense relating to non-China operations	(2	)	(5	)	(142	)
- U.S.	(2	)	(5	)	(11	)
- Hong Kong	—		—		(131	)

	99		(305	)	(91	)

F-36

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

17. TAXATION (CONT’D)

(a)

Income taxes (cont’d)

As of and for the three years ended December 31, 2009, no unrecognized tax benefits or interest and penalties have been recognized.

The Company’s tax years from 2003 through 2009, are still open for examination in various tax jurisdictions. The Company does not anticipate any significant change within 12 months of this report date of its uncertain tax positions.

The People’s Republic of China:

On March 8, 2004, Vimicro China was approved as a “Foreign Investment Advanced Technology Enterprise” by the Ministry of Commerce of the People’s Republic of China, and is entitled to a preferential tax rate at 10% for 3 years from 2006 to 2008. In March 2007, the National People’s Congress adopted the New Enterprise Income Tax Law (“New EIT Law”), which became effective as of January 1, 2008. The above preferential treatment discontinued to be effective under the New EIT Law, thus the 10% income tax rate is not applicable since 2008.

Under the New EIT Law, the enterprise income tax rate for domestic and foreign enterprises is unified at 25% and enterprises established prior to March 16, 2007 that were eligible for preferential tax treatment according to the previously effective PRC EIT Law for Foreign Investment Enterprises and Foreign Enterprises tax laws, administrative regulations and circulars with equivalent effect shall be subject to transitional rules to gradually change their rates to 25%. Certain qualified “high and new technology companies” may be entitled to a 15% preferential tax rate if they meet the definition of “high and new technology enterprise” set out in the Implementation Rules of the New EIT Law. In accordance with the Implementation Rules of the New EIT Law, the preferential tax rate treatments granted to PRC entities that previously qualified for “high and new technology enterprise” will not automatically be applicable under the new tax regime unless they qualify as a “high and new technology enterprise” pursuant to the New EIT Law, its Implementation Rules and relevant working guidance promulgated by the government authorities. Vimicro China obtained the certificate as a “high and new technology enterprise” which is subject to examination every three years and is entitled to a preferential income tax rate of 15% for 2008 to 2010.

Under the New EIT Law, an enterprise established outside of the PRC with effective management located in the PRC is considered a resident enterprise and will be subject to the enterprise income tax on its worldwide income. The Implementation Regulations of the New EIT Law further defines effective management as substantial and overall management and control over production and business operations, personnel, accounting and properties of an enterprise. If the PRC tax authorities subsequently determine that any of the entities in the Group registered outside PRC should be deemed a resident enterprise, they will be subject to a 25% PRC income tax rate on their worldwide income. Also, dividends distributed by these Group entities to their non-China resident shareholders may also be subject to China withholding tax of 10%.

F-37

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

17. TAXATION (CONT’D)

(a)

Income taxes (cont’d)

The People’s Republic of China (cont’d):

Furthermore, under the New EIT Law, dividends payable by a foreign investment enterprise to its foreign non-resident enterprise investors shall be subject to a 10% withholding tax, unless such foreign investor’s jurisdiction of incorporation has signed a tax treaty or arrangement for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income with China that provides for a reduced rate of withholding tax. A subsequent circular issued in January 2008 stipulates that no income tax will be payable on the distribution of earnings of foreign invested enterprises where the relevant earnings were generated prior to January 1, 2008 with dividends distribution declared in 2008 and beyond. However, the income tax withholding rate on earnings generated after December 31, 2007 will be 10% or the applicable treaty rate.

Vimicro China, as an advanced technology enterprise, is entitled to an extra 50% deduction on qualified R&D expenditure. However Vimicro China is required to obtain the approval from related government authority to enjoy the R&D super deduction since year 2008. Vimicro China did not obtain the approval from the government authority in 2008. Accordingly in order to be prudent, Vimicro China does not believe it is more likely than not that it can get the approval in 2009.

