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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended DECEMBER 31, 1998
[ ] Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the transition period from
________________________ to ______________________
Commission File Number: 0-27246
ZORAN CORPORATION
(Exact Name of registrant as specified in its charter)
DELAWARE 94-2794449
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3112 SCOTT BOULEVARD, SANTA CLARA, CALIFORNIA 95054
(Address of principal executive offices)(Zip code)
(408) 919-4111
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of Exchange on which registered
------------------- ------------------------------------
NONE NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.001 PAR VALUE
(Title of Class)
Indicate by check mark whether registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of registrant's voting stock held by
non-affiliates of registrant based upon the closing sale price of the Common
Stock on March 19, 1999, as reported on the Nasdaq National Market, was
approximately $176,000,000. Shares of Common Stock held by each officer,
director and holder of 5% or more of the outstanding Common Stock have been
excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive
determination for other purposes.
Outstanding shares of registrant's Common Stock, $0.001 par value, as of
March 19, 1999: 10,323,376
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the definitive proxy statement for registrant's 1999 Annual Meeting
of Stockholders to be filed with the Commission pursuant to Regulation 14A
not later than 120 days after the end of the fiscal year covered by this
Report are incorporated by reference into Part III of this Report.
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PART I
THIS REPORT INCLUDES A NUMBER OF FORWARD-LOOKING STATEMENTS WHICH
REFLECT THE COMPANY'S CURRENT VIEWS WITH RESPECT TO FUTURE EVENTS AND FINANCIAL
PERFORMANCE. THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND
UNCERTAINTIES, INCLUDING THOSE DISCUSSED IN "ITEM 7 MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - FUTURE PERFORMANCE
AND RISK FACTORS" AND ELSEWHERE IN THIS REPORT, THAT COULD CAUSE ACTUAL RESULTS
TO DIFFER MATERIALLY FROM HISTORICAL RESULTS OR THOSE ANTICIPATED. IN THIS
REPORT, THE WORDS "ANTICIPATES," "BELIEVES," "EXPECTS," "INTENDS," "FUTURE" AND
SIMILAR EXPRESSIONS IDENTIFY FORWARD-LOOKING STATEMENTS. READERS ARE CAUTIONED
NOT TO PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS, WHICH SPEAK
ONLY AS OF THE DATE HEREOF.
ITEM 1. BUSINESS.
GENERAL
Zoran Corporation develops and markets software, integrated circuits
(ICs) and IC Intellectual Property (IP) cores for digital audio and video
applications enabled by compression. Zoran also provides complete reference
designs based on Zoran's technology. Zoran's product lines and IP include JPEG
codecs, MPEG and DVD decoders, digital audio processors and real-time DVD
software for PCs. All these standard-based products benefit from Zoran's
Standard Plus-TM- technology. The Company's software is bundled by PC and
graphics-card manufacturers for software and software assisted DVD playback on
PCs. The Company's ICs are used in numerous digital audio and video products.
Leading applications incorporating Zoran's products and IP include professional
and consumer video editing systems, filmless digital cameras, standalone and
PC-based DVD players, Super VCD players, digital speakers and audio systems.
Zoran Corporation was incorporated in California in December 1981 and
reincorporated in Delaware in November 1986. Unless the context otherwise
requires, the terms "Zoran" and the "Company," as used in this report, refer to
Zoran Corporation and its consolidated subsidiaries.
INDUSTRY BACKGROUND
Electronic processing of visual images and sound is pervasive in
today's society with televisions, VCRs, computers, and sound systems present in
homes and businesses throughout the developed world. Historically, video images
and audio soundtracks have been transmitted, edited and stored almost
exclusively using analog formats. More recently, however, advances in technology
have allowed video and audio to be processed and stored in digital form. Unlike
analog formats which are inherently unstable and difficult to edit and enhance,
digital formats permit the manipulation of video and audio signals through
digital signal processing ("DSP"), and offer a number of fundamental advantages
over analog technologies. Through complex DSP operations, digital video and
audio signals may be compressed providing significant storage and transmission
efficiencies, they may be filtered allowing for noise reduction, and they may be
transmitted and reproduced without perceptible image or sound degradation.
Digital formats also provide users with additional benefits including random
access to data and superior editing capabilities.
The transition to the use of digital video and audio formats has been
dependent upon continuing technological advances which have steadily improved
the quality and flexibility of digital technology and reduced its cost. Initial
advances in DSP technology took place in military and industrial applications
where high performance and speed were of paramount importance and cost was a
secondary consideration. As costs have decreased and technology has improved,
digital technology has increasingly been applied to commercial and consumer
applications. One of the first applications of digital audio formats in the
consumer electronics market was the digital audio compact disc. The benefits of
digital audio processing led the consumer audio industry to convert from analog
long playing records to digital compact discs resulting in the rapid growth in
the market for compact disc players. Subsequently, digital formats have
increasingly been applied in the development of a variety of consumer
electronics products such as video editing systems, filmless digital cameras,
digital surround sound systems, video conferencing systems, digital cable
television systems, direct broadcast satellite systems, multimedia computer
products, and more recently, DVD players and high definition TV.
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One of the most significant barriers to the widespread acceptance of
digital technology has been the huge amount of data required to represent images
and sounds in a digital format making cost-effective storage or transmission
impractical. For example, storage of an hour-long video program in uncompressed
digital form would require approximately 100 CD-ROMs. Through digital
compression techniques a substantial number of the redundancies inherent in
video and audio data can be identified and eliminated significantly reducing the
overall amount of data which needs to be retained. These compression techniques
allow the same hour long video program which required 100 CD-ROMs for storage to
be compressed and stored on a single CD-ROM. Additionally, digital compression
of video data allows previously unmanageable amounts of data to be stored in the
memory of a standard personal computer thereby permitting the data to be
accessed and edited easily.
To drive the implementation and speed the adoption of compression
technologies, industry participants organized committees to define international
compression standards. Leaders in consumer electronics, computers, and
telecommunications joined together through the International Standards
Organization (the "ISO") to define standards for the compression of still
images, motion video and audio for consumer electronics and broadcast
applications. The first standard adopted was JPEG (Joint Photographic Experts
Group), a standard designed for the high quality compression of still images and
the real-time, low cost compression and decompression (or playback) of moving
images. The first commercial products complying with the JPEG standard were
introduced in 1992. MPEG 1 (Moving Pictures Experts Group), a standard for
compression of both video and audio, was subsequently adopted. MPEG 1 was
designed to allow the high compression ratios necessary for the limited storage
capacity of the CD-ROM format. The first commercial products complying with the
MPEG 1 standard were introduced in 1993. MPEG 2, a compression standard for both
video and audio, was designed to provide improved quality in broadcast and video
playback applications. The MPEG 2 standard is used in digital satellite and
cable TV systems. The first consumer application of the MPEG 2 standard is the
DVD player and the DVD ROM, used in the personal computer. The first commercial
DVD players were introduced in Japan in late 1996 and early 1997. The first DVD
ROMs were introduced in the United States in the summer of 1997. Over 2,000
movie titles are now available in DVD format, and new DVD players and DVD ROMs
aimed at existing and new markets (including Europe, China and Australia) are
continuing to be introduced.
In addition to the ISO standards, industry participants have from time
to time introduced technologies which have become industry standards. In 1992,
Dolby Laboratories, Inc. ("Dolby") launched Dolby AC-3 ("Dolby Digital"), an
audio compression technique which has emerged as an industry standard. Dolby
Digital was developed as a successor to Dolby's Pro-Logic analog technique for
use in multi-channel digital surround sound systems. Dolby Digital has been
principally used in movie theater sound systems and has recently been introduced
in home theater applications. Digital compression of audio data facilitates
enhanced audio playback in video-oriented formats by allowing storage of
additional information in the limited space allocated for audio and facilitates
the seamless integration of sound with compressed video. The Company believes
that Dolby Digital is the most advanced audio compression technique currently
available and will be the principal audio compression technique used in
conjunction with MPEG 2 video compression in DVD players. Dolby Digital has also
been adopted by the High Definition Television ("HDTV") Grand Alliance, and
several large cable television operators have announced their intention to
incorporate Dolby Digital in their cable systems.
Each of these standard compression techniques specify data formats in
which compressed data must be presented in order to enable equipment from
multiple vendors to be integrated into a single system that can transmit and
display the data in digital video and audio forms. These standards do not,
however, specify the compression methodologies to be employed or additional
functionality which may be used to enhance or manipulate digital signals. These
standards therefore, do not determine image or sound quality or compression
efficiency. For example, data compression may comply with relevant standards
despite being poorly processed and containing artifacts which result in image
degradation in video applications or poor sound quality in audio applications.
As a result there can be significant differences in overall image or sound
quality between two solutions based on the same standard. Therefore, integrated
circuit manufacturers and software developers can differentiate their products
through the quality of their compression solution, image enhancement
capabilities and audio effects.
Historically, as system vendors sought compression solutions, the cost,
complexity, and time required to compress and decompress data have imposed
significant limitations on the use of digital compression. Over the last several
years, as cost-effective compression solutions have emerged, product
manufacturers have increasingly sought to
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design and market lower-cost digital video and audio systems and products to
address high volume consumer applications. The current challenge to
manufacturers of compression integrated circuits and software developers is,
therefore, to provide product manufacturers with high-quality,
cost-effective, standards-based solutions.
THE ZORAN SOLUTION
Zoran provides high-quality, cost-effective, standards-based
compression solutions to address a broad range of video and audio applications.
Zoran was a pioneer in the development of high performance DSP products and has
developed expertise in digital signal processing, integrated circuit design,
algorithms and software development, as well as proprietary DSP and compression
technologies. The Company is focused on bringing its multi-disciplinary
expertise and proprietary technologies to bear in the development of compression
solutions for commercial and consumer applications in evolving multimedia
markets. The key elements of Zoran solution are:
STANDARDS-PLUS METHODOLOGY. Zoran has leveraged its broad
multi-disciplinary expertise and proprietary DSP and compression technologies to
develop integrated circuits and software that are fully compliant with industry
compression standards. Zoran's products go beyond industry standards by
improving image and sound quality and allowing more efficient use of memory,
processing and communication resources. This "standards-plus" functionality
includes OEM-programmable effects for audio and user selectable compression
ratios for video.
EXPANDABLE AND PROGRAMMABLE ARCHITECTURE. The Company's integrated
circuits are based on a design that permits easy adaptation for a broad range of
specific applications. This adaptation is achieved through the addition of
modules to, or deletion of modules from, the architecture of the integrated
circuit or modification of the software embedded in the integrated circuit as
well as by the use of ready-to-manufacture "cores" that can be integrated into a
customer's chips. Combined with the enhanced functionality of the Company's
"standards-plus" technology, the Company's expandable and programmable
architecture facilitates product design and upgrades and thereby substantially
accelerates customers' time to market.
COST-EFFECTIVE SOLUTIONS. The Company focuses on reducing the feature
size, power consumption and number of integrated circuits necessary to perform
the required system functions, including the compression functions. This reduces
the cost of manufacturing and operating end products incorporating the Company's
integrated circuits, and permits the use of these products in a broader variety
of high volume applications. In addition, the modular nature of the Company's
architecture lowers the Company's cost of new product development, and the
Company's design engineers work closely with its customers to meet new product
specification requirements within the customers cost parameters.
ALL SOFTWARE TO ALL HARDWARE SOLUTIONS. With recent advances in CPU
speed and capabilities, certain compression functions can be accomplished
through software solutions that replace expensive ICs. Zoran has developed
low-cost compression solutions based solely on real-time software running on
powerful Windows-based PCs, utilizing either Intel or AMD processors. For
customers using slower processors, the Company offers a software navigator which
is used in conjunction with an IC decoder to decode DVD video and audio on the
PC. If a customer is using a medium powered processor to implement this
function, the Company can provide audio only or combined audio and video
decoding capability in a cost-effective, software-only solution using the same
navigator and graphical user interface. Thus, the Company offers its PC
customers a full range of solutions, from hardware-based to software-based,
allowing them to seamlessly change their solutions as their requirements vary
over time.
INTEGRATED SYSTEM SOLUTIONS. Zoran assists its customers in solving
their total system requirements by providing integrated products that combine
hardware and software to address multiple system functions on a single
integrated circuit or chip set, thereby reducing the customers' total system
cost and allowing the customer to concentrate on differentiating its products
from those of its competitors. For example, the Company offers a software
navigator which is used in conjunction with an IC decoder to decode DVD video
and audio on the PC. Another example is the Company's VaddisPlayer reference
product which provides not only the video and audio decoding functions but also
a full design with DVD navigation software running in real-time on a
cost-effective microprocessor.
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STRATEGY
The Company's objective is to be a leading provider of cost-effective,
high-performance digital video and audio solutions addressing selected high
volume applications enabled by compression in evolving multimedia markets. Key
elements of the Company's strategy include:
FOCUS ON HIGH VOLUME APPLICATIONS. The Company's strategy is to focus
on providing compression solutions for manufacturers seeking to design video and
audio products for emerging high volume PC and consumer applications. In
cooperation with leading manufacturers of video and audio equipment in the
commercial and consumer markets, Zoran attempts to identify market segments
which have the potential for substantial growth.
MAINTAIN AND LEVERAGE TECHNOLOGICAL LEADERSHIP. The Company's years of
experience in the fields of DSP, integrated circuit design, algorithms and
software development have enabled it to become a leader in the development of
audio and video solutions enabled by compression. Using its multi-disciplinary
expertise, the Company has developed new technologies for compression of both
video and audio. For example, the Company believes that its proprietary bit rate
control technology has helped the Company provide reliable and inexpensive
JPEG-based video compression and that its implementation of Dolby Digital
technology on a single chip is facilitating the emergence of Dolby Digital as a
standard for multi-channel digital sound. The Company's SoftDVD was the first
software product available for DVD decoding and has enabled PC manufacturers to
offer DVD ROM drives without hardware decoding, significantly reducing the cost
of including the DVD in the PC. The Company intends to continue to invest in
research and development in order to maintain its technological leadership and
leverage its proprietary DSP and compression technologies.
ESTABLISH STRATEGIC PARTNERSHIPS. The Company works closely in the
product development process with leading manufacturers of products that
incorporate the Company's integrated circuits. Potential products are designed
to meet customer-driven product requirements defined jointly by the Company and
its partners with the partner providing technological input and, in selected
cases, a portion of the development funding. This strategy has permitted the
Company to develop products with substantial financial and other assistance
while retaining ownership of the technology and ensuring an established customer
for the product once development is completed. In some cases, the Company's
strategic partners also provide sales and marketing support. The Company has
also established long-term relationships with strategic partners that provide
manufacturing capacity and will seek to develop additional strategic
relationships with manufacturers. See "Research and Development," "Sales and
Marketing" and "Manufacturing" for descriptions of the Company's relationships
with certain of its current strategic partners.
ACCELERATE CUSTOMERS' TIME-TO-MARKET. Being early to market is critical
to a customer's ability to capture market share and therefore to Zoran's ability
to make volume sales to the customer. Zoran works closely with key customers and
provides them early access to its technologies. In addition to providing
integrated solutions, the Company provides its customers with a broad range of
engineering reference boards and products complete with device driver software,
embedded software, and detailed schematics, substantially shortening the
customer's product design time. Zoran's expandable modular architecture also
allows the development of fully compatible upgrade products, which accelerates
its customers' time-to-market and reduces their development costs. The Company
also offers ready-to-manufacture "cores" that can be integrated into chips
manufactured by its OEM customers, allowing these customers to reduce the cost
of custom chip design and accelerate the time-to-market of their products.
THE FOREGOING DISCUSSION OF THE COMPANY'S STRATEGY INCLUDES
FORWARD-LOOKING STATEMENTS. THE COMPANY'S STRATEGY MAY CHANGE AND ITS ACTUAL
RESULTS MAY VARY SUBSTANTIALLY DEPENDING UPON A VARIETY OF FACTORS, INCLUDING
THOSE DESCRIBED IN "ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS -- FUTURE PERFORMANCE AND RISK FACTORS."
MARKETS AND APPLICATIONS
The availability of standards-based digital video and audio compression
technology has facilitated the development of products for a wide variety of
multimedia markets. Typically, new technology is initially adopted by
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manufacturers of relatively expensive products designed primarily for commercial
and high-end consumer applications. As technology becomes less expensive to
produce and is more broadly accepted, manufacturers design lower-cost products
for high-volume consumer applications. Historically, the Company's products have
been implemented principally in commercial and high-end consumer applications.
The Company believes, however, that the markets for its products will
increasingly extend to high volume consumer applications. The Company's products
are currently used in a variety of PC and consumer multimedia applications.
VIDEO EDITING SYSTEMS
Video editing systems are used in the video post-production process to
"cut and paste" video sequences and add special audio and video effects.
Historically, professional video editing systems have been comprised of
expensive pieces of analog video and audio equipment interconnected by means of
various interface devices. Compression technology allows video images to be
stored in a computers' memory in sufficient volume to permit "cut and paste"
editing to be performed through random access to stored images. Since the early
1990s, a number of companies have introduced digital video editing systems
designed for the professional market. Companies such as Avid Technology, Inc.
("Avid"), Digital Processing Systems, Inc., Fast Multimedia, Inc. ("Fast"),
Iomega Corporation ("Iomega"), Matrox Electronic Systems Ltd. ("Matrox"),
Pinnacle Systems GmbH ("Pinnacle") and Truevision Inc. ("Truevision") utilize
the Company's JPEG-based products in their professional video editing systems.
As costs of compression technology have declined, a number of
manufacturers have designed low cost digital video editing equipment. Add-in
boards and software allowing the creation of PC-based video editing systems are
now available with list prices starting under $200. The availability of these
low cost systems has created a new category of users in the corporate, education
and government markets. Add-in boards incorporating the Company's JPEG-based
products are offered by several manufacturers, including Avid, Iomega, Matrox
and Pinnacle.
The availability of universal serial bus ("USB") connectors on most PCs
currently being manufactured creates an opportunity for the development of
low-cost external video capture and editing accessories that can be easily
installed by consumers. The Company has developed a reference design
demonstrating the capture of high-quality video using a small external box based
on the Company's JPEG and software technologies. This solution was recently
adopted by several customers. The Company believes that enhanced support of the
USB port by the Windows 98 operating system and the success of the USB equipped
Apple iMac computer will encourage the development of products of this type.
VIDEO PLAYBACK SYSTEMS
COMPUTER APPLICATIONS. Almost all desktop personal computers now on
the market have accelerated graphics capability, and the Company believes
that most of the PCs sold in 1997 included CD-ROM and audio capabilities. In
1997, DVD-ROM drives began to replace the CD-ROM drives, and the Company
believes that over the next several years DVD-ROMs will replace most of the
CD-ROMs in the PC. MPEG 1 compression technology is currently used to enable
video playback in personal computers equipped with CD-ROM. The high
compression ratios offered by this technology allow over one hour of video to
be stored in digital format on a single CD-ROM. Millions of computers
worldwide are equipped with software for real-time playback of CDs. With
powerful Intel Pentium II processors (and equivalent processors offered by
AMD and Cyrix) becoming more prevalent it is possible to play back on DVD-ROM
equipped PCs high quality DVD disks containing full length movies using
software DVD decoding (MPEG 2 video decoding and Dolby Digital Audio
decoding). The Company's SoftDVD-TM- was the first commercially available
software to decode DVD on the PC in real-time. The Company's SoftDVD-TM-
software is bundled by leading PC, board, and DVD ROM manufacturers, such as
Matrox Graphics, Ltd., Micron Computers, NEC Corporation, NewCom, and Packard
Bell. In addition, some companies are using hardware decoding solutions for
DVD on the PC. The Company's audio IC, integrated DVD decoder IC and PCI
controller are used for these hardware based solutions. During 1998 companies
such as Quadrant International, Matrox Graphics, and Real3D provided hardware
DVD decoding solutions to OEMs and to consumers using Zoran's ICs. The
Company does not anticipate that this market will grow in the future, as
software solutions replace hardware solutions for PC applications.
