FAROUDJA INC, S-1/A, 1997-10-02

FAROUDJA INC
S-1/A, 1997-10-02
HOUSEHOLD AUDIO & VIDEO EQUIPMENT

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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 2, 1997

REGISTRATION NO. 333-32375
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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AMENDMENT NO. 2
FORM S-1/A

REGISTRATION STATEMENT UNDER

THE SECURITIES ACT OF 1933
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FAROUDJA, INC.

(Exact name of registrant as specified in its charter)

<TABLE>
<S> <C> <C>
DELAWARE 3651 77-0444978
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of Classification Code Number) Identification
incorporation or organization) Number)
</TABLE>

750 PALOMAR AVENUE, SUNNYVALE, CALIFORNIA 94086
(408) 735-1492

(Address, including zip code, and telephone number, including
area code, of registrant's principal executive offices)

MICHAEL J. MOONE
PRESIDENT AND CHIEF EXECUTIVE OFFICER
FAROUDJA, INC.
750 PALOMAR AVENUE
SUNNYVALE, CALIFORNIA 94086
(408) 735-1492

(Name, address, including zip code, and telephone number, including area code of
agent for service)
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COPIES TO:

MARK A. BONENFANT PATRICK J. SCHULTHEIS
Buchalter, Nemer, Fields & Younger Wilson Sonsini Goodrich & Rosati
a Professional Corporation Professional Corporation
601 South Figueroa Street, Suite 2400 650 Page Mill Road
Los Angeles, California 90017 Palo Alto, California 94304
(213) 891-0700 (415) 493-9300

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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
AS SOON AS PRACTICABLE AFTER THIS REGISTRATION STATEMENT BECOMES EFFECTIVE.

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If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. / /

If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. / / ______________

If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / / ______________
------------------------

THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION,
ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.

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INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
<PAGE>

SUBJECT TO COMPLETION, DATED OCTOBER 2, 1997

[LOGO]

3,000,000 SHARES

COMMON STOCK

All of the 3,000,000 shares of Common Stock offered hereby are being offered
by Faroudja, Inc. ("Faroudja" or the "Company"). Prior to this Offering, there
has been no public market for the Common Stock of the Company. It is currently
estimated that the initial public offering price will be between $8.00 and
$10.00 per share. See "Underwriting" for information relating to the method of
determining the initial public offering price. Application has been made to have
the Common Stock approved for quotation on the Nasdaq National Market under the
symbol "FDJA."

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THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" BEGINNING AT PAGE 6.

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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.

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<CAPTION>
UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS (1) COMPANY (2)
<S> <C> <C> <C>
Per Share............................. $ $ $
Total (3)............................. $ $ $
</TABLE>

(1) The Company and the Selling Stockholder have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933, as amended. See "Underwriting."

(2) Before deducting expenses payable by the Company, estimated at $750,000.

(3) One of the Company's stockholders has granted the Underwriters a 30-day
option to purchase up to an additional 450,000 shares of Common Stock solely
to cover over-allotments, if any. See "Principal and Selling Stockholders"
and "Underwriting." If such option is exercised in full, the total Price to
Public, Underwriting Discounts and Commissions and Proceeds to Selling
Stockholder will be $ , $ and $ , respectively.

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The Common Stock is offered by the Underwriters as stated herein, subject to
receipt and acceptance by them and subject to their right to reject any order in
whole or in part. It is expected that delivery of such shares will be made
through the offices of BancAmerica Robertson Stephens, San Francisco,
California, on or about , 1997.

BANCAMERICA ROBERTSON STEPHENS VOLPE BROWN WHELAN & COMPANY

The date of this Prospectus is , 1997
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Description of Front Cover Spread

1. Heading that states "Faroudja. The quality standard for digital video
solutions."

2. Graphic presentation indicating how Faroudja current products and Faroudja
future products are utilized from the origination and production of video
signals to the reception and presentation of the video signal to a viewer

3. Picture of a Faroudja "system"

4. Picture of Faroudja board level product.

5. Picture of a Faroudja integrated circuit.

6. Picture of S3 trademark to represent Faroudja licensing.

7. Text:

"Faroudja designs, develops and markets video image enhancement products
that significantly improve images to achieve cinema-like quality.

Faroudja's technology, experience and reputation for providing sophisticated
video processing products will enable it to address opportunities in the
emerging Digital Television (DTV)/High Definition Television (HDTV)
broadcast environment and in the converging Personal Computer (PC) and TV
markets.

Description of Inside Front Cover

1. Actual photograph of a standard television image.

2. Actual photograph of same television image with Faroudja line processing,
color decoding and detail enhancement technology.

3. TEXT:

Through more than 25 years of product development and technological
advances, Faroudja and its predecessors have established a reputation
for excellence in video signal processing and video image enhancement in
the high end home theater, industrial and broadcast markets.

4. Faroudja Picture Plus trademark.

5. 25 year logo.

CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT
STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING BY ENTERING STABILIZING BIDS, EFFECTING SYNDICATE COVERING
TRANSACTIONS OR IMPOSING PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES,
SEE "UNDERWRITING."

IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS MAY ENGAGE IN PASSIVE
MARKET MAKING TRANSACTIONS IN THE COMMON STOCK ON THE NASDAQ NATIONAL MARKET IN
ACCORDANCE WITH RULE 103 OF REGULATION M. SEE "UNDERWRITING."
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NO DEALER, SALES REPRESENTATIVE, OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO
GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THIS
OFFERING OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE,
SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, ANY
SECURITIES OTHER THAN THE REGISTERED SECURITIES TO WHICH IT RELATES OR AN OFFER
TO, OR SOLICITATION OF, ANY PERSON IN ANY JURISDICTION WHERE SUCH OFFER OR
SOLICITATION WOULD BE UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY
SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT
THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR
THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO
THE DATE HEREOF.

UNTIL , 1997 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT
PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS DELIVERY REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER
A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENTS OR SUBSCRIPTIONS.
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TABLE OF CONTENTS

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PAGE
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<S> <C>
Summary........................................................................................ 4
Risk Factors................................................................................... 6
Use of Proceeds................................................................................ 17
Dividend Policy................................................................................ 17
Capitalization................................................................................. 18
Dilution....................................................................................... 19
Selected Consolidated Financial Data........................................................... 20
Management's Discussion and Analysis of Financial Condition and Results of Operations.......... 22
Business....................................................................................... 31
Management..................................................................................... 44
Certain Transactions........................................................................... 55
Principal and Selling Stockholders............................................................. 58
Description of Capital Stock................................................................... 60
Shares Eligible for Future Sale................................................................ 64
Underwriting................................................................................... 66
Legal Matters.................................................................................. 67
Experts........................................................................................ 67
Available Information.......................................................................... 68
Index to Consolidated Financial Statements..................................................... F-1
</TABLE>

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The Company intends to furnish its stockholders with annual reports
containing audited consolidated financial statements examined by an independent
public accounting firm and quarterly reports for the first three quarters of
each year containing interim unaudited financial information. Upon completion of
the Offering contemplated hereby, the Company will be subject to the
informational requirements of the Securities and Exchange Act of 1934, and in
accordance therewith, will be filing reports and other information with the
Securities and Exchange Commission.

FAROUDJA, PICTURE PLUS and PRESENTATION PLUS are trademarks of the Company.
All other trademarks or tradenames referred to in the Prospectus are the
property of their respective owners. Digital Light Processing-TM- is a trademark
of Texas Instruments Incorporated.

The Company was incorporated in the State of Delaware on December 26, 1996.
The Company's principal executive offices are located at 750 Palomar Avenue,
Sunnyvale, California 94086 and its telephone number is (408) 735-1492. All
references to the "Company" shall mean Faroudja, Inc. and its predecessors and
subsidiaries, unless the context otherwise requires.

3
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SUMMARY

THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION AND CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO APPEARING
ELSEWHERE IN THIS PROSPECTUS. PROSPECTIVE INVESTORS SHOULD CONSIDER CAREFULLY
THE INFORMATION DISCUSSED UNDER "RISK FACTORS." THIS PROSPECTUS CONTAINS
FORWARD-LOOKING STATEMENTS BASED UPON CURRENT EXPECTATIONS THAT INVOLVE RISKS
AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS AND THE TIMING OF CERTAIN EVENTS
COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING
STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING THOSE SET FORTH UNDER "RISK
FACTORS" AND ELSEWHERE IN THIS PROSPECTUS.

THE COMPANY

Faroudja designs, develops and markets a range of video image enhancement
products that significantly improve displayed images to achieve cinema-like
quality. Through more than 25 years of product development and technological
advances, the Company and its predecessors have established a reputation for
excellence in video signal processing and video image enhancement in the
high-end home theater, industrial and broadcast markets. The Company believes
that its technology, experience and reputation in these markets will enable it
to address opportunities in the emerging digital television ("DTV") and digital
high definition television ("HDTV") broadcast environment and to facilitate the
convergence of the personal computer ("PC") and the television ("TV").

Video images can currently be displayed on a variety of media, including
color TVs, projection systems and PCs. Historically, there has been a
substantial difference in the quality of these various media. TV signals are
produced in accordance with the NTSC standard, which was originally developed in
the 1940s for black and white programs. This standard was last modified in the
1950s to make possible the compatible transmission of black and white and color
programs. The technical compromises required to achieve compatibility introduced
image degrading imperfections, which are increasingly visible as screen sizes
become larger. Over the last decade, consumer interest in home theaters and
large screen TVs has increased dramatically, fueled by decreasing equipment
prices and the advent of cable TV, direct broadcast satellite, laser discs, VCRs
and most recently digital video discs ("DVD").

The Company's products for the TV market substantially reduce the
imperfections inherent in analog NTSC signals and dramatically improve displayed
images, giving the observer a far richer viewing experience. The Company's
technology improves picture quality by removing artifacts and noise, detecting
and compensating for motion, enhancing resolution and multiplying the number of
lines displayed on the TV screen.

Faroudja intends to capitalize on its experience and core technologies to
address the problems of standards conversion and upscaling anticipated in the
emerging DTV/HDTV broadcast equipment market. The Federal Communications
Commission ("FCC") recently established standards for DTV broadcasting in the
U.S. and has targeted the eventual phase out of analog (NTSC) broadcasting by
the year 2006. Faroudja is developing products that it believes will assist
broadcasters in responding to evolving regulatory and market requirements by
allowing them to continue to use a significant portion of their current
infrastructure, thereby reducing capital costs associated with the transition
from analog to digital transmission.

The Company believes that the use of the PC as an entertainment device in
the future will depend in large part on the PC's ability to display TV images.
The two media use different display formats--TV signals use an interlaced format
while PCs use a progressive scanning format. The Company's technology
significantly reduces the image imperfections caused by the
interlace/progressive conversion, which will enable the display of high quality
TV pictures on PC screens. The Company and S3 Incorporated ("S3"), a leading
supplier of advanced graphics accelerators for multimedia computer systems, are
working jointly, pursuant to a recent license agreement, to develop integrated
circuits incorporating the Company's video processing technology for use in PCs.

The Company intends to establish additional relationships with companies
whose technology, products and product strategies complement those of the
Company. The Company markets its products for the TV market through a network of
home theater, industrial and commercial dealers as well as OEM customers. For
the broadcast market, the Company utilizes its direct sales force. The Company
intends to expand its international sales and marketing activities in order to
increase export sales.

The Company began operations in 1971 through two related companies, Faroudja
Laboratories, Inc. ("FLI") and later Faroudja Research Enterprises, Inc.
("FRE"). The Company was incorporated in December 1996 under the laws of the
state of Delaware to succeed to the business of FLI and FRE.

4
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THE OFFERING

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<CAPTION>
Common Stock offered by the Company.......... 3,000,000 shares
<S> <C>
Common Stock outstanding after the
Offering................................... 11,733,696 shares(1)
Use of Proceeds.............................. For general corporate purposes, including
working capital and research and development.
See "Use of Proceeds."
Proposed Nasdaq National Market symbol....... FDJA
</TABLE>

SUMMARY CONSOLIDATED FINANCIAL DATA
(in thousands, except per share data)

PRO FORMA DATA(3):
Pro forma adjustments.................... $ (701) $ (939) $ (192) $ (192)
Pro forma net income..................... 1,228 3,070 1,319 616
Pro forma net income per share........... $ 0.15 $ 0.38 $ 0.15 $ 0.07
Shares used in per share
calculation(2)......................... 7,979 7,998 9,012 8,784
</TABLE>

<TABLE>
<CAPTION>
JUNE 30, 1997
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AS
ACTUAL ADJUSTED(4)
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<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments..................................... $ 7,793 $ 32,153
Working capital....................................................................... 11,185 35,545
Total assets.......................................................................... 15,225 39,585
Total long-term debt.................................................................. -- --
Total stockholders' equity............................................................ 12,923 37,283
</TABLE>

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(1) Based on shares outstanding as of June 30, 1997. Excludes (i) 1,578,349
shares of Common Stock issuable upon exercise of stock options outstanding
as of June 30, 1997, (ii) an aggregate of 864,271 shares of Common Stock
reserved for future issuance pursuant to the Company's stock option and
stock purchase plans, (iii) 179,601 shares of Common Stock issuable upon
exercise of outstanding warrants and (iv) 29,240 shares of Common Stock
issuable to S3 pursuant to certain anti-dilution rights which the Company
granted to S3 under a Stock Purchase Agreement, assuming an Offering price
of $9.00 per share. See "Capitalization," "Management--Stock Plans,"
"Certain Transactions," "Description of Capital Stock" and Note 6 of Notes
to Consolidated Financial Statements.

(2) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of the basis used to calculate net income per share.

(3) Reflects the pro forma effect of the Company being treated as a C
Corporation rather than an S Corporation for federal and state income tax
purposes, effective January 1, 1994. See "Certain Transactions--Subchapter S
Distributions."

(4) Adjusted to give effect to the sale and issuance of 3,000,000 shares of
Common Stock offered by the Company hereby at an assumed initial public
offering price of $9.00 per share and receipt of the estimated net proceeds
therefrom. See "Use of Proceeds" and "Capitalization."

5
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RISK FACTORS

AN INVESTMENT IN THE SHARES OF COMMON STOCK OFFERED BY THIS PROSPECTUS
INVOLVES A HIGH DEGREE OF RISK. PROSPECTIVE PURCHASERS OF THE COMMON STOCK
OFFERED HEREBY SHOULD CAREFULLY REVIEW THE FOLLOWING RISK FACTORS AS WELL AS THE
OTHER INFORMATION SET FORTH IN THIS PROSPECTUS. THIS PROSPECTUS CONTAINS
FORWARD-LOOKING STATEMENTS BASED UPON CURRENT EXPECTATIONS THAT INVOLVE RISKS
AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS AND THE TIMING OF CERTAIN EVENTS
COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING
STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING THOSE SET FORTH IN THE
FOLLOWING RISK FACTORS AND ELSEWHERE IN THIS PROSPECTUS.

POTENTIAL FLUCTUATIONS IN FUTURE OPERATING RESULTS; SEASONALITY

The Company's operating results have varied in the past and are likely to
vary significantly in the future from period to period as a result of a number
of factors, including the volume and timing of orders received during the
period, fluctuations in the amount and timing of license and royalty revenues,
the timing of new product introductions by the Company and its competitors,
demand for and market acceptance of the Company's products, product line
maturation, the impact of price competition on the Company's average selling
prices, delays encountered by the Company's strategic partners, the availability
and pricing of components for the Company's products, changes in product or
distribution channel mix, product returns or price protection charges (price
protection is currently afforded to one of the Company's customers (see
"Business--Sales and Marketing")) from customers and the unexpected loss of key
customers. Many of these factors are beyond the Company's control. For example,
in 1996, the Company experienced an unexpected decline in sales of its broadcast
products resulting from a major customer which developed internally products
previously purchased from the Company. In addition, due to the short product
life cycles that characterize the markets for the Company's products, the
Company's failure to introduce new, competitive products consistently and in a
timely manner could materially adversely affect operating results for one or
more product cycles. The Company recently entered into a license agreement with
S3 pursuant to which the Company may receive royalties and may receive quarterly
prepaid license fees to maintain exclusivity. S3 is under no obligation to
market any products or to make the payments necessary to maintain its exclusive
license rights. There can be no assurance that the Company will receive any
further payments pursuant to this agreement, and the amount of any such payments
cannot be predicted. As a result, license and royalty revenues may be higher or
lower than expected in any given quarter. S3 is a key customer of the Company, a
licensee of the Company's technology and a potential competitor of the Company.
See "--Distribution Risks; Diversification of Sales Channels," "--Dependence on
Strategic Relationships," "Business--Strategic Relationships" and "Certain
Transactions--License Agreement with S3" for further information relating to the
relationship between the Company and S3.