The composition of income tax expense relating to China operations is as follows:


	Years ended December 31
	2007	2008		2009
	(in thousands)
Deferred income tax benefit /(expense)	101	(300	)	51

Income tax benefit /(expense)	101	(300	)	51

Cayman Islands

Under the current tax laws of the Cayman Islands, the Company is not subject to tax on income or capital gains. In addition, no Cayman Islands withholding tax will be imposed on payments of dividends by the Company to its shareholders.

United States of America

Viewtel, the subsidiary incorporated in the United States of America, is subject to state income tax and federal income tax at different tax rates, depending upon taxable income levels. Viewtel had income tax expenses of approximately $2,000 $5,000 and $11,000 in 2007, 2008 and 2009, respectively.

F-38

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

17. TAXATION (CONT’D)

(a)

Income taxes (cont’d)

Hong Kong

Subject to certain provisions of the Inland Revenue Ordinance in Hong Kong, A non-Hong Kong person or entity is subject to withholding tax on gross royalty income received or accrued for the use of or right to use certain intellectual property in Hong Kong. Additionally, the Hong Kong payer must withhold if the payer will seek a deduction in Hong Kong for the royalty. Where the royalty is paid to a related party and intellectual property in question has never been owned, wholly or in part, by a person carrying on a business in Hong Kong, the effective rate of withholding rate was 5.25% for the years 2006/07 to 2007/08 and 4.95% in 2008/09 and 2009/10. Vimicro Hong Kong makes royalty payments to Vimicro China for certain technologies licensed from Vimicro China. Vimicro Hong Kong withheld and paid over to the tax authorities in Hong Kong on behalf of Vimicro China certain amounts in respect of prior years. Upon approval by the relevant PRC tax authorities, the amount of withholding tax paid on royalty income to the Hong Kong tax authority can be treated as a foreign tax credit by Vimicro China. Thus, it can be used to offset the tax payable on the same source of income for PRC tax purpose.

Since the year of assessment 2005/2006 (for the assessment year ended 31 December 2005), Vimicro Hong Kong has filed non-taxable offshore claims in its Hong Kong profits tax returns. In December 2009, the Hong Kong Inland Revenue Department (“IRD”) issued the Departmental Interpretation and Practice Notes No. 21(Revised) (“Revised DIPN21”) to redefine the locality of profits. The Company has technical grounds to claim that its profits are sourced offshore Hong Kong and, where duly substantiated by documentation, it is more likely than not that Vimicro Hong Kong’s offshore claim would be accepted by the Hong Kong Inland Revenue Department and the profits of Vimicro HK would therefore not be subject to Hong Kong profit tax. As a result, Vimicro HK would not require a deduction in Hong Kong for the royalty paid to Vimicro China. Furthermore, to the extent that the intellectual property in question is not used in Hong Kong, Vimicro China would not be subject to Hong Kong withholding tax on the royalty income derived from Vimicro Hong Kong.

As a result of Vimicro HK changing its filing basis to offshore, a refund of the tax previously withheld overpaid was applied for in respect of the years of assessment of 2004/2005 and 2005/2006. Accordingly, the Company recorded a withholding tax refundable of approximately $982,000 as of December 31, 2006. In addition, Vimicro Hong Kong reversed all tax account balances related to the onshore filing positions previously taken and recognized a tax benefit of $201,000 for the year ended December 31, 2006, as a result of changing its filing position. The offshore claim of Vimicro Hong Kong is subject to a review by the IRD Hong Kong tax authorities’ review as of December 31, 2009.

Pursuant to relevant PRC tax rule, Vimicro Hong Kong is probably deemed to create a permanent establishment in Mainland China because Vimicro China conducted certain trading activities on behalf of Vimicro Hong Kong in China. Consequently the profits of Vimicro Hong Kong attributable to its permanent establishment in China are probably subject to income tax in PRC. Furthermore according to New EIT Law and related implementation rule effective from January 1, 2008, if the PRC tax authorities subsequently deem Vimicro Hong Kong as a PRC resident enterprise, it will be subject to PRC income tax of 25% on its worldwide income. In order to be prudent, Vimicro Hong Kong accrued PRC income tax expenses of $131,000 for the year ended December 31, 2009.