STAND-ALONE PLAYBACK APPLICATIONS. Currently, three types of
digital video playback systems are available for consumer video applications:
video CD ("VCD") players, Super VCD ("SVCD") players, and DVD players.
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VCD players are essentially CD audio players with MPEG 1 decoders
and a video output. This functionality adds between $50 and $200 to the
retail cost of a typical audio player. VCD players offer video playback of
near-VCR quality and two-channel stereo audio playback. MPEG 1 compression
enables 60 to 70 minutes of video to be stored on a single compact disc. A
number of major film studios have released titles in VCD format. VCD players
can also play karaoke titles and are particularly popular in China, which the
Company believes will continue to be the primary market for these products.
The Company formerly sold MPEG 1-based products to manufacturers of
stand-alone video CD players but is no longer selling these products for this
market. The VCD is a very large market focused in a single country - China.
In an effort to improve the quality of VCD movies, while relying on IP
and definition, the Chinese government has recently defined the SVCD standard.
By utilizing MPEG 2 compression technology as well as graphics, SVCD offers
improvements over VCD in video quality. SVCD aslo offers improved audio quality.
The SVCD standard is rapidly replacing VCD in China. The Company has introduced
an integrated audio and video SVCD decoder IC as well as a full reference SVCD
player and has begun shipments to China.
The latest generation of video playback systems, DVD players, use MPEG
2 video compression and Dolby Digital audio technology to provide significantly
higher quality playback than is possible with either VCD or SVCD players. DVD
players are sold as stand-alone products and are also included in some newer
personal computers (where they are referred to as DVD-ROMs) in place of CD-ROM
drives. DVD-ROMs are also sold as upgrade products. There have been delays in
the development of the DVD market, and there still is uncertainty regarding the
timing of production ramp-up and shipment of DVD players. Initial models of DVD
players were introduced in Japan in late 1996 and to the U.S. consumer market in
early 1997. The growth in the DVD market has been demonstrated by the rapidly
growing sales of DVD players, the increasing number of models and manufacturers,
and the increasing number of DVD titles available for purchase and rental. The
Company's audio products were included in the first generation of DVD players
for Toshiba Corporation ("Toshiba"), the leading manufacturer in the DVD market,
as well as in players offered by Samsung Electronics and Pioneer. The Company's
integrated DVD decoder IC enabled Sharp Electronics ("Sharp") to be the first
company to introduce a second generation DVD decoder. Since then, the Company's
DVD decoders have been integrated in numerous models (including portable models)
under the Sharp and Toshiba names as well as under several original equipment
manufacturers ("OEMs"). Recently, Toshiba announced that it will introduce a
broad range of DVD players in the next several months, all using the Company's
DVD decoder.
DIGITAL AUDIO SYSTEMS
In 1992, Dolby launched Dolby Digital, an audio compression technique
which has emerged as an industry standard. Dolby Digital was developed as a
successor to Dolby's Pro-Logic analog technique for use in multi-channel digital
surround sound systems. Dolby Digital is used in movie theater sound systems and
in home theater applications. Digital compression of audio data facilitates
enhanced audio playback in video-oriented formats by allowing storage of
additional information in the limited space allocated for audio and facilitates
the seamless integration of sound with compressed video. The principal products
using for Dolby Digital audio in the home are DVD players and PCs incorporating
DVD ROMs. In addition, cable and satellite programming companies are planning to
offer multi-channel digital sound through digital television services. Companies
such as Denon, Marantz and Sharp incorporate the Company's Dolby Digital-based
products into equipment used in home theater applications, while Dolby uses
Zoran components in its movie theater playback systems. Digital speakers were
introduced during 1998. These speakers receive compressed data from the PC or
the DVD, decode the information within the speaker system, and then transfer it
directly to the other speakers. Digital speakers improve audio quality due to
reduced noise on the analog lines. In addition, digital speakers enable PC and
consumers to enjoy the benefits of surround sound at affordable prices with
minimal wiring and external boxes. Leading speaker companies like Altec Lansing,
Boston Accoustics and Cambridge Soundworks (a subsidiary of Creative Labs) are
shipping digital speakers based on Zoran's technology. These speakers are
bundled as an option by PC companies like Dell and Gateway or sold directly at
retail stores. As DVD technology becomes increasingly available, the Company
expects consumer demand for Dolby Digital-based home systems and speakers to
increase. The Company believes that the availability of broadcast data in this
form will further increase the demand for Dolby Digital-based systems.
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FILMLESS DIGITAL CAMERAS
In 1990, the Company introduced video compression devices that
facilitated the development of the first filmless digital cameras. These cameras
allow the capture of high resolution images, the viewing, editing and storage of
such images on a computer system and their transmission over telephone lines and
computer networks. High quality copies of these images can be printed using
color laser printers. As technology has advanced and manufacturing costs have
decreased, filmless digital cameras have been introduced in the $500 to $2,000
price-range. Recently, several manufacturers announced filmless digital cameras
with list prices below $300. The Company's JPEG-based products are used in
filmless digital cameras manufactured for the consumer market by companies such
as Samsung and Sony Corporation ("Sony"). The Company believes that consumer
demand for filmless digital cameras will increase as their image quality
improves, they become available at prices approaching those of conventional
single lens reflex cameras, and the evolving desktop multimedia market creates
increasing uses for them. To address this growing market the Company has
developed a highly integrated system on a chip solution for a digital camera -
COACH ("Camera On A CHip"). The Company believes that the COACH and a CCD/CMOS
sensor are an optimal solution for the new generation of high quality, cost
effective digital cameras that will become the main stream of the growing market
over the next several years.
Compression technology has also enabled the development of tapeless
digital video cameras that are currently marketed for professional use. The
Company's JPEG-based products are currently used in tapeless digital video
cameras manufactured by Avid and Ikegami Electronics U.S.A. Inc.
OTHER APPLICATIONS
Other existing and potential applications for audio and video
compression devices include arcade games and video kiosks, digital video,
digital security cameras, and color laser printers and scanners. To date, the
Company has made limited sales to manufacturers developing products for these
markets, and the Company does not anticipate that sales of its integrated
circuits and software for use in these products will account for significant
revenues in the foreseeable future.
THE FOREGOING DISCUSSION OF MARKETS AND APPLICATIONS FOR THE COMPANY'S
PRODUCTS INCLUDES FORWARD-LOOKING STATEMENTS AND THE ACTUAL DEVELOPMENT OF SUCH
MARKETS MAY DIFFER SUBSTANTIALLY DEPENDING UPON A VARIETY OF FACTORS INCLUDING
THOSE DESCRIBED IN "ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS -- FUTURE PERFORMANCE AND RISK FACTORS."
PRODUCTS AND TECHNOLOGY
The Company's multimedia product line consists of three product
families: video compression and decompression products based on JPEG technology;
audio and video decompression products based on MPEG technology; and audio
decompression products for use in products using MPEG or Dolby Digital
technology.
The following table lists the Company's principal multimedia products
currently in production, including the months in which initial production units
were first made available to customers:
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<TABLE>
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INITIAL
COMMERCIAL PRINCIPAL
MARKET PRODUCTS SHIPMENT APPLICATIONS
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<S> <C> <C> <C>
JPEG codec (ZR36050) April 1993 PC video editing, office automation
JPEG PCI multimedia controller (ZR36057) June 1996 PC video editing
JPEG codec (ZR36060) February 1997 PC video editing, security
JPEG JPEG PCI multimedia controller (ZR36067) September 1997 PC video editing
Color space converter (ZR36011) December 1993 PC video editing
Raster-to-block converter (ZR36015)* September 1993 PC video editing
Integrated converter (ZR36016)* February 1995 Color scanners and printers
Digital still camera processor - COACH (ZR36400) February 1999 Filmless digital cameras
- -------------- ------------------------------------------------- ------------------ ------------------------------------
SoftPEG 1, MPEG 1 decoder software (ZR5SPEG1) June 1995 PC-based Video CD
MPEG 1 decoder core (ZR4MPEG1) January 1996 Video CD players
MPEG 1 decoder (ZR36110) February 1996 MPEG 1 networks
PCI multimedia controller (ZR36120) January 1996 Video capture, DVD boards
PCI multimedia controller (ZR36125) March 1997 Video capture, DVD boards
MPEG 2 decoder core (ZR4MPEG2) November 1996 Set top boxes
MPEG SoftPEG 2, MPEG 2/Dolby Digital decoder March 1997 DVD players and
software (ZR5SPEG2) PC-based entertainment
SoftDVD decoder software (ZR5SDVD1) September 1997 DVD playback on PC
Vaddis DVD decoder (ZR36700) December 1997 DVD players
Vaddis III Integrated DVD decoder (ZR36710) August 1998 DVD players
Vaddis-VX DVD decoder for PC (ZR36205) August 1998 DVD on PC
SupraAV SVCD decoder (ZR36215) September 1998 SVCD players
- -------------- ------------------------------------------------- ------------------ ------------------------------------
6-channel Dolby Digital decoder (ZR38500) December 1994 Home theater
2-channel Dolby Digital audio decoder (ZR38501) February 1995 Home theater
2-channel Dolby Digital/MPEG 2 audio decoder February 1995 DVD players and
(ZR38521) Television set-top boxes
Audio Integrated Dolby Digital decoder (ZR38600) December 1996 Digital speakers, home theater
Programmable audio processor (ZR38001) November 1994 Programmable audio effects
SoundPEG audio decoder software (ZRSNDPG) May 1995 PC-based CD players
Programmable Digital audio processor (ZR38601) 1998 Digital speakers, home theater
Programmable Digital audio processor (ZR38650) 1998 Digital speakers, home theater
SoundPEG audio decoder software (ZRSNDPG) May 1995 PC-based CD players
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Designed and manufactured by a third party and sold by Zoran under its
name pursuant to a non-exclusive license. See "Proprietary Rights and
Licenses."
JPEG TECHNOLOGY AND PRODUCTS
THE JPEG STANDARD. In 1991, the JPEG (Joint Photographic Experts Group)
Committee of the ISO completed a technical specification for a standard to
compress individual digitized images which may consist of still images or
consecutive frames of video data. JPEG has been widely adopted for video editing
applications, since each frame in the video is individually compressed, allowing
cutting and pasting of sequences as well as modification of individual frames or
sequences. Images are compressed through elimination of spatial redundancies
within an image and the filtering of high frequency areas to which the eye is
less sensitive. Using these techniques, the JPEG compression standard is able to
reduce the data necessary to represent an image without significant degradation
of image quality. Still images or motion video can be compressed to varying
degrees using JPEG, with greater compression resulting in lower quality.
Typically, four-to-one or five-to-one compression yields broadcast image quality
while 20-to-one compression is similar to VHS quality.
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<PAGE>
ZORAN JPEG TECHNOLOGY. Zoran JPEG technology incorporates a
proprietary bit rate control algorithm that enables its JPEG-based products
to compress any image to a predetermined size while optimizing video quality
using pre-selected parameters. Without this feature, the JPEG compression
process results in compressed data files of various sizes based on the actual
content of the original image given a constant degree of compression. An
image with large amounts of visual detail will generate a larger data file
than that generated from an image with less detail. Performance of many video
applications is hampered by variability in the size of the compressed images
in a video sequence, which can result in inefficient use of available memory,
bus speed or communication channel capacity or even the loss of images.
Zoran's bit rate control is a "standards-plus" solution that uses real-time
DSP algorithms to optimize video quality based on pre-selected parameters,
which can be programmed by OEMs, without the loss of any image or video
frame. Zoran's bit rate control has been incorporated in its JPEG-based
devices that are used in video editing systems, filmless and tapeless digital
cameras, color scanners, PC-based security systems, video conferencing and
other applications. Other features of Zoran's JPEG-based products include
their ability to handle a wide range of compression ratios, to perform a
"lossless" compression algorithm in the same JPEG device and to rapidly scan
or browse a large number of images. Zoran implements these functions in a
single integrated circuit while the Company believes most other
manufacturers' solutions require multiple chips, resulting in higher
manufacturing costs and greater power consumption.
JPEG-BASED PRODUCTS. The Company's ZR36050 and ZR36060 codecs are
compression/decompression devices used for real time encoding and decoding of
JPEG video for video editing applications. They are fully compliant with JPEG
standards. The ZR36050 and ZR36060 utilize the Company's proprietary bit rate
control technology for high quality video capture. The ZR36050 also features
a unique embedded "lossless" mode that allows customers to elect to use low
compression ratio techniques that result in no data loss for applications
where quality is the primary consideration. The ZR36050 and the ZR36060 can
be installed in a chipset that includes the ZR36067 motion controller for PCI
board implementation or pre/post-processing devices such as the ZR36011 color
space converter, ZR36015 raster-to-block converter and the ZR36016 integrated
color space/raster-to-block converter. The ZR36060 integrates the functions
of the ZR36050, ZR36015 and an additional SRAM device in a single chip. The
ZR36067 is a PCI motion JPEG controller targeting consumer-priced but
professional quality desktop PCI video editing systems.
DIGITAL STILL CAMERA TECHNOLOGY. Digital still cameras ("DSCs")
capture a still picture directly into a re-writable digital memory (like
Flash). The pictures are compressed prior to capture and decompressed prior
to being displayed. The display is typically on a built-in LCD display.
Digital cameras can be connected directly to a PC for downloading of pictures
and to a TV for displaying a picture. The Company's JPEG technology is used
in DSC. Recently the Company has introduced the COACH - an integrated system
on a chip solution that includes most of the electronics of a DSC. The COACH
can be connected directly to a high-resolution (up to 4 mega pixel) CCD or
CMOS sensor, process the video information in real time, compress the
captured image in real time to a Flash memory, interface an LCD display and
more. Among the unique capabilities of the COACH is the ability to transfer
in real-time, over a USB bus, high quality video to the PC and thus serve
also as a PC video camera (not only for still images). The COACH also allows
for direct connection to a printer, including color correction and special
effects, for the non-PC consumer environment. The COACH is supplemented by a
full DSC reference design, "Cam ON," shortening the time to market for COACH
customers.
MPEG TECHNOLOGY AND PRODUCTS
THE MPEG STANDARDS. In 1991, the MPEG (Moving Pictures Expert Group)
Committee of the ISO completed a technical specification for a standard to
compress moving video and audio into a single data stream. Like JPEG, MPEG 1
removes spatial redundancies from single frames of video data. MPEG 1
improves on JPEG by also removing redundancies that occur between consecutive
video frames. Because video represents movement, it is possible to detect and
estimate the movement of similar picture elements between video frames, a
process called motion estimation. MPEG motion estimation uses the content of
previous and future frames to predict the content of the current frame
without using its full content. MPEG 1 implements audio compression by
exploiting psycho-acoustic masking, taking advantage of the fact that the ear
is less sensitive to a quiet note at one frequency when a much louder note is
present at a nearby frequency. MPEG 1 often achieves video compression ratios
of over 100-to-one and audio compression ratios of six-to-one. MPEG 1 is
particularly suitable for low-cost CD-ROM applications due to its low-cost
implementation.
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<PAGE>
In 1993, the MPEG 2 video committee completed a technical
specification to address the more stringent requirements of the broadcast
industry. MPEG 2 provides more sophisticated prediction techniques, enabling
a compression solution to comprehend video as interlaced fields of data,
rather than individual frames. MPEG 2 also allows for operation at higher
resolution and at higher bit rates than MPEG 1, resulting in improved image
quality for high motion, high detail video. MPEG 2 typically achieves
compression ratios of 50-to-one. Because of its higher bit rate, MPEG 2
technology cannot be used in standard CD-ROM applications, but can be used in
DVD players.
ZORAN MPEG TECHNOLOGY. Starting in 1997, the Company established
itself as a leading provider of MPEG 2 technology for DVD and SVCD
applications. The Company introduced the first integrated DVD decoder device
used in a stand-alone DVD system and the first real-time software for DVD
decoding on the PC. The Company also introduced new MPEG compression chip
cores that can be integrated into chips manufactured by OEM customers that
enables these customers to reduce the cost of custom chip design and
accelerate the time-to-market of their products.
MPEG-BASED PRODUCTS. In 1997, the Company introduced the first
member of the Company's Vaddis line of DVD decoders, the ZR36700 (Vaddis I).
During 1998, the Company introduced the Vaddis III. The Vaddis decoders
perform all the audio/video decoding requirements of the DVD specification,
including MPEG 2 video and audio decoding, Dolby Digital audio decoding,
on-screen display ("OSD"), decryption required for copyright protection
("CSS") and presentation of graphics information (sub-picture). The Vaddis
has additional computation power that can be utilized for customer
differentiation features. For example, it can incorporate virtual surround
sound algorithms without the addition of hardware. This allows the user to
enjoy the "theater-like" sound obtained from six speakers using a system that
includes only two speakers and the Vaddis. Vaddis DVD decoders are being used
in DVD players manufactured by Sharp, Toshiba and others. The ZR36215
(SupraAV) is the Company's single chip solution for the Super VCD market.
This single chip performs all of the video and audio decoding required by the
SVCD standard and also allows additional features, like Karaoke, to be
implemented without any additional hardware. The Company provides a full
reference design of an SVCD player, based on the ZR36215, that helps its
customers accelerate time to market for their players. The Company's ZR36110
is a single-chip MPEG 1 system and video decoder optimized for use in video
CD playback applications. The ZR36125 PCI multimedia controller enables the
cost-effective integration of high performance multimedia functions in PCI
systems such as MPEG 2 decoding, TV tuner, and video capture. The ZR36125 is
used in PCI DVD decoding boards. The Company also offers chip cores based on
MPEG 1 and MPEG 2 compression standards. The Company believes that its MPEG
hardware designs have a smaller gate count and require less memory than
competing designs, resulting in integrated circuits that offer significantly
lower costs, lower power consumption and higher performance. The Company's
MPEG 1 software decoder, SoftPEG, is designed to offer a low-cost MPEG 1
solution by generating high video and audio quality in a PC environment
without the need for additional hardware. During 1997, the Company introduced
SoftDVD, a full DVD decoding software package designed for use with an Intel
Pentium processor supporting multimedia extension ("MMX") technology. SoftDVD
supports new PC entertainment applications (including the WHQL certified
Direct Show version) without the need for specialized hardware. SoftDVD
includes MPEG 2 video and Dolby Digital audio decoding, tamper-resistant
software, a DVD navigator, a user-friendly graphical user interface and full
support of DVD features. SoftDVD is licensed as a complete package or in
modules that are used by customers in conjunction with hardware decoders
manufactured by the Company or other suppliers. The Company also offers a
motion compensation VLSI core that is licensed to graphics IC companies. This
core, when integrated in graphics chips, enables SoftDVD to run significantly
faster on the PC, thus enhancing the quality of the DVD decoding.
AUDIO TECHNOLOGY AND PRODUCTS
THE DOLBY DIGITAL STANDARD. In 1992, Dolby launched Dolby Digital,
an audio compression technique which has emerged as an industry standard.
Dolby Digital was developed as a successor to Dolby's Pro-Logic analog
technique for use in multi-channel digital surround sound systems. Dolby
Digital has been used in sound systems that have been installed in over
20,000 movie theaters and is also used in home theater applications. Digital
compression of audio data facilitates multi-channel audio playback in
video-oriented formats by allowing storage of additional information in the
limited space allocated for audio. It also facilitates the seamless
integration of sound with compressed video. The Dolby Digital audio
compression technique is currently used as the principal audio compression
technique in DVD players. Dolby Digital has also been adopted by the HDTV
Grand Alliance, and several large cable operators have announced their
intention to incorporate Dolby Digital in their cable systems.
11
<PAGE>
ZORAN AUDIO TECHNOLOGY. Zoran, working very closely with Dolby
Laboratories, has developed a programmable DSP engine with an architecture
optimized for Dolby Digital and other demanding audio applications and was
the first to develop a single-chip solution for Dolby Digital decoding.