Gross margins may vary from period to period as a result of a number of
factors, including the mix of products sold, new product introductions,
fluctuations in the receipt of license and royalty revenues, and the mix of
distribution channels. The Company's gross margins may also be adversely
affected by shortages in the availability of key components for the Company's
products. To maintain favorable margin levels on product sales, the Company must
introduce new products, must introduce enhanced versions of its products, and
must continue its cost reduction efforts. The Company anticipates that it will
incur lower overall gross margins in future periods as it introduces lower
margin products for consumer markets.

Customers generally order on an as-needed basis and, accordingly, the
Company has historically operated with a relatively small backlog.
Notwithstanding the difficulty in forecasting future sales and the relatively
small level of backlog at any given time, the Company generally must plan
production, order components and undertake its development, sales and marketing
activities and other commitments months in advance of orders for its products.
Accordingly, any shortfall in revenues in a given quarter may adversely impact
the Company's operating results due to an inability to adjust expenses during
the quarter to offset any reduced level of revenues for the quarter.

The Company currently derives a substantial portion of its total revenues
from the sale of a relatively small number of high priced products. The
Company's backlog at the beginning of a quarter typically does not include

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all sales required to achieve the Company's sales objectives for that quarter.
Consequently, the Company's total revenues and operating results for a quarter
depend upon the Company obtaining orders for products to be shipped in the same
quarter. In addition, from time to time, a significant portion of the Company's
sales have been derived from sales of multiple products to a limited number of
customers. The volume and timing of orders received during a quarter are
difficult to forecast. As a result of the Company's typical sales cycle, a
disproportionate percentage of the Company's total revenues in any quarter may
be generated in the last month of a quarter. As a result, a shortfall in sales
in any quarter as compared to expectations may not be identifiable until the end
of the quarter. A delay in shipment near the end of a particular quarter, due,
for example, to an unanticipated shipment rescheduling, to cancellations by
customers or to unexpected manufacturing difficulties experienced by the Company
or its suppliers may cause total revenues in a particular quarter to fall
significantly below the Company's expectations and may thus materially adversely
affect the Company's operating results for such quarter. The Company's industry
is subject to a high degree of seasonality, and demand for the Company's
products has historically been highest in the third and fourth quarters of each
calendar year. As a result, sales are typically highest in these quarters and
may be lower in following quarters.

RISKS ASSOCIATED WITH NEW MARKETS AND APPLICATIONS; MARKET ACCEPTANCE

Substantially all of the Company's revenues in 1996 were derived from sales
of products that address the high-end home theater and industrial TV markets.
Certain of the Company's current products and certain of its planned future
products generally address markets that are not now and may never become
substantial commercial markets. The Company's future growth will depend, in
large part, on the Company's ability to identify new markets for its products
and to apply its video enhancement technology to evolving markets and
applications that require superior visual images. There can be no assurance that
these markets will become substantial commercial markets or that they will
evolve in such a manner that the Company's products achieve market acceptance.
For example, one of the products the Company manufactures for the TV market is
the DV1000, a DVD player. However, a significant market for DVD players has not
yet developed. The Company also intends to exploit what it believes will be the
convergence of the TV and PC markets. There can be no assurance that the TV and
PC markets will converge, that this new market will present substantial
commercial opportunities, or that the Company's products will adequately address
this market in a timely manner. The Company has experienced, and expects to
continue to experience, technological and pricing constraints that may preclude
the development of products that address emerging markets. There can be no
assurance that the Company or its original equipment manufacturer ("OEM")
customers will continue their existing product development efforts, or, if
continued, that such efforts will be successful, that markets will develop in a
timely manner, or at all, for any of the Company's or such customers' products,
or that the Company's and its customers' products will not be superseded by
other technology or products.

RISKS ASSOCIATED WITH CHANGING TV STANDARDS

The Company is developing products that are designed to conform with certain
current industry broadcast standards. However, 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 or consumers.
The acceptance of the Company's products also depends 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.

The FCC has required broadcasters to begin broadcasting digital signals in
May 1999, targeting the phase out of the current analog signals by the year
2006. There is considerable uncertainty among broadcasters and providers of
broadcast, reception and display equipment as to how DTV will be implemented, as
to how broadly and rapidly DTV will be deployed, and as to when, if ever, analog
TV will be discontinued. There can be no assurance that the market for the
Company's products will continue following the introduction of DTV or if
competing standards or technologies emerge that are preferred by manufacturers
and consumers. In addition,

7
<PAGE>
there can be no assurance that DTV and related products will gain market
acceptance or that third-party content providers will develop and market content
for end user systems using a digital format or a format compatible with the
Company's products. There can be no assurance that such factors beyond the
Company's control will not adversely affect the development of markets for the
Company's products.

DEPENDENCE ON NEW PRODUCT DEVELOPMENT AND RISK OF TECHNOLOGICAL CHANGE

The markets for the Company's products are characterized by evolving
industry standards, rapid technological change, frequent new product
introductions and short product life cycles. The Company's future success will
depend, in large part, on its ability to continue to enhance its existing
products and to develop new products and features to meet changing customer
requirements and evolving industry standards. The Company anticipates that sales
from its line multiplier product lines will experience limited growth, or may
decline, in future periods as the Company's technology migrates to board and
chip level products. The percentage of revenues derived from sales of the
Company's line multiplier product lines was 80% and 75% during fiscal 1996 and
the six months ended June 30, 1997, respectively. The Company expects that more
than one-half of its total revenues in 1998 will be derived from license and
royalty revenues and sales of recently introduced products, as well as products
which the Company is developing. The success of new products depends on a number
of factors, including proper selection and timely introduction of planned new
products, successful and timely completion of product development, accurate
estimation of demand for new products, market acceptance of new products of the
Company and its OEM customers, the Company's ability to offer new products at
competitive prices, the availability of adequate staffing to produce and sell
such new products, and competition from products introduced by competitors.
Certain of these factors are outside the control of the Company. See "--Risks
Associated with New Markets and Applications; Market Acceptance." For example,
to date sales of the Company's DVD players have been minimal, and initial sales
of the Company's rear projection TV system are not expected until the fourth
quarter of 1997. Sales of the Company's board level products, and future license
and royalty revenues, depend in part upon the ability of the Company's OEM
customers and licensees to successfully develop and market products
incorporating the Company's products or technology. The Company's products
intended for the digital broadcast market are not expected to be field tested
until the fourth quarter of 1997 and are not expected to be available for sale
until 1998. There can be no assurance that the Company's broadcast products,
assuming timely development and satisfactory completion of field tests, will be
accepted by the broadcast market. There can be no assurance as to the amount of
royalties, if any, to be paid to the Company under the S3 agreement because S3
is under no obligation to maintain its exclusive license with the Company or to
develop products incorporating the Company's technology under the agreement.

The incorporation of the Company's products into its OEM customers' product
designs often requires significant expenditures by the Company, which
expenditures may precede volume sales of the Company's products, if any, by one
year or more. 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, to avoid excessive levels of older
product inventories and to ensure that adequate supplies of new products can be
delivered to meet customer demand.

There can be no assurance that the Company will identify new product
opportunities, will successfully develop and bring to market new products, will
achieve design wins or will respond effectively to technological changes or
product announcements by others, or that the Company's new products will achieve
market acceptance. A failure in any of these areas would have a material adverse
effect on the Company's business, financial condition and operating results.

DISTRIBUTION RISKS; DIVERSIFICATION OF SALES CHANNELS

The Company sells its products domestically and internationally through
distributors and dealers, as well as to OEM customers, and the Company's success
depends on the continued efforts of its network of direct and indirect
distributors and dealers. The Company's key distribution and OEM customers are
S3, Ampro Corp. ("Ampro"), Hughes-JVC Technology Corporation ("Hughes/JVC"), NEC
Technologies, Inc. USA ("NEC"),

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Cinema Pro Corporation dba Runco International ("Runco") and Vidikron of
America, Inc. ("Vidikron"). The loss of, or reduction in sales to, any of the
Company's key customers could have a material adverse affect on the Company's
operating results. The short life cycles of the Company's products and the
difficulty in predicting future sales increase the risk that new product
introductions, price reductions by the Company or its competitors or other
factors affecting the video imaging industry could result in significant product
returns. In addition, there can be no assurance that new product introductions
by competitors or other market factors will not require the Company to reduce
prices in a manner or at a time which has a material adverse impact upon the
Company's business, financial condition and operating results.

An integral element of the Company's strategy is to enhance and diversify
its international and domestic distribution channels. The Company has
distribution relationships with Ampro, Hughes/JVC, NEC, Runco and Vidikron.
However, none of such distributors is obligated to purchase the Company's
products. The Company's ability to achieve revenue growth in the future will
depend in large part on its success in recruiting and training sufficient sales
personnel, distributors and resellers. Certain of the Company's existing
distributors currently distribute, or may in the future distribute, the product
lines of the Company's competitors. There can be no assurance that the Company
will be able to attract, train and retain a sufficient number of its existing or
future third-party distributors or direct sales personnel or that such
third-party distributors will recommend, or continue to recommend, the Company's
products or devote sufficient resources to market and provide the necessary
customer support for such products. All of these factors could have a material
adverse effect on the Company's business, financial condition and operating
results.

COMPETITION

The markets in which the Company competes are intensely competitive and are
characterized by rapid technological change, rapid product obsolescence and
price competition. 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 products or technologies which may be less
costly or provide higher performance or more desirable features than the
Company's products. The Company's existing and potential competitors include
several large domestic and international companies that have substantially
greater financial, manufacturing, technical, marketing, distribution and other
resources than the Company. In the TV market for video processors, the Company's
principal competitors are DWIN Electronics, Inc. ("DWIN"), Extron Electronics
("Extron"), NEC, Snell & Wilcox Inc. ("Snell & Wilcox"), Sony Corporation
("Sony") and Yamashita Engineering Manufacturing, Inc. ("YEM"). In the market
for broadcast products, the Company's principal competitors are Extron, Leitch,
Incorporated ("Leitch"), Matsushita Consumer Electronics Co. ("Matsushita"),
Snell & Wilcox, Sony Broadcast Products, Incorporated ("Sony Broadcast") and
Vistek Electronics, Ltd. ("Vistek").

As the Company's products penetrate broader markets and as these markets
become commercial markets, the Company expects to face competition from
diversified electronic and semiconductor companies.

Certain of the Company's principal competitors maintain their own
manufacturing facilities, including semiconductor foundries, and may therefore
benefit from certain capacity, cost and technical advantages. Since the Company
does not operate its own semiconductor manufacturing, assembly or test
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.

The Company believes that its ability to compete successfully in the rapidly
evolving markets for high performance video technology depends on a number of
factors, including protection of its proprietary technology and information, the
price, quality and performance of the Company's and its competitors 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 and locate adequate foundry capacity, the number and
nature of the Company's competitors in a given market and general market and
economic

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conditions. There can be no assurance that the Company will compete successfully
in the future with respect to these or any other competitive factors. See
"--Limited Protection of Proprietary Rights; Risk of Third Party Infringement."

DEPENDENCE ON STRATEGIC RELATIONSHIPS

The Company expects that a significant portion of its annual revenues and
profits in the future will depend on strategic relationships. In particular,
under the license agreement with S3, the Company depends on S3 to develop and
market products incorporating the Company's technology for use in PCs.
Similarly, the Company depends on Runco and Vidikron to sell products which
incorporate the Company's technology, and a failure by these companies to make
such sales will adversely affect the Company's total revenues in the future. The
Company and Texas Instruments Incorporated ("TI") have entered into an agreement
pursuant to which TI has engaged the Company to develop improvements for the TI
Digital Light Processing-TM- based projector systems ("DLP"). TI may, but is not
required to, incorporate the results of such development in its DLPs. If TI
chooses to incorporate such improvements, it will enter into a royalty agreement
with the Company for the sale of DLPs incorporating the Company's technology.
There can be no assurance that any of the Company's strategic relationships will
result in the introduction of new products incorporating the Company's
technology or will result in substantial revenues for the Company. In the event
that the Company's strategic relationships fail to result in substantial
revenues to the Company, the Company's business, financial condition and
operating results will be materially adversely affected.

The Company has licensed, and intends to continue to license, its
technologies and intellectual property to others. The Company also offers for
sale board level or chip level products developed by or for the Company, which
implement certain of the Company's technologies. The Company's licensees and OEM
customers may be larger and have greater market recognition and financial,
technological, engineering, manufacturing and distribution capabilities than the
Company. In addition, such licensees and OEM customers may use such technologies
and subsystems either alone or in combination with other technologies to develop
products which could compete with the Company's technologies and products. At
present, the Company believes that S3 and General Instrument Corporation ("GI")
are licensees which could compete with certain of the Company's technologies and
products. While the Company may sell board level or chip level products and may
receive royalties from licensees, there can be no assurance that the
technologies and products offered by such licensees and OEM customers will not
compete directly with those of the Company, have performance, cost or other
advantages over those of the Company or have an adverse impact on the sales or
other licensing activities of the Company.

MANAGEMENT OF GROWTH

Since 1993, the Company has experienced, and expects to continue to
experience, a significant expansion in its overall level of business and
operations, including research and development, marketing, technical support and
sales and distribution. This growth has placed, and is expected to continue to
place, significant strain on the Company's management, operating and financial
resources resulting in new and increased responsibilities for management
personnel. There can be no assurance that the Company's management, personnel,
systems, procedures and controls will be adequate to support the Company's
existing and future operations. The Company's ability to effectively manage its
recent growth and any future growth will require the Company to expand its
operating, manufacturing and financial procedures and controls, to improve
coordination among different operating functions, to replace or upgrade its
management information systems and telecommunications systems, and to continue
to hire additional personnel, particularly in the areas of engineering and sales
and marketing. There can be no assurance that the Company will be able to manage
these activities and implement these additional systems and controls
successfully, and any failure to do so could have a material adverse effect upon
the Company's business, financial condition and operating results.

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RELIANCE ON INDEPENDENT FOUNDRIES AND MANUFACTURERS

The Company currently relies on independent foundries to manufacture,
assemble and test all of its semiconductor components and products. The
Company's primary foundries are SGS-Thomson Microelectronics, Inc.
("SGS-Thomson"), Micro Devices Technology, Inc. ("MDT") and TEMIC North America,
Inc. ("TEMIC"). These independent foundries fabricate products for other
companies and may also manufacture products of their own design. The Company
currently purchases products from all of its foundries pursuant to individually
negotiated purchase orders. The Company does not have a long-term supply
contract with any of these foundries, and, therefore, none of them 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 involves a number of risks,
including the inability to obtain adequate capacity, unavailability of or
interruption of 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. From time to
time, the semiconductor industry has experienced severe capacity constraints,
and this pattern is expected to continue. The Company obtains foundry capacity
through forecasts that are generated in advance of expected delivery dates, and
the Company places purchase orders up to six months prior to scheduled delivery.
The Company's ability to obtain the foundry capacity necessary to meet the
demand for its products is based in part on its ability to accurately forecast
demand. 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 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 could have a material adverse effect on the Company's business, financial
condition and operating results.

The Company subcontracts the manufacturing of its broadcast and TV products
pursuant to individually negotiated purchase orders. Bestronics, Inc.
("Bestronics") assembles more than 80% of the Company's circuit boards and DC
Electronics, Inc. ("DC Electronics") builds all of the Company's wire and cable
harnesses. The Company does not have any long term agreements with its
subcontractors and contract manufacturers, including SGS-Thomson, MDT and TEMIC.
The Company's reliance on third-party manufacturers limits its control over
delivery schedules, quality assurance and product cost. Disruptions in the
provision of services by the Company's assemblers or other circumstances that
would require the Company to seek alternative sources of assembly could lead to
supply constraints or delays in the delivery of the Company's products. In
addition, the need for high quality assurance by the Company may increase costs
paid by the Company to third parties for manufacturing and assembly of the
Company's products. These constraints or delays could damage relationships with
current and prospective customers and could have a material adverse effect on
the Company's business, financial condition and operating results.