The following table sets forth the reconciliation between the statutory PRC EIT rate and the effective tax rate for the Group (Prior to 2009, the Company disclosed effective tax rate reconciliation for the Company’s China operations. The Company has restated the presentation for prior periods to conform to the current presentation):

F-39

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

17. TAXATION (CONT’D)

(a)

Income taxes (cont’d)


	Years ended December 31
	2007		2008		2009
Statutory tax rate	33	%	25	%	25	%
Effect of preferential tax treatment	8	%	(8	)%	(1	)%
Additional R&D deduction	1	%	14	%	—
Other permanent differences	(43	)%	(18	)%	(19	)%
Change in tax rate	9	%	(1	)%	—
Change in valuation allowance	(3	)%	(14	)%	(5	)%

Effective income tax rate	5	%	(2	)%	0	%

The tax holidays granted to the entities of the Company have no impact for the three years ended December 31, 2009 as the entities recorded loss in the period.

F-40

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

17. TAXATION (CONT’D)

(b)

Deferred tax

The Group’s significant components of deferred tax assets and liabilities as of year end are as follows:


	As of December 31
	2008		2009
	*(in thousands)*
Deferred tax assets
Provision for doubtful accounts and slow-moving inventories	4		125
Operating loss carry forwards	1,703		2,397
Other accruals	271		470
Difference in tax basis from ViSS acquisition	—		519

Total deferred tax assets	1,978		3,511
Valuation allowance	(1,976	)	(3,508	)

Net deferred tax assets	2		3
Less: Current portion of deferred tax assets	(2	)	(3	)

Deferred tax assets, non-current	—		—


Deferred tax liabilities
Difference in tax basis from ViSS acquisition, current	—		153

Differences in tax basis for property equipment and software, non-current	31		43

Total deferred tax liabilities	31		196

The change in the valuation allowance reported during 2008 includes the impact of a change in judgment regarding the realizability of $281,000 of China deferred tax assets recorded as of December 31, 2007. The change in judgment resulted from the Company’s pre-tax losses incurred in 2008. There were no adjustments of the beginning-of-the-year balances of valuation allowances for the years ended December 31, 2007 and 2009 because of a change in circumstances that caused a change in judgment about the realizability of the related deferred tax assets in future years.

PRC

Subject to the approval of the relevant tax authorities, the Group has tax losses carried forward from its subsidiaries in China totalling approximately $13,996,000 as at December 31, 2009, of which $270,000, $3,682,000 and $10,044,000 will expire in 2012, 2013 and 2014, respectively.

As of December 31, 2008 and 2009, valuation allowances of approximately $1,703,000 and $2,397,000 was provided mainly on the losses carried forward as it is more likely than not that the Group will not be able to utilize the loss carry-forwards before expiration.

As of December 31, 2009, the Group had deferred tax liabilities of US$196,000, of which $153,000 arosed from the ViSS acquisition.

F-41

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

17. TAXATION (CONT’D)

(b)

Deferred tax (cont’d)

USA

Viewtel had no material deferred tax assets and liabilities as of December 31, 2008 and 2009.

Hong Kong

As Vimicro Hong Kong filed for offshore claims in its Hong Kong profit tax returns since the year of assessment 2005/2006, no deferred tax assets and liabilities are recognized.

(c)

PRC Value Added Tax (“VAT”)

According to the value-added tax policy from the relevant tax authorities, the sales of integrated circuits (IC, including mono crystalline silicon chips) by Vimicro China is subject to an output VAT of 17%, while the purchase of products by Vimicro China is subject to an input VAT tax rate of 17%. VAT payable or receivable is the net difference between periodic output VAT and deductible input VAT. On November 5, 2008, the PRC State Council passed The Provisional Regulations of the People’s Republic of China on Value-Added Tax ”New VAT Law”. In accordance with the New VAT Law and its Implementation Rules, which became effective as of January 1, 2009, input VAT on fixed asset purchases are included in the input VAT for VAT payable purposes.