Zoran's audio products incorporate the Dolby Digital algorithm for
decompression of multi-channel digital surround sound, along with additional
standards such as Dolby Pro-Logic decoding, Digital Theater System's DTS
multi-channel decode, various layers of MPEG audio decompression and other
functions such as virtual surround, 3D headphones, digital filtering and
equalization. Zoran's programmable audio DSP architecture enables system
manufacturers to reduce system cost through software that allows these
manufacturers to program proprietary functions into Zoran's digital audio
processors and eliminate the need for additional DSP devices and system
components, while maintaining their own differentiation, flexibility and
standards compliance.
AUDIO PRODUCTS. The ZR38601 is a single-chip Digital Audio Processor
for high quality audio systems that can support up to eight digital audio
channels and includes implementation of Dolby Digital, Dolby Pro-Logic, THX
sound processing, and seven virtual surround algorithms. It significantly
reduces digital audio system implementation cost by including in hardware
both a Sony/Philips Digital Interface Format ("S/PDIF") receiver and
transmitter, and a dual audio and system clock which utilized Zoran patented,
wide range phase lock loop technology. The ZR38650 is a true multi-standard
digital audio processor which, in addition to the features of the ZR38601,
also provides decode of Digital Theater System's DTS multi-channel audio
coding, Advanced Audio Coding ("AAC") multi-channel decode, and MPEG 5.1
multi-channel decode. The Company also offers a Dolby Digital core, which
provides full two channel Dolby Digital decode using an extremely small
number of gates, as well as complete two and six channel Dolby Digital
decoding software, which can be bundled with MPEG 2 video chips. The
combination of hardware video and software audio offers a complete DVD
solution for the personal computer which minimizes the processor resources
required to provide high quality DVD playback.
OTHER PRODUCTS
From the Company's inception through 1991, the Company's principal
products consisted of digital filter processors ("DFPs") and vector signal
processors ("VSPs"), which are DSP-based integrated circuits used for image
enhancement and processing, principally in military, industrial and medical
applications. In mid-1994, the Company advised its customers that it was
discontinuing production of these products. In June 1995, the Company
licensed the manufacture of these products to a third party under a
nonexclusive ten-year license agreement. In the future, the Company's
revenues from these products will be principally derived from license
revenues. The Company does not expect these products to produce significant
revenues in future periods. See "Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations."
CUSTOMERS
The following table lists substantially all of the Company's
customers who purchased at least $100,000 of the Company's JPEG, MPEG or
Dolby Digital-based products from January 1, 1998 through December 31, 1998:
12
<PAGE>
<TABLE>
<CAPTION>
- --------------------------- -------------------------------------------- -----------------------------------------
PRODUCT FAMILY CUSTOMERS
- --------------------------- -------------------------------------------- -----------------------------------------
<S> <C> <C>
JPEG-based Products Alpha Systems Lab PAGG Corporation
ATD Electronique Pinnacle Systems GmbH
Avermedia Technologies Pinnacle Systems, Inc.
Digital Processing Systems Inc. Q.S.R. Ltd.
Eastman Kodak Co. Quadrant International Inc.
Edge Electronics Co. Solectron Texas
Electronics for Imaging Solectron Washington, Inc.
Fujifilm Microdevices Co. Ltd. Tekram Technology Co. Ltd.
Hauppauge Computer Works, Inc. The SMT Centre of Texas
Manufacturers' Services Topas Electronics GmbH
Matrox Electronic Systems Ltd. Unique Technologies, Inc.
Matrox Graphics Ltd.
- --------------------------- -------------------------------------------- -----------------------------------------
MPEG-based Products Compaq Computer Corp. Newcom, Inc
Creative Labs Sharp Corporation
Diamond Multimedia Silicon Magic Corp.
Fujifilm Microdevices Co. Ltd. Sun Microsystems, Inc.
Fujitsu Limited Technology Zone
Gallent Computer, Inc. Telecruz Technology, Inc.
Hewlett-Packard Trident Microsystems Inc.
Imaginon Incorporated Vobis AG
Imedia Wyan Micro Electronic Systems
Matrox Electronic Systems Xiamen Xiaxin Electronic Co. Ltd.
Matrox Graphics, Ltd.
Micron Electronics, Inc.
- --------------------------- -------------------------------------------- -----------------------------------------
Audio Products Altec Lansing Technology, Inc. Fujifilm Microdevices Co. Ltd.
Amega Technology N-TEK Incorporated
Boston Acoustics Sigma Designs
Creative Technology Ltd. Unidux Inc.
Dolby Laboratories, Inc Unique Technologies, Inc.
Dooin Electric Co. Ltd
Edge Electronics Co.
- --------------------------- -------------------------------------------- -----------------------------------------
</TABLE>
Fujifilm purchases the Company's products primarily as a distributor
and resells these products, in many cases under its own trade name. Fujifilm
acts as the Company's primary distributor in Japan and accounts for most of
the Company's product sales in Japan. The Company's products are integrated
into products purchased from Fujifilm by consumer products manufacturers,
including Denon, Hitachi, Marantz, Sharp, Sony and Toshiba. See "Sales and
Marketing."
During 1996, sales to Fujifilm accounted for 38% of the Company's
total revenues, including 43% of product sales, sales to Pinnacle GmbH
accounted for 16% of revenues, including 20% of product sales, and sales to
Fast accounted for 5% of revenues, including 6% of product sales. During
1997, sales to Matrox accounted for 15% of the Company's total revenues,
including 14% of product sales, sales to Pinnacle accounted for 15% of
revenues, including 21% of product sales, and sales to Iomega accounted for
15% of revenues, including 20% of product sales. During 1998, sales to
Fujifilm accounted for 23% of the Company's total revenues, including 30% of
product sales and sales to Pinnacle accounted for 14% of revenues, including
19% of product sales. During 1996, 1997, and 1998 the Company's four largest
customers accounted for approximately 61%, 54% and 48% of its revenues,
respectively.
RESEARCH AND DEVELOPMENT
The Company believes that its future success depends on its ability
to continue to enhance its existing products and to develop new products that
maintain technological competitiveness and compliance with new standards in
rapidly evolving video and audio compression markets. The Company attempts to
leverage its expertise in the fields of DSP,
13
<PAGE>
integrated circuit design, algorithms and software development to maintain
its position as a leader in the development of compression solutions.
Accordingly, the Company devotes a significant portion of its resources to
sustaining and upgrading its products to reduce integrated circuit cost,
feature size, power consumption and the number of integrated circuits
required to perform compression functions as well as to provide lower-cost,
software-based solutions for certain compression applications. In addition,
the Company seeks to design integrated circuits and chip cores which can
reduce the time needed by manufacturers to integrate the Company's products
into the manufacturer's products.
Zoran has historically generated a significant percentage of its
total revenues from development contracts with its strategic partners. These
development contracts provide that the Company will receive payments upon
reaching certain development milestones and that the Company will retain
ownership of the intellectual property developed. Development contracts have
enabled the Company to fund portions of its product development efforts, to
respond to the feature requirements of its customers, to accelerate the
incorporation of the Company's products into customer products and to
accelerate the time-to-market of the products the Company's customers. The
Company is currently developing new integrated circuits based on MPEG and
Dolby Digital compression standards pursuant to a development contract with
Fujifilm under which Fujifilm is providing a portion of the development
funding. Fujifilm has participated directly in product definition for these
development programs and will have the right to sell any resulting products
in Japan under its distribution agreement with the Company. Fujifilm will
also have the right to manufacture a portion of the Company's requirements
for these products, subject to certain conditions. In addition, the Company
developed its ZR36120 PCI multimedia controller pursuant to a development
contract with Siemens under which Siemens has provided a portion of the
development funding. See "Products and Technology." Siemens participated
directly in product definition for this product and has the right to purchase
the product as an OEM customer. See "Sales and Marketing" and "Manufacturing."
The Company is a party to certain research and development
agreements with the Chief Scientist in Israel's Ministry of Industry and
Trade (the "Chief Scientist") and the Israel-United States Binational
Industrial Research and Development Foundation ("BIRDF"). These organizations
fund up to 50% of incurred project costs for approved projects up to
specified contract maximums. The agreements require the Company to use its
best efforts to achieve specified results and to pay royalties at rates of 3%
to 5% of resulting product sales and up to 30% of resulting license revenues,
up to a maximum of 100% to 150% of the total funding received. Reported
research and development expenses are net of these grants, which fluctuate
from period to period. Total grants earned during 1996 and 1998 were $182,000
and $851,000, respectively. No grants were earned in 1997. The terms of
Israeli Government participation also contain restrictions on the location of
research and development activities, and the terms of the grants from the
Chief Scientist prohibit the transfer of technology developed pursuant to
these grants to any person without the prior written consent of the Chief
Scientist. The Company is currently engaged in the development of new
JPEG-based digital still camera chip called COACH (Camera On A CHip) under
grant from the Chief Scientist. Although the Company has received grants from
the Chief Scientist and BIRDF in the past, the Company intends to fund future
research and development efforts for new products primarily from its own
funds and through research and development arrangements with its major OEM
customers.
As of December 31, 1998, the Company had a staff of 88 full-time and
22 part-time research and development personnel, 74 of whom are based in
Israel. During 1996, 1997 and 1998, the Company's net research and
development expenses, net of grants from the Chief Scientist and BIRDF, were
approximately $9.0 million, $13.8 million and $13.5 million, respectively.
See "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations."
SALES AND MARKETING
Zoran's sales and marketing strategy is to focus on providing
compression solutions for manufacturers seeking to design video and audio
products for emerging high volume consumer applications. In cooperation with
leading manufacturers of video and audio equipment in the commercial and
consumer markets, Zoran attempts to identify market segments which have the
potential for substantial growth. To implement its strategy, the Company has
established a direct sales force (located at several sales and marketing
offices) and a worldwide network of independent
14
<PAGE>
sales representatives and distributors. In some cases, the
Company's strategic partners also provide sales and marketing support to the
Company.
The Company works closely in the product development process with
strategic partners to incorporate the Company's integrated circuits and
software into their products. Potential products are designed to meet
customer-specific product requirements defined jointly by the Company and its
strategic partners with the partners providing technological input and, in
selected cases, a portion of the development funding. This strategy has
permitted the Company to develop products with substantial financial and
other assistance, while retaining ownership of the technology and ensuring an
established customer for the product once development is completed. In
addition, Zoran's application engineers assist other customers in designing
their products to incorporate the Company's integrated circuits.
The Company's sales are generally made pursuant to purchase orders
received between one and six months prior to the scheduled delivery date. The
Company sells its products, and in certain cases distributes the products of
other companies, primarily through its 12-person direct sales staff, of whom
nine are located in the United States and three are located in Israel. The
Company's United States sales staff is primarily responsible for sales in
North America, South America and Asia, and the Company's Israeli sales staff
is primarily responsible for sales in Europe and the Middle East. In
addition, the Company sells its products indirectly through 23 commissioned
sales representatives as well as certain distributors. The Company typically
warrants its products for a 12-month period. To date, the Company has not
experienced material product returns or warranty expense.
During 1998, the Company opened an office in Shezhen, China as part
of its effort to capture a leadership position in the Chinese digital video
and audio markets. The Company employs 11 people at its China office,
including sales, applications and customer support (software and hardware)
employees.
The Company distributes its integrated circuit products in Japan
primarily under an agreement with Fujifilm. Under this agreement, Fujifilm
acts as the primary distributor in Japan of products developed by the Company
under development contracts with Fujifilm. Fujifilm also sells certain of
these products in Japan under its own name. The Company may sell these
products directly in Japan only to specified customers and must first buy the
products from Fujifilm. Fujifilm also has a nonexclusive license to
distribute most of the Company's products outside of Japan. During 1997, the
Company opened a representative office in Tokyo to help promote its products
in Japan and to manage the sale of products not sold through Fujifilm like
software, VLSI cores and certain JPEG products.
The Company sells its Dolby Digital-based products under a
perpetual, non-exclusive license from Dolby to sell products that incorporate
Dolby's Digital algorithm. The Company is not required to pay license fees or
royalties to Dolby under this agreement. The Company's customers enter into
license agreements directly with Dolby, pursuant to which they pay royalties
to Dolby. Under the Company's agreement with Dolby, the Company may sell its
Dolby Digital-based products only to customers who are licensees of Dolby. To
date, most potential customers for the Company's Dolby Digital-based products
are licensees of Dolby. However, the failure or refusal of potential
customers to enter into license agreements with Dolby in the future could
adversely affect the Company's business, operating results or financial
condition.
The Company licenses the manufacture and distribution of products
incorporating its DFP and VSP technologies to an OEM on a non-exclusive
basis. Under this license arrangement the Company received a one-time payment
and receives royalties on each sale by its licensee. The Company does not
expect to derive significant revenues in future periods from the licensing of
its DFP and VSP technologies.
BACKLOG
Sales of the Company's products are made pursuant to firm purchase
orders. However, the Company at times allows customers to cancel or
reschedule deliveries. In addition, purchase orders are subject to price
renegotiations and to changes in quantities of products ordered as a result
of changes in customers' requirements and manufacturing availability. The
Company's business is characterized by short lead times and quick delivery
schedules. As a result of the foregoing factors, the Company does not believe
that backlog at any given time is a meaningful indicator of future sales.
15
<PAGE>
MANUFACTURING
The Company contracts its wafer fabrication, assembly and testing to
independent foundries and contractors, which enables the Company to focus on
its design strengths, minimize fixed costs and capital expenditures and gain
access to advanced manufacturing facilities. The Company's engineers work
closely with the its foundry partners and subcontractors to increase yields,
lower manufacturing costs and assure quality.
The Company's primary foundries are Taiwan Semiconductor
Manufacturing Company, Ltd. ("TSMC"), which has manufactured certain of the
Company's integrated circuits since 1987, Fujifilm, which has manufactured
certain of the Company's integrated circuits since 1993, and Motorola Inc.
("Motorola"), which has manufactured gate array-based products for the
Company since 1993. In 1996, 1997 and 1998, these three foundries
manufactured substantially all of the Company's products. Fujifilm is
currently manufacturing the Company's JPEG codec, its JPEG-based converter
products and its MPEG 1 decoder. Motorola is currently manufacturing the
Company's motion JPEG controller and PCI multimedia controller, and TSMC is
currently manufacturing the Company's audio and JPEG products. The Company's
independent foundries fabricate products for other companies and may also
produce products of their own design.
All of the Company's devices are currently fabricated using
complementary metal oxide semiconductor ("CMOS") process technology with 0.25
micron to 0.8 micron feature sizes. All of the Company's semiconductor
products are currently being assembled by one of two independent contractors,
ASAT, Inc. ("ASAT") and Anam Industrial ("Anam") and tested by those
contractors or other independent contractors.
Zoran's ZR36050 JPEG codec was developed jointly with Fujifilm and
is currently manufactured by Fujifilm pursuant to an agreement that grants
Fujifilm the right to manufacture up to 80% of the Company's requirements for
this product subject to Fujifilm's ability to manufacture the product on
substantially the same or better terms and conditions as the Company could
obtain from a third party. This agreement also grants Fujifilm certain
marketing rights in Japan with respect to these products. See "Sales and
Marketing."
The Company currently purchases products from all of its foundries
under individually negotiated purchase orders. Zoran's agreement with
Fujifilm entitles Zoran to obtain wafer foundry services from Fujifilm on
most favored pricing and availability terms, subject to Fujifilm's
technological capabilities and reasonable limitations as to quality and
delivery terms requested by Zoran.
The Company does not currently have a long-term supply contract with
TSMC or Motorola, and therefore neither TSMC nor Motorola is obligated to
supply products to the Company for any specific period, in any specific
quantity or at any specified price, except as may be provided in a particular
purchase order.
THE COMPANY'S RELIANCE ON INDEPENDENT FOUNDRIES AND ASSEMBLY AND
TESTING HOUSES INVOLVES A NUMBER OF RISKS, INCLUDING THOSE DESCRIBED IN "ITEM
7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS -- FUTURE PERFORMANCE AND RISK FACTORS."
COMPETITION
The Company's existing and potential competitors include many large
domestic and international companies that have substantially greater
financial, manufacturing, technical, marketing, distribution and other
resources, broader product lines and longer standing relationships with
customers than the Company. Certain of the Company's principal competitors
maintain their own semiconductor foundries and may therefore benefit from
certain capacity, cost and technical advantages. In the market for JPEG-based
products for desktop video editing applications, the Company's principal
competitors are C-Cube Microsystems, Inc. ("C-Cube") and LSI Logic
Corporation ("LSI Logic"). Cirrus Logic (Crystal Semiconductors), Fujitsu
Limited, Motorola, SGS Thomson Microelectronics, NV ("SGS") and Yamaha are
currently shipping Dolby Digital-based audio compression products. C-Cube,
ESS Inc., LSI Logic, Luxonor, Matsushita Electric, Oak Technology Inc., SGS,
Sony and Winbond Electronics Corp. have introduced integrated audio and video
devices for DVD and SVCD applications. These manufacturers, as well as others,
are licensed by Dolby to incorporate Dolby Digital technology in their
products. In addition, certain manufacturers, including Sony, incorporate
compression technologies other than
16
<PAGE>
Dolby Digital in certain audio products that compete with products using the
Company's integrated circuits. In the markets for JPEG-based products for use
in filmless digital cameras, the Company's principal competitors are in-house
solutions used by major Japanese OEMs. LSI and Ricoh Co. Ltd. are providing
system-on-a-chip solutions for DSC to third parties. In the market for
MPEG-based chip core products, the Company's principal competitors are David
Sarnoff Research Center and SICAN Microelectronics Corp. In the market for
the Company's MPEG-based software products, the Company's principal
competitors are Cyberlink Systems Corp., Mediamatics Corporation, Quadrant
International and Xing Technology Corporation. The Company believes that its
ability to compete successfully in the rapidly evolving markets for high
performance video and audio compression technology depends on a number of
factors, including: price, quality, and performance of its products; the
timing and success of new product introductions by the Company, its customers
and its competitors; the emergence of new industry standards; the Company's
ability to obtain adequate foundry capacity; the number and nature of the
Company's competitors in a given market; and general market and economic
conditions.
The markets in which the Company competes are intensely competitive
and are characterized by rapid technological change, declining average unit
selling prices ("ASPs") and rapid product obsolescence. The Company expects
competition to increase in the future from existing competitors and from
other companies that may enter the Company's existing or future markets with
solutions which may be less costly or provide higher performance or more
desirable features than the Company's products.
The DVD market is in its infancy, and additional competitors are
expected to enter the market for DVD players and software. The Company
believes that several large Japanese consumer electronics companies may be
planning to enter this market and may, accordingly, attempt to develop MPEG 2
hardware or software that may be competitive with the Company's products.
Certain of these potential competitors may develop captive implementations
for use only with their own PCs and consumer electronics products. It is also
possible that application software vendors, such as Microsoft Corporation,
may attempt to enter the DVD application market in the future. This increased
competition may result in price reductions, reduced profit margins and loss
of market share.
Historically, ASPs in the semiconductor industry in general, and for
the Company's products in particular, have decreased over the life of a
particular product. The Company expects that the ASPs of its products will
continue to be subject to significant pricing pressures in the future. In
order to offset expected declines in the ASPs of its products, the Company
will likely need to reduce the cost of its products by implementing design
changes that lower the cost of manufacture, assembly and testing, by
negotiating reduced charges by its foundries as and if volumes increase, and
successfully managing its manufacturing and subcontracting relationships.
Since the Company does not operate its own manufacturing, assembly or testing
facilities, it may not be able to reduce its costs as rapidly as companies
that operate their own facilities. The failure of the Company to introduce
lower cost versions of its products in a timely manner or to successfully
manage its manufacturing, assembly and testing relationships would have a
material adverse effect on its business, operating results and financial
condition.
PROPRIETARY RIGHTS AND LICENSES
The Company's ability to compete successfully is dependent in part
upon its ability to protect its proprietary technology and information.