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LIMITED PROTECTION OF PROPRIETARY RIGHTS; RISK OF THIRD PARTY INFRINGEMENT

The Company's future success depends in part upon its ability to protect its
proprietary technology and information. The Company seeks to protect its
intellectual property rights and to limit access to its proprietary information
through a combination of patents, trademarks, copyrights, trade secrets, and
nondisclosure and licensing arrangements, all of which afford only limited
protection. Yves Faroudja, the Company's founder and Chief Technical Officer,
personally holds or was assigned 35 U.S. and 8 foreign patents, and 7 U.S. and
22 foreign patent applications, which have been licensed to the Company, and on
which the Company depends for the enhancement of its current products and the
development of future products. Mr. Faroudja has granted the Company a
perpetual, royalty-free license to use patented and unpatented technologies
developed by him prior to January 20, 1997. See "Certain Transactions--Yves
Faroudja License Agreement." There can be no assurance that patents will issue
from any pending applications or that any claims allowed from pending
applications will be of sufficient scope or strength, or be issued in all
countries where the Company's products can be sold, to provide meaningful
protection or any commercial advantage to the Company. Also, competitors of the
Company may be able to design around the licensed patents. 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 the
laws of the United States, and thus, may increase the likelihood of piracy of
the Company's technology and products. There can be no assurance that the steps
taken by the Company to protect its intellectual property rights will be
adequate to prevent misappropriation of its technology or that the Company's
competitors will not independently develop technologies that are substantially
equivalent or superior to the Company's technology.

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 license or obtain patents or other intellectual property
protection in the future.

Substantially all of the intellectual property used by the Company is
licensed to the Company by Yves Faroudja. See "Certain Transactions--Yves
Faroudja License Agreement." The Company faces certain risks because the Company
is a licensee and not the owner of such intellectual property rights. Under his
agreement with the Company, Mr. Faroudja retains the non-exclusive right to
license his patents and technologies to third parties for use outside the
Company's field of use. Mr. Faroudja previously granted licenses in the
Company's field of use to approximately 20 other companies covering various
applications such as video recorders and players, color TV cameras, broadcast
encoders and video compression and decompression equipment. In the event that
preexisting licenses granted to third parties relate to the Company's field of
use, the Company would not be able to exclude such third parties from making,
using, selling, or importing devices or practicing methods, covered by such
patents or technologies. Notwithstanding the particular terms of the license
agreement with Mr. Faroudja, the Company faces the risk that he may attempt to
terminate the granted licenses and that such an attempt may be successful or
that the response to such attempt may consume substantial financial and
personnel resources. In the event the Company's resources are so consumed, such
consumption may have a material adverse effect on the Company's business,
financial condition and operating results. See "Business--Proprietary Rights and
Licenses" and "Certain Transactions--Yves Faroudja License Agreement."

The video image enhancement and related industries are characterized by
vigorous protection and pursuit of intellectual property rights or positions,
which have resulted in significant and often protracted and expensive
litigation. Although to date the Company has received no notification of alleged
infringement of other companies' intellectual property rights, the Company may
from time to time be subject to proceedings alleging infringement by the Company
of intellectual property rights owned by third parties. If necessary or
desirable, the Company may seek licenses under such intellectual property
rights. However, there can be no assurance that such licenses will be offered or
that the terms of any offered license will be acceptable to the Company. The
failure to obtain such a license from a third party for technology used by the
Company could cause the Company to incur substantial liabilities and to suspend
or cease the manufacture of products requiring such technology.

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The Company may initiate claims or litigation against third parties for
infringement of the Company's proprietary rights or to establish the validity of
the Company's proprietary rights. For example, in January 1997 and May 1997, the
Company filed actions against DWIN and Snell & Wilcox, respectively, seeking
relief and damages for the infringement of US Patent Number 4,876,596, which was
issued on October 24, 1989, is owned by Yves Faroudja and is licensed to the
Company. DWIN and Snell & Wilcox have raised defenses and counterclaims that the
patent is invalid and that it has not been infringed. See
"Business--Litigation."

Litigation by or against the Company could result in significant expense to
the Company and could divert the efforts of the Company's technical and
management personnel, whether or not such litigation results in a favorable
determination for the Company and such diversion may have a material adverse
effect on the Company's business, financial condition and operating results. In
addition, such litigation could result in the assertion of counter claims
against the Company. In the event of an adverse result in any such litigation,
the Company could be required to pay substantial damages, attorney fees, costs
and expenses, to cease infringing a third-party's intellectual property rights
(including, marketing, using, selling and importing infringing products, and
employing infringing methods or processes), to expend significant resources to
develop non-infringing technology, or to obtain licenses to the technology
allegedly infringed. There can be no assurance that the Company would be
successful in such development or that any such license would be available on
reasonable terms, or at all, and any such development or license could require
expenditures by the Company of substantial time and other resources. In the
event that any third party makes a successful intellectual property claim
against the Company or its customers, the Company's business, financial
condition and operating results could be materially adversely affected. See
"Business--Proprietary Rights and Licenses."

RISKS ASSOCIATED WITH EXPORT SALES AND OPERATIONS

For the year ended December 31, 1996, and for the six months ended June 30,
1997, export sales accounted for approximately 15.3% and 9.5%, respectively, of
the Company's total revenues. The Company intends to substantially expand its
export sales efforts. However, there can be no assurance that the Company will
be successful in increasing export sales. Export sales to international
customers entail a number of risks which include unexpected changes in, or
impositions of, legislative or regulatory requirements, delays resulting from
difficulty in obtaining export licenses for certain technology, tariffs, quotas
and other trade barriers and restrictions, longer payment cycles, greater
difficulty in accounts receivable collection, potentially adverse taxes,
currency exchange fluctuations, the burdens of complying with a variety of
foreign laws and other factors beyond the Company's control. The Company would
also be subject to general geopolitical risks in connection with international
operations, such as political, social and economic instability, potential
hostilities and changes in diplomatic and trade relationships. Although the
Company has not to date experienced any material adverse effect on its
operations as a result of such regulatory, geopolitical and other factors, there
can be no assurance that such factors will not adversely affect the Company's
operations in the future or require the Company to modify its current business
practices. In addition, 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. There can be no assurance that one or more of the
foregoing factors will not have a material adverse effect on the Company's
business, financial condition and operating results or require the Company to
modify its current business practices. See "Business--Sales and Marketing."

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DEPENDENCE ON SENIOR MANAGEMENT AND OTHER KEY EMPLOYEES; NEW MANAGEMENT
PERSONNEL

The Company's future success will depend to a significant extent upon the
continued service of members of senior management and other key employees of the
Company, particularly Yves Faroudja, the Company's founder and Chief Technical
Officer, and Michael Moone, the Company's President and Chief Executive Officer.
The loss of the service of any of these individuals could have a material
adverse effect on the Company. The Company does not maintain key man life
insurance on any of its employees. The Company believes that its future success
will depend to a significant extent upon its ability to attract, train and
retain highly skilled technical, management, sales, marketing and consulting
personnel. Competition for such personnel is intense, and the Company expects
that such competition will continue for the foreseeable future. The Company has
from time to time experienced difficulty in locating candidates with appropriate
qualifications. There can be no assurance that the Company will be successful in
attracting or retaining such personnel, and the failure to attract or retain
such personnel could have a material adverse effect on the Company's business,
financial condition and operating results. See "Management--Executive Officers
and Directors."

The Company has recently effected significant changes in its management team
and key employees. In particular the Company's Chief Executive Officer, its
Chief Financial Officer and its Vice President--Engineering joined the Company
in June 1996, December 1996 and May 1996, respectively. Further, the Company
hired its General Counsel and Vice President--Business Development and its Vice
President--Sales and Marketing in June 1997. The Company's headcount has grown
from 39 at December 31, 1995, to 67 at June 30, 1997. There can be no assurance
that the Company's new management team can successfully manage the Company's
rapidly evolving business, and failure to do so would have a material adverse
effect upon the Company's business, financial condition and operating results.
See "--Management of Growth."

NEED FOR ADDITIONAL CAPITAL TO FINANCE GROWTH AND CAPITAL REQUIREMENTS

While the Company expects that the proceeds from this Offering, its existing
cash balances and the amounts, if any, generated from operations will be
sufficient to meet its cash requirements for at least the next 12 months, the
Company is operating in a rapidly changing industry. There can be no assurance
that the Company will not seek to exploit business opportunities that will
require it to raise additional capital from equity or debt sources to finance
its growth and capital requirements. In particular, the development and
marketing of new products could require a significant commitment of resources,
which could in turn require the Company to obtain additional financing earlier
than otherwise expected. There can be no assurance that the Company will be able
to raise such capital on acceptable terms, if at all. If the Company is unable
to obtain such additional capital, the Company may be required to reduce the
scope of its planned product development and marketing, which could have a
material adverse effect on the Company's business, financial condition and
operating results. See "Use of Proceeds" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."

BROAD MANAGEMENT DISCRETION OVER USE OF PROCEEDS

The Company intends to use the net proceeds of the Offering for general
corporate purposes, including an increase in the Company's research and
development activities, an expansion of its internal sales, marketing and
distribution operations and an increase in working capital. A significant
portion of the net proceeds to the Company from this Offering have not been
designated for specific uses. Accordingly, management of the Company will have
broad discretion with respect to the use of these funds. See "Use of Proceeds."

CONTROL BY MANAGEMENT AND EXISTING STOCKHOLDERS

Upon the consummation of this Offering, the current officers, directors and
major stockholders of the Company will own or control approximately 73.6% of the
outstanding shares of Common Stock (including outstanding options and warrants
to purchase Common Stock). Accordingly, these stockholders, if they were to act
as a group, would be able to control the Company's Board of Directors, increase
the authorized capital and

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<PAGE>

otherwise control the policies of the Company. The control of such stockholders
could delay or prevent a change in control of the Company, impede a merger,
consolidation, takeover or other business combination involving the Company, or
discourage a potential acquiror from making a tender offer or otherwise
attempting to obtain control of the Company. See "Management," "Principal and
Selling Stockholders" and "Description of Capital Stock."

POTENTIAL ANTI-TAKEOVER EFFECTS OF CHARTER DOCUMENTS AND DELAWARE LAW

The Company's Certificate of Incorporation and By-Laws contain various
provisions, including a classified Board of Directors, and Delaware law contains
certain provisions that could delay or impede the removal of incumbent directors
and could make more difficult a merger, tender offer or proxy contest involving
the Company, even if such events would be beneficial to the interests of the
stockholders of the Company. Such provisions could limit the price that certain
investors might be willing to pay in the future for shares of the Company's
Common Stock. In addition, the Company may issue shares of Preferred Stock
without stockholder approval on such terms as the Board of Directors may
determine. The rights of the holders of Common Stock will be subject to, and may
be adversely affected by, the rights of the holders of any Preferred Stock that
may be issued in the future. Moreover, although the ability to issue Preferred
Stock may provide flexibility in connection with possible acquisitions and other
corporate purposes, such issuance may make it more difficult for a third party
to acquire, or may discourage a third party from acquiring, a majority of the
voting stock of the Company. The Company has no current plans to issue any
shares of Preferred Stock. The Company may in the future adopt other measures
that may have the effect of delaying, deferring or preventing a change in
control of the Company. Certain of such measures may be adopted without any
further vote or action by the stockholders, although the Company has no present
plans to adopt any such measures. See "Description of Capital Stock."

NO PRIOR PUBLIC MARKET; POTENTIAL LIMITED TRADING MARKET; POSSIBLE VOLATILITY OF
STOCK PRICE

Prior to this Offering, there has been no public market for the Company's
Common Stock and there can be no assurance that an active public market for the
Common Stock will develop or be sustained after this Offering or that the market
price of the Common Stock will not decline below the initial public offering
price. The initial price to the public for the Common Stock offered hereby will
be determined by negotiation between the Company and the Representatives.
Factors such as announcements of developments related to the Company's business,
announcements of technological innovations or new products or enhancements by
the Company or its competitors, sales of the Company's Common Stock into the
public market, developments in the Company's relationships with its customers,
distributors and suppliers, shortfalls or changes in total revenues, gross
margin, earnings or other financial results from analysts' expectations,
regulatory developments, fluctuations in results of operations and general
conditions in the Company's market or the market served by the Company's
customers or the economy could cause the price of the Company's Common Stock to
fluctuate, perhaps substantially. In addition, in recent years the stock market
in general, and the market for shares of small capitalization and technology
stocks in particular, have experienced extreme price and volume fluctuations,
which have often been unrelated or disproportionate to the operating performance
of affected companies. Many technology companies have recently experienced
historic highs in the market price of their Common Stock. There can be no
assurance that the market price of the Company's Common Stock will not decline
substantially from the initial public offering price, or otherwise experience
significant fluctuations in the future, including fluctuations that are
unrelated to the Company's performance.

SHARES ELIGIBLE FOR FUTURE SALE

Sales of substantial amounts of Common Stock (including shares issued upon
the exercise of outstanding options) in the public market after this Offering
could materially adversely affect the market price of the Common Stock. Such
sales might also make it more difficult for the Company to sell equity
securities or equity related securities in the future at a time and price that
the Company deems appropriate. In addition to the 3,000,000 shares of Common
Stock offered hereby, as of the date of this Prospectus there will be 8,751,895

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<PAGE>

shares of Common Stock outstanding, all of which are "restricted" shares under
the Securities Act of 1933, as amended (the "Securities Act"). Approximately
3,000,000 shares will be available for sale in the public market on the date of
this Prospectus and approximately 8,207,380 shares will be available for sale in
the public market 180 days after the date of this Prospectus upon expiration of
certain lockup agreements with the Underwriters or the Company and pursuant to
Rules 144, 144(k) or 701 promulgated under the Securities Act, subject in some
cases to certain volume and other resale restrictions pursuant to Rule 144. In
addition, the Company is required to register for re-sale 180 days after the
date of this Prospectus an aggregate of 8,200,000 shares of Common Stock. Of
these shares, 6,150,000 are held by Adelson Investors, LLC ("Adelson"), Faroudja
Images Investors, LLC and Images Partners, L.P. ("Images"). See "Certain
Transactions--1996 Financing." The Company intends to register on a registration
statement on Form S-8, within 90 days after the date of this Offering, a total
of 2,442,620 shares of Common Stock for issuance pursuant to the Company's 1995
Stock Option Plan (the "1995 Option Plan"), 1997 Performance Stock Option Plan
(the "1997 Option Plan"), 1997 Directors Stock Option Plan (the "Directors
Plan") and the 1997 Employee Stock Purchase Plan ("Purchase Plan"). BancAmerica
Robertson Stephens in its sole discretion and at any time without notice can
release all or any portion of the securities subject to lock-up agreements. See
"Shares Eligible for Future Sale."

DILUTION

Investors purchasing shares in this Offering will incur immediate and
substantial dilution in net tangible book value of $5.84 per share, based upon
an assumed initial public offering price of $9.00 per share. To the extent that
outstanding options to purchase the Company's Common Stock are exercised, there
will be further dilution to the new public investors. See "Dilution."

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USE OF PROCEEDS

The net proceeds to the Company from the sale of 3,000,000 shares of Common
Stock offered by the Company hereby are estimated to be approximately $24.4
million, assuming an initial public offering price of $9.00 per share and after
deducting the estimated underwriting discounts and commissions and the estimated
offering expenses payable by the Company.

The Company intends to use the net proceeds of this Offering for general
corporate purposes. The Company anticipates that net proceeds will be used for
additions to working capital, an increase of research and development activities
through the hiring of additional personnel and the acquisition of test equipment
and design tools, and an expansion of the Company's internal sales, marketing
and distribution operations, with a particular emphasis on international
markets. The Company has not determined the amount of net proceeds to be applied
to each of the foregoing. The Company may also use a portion of the net proceeds
for the acquisition of technologies, businesses or products that are
complementary to those of the Company, although no such acquisitions are planned
or are being negotiated as of the date of this Prospectus, and no portion of the
net proceeds has been allocated for any specific acquisition. See "Risk
Factors--Broad Management Discretion Over Use of Proceeds" and "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources." Pending such uses, the Company
will invest the net proceeds of this Offering in short-term, interest-bearing
investment grade securities.

DIVIDEND POLICY

The Company has never declared or paid cash dividends on its capital stock.
The Company currently expects to retain any future earnings for use in the
operation and expansion of its business and does not anticipate paying any cash
dividends in the foreseeable future. The Company's revolving credit facility
restricts the payment of dividends without the consent of the bank.

From its inception through March 1996, the Company was treated for federal
income tax purposes as an S Corporation under Subchapter S of the Internal
Revenue Code of 1986, as amended (the "Code"). In connection with its status as
an S Corporation, the Company distributed a portion of its earnings to its
stockholders. As a result, the Company's earnings from its inception through
March 1996 (the "Termination Date") were for federal income tax purposes taxed
directly to the Company's stockholders, at their individual federal income tax
rate, rather than to the Company. Subsequent to the Termination Date, the
Company was no longer treated as an S Corporation and, accordingly, has been
subject to federal and state income taxes on its earnings after March 1996.

17
<PAGE>
CAPITALIZATION

The following table sets forth the capitalization of the Company (i) as of
June 30, 1997 and (ii) as adjusted to give effect to the sale and issuance of
3,000,000 shares of Common Stock offered by the Company at an assumed initial
public offering price of $9.00 per share (after deducting the estimated
underwriting discounts and commissions and the estimated offering expenses
payable by the Company). See "Use of Proceeds."