(d)

PRC Business Tax (“BT”)

According to PRC business tax policy, service income generally is subject to BT at 5%. Vimicro Corporation is entitled to BT exemption on income arising from or related to technology transfers provided these technology transfer agreements are registered with the relevant government agencies. Vimicro Corporation also has incidental customer technology service income which is subject to BT at 5%.

In December 2008, the Ministry of Finance and State Administration of Taxation revised the Business Tax Detailed Implementation Rules, under which all entities or individuals that provide labor services within PRC are mandatory payers of BT and the “provision of labor services in China” is defined to mean where either the service provider or the service recipient is located in China. Accordingly the Company incurred additional business tax beginning January 1, 2009 primarily in connection with its PRC subsidiaries’ procurement of overseas intellectual properties and the purchase of the research and development services from Viewtel by Vimicro China.

18. SEGMENT REPORTING

Based on the criteria established by ASC 280 “Segment Reporting”, the Company has determined that the business segments that constitute its primary reporting segments are multimedia processors and surveillance and security products in accordance with the Group’s organization and internal financial reporting structure. As no measures of assets by segment are reported and used by the chief operating decision makers, the Group has not made disclosure of total assets by reportable segment.

F-42

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

18. SEGMENT REPORTING (CONT’D)

Summarized information by business segment for the years ended December 31, 2007, 2008 and 2009 is as follows:


	Years Ended December 31, 2007
	*(in thousands)*
	Multimedia processors		Surveillance and security products	Intersegment elimination*	Consolidated
Revenue	92,753		—	—	92,753
Cost of revenue	(64,290	)	—	—	(64,290	)

Gross profit	28,463		—	—	28,463
Unallocated operating expense					(35,138	)
Unallocated non-operating income, net					4,571
Loss before income tax expense					(2,104	)


	Years Ended December 31, 2008
	*(in thousands)*
	Multimedia processors		Surveillance and security products	Intersegment elimination*	Consolidated
Revenue	86,497		—	—	86,497
Cost of revenue	(61,814	)	—	—	(61,814	)

Gross profit	24,683		—	—	24,683
Unallocated operating expense					(41,919	)
Unallocated non-operating income, net					3,902
Loss before income tax expense					(13,334	)


	Years Ended December 31, 2009
	*(in thousands)*
	Multimedia processors		Surveillance and security products		Intersegment elimination*		Consolidated
Revenue	70,825		2,165		(19	)	72,971
Cost of revenue	(50,607	)	(1,310	)	19		(51,898	)

Gross profit	20,218		855		0		21,073
Unallocated operating expense							(46,514	)
Unallocated non-operating income, net							4,848
Loss before income tax expense							(20,593	)

*	The intersegment eliminations represented the surveillance products Visiondigi sold to Vimicro China in 2009.

F-43

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

18. SEGMENT REPORTING (CONT’D)

The revenue presented below is attributed by country of domicile of the entity that recorded the revenue


	Years Ended December 31
	2007	2008	2009
	*(in thousands)*
Revenue distribution
Mainland China	2,423	1,622	3,392
Hong Kong	90,330	84,875	69,579

	92,753	86,497	72,971

The following table summarizes information regarding the distribution of long-lived assets by geographic region:


	As of December 31
	2008	2009
	*(in thousands)*
Long-lived Assets
Mainland China	13,617	17,779
Hong Kong	3,321	2,838
U.S.A	278	276

	17,216	20,893

The following table summarizes the Group’s revenues for each product class in multimedia processors segment for the years ended December 31, 2007, 2008 and 2009 respectively:


	Years Ended December 31
	2007	2008	2009
	*(in thousands)*
PC camera multimedia products	38,869	36,334	36,802
Image sensors	19,422	17,166	12,101
Mobile phone multimedia processors	24,003	20,284	12,836
Other products	10,459	12,713	9,086

Total multimedia processors	92,753	86,497	70,825

F-44

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

19. COMMITMENTS AND CONTINGENCIES

(a)

Operating lease commitments

The Group entered into various operating lease arrangements with various expiration dates relating to office facilities, corporate apartments and software for research and development. Future minimum lease payments for non-cancelable operating leases as of December 31, 2009 are as follows:


		$ (in thousands)
Payable in:
2010		2,389
2011		160

		2,549

As of December 31, 2009, the Group had no operating lease commitment beyond 2011.