Although the Company relies on a combination of patents, copyrights,
trademarks, trade secret laws and licensing arrangements to protect certain
of its intellectual property, the Company believes that factors such as the
technological and creative skills of its personnel and the success of its
ongoing product development efforts are more important in maintaining its
competitive position. The Company generally enters into confidentiality or
license agreements with its employees, distributors, customers and potential
customers and limits access to its proprietary information. The Company
currently holds several United States patents, and has additional patent
applications pending, that pertain to technologies and processes relating to
the Company's current business. There can be no assurance that the Company's
intellectual property rights, if challenged, will be upheld as valid, will be
adequate to prevent misappropriation of its technology or will prevent the
development of competitive products. Additionally, there can be no assurance
that the Company will be able to obtain patents or other intellectual
property protection in the future. In particular, patents relating to the
establishment, development and maintenance of the MPEG standard are unclear
and may be subject to continuing claims by numerous third parties.
Furthermore, the laws of certain foreign countries in which the Company's
products are or may be developed, manufactured or sold, including various
countries
17
<PAGE>
in Asia, may not protect the Company's products or intellectual property
rights to the same extent as do the laws of the United States and thus make
the possibility of piracy of the Company's technology and products more
likely in these countries.
The Company sells its Dolby Digital-based products under a perpetual
non-exclusive license from Dolby which permits the Company to incorporate
Dolby's Digital algorithm into its products. The Company's customers enter
into license agreements with Dolby pursuant to which they pay royalties
directly to Dolby. Under the Company's agreement with Dolby, the Company may
sell its Dolby Digital-based products only to customers who are licensees of
Dolby. To date, most potential customers for the Company's Dolby
Digital-based products are licensees of Dolby. However, the failure or
refusal of potential customers to enter into license agreements with Dolby in
the future could adversely affect the Company's business, operating results
or financial condition.
The color space converter, raster-to-block converter and integrated
converter sold by the Company under its name are manufactured by Fujifilm and
sold by the Company pursuant to a non-exclusive agreement which expires in
1999. This agreement entitles the Company to purchase these products from
Fujifilm under the most favorable terms and conditions granted by Fujifilm to
its customers.
The semiconductor industry is characterized by vigorous protection
and pursuit of intellectual property rights, which have resulted in
significant and often protracted and expensive litigation. The Company or its
foundries from time to time are notified of claims that the Company may be
infringing patents or other intellectual property rights owned by third
parties. The Company is currently the subject of a pending patent
infringement proceeding. See "Item 3-Legal Proceedings." The Company may be
subject to additional claims in the future. In particular, given the
uncertainty discussed above regarding patents relating to the MPEG standard,
it is difficult for the Company to assess the possibility that its activities
in the MPEG field may give rise to future patent infringement claims.
Litigation by or against the Company relating to patent infringement or other
intellectual property matters could result in significant expense to the
Company and divert the efforts of the Company's technical and management
personnel, whether or not such litigation results in a determination
favorable to the Company. In the event of an adverse result in any such
litigation, the Company could be required to pay substantial damages, cease
the manufacture, use and sale of infringing products, expend significant
resources to develop non-infringing technology, discontinue the use of
certain processes or obtain licenses to the infringing technology. There can
be no assurance that licenses would be offered or that the terms of any
offered licenses would be acceptable to the Company. The failure to obtain a
license from a third party for technology used by the Company could cause the
Company to incur substantial liabilities and to suspend the manufacture of
products, or the use by the Company's foundries of certain processes.
EMPLOYEES
As of December 3l, 1998, the Company had 169 full-time and 32
part-time and contract employees, including 88 full-time and 22 part-time and
contract employees primarily involved in research and development activities,
50 in marketing and sales, 20 in finance and administration and 21 in
manufacturing control and quality assurance. Seventy-five of the Company's
full-time employees and 25 of its part-time and contract employees, including
74 of the personnel who are primarily involved in engineering and research
and development, are based in Israel. There are 84 individuals at the
Company's facilities in Santa Clara, California including 32 employees who
are primarily involved in research and development. The remaining employees
are located in the Company's international offices in Europe, Canada, Japan,
and China. The Company believes that its future success will depend, in large
part on its ability to attract and retain highly-skilled, engineering,
managerial, sales and marketing personnel. Competition for such personnel is
intense. The Company's employees are not represented by any collective
bargaining unit, and the Company has never experienced a work stoppage. The
Company believes that its employee relations are good.
ITEM 2. PROPERTIES.
The Company's executive offices and its principal administration,
marketing and sales operations and a portion of its research and development
operations are located in approximately 24,000 square feet of leased space in
Santa Clara, California under a lease which expires in March 2000. The
Company's principal research and development and engineering facilities and
the balance of its administration, marketing and sales operations are located
in approximately
18
<PAGE>
14,000 square feet of leased space in an industrial park in Haifa, Israel
under a lease which expires in 2002. The aggregate annual gross rent for the
Company's facilities was approximately $887,000 in 1998. See Note 7 of Notes
to Consolidated Financial Statements. The Company believes that its current
facilities are adequate for its needs for the foreseeable future and that,
should it be needed, suitable additional space will be available to
accommodate expansion of the Company's operations on commercially reasonable
terms.
ITEM 3. LEGAL PROCEEDINGS.
On February 26, 1999, the Company was named in a complaint, along with 87
other defendants, brought by the Lemelson Medical, Education & Research
Foundation (the "Lemelson Foundation") in the United States District Court
for the District of Arizona. The complaint alleges infringement of
unspecified claims in some or all of 16 U.S. patents, and seeks both
injunctive relief and unspecified damages, with a request for additional
damages for alleged willful infringement (pursuant to which the court can
award total damages of up to three times the amount of actual damages) and
attorneys' fees. The Company has not yet been formally served with the
complaint, but has been approached by representatives of the Lemelson
Foundation suggesting that it agree to a license with respect to the patents
that are alleged to be infringed. The Company is studying this proposal, and
has also contacted one of its principal IC suppliers concerning possible
indemnification for the Lemelson Foundation's claims.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matter was submitted to a vote of the Company's security holders
during the fourth quarter of the Company's fiscal year ended December 31,
1998.
EXECUTIVE OFFICERS.
The executive officers of the Company are as follows:
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Levy Gerzberg, Ph.D. 53 President, Chief Executive Officer and Director
Aharon Aharon 44 Senior Vice President, Chief Operating Officer
Isaac Shenberg, Ph.D. 47 Senior Vice President, Business and Strategic Development
Paul R. Goldberg 52 Vice President, Audio Products and Intellectual Properties
Karl Schneider 44 Vice President, Finance and Chief Financial Officer
Ronald Richter 46 Vice President, Worldwide Sales
Shmuel Farkash 42 Vice President, Video Products
Paul Farrelle, Ph.D. 39 Vice President, Engineering, U.S.
Alon Ironi, Ph.D. 36 Vice President, Engineering, Israel
</TABLE>
Dr. Gerzberg was a co-founder of the Company in 1981 and has served
as its President and Chief Executive Officer since December 1988 and as a
director since 1981. Dr. Gerzberg also served as the Company's President from
1981 to 1984 and as its Executive Vice President and Chief Technical Officer
from 1985 to 1988. Prior to co-founding the Company, Dr. Gerzberg was
Associate Director of Stanford University's Electronics Laboratory. Dr.
Gerzberg holds a Ph.D. in Electrical Engineering from Stanford University and
an M.S. in Medical Electronics and a B.S. in Electrical Engineering from the
Technion-Israel Institute of Technology (the "Technion") in Haifa, Israel.
Mr. Aharon joined the Company as Vice President, Engineering-Haifa
Operations in February 1997 and was elected Vice President, Engineering in
August 1997 and Senior Vice President and Chief Operating Officer in October
1998. From 1983 to February 1997, Mr. Aharon was employed by IBM in a variety
of engineering and management positions, including Senior Manager of VLSI
Design Tools from 1993 to February 1997 and Design Automation Manager from
1989 to 1993. Mr. Aharon holds a B.S. and M.S. in Electrical Engineering from
the Technion.
Dr. Shenberg has served as Vice President, Sales and Marketing of
the Company since January 1995 and as Senior Vice President, Business and
Strategic Development since October 1998. From August 1990 to January 1995,
Dr. Shenberg served as the Company's Product Line Business Manager. Dr.
Shenberg holds a Ph.D. in Electrical Engineering from Stanford University and
a B.S. and M.S. in Electrical Engineering from the Technion.
Mr. Goldberg joined Zoran as Vice President, Systems Solutions in
June 1996 and was elected Vice President, Audio Products in October 1998.
From April 1991 to June 1996, Mr. Goldberg was employed as film products
group
19
<PAGE>
leader at Dolby Laboratories, Inc. From 1988 to 1990, Mr. Goldberg was
Director of the Tandy Electronic Research Center. From 1979 to 1988, Mr.
Goldberg was employed by Wavetek Incorporated and its spin-off, Advanced
Image Data ("AID"), most recently as Vice President of Research and
Development and Market Development of AID. Prior thereto, Mr. Goldberg was
employed by Smith Kline Instruments, most recently as Director of Biomedical
Research and Development. Mr. Goldberg holds a B.S. in Electrical Engineering
from the University of Minnesota.
Mr. Schneider joined the Company as Corporate Controller in January
1998 and was elected Vice President, Finance and Chief Financial Officer in
July 1998. From September 1996 through 1997, Mr. Schneider served as
Controller for the Film Measurement and Robotics and Integrated Technologies
divisions of KLA-Tencor, a semiconductor equipment company. Mr. Schneider
served as the Corporate Controller for SCM Microsystems, Inc. from October
1995 to September 1996, Controller for Reply Corporation from January 1994 to
September 1995, Director of Finance for Digital F/X from October 1992 to
January 1994 and Controller for Flextronics from September 1987 through June
1991. Mr. Schneider holds a B.S. in Business Administration from San Diego
State University.
Mr. Richter has served as Vice President, Worldwide Sales of the
Company since October 1997. From December 1996 to October 1997, Mr. Richter
served as the Company's Director of North American Sales. Mr. Richter was
employed as Vice President of Sales of Marketing of CompCore Multimedia, Inc.
("CompCore") from July 1995 to December 1996, when CompCore was acquired by
the Company. From January 1994 to June 1995, Mr. Richter was employed as
Director of Technology Licensing at DSP Group. From January 1990 to December
1994, he was employed as Business Manager at Adobe Systems Incorporated. Mr.
Richter holds a B.S. in Electrical Engineering and a M.B.A. from the
University of Southern California.
Dr. Farkash joined Zoran in March 1992 as a senior R&D engineer. In
1994 Dr. Farkash became the marketing and sales manager for Europe. Beginning
in 1996 Dr. Farkash became Director of Marketing for the JPEG product line.
In July 1998 Dr. Farkash became Vice President, Video with responsibilities
for the JPEG and DVD product lines. Dr. Farkash holds a Ph.D., M.S., and a
B.S. in Electrical Engineering from the Technion-Israel Institute of
Technology in Haifa, Israel.
Dr. Farrelle joined the Company in May 1998 as Vice President,
Engineering. Prior to joining the Company Dr. Farrelle served as Vice
President of Engineering at Zapex Technologies from February 1997 to May
1998. From 1988 to February 1997 Dr. Farrelle was employed as a Director and
then Chief Technologist for Optivision, Inc. Dr. Farrelle holds a Ph.D. and
M.S. in Electrical Engineering from the University of California at Davis and
a B.A. in Electrical Sciences from Cambridge University, England.
Mr. Ironi joined the Company as a system engineer in March 1993. Mr.
Ironi subsequently became Manager, System Engineering and Manager,
Architecture and Algorithms. Mr. Ironi was promoted to Vice President of
Engineering-Haifa Operations in January 1999. Prior to Zoran, Mr. Ironi
served as a staff engineer for the Analog Cellular group. Mr. Ironi holds a
B.S. in Electrical Engineering from the Technion.
20
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS.
The Company effected the initial public offering of its Common Stock on
December 15, 1995. Since that date, the Company's Common Stock has been quoted
on The Nasdaq National Market under the symbol "ZRAN." The following table sets
forth the high and low closing sales price of the Company's Common Stock as
reported as The Nasdaq National Market for the periods indicated:
<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
1998:
First Quarter.......................................................$18.25 $12.50
Second Quarter......................................................$14.75 $ 9.50
Third Quarter.......................................................$12.06 $ 5.88
Fourth Quarter......................................................$18.00 $ 5.19
1997:
First Quarter.......................................................$30.75 $15.75
Second Quarter......................................................$26.50 $12.75
Third Quarter.......................................................$28.625 $17.50
Fourth Quarter......................................................$26.625 $11.50
</TABLE>
As of December 31, 1998, there were 352 holders of record of the
Company's Common Stock.
The Company has never paid cash dividends on its capital stock. It is
the present policy of the Company to retain earnings to finance the growth and
development of its business and, therefore, the Company does not anticipate
paying any cash dividends in the foreseeable future.
21
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA.
The following selected consolidated financial data should be read in
conjunction with the consolidated financial statements and the notes thereto
included elsewhere herein.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------
1998 1997 1996 1995 1994
---------- ----------- ------------- ----------- ----------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues:
Product sales................................ $33,465 $32,717 $35,503 $18,086 $ 6,243
Software, licensing and development.......... 10,760 12,210 8,606 5,378 3,256
------- ------- ------- ------- -------
Total revenues............................. 44,225 44,927 44,109 23,464 9,499
------- ------- ------- ------- -------
Costs and expenses:
Cost of product sales........................ 19,036 16,032 20,262 9,306 4,677
Research and development..................... 13,548 13,787 8,954 5,916 4,887
Selling, general and administrative.......... 11,551 11,209 10,739 6,748 4,376
Merger and related........................... -- -- 2,153 -- --
------- ------- ------- ------- -------
Total costs and expenses................... 44,135 41,028 42,108 21,970 13,940
------- ------- ------- ------- -------
Operating income (loss)........................ 90 3,899 2,001 1,494 (4,441)
Interest and other income
(expense), net............................ 1,071 1,258 1,027 (147) (225)
------- ------- ------- ------- -------
Income (loss) before income taxes.............. 1,161 5,157 3,028 1,347 (4,666)
Provision for income taxes..................... 232 928 665 399 229
------- ------- ------- ------- -------
Net income (loss).............................. $ 929 $ 4,229 $ 2,363 $ 948 $(4,895)
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Basic net income (loss) per share (1).......... $ 0.09 $ 0.45 $ 0.27 $ 0.35 $ (4.82)
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Diluted net income (loss) per share (1)........ $ 0.08 $ 0.38 $ 0.22 $ 0.11 $ (4.82)
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Shares used to compute basic net income (loss)
per share (1)............................. 10,042 9,412 8,802 2,391 1,015
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Shares used to compute diluted net income (loss)
per share (1).............................. 11,119 11,072 10,661 8,397 1,015
------- ------- ------- ------- -------
------- ------- ------- ------- -------
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------------
1998 1997 1996 1995 1994
---------- ----------- ------------- ----------- ----------
(in thousands)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, equivalents and short-term investments... $ 19,175 $ 22,376 $ 23,419 $ 21,438 $ 1,743
Working capital (deficit)...................... 30,830 28,582 24,673 19,753 (2,272)
Total assets................................... 49,170 50,944 41,382 31,264 7,205
Long-term debt, less current portion........... -- -- -- 601 1,027
Accumulated deficit............................ (44,176) (45,105) (49,334) (51,697) (52,545)
Total stockholders' equity (deficit)........... 36,186 34,286 28,530 20,917 (1,176)
</TABLE>
- ----------------------
(1) See Note 2 of Notes to Consolidated Financial Statements for a
description of the computation of the number of shares and net
income (loss) per share.
22
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
OVERVIEW
From the Company's inception in 1981 through 1991, the Company derived
the substantial majority of its revenue from DFPs and VSPs used principally in
military, industrial and medical applications. In 1989, the Company repositioned
its business to develop and market data compression products for the evolving
multimedia markets and discontinued development of DFP and VSP products. In
1994, the Company discontinued production of these products, which are not
expected to contribute significant revenues in future periods. The Company's
current lines of multimedia compression products include JPEG-based products
used in video editing systems and filmless digital cameras, MPEG-based products
used in video playback and Dolby Digital-based audio products used in movie and
home theater systems and DVD players.
In December 1996, the Company expanded its compression based product
offerings through the acquisition of CompCore Multimedia, a provider of
software-based compression products and a designer of cores for video and audio
decoder integrated circuits.
Historically, average selling prices ("ASPs") in the semiconductor
industry in general, and for the Company's products in particular, have
decreased over the life of a particular product. Although ASPs for the Company's
hardware products have fluctuated substantially from period to period, these
fluctuations have been driven principally by changes in customer mix (OEM sales
versus sales to distributors) and the transition from low-volume to high-volume
production sales rather than by factors related to product life cycles. During
1997 and 1998, the Company reduced its ASPs on certain products in order to
better penetrate the consumer market. The Company believes that, as its product
lines continue to mature and competitive markets evolve, it is likely to
experience further declines in the ASPs of its products, although the timing and
amount of such future changes cannot be predicted with any certainty. There can
be no assurance that costs will decrease at the same rate as such declines in
ASPs or at all.
The Company sells its products, either directly or through distributors
or independent sales representatives, to OEMs worldwide. Sales prices to
distributors are generally lower than prices for direct sales, as distributors
are responsible for certain sales and marketing expenses, maintenance of
inventories, customer support and training. Lower gross margins on sales to
distributors are partially offset by reduced selling and marketing expenses
related to such sales. Product sales in Japan are primarily made through
Fujifilm, the Company's strategic partner and distributor in Japan. Fujifilm
provides more sales and marketing support than Zoran's other distributors.
Zoran has historically generated a significant percentage of its total
revenues from development contracts, primarily with key customers. These
development contracts have provided the Company with partial funding for the
development of certain of its products. Payments received by the Company under
these development contracts are recorded as development revenue. The Company
classifies all development costs, including costs related to these development
contracts, as research and development expenses. The Company retains ownership
of the intellectual property developed by it under these development contracts.
While the Company intends to continue to enter into development contracts with
certain strategic partners, it expects development revenue to decrease as a
percentage of total revenues.
The Company is a party to certain research and development agreements
with the Chief Scientist and BIRDF, which fund up to 50% of incurred project
costs for approved products up to specified contract maximums. These agreements
require the Company to use its best efforts to achieve specified results and
require the Company to pay royalties at rates of 3% to 5% of resulting product
sales, and up to 30% of resulting license revenues, up to a maximum of 100% to
150% of total funding received. Reported research and development expenses are
net of these grants, which fluctuate from period to period.
The Company conducts a substantial portion of its research and
development and certain sales and marketing and administrative operations in
Israel through its wholly-owned Israeli subsidiary. As a result, certain
expenses are incurred in Israeli shekels. Until May 1995, substantially all of
the Company's product sales were made from the Company's U.S. facility. In May
1995, the Company restructured its manufacturing and sales organizations and
began
23
<PAGE>
selling a portion of its products directly from its facility in Israel. To
date, substantially all of the Company's product sales and its development
and licensing revenue have been denominated in U.S. dollars and most costs of
product sales have been incurred in U.S. dollars. The Company expects that
most of its sales and costs of sales will continue to be denominated and
incurred in U.S. dollars for the foreseeable future. The Company has not
experienced material losses or gains as a result of currency exchange rate
fluctuations and has not engaged in hedging transactions to reduce its
exposure to such fluctuations. The Company intends to actively monitor its
foreign exchange exposure and to take appropriate action to reduce its
foreign exchange risk, if such risk becomes material.