<TABLE>
<CAPTION>
JUNE 30, 1997
----------------------
ACTUAL AS ADJUSTED
--------- -----------
(IN THOUSANDS)
<S> <C> <C>
Long-term debt............................................................................ $ -- $ --
--------- -----------
Stockholders' equity:
Preferred Stock, $.001 par value; 2,000,000 shares authorized; none issued and
outstanding, actual and as adjusted................................................... -- --
Common Stock, $.001 par value; 18,000,000 shares authorized; 8,733,696 shares issued and
outstanding actual; 11,733,696 shares issued and outstanding, as adjusted(1).......... 9 12
Additional paid-in capital.............................................................. 13,307 37,664
Deferred compensation................................................................... (272) (272)
Retained earnings (deficit)............................................................. (121) (121)
--------- -----------
Total stockholders' equity............................................................ 12,923 37,283
--------- -----------
Total capitalization...................................................................... $ 12,923 $ 37,283
--------- -----------
--------- -----------
</TABLE>

- ------------------------

(1) Based on shares outstanding as of June 30, 1997. Excludes (i) 1,578,349
shares of Common Stock issuable upon exercise of stock options outstanding
and (ii) an aggregate of 864,271 shares of Common Stock reserved for future
issuance pursuant to the Company's stock option and stock purchase plans,
(iii) 179,601 shares of Common Stock issuable upon exercise of outstanding
warrants and (iv) 29,240 shares of Common Stock issuable to S3 pursuant to
certain anti-dilution rights which the Company granted to S3 under a Stock
Purchase Agreement, assuming an Offering price of $9.00 per share. See
"Management--Stock Plans," "Certain Transactions" and Note 6 of Notes to
Consolidated Financial Statements.

18
<PAGE>
DILUTION

The net tangible book value of the Company as of June 30, 1997 was
approximately $12.7 million or $1.45 per share of Common Stock. "Net tangible
book value" per share represents the amount of total tangible assets less total
liabilities, divided by the number of shares of Common Stock outstanding. After
giving effect to the receipt of the net proceeds from the sale of 3,000,000
shares of Common Stock offered by the Company hereby (after deducting the
estimated underwriting discounts and commissions and the estimated offering
expenses payable by the Company), the Company's net tangible book value as of
June 30, 1997 would have been approximately $37.0 million or $3.16 per share of
Common Stock. This represents an immediate increase in net tangible book value
of $1.71 per share to existing stockholders and an immediate dilution of $5.84
per share to new investors. The following table illustrates this per share
dilution:

<TABLE>
<S> <C> <C>
Assumed initial public offering price...................... $ 9.00
Net tangible book value per share as of June 30, 1997.... $ 1.45
Increase attributable to new investors................... 1.71
As adjusted net tangible book value per share after
Offering................................................. 3.16
---------
Dilution to new investors.................................. $ 5.84
---------
---------
</TABLE>

The following table summarizes, on a pro forma basis as of June 30, 1997,
the difference between the number of shares of Common Stock purchased from the
Company, the total consideration paid and the average price per share paid by
existing stockholders and by new public investors purchasing shares in this
Offering (before deducting underwriting discounts and commissions and estimated
offering expenses payable by the Company).

<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
------------------------- -------------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
------------ ----------- ------------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Existing stockholders............. 8,733,696 74.4% $ 12,623,450 31.9% $ 1.45
New investors..................... 3,000,000 25.6 27,000,000 68.1 9.00
------------ ----- ------------- -----
Total........................... 11,733,696 100.0% $ 39,623,450 100.0%
------------ ----- ------------- -----
------------ ----- ------------- -----
</TABLE>

The foregoing computations assume no exercise of stock options or warrants
after June 30, 1997. As of June 30, 1997, there were outstanding options under
the 1995 Option Plan to purchase 1,217,019 shares of Common Stock at a weighted
average exercise price of $3.42 per share, outstanding options under the 1997
Option Plan to purchase 315,725 shares of Common Stock at a weighted average
exercise price of $7.44 per share, outstanding options under the Directors Plan
to purchase 45,605 shares of Common Stock at a weighted average exercise price
of $3.91 per share, and outstanding warrants to purchase 179,601 shares of
Common Stock at a weighted average exercise price of $4.50 per share. Assuming
the exercise of all outstanding options and warrants, the per share dilution to
new investors would be $5.70. In addition, as of June 30, 1997, 864,271 shares
of Common Stock were reserved for future issuance under the Company's stock
option and stock purchase plans. To the extent that any shares available for
issuance upon exercise of outstanding options, warrants or reserved for future
issuance under the Company's stock option plans are issued, there will be
further dilution to new public investors. See "Capitalization,"
"Management--Stock Plans," "Description of Capital Stock" and Note 6 of Notes to
Consolidated Financial Statements.

19
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated balance sheet data as of December 31,
1993 and 1994, and the selected consolidated statement of operations data for
the year ended December 31, 1993, have been derived from consolidated financial
statements not included herein, which were audited by Ernst & Young LLP,
independent auditors. The selected consolidated statement of operations data for
each of the three years in the period ended December 31, 1996 and the six months
ended June 30, 1997, and the related consolidated balance sheet data as of
December 31, 1995 and 1996 and June 30, 1997, are derived from the consolidated
financial statements of the Company which have been audited by Ernst & Young
LLP, independent auditors, and are included elsewhere in this Prospectus. The
data should be read in conjunction with such consolidated financial statements.
The selected consolidated balance sheet data at December 31, 1992 and the
selected consolidated statement of operations data for the year ended December
31, 1992 have been derived from unaudited consolidated financial statements not
included herein. The consolidated statement of operations data for the six
months ended June 30, 1996 has been derived from unaudited consolidated
financial statements of the Company that include, in the opinion of management,
all adjustments, consisting only of normal and recurring adjustments, that
management considers necessary for a fair statement of the results for the
period. The operating results for the six months ended June 30, 1997 are not
necessarily indicative of results that may be expected for the year ending
December 31, 1997 or any other interim period or future fiscal year.

<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED JUNE 30,
----------------------------------------------------- --------------------
1992 1993 1994 1995 1996 1996 1997
--------- --------- --------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues:
Product sales................................ $ 3,437 $ 5,684 $ 8,065 $ 11,954 $ 12,626 $ 5,590 $ 6,864
License and royalty revenues................. -- -- -- -- 500 -- 1,000
--------- --------- --------- --------- --------- --------- ---------
Total revenues............................. 3,437 5,684 8,065 11,954 13,126 5,590 7,864
Cost of product sales.......................... 2,139 2,127 2,998 4,215 4,797 2,067 2,286
--------- --------- --------- --------- --------- --------- ---------
Gross profit................................... 1,298 3,557 5,067 7,739 8,329 3,523 5,578
Operating expenses:
Research and development..................... 811 869 1,277 1,484 2,464 990 1,840
Sales and marketing.......................... 354 525 778 1,070 2,127 880 1,793
General and administrative................... 581 957 1,153 1,179 1,623 664 866
Financing expense............................ -- -- -- -- -- -- 312
--------- --------- --------- --------- --------- --------- ---------
Total operating expenses................... 1,746 2,351 3,208 3,733 6,214 2,534 4,811
--------- --------- --------- --------- --------- --------- ---------
Operating income (loss)........................ (448) 1,206 1,859 4,006 2,115 989 767
Other income:
Interest income.............................. 60 39 69 82 83 38 48
Other, net................................... -- 20 14 5 -- -- 47
--------- --------- --------- --------- --------- --------- ---------
Income (loss) before provision for income
taxes........................................ (388) 1,265 1,942 4,093 2,198 1,027 862
Provision for income taxes..................... 5 14 13 84 687 219 328
--------- --------- --------- --------- --------- --------- ---------
Net income (loss).............................. $ (393) $ 1,251 $ 1,929 $ 4,009 $ 1,511 $ 808 $ 534
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Net income per share(1)........................ $ 0.05
---------
---------
Shares used in per share calculation........... 9,730
---------
---------
</TABLE>

20
<PAGE>

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, SIX MONTHS
------------------------------- ENDED JUNE 30,
1994 1995 1996 1996
--------- --------- --------- ---------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
PRO FORMA DATA (UNAUDITED)(2):
Historical income before provision for income taxes............ $ 1,942 $ 4,093 $ 2,198 $ 1,027
Pro forma provision for income taxes........................... 714 1,023 879 411
--------- --------- --------- ------
Pro forma net income........................................... $ 1,228 $ 3,070 $ 1,319 $ 616
--------- --------- --------- ------
--------- --------- --------- ------
Pro forma net income per share(1).............................. $ 0.15 $ 0.38 $ 0.15 $ 0.07
--------- --------- --------- ------
--------- --------- --------- ------
Shares used in per share calculation........................... 7,979 7,998 9,012 8,784
--------- --------- --------- ------
--------- --------- --------- ------
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------- JUNE 30,
1992 1993 1994 1995 1996 1997
--------- --------- --------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments..... $ 1,215 $ 1,455 $ 1,064 $ 2,759 $ 3,083 $ 7,793
Working capital....................................... 1,824 2,599 2,223 4,744 5,861 11,185
Total assets.......................................... 2,797 3,652 3,434 6,734 9,604 15,225
Total long-term debt.................................. 457 996 -- -- -- --
Stockholders' equity.................................. 1,882 2,166 2,826 5,515 7,245 12,923
</TABLE>

- ------------------------

(1) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of the basis used to calculate net income per share.

(2) Reflects the pro forma effect of the Company being treated as a C
Corporation rather than an S Corporation for federal and state income tax
purposes, effective January 1, 1994. See "Certain Transactions--Subchapter S
Distributions."

21
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

THE FOLLOWING MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTAINS FORWARD-LOOKING STATEMENTS BASED UPON CURRENT
EXPECTATIONS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS
AND THE TIMING OF CERTAIN EVENTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED
IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING
THOSE SET FORTH UNDER "RISK FACTORS" AND ELSEWHERE IN THIS PROSPECTUS.

OVERVIEW

From inception to 1988 the Company specialized in the development,
manufacturing and sale of products to the broadcast industry. In 1988 the
Company introduced its initial product for the high-end home theater market, a
line multiplier. In 1996 and the first six months of 1997, sales of products for
the home theater and industrial markets comprised approximately 80% and 81%,
respectively, of the Company's total revenues. As the Company emphasized product
development for the home theater and industrial markets, sales of existing
broadcast products have declined.

The Company's total revenues increased sequentially on an annual basis from
1992 through 1996, primarily as a result of the introduction of a number of new
products for the home theater and industrial markets. Sales growth in 1996 was
limited from the prior year in part because of the diversion of management time
while the Company obtained external financing. Additionally, the Company
experienced an unexpected decline in sales of the Company's broadcast products
as a major customer began to develop products internally. In 1996, the Company
established an in-house very large scale integration ("VLSI") design department
to develop high performance application specific integrated circuits ("ASIC") to
enhance video image quality in the Company's traditional home theater market as
well as for use in the TV and PC industries. Net income declined in 1996 from
the prior year primarily as a result of increased research and development
expenses, as well as expenses relating to the expansion of the sales and
marketing staff and a provision for income taxes resulting from the termination
of the Company's status as an S Corporation in March 1996.

To maintain favorable margin levels on product sales, the Company must
introduce new products, must introduce enhanced versions of its products, and
must continue its cost reduction efforts. The Company anticipates that it will
incur lower overall gross margins in future periods as it introduces lower
margin products for consumer markets. The Company intends to increase both
engineering and sales and marketing efforts in the design, development and sale
of board and chip level products while continuing the sale of stand alone
products for the high-end home theater, industrial and broadcast markets. As a
percentage of sales, sales and marketing expenses, general and administrative
expenses and research and development expenses are expected to increase in 1997
over 1996. Accordingly, the Company expects net income to slightly decline in
1997 compared to 1996. The Company expects these expenses to increase on an
absolute dollar basis. Consequently, without a corresponding increase in
revenues, net income will be adversely impacted.

22
<PAGE>
performance criteria, S3 must make minimum royalty payments to maintain
exclusivity. If royalties on product sales do not reach prescribed minimum
levels, S3 may maintain exclusivity by prepaying royalties to prescribed levels,
but there is no requirement for it to do so. S3 expects to ship products that
incorporate the Company's technology in 1998. There can be no assurance that S3
and the Company will develop products as a result of the agreement or that
future royalties will be received by the Company. In June 1997, the Company sold
a total of 526,316 shares of its Common Stock to S3 for an aggregate purchase
price of $5.0 million. The number of shares held by S3 may be subject to
adjustment based on the price to the public of the shares sold in this Offering.
S3 is also entitled to certain registration rights. See "Certain
Transactions--License Agreement with S3."

In March 1996, (i) the Company issued 1,043,105 shares of Common Stock for
an aggregate purchase price of $4.0 million to a predecessor of Faroudja Images
Investors, LLC ("Investors LLC"), Images and Adelson (Adelson, Investors LLC and
Images are collectively referred to herein as the "Investor Group"), of which
213,642 shares were issued to Adelson, 682,153 shares were issued to Investors
LLC and 147,310 shares were issued to Images, (ii) the Investor Group purchased
a total of 3,569,395 shares of Common Stock from Yves and Isabell Faroudja for
an aggregate purchase price of $14.0 million, of which 731,062 shares were
purchased by Adelson, 2,334,253 shares were purchased by Investors LLC and
504,080 shares were purchased by Images, and (iii) Yves and Isabell Faroudja
granted the Investor Group an option to purchase 1,537,500 shares of the
Company's Common Stock for an aggregate purchase price of $6.0 million or $3.90
per share (the "Faroudja Option"), of which Adelson had an option to purchase
486,875 shares of Common Stock for $1.9 million, Investors LLC had an option to
purchase 666,250 shares of Common Stock for $2.6 million and Images had an
option to purchase 384,375 shares of Common Stock for $1.5 million. The Faroudja
Option was exercised by the Investor Group on September 5, 1997.

ANTICIPATED THIRD QUARTER RESULTS

Revenues for the third quarter of 1997 are expected to be approximately $5.0
million, an increase of 35.0% over revenues of $3.7 million for the comparable
period in 1996. Although net income for the third quarter of 1997 has not yet
been conclusively determined, the Company anticipates that net income will be
within the range of $0.03-$0.04 per share compared to $0.04 per share for the
comparable period in 1996.

23
<PAGE>
RESULTS OF OPERATIONS

The following table sets forth certain items from the Company's consolidated
statements of operations expressed as a percentage of total revenues for the
periods indicated.

<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED JUNE 30,
------------------------------- --------------------
1994 1995 1996 1996 1997
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Revenues:
Product sales.................................................. 100.0% 100.0% 96.2% 100.0% 87.3%
License and royalty revenues................................... -- -- 3.8 -- 12.7
--------- --------- --------- --------- ---------
Total revenues............................................... 100.0 100.0 100.0 100.0 100.0
Cost of product sales............................................ 37.2 35.3 36.5 37.0 29.1
--------- --------- --------- --------- ---------
Gross margin..................................................... 62.8 64.7 63.5 63.0 70.9

Operating expenses:
Research and development....................................... 15.8 12.3 18.8 17.7 23.4
Sales and marketing............................................ 9.7 9.0 16.2 15.7 22.7
General and administrative..................................... 14.3 9.9 12.4 11.9 11.0
Financing expense.............................................. -- -- -- -- 4.0
--------- --------- --------- --------- ---------
Total operating expenses..................................... 39.8 31.2 47.4 45.3 61.1
--------- --------- --------- --------- ---------
Operating income................................................. 23.0 33.5 16.1 17.7 9.8
Other income:
Interest income................................................ 0.9 0.7 0.6 0.7 0.6
Other, net..................................................... 0.2 -- -- -- 0.6
--------- --------- --------- --------- ---------
Income before provision for income taxes......................... 24.1 34.2 16.7 18.4 11.0
Provision for income taxes....................................... 0.2 0.7 5.2 3.9 4.2
--------- --------- --------- --------- ---------
Net income....................................................... 23.9% 33.5% 11.5% 14.5% 6.8%
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>

FISCAL 1994, 1995 AND 1996

TOTAL REVENUES. Total revenues increased 48.2% and 9.8%, respectively, for
1995 and 1996 from their respective prior years. The increase in 1995 was due
primarily to shipments of the VP400 NTSC line quadrupler, which was introduced
in 1995, and to increased customer acceptance of the Company's other consumer
products. The increase in 1996 was primarily due to the introduction of the
LD200 NTSC line doubler for the home theater market, increased shipments of the
DFD-U PAL/NTSC digital decoder, which was first introduced in 1995 for the
direct broadcast satellite market, fees on the license of the Company's
technology for ASIC products for the PC market and the expansion of the home
theater dealer network. These factors were partially offset by a reduction in
sales in 1996 of the CFD decoder for the broadcast market resulting from a sharp
decline in sales to this product's primary customer, which began developing its
own products internally. Sales to GI, accounted for 19.3% of total revenues in
1994. Sales to Hughes/JVC accounted for 12.1% of total revenues in 1995. Sales
to Vidikron accounted for 10.5% of total revenues in 1996.