Total rental expense amounted to approximately $1,967,000, $2,538,000 and $3,131,000 for the years ended December 31, 2007, 2008 and 2009, respectively.

(b)

Product purchase commitments

As of December 31, 2009, the Group had commitments to purchase products from suppliers that had not been recognized in the financial statements for approximately $5,112,000 payable within one year.

(c)

Capital commitments

As of December 31, 2009, the Group had commitments to purchase fixed assets that had not been recognized in the financial statements for approximately $198,000 payable within one year.

Vimicro China had executed an agreement in December 2006 with Beijing Haidian Xinhua Agricultural Industrial & Commercial Co., providing that Vimicro China, upon completion of the construction of the office building, shall transfer 35% of the total construction area of the same developed property to the original land users as compensation in kind for expropriation of the land.

In November 2007, Vimicro Shanghai entered into an agreement with Zhangjiang Semiconductor Industry Park Co., Ltd., pursuant to which, in consideration of approximately RMB 42.2 million ($6.2 million), Vimicro Shanghai would acquire land use rights for approximately 21,123 square meters of land in Zhangjiang Hi-Tech Park, Shanghai. Vimicro Shanghai has paid RMB 29.3 million ($4.3 million) for the land use right as of December 31, 2009. The land will be the site of a new building, which will become Vimicro Shanghai’s office building and accommodate a research and development center.

F-45

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

19. COMMITMENTS AND CONTINGENCIES (CONT’D)

(d)

Contingencies

In June 2007, Vimicro Shenzhen entered into an agreement with Shenzhen Municipal Bureau of Land Resources and Housing Management, pursuant to which, in consideration of approximately RMB 6.7 million ($ 1.0 million), Vimicro Shenzhen acquired the land use right for approximately 3,947 square meters of land in Shenzhen High-Tech Industrial Park to build office building and accommodate a research and development center. According to the land use right transfer agreement, Vimicro Shenzhen had to complete construction of the site by June 22, 2009 . As of June 2009, the construction had not commenced. The relevant government agencies received Vimicro Shenzhen’s construction extension application in June 2009 and the extension remained subject to local government agencies’ approval as of December 31, 2009. Vimicro Shenzhen might be subject to the withdrawal of the land use rights with refund of the land consideration after deduction of the monetary penalty amount should the local government agencies deny the application. The potential penalty, if any, cannot be reasonably estimated as of December 31, 2009.

According to the land use right agreements entered by Vimicro Jiangsu, the construction of the proposed research and development center should commence prior to December 31, 2009. Vimicro Jiangsu has not received the land use right certificate and therefore can not commence construction Vimicro Jiangsu is in discussion with the relevant authorities on amending relevant agreements and extension of construction. However, the relevant government authorities could deny the request and impose penalties or fines for the construction delay.

The construction plan of an office building of Vimicro China, indicates that the building will block the sunlight of a kindergarten. It is reasonably possible that Vimicro China will be subject to a claim for compensation by the kindergarten before the government approves the building construction.

F-46

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

20. SUBSEQUENT EVENTS

(a) PRC regulations currently restrict companies with foreign ownership from engaging in the provision of value-added telecommunications service. To comply with the PRC regulations, the Company, through Vimicro China and two of the company’s senior executives, established Vimicro Sky-Vision Technology Corporation (“Vimicro Sky-Vision”), which was established in Beijing, PRC in March 2010 with the two senior executives as the same shareholders (the “Registered Shareholders”), Vimicro Sky-Vision will provide wireless value-added telecommunication services, particularly for the mobile surveillance business.