RESULTS OF OPERATIONS
The following table sets forth certain consolidated statement of
operations data as a percentage of total revenues for the periods indicated:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------
1998 1997 1996
----------- ------------- -----------
<S> <C> <C> <C>
Revenues:
Product sales................................................ 75.7% 72.8% 80.5%
Software, licensing and development.......................... 24.3 27.2 19.5
------- ------- -------
Total revenues............................................. 100.0 100.0 100.0
------- ------- -------
Costs and expenses:
Cost of product sales........................................ 43.0 35.7 45.9
Research and development..................................... 30.7 30.7 20.3
Selling, general and administrative.......................... 26.1 24.9 24.3
Merger and related........................................... -- -- 4.9
------- ------- -------
Total costs and expenses................................... 99.8 91.3 95.4
------- ------- -------
Operating income.................................................. 0.2 8.7 4.6
Interest expense.................................................. -- -- (0.3)
Interest and other income, net.................................... 2.4 2.8 2.6
Income before income taxes........................................ 2.6 11.5 6.9
Provision for income taxes........................................ 0.5 2.1 1.5
------- ------- -------
Net income ....................................................... 2.1% 9.4% 5.4%
------- ------- -------
------- ------- -------
</TABLE>
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
REVENUES. Total revenues decreased by 1.6% to $44.2 million in 1998
from $44.9 million in 1997. Product sales increased by 2.3% to $33.5 million
in 1998 from $32.7 million in 1997. The increase in product sales resulted
primarily from increased unit sales of DVD and SCVD products. Software,
licensing and development revenues decreased by 11.9% to $10.8 million in
1998 from $12.2 million in 1997. This decrease was due to a reduction in
SoftPEG royalties.
Product sales consist of revenues from sales of the Company's
integrated circuits. Software, licensing and development revenue consists of
revenue from license and royalty agreements, primarily for audio and video
decoder software, that generally provide for the license of software for a
specified period of time for either a single fee or a fee based on the number of
units distributed by the licensee. Development revenue is derived from hardware
design contracts that provide for license and milestone payments to be made at
specified times.
24
<PAGE>
PRODUCT GROSS PROFIT. Product gross margin decreased by 15.5% to 43.1%
in 1998, compared to 51.0% in 1997. The decrease was due to a product sales mix
that included an increased percentage of lower margin products, and higher
manufacturing costs during 1998.
Product gross profit consists of product sales less cost of product
sales. Cost of product sales consists primarily of fabrication costs, assembly
and test costs, and the cost of materials and overhead from operations. The
Company's product gross margin is dependent on product mix and on the percentage
of products sold directly to the Company's OEM customers versus indirectly
through its marketing partners who purchase the Company's products at lower
prices but absorb most of the associated marketing and sales support expenses.
The Company expects product and customer mix to continue to fluctuate in future
periods, causing further fluctuations in margins.
RESEARCH AND DEVELOPMENT. Research and development ("R&D") expenses
decreased by 1.7% to $13.5 million in 1998 from $13.8 million in 1997. R&D
expenses in 1998 were net of reimbursements in the amounts of $851,000 under
product development agreements with the Chief Scientist. There were no such
reimbursements during 1997. Gross R&D expenses increased as a result of the
Company's planned enhancement to its technology and development capabilities.
R&D expenses decreased as a percentage of total revenues to 30.6% in 1998,
compared to 30.7% in 1997.
R&D expenses consist of salaries and related costs of employees engaged
in ongoing research, design and development activities and costs of engineering
materials and supplies. The Company continues to believe that significant
investments in R&D are required for it to remain competitive and expects to
continue to devote significant resources to product development, although such
expenses as a percentage of total revenues may fluctuate.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and
administrative ("SG&A") expenses increased by 3.1% to $11.5 million in 1998 from
$11.2 million in 1997. The increase was primarily due to increased sales and
marketing expenses related to product market development and to support planned
revenue growth in China.
SG&A expenses consist primarily of employee-related expenses,
royalties, sales commissions, product promotion and other professional services.
The Company expects that SG&A expenses will continue to increase to support the
anticipated growth of the Company.
INTEREST AND OTHER INCOME (EXPENSE), NET. Net interest and other income
decreased by 14.9% to $1.1 million in 1998 from $1.3 million in 1997. The
decrease resulted primarily from decreased interest income as a result of lower
balances of cash, cash equivalents and short-term investments.
PROVISION FOR INCOME TAXES. The Company's estimated effective tax rate
increased to 20.0% for 1998 from 18.0% in 1997. The increase reflects the
Company's income tax expectation going forward.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
REVENUES. Total revenues increased by 1.8% to $44.9 million in 1997
from $44.1 million in 1996. Product sales decreased by 7.8% to $32.7 million in
1997 from $35.5 million in 1996. The decreases in product sales resulted
primarily from unit sales and revenue decreases for the Company's Dolby Digital
audio compression ICs due to delays in the development of the DVD market. These
decreases were partially offset by unit sales and revenue increases for the
Company's JPEG-based products used in desktop video editing. Software, licensing
and development revenues increased by 41.9% to $12.2 million in 1997 from $8.6
million in 1996. This increase was due to significant new licensing contracts
for software and hardware design as well as progress on long-term development
contracts in place from the prior year.
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PRODUCT GROSS PROFIT. Product gross margin increased by 18.9% to 51.0%
in 1997, compared to 42.9% in 1996. The increase was due to a product sales mix
that included an increased percentage of higher margin products, an increased
percentage of products sold directly to OEM customers and lower manufacturing
costs during 1997.
RESEARCH AND DEVELOPMENT. Research and development ("R&D") expenses
increased by 53.9% to $13.8 million in 1997 from $8.9 million in 1996. The
increase was a result of the planned enhancement of the Company's technology and
development capabilities in conjunction with the Company's growth in general and
its increased software, licensing and development revenue. R&D expenses in 1996
were net of reimbursements in the amounts of $182,000 under product development
agreements with the Chief Scientist. There were no such reimbursements during
1997. R&D expenses increased as a percentage of total revenues to 30.7% in 1997,
compared to 20.3% in 1996.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and
administrative ("SG&A") expenses increased by 4.4% to $11.2 million in 1997 from
$10.7 million in 1996. The increase was primarily due to increased sales and
marketing expenses related to product market development and to support planned
revenue growth.
MERGER AND RELATED EXPENSES. Total costs and expenses in 1996
include non-recurring merger and related expenses of $2.2 million. These
expenses related to the acquisition of CompCore in December 1996 and included
professional fees, other direct transaction costs and other merger-related
costs associated with combining the operations of the two companies.
INTEREST AND OTHER INCOME (EXPENSE), NET. Net interest and other income
increased by 22.5% to $1.3 million in 1997 from $1.0 million in 1996. The
increase resulted primarily from decreased interest expense as a result of the
repayment of the Company's remaining debt during 1996.
PROVISION FOR INCOME TAXES. The Company's estimated effective tax rate
decreased to 18.0% for 1997 from 22.0% in 1996. The decrease was primarily due
the tax benefits derived from revenue and net income attributable to the
Company's operations in Israel which receives favorable tax treatment.
LIQUIDITY AND CAPITAL RESOURCES
Until the initial public offering of its common stock (the "IPO") in
December 1995, the Company had financed its operations primarily through private
placements of equity securities and, to a lesser extent borrowings from banks
and its stockholders. Net proceeds from the IPO and the exercise of certain
warrants in connection with the IPO and net proceeds from the exercise of the
underwriters' over-allotment option in January 1996 totaled $21.0 million. At
December 31, 1998, the Company had $8.2 million of cash and cash equivalents,
$11.0 million of short-term investments and $30.8 million of working capital.
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The Company's operating activities used cash of $2.4 million in 1998,
and provided cash of $1.8 million in 1997 and $1.4 million in 1996. Cash
provided by operating activities reflected net income excluding charges for
depreciation and amortization, offset by cash used for working capital.
The Company's capital expenditures totaled $1.8 million in 1998, $3.6
million in 1997 and $3.5m in 1996. Capital expenditures for 1999 are expected to
be approximately $2.8 million. The Company had no bank debt at December 31, 1998
or at December 31, 1997.
The Company believes that its current balances of cash, cash
equivalents and short-term investments, together with existing sources of
liquidity and anticipated cash flow from operations, will satisfy the Company's
anticipated working capital and capital equipment requirements through 1999.
STOCK OPTION REPRICING
In August 1998, employees of the Company were offered the opportunity of
repricing their options. Repricing was conditional on employees accepting the
restart of their vesting schedule. The vesting schedule would however, revert
back to the original schedule if the Company met significant performance
goals. Substantially all options with an exercise price in excess of $5.94
were cancelled and replaced with new options having an exercise price of
$5.94, the market price on the date that the employees accepted the
repricing. A total of 924,164 shares were repriced.
MARKET RISK DISCLOSURE
Zoran is exposed to financial market risks including changes in
interest rates and foreign currency exchange rates.
The fair value of Zoran's investment portfolio or related income would
not be significantly impacted by either a 10% increase or decrease in interest
rates due mainly to the short term nature of the major portion of the Company's
investment portfolio.
A majority of the Company's revenue and capital spending is
transacted in U.S. dollars, although some of these transactions are
denominated in Israeli Shekels. The Company has not engaged in hedging
transactions to reduce its exposure to fluctuations that may arise from
changes in foreign exchange rates. Based on the Company's overall currency
rate exposure at December 31, 1998 a near-term 10% appreciation or
depreciation would have an immaterial affect on the Company's operating
results or financial condition.
FUTURE PERFORMANCE AND RISK FACTORS
THE COMPANY'S FUTURE BUSINESS, OPERATING RESULTS AND FINANCIAL
CONDITION ARE SUBJECT TO VARIOUS RISKS AND UNCERTAINTIES, INCLUDING THOSE
DESCRIBED BELOW.
PRODUCT CONCENTRATION; EVOLVING MARKETS. Since the Company's markets
are still evolving, only a limited number of commercial and consumer products
that incorporate the Company's integrated circuits are currently in volume
production. Current applications for the Company's products and IP include
professional and consumer video editing systems, filmless digital cameras,
standalone and PC-based DVD players, Super VCD players, digital speakers and
audio systems. During 1994 and 1995, the Company derived a majority of its
product revenues from the sale of integrated circuits for video editing
applications. Video editing applications continued to account for the largest
percentage of the Company's product sales in 1997 and 1998. The Company
expects that sales of its devices for video capture and editing applications
and digital audio applications will continue to account for a significant
portion of its revenues for the near future. Over the longer term, the
Company's ability to generate increased revenues will be dependent on the
expansion of sales of its products for use in other existing applications, as
well as the development and acceptance of new applications for the Company's
technologies and products. The potential size of the markets for new
applications and the timing of their development and acceptance is uncertain.
The Company's future success will depend upon whether manufacturers select
the Company's integrated circuits and software for incorporation into their
products, and upon the successful marketing of these products by the
manufacturers. There can be no assurance that demand for existing
applications will be sustained, that new markets will develop or that
manufacturers developing products for any of these markets will design the
Company's integrated circuits into their products or successfully market
them. The failure of existing and new markets to develop or to be receptive
to the Company's products would have a material adverse effect on the
Company's business, operating results and financial condition.
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The emergence of markets for the Company's products will be affected by
a variety of factors beyond the Company's control. In particular, the Company's
products are designed to conform with certain current industry standards. There
can be no assurance that manufacturers will continue to follow these standards
or that competing standards will not emerge which will be preferred by
manufacturers. The emergence of markets for the Company's products is also
dependent in part upon third-party content providers developing and marketing
content for end user systems, such as video and audio playback systems, in a
format compatible with the Company's products. There can be no assurance that
these or other factors beyond the Company's control will not adversely affect
the development of markets for the Company's products. See "Item 1. Business --
Strategy" and "-- Markets and Applications."
RELIANCE ON INDEPENDENT FOUNDRIES AND CONTRACTORS. The Company does not
operate any manufacturing facilities, and from time to time shortages of foundry
capacity develop for certain process technologies in the semiconductor industry.
The Company currently relies on independent foundries to manufacture
substantially all of its products. The Company's independent foundries fabricate
products for other companies and may also produce products of their own design.
The Company does not have a long-term supply contract with either TSMC or
Motorola, its principal suppliers, and, therefore, neither TSMC nor Motorola is
obligated to supply products to the Company for any specific period, in any
specific quantity or at any specified price, except as may be provided in a
particular purchase order. See "Item 1. Business -- Manufacturing."
The Company's reliance on independent foundries involves a number of
risks, including the inability to obtain adequate capacity, the unavailability
of or interruption in access to certain process technologies, reduced control
over delivery schedules, quality assurance, manufacturing yields and cost, and
potential misappropriation of the Company's intellectual property. The Company
obtains foundry capacity through forecasts that are generated in advance of
expected delivery dates and places its purchase orders up to three months prior
to scheduled delivery. The Company's ability to obtain the foundry capacity
necessary to meet the future demand for its products is based in part on its
ability to accurately forecast future demand. Due to periodic limitations on
semiconductor foundry capacity, if the Company fails to accurately forecast its
future demand, the Company may be unable to obtain adequate supplies of
integrated circuits on a timely basis. There can be no assurance that the
Company will be able to accurately forecast the future demand for its products
or obtain sufficient foundry capacity in the future. In addition, the Company's
obligation to place purchase orders in advance of delivery subjects the Company
to inventory risks, including the risk of obsolescence. While the Company has
not experienced any material disruptions in supply to date, there can be no
assurance that manufacturing problems will not occur in the future. In the event
that any of the Company's foundries are unable or unwilling to produce
sufficient supplies of the Company's products, in required volumes at acceptable
costs, the Company will be required to reallocate production among its other
existing foundries or to identify and qualify acceptable alternative foundries.
This qualification process could take six months or longer, and no assurance can
be given that any additional source would become available to the Company or
would be in a position to satisfy the Company's production requirements on a
timely basis. The loss of any of the Company's foundries as a supplier, the
inability of the Company in a period of increased demand for its products to
expand supply or the Company's inability to obtain timely and adequate
deliveries from its current or future suppliers could reduce or delay shipments
of the Company's products. Any of these developments could damage relationships
with the Company's current and prospective customers and have a material adverse
effect on the Company's business, operating results or financial condition.
All of the Company's semiconductor products are currently being
assembled by one of two independent contractors, ASAT and Anam, and tested by
those contractors or other independent contractors. See "Item 1. Business --
Manufacturing." The Company's reliance on independent assembly and testing
houses limits its control over delivery schedules, quality assurance and product
cost. Disruptions in the provision of services by the Company's assembly or
testing houses or other circumstances that would require the Company to seek
alternative sources of assembly or testing could lead to supply constraints or
delays in the delivery of the Company's products. These constraints or delays
could damage relationships with current and prospective customers and have a
material adverse effect on the Company's business, operating results or
financial condition.
NEW PRODUCT DEVELOPMENT AND TIMELY INTRODUCTION OF NEW AND ENHANCED
PRODUCTS. The markets for the Company's products are characterized by rapidly
changing technologies, evolving industry standards, frequent new product
introductions and short product life cycles. The Company expects to increase its
expenses relating to product
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development, and its future success will depend to a substantial degree upon
its ability to develop and introduce, on a timely and cost-effective basis,
new and enhanced products that meet changing customer requirements and
industry standards. The development and introduction of new semiconductor
products is a complex and uncertain process requiring high levels of
innovation, the accurate anticipation of technological and market trends, the
successful and timely completion of product development, the ability of the
Company to convince its customers to incorporate the Company's products into
the design of their own products, the securing of sufficient foundry capacity
and the achievement of acceptable wafer yields by the Company's independent
foundries. Development of new product designs can often require significant
expenditures by the Company, which expenditures may precede volume sales of
the new product, if any, by a year or more. In addition, software products as
complex as those offered by the Company typically contain undetected errors
or failures when first introduced or as new versions are released.
Accordingly, there can be no assurance that, despite testing by the Company
and by current and potential customers, errors will not be found after
commencement of commercial shipments, resulting in loss of or delay in market
acceptance which, in turn, could have a material adverse effect upon the
Company's business, operating results and financial condition. The
introduction of new or enhanced products also requires the Company to manage
the transition from older products in order to minimize disruption in
customer ordering patterns, avoid excessive levels of older product
inventories and ensure that adequate supplies of new products can be
delivered to meet customer demand. There can be no assurance that the Company
will successfully develop, introduce or manage the transition to new
products. Future delays in the introduction or shipment of new or enhanced
products, the inability of such products to gain market acceptance or
problems associated with new product transitions could adversely affect the
Company's business, operating results and financial condition. See "Item 1.
Business -- Industry Background" and " -- Research and Development."
COMPETITION; PRICING PRESSURES. The Company's existing and potential
competitors include many large domestic and international companies that have
substantially greater financial, manufacturing, technical, marketing,
distribution and other resources, broader product lines and longer standing
relationships with customers than the Company. The markets in which the Company
competes are intensely competitive and are characterized by rapid technological
change, declining ASPs and rapid product obsolescence. There can be no assurance
that the Company's products will continue to compete favorably or that the
Company will be successful in the face of increasing competition from new
products and enhancements introduced by existing or new competitors. In
addition, increased competition may result in price reductions, reduced margins
and loss of market share, any of which could have a material adverse effect on
the Company's business, operating results and financial condition. See "Item 1.
Business -- Competition."
CUSTOMER CONCENTRATION; CHANGES IN CUSTOMER MIX. The Company's largest
customers have accounted for a substantial percentage of its revenues, and sales
to these large customers have varied materially from year to year. See "Item 1.
Business -- Customers." There can be no assurance that the Company will be able
to retain its key customers or that such customers will not cancel purchase
orders or reschedule or decrease their level of purchases. In addition, sales to
these key customers may fluctuate significantly from quarter to quarter. Any
development that would result in a substantial decrease or delay in sales to one
or more key customers, including actions by competitors or technological
changes, could have a material adverse effect on the Company's business,
operating results or financial condition. In addition, any development that
would adversely affect the collectability of account balances from one or more
key customers could have a material adverse effect on the Company's business,
operating results or financial condition.
FLUCTUATIONS IN OPERATING RESULTS; NET OPERATING LOSS CARRYFORWARDS.
The Company's quarterly operating results have varied significantly due to a
number of factors, including the timing of new product introductions by the
Company and its competitors, market acceptance of new and enhanced versions of
the Company's products and products of its customers, the timing of large
customer orders, the availability of development funding and the timing of
development revenue, changes in the mix of products sold, and competitive
pricing pressures. The Company expects that its operating results will fluctuate
in the future as a result of these factors and a variety of other factors,
including the availability of adequate foundry capacity, fluctuations in
manufacturing yields, the emergence of new industry standards, product
obsolescence, changes in pricing policies by the Company, its competitors or its
suppliers, the cyclical nature of the semiconductor industry, the evolving and
unpredictable nature of the markets for products incorporating the Company's
integrated circuits and software and the amount of research and development
expenses associated with new product introductions. The Company's operating
results could also be adversely affected by economic conditions generally or in
various geographic areas where the Company or its customers do business, other
conditions affecting the timing of customer orders, a downturn in the markets
for its customer's products, particularly
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the consumer electronics market, or order cancellations or reschedulings.
These factors are difficult or impossible to forecast, and these or other
factors could materially affect the Company's quarterly or annual operating
results. The Company places orders to purchase its products from independent
foundries several months in advance of the scheduled delivery date, often in
advance of receiving non-cancelable orders from its customers. If anticipated
shipments or development revenue in any quarter are canceled or do not occur
as quickly as expected, expense and inventory levels could be
disproportionately high. A significant portion of the Company's expenses is
relatively fixed, and the timing of increases in expenses is based in large
part on the Company's forecast of future revenues. As a result, if revenues
do not meet the Company's expectations it may be unable to quickly adjust
expenses to levels appropriate to actual revenues, which could have a
material adverse effect on the Company's business, operating results or
financial condition. To date, the Company's operating results have not been
materially affected by seasonal factors. However, as markets for consumer
products incorporating the Company's integrated circuits mature, the Company
expects that sales will tend to be stronger during the last several months of
the calendar year than at other times due to increased demand for consumer
products during the holiday season. As a result of the foregoing, the
Company's operating results and stock price may be subject to significant
volatility, particularly on a quarterly basis. Any shortfall in revenues or
net income from levels expected by securities analysts could have an
immediate and significant adverse effect on the trading price of the
Company's Common Stock.