Export sales, consisting primarily of VP400 and LD200 products shipped to
dealers and distributors in Asia and Europe, represented 16.9%, 13.2% and 15.3%
of total revenues in 1994, 1995 and 1996, respectively. All export sales are
denominated in U.S. dollars. The Company intends to pursue efforts to increase
its export sales in the future; however, there can be no assurance that any
growth in export sales will be achieved. Export sales are subject to a number of
risks. See "Risk Factors--Risks Associated with Export Sales and Operations."

The Company's future success will depend, in large part, on its ability to
continue to enhance its existing products and to develop new products and
features to meet changing customer requirements and evolving

24
<PAGE>
industry standards. The Company anticipates that sales from its line multiplier
product line will experience limited growth, or may decline, in future periods.
The Company expects that approximately one-half of its total revenues in 1998
will be derived from license and royalty revenues and from sales of new
products. See "Risk Factors--Dependence on New Product Development and Risk of
Technological Change."

GROSS PROFIT. Gross profit as a percentage of total revenues was 62.8% in
1994, 64.7% in 1995 and 63.5% in 1996. The increase in gross margin in 1995
compared to 1994 was primarily due to the introduction of new higher margin
products and product cost reduction efforts. The decline in gross margin in 1996
resulted from an increased proportion of sales to distributors and OEMs, who
typically receive higher discounts than dealers, increased dealer discounts, the
introduction of a new, lower margin product line and increased manufacturing
costs and expenses. The Company anticipates that it will incur lower overall
gross margins in future periods as it introduces lower margin products for high
volume markets. See "Risk Factors--Potential Fluctuations in Future Operating
Results; Seasonality."

RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased from $1.3 million in 1994 to $1.5 million in 1995 and to $2.5 million
in 1996. The increase in 1995 from the prior year was primarily due to fees
incurred by the Company for the development of ASIC components used in the full
range of the Company's products. Research and development expenses as a
percentage of total revenues declined from 15.8% in 1994 to 12.3% in 1995
primarily because of increased total revenue growth. Research and development
expenses increased as a percentage of total revenues to 18.8% in 1996 due to the
establishment in 1996 of a VLSI design department. The Company increased its
engineering and management personnel, and increased equipment depreciation, to
enable the ongoing development of its high performance VLSI design capability.
The Company intends to increase its engineering efforts in the design and
development of board and chip level products, and therefore expects that
research and development expenses will continue to increase in absolute dollars.

SALES AND MARKETING EXPENSES. Sales and marketing expenses increased from
$778,000 in 1994 to $1.1 million in 1995 and to $2.1 million in 1996. The
increase in 1995 from the prior year was primarily due to the Company's
increased participation at trade shows. Sales and marketing expenses as a
percentage of total revenues decreased from 9.7% in 1994 to 9.0% in 1995 because
of the growth in total revenues. Sales and marketing expenses increased as a
percentage of total revenues to 16.2% in 1996 from the prior year primarily due
to increases in the Company's sales and marketing staff, including the addition
of sales executives and the development of a network of regional managers. The
Company intends to increase its sales and marketing efforts, and intends to
increase its international market presence. Accordingly, sales and marketing
expenses are expected to increase in absolute dollars in the future.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $1.2 million in 1994 and 1995 and increased to $1.6 million in 1996. Due to
the growth in total revenues, general and administrative expenses as a
percentage of total revenues decreased from 14.3% in 1994 to 9.9% in 1995.
General and administrative expenses increased as a percentage of total revenues
to 12.4% in 1996, primarily due to additions to the Company's general and
administrative staff, including the hiring of a new chief executive officer, and
an increase in professional fees. The Company anticipates that it will incur a
significant increase in general and administrative expenses in future periods
associated with legal, accounting and other expenses of being a public company.

OTHER INCOME. Interest and other income was $83,000 in 1994, $87,000 in
1995 and $83,000 in 1996. The amount of the securities investments has been
approximately equivalent during the periods.

PROVISION FOR INCOME TAXES. The Company's FLI subsidiary was an S
Corporation from inception until March 1996. As an S Corporation, FLI earnings
were taxed directly to its stockholders, and FLI's tax provision through March
1996 consisted solely of a California franchise fee. FRE was a C Corporation
since its inception. FRE had significant losses and its tax provision consisted
of alternative minimum taxes. The Company has incurred minimal foreign taxes.
The pro forma provision for income taxes, calculated assuming FLI's S

25
<PAGE>
Corporation status terminated January 1, 1996, reflects an effective tax rate
for the year ended December 31, 1996 of 40%. The Company anticipates
implementing certain tax planning strategies to reduce the effective tax rate in
future periods.

SIX MONTHS ENDED JUNE 30, 1996 AND 1997

TOTAL REVENUES. Total revenues increased from $5.6 million in the six
months ended June 30, 1996 to $7.9 million in the six months ended June 30,
1997. The growth in total revenues in the first six months of 1997 was due
primarily to increased shipments of products for the home theater, shipments of
the new VP100 decoder, and $1.0 million of license and royalty revenues. These
factors offset a reduction in sales to the broadcast market. Revenues from
Vidikron accounted for 10.5% of total revenues in the six months ended June 30,
1996. Revenues from S3 and Vidikron accounted for 14.9% and 11.4% respectively,
of total revenues in the six months ended June 30, 1997. Export sales,
consisting primarily of VP400 and LD200 products shipped to dealers and
distributors in Asia and Europe, represented 9.5% of total revenues in the six
months ended June 30, 1997. See "Risk Factors--Risks Associated with Export
Sales and Operations."

GROSS PROFIT. Gross profit as a percentage of total revenues was 63.0% in
the six months ended June 30, 1996 and 70.9% in the six months ended June 30,
1997. The increase in gross margin was primarily due to license and royalty
revenues and product cost reduction efforts.

RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased from $990,000 in the six months ended June 30, 1996 to $1.8 million in
the six months ended June 30, 1997. The increase was primarily due to the
establishment of a VLSI design department. Consequently, research and
development expenses as a percentage of total revenues increased from 17.7% in
the six months ended June 30, 1996 to 23.4% in the six months ended June 30,
1997.

SALES AND MARKETING EXPENSES. Sales and marketing expenses increased from
$880,000 in the six months ended June 30, 1996 to $1.8 million in the six months
ended June 30, 1997. The increase was primarily due to increases in the
Company's sales and marketing staff and increased participation in trade shows.
The Company hired sales executives and developed a network of regional managers
beginning in 1996 and developed a network of sales representatives in 1997.
Consequently, sales and marketing expenses as a percentage of total revenues
increased from 15.7% in the six months ended June 30, 1996 to 22.7% in the six
months ended June 30, 1997.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased from $664,000 in the six months ended June 30, 1996 to $867,000 in the
six months ended June 30, 1997. This increase was due to additions to the
Company's administrative staff, including the hiring of a new chief executive
officer, chief financial officer and general counsel. Due to the growth in total
revenues, general and administrative expenses as a percentage of total revenues
decreased from 11.9% in the six months ended June 30, 1996 to 11.0% in the six
months ended June 30, 1997.

FINANCING EXPENSE. The Company incurred $312,000 of expenses related to
financing activities in the first quarter of 1997.

OTHER INCOME. Interest and other income increased from $38,000 in the six
months ended June 30, 1996 to $95,000 in the six months ended June 30, 1997 as
the Company incurred a net realized gain of $83,000 on available-for-sale
securities in the first half of 1997.

PROVISION FOR INCOME TAXES. The Company's effective tax rate for the six
months ended June 30, 1997, was 38%. The provision for income taxes for the six
months ended June 30, 1997, is based on the estimated annual effective tax rate
for the year.

26
<PAGE>
QUARTERLY RESULTS OF OPERATIONS

The following table sets forth certain unaudited quarterly financial
information for the six quarters ended June 30, 1997. The Company believes that
all necessary adjustments, consisting only of normal recurring adjustments, have
been included in the amounts stated below to present fairly the selected
quarterly information when read in conjunction with the Consolidated Financial
Statements and the Notes thereto included elsewhere herein. The operating
results for any quarter are not necessarily indicative of results for any
subsequent period or for the entire fiscal year.

<TABLE>
<CAPTION>
THREE MONTHS ENDED
----------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30,
1996 1996 1996 1996 1997 1997
----------- ----------- ----------- ----------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Product sales............................ $ 2,837 $ 2,753 $ 3,662 $ 3,374 $ 2,835 $ 4,029
License and royalty revenues............. -- -- -- 500 750 250
----------- ----------- ----------- ----------- ----------- -----------
Total revenues......................... 2,837 2,753 3,662 3,874 3,585 4,279
Cost of product sales...................... 1,071 996 1,272 1,458 998 1,287
----------- ----------- ----------- ----------- ----------- -----------
Gross profit............................... 1,766 1,757 2,390 2,416 2,586 2,992

Operating expenses:
Research and development................. 455 535 686 788 899 941
Sales and marketing...................... 356 524 622 625 678 1,115
General and administrative............... 261 403 468 491 392 474
Financing expense........................ -- -- -- -- 312 --
----------- ----------- ----------- ----------- ----------- -----------
Total operating expenses............... 1,072 1,462 1,776 1,904 2,281 2,530
----------- ----------- ----------- ----------- ----------- -----------
Operating income........................... 694 295 614 512 305 462
Other income (loss)........................ 19 19 27 18 97 (2)
----------- ----------- ----------- ----------- ----------- -----------
Income before provision for income taxes... 713 314 641 530 402 460
Provision for income taxes................. 93 126 256 212 153 175
----------- ----------- ----------- ----------- ----------- -----------
Net income................................. $ 620 $ 188 $ 385 $ 318 $ 249 $ 285
----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- -----------
</TABLE>

27
<PAGE>
The following table sets forth certain unaudited financial information as a
percentage of total revenues for the quarter represented.

<TABLE>
<CAPTION>
THREE MONTHS ENDED
----------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30,
1996 1996 1996 1996 1997 1997
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Product sales............................ 100.0% 100.0% 100.0% 87.1% 79.1% 94.2%
License and royalty revenues............. -- -- -- 12.9 20.9 5.8
----- ----- ----- ----- ----- -----
Total revenues......................... 100.0 100.0 100.0 100.0 100.0 100.0
Cost of product sales...................... 37.8 36.2 34.7 37.6 27.9 30.0
----- ----- ----- ----- ----- -----
Gross margin............................... 62.2 63.8 65.3 62.4 72.1 70.0

Operating expenses:
Research and development................. 16.0 19.4 18.7 20.3 25.1 22.0
Sales and marketing...................... 12.5 19.0 17.0 16.1 18.9 26.1
General and administrative............... 9.2 14.7 12.8 12.7 10.9 11.1
Financing expense........................ -- -- -- -- 8.7 --
----- ----- ----- ----- ----- -----
Total operating expenses............... 37.7 53.1 48.5 49.1 63.6 59.2
----- ----- ----- ----- ----- -----
Operating income........................... 24.5 10.7 16.8 13.3 8.5 10.8
Other income (loss)........................ 0.7 0.7 0.7 0.4 2.7 --
----- ----- ----- ----- ----- -----
Income before provision for income taxes... 25.2 11.4 17.5 13.7 11.2 10.8
Provision for income taxes................. 3.3 4.6 7.0 5.5 4.3 4.1
----- ----- ----- ----- ----- -----
Net income................................. 21.9% 6.8% 10.5% 8.2% 6.9% 6.7%
----- ----- ----- ----- ----- -----
----- ----- ----- ----- ----- -----
</TABLE>

The Company's industry is subject to a high degree of seasonality, and
demand for the Company's products is highest in the third and fourth quarters of
each calendar year. As a result, sales are typically highest in these quarters
and may be lower in succeeding quarters.

The decrease in total revenues in the first quarter of 1997 as compared to
the fourth quarter of 1996 was due to seasonal factors and decreased sales of
the Company's broadcast products, which were partially offset by $750,000 of
license and royalty revenues. The increase in total revenues in the second
quarter of 1997 from prior quarters was due to sales to new customers under
co-branding agreements, an enlarged dealer network and sales of the new VP100
decoder.

The Company's gross margin in the fourth quarter of 1996 was adversely
affected by inventory write-downs and manufacturing consulting and other
manufacturing expenses. These factors were partially offset by $500,000 of
license and royalty revenues. The increase in gross margin in the first quarter
of 1997 as compared to the fourth quarter of 1996 was due to $750,000 of license
and royalty revenues. The decline in gross margin during the second quarter of
1997 as compared to the first quarter of 1997 was due primarily to the decline
in license and royalty revenues to $250,000 in the second quarter of 1997.

The sequential increase in quarterly research and development expenses in
1996 and the first half of 1997 was primarily due to the establishment and
expansion of the Company's VLSI department. The sequential increase in quarterly
sales and marketing expenses in 1996 and in the first half of 1997 was due to
the expansion of the sales and marketing staff, increased marketing activities,
and the establishment of a network of sales representatives in 1997.

28
<PAGE>
The Company realized $97,000 of other income in the first quarter of 1997
primarily due to the realization of gains on available-for-sale securities.

The Company's operating results have varied in the past and are likely to
vary significantly in the future from period to period as a result of a number
of factors. See "Risk Factors--Potential Fluctuations in Future Operating
Results; Seasonality" for a discussion of factors that could have a material
adverse effect on the Company's quarterly results.

LIQUIDITY AND CAPITAL RESOURCES

The Company has historically funded its capital requirements from its cash
flow from operations. Funding requirements in the past have been primarily
related to the growth in accounts receivable, inventories and capital equipment.

OPERATING ACTIVITIES. In 1994, net cash provided by operating activities
was $1.7 million, primarily composed of (i) $1.9 million of net income, (ii)
$172,000 of depreciation and amortization and (iii) a $165,000 increase in
accrued compensation and benefits. These were partially offset by (i) a $359,000
increase in accounts receivable, (ii) a $119,000 decrease in accounts payable
and (iii) a $100,000 decrease in other accrued liabilities.

In 1995, net cash provided by operating activities was $3.4 million,
primarily composed of (i) $4.0 million of net income, (ii) $224,000 of
depreciation and amortization, (iii) a $417,000 increase in accounts payable and
(iv) a $118,000 increase in accrued compensation and benefits. These were
partially offset by (i) a $793,000 increase in inventory and (ii) a $642,000
increase in accounts receivable.

In 1996, net cash provided by operating activities was $1.3 million,
primarily composed of (i) $1.5 million of net income, (ii) $422,000 of
depreciation and amortization, (iii) a $128,000 increase in accounts payable,
(iv) a $186,000 increase in accrued compensation and benefits, (v) a $258,000
increase in other liabilities and (vi) $500,000 of deferred revenues. These were
partially offset by a (i) a $96,000 increase in inventory, (ii) a $1.2 million
increase in accounts receivable primarily attributable to $1.0 million due from
a licensing customer from an agreement completed in December, 1996 and (iii) an
increase in deferred tax assets of $462,000.

For the six months ended June 30, 1996, net cash provided by operating
activities was $1.3 million, primarily composed of (i) $808,000 of net income,
(ii) a $559,000 decrease in accounts receivable, (iii) a $356,000 increase in
accounts payable, (iv) an increase in income taxes payable of $198,000 and (v)
$152,000 of depreciation and amortization. These were offset by a $412,000
increase in inventory.

For the six months ended June 30, 1997, net cash provided by operating
activities was $78,000, primarily composed of (i) $534,000 of net income, (ii)
$224,000 of depreciation and amortization, (iii) a $132,000 increase in other
accrued liabilities, (iv) a $123,000 decrease in accounts receivable and (v) a
$252,000 increase in income taxes payable. These were offset by (i) a $500,000
decrease in deferred revenues, (ii) a $411,000 increase in inventory, (iii) a
$139,000 increase in deferred tax assets and (iv) a $131,000 increase in other
current assets.

INVESTING ACTIVITIES. Capital equipment purchases in the six months ended
June 30, 1996 and 1997 were $347,000 in each six month period, and in 1994, 1995
and 1996 were $212,000, $392,000 and $967,000, respectively, primarily for
computer hardware and software used in research and development, engineering
test equipment and furniture and fixtures.