Vimicro China extended loans of RMB10 million ($1.5 million) in February 2010 to the Registered Shareholders to finance their investments in Vimicro Sky-Vision. Vimicro China does not have direct equity ownership interest in Vimicro Sky-Vision but absorbs the risks and the rewards associated with the investment in Vimicro Sky-Vision through a series of contractual arrangements with Vimicro Sky-Vision and its shareholders. Vimicro Sky-Vision is a variable interest entity (“VIE”) to the Vimicro China, in which it has a variable interest. Vimicro China is the primary beneficiary and will control Vimicro Sky-Vision.

(b) In January 2010, Ningbo Sunny invested RMB 20 million ($2.9 million) in Visiondigi. Vimicro China increased its shareholding for the consideration of RMB 9.85 million ($1.4 million). As of the end of March 2010, Vimicro China, Ningbo Sunny and the three individuals as a group held 50.95%, 26.16% and 22.89% of equity interests in Visiondigi, respectively.

(c) In February 2010, Vimicro China entered into an agreement with Beijing Municipal Bureau of Land and Resources to acquire the construction land use rights for 5,046.52 square meters located in Beijing, PRC. The aggregate consideration for the acquisition of the land use right is RMB39.1 million ($5.7 million) and was fully paid in March, 2010.

(d) In April 2010, Vimicro Shanghai obtained the land use right certificate for the land located in Shanghai, PRC after payment of the remaining consideration of RMB12.9 million ($1.9 million).

F-47

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

21. CONDENSED FINANCIAL INFORMATION OF THE COMPANY

As of December 31, 2008 and 2009, the restricted net assets held by the Group’s consolidated PRC subsidiaries exceeded 25% of the Group’s consolidated net assets.

The separate condensed financial statements of the Company as presented below have been prepared in accordance with Securities and Exchange Commission Regulation S-X Rule 5-04 and Rule 12-04 and present the Company’s investments in its subsidiaries under the equity method of accounting as prescribed in ASC 323 “The Equity Method of Accounting for Investments in Common Stock”. Such investment is presented as “Investment in subsidiaries” on the separate condensed balance sheets of the Company and share of its subsidiaries’ profits or losses as “Share of net profits of subsidiaries” on the separate condensed statements of operations and comprehensive income of the Company.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with US GAAP have been condensed and omitted. The footnote disclosures contain supplemental information relating to the operations of the Company, as such, these statements should be read in conjunction with the notes to the consolidated financial statements of the Company.

The Company did not have significant capital and other commitments, long-term obligations, or guarantees as of December 31, 2008 and 2009.

Regulations in the PRC permit payments of dividends by the Company’s PRC subsidiaries only out of their retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. Subject to certain cumulative limits, a statutory reserve fund requires annual appropriations of at least 10% of after-tax profit, if any, of the relevant PRC subsidiary. The statutory reserve funds are not distributable as cash dividends. As a result of these PRC laws and regulations, the Company’s PRC subsidiaries are restricted in their abilities to transfer a portion of their net assets to the Company. As of December 31, 2008 and 2009, the balance of the Company’s PRC subsidiaries’ statutory reserves was approximately $2,782,000 and $2,782,000, respectively.

Foreign exchange and other regulation in the PRC may further restrict the Company’s PRC subsidiaries from transferring funds to the Company in the form of dividends, loans and advances. The Company has approximately $111,970,000 and $97,487,000 of cash and bank deposits in the PRC as of December 31, 2008 and 2009, respectively, of which approximately $104,685,000 and $89,661,000 are denominated in RMB as of December 31, 2008 and 2009 respectively. The Company’s PRC subsidiaries had restricted cash of $73,157,000 and $132,000 as of December 31, 2008 and 2009 respectively, which was denominated in RMB.

In addition, the registered capital of the Company’s PRC subsidiaries are also restricted.

The Company had restricted net assets of approximately $81,747,000 and $77,200,000 as of December 31, 2008 and 2009, respectively.