The Company's future net income and cash flow will also be affected by
its ability to apply its net operating losses ("NOLs"), which totaled
approximately $36.0 million for federal tax reporting purposes as of December
31, 1998, against taxable income in future periods. Under the Tax Reform Act of
1986, the utilization of NOLs may be impaired or limited in certain
circumstances, including a cumulative ownership change of greater than 50% over
a three-year period. The consummation of the IPO in December 1995 resulted in a
cumulative ownership change of greater than 50%. Accordingly, the Company's NOLs
incurred prior to the consummation of the IPO that can be utilized to reduce
future taxable income for federal tax purposes is limited to approximately $3
million per year. The Company does not believe that its acquisition of CompCore
in December 1996 adversely affected its ability to utilize its NOLs. However,
future changes of ownership could further limit the Company's utilization of
NOLs and could have an adverse effect on the Company's net income and cash flow.
Beginning in 1997, the Company's Israeli subsidiary has benefitted from its
status as an "Approved Enterprise" pursuant to the Israeli Law for the
Encouragement of Capital Investments, 1959, as amended. There can be no
assurance that changes in tax laws in the United States or Israel or in the
Company's status will not limit the Company's ability to utilize its NOLs or its
"Approved Enterprise" status. Any limitation on the Company's ability to utilize
its NOLs or its "Approved Enterprise" status could have a material adverse
effect on the Company's business, operating results or financial condition. See
Note 10 of Notes to Consolidated Financial Statements.
RISKS ASSOCIATED WITH CUSTOMER FUNDED RESEARCH AND DEVELOPMENT. The
Company historically has generated a significant percentage of its total
revenues from development contracts, primarily with key customers. These
development contracts have provided the Company with partial funding for the
development of certain of its products. Under these contracts, the Company
receives payments upon reaching certain development milestones. See "Item 1.
Business -- Research and Development." The Company intends to continue to enter
into development contracts with strategic partners, although it expects
development revenue to remain relatively constant or decrease, and to decrease
as a percentage of total revenues. The Company's failure to achieve the
milestones specified in its existing development contracts, the termination of
existing contracts or the Company's inability to secure future development
contracts could have an adverse effect on the Company's business, operating
results or financial condition.
POSSIBLE TRANSACTIONS TO OBTAIN ADDITIONAL FOUNDRY CAPACITY. In order
to secure additional foundry capacity, the Company has considered and will
continue to consider various transactions, which could include, among other
things, equity investments from, option payments or other prepayments to,
nonrefundable deposits with or loans to foundries in exchange for capacity,
contracts that commit the Company to purchase specified quantities of wafers
over extended periods or joint ventures or other partnership relationships with
foundries. There can be no assurance that the Company will be able to make any
such arrangement in a timely fashion or at all or that such arrangements, if
any, will be on terms favorable to the Company. If the Company were not able to
obtain additional foundry capacity as required, its business and operating
results would be materially and adversely affected. See "Item 1. Business --
Manufacturing."
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FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING. The Company
may require substantial additional capital to finance its future growth, secure
additional foundry capacity and fund its ongoing research and development
activities beyond 1999. The Company's capital requirements will depend on many
factors, including, but not limited to, acceptance of and demand for the
Company's products, the types of arrangements that the Company may enter into
with its independent foundries and the extent to which the Company invests in
new technology and research and development projects. To the extent that the
Company's existing sources of liquidity and cash flow from operations are
insufficient to fund the Company's activities, the Company may need to raise
additional funds. If additional funds are raised through the issuance of equity
securities, the percentage ownership of the Company's stockholders would be
reduced. Further, such equity securities may have rights, preferences or
privileges senior to those of the Company's Common Stock. No assurance can be
given that additional financing will be available when needed or that, if
available, it will be available on terms favorable to the Company.
MANAGEMENT OF GROWTH. The Company anticipates that future growth, if
any, will require it to recruit and hire a substantial number of new
engineering, managerial, sales and marketing personnel. The Company's ability to
manage its growth successfully will also require the Company to expand and
improve its administrative, operational, management and financial systems and
controls. Many of the Company's key operations, including the major portion of
its research and development operations and a significant portion of its sales
and administrative operations, are located in Israel, while a majority of its
sales and marketing and certain of its research and development and
administrative personnel, including its President and Chief Executive Officer
and other officers, are based in the United States. The geographic separation of
these operations is likely to place additional strain on the Company's resources
and its ability to effectively manage its growth. If the Company's management is
unable to manage growth effectively, the Company's business, operating results
or financial condition could be materially and adversely affected.
DEPENDENCE ON INTELLECTUAL PROPERTY; LICENSED PRODUCTS; RISK OF
DISPUTES AND LITIGATION. The Company's ability to compete successfully is
dependent in part upon its ability to protect its proprietary technology and
information. Although the Company relies on a combination of patents,
copyrights, trademarks, trade secret laws and licensing arrangements to protect
certain of its intellectual property, the Company believes that factors such as
the technological and creative skills of its personnel and the success of its
ongoing product development efforts are more important in maintaining its
competitive position. The Company generally enters into confidentiality or
license agreements with its employees, distributors, customers and potential
customers and limits access to its proprietary information. The Company
currently holds several United States patents, and has additional patent
applications pending, that pertain to technologies and processes relating to the
Company's current business. There can be no assurance that the Company's
intellectual property rights, if challenged, will be upheld as valid, will be
adequate to prevent misappropriation of its technology or will prevent the
development of competitive products. Additionally, there can be no assurance
that the Company will be able to obtain patents or other intellectual property
protection in the future. Furthermore, the laws of certain foreign countries in
which the Company's products are or may be developed, manufactured or sold,
including various countries in Asia, may not protect the Company's products or
intellectual property rights to the same extent as do the laws of the United
States and thus make the possibility of piracy of the Company's technology and
products more likely in these countries.
The Company sells its Dolby Digital-based products under a perpetual,
non-exclusive license from Dolby which permits the Company to incorporate
Dolby's Digital algorithm into its products. The Company's customers enter into
license agreements with Dolby pursuant to which they pay royalties directly to
Dolby. Under the Company's agreement with Dolby, the Company may sell its Dolby
Digital-based products only to customers who are licensees of Dolby. To date,
most potential customers for the Company's Dolby Digital-based products are
licensees of Dolby. However, the failure or refusal of potential customers to
enter into license agreements with Dolby in the future could adversely affect
the Company's business, operating results or financial condition.
The semiconductor industry is characterized by vigorous protection and
pursuit of intellectual property rights, which have resulted in significant and
often protracted and expensive litigation. The Company or its foundries are from
time to time be notified of claims that the Company may be infringing patents or
other intellectual property rights owned by third parties. The Company is
currently the subject of a pending patent infringement proceeding and may be
subject to additional claims in the future. Litigation by or against the Company
relating to patent infringement or other intellectual property matters could
result in significant expense to the Company and divert the efforts of the
Company's
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technical and management personnel, whether or not such litigation results in
a determination favorable to the Company. In the event of an adverse result
in any such litigation, the Company could be required to pay substantial
damages, cease the manufacture, use and sale of infringing products, expend
significant resources to develop non-infringing technology, discontinue the
use of certain processes or obtain licenses to the infringing technology.
There can be no assurance that licenses would be offered or that the terms of
any offered licenses would be acceptable to the Company. The failure to
obtain a license from a third party for technology used by the Company could
cause the Company to incur substantial liabilities and to suspend the
manufacture of products, or the use by the Company's foundries of certain
processes. See "Item 1. Business -- Proprietary Rights and Licenses" and "Item
3A-Legal Proceedings."
DEPENDENCE ON KEY PERSONNEL. The Company's success depends to a
significant degree upon the continuing contributions of its senior management.
The loss of key management personnel could delay product development cycles or
otherwise have a material adverse effect on the Company's business, operating
results or financial condition. There can be no assurance that the Company will
be able to retain the services of any of its key employees. The Company believes
that its future success will also depend in large part on its ability to attract
and retain highly-skilled engineering, managerial, sales and marketing
personnel, both in the United States and in Israel. Competition for such
personnel is intense, and there can be no assurance that the Company will be
successful in attracting, integrating and retaining such personnel. Failure to
attract and retain key personnel could have a material adverse effect on the
Company's business, operating results or financial condition.
RELIANCE ON INTERNATIONAL SALES AND OPERATIONS; RELIANCE ON OPERATIONS
IN ISRAEL. Sales to non-U.S. customers in 1998, 1997 and 1996 accounted for 59%,
43% and 74%, respectively, of the Company's total revenues, and the Company
anticipates that international sales will continue to represent a significant
portion of total revenues. In addition, substantially all of the Company's
semiconductor products are manufactured, assembled and tested outside of the
United States by independent foundries and subcontractors. The Company is
subject to the risks of doing business internationally, including unexpected
changes in regulatory requirements, fluctuations in exchange rates, imposition
of tariffs and other barriers and restrictions and the burdens of complying with
a variety of foreign laws. The Company is also subject to general geopolitical
risks, such as political and economic instability and changes in diplomatic and
trade relationships, in connection with its international operations.
A substantial portion of the Company's research and development and
sales operations are located in the State of Israel and, as of December 31,
1998, 75 of the Company's 169 full-time employees were located in Israel,
including a majority of the Company's research and development personnel.
Therefore, the Company is directly affected by the political, economic and
military conditions to which that country is subject. In addition, many of the
Company's expenses in Israel are paid in Israeli shekels, thereby subjecting the
Company to the risk of foreign currency fluctuations and to economic pressures
resulting from Israel's generally high rate of inflation. There can be no
assurance that such factors will not have a material adverse effect of the
Company's business, operating results or financial condition. In the past, the
Company has obtained royalty-bearing grants from the Chief Scientist and BIRDF
to fund research and development. The terms of the grants from the Chief
Scientist prohibit the transfer of technology developed pursuant to the terms of
these grants to any person without the prior written consent of the Chief
Scientist. The Company may apply for additional grants for new or existing
products, although there can be no assurance that these grants will be available
in the future or that the royalty rates payable by the Company, or other terms
of such grants, will not be less favorable to the Company than the terms of
previous grants. See "Item 1. Business -- Research and Development."
VOLATILITY OF STOCK PRICE. The market price of the Company's Common
Stock has fluctuated significantly since the IPO and is subject to material
fluctuations in the future in response to announcements concerning the Company
or its competitors or customers, quarterly variations in operating results,
announcements of technological innovations, the introduction of new products or
changes in product pricing policies by the Company or its competitors,
proprietary rights or other litigation, changes in analysts' earnings estimates,
general conditions in the semiconductor industry, developments in the financial
markets and other factors. In addition, the stock market has, from time to time,
experienced extreme price and volume fluctuations that have particularly
affected the market prices for semiconductor companies or technology companies
generally and which have been unrelated to the operating performance of the
affected companies. Broad market fluctuations of this type may adversely affect
the future market price of the Common Stock.
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RISKS RELATED TO YEAR 2000 PROBLEM. In the next year, most companies
could face potentially serious consequences due to the inability of many older
software applications and operational programs to properly recognize calendar
dates beginning in the Year 2000. The risk for Zoran exists in three areas:
systems used by the Company to run its business, embedded software and software
products sold to its customers, and the Year 2000 readiness of the Company's key
suppliers and customers. The Company is currently evaluating its exposure in all
of these areas based on a Year 2000 compliance plan it has developed.
The Company has begun conducting a comprehensive inventory and
evaluation of the systems used in running its business. This includes its IT
systems, equipment, and facilities. To date, the Company has not found any
potential Year 2000 issues that would have a material impact on its
operations. The company believes that it is approximately 85% complete for
this portion of the investigation and expects to complete the remainder in
the second quarter of 1999. Since the Company has not yet identified any
significant non-compliance problems there are currently no contingency plans
in place for Year 2000 issues. As the Company continues through its
investigation however, it may find it necessary to create contingency plans
in order to address Year 2000 compliance problems. The Company expects to
complete any necessary contingency planning by the second quarter of 1999.
The Company believes that its current software products are Year
2000 compliant. This is based on extensive testing of the software in Year
2000 simulated conditions. However, since all customer situations cannot be
anticipated, particularly those involving third party products, the Company's
software products could prove to be non-compliant in some circumstances. The
impact of these claims could have a material impact on the Company's results
of operations or financial condition.
Zoran has begun the process of contacting each of its critical
suppliers to determine that the suppliers' operations and the products and
services they provide are Year 2000 compliant. Where practicable, Zoran will
attempt to mitigate its risks with respect to the failure of suppliers to be
Year 2000 ready. For instance the Company may seek alternative suppliers who
are found to be in Year 2000 conformance. To date, no supplier has been
identified that will not be Year 2000 ready by the appropriate timeframe.
However, the Company has not yet completed contacting all of its key
suppliers and does not anticipate completing this portion of the
investigation until the second quarter of 1999. The Company has just begun to
contact its key customers in order to ascertain their Year 2000 compliance
status. Failure of the Company's customers to be Year 2000 ready may result
in lost sales and reduced revenue or diminish the ability of customers to pay
on a timely basis. The Company expects to complete contacting all of its key
customers by the second quarter of 1999.
Based on the investigation to date the Company has not incurred and
does not anticipate incurring costs that would materially impact the Company's
operating results or financial condition. However, the investigation is ongoing
and no assurances can be given that unidentified non-compliance issues will not
have a material impact on the Company's operations or financial condition.
Failure to ensure that the Company has fully identified and addressed the Year
2000 problem could result in the Company or any of its key vendors being unable
for a period of time to conduct critical business activities, which include but
are not restricted to, shipping product to customers, invoicing customers and
paying vendors.
33
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants......................................................................... 35
Consolidated Balance Sheets as of December 31, 1998 and 1997.............................................. 36
Consolidated Statements of Operations for the three years ended
December 31, 1998................................................................................ 37
Consolidated Statements of Stockholders' Equity for the three years ended
December 31, 1998................................................................................ 38
Consolidated Statements of Cash Flows for the three years ended
December 31, 1998................................................................................ 39
Notes to Consolidated Financial Statements................................................................ 40
Supplemental Data: Selected Quarterly Financial Information (Unaudited).................................. 56
</TABLE>
34
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Zoran Corporation
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, of stockholders' equity and of
cash flows present fairly, in all material respects, the financial position
of Zoran Corporation and its subsidiaries at December 31, 1998 and 1997, and
the results of its operations and its cash flows for each of the three years
in the period ended December 31, 1998, in conformity with generally accepted
accounting principles. 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 of
these statements in accordance with generally accepted auditing standards
which 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, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
San Jose, California
January 27, 1999
35
<PAGE>
ZORAN CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1998 1997
----------------- ----------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 8,221 $ 9,903
Short-term investments 10,954 12,473
Accounts receivable, net 15,558 16,509
Inventory 7,063 4,123
Prepaid expenses and other current assets 2,018 2,232
----------------- ----------------
Total current assets 43,814 45,240
Property and equipment, net 5,356 5,704
----------------- ----------------
$ 49,170 $ 50,944
----------------- ----------------
----------------- ----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 6,530 $ 9,572
Accrued expenses and other liabilities 6,454 7,086
----------------- ----------------
Total current liabilities 12,984 16,658
----------------- ----------------
Commitments and Contingencies (Note 7)
Stockholders' Equity:
Common Stock: $0.001 par value; 20,000,000
shares authorized; 10,213,394 and 9,800,679 shares
issued and outstanding 10 10
Additional paid-in capital 79,635 78,664
Warrants 717 717
Accumulated deficit (44,176) (45,105)
----------------- ----------------
Total stockholders' equity 36,186 34,286
----------------- ----------------
$ 49,170 $ 50,944
----------------- ----------------
----------------- ----------------
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
36
<PAGE>
ZORAN CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------
1998 1997 1996
--------------- --------------- ----------------
<S> <C> <C> <C>
Revenues:
Product sales $ 33,465 $ 32,717 $ 35,503
Software, licensing and development 10,760 12,210 8,606
--------------- --------------- ----------------
Total revenues 44,225 44,927 44,109
--------------- --------------- ----------------
Cost and expenses:
Cost of product sales 19,036 16,032 20,262
Research and development 13,548 13,787 8,954
Selling, general and administrative 11,551 11,209 10,739
Merger and related -- -- 2,153
--------------- --------------- ----------------
Total costs and expenses 44,135 41,028 42,108
--------------- --------------- ----------------
Operating income 90 3,899 2,001
Interest expense -- -- (146)
Interest and other income 1,071 1,258 1,173
--------------- --------------- ----------------
Income before income taxes 1,161 5,157 3,028
Provision for income taxes 232 928 665
--------------- --------------- ----------------
Net income $ 929 $ 4,229 $ 2,363
--------------- --------------- ----------------
--------------- --------------- ----------------
Basic net income per share $ 0.09 $ 0.45 $ 0.27
--------------- --------------- ----------------
--------------- --------------- ----------------
Diluted net income per share $ 0.08 $ 0.38 $ 0.22
--------------- --------------- ----------------
--------------- --------------- ----------------
Shares used to compute basic net income per share 10,042 9,412 8,802
--------------- --------------- ----------------
--------------- --------------- ----------------
Shares used to compute diluted net income per share 11,119 11,072 10,661
--------------- --------------- ----------------
--------------- --------------- ----------------
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
37
<PAGE>
ZORAN CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
CONVERTIBLE
PREFERRED STOCK COMMON STOCK ADDITIONAL
------------------ ------------------- PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL WARRANT DEFICIT TOTAL
-------- --------- --------- --------- ---------- --------- ------------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 -- $ -- 8,410 $ 8 $ 72,606 $ -- $ (51,697) $ 20,917
Issuance of Common Stock
pursuant to public offering
over-allotment, net of
expenses -- -- 308 1 3,531 -- -- 3,532
Issuance of Common Stock, net -- -- 183 -- 468 -- -- 468
Conversion of note -- -- 128 -- 1,032 -- -- 1,032
Amortization of deferred
compensation -- -- -- -- 218 -- -- 218
Net income -- -- -- -- -- -- 2,363 2,363
-------- --------- --------- --------- ---------- --------- ------------- ----------
Balance at December 31, 1996 -- -- 9,029 9 77,855 -- (49,334) 28,530
Issuance of Common Stock, net -- -- 772 1 769 -- -- 770
Issuance of Warrant -- -- -- -- -- 717 -- 717
Amortization of deferred
compensation -- -- -- -- 40 -- -- 40
Net income -- -- -- -- -- -- 4,229 4,229
-------- --------- --------- --------- ---------- --------- ------------- ----------
Balance at December 31, 1997 -- -- 9,801 10 78,664 717 (45,105) 34,286
Issuance of Common Stock, net -- -- 412 -- 971 -- -- 971
Net income -- -- -- -- -- -- 929 929
-------- --------- --------- --------- ---------- --------- ------------- ----------
Balance at December 31, 1998 -- $ -- 10,213 $ 10 $ 79,635 $ 717 $ (44,176) $ 36,186
-------- --------- --------- --------- ---------- --------- ------------- ----------
-------- --------- --------- --------- ---------- --------- ------------- ----------
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
38
<PAGE>
ZORAN CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1998 1997 1996
------------ ------------- -------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 929 $ 4,229 $ 2,363
Adjustments:
Depreciation, amortization and other 2,306 1,862 1,420
Amortization of deferred compensation -- 40 218
Deferred revenue (112) 121 (1,758)
Changes in current assets and liabilities:
Accounts receivable 951 (5,421) (5,815)
Inventory (2,940) (2,324) 456
Prepaid expenses and other current assets 214 (356) (686)
Accounts payable (3,042) 3,151 2,868
Accrued expenses and other liabilities (700) 534 2,368
------------ ------------- -------------
Net cash provided by (used in) operating activities (2,394) 1,836 1,434
------------ ------------- -------------
Cash flows from investing activities:
Capital expenditures for property and equipment (1,778) (3,649) (3,480)
Sales (Purchase) of short-term investments, net 1,519 (230) (12,243)
------------ ------------- -------------
Net cash provided by (used in) investing activities (259) (3,879) (15,723)
------------ ------------- -------------
Cash flows from financing activities:
Proceeds from debt -- -- 1,000
Repayments of debt -- -- (973)
Proceeds from issuance of Common Stock, net 971 770 4,000
------------ ------------- -------------
Net cash provided by financing activities 971 770 4,027
------------ ------------- -------------
Net decrease in cash and cash equivalents (1,682) (1,273) (10,262)
Cash and cash equivalents at beginning of year 9,903 11,176 21,438
------------ ------------- -------------
Cash and cash equivalents at end of year $ 8,221 $ 9,903 $ 11,176
------------ ------------- -------------
------------ ------------- -------------
Supplemental disclosures:
Interest paid $ -- $ -- $ 145
------------ ------------- -------------
------------ ------------- -------------
Income taxes paid $ -- $ 368 $ 468
------------ ------------- -------------
------------ ------------- -------------
Conversion of debt to Common Stock $ -- $ -- $ 1,032
------------ ------------- -------------
------------ ------------- -------------
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
39
<PAGE>
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - THE COMPANY:
Zoran Corporation ("Zoran" or the "Company") was incorporated in
California in December 1981 and reincorporated in Delaware in November 1986.