FINANCING ACTIVITIES. In June 1997, the Company received $5.0 million from
a private placement of 526,316 shares of Common Stock with S3. See "Certain
Transactions--License Agreement with S3" and "--1996 Financing." The Company
issued $4.0 million of Common Stock in 1996. In connection with its status as a
Subchapter S Corporation, the Company distributed $1.5 million, $1.4 million and
$4.0 million to stockholders in 1994, 1995 and 1996 respectively. In 1994, the
Company repaid a $420,000 loan from a related party.

29
<PAGE>
LIQUIDITY. At June 30, 1997, the Company's principal source of liquidity
consisted of cash, cash equivalents and short-term investments totaling $7.8
million, and a bank credit facility for $2.5 million. The Company's working
capital at June 30, 1997 was $11.2 million. In April 1997, the Company
established a revolving line of credit with a bank. Borrowings are
collateralized by substantially all tangible assets, are limited to defined
percentages of eligible accounts receivable, and the Company must satisfy
certain financial covenants. In June 1997, the line of credit, which expires May
1998, was increased to $2.0 million. The Company also obtained a three year
equipment line of credit of up to $500,000 available through December 1997.

The Company's future capital requirements are expected to include (i)
supporting the expansion of the research and development and sales and marketing
departments, (ii) funding the acquisition of capital equipment, primarily for
research and development and consisting of such items as engineering equipment,
computers and furniture, and (iii) funding the growth of working capital items
such as receivables and inventory.

The Company may investigate means to acquire greater control over
semiconductor production, whether by joint venture, prepayments, equity
investments in or loans to wafer suppliers. In addition, as part of its business
strategy, the Company occasionally evaluates potential acquisitions of
businesses, products and technologies. Accordingly, a portion of its available
cash may be used for the acquisition of complementary products, technologies or
businesses or to assure foundry capacity. Such potential transactions may
require substantial capital resources, which may require the Company to seek
additional debt or equity financing. There can be no assurance that the Company
will consummate any such transactions.

The Company believes that its current cash, cash equivalents and short-term
investments and the anticipated net proceeds from this Offering will be
sufficient to support the Company's planned activities through at least the next
twelve months.

30
<PAGE>
BUSINESS

OVERVIEW

Faroudja designs, develops and markets a range of video image enhancement
products that significantly improve displayed images to achieve cinema-like
quality. Through more than 25 years of product development and technological
advances, the Company and its predecessors have established a reputation for
excellence in video processing and video signal image enhancement in the
high-end home theater, industrial and broadcast markets. The Company believes
that its technology, experience and reputation in these markets will enable it
to address opportunities in the emerging DTV and HDTV broadcast environment and
to facilitate the convergence of the PC and the TV.

The Company began operations in 1971 through two related companies, FLI and
later FRE. The Company was incorporated in December 1996 under the laws of the
state of Delaware to succeed to the business of FLI and FRE. Thereafter, FRE was
merged into FLI with FLI surviving the merger and FLI was subsequently merged
into a newly-formed wholly-owned subsidiary of the Company. Prior to March 1996,
FRE and FLI were each owned 100% by two individuals (the "Founders"). In March
1996, the Investor Group acquired a 56.25% ownership interest in both entities
through the purchase of shares held by the Founders for $14,000,000 and newly
issued FLI shares for $4,000,000. The Investor Group also acquired the Faroudja
Option from the Founders to acquire an additional 1,537,500 shares held by the
Founders for a total of $6,000,000 or $3.90 per share. Such option was exercised
by the Investor Group on September 5, 1997. See "Certain Transactions-- 1996
Financing" and Note 1 of Notes to Consolidated Financial Statements.

INDUSTRY BACKGROUND

Video images are pervasive in today's society as sources of entertainment
and information. Since the introduction of motion pictures, cinema has evolved
from low resolution black and white pictures (such as the Charlie Chaplin movies
of the 1920s) to spectacular color movie productions (such as JURASSIC PARK).
Today, images are displayed on a variety of electronic media including color
TVs, projection systems and PCs. Historically, there has been a substantial
difference in the quality of these various media, ranging from low quality TV
pictures to very high quality cinema pictures. This difference resulted from a
host of technical issues related to the capture, transmission and display of
video images. Current technologies make it possible to replicate cinema quality
on TVs, projection systems and PCs.

With U.S. households owning approximately 250 million television sets, TV is
the dominant medium for viewing video images. While TV is an integral part of
modern life, it is optimized around image production, transmission and display
technology created more than 40 years ago. TV signals are produced in accordance
with the NTSC standard developed in the 1940s for black and white programs. This
standard was last modified in the 1950s to make possible the compatible
transmission of black and white and color programs. Technical compromises
required to achieve compatibility introduce image degrading imperfections, known
as artifacts. Additionally, analog transmission introduces noise in the TV
image. While always present, these imperfections are less evident on TV screens
smaller than 25 inches in size than on larger screens. Over the last decade,
consumer interest in larger screen TVs has increased dramatically, fueled by
decreasing equipment prices and an ever expanding universe of movies, sporting
events and other programming available via cable TV, video cassette, direct
broadcast satellite, laser disc and, most recently, DVD. As TV screen sizes have
increased, impairments in the image, such as low resolution, artifacts and
noise, have become more readily apparent. The

- ------------------------

* NTSC is the current analog television system named for the National
Television Systems Committee, the industry group that developed the
monochrome (black and white) television standard in 1940-41 and the color
television standard in the 1950s. NTSC was developed in the United States
for 60 Hz, 525 line transmissions. PAL is the acronym for Phase Alternating
Line which was developed in Europe for 50 Hz, 625 line transmissions. PAL
uses many of the same coding techniques developed for NTSC resulting in
similar image imperfections.

31
<PAGE>
better quality images produced by DVDs, digital satellite transmission and high
resolution computer monitors have made viewers more discriminating and have
elevated their image quality expectations.

The Company believes that this trend will accelerate with the announced
introduction of HDTV by some broadcasters in late 1998. HDTV images are expected
to incorporate cinema-like image quality in a wider screen format. The FCC
recently established standards for DTV broadcasting in the United States and
adopted rules mandating the gradual introduction of DTV broadcasting. The FCC
has targeted the eventual phase-out of analog (NTSC) broadcasting by the year
2006. Current analog broadcasting equipment is not compatible with the new DTV
standards. In order to transmit digital signals in accordance with the new DTV
standards, broadcasters will need to acquire new equipment, including digital
transmission equipment, at costs estimated to be as high as $10 million per
station. Broadcasters are seeking to reduce the costs of transitioning from
analog to digital broadcasting through strategies which will allow them to
continue to use much of their existing equipment.

Advances in microprocessors, the availability of low cost memory and
storage, high quality displays, sophisticated software and the emergence of the
World Wide Web have fueled the growth in multimedia applications on the PC. The
PC is increasingly being used to view video stored on hard disk, CD-ROM, DVD and
laser disc, and video over the Internet. The Company believes that the use of
the PC as an entertainment device in the future will depend in large part on the
PC's ability to display TV images. Since TV signals use an interlaced format
while PCs use a progressive scanning display format, a TV signal must be
converted before being displayed on a PC. Until now, the interlace/progressive
conversion, along with other steps in the conversion of the TV signal, has
caused color distortion, motion artifacts, noise and other imperfections, which
have resulted in poor video quality on the PC. Image problems become even more
apparent when TV signals are viewed on a PC, as PC users sit relatively close to
their screens and PC monitors have higher resolution than most TVs.

FAROUDJA SOLUTION

Faroudja designs, develops and markets video image enhancement products that
significantly improve images to achieve a cinema-like quality. The Company
believes that once viewers experience cinema quality displays in their homes and
offices, they will demand it from all video platforms. The Company believes that
its technology, experience and reputation will enable the Company to address
opportunities in the emerging DTV/ HDTV broadcast environment and to facilitate
the PC/TV convergence.

The Company's products for the TV market substantially reduce the
imperfections inherent in analog NTSC signals, which become increasingly
apparent on large screen TV displays. The Company's technology improves picture
quality by removing artifacts and noise, detecting and compensating for motion,
enhancing resolution, and multiplying the number of lines displayed. Faroudja's
product sales for the TV market include sales of stand alone products to home
and industrial consumers and board level products to OEM customers.

Faroudja intends to capitalize on its experience and core technologies to
develop products which support the transition from analog to DTV/HDTV
broadcasting. As broadcasters make significant investments to satisfy regulatory
requirements, the Company believes that product solutions which interface with
additional necessary digital transmission equipment and current studio equipment
will help broadcasters minimize transition costs and maintain flexibility in
responding to evolving regulatory and market requirements. The Company is
developing standards conversion and upscaling products which it believes will
enable broadcasters to use much of the equipment present in their existing
studios to produce programming in various DTV/HDTV video formats.

The Company is also developing products and technology that are intended to
solve the interlacing problem by significantly reducing the noise and artifacts
inherent in the display of high quality TV pictures on PC screens. In March
1997, the Company executed a license agreement with S3, a leading supplier of
advanced graphics accelerators for multimedia computer systems. The Company and
S3 are working jointly to develop integrated circuits that will enable the
display of near cinema quality images on PC screens.

32
<PAGE>
STRATEGY

The Company's objective is to maintain and expand its position as the
industry standard of excellence for video image quality. Key elements of the
Company's strategy to achieve this objective include:

MAINTAIN AND EXTEND TECHNOLOGY LEADERSHIP. The Company intends to build
upon its technology leadership in video image processing by increasing its
investment in research and development. These efforts will focus on developing
patentable technology and innovative products for the TV and broadcast markets.
The Company also intends to leverage its image enhancement expertise in TV into
broadcast and PC products and applications.

PENETRATE BROADER MARKET SEGMENTS. The Company has historically sold
products that addressed the needs of the industrial and high-end home theater
markets. The Company recently introduced a decoder and signal enhancer with
prices and capabilities appealing to broad segments of the consumer markets. The
Company intends to continue to seek opportunities in new and broader market
segments, such as the converging PC and TV markets and the emerging DTV/HDTV
markets.

INCREASE BRAND NAME AWARENESS. The Company has established a reputation for
excellence in video processing and video image enhancement in the commercial
broadcast, industrial and high-end home theater markets. The Company intends to
increase brand name awareness through increased advertising, the marketing of
stand alone image enhancement products and video source players carrying the
Company's trademarks, and co-branding agreements with OEM customers. The
distribution of Company-branded and co-branded products (particularly PC/TV
products) in new and broader market segments is also intended to increase
Faroudja brand awareness.

BUILD AND LEVERAGE STRATEGIC RELATIONSHIPS. The Company intends to
establish and maintain strategic relationships with companies whose technology,
products and product strategies complement those of the Company. Through
selective licensing of its patented technologies, the Company intends to
increase penetration and recognition of its capabilities in markets currently
served and to facilitate migration into new markets. The agreement with S3 and
the potential agreement with TI are examples of attempts to incorporate the
Company's technology into applications outside the Company's historical
products.

EXPAND INTERNATIONAL PRESENCE. The Company intends to expand its
international presence in order to increase its export sales. These efforts will
include establishing a sales force and marketing activities for the European and
Asian markets, expanding the Company's international network of distributors and
dealers, continuing the development of OEM relationships with customers serving
international markets, such as Hughes/JVC, Vidikron, Runco and NEC, and product
development that incorporates various international specifications.

33
<PAGE>
PRODUCTS

Faroudja designs, develops and markets a range of video image enhancement
products for the TV and broadcast markets. The following table sets forth
certain information regarding the Company's current stand alone industrial and
home products:

<TABLE>
<CAPTION>
SUGGESTED
MARKET PRODUCT DESCRIPTION RETAIL PRICE
<S> <C> <C> <C>
TV--Image Enhancement/ VP400A Line quadrupler and video processor for $24,000-$25,500
Line Multiplying VP400AU large screen high resolution video
projection systems.
VP250 Line doubler and video processor for $9,950-$13,500
LD200 large screen high resolution direct
LD200U view, front and rear screen projection
systems.

VP100 Video decoder with detail and color $799
VP100U enhancement.

TV--Source Players DV1000 DVD/CD player with detail and color $5,500
enhancement.

LD1000 Laser disc player with audio $5,500
enhancement.

Broadcast DFD-U Low noise video decoder/frame $12,400-$19,950
synchronizer with video adjustments.
Analog and digital red, green and blue
(RGB) outputs.

CFD Very low noise video decoder with video $6,550
adjustments and analog red, green and
blue (RGB) outputs.
</TABLE>

TV PRODUCTS

LINE QUADRUPLERS (VP400A (NTSC) AND VP400AU (NTSC/PAL)). Faroudja line
quadrupler video processors produce cinema-like images. The processors accept
input from sources formatted for conventional 525-line or 625-line TV standards,
and convert them into line-quadrupled, noticeably artifact-free, high resolution
signals for direct-view or projector TV screens. The processors are precision
instruments employing three complex digital signal processes utilizing patented
technology in the fields of decoding, scan conversion and detail enhancement.
These products substantially reduce color blurring, rainbow patterns, dot crawl
and visible scan lines, and deliver sharp image details.

LINE DOUBLING VIDEO PROCESSORS (VP250 (NTSC/PAL), LD200(NTSC), LD200U
(NTSC/PAL)). The Company's line doubling video processors utilize certain of
the same technologies as the Company's line quadruplers, and deliver similar
results for smaller direct-view or projector TV screens.

VP100 TV ENHANCER (NTSC) AND VP100U (NTSC/PAL). The VP100 and VP100U set
top components apply patented adaptive decoding, detail processing and color
alignment correction for use in standard and large screen S-video compatible
TVs. These products substantially reduce color decoding artifacts and greatly

34
<PAGE>
increase image detail and depth. These products offer consumers a moderately
priced video enhancement technology that plugs directly into the TV unit.

DV1000 HIGH DEFINITION DIGITAL VIDEO DISC AND CD PLAYER. The DV1000 applies
custom circuitry to both video and audio processing to provide significantly
enhanced image detail and depth exceeding what is expected to be available from
standard DVD players.

LD1000 HIGH DEFINITION LASER DISC AND CD PLAYER. The LD1000 applies custom
circuitry for audio enhancement to provide an experience exceeding what is
available from standard laser disc players.

TV product sales as a percentage of total revenues for fiscal 1994, 1995 and
1996 and the six months ended June 30, 1997 were 67%, 80%, 80% and 81%,
respectively.

BROADCAST PRODUCTS

DFD-U PAL/NTSC DIGITAL DECODER. The DFD-U uses 10-bit processing with
patented decoding and bandwidth expansion circuitry to convert PAL or NTSC
analog signals into the digital component data required for video compression.
Additional circuits include time base correction and full frame synchronization.
The combination results in a significantly artifact-free digital signal that
enables additional channel capacity with reduced noise levels and higher quality
video signals from MPEG video compression engines.

CFD. The CFD decodes NTSC signals into high quality, artifact-free
components prior to the time the signal is transmitted. The output signal is
used in applications such as studio manipulation, display and digital video
compression.

Broadcast product sales as a percentage of total revenues for fiscal 1994,
1995 and 1996 and the six months ended June 30, 1997 were 33%, 20%, 16% and 3%,
respectively.

OEM PRODUCTS

The Company has designed and developed board level products incorporating
the Company's technologies for the OEM market. To date, sales from board level
products have not been material.

RESEARCH AND DEVELOPMENT; NEW PRODUCTS

The Company's research and development efforts are headed by Yves Faroudja,
the Company's founder and Chief Technology Officer. The Company has devoted, and
expects to continue to devote, significant resources to its research and
development efforts. In 1996, the Company established a VLSI design group to
develop high performance video ASICs. In June 1997, the Company expanded its
VLSI department by establishing a facility in Phoenix, Arizona with five
engineers. As of June 30, 1997, the Company had a staff of twenty-six full-time
and one part-time research and development personnel. During 1994, 1995 and 1996
and the first six months of 1997, the Company's research and development
expenses were approximately $1.3 million, $1.5 million, $2.5 million and $1.8
million, respectively. The Company anticipates that its research and development
expenses will increase in absolute dollars for the foreseeable future. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations."

The Company has a number of products in development with introduction
planned during the next several years. For the TV market, the Company is
developing an advanced line multiplier and scaling video processor for very
large screen high resolution systems, a video processor for liquid crystal
display ("LCD") and Digital Light Processing-TM- based projector systems ("DLP")
products and a video processor for less sophisticated industrial applications.
The Company is also developing a rear screen projection TV incorporating the
Company's line multiplication and enhancement technology. For the OEM TV
projection market, the Company is developing a board level decoder with video
enhancement features.

For the broadcast market, the Company is developing an upconverter that
utilizes Faroudja technology to deliver HDTV quality video images from NTSC
sources. Field testing is planned for the fourth quarter of 1997

35
<PAGE>
and, if such testing is successful, the Company expects to begin sales of this
product in the first quarter of 1998. The upconverter is intended to provide
broadcasters with the ability to leverage their existing analog equipment and
systems to produce programming in various DTV/HDTV video formats. The Company is
also developing studio quality NTSC/PAL decoders for broadcast and
postproduction applications.