F-48

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

21. CONDENSED FINANCIAL INFORMATION OF THE COMPANY (CONT’D)

BALANCE SHEETS

(Amounts expressed in thousands of U.S. dollars, except number of shares data)


	December 31
	2008		2009
Assets
Current assets:
Cash and cash equivalents	25,199		16,306
Marketable equity securities	731		543
Amounts due from subsidiaries	44,957		54,349
Prepayments and other current assets, net	204		245

Total current assets	71,091		71,443
Investment in subsidiaries	65,456		54,867

Total assets	136,547		126,310


Liabilities and Shareholders’ Equity
Current liabilities:
Accrued expenses and other current liabilities	304		324


Shareholders’ equity:
Ordinary shares, $0.0001 par value. 500,000,000 shares authorized, 137,778,145 and 147,643,168 shares issued and outstanding as of December 31, 2008 and December 31, 2009, respectively	14		15
Additional paid-in capital	142,681		151,672
Treasury stock	(1,650	)	(2,664	)
Accumulated other comprehensive income	9,435		9,967
Accumulated deficit	(17,019	)	(35,786	)
Statutory reserve	2,782		2,782

Total shareholders’ equity	136,243		125,986

Total liabilities and shareholders’ equity	136,547		126,310

F-49

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

21. CONDENSED FINANCIAL INFORMATION OF THE COMPANY (CONT’D)

STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(Amounts expressed in thousands of U.S. dollars)


	For the year ended December 31
	2007		2008		2009
Operating expenses:
Research and development, net	(2,240	)	(2,612	)	(3,120	)
Selling and marketing	(654	)	(852	)	(261	)
General and administrative	(2,829	)	(3,872	)	(7,570	)


Loss from operations	(5,723	)	(7,336	)	(10,951	)

Other income:
Interest income	2,623		700		60
Gain on disposal of marketable equity securities	—		—		2,461
Others, net	300		300		300


Loss before share of net profits / (loss) of subsidiaries	(2,800	)	(6,336	)	(8,130	)

Share of net profits / (loss) of subsidiaries, net of taxes	796		(7,304	)	(10,637	)


Net loss	(2,004	)	(13,640	)	(18,767	)


Loss attributed to ordinary shareholders	(2,004	)	(13,640	)	(18,767	)


Other comprehensive income / (loss):

Foreign currency translation adjustment	3,380		4,097		48
Unrealized (loss)/gain on securities	—		(29	)	484


Comprehensive income / (loss)	1,376		(9,572	)	(18,235	)

F-50

VIMICRO INTERNATIONAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

21. CONDENSED FINANCIAL INFORMATION OF THE COMPANY (CONT’D)

STATEMENTS OF CASH FLOWS

(Amounts expressed in thousands of U.S. dollars)


	Years ended as of December 31
	2007		2008		2009
Cash flows from operating activities:
Net loss	(2,004	)	(13,640	)	(18,767	)
Adjustments to reconcile net loss to net cash (used in)/ provided by operating activities:
Share of net (profits)/loss of subsidiaries	(796	)	7,304		10,637
Share-based compensation expense	4,947		6,276		8,955
Gain on disposal of marketable equity securities	—		—		(2,461	)
Changes in assets and liabilities:
Amounts due from subsidiaries	(43,424	)	8,354		(9,390	)
Prepayments and other current assets	22		40		(41	)
Accrued expenses and other current liabilities	95		20		20

Net cash (used in)/ provided by operating activities	(41,160	)	8,354		(11,047	)


Cash flows from investing activities:
Purchase of marketable equity securities	—		(760	)	(627	)
Capital contribution in subsidiaries	(9,000	)	(11,000	)	—
Proceeds from disposal of marketable equity securities	—		—		3,759

Net cash (used in)/ proved by investing activities	(9,000	)	(11,760	)	3,132


Cash flows from financing activities:
Payment for repurchasing of exercised share options	(31	)	—		—
Refund of payment for share option	—		(38	)	—
Repurchase of shares	—		(1,650	)	(1,014	)
Proceeds from exercise of share options	53		25		36

Net cash provided by/(used in) financing activities	22		(1,663	)	(978	)


Net decrease in cash and cash equivalents	(50,138	)	(5,069	)	(8,893	)

Cash and cash equivalents at beginning of year	80,406		30,268		25,199


Cash and cash equivalents at end of year	30,268		25,199		16,306

F-51

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