On December 27, 1996, the Company completed its merger with CompCore
Multimedia, Inc. ("CompCore"), a developer of decompression technology for
digital video and audio applications (see Note 3). Zoran develops and markets
integrated circuits and software products for digital video and audio
applications enabled by compression. The Company's integrated circuits and
software products are used in a variety of video and audio products
addressing PC and consumer multimedia markets. Current applications
incorporating Zoran's products and IP include professional and consumer video
editing systems, filmless digital cameras, standalone and PC-based DVD
players, Super VCD players, digital speakers and audio systems. The Company
operates predominantly in one industry segment.
The Company's performs research and development and generates a
substantial portion of its sales from its operations located in the State of
Israel. A significant number of the Company's full-time employees are located
in Israel, including a majority of the Company's research and development
personnel. Therefore, the Company is directly affected by the political,
economic and military conditions to which that country is subject.
The semiconductor business is highly cyclical and has been subject to
significant downturns at various times that have been characterized by
diminished product demand, production, overcapacity, and accelerated erosion of
average selling prices. As such, the selling price that the Company is able to
command for its products is highly dependent on industry-wide production
capacity and demand, both of which factors could result in rapid deviations in
product pricing and therefore could adversely effect the Company's operating
results.
The consolidated financial statements include the accounts of Zoran and all
its subsidiaries, Intercompany transactions and balances have been eliminated in
consolidation.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES:
Zoran has adopted accounting policies which are generally accepted in the
industry in which it operates. The following is a summary of the Company's
significant accounting policies.
Use of estimates
The preparation of these financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates, although such differences are not expected to be material to the
consolidated financial statements.
40
<PAGE>
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Translation of foreign currencies
ZML, an Israeli subsidiary, treats the U.S. dollar as its functional
currency. In accordance with Statement of Financial Accounting Standards No. 52
("SFAS 52"), gains and losses resulting from translation of accounts designated
in other than the functional currency are reflected in results of operations and
to date have been insignificant.
To date, substantially all of the Company's product sales have been
denominated in U.S. dollars and most costs of product sales have been incurred
in U.S. dollars. The Company has not experienced material losses or gains as a
result of currency exchange rate fluctuations and has not engaged in hedging
transactions to reduce its exposure to such fluctuations. The Company intends to
actively monitor its foreign exchange exposure and to take appropriate action to
reduce its foreign exchange risk, if such risk becomes material.
Revenue recognition
Revenue from product sales is generally recognized upon shipment. A
provision for estimated future returns and potential warranty liability is
recorded at the time revenue is recognized. Development revenue under
development contracts is recognized on the percentage-of-completion method.
Amounts received in advance of performance under contracts are recorded as
deferred revenue and are generally recognized within one year from receipt.
Estimates are reviewed and revised periodically throughout the lives of the
contracts. Any revisions are recorded in the accounting period in which the
revisions are made. Costs associated with development revenues are included
primarily in research and development expenses. Revenue resulting from the
licensing of the Company's technology is recognized when significant
contractual obligations have been fulfilled. The Company does not provide
customers with product return or exchange rights in connection with the sale
of software licenses. Periodic service and maintenance fees provide customers
access to technical support and minor enhancements to licensed releases are
recognized ratably over the service or maintenance period. Royalty revenue is
recognized in the period licensed sales are reported to the Company.
Research and development costs
Costs related to the conceptual formation and design of internally
developed software are expensed as research and development as incurred. It is
the Company's policy that certain internal software development costs incurred
after technological feasibility has been demonstrated and which meet
recoverability tests are capitalized and amortized over the estimated economic
life of the product. To date, the Company has incurred no significant internal
software development costs which meet the criteria for capitalization.
Fair value of financial instruments
For certain of Zoran's financial instruments, including cash and cash
equivalents, accounts receivable, accounts payable and other current
liabilities, the carrying value amounts approximate their fair value due to the
relatively short maturity of these items.
Cash equivalents and short-term investments
All highly liquid investments purchased with an original maturity of 90
days or less are considered to be cash and cash equivalents.
41
<PAGE>
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
All of Zoran's investment portfolio is classified as available-for-sale
and, therefore, is reported at fair value with unrealized gains and losses, net
of related tax, if any, included as a separate component of stockholders'
equity. At December 31, 1998, the fair value of the Company's marketable
securities approximates cost.
Concentration of credit risk of financial instruments
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash and cash equivalents,
short-term investments and trade accounts receivable. The Company places its
cash in banks and cash equivalents primarily in auction rate preferred,
certificates of deposit and commercial paper. The Company, by policy, limits the
amount of credit exposure through diversification and highly-rated securities.
The Company has not experienced any significant losses on its cash equivalents
or short-term investments.
The Company markets integrated circuits and technology to manufacturers and
distributors of electronic equipment primarily in North America, Europe and the
Pacific Rim. The Company performs ongoing credit evaluations of its customers'
financial condition and limits the amount of credit extended when deemed
necessary, but generally does not require collateral. Management believes that
any risk of loss is significantly reduced due to the diversity of its customers
and geographic sales areas. The Company maintains a provision for potential
credit losses, and write-offs of accounts receivable were insignificant in each
of the three years in the period ended December 31, 1998. As of December 31,
1998, five customers accounted for approximately 20%, 14%, 7%, 7%, and 5% of the
accounts receivable balance. As of December 31, 1997, three customers accounted
for approximately 29%, 17% and 11% of the accounts receivable balance.
Inventory
Inventories are stated at the lower of standard cost (which approximates
actual cost on a first-in, first-out basis) or market. Market is based on
estimated net realizable value.
Property and equipment
Property and equipment are recorded at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of three to five years.
Leasehold improvements are amortized on a straight-line basis over the shorter
of the estimated useful lives of the assets or the remaining term of the lease.
Income taxes
The Company follows the liability method of accounting for income taxes
which requires recognition of deferred tax liabilities and assts for the
expected future tax consequence of temporary differences between the financial
statement carrying amounts and the tax bases of assets and liabilities.
Earnings per share
In accordance with Statement of Financial Accounting Standards no. 128
("SFAS 128") Zoran reports Earnings per Share ("EPS"), both basic and diluted,
on the statement of operations. Basic EPS is based upon the weighted average
number of common shares outstanding. Diluted EPS is computed using the weighted
average common shares outstanding plus any potentially dilutive securities,
except when their effect is anti-dilutive. Dilutive securities include stock
options and warrants. See Note 9.
42
<PAGE>
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Stock compensation
The Company accounts for stock-based compensation using the intrinsic value
method prescribed in Accounting Principles Board Opinion No. 25 ("APB 25"),
"Accounting for Stock Issued to Employees" and related interpretations. The
Company provides additional pro forma disclosures as required under Statement of
Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based
Compensation." See Note 3 and 8.
Segment reporting
In 1998, the Company adopted Statement of Financial Accounting Standards
No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related
Information." SFAS 131 supersedes SFAS 14 "Financial Reporting for Segments of a
Business Enterprise," replacing the "Industry Segment" approach with the
"Management" approach. The management approach designates the internal
organization that is used by management for making operating decisions and
assessing performance as the source of the Company's reportable segments. SFAS
131 also requires disclosures about products and services, geographic areas, and
major customers. The Company operates in one industry segment comprising the
development and marketing of integrated circuits and software products for use
in a variety of video and audio products addressing PC and consumer multimedia
markets.
Comprehensive income
In 1998, the Company adopted Statement of Financial Accounting
Standards No. 130 ("SFAS 130") reporting comprehensive income. The adoption
of SFAS 130 did not affect the results of the Company's operations.
Recent accounting pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). FAS 133 establishes a new model for
accounting for derivatives and hedging activities and supercedes and amends a
number of existing accounting standards. SFAS 133 requires that all derivatives
be recognized in the balance sheet at their fair market value, and the
corresponding derivative gains or losses be either reported in the statement of
operations or as a deferred item depending on the type of hedge relationship
that exists with respect to such derivative. Adopting the provisions of SFAS
133, which will be effective for the Company's fiscal year 2000, are not
expected to have a material effect on the Company's consolidated financial
statements.
NOTE 3 - ACQUISITION OF COMPCORE:
On December 27, 1996, the Company completed its merger with CompCore. The
Company issued 1,957,308 shares of Common Stock in connection with the merger.
This transaction was accounted for as a pooling of interests; therefore, prior
financial statements have been restated to reflect this merger.
Net income for 1996 includes $2,153,000 of merger costs and expenses which
were incurred and have been charged to merger and related expenses in 1996. The
charge includes professional fees, costs associated with merging the companies
and other direct transaction costs associated with the merger.
CompCore granted 1,244,434 shares of Common Stock and stock options for
735,157 shares which were considered to have been issued below fair market value
during the years ended December 31, 1995 and 1996, respectively. The Company is
amortizing approximately $201,000 of compensation expense over their vesting
periods of two and four years, respectively.
43
<PAGE>
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4 - BALANCE SHEET COMPONENTS:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------
1998 1997
---------------- ---------------
(in thousands)
<S> <C> <C>
Accounts receivable, net:
Trade $ 14,486 $ 17,253
Unbilled 1,871 245
---------------- ---------------
16,357 17,498
Less: allowance (799) (989)
---------------- ---------------
$ 15,558 $ 16,509
---------------- ---------------
---------------- ---------------
</TABLE>
Unbilled accounts receivable consists of both development revenue
recognized, but not yet billed and research and development funding not yet
received. Unbilled development revenue represents revenue recognized under the
percentage-of-completion method prior to achievement of the related contract
milestones. The Company bills development revenue when contract milestones are
achieved. The Company recognizes research and development funding as
reimbursable expenses, under research and development agreements, as incurred.
This funding is offset against research and development expenses.
44
<PAGE>
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------
1998 1997
---------------- ---------------
(in thousands)
<S> <C> <C>
Inventory:
Work-in-process $ 1,781 $ 1,860
Finished goods 5,282 2,263
---------------- ---------------
$ 7,063 $ 4,123
---------------- ---------------
---------------- ---------------
Property and equipment: (in thousands)
Computer equipment $ 9,573 $ 9,100
Office equipment and furniture 706 702
Machinery and equipment 860 824
Leasehold improvements 544 493
---------------- ---------------
11,683 11,119
Less: accumulated depreciation and amortization (6,327) (5,415)
---------------- ---------------
$ 5,356 $ 5,704
---------------- ---------------
---------------- ---------------
Accrued expenses and other liabilities: (in thousands)
Accrued payroll and related expenses $ 1,910 $ 2,765
Accrued royalties 808 1,187
Taxes payable 1,592 1,266
Deferred revenue 352 464
Other accrued liabilities 1,792 1,404
---------------- ---------------
$ 6,454 $ 7,086
---------------- ---------------
---------------- ---------------
</TABLE>
NOTE 5 - RESEARCH AND DEVELOPMENT ARRANGEMENTS:
The Company is a party to certain research and development agreements with
the Chief Scientist in Israel's Ministry of Industry and Trade Department (the
"Chief Scientist") and the Israel-United States Binational Industrial Research
and Development Foundation ("BIRDF"), which fund up to 50% of incurred project
costs for approved products up to specified contract maximums. The Company is
not obligated to repay funding regardless of the outcome of its development
efforts; however, these agreements require the Company to use its best efforts
to achieve specified results and require the Company to pay royalties at rates
of 3% to 5% of resulting products sales, and up to 30% of resulting license
revenues, up to a maximum of 100% to 150% of the total funding received.
Reported research and development expenses are net of these grants, which
fluctuate from period to period.
45
<PAGE>
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Gross research and development expenses and the related grants are as
follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------
1998 1997 1996
--------------- --------------- --------------
(in thousands)
<S> <C> <C> <C>
Research and development expenses:
Gross research and development expenses $ 14,399 $ 13,787 $ 9,136
Less: grants earned (851) -- (182)
--------------- --------------- --------------
$ 13,548 $ 13,787 $ 8,954
--------------- --------------- --------------
--------------- --------------- --------------
</TABLE>
Royalty expenses related to these grants were $196,000, $301,000, and
$1,248,000 in 1998, 1997 and 1996, respectively.
NOTE 6 - DEVELOPMENT CONTRACTS:
The Company has generated a portion of its total revenues from development
contracts, primarily with key customers. These development contracts have
provided the Company with partial funding for the development of certain of its
products. The Company classifies costs related to these development contracts as
research and development expenses. The Company is not obligated to repay funding
regardless of the outcome of its development efforts; however, the agreements
require the Company to use its best efforts to achieve specified results as per
the agreements. The Company retains ownership of the intellectual property
developed under the contracts; however, some contracts limit the product markets
in which the Company may directly sell the developed product. Revenues generated
under these contracts were $2,960,000, $1,752,000 and $3,698,000 in 1998, 1997
and 1996, respectively.
NOTE 7 - COMMITMENTS:
The Company rents facilities and equipment under various lease agreements
expiring through 2000. Rent expense for 1998, 1997 and 1996 totaled
approximately $887,000, $748,000 and $405,000 respectively. Future minimum lease
payments required under noncancelable leases at December 31, 1998 are as
follows:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
<S> <C>
1999 $ 882,000
2000 482,000
2001 289,000
2002 289,000
2003 108,000
----------------
Total minimum lease payments $ 2,050,000
----------------
----------------
</TABLE>
46
<PAGE>
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8 - STOCKHOLDERS' EQUITY:
Common Stock
In December 1995, the Company issued shares of Common Stock in conjunction
with the Company's initial public offering ("IPO"). In January 1996, the
underwriters exercised their over-allotment option to purchase additional shares
of Common Stock. In December 1996, the Company acquired CompCore through a
merger which was accounted for as a pooling of interest (see Note 3).
Warrants
In September 1997, in connection with a software license agreement, the
Company issued a warrant to purchase 75,000 shares of its Common Stock at an
exercise price of $24.31 per share. The warrant is exercisable for a period
of four years from a date beginning one year after the issuance date of the
warrant. The $717,000 estimated value of the warrant, is being amortized over
the four-year period of the license agreement. The unamortized balance at
December 31, 1998 of $477,000 is included in prepaid expenses and other
current assets.
47
<PAGE>
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Stock option plans
1993 Stock option plan
The Company's 1993 Stock Option Plan (the "1993 Option Plan") was adopted
by the Board of Directors of the Company and approved by the stockholders of the
Company in July 1993. A total of 2,140,000 shares of Common Stock have been
reserved for issuance under the 1993 Option Plan. The 1993 Option Plan provides
for grants of options to employees, non-employee directors and consultants. The
1993 Option Plan is currently being administered by the Compensation Committee
of the Board of Directors of the Company, which determines the optionees and the
terms of the options granted, including the exercise price, number of shares
subject to the option plan and the exercisability thereof. The option price for
shares granted under the 1993 Option Plan is typically equal to the fair market
value of the common stock at the date of grant. The 1993 Option Plan will
terminate in July 2003, unless sooner terminated by the Board of Directors.
Generally, options granted under the 1993 Option Plan are fully exercisable
on and after the date of grant, subject to the Company's right to repurchase
from an optionee, at the optionee's original per share exercise price, any
unvested shares which the optionee has purchased and holds in the event of the
termination of the Optionee's employment, with or without cause. The Company's
right lapses as shares subject to the option become vested. Such shares
generally vest in monthly installments over two or four years following the date
of grant (as determined by the Compensation Committee of the Board of
Directors), subject to the optionee's continuous service. Options expire ten
years from the date of grant and an option shall generally terminate three
months after termination of employment.
In August 1998, substantially all options with an exercise price in excess
of $5.94 were cancelled and replaced with new options having an exercise price
of $5.94, the market price on the date that the employees accepted the
repricing. A total of 924,164 shares were repriced.
At December 31, 1998, shares available for grant under this plan were
142,000.
48
<PAGE>
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1995 Outside directors stock option plan
The Company's Outside Directors Stock Option Plan (the "Directors Plan")
was adopted by the Company's Board of Directors in October 1995, and was
approved by its stockholders in December 1995. A total of 200,000 shares of
Common Stock have been reserved for issuance under the Directors Plan. The
Directors Plan provides for the grant of nonstatutory stock options to
nonemployee directors of the Company. The Directors Plan provides that each new
nonemployee director will automatically be granted an option to purchase 20,000
shares on the date the optionee first becomes a nonemployee director (the
"Initial Grant"). Thereafter, on the date immediately following each annual
stockholders' meeting, each nonemployee director who is reelected at the meeting
to an additional term shall be granted an additional option to purchase 4,800
shares of Common Stock if, on such date, he or she shall have served on the
Company's Board of Directors for at least six months (the "Annual Grant"). The
Initial Grant is exercisable in four equal annual installments, and each Annual
Grant shall become exercisable in full one year after the date of grant, subject
to the director's continuous service. The exercise price of all stock options
granted under the Directors Plan is equal to the fair market value of the
Company's Common Stock on the date of grant. Options granted under the Directors
Plan have a term of ten years.
At December 31, 1998 shares available for future issuance under this plan
was 64,000.
The following table summarizes the Company's stock option activity for the
years ended December 31, 1998, 1997 and 1996. The weighted average exercise
price for each category presented is also shown in the table below:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------
1998 1997 1996
-------------------------- ----------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------------- ----------- ---------- ----------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of
period 2,053,171 $8.62 2,164,208 $ 2.30 1,328,084 $2.09
Granted 1,665,491 7.23 771,890 18.86 980,546 2.24
Exercised (329,963) 0.56 (727,882) 0.39 (140,253) 0.17
Canceled (1,162,434) 15.64 (155,045) 10.01 (4,169) 0.29
------------- ---------- ------------
Options outstanding at period
end 2,226,265 5.11 2,053,171 8.62 2,164,208 2.30
------------- ---------- ------------
------------- ---------- ------------
Options exercisable at period
end 2,132,151
-------------
-------------
</TABLE>
49
<PAGE>
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Significant option groups outstanding as of December 31, 1998 and the
related weighted average exercise price and contractual life information, are as
follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------ ----------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE CONTRACTUAL
EXERCISE PRICE NUMBER PRICE NUMBER PRICE LIFE (YEARS)
---------------- ------------------ ---------------- ---------------- ----------------
<S> <C> <C> <C> <C> <C>
$0.13 - $0.60 585,803 $ 0.15 561,055 $ 0.15 5.8
$1.57 - $4.69 92,019 2.66 41,156 2.94 7.5
$5.94 - $5.94 1,292,997 5.94 1,292,997 5.94 9.6
$8.50 - $13.50 200,396 10.97 181,893 11.13 8.2
$14.00 - $24.13 55,050 21.12 55,050 21.12 8.3
---------------- ----------------
2,226,265 $ 5.11 2,132,151 $ 5.19 8.4
---------------- ----------------
---------------- ----------------
</TABLE>
The weighted average grant date fair value of options granted during the
years ended December 31, 1998, 1997 and 1996 as defined by SFAS 123, were $7.23,
$9.19 and $7.05 per share, respectively. Included in the grants in 1996 were
options issued by CompCore and assumed by Zoran at exercise prices below market
prices of the Company's Common Stock at the date of grant, of which their
weighted average fair value was $6.41 per share (see Note 3).