For the PC/TV market, the Company is in the final stages of developing a
video decoder integrated circuit, which includes synchronization, time base
correction and detail enhancement. The Company is also developing "Presentation
Plus," a line multiplier and scaling video product for high resolution video
computer monitors that incorporates time base correction, image enhancement and
video synchronization.

The Company's other planned research products include expanded development
of line multipliers and compression pre-processors which include noise reduction
to increase compressor efficiency, and the extension of the Company's technology
to low bandwidth use for such applications as teleconferencing and video
telephones.

The markets for the Company's products are characterized by evolving
industry standards, rapid technological change, frequent new product
introductions and short product life cycles. The Company's future success will
depend, in large part, on its ability to continue to enhance its existing
products and to develop new products and features to meet changing customer
requirements and evolving industry standards. The Company anticipates that sales
from its line multiplier product lines will experience limited growth, or may
decline, in future periods. The Company expects that more than one-half of its
total revenues in 1998 will be derived from licensing revenue and sales of
recently introduced products, as well as products which the Company is
developing. The success of new products depends on a number of factors,
including proper selection and timely introduction of planned new products,
successful and timely completion of product development, accurate estimation of
demand for new products, market acceptance of new products of the Company and
its OEM customers, the Company's ability to offer new products at competitive
prices, the availability of adequate staffing to produce and sell such new
products, and competition from products introduced by competitors. Certain of
these factors are outside the control of the Company. See "Risk Factors--Risks
Associated with New Markets and Applications; Market Acceptance." For example,
to date sales of the Company's DVD players have been minimal, and initial sales
of the Company's rear projection TV are not expected until the fourth quarter of
1997. Sales of the Company's board level products, and future license and
royalty revenues, depend in part upon the ability of the Company's OEM customers
and licensees to successfully develop and market products incorporating the
Company's products or technology. The Company's products intended for the
digital broadcast market are not expected to be field tested until the fourth
quarter of 1997 and are not expected to be available for sale until 1998. There
can be no assurance that the Company's broadcast products, assuming timely
development and satisfactory completion of field tests, will be accepted by the
broadcast market. There can be no assurance as to the amount of royalties, if
any, to be paid to the Company under the S3 agreement because S3 is under no
obligation to maintain its exclusive license with the Company or to develop
products incorporating the Company's technology under the agreement.

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<PAGE>
TECHNOLOGY

The Company has significant expertise in a number of technologies relating
to video image enhancement.

ENCODING TECHNOLOGY. A NTSC or PAL signal consists of a luminance signal
and two color-difference signals. In a conventional NTSC or PAL encoder, the
color-difference signals are modulated on a subcarrier and added to the
luminance signal. In this case, the spectrum of both the luminance signal and
the modulated chrominance signal are mixed together, which generates "rainbow
patterns," "dot crawl" and other artifacts in TV receivers. Faroudja's patented
pre-filtered technology is applied to luminance and chrominance signals
separately so that they will not interfere with each other. The two signals are
added together without an overlaid spectrum, which significantly reduces rainbow
patterns and other artifacts.

DECODING TECHNOLOGY. The color section of the NTSC standard was originally
designed with severe bandwidth restrictions. This causes colors in various video
images to "blur" and "smear." These effects are aggravated by storage media,
such as VHS tapes, that further degrade the chroma or color signal. The Faroudja
decoder technology utilizes proprietary circuitry to recreate and correct color
details. This is accomplished by making use of the sharper black and white
transitions to develop a correction signal that is then used to sharpen the
color transitions. As a result, colors are restored with sharp details and video
images retain their original crisp image. Digital adaptive comb filter circuitry
eliminates decoding errors from imperfect separation of the luminance and
chrominance signals and enables the reproduction of sharper, cleaner color
images. The Company's decoder technology has two separate correction circuits
that create color transitions that are clear, sharp and natural by eliminating
dot crawl, a rapid upward movement of colored dots on sharp vertical
transitions, and hanging dots which lie underneath all the colored horizontal
transitions. Dot crawl and hanging dots are easily apparent with large, highly
saturated, stationary graphics such as titles and credits.

LINE MULTIPLIER TECHNOLOGY. The line multiplier technology reduces scan
line visibility resulting from utilizing a 525 line broadcast standard on
today's large screen TVs by changing the interlaced video signal to a
progressively scanned signal. The Company's line multiplier technology detects
motion and interpolates correctly to "fill in the blanks." This technology can
detect the difference between a film image that has been transferred to video or
a video image that emanates from a video camera. After detecting the image type,
the line multiplier technology selects its algorithm to compensate accordingly.
This is critical because today's home theaters are primarily used to show films
that were transferred to video, whether on tape, laser disc or off the air.

DETAIL ENHANCEMENT TECHNOLOGY. The best video sources such as DVD (if
properly recorded) provide good resolution while others such as digital
satellite reception and laser discs often provide acceptable resolution.
However, common sources such as broadcast or VHS tapes are noticeably deficient.
The problem is compounded when scan lines are doubled or quadrupled and when
other signal processing is applied. The resulting picture is free of artifacts
(including visible scan lines) but dull, with loss of definition and a general
blurriness. The Company's proprietary technology increases the visibility of
small image details, whether horizontal or vertical, without introducing ringing
or noise artifacts and without modifying large edge response. The Company's
technology also uses a form of non-linear processing similar to controlled
distortion. This technique expands the bandwidth of large edge signals without
introducing artifacts, such as ringing, in both the horizontal and vertical
domains. The combination of these two techniques results in a line doubled or
quadrupled image that gives a greater feeling of depth.

MOTION COMPENSATION TECHNOLOGY. The inherent scan and frame rate changes
that are required to display the enhanced video image makes motion compensation
necessary in the reconstruction of the enhanced picture. TV images are
transmitted in an interlaced fashion in which the picture is transmitted in two
parts, the first being the even lines of the picture, the second the odd lines.
This creates a time delay of 16 milliseconds between the odd and even lines of
the image. If motion is present, artifacts can be generated in the conversion to
a line doubled or quadrupled image. Also, while TV images are displayed at
approximately 60 frames per second, cinema film sources are displayed at 24
frames per second. To ensure an image noticeably free from artifacts, the motion
of the video has to be taken into account and identification of the source
material as video or film is necessary. The Company's motion and film detection
technology is used in most of its video enhancement products.

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<PAGE>
NOISE REDUCTION. All analog video sources contain some degree of picture
noise. This is manifested as low level moving or shimmering artifacts, or an
excessive graininess in the picture. High quality digital sources such as DVDs
have much reduced noise content. Noise reduction processing is required to bring
analog sources, either existing archive material or new material from
traditional cameras, up to digital standards. Small static details in the
picture have to be distinguished from the moving noise artifacts so that correct
discrimination can be accomplished. The Company makes use of its motion
detection and adaptive video filtering technologies to optimize noise reduction
in the video images.

TIME BASE CORRECTION. Video sources which are being transmitted from a
broadcast studio or by a satellite or cable TV head end derive line and frame
scan rates from stable crystal controlled sources which are timing accurate.
Video produced by consumer video cassette recorders, camcorders and, to a lesser
extent, video discs are subject to timing errors, because the playback relies on
the mechanical rotation of the storage medium for timing accuracy. In the case
of VCRs, line lengths may vary causing color decoding and video picture
alignment problems. If a VCR source is to be transmitted in the industry
standard digital D1 format, this line timing variability is not permissible. The
Company's time base correction technology permits its decoders not only to
separate the luminance and chrominance components of the video source but to
re-lock the video to a crystal reference. This stabilizes the picture,
particularly when video is overlaid on other video sources, and makes it
compliant with digital studio transmission standards.

SCALING. As new video standards become available, the need to reformat the
video picture by scaling in both the horizontal and vertical domains becomes
more important. The Company currently produces line doublers and quadruplers
which scale the picture by a factor of two. The Company has under development
products which scale the picture by non-integer ratios. This will be required
for the Company's PC interface products, which will permit the adjustment of the
size of a video image in a window on the PC monitor. This is a completely
variable scaling application. LCD panels or TI's DLP mirror products have finite
numbers of pixels in the display format. At present, 800 horizontal pixels by
600 vertical pixels is a common size and was developed to match computer SVGA
display sizes. In the case of video being interfaced to pixel based displays to
ensure that video artifacts are not developed at the display device, the video
source is scaled to convert the original number of lines to the number of lines
in the display device. Non-integer scaling is employed in this transfer. Scaling
will also be used in the conversion of video between traditional sources and the
new DTV and HDTV formats.

STRATEGIC RELATIONSHIPS

The Company believes that strategic relationships with other manufacturers
will provide opportunities to facilitate the entry of video image enhancement
products into new markets.

In March 1997, the Company entered into a license agreement with S3, a
leading supplier of advanced graphics accelerators for use in mainstream
multimedia PC systems. Under the terms of the agreement, the Company and S3 are
working jointly to develop integrated circuits using the Company's video
processing technologies and S3's advanced graphics accelerator technology for
use in PCs. The Company has granted S3 a worldwide license to certain
technology, including line doubling, detail enhancement, cross-color
suppression, motion tracking and compensation, and digital compression filtering
technology. Portions of such license are exclusive for certain markets for a
period of five years provided that performance criteria are satisfied. The
Company is obligated to negotiate with S3 to extend this five year period. The
Company is to receive certain per unit royalties for products sold incorporating
the Company's technology. In addition to other performance criteria, S3 must
make minimum royalty payments to maintain exclusivity. If royalties on product
sales do not reach prescribed minimum levels, S3 may maintain exclusivity by
prepaying royalties to prescribed levels, but there is no requirement for it to
do so. S3 expects to ship products that incorporate the Company's technology in
1998. There can be no assurance that S3 and the Company will develop products as
a result of the agreement or that future royalties will be received by the
Company.

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<PAGE>
In April 1997, the Company entered into a development agreement with TI.
Under the terms of the agreement, the Company and TI are working jointly to
enhance and improve the images displayed by TI's DLP. If TI is satisfied with
the development related to the DLP, TI and the Company may enter into a further
agreement that would provide, among other things, that the Company sell board
level decoder products to TI, and/or license certain of the Company's technology
to TI. However, there can be no assurance that the Company will develop any such
improvements, that TI and the Company will enter into any further agreement or
that the Company will receive any royalty payments from TI. See "Risk
Factors--Dependence on Strategic Relationships" and "Certain
Transactions--License Agreement with S3."

SALES AND MARKETING

Faroudja markets its products for the TV market through a network of home
theater, industrial and commercial dealers as well as OEM customers. As of June
30, 1997, the Company maintained a sales force of eight persons at its
headquarters in Sunnyvale, California, and six employees in regional offices.
The Company's marketing programs include trade shows, training seminars, public
relations and advertising. Revenues from GI accounted for 19.3% of total
revenues in 1994. Revenues from Hughes/JVC accounted for 12.1% of total revenues
in 1995. Revenues from Vidikron accounted for 10.5% of total revenues in 1996.
Revenues from S3 and Vidikron accounted for 14.9% and 11.4% respectively, of
total revenues in the six months ended June 30, 1997.

The Company currently distributes its home theater products through
approximately 330 home theater dealers throughout the United States. This
distribution channel is managed by a Company national sales manager, four
regional managers, one field training manager, twelve independent sales
representatives and a customer service department. Through the recent
introduction of new, lower priced products for home theaters and the addition of
independent sales representatives, the Company intends to increase its home
theater dealer network locations in the U.S. over the next twelve months.

The Company services industrial applications, such as corporate board rooms,
executive conference centers and auditoriums, through a network of more than 70
industrial dealers. These dealers typically provide installation, product
integration, on site training and customer support. This network is managed
directly by a national sales manager and four regional managers.

For the broadcast market, the Company has relied, and expects to continue to
rely in the future, on direct sales marketing. The Company has three employees
who sell directly to the broadcast markets.

The Company has OEM relationships with Runco, Vidikron and Ampro. Vidikron
is also integrating the VP100 decoder into certain of its projection systems,
including the new Helios I projector based on TI's DLP. There can be no
assurance that the Company will continue to receive any revenues from any of
these relationships.

The Company has entered into co-branding arrangements with NEC and Runco
pursuant to which NEC and Runco have non-exclusive distribution rights to the
Company's line multiplier products. NEC and Runco are required to purchase a
certain minimum number of units per year to maintain their rights to co-brand
Company products. Under the NEC agreement, the Company has afforded NEC certain
price protections with respect to products listed therein. Specifically, in the
event of a price decrease for any such product, the Company will provide a
credit equal to the decrease for all such products remaining in inventory at
NEC. The Company has also entered into a co-branding arrangement with Ampro for
the development and sale of decoder boards for incorporation into the Ampro
three chip TI DLP product. There can be no assurance that the Company will
continue to receive any revenues from any of these arrangements.

In 1996 and in the six months ended June 30, 1997, the Company generated
approximately 15.3% and 9.5%, respectively, of its total revenues from export
sales. The decrease in the percentage of total revenues generated from export
sales in the six months ended June 30, 1997 from the prior year was primarily
due to (i) increased sales to certain U.S. customers which, the Company
believes, in turn exported the Company's products and (ii) a reduction in
international sales personnel. The Company intends to expand its international
presence in order to

39
<PAGE>

increase its export sales and intends to hire a sales manager in the fourth
quarter of 1997 to handle export sales. Consequently, the Company believes that
export sales will increase as a percentage of total revenues in future periods.
The Company has a non-exclusive worldwide distribution arrangement with Vidikron
pursuant to which Vidikron distributes the Company's line doublers and line
quadruplers. Further, Faroudja has a non-exclusive worldwide distribution
arrangement with Hughes/JVC for the industrial and consumer market. Hughes/JVC
distributes Faroudja's line doublers, quadruplers and broadcast products. In
addition, Faroudja has distributors or dealers in over 35 countries worldwide.
Export sales to international customers entail a number of risks, including
unexpected changes in, or impositions of, legislative or regulatory
requirements, delays resulting from difficulty in obtaining export licenses for
certain technology, tariffs, quotas and other trade barriers and restrictions,
longer payment cycles, greater difficulty in accounts receivable collection,
potential adverse taxes, currency exchange fluctuations, the burdens of
complying with a variety of foreign laws and other factors beyond the Company's
control. See "Risk Factors--Risks Associated with Export Sales and Operations."

The Company's future success will depend, in large part, on the continued
efforts of its network of direct and indirect distributors and dealers. The loss
of, or reduction in sales to any of the Company's key customers could have a
material adverse effect on the Company's operating results. See "Risk
Factors--Distribution Risks; Diversification of Sales Channels."

The Company's business is characterized by short lead times and quick
delivery schedules. As a result, the Company does not believe that backlog at
any given time is a meaningful indication of future sales.

MANUFACTURING

TV AND BROADCAST PRODUCTS. The Company focuses its manufacturing efforts on
producing high quality products in a cost-effective manner. The Company's
manufacturing operations are located in Sunnyvale, California and consist mainly
of materials procurement, final assembly, testing, quality assurance and
shipping of products. The only product assembly performed by the Company is
final assembly, which consists of building chassis and installing circuit boards
and wires and cables. The Company performs testing and quality assurance of all
products at its Sunnyvale facilities and plans to expand its in-house automated
testing efforts as its product volume increases.

The Company subcontracts other manufacturing functions, including the
production of its printed circuit boards. Bestronics assembles more than 80% of
the Company's circuit boards. The Company's reliance on independent printed
circuit board assemblers limits its control over delivery schedules, quality
assurance and product cost. The Company also relies on suppliers for components,
such as DC Electronics which builds all of the Company's wire and cable
harnesses. Disruption in service by any of the Company's subcontractors or the
Company's suppliers could lead to supply constraints or delays in the delivery
of the Company's products. Such supply constraints or delays could have a
material adverse effect on the Company's business, operating results and
financial condition. See "Risk Factors--Reliance on Independent Foundries and
Manufacturers."

WAFER FABRICATION. The Company contracts all of 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. As the
Company continues to develop ASIC products, it will continue to contract out its
wafer production. The Company's engineers work closely with the Company's
foundries and subcontractors to increase yields, lower manufacturing costs and
assure quality. The Company's primary foundry is SGS-Thomson. In addition, MDT
and TEMIC have manufactured the Company's integrated circuits since 1993 and
1996, respectively. Most of the Company's devices are currently fabricated using
complementary metal oxide semiconductor ("CMOS") process technology with 0.8
micron feature sizes. New devices that are being designed are in 0.5 micron and
0.35 micron sizes. The Company currently purchases products from all of its
foundries under individually negotiated purchase orders. The Company does not
currently have a long-term supply contract with any of its wafer fabrication
foundries and, therefore, none are 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

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<PAGE>
reliance on independent foundries and assembly and testing houses involves a
number of risks. See "Risks Factors--Reliance on Independent Foundries and
Manufacturers."