50
<PAGE>
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1995 Employee stock purchase plan
The Company's 1995 Employee Stock Purchase Plan ("ESPP") was adopted by the
Company's Board of Directors in October 1995, and approved by its stockholders
in December 1995. The ESPP enables employees to purchase shares through payroll
deductions at approximately 85% of the lesser of the fair value of Common Stock
at the beginning of a 24-month offering period or the end of each six-month
segment within such offering period. The ESPP is intended to qualify as an
"employee stock purchase plan" under Section 423 of the U.S. Internal Revenue
Code. During the years ended December 31, 1998 and 1997, 84,354 and 42,669
shares were purchased by employees under the terms of the plan agreements at a
weighted average price of $9.57 and $13.33 per share, respectively. At December
31, 1998, 148,780 shares were reserved and available for issuance under this
plan.
The weighted average grant date fair value of rights granted during the
year ended December 31, 1998, 1997 and 1996 as defined by SFAS 123, was $3.55,
$3.64 and $5.46 per share, respectively.
Fair value disclosures
Had compensation cost for the Company's option and stock purchase plans
been determined based on the fair value at the grant dates, as prescribed in FAS
123, the Company's net income (loss) and net income (loss) per share for each of
the three years ended December 31, 1998 would have been as follows (in
thousands, except per share data):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------
1998 1997 1996
--------------- --------------- ---------------
<S> <C> <C> <C>
Net income (loss):
As reported $ 929 $ 4,229 $2,363
Pro forma $(4,144) $ 547 $1,749
Net income (loss) per share:
As reported
Basic $ 0.09 $ 0.45 $ 0.27
Diluted $ 0.08 $ 0.38 $ 0.22
Pro forma
Basic $ (0.41) $ 0.06 $ 0.20
Diluted $ (0.41) $ 0.05 $ 0.17
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black Scholes model with the following assumptions used for options and
purchase grants during the applicable period.
51
<PAGE>
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------
1998 1997 1996
--------------- ---------------- ---------------
<S> <C> <C> <C>
Dividend rate 0.0% 0.0% 0.0%
Risk-free interest rates 4.2% to 5.6% 5.1% to 6.3% 5.3% to 6.6%
Volatility 61.0% 67.0% 67.0%
Expected life
Option plans 5 years 5 years 5 years
Purchase plan 0.5 years 0.5 years 0.5 years
</TABLE>
The pro forma amounts reflect compensation expense related to stock options
and purchase rights granted during the years ended December 31, 1998, 1997 and
1996. In future years, the annual compensation expense will increase relative to
the fair values of stock options granted in those years.
NOTE 9 - EARNINGS PER SHARE:
A reconciliation of the numerators and the denominators of the basic and
diluted per share computation is as follows: (in thousands)
<TABLE>
<CAPTION>
1998 1997 1996
---------------------------------- ---------------------------------- ----------------------------------
INCOME SHARES PER INCOME SHARES PER INCOME SHARES PER
SHARE SHARE SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT
--------- ----------- --------- --------- ----------- --------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Basic EPS:
Net income $ 929 10,042 $0.09 $ 4,229 9,412 $0.45 $ 2,363 8,802 $0.27
----- ----- -----
----- ----- -----
Effects of Dilutive
Securities:
Stock Options - 1,064 - 1,539 - 1,706
Warrants - 13 - 121 - 153
Diluted EPS:
------ ------ ------- ------ ------- ------
Net income $ 929 11,119 $0.08 $ 4,229 11,072 $0.38 $ 2,363 10,661 $0.22
------ ------ ----- ------- ------ ----- ------- ------ -----
------ ------ ----- ------- ------ ----- ------- ------ -----
</TABLE>
NOTE 10 - INCOME TAXES:
The components of income before income taxes are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------------------
1998 1997 1996
----------------- ----------------- ---------------
(in thousands)
<S> <C> <C> <C>
U.S. $ 475 $ 1,925 $ (783)
Foreign 686 3,232 3,811
----------------- ----------------- ---------------
$ 1,161 $ 5,157 $ 3,028
----------------- ----------------- ---------------
----------------- ----------------- ---------------
</TABLE>
52
<PAGE>
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The components of the provision for income taxes are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------------------
1998 1997 1996
---------------- ----------------- ---------------
(in thousands)
<S> <C> <C> <C>
Current:
U.S. $ 106 $ 360 $ 103
State 26 98 66
Foreign 100 470 496
---------------- ----------------- ---------------
Total current 232 928 665
Deferred -- -- --
---------------- ----------------- ---------------
Total $ 232 $ 928 $ 665
---------------- ----------------- ---------------
---------------- ----------------- ---------------
</TABLE>
The tax provision differs from the amounts obtained by applying the
statutory U.S. Federal Income Tax Rate to income taxes as shown below.
Tax provision difference
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------------
1998 1997 1996
--------------- --------------- --------------
(in thousands)
<S> <C> <C> <C>
Tax at U.S. statutory rate $ 395 $ 1,753 $ 1,030
Utilization of net operating loss carryovers (35) (856) (575)
Foreign Earnings (156) (213) (309)
State taxes net of federal benefit - 65 13
Merger expenses - - 455
Gain on transfer of holding in LLC - - 29
Alternative minimum tax - 50 -
Other 28 129 22
--------------- --------------- --------------
$ 232 $ 928 $ 665
--------------- --------------- --------------
--------------- --------------- --------------
</TABLE>
Deferred income tax assets comprise the following:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------------
1998 1997 1996
--------------- --------------- ---------------
(in thousands)
<S> <C> <C> <C>
Federal and state net operating loss carryforwards $ 12,279 $ 12,286 $ 13,176
Capitalized research and development expenses 372 216 392
Nondeductible reserves and accruals 951 886 1,051
--------------- --------------- ---------------
Total deferred tax assets 13,602 13,388 14,619
Deferred tax liabilities -- -- --
--------------- --------------- ---------------
Net deferred tax assets 13,602 13,388 14,619
Valuation allowance (13,602) (13,388) (14,619)
--------------- --------------- ---------------
$ -- $ -- $ --
--------------- --------------- ---------------
--------------- --------------- ---------------
</TABLE>
53
<PAGE>
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
As of December 31, 1998, the Company has NOLs of approximately $36
million for federal tax reporting purposes. The federal NOLs expire on
various dates between 2000 and 2009. Management has recorded a full valuation
allowance against all U.S. deferred tax assets on the basis that significant
uncertainty exists regarding the realizability of the assets.
Pursuant to the Tax Reform Act of 1986, the amounts of and the benefit
from NOLs that can be carried forward may be impaired or limited in certain
circumstances, including a cumulative stock ownership change of more than 50%
over a three-year period. The Company's IPO resulted in a cumulative change
of ownership of greater than 50%. Accordingly, the Company's NOLs incurred
prior to the completion of the IPO that can be utilized to reduce future
taxable income for federal tax purposes will be limited to approximately $3.0
million per year.
The Company's Israeli subsidiary has been granted the status of an
"Approved Enterprise" pursuant to the Israeli law for the Encouragement of
Capital Investments, 1959, as amended. The Company has four approved programs
pursuant to this law. The first program was approved in 1984. Income subject
to this program is taxed at an annual rate of 10% from the first year in
which the enterprise generates taxable income (net of NOLs). Benefits under
the first program expired in 1997. The second program was approved in 1991.
Income subject to this program is exempt from tax for two years from the
first year in which the Company has taxable income (net of NOLs) and is taxed
at a rate of 10% thereafter. Benefits under the second program expire in
2003. The third program was approved in 1995. Income subject to this program
is exempt from tax for four years from the first year in which the Company
has taxable income (net of NOLs) and is taxed at a rate of 10% during the
remaining period of six years. The fourth program was approved in 1997.
Income subject to this program is exempt from tax for two years from the
first year in which the Company has taxable income (net of NOLs) and is taxed
at a rate of 10% during the remaining period of eight years. Benefits under
the third and the fourth program are limited to fourteen years from approval
or twelve years from commencement of production. The net impact of the tax
holidays was an increase in net income of $170,000 in fiscal 1998 and to
increase net income per share by $0.01.
Note 11 - SEGMENT REPORTING:
The Company operates in one industry segment comprising the design,
development, manufacture and sale of integrated circuits. The following is a
summary of the Company's operations:
Sales to customers located in:
<TABLE>
<CAPTION>
1998 1997 1996
--------------- -------------- ---------------
(in thousands)
<S> <C> <C> <C>
United States $17,935 $25,480 $11,617
Pacific Rim 15,850 9,825 21,374
Europe 10,440 9,622 11,118
--------------- -------------- ---------------
$44,225 $44,927 $44,109
--------------- -------------- ---------------
--------------- -------------- ---------------
</TABLE>
54
<PAGE>
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------
1998 1997
--------------- ---------------
(IN THOUSANDS)
<S> <C> <C>
Identifiable assets:
U.S. $ 38,509 $ 37,774
Israel 10,661 13,170
--------------- ---------------
Total $ 49,170 $ 50,944
--------------- ---------------
--------------- ---------------
</TABLE>
Significant customers are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------------
1998 1997 1996
-------------- --------------- ---------------
<S> <C> <C> <C>
Customers comprising 10% or more of the
Company's total revenues for the period indicated:
A 23% -- 38%
B -- 15% 16%
C 14% 15% --
D -- 15% --
</TABLE>
55
<PAGE>
ZORAN CORPORATION
SELECTED QUARTERLY FINANCIAL INFORMATION
(UNAUDITED)
<TABLE>
<CAPTION>
QUARTERS ENDED
---------------------------------------------------------------------------------------
DEC 31, SEPT 30, JUNE 30, MARCH 31, DEC 31, SEPT 30, JUNE 30, MARCH 31,
1998 1998 1998 1998 1997 1997 1997 1997
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Product sales $ 11,235 $ 8,986 $ 4,610 $ 8,634 $ 11,699 $ 8,486 $ 6,216 $ 6,316
Software, licensing and
development 2,901 2,860 2,465 2,534 2,322 3,101 3,036 3,751
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total revenues 14,136 11,846 7,075 11,168 14,021 11,587 9,252 10,067
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Cost and expenses:
Cost of product sales 6,286 5,153 2,940 4,657 5,984 4,044 2,478 3,526
Research and development 3,894 3,476 2,944 3,234 3,550 3,722 3,203 3,312
Selling, general and
administrative 3,240 2,877 2,686 2,748 3,052 2,986 2,567 2,604
Merger and related -- -- -- -- -- -- -- --
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total costs and expenses 13,420 11,506 8,570 10,639 12,586 10,752 8,248 9,442
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Operating income (loss) 716 340 (1,495) 529 1,435 835 1,004 625
Interest and other income
(expense), net 375 176 275 245 314 316 350 278
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Income (loss) before taxes 1,091 516 (1,220) 774 1,749 1,151 1,354 903
Provision (benefit) for income
taxes 218 103 (244) 155 76 288 338 226
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income (loss) $ 873 $ 413 $ (976) $ 619 $ 1,673 $ 863 $ 1,016 $ 677
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income (loss) per share:
Basic $ 0.09 $ 0.04 $ (0.10) $ 0.06 $ 0.17 $ 0.09 $ 0.11 $ 0.07
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Diluted $ 0.08 $ 0.04 $ (0.10) $ 0.06 $ 0.15 $ 0.08 $ 0.09 $ 0.06
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Shares used to compute basic net
income (loss) per share 10,154 10,064 9,975 9,856 9,741 9,504 9,301 9,103
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Shares used to compute diluted net
income (loss) per share 11,469 10,941 9,975 10,952 11,052 11,131 11,036 11,070
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
</TABLE>
56
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
57
<PAGE>
PART III
Certain information required by Part III is omitted from this report
in that the Company intends to file its definitive proxy statement pursuant
to Regulation 14A (the "Proxy Statement") not later than 120 days after the
end of the fiscal year covered by this report and certain information therein
is incorporated herein by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this Item is incorporated by reference
to information set forth in the Proxy Statement under the heading "Proposal
No. 1 -- Election of Directors" and in Part I of this Report under the
heading "Executive Officers of the Registrant."
The information required by this Item with respect to compliance
with Section 16(a) of the Securities Exchange Act of 1934 is incorporated by
reference to information set forth in the Proxy Statement under the heading
"Section 16(a) Beneficial Ownership Reporting Compliance."
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item is incorporated by reference
to information set forth in the Proxy Statement under the heading "Executive
Compensation."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item is incorporated by reference
to information set forth in the Proxy Statement under the heading "Principal
Stockholders and Share Ownership by Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item is incorporated by reference
to information set forth in the Proxy Statement under the heading "Certain
Transactions."
58
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as a part of this report:
(1) Financial Statements:
See Index to Consolidated Financial Statements at page 34
of this report.
(2) Financial Statement Schedules:
All financial statement schedules are omitted because they
are not applicable or not required, or because the
required information is included in the Consolidated
Financial Statements and Notes thereto which are included
herein.
(3) Exhibits:
The exhibits listed on the accompanying Exhibit Index are
filed as part of, or are incorporated by reference into,
this report.
(b) Reports on Form 8-K during the quarter ended December 31,
1998:
None
59
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: March 31, 1999 ZORAN CORPORATION
By: /s/ Levy Gerzberg
------------------------------
Levy Gerzberg, President and
Chief Executive Officer
Pursuant to the requirements of the Security Exchange Act of 1934,
this report has been signed by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Levy Gerzberg President, Chief Executive Officer and Director March 31, 1999
- --------------------------- (Principal Executive Officer)
Levy Gerzberg
/s/ Karl Schneider Vice President, Finance and Chief Financial Officer March 31, 1999
- --------------------------- (Principal Financial and Accounting Officer)
Karl Schneider
/s/ Uzia Galil Chairman of the Board of Directors March 31, 1999
- ---------------------------
Uzia Galil
/s/ George T. Haber Director March 31, 1999
- ---------------------------
George T. Haber
/s/ James D. Meindl Director March 31, 1999
- ---------------------------
James D. Meindl
/s/ Arthur B. Stabenow Director March 31, 1999
- ---------------------------
Arthur B. Stabenow
/s/ Philip M. Young Director March 31, 1999
- ---------------------------
Philip M. Young
</TABLE>
60
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Title
------- -------------
<S> <C>
3.1(1) Form of Restated Certificate of Incorporation of the Registrant.
3.2(2) Amended and Bylaws of the Registrant.
4.1(3) Amended and Restated Stock Rights Agreement dated July 30,
1993 among the Registrant and certain of its stockholders,
as amended.
*10.1(3) 1993 Stock Option Plan, as amended.
*10.2(3) 1995 Outside Directors Stock Option Plan.
*10.3(4) Amended and Restated 1995 Employee Stock Purchase Plan.
*10.4(3) Form of Indemnity Agreement for officers and directors.
+10.5(3) Agreement dated June 28, 1991 between the Registrant and
Fujifilm Microdevices Co., Ltd. ("Fujifilm"), as amended.
+10.6(3) Agreement dated July 27, 1992 between the Registrant and
Fujifilm.
10.7(3) Letter Agreement dated December 16, 1991 between the
Registrant and Dolby Laboratories Licensing Corporation, as
amended.
10.11(3) Lease Agreement dated October 1, 1992 between the
Registrant's subsidiary, Zoran Microelectronics Ltd.
("ZML"), and Matam-Haifa Scientific Industries Center Ltd.
+10.12(3) License Agreement for ZR33891 Digital Filter Processor dated
June 8, 1995 between the Registrant and Atmel Corporation
("Atmel").
+10.13(3) License Agreement for ZR34325 Vector Signal Processor dated June
8, 1995 between the Registrant and Atmel.
+10.14(3) Cooperation and Project Funding Agreement dated June 16, 1991
between ZML and the Israel-United States Binational Industrial
Research and Development Foundation ("BIRDF").
+10.15(3) Cooperation and Project Funding Agreement dated June 9, 1992
between ZML and BIRDF.
10.16(3) Note of Approval No. 17391 dated September 5, 1994 issued to ZML
by the Office of Chief Scientist, Head of the Industrial
Research and Development Administration of the Israeli Ministry
of Industry and Trade (the "Chief Scientist"), together with
ZML's Letter of Undertaking dated September 4, 1994.
10.17(3) Note of Approval No. 17337 dated September 5, 1994 issued to ZML
by the Chief Scientist, together with ZML's Letter of
Undertaking dated September 4, 1994.
</TABLE>
61
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
10.18(3) Loan Agreements dated July 25, 1995, August 1, 1995,
August 15, 1995, August 31, 1995 and November 1, 1995
between ZML and the Israel Discount Bank.
10.29(5) Summary of Discussion dated April 23, 1996 between ZML and
Matam regarding Lease Agreement dated October 1, 1992
between ZML and Matam.
10.30(6) Memorandum of Understanding Dated April 23, 1996 between ZML and
IBM Israel Ltd. regarding Lease Agreement dated October 1, 1992
between ZML and Matam.
10.33(7) Sub-Sublease dated April 1, 1997 between the Registrant and
Integrated Silicon Solutions, Inc.
*10.34(8) Confidential Separation Agreement dated August 4, 1997
between the Registrant and George T. Haber.
21.1 List of subsidiaries of the Registrant.
23.1 Consent of PricewaterhouseCoopers LLP.
27 Financial Data Schedule.
</TABLE>
------------------------------
* Constitutes a management contact or compensatory plan
required to be filed pursuant to Item 14(c) of Form 10-K.
+ Confidential treatment has been granted as to a portion of
this Exhibit.
(1) Incorporated by reference to Exhibit 3.2 to Registrant's Form
SB-2 Registration Statement (No. 33-98630-LA), which became
effective on December 14, 1995 (the "1995 Registration
Statement").
(2) Incorporated by reference to Exhibit 3.3 to Registrant's Form 10-Q
Quarterly Report for the quarter ended September 30, 1998.
(3) Incorporated by reference to identically numbered exhibit to
the 1995 Registration Statement.
(4) Incorporated by reference to identically numbered exhibit to
Registrant's Form 10-K Annual Report for the year ended
December 31, 1995.
(5) Incorporated by reference to Exhibit 10-1 to the
Registrant's Form 10-Q Quarterly Report for the quarter
ended June 30, 1996 (the "June 1996 Form 10-Q").
(6) Incorporated by reference to Exhibit 10.2 to the June 1996
Form 10-Q.
(7) Incorporated by reference to identically numbered exhibit to
Registrant's Form 10-Q Quarterly Report for the quarter
ended March 31, 1997.
(8) Incorporated by reference to Exhibit 10.34 to Registrant's Form
10-K Annual Report for the year ended December 31, 1997.
62
<PAGE>
EXHIBIT 21.1
SUBSIDIARIES OF THE REGISTRANT
The subsidiaries of Zoran Corporation are the following:
1. Zoran Microelectronics Ltd., a corporation organized
under the laws of the State of Israel;
2. CompCore Multimedia, Inc., a California corporation.;
and
3. Zoran International, Inc., a Delaware corporation.
<PAGE>
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statements of Forms S-8 (No. 333-59843, 333-37111) of our report dated
January 27, 1999, appearing on page 35 of Zoran Corporation's Annual Report
on Form 10-K for the year ended December 31, 1998.
PricewaterhouseCoopers LLP
San Jose, California
March 30, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED INCOME STATEMENTS, THE CONSOLIDATED BALANCE SHEETS AND THE
ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 8,221
<SECURITIES> 10,954
<RECEIVABLES> 16,357
<ALLOWANCES> (799)
<INVENTORY> 7,063
<CURRENT-ASSETS> 43,814
<PP&E> 11,683
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0
0
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</TABLE>