COMPETITION

The markets in which the Company competes are intensely competitive and are
characterized by rapid technological change, rapid product obsolescence and
price competition. 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 products or technologies which may be less
costly or provide higher performance or more desirable features than the
Company's products. The Company's existing and potential competitors include
several large domestic and international companies that have substantially
greater financial, manufacturing, technical, marketing, distribution and other
resources than the Company. In the market for TV video processors, the Company's
principal competitors are DWIN, Extron, NEC, Snell & Wilcox, Sony and YEM. In
the market for broadcast products, the Company's principal competitors are
Extron, Leitch, Matsushita, Snell & Wilcox, Sony Broadcast and Vistek. As the
Company's products penetrate broader markets and as these markets become
commercial markets, the Company expects to face competition from diversified
electronic and semiconductor companies.

Certain of the Company's principal competitors maintain their own
manufacturing facilities, including semiconductor foundries, and may therefore
benefit from certain capacity, cost and technical advantages. Since the Company
does not operate its own semiconductor 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.

The Company believes that its ability to compete successfully in the rapidly
evolving markets for high performance video image enhancement technology depends
on a number of factors, including protection of its proprietary technology and
information, the price, quality and performance of the Company's and its
competitors' 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. There can be no assurance that the Company will compete
successfully in the future with respect to these or any other competitive
factors. See "Risk Factors--Competition."

The Company has licensed and intends to continue to license its technologies
and intellectual property. The Company also offers for sale board level or chip
level products, developed by or for the Company, which implement certain of the
Company's technologies. The Company's licensees and OEM customers may be larger
and have greater market recognition and financial, technological, engineering,
manufacturing and distribution capabilities than the Company. In addition, such
licensees and OEM customers may use such technologies and subsystems either
alone or in combination with other technologies to develop products which could
compete with the Company's technologies and products. While the Company may sell
board level or chip level products and receive royalties from such licensees,
there can be no assurance that the technologies and products offered by such
licensees and OEM customers will not compete directly with those of the Company,
have performance, cost or other advantages over those of the Company or have an
adverse impact on the sales or other licensing activities of the Company.

PROPRIETARY RIGHTS AND LICENSES

The Company's future success depends in part upon its ability to protect its
proprietary technology and information. Although the Company relies on a
combination of licensed patents, copyrights, trademarks, trade secrets and
licensing arrangements with third parties 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

41
<PAGE>

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. Yves Faroudja, the Company's
founder and Chief Technical Officer, personally holds or was assigned 35 U.S.
and 8 foreign patents, and 7 U.S. and 22 foreign patent applications, which have
been licensed to the Company, and on which the Company depends for the
enhancement of its current products and the development of future products. Mr.
Faroudja has granted the Company a perpetual, royalty-free, license to use
patented and unpatented technologies developed by him prior to January 20, 1997.
See "Certain Transactions--Yves Faroudja License Agreement." As the Company is a
licensee of such patents and applications, it is subject to risks not generally
faced by other companies which own the intellectual property upon which their
businesses rely. See "Risk Factors--Limited Protection of Proprietary Rights;
Risk of Third Party Infringement." There can be no assurance that patents will
issue from any pending applications or that any claims allowed from pending
applications will be of sufficient scope or strength, or be issued in all
countries where the Company's products can be sold, to provide meaningful
protection or any commercial advantage to the Company. Also, competitors of the
Company may be able to design around the licensed patents. 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 the
laws of the United States, and thus, may increase the likelihood of piracy of
the Company's technology and products. There can be no assurance that the steps
taken by the Company to protect its intellectual property rights will be
adequate to prevent misappropriation of its technology or that the Company's
competitors will not independently develop technologies that are substantially
equivalent or superior to the Company's technology.

The Company may initiate claims or litigation against third parties for
infringement of the Company's proprietary rights or to establish the validity of
the Company's proprietary rights. For example, in January 1997 and May 1997, the
Company filed actions against DWIN and Snell & Wilcox, respectively, seeking
relief and damages for the infringement of US Patent Number 4,876,596 owned by
Yves Faroudja and licensed to the Company. DWIN and Snell & Wilcox have raised
defenses and counterclaims that the patent is invalid and not infringed. See
"Limited Protection of Proprietary Rights; Risk of Third Party Infringement" and
"--Litigation."

Yves Faroudja, the Company and GI are parties to a royalty free, world-wide
license agreement dated May 1, 1996 pursuant to which GI licensed certain
patents to the Company and the Company licensed certain patents to GI relating
to video compression and decompression. As a result of that agreement, GI could
produce products in the field of scan conversion of source material presented to
a compression system competitive with certain present or proposed products of
the Company. See "Certain Transactions--Yves Faroudja License Agreement."

EMPLOYEES

As of June 30, 1997, the Company had 67 full-time and six part-time and
contract employees, including 26 full-time employees primarily involved in
research and development activities, 14 in marketing and sales, 11 in finance
and administration and 16 in manufacturing and quality assurance. Most employees
are based at the Company's headquarters in Sunnyvale, California. The Company's
employees are not represented by any

42
<PAGE>
collective bargaining unit with respect to their employment with the Company,
and the Company has never experienced a work stoppage. The Company believes that
its employee relations are good. The Company intends to significantly expand its
employee base in 1997, primarily in research and development and sales and
marketing, and believes that its future success will depend largely on its
ability to attract and retain highly-skilled managerial, sales and marketing
personnel. Competition for such personnel is intense. The Company's future
success will depend to a significant extent upon the continued services of
members of senior management and other key employees of the Company. The loss of
the service of any of these individuals could have a material adverse effect on
the Company. See "Risk Factors--Dependence on Senior Management and Other Key
Employees; New Management Personnel."

FACILITIES

The Company's headquarters is located in approximately 20,000 square feet of
space in Sunnyvale, California pursuant to a lease which expires September 30,
2003. In 1997, the Company also entered into a lease for approximately 2,000
square feet for a research and development facility in Phoenix, Arizona which
expires in June 1999. The aggregate annual gross rent for the Company's
facilities was approximately $172,000 in 1996. The Company intends to expand its
facilities in the second half of 1997.

LITIGATION

In January 1997 and May 1997, the Company filed actions against DWIN and
Snell & Wilcox, respectively, seeking relief and damages for the infringement of
US Patent Number 4,876,596, which was issued on October 24, 1989, is owned by
Yves Faroudja and is licensed to the Company. DWIN and Snell & Wilcox have
raised defenses and counterclaims that the patent is invalid and not infringed.
The actions against DWIN and Snell & Wilcox were filed in the United States
District Court, Northern District of California--San Jose Division as Civil
Action No. C-97 20010 SW (PVT) and Civil Action No. C-97 20422 SW (PVT),
respectively. The Company is seeking an injunction and unspecified monetary
damages against both DWIN and Snell & Wilcox. DWIN and Snell & Wilcox have filed
counterclaims seeking declaratory judgements that all of the claims of the
patents are invalid and/or that US Patent Number 4,876,596 has not been
infringed. They are also seeking recovery of their respective attorneys' fees
and costs. Discovery has commenced in both matters. The Company's management
believes that a finding that all of the claims of the patent are invalid or that
the patent has not been infringed in one or both actions would not have a
material adverse effect on the Company.

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MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The following table sets forth certain information concerning the Company's
executive officers and directors as of the date of this Prospectus:

<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------------------ --- ---------------------------------------------------------------
<S> <C> <C>
Michael J. Moone.......................... 51 President, Chief Executive Officer and Director

Yves C. Faroudja(3)....................... 63 Chief Technical Officer, Chairman of the Executive Committee,
Secretary and Director

Michael C. Hoberg......................... 45 Vice President--Finance and Chief Financial Officer

Donald S. Butler.......................... 51 Vice President--Engineering

Kenneth S. Boschwitz...................... 43 Vice President--Business Development and General Counsel

Thomas A. Harvey.......................... 49 Vice President--Sales and Marketing

William J. Turner(1)...................... 54 Chairman of the Board of Directors

Kevin B. Kimberlin(2)..................... 44 Director

Matthew D. Miller(3)...................... 50 Director

William N. Sick, Jr.(1)................... 62 Director

Stuart D. Buchalter(2).................... 60 Director

Merv L. Adelson(3)........................ 67 Director
</TABLE>

- ------------------------

(1) Member of the Compensation Committee

(2) Member of the Audit Committee

(3) Member of the Executive Committee

MICHAEL J. MOONE has served as President, Chief Executive Officer and a
director of the Company since joining the Company in July 1996. From February
1995 to June 1996, Mr. Moone was President, Chief Executive Officer and a
director of Healthrider, Inc., a home fitness equipment supplier. In June 1993,
he co-founded Kid One, Inc., a developer of electronic toys and games, and
served as its Chief Executive Officer and a director through February 1995. In
1985, Mr. Moone founded Merchantec International, a credit card processing
company, and served as its President, Chief Executive Officer and a director
through May 1993. In 1983 he founded Electronic Publishing Systems Inc., a
software development and marketing company and served as its President through
May 1985. From November 1979 to April 1983 he was President of Atari, Inc., a
developer and manufacturer of home video games and a subsidiary of Warner
Communications, Inc. From July 1978 to November 1979, he was Vice President and
General Manager of Milton Bradley Co. ("MBC"), a developer and manufacturer of
toys and games. Previously, he held a number of marketing and general management
positions with MBC. Mr. Moone holds a B.S. in Political Science and Economics
from Xavier University.

YVES C. FAROUDJA is co-founder of the Company and has served as a director
of the Company since its inception in 1971. Mr. Faroudja served as the Company's
President from 1971 to July 1996, has been the Company's Chief Technical Officer
since July 1996 and is currently Chairman of its Executive Committee of the
Board of Directors. Prior to founding the Company, Mr. Faroudja worked as a
research and development engineer at ITT Research Laboratories in France, as a
research scientist at the North Atlantic Treaty Organization in Italy and for
Memorex Corporation, a systems integrator and distributor of computer products,
in the United States. Mr. Faroudja holds a M.S.E.E. from Ecole Superieure
d'Electricite, Paris.

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<PAGE>
MICHAEL C. HOBERG joined the Company in December 1996 as Vice
President--Finance and Chief Financial Officer. From March 1995 to December
1996, Mr. Hoberg was Principal Accounting Officer of DSP Group, Inc. ("DSP"), a
semiconductor company, and from January 1994 to March 1995 he was DSP's
Corporate Controller. From March 1992 to January 1994, Mr. Hoberg served as Vice
President of Finance and Chief Financial Officer at Arix Corporation ("Arix"), a
UNIX superminicomputer manufacturer, and from 1989 to March 1992 was Arix's
Corporate Controller. From 1986 to 1989, Mr. Hoberg was the Controller of the
Therapeutic Products Division of Diasonics, Inc., a manufacturer of therapeutic
medical equipment, and from 1983 to 1986 served as the Chief Financial Officer
of Technics, Inc., a semiconductor equipment manufacturer. Mr. Hoberg holds a
B.B.A. in Accounting from the University of Wisconsin at Madison and is a
Certified Public Accountant.

DONALD S. BUTLER joined the Company in May 1996 as Vice President and
General Manager of the VLSI Division. In October 1996, as Vice
President--Engineering, he assumed responsibility for all engineering functions
other than research and development. Prior to joining the Company, Mr. Butler
was Vice President of Engineering at the Integrated Systems Center of GI, a
manufacturer of satellite and cable TV equipment, a position he held from 1989
to May 1996. From 1974 to 1989, he held several engineering and engineering
management positions within GI's Microelectronics Division. Mr. Butler holds a
B.S. in Electrical Engineering from the University of Strathclyde, Glasgow,
Scotland.

KENNETH S. BOSCHWITZ joined the Company in June 1997 as Vice
President--Business Development and General Counsel. From May 1984 to September
1996, Mr. Boschwitz held various legal and management positions with GI,
including Vice President & General Counsel of GI's Communications Division. From
November 1979 to May 1984, Mr. Boschwitz practiced corporate and securities law
with several private law firms. From August 1977 to November 1979, Mr. Boschwitz
was a Staff Attorney at the Securities and Exchange Commission's Division of
Corporation Finance. Mr. Boschwitz holds a J.D. from Washington College of Law
at The American University and a B.A. from Rutgers College.

THOMAS A. HARVEY joined the Company in June 1997 as Vice President--Sales
and Marketing. From September 1990 to May 1997, Mr. Harvey was Senior Vice
President of the Western Zone Sales Consumer Products Group of Sony Electronics,
Inc. ("Sony Electronics"), a leading electronics supplier. From June 1989 to
August 1990, Mr. Harvey was the President of the Consumer Sales Company division
of Sony Electronics. From August 1987 to May 1989, he was the President of the
Consumer Audio Products group of Sony Electronics. Prior thereto, he held
numerous positions of increasing responsibility with various divisions of Sony
Electronics. Mr. Harvey holds a M.S. in Education and a B.S. in Education from
Northern Illinois University.

WILLIAM J. TURNER has served as Chairman of the Board of Directors of the
Company since December 1995. From November 1989 to the present, Mr. Turner has
been chairman of Turner & Partners, a management and financial consulting
company. In February 1997, Mr. Turner also became a co-founder and co-manager of
Signature Capital, LLC, a venture capital company ("Signature Capital"). From
1983 to 1989, Mr. Turner was the President, Chief Operating Officer and a
director of Automatic Data Processing, a computer and information services firm.
Mr. Turner is currently a director of Federal Home Loan Mortgage Corporation.
Mr. Turner holds a M.A. in Mathematics from the University of Maine and a M.B.A.
from Northeastern University.

KEVIN B. KIMBERLIN has served as a director of the Company since December
1995. Since 1991, Mr. Kimberlin has been Chairman of Spencer Trask Holdings,
Inc., an investment banking firm. Mr. Kimberlin is a co-founder of Ciena
Corporation, Myriad Genetics and The Immune Response Corporation. He has been a
director of The Immune Response Corporation since 1986. Mr. Kimberlin holds a
M.B.A. from Harvard Business School and a B.S. from Indiana University.

MATTHEW D. MILLER has served as a director of the Company since December
1995. Since July 1994, Mr. Miller has served as President of M-Squared Media and
Technology L.L.C., a venture capital investment and consulting firm focusing on
high technology companies ("M-Squared"). From January 1993 to December 1993, Mr.
Miller served as Chairman of the Center for Advanced TV Studies, a non-profit
research and development consortium. From August 1988 to July 1994, he served as
Vice President of Technology at GI, and from March 1984 to August 1988, he was
Vice President of Technology at Viacom Inc. ("Viacom"), a media and

45
<PAGE>
communications company. Before joining Viacom, he served as a technology manager
at both Perkin-Elmer Corporation and RCA Corporation's David Sarnoff Research
Center. Mr. Miller holds a M.A. and a Ph.D. in Physics from Princeton
University, and a B.A. in Physics from Harvard University. He is a director of
Lumisys Inc. and several private technology companies.

WILLIAM N. SICK has served as a director of the Company since December 1995.
Mr. Sick is Chairman and Chief Executive Officer of Business Resources
International, an investment services company he founded in 1989. In February
1997, Mr. Sick became a co-founder and co-manager of Signature Capital. In 1988
and 1989, he served as Chief Executive Officer and a director of American
National Can Company ("ANC"), a packaging company. During this period, he was
also Vice Chairman of Triangle Industries Inc., the owner of ANC. From 1958 to
1987, Mr. Sick was employed by Texas Instruments Incorporated ("TI") where he
served in several management capacities, including five years as President of TI
Semiconductor Group and Executive Vice President and a director of the Company.
Prior to that time, he was President of TI Asia in Tokyo and President of the TI
Europe Division. Mr. Sick is currently Chairman of the Board of Trustees of the
Shedd Aquarium in Chicago and a member of the Board of Governors of Rice
University. Mr. Sick holds a B.A. and a B.S. in Electrical Engineering from Rice
University.

STUART D. BUCHALTER has served as a director of the Company since April
1996. Mr. Buchalter has been of counsel with the law firm of Buchalter, Nemer,
Fields & Younger, a Professional Corporation, since August 1980. From August
1980 to June 1993, he served as Chairman of the Board of Directors and Chief
Executive Officer of Standard Brands Paint Company, a paint retailer and
manufacturer. Mr. Buchalter is a director of Authentic Fitness Corp., an
athletic apparel manufacturer, Earl Scheib, Inc., an automotive painting
company, and City National Corp., the holding company for City National Bank. He
is also Vice-Chairman of the Board of Trustees of Otis College of Art and
Design. Mr. Buchalter holds a L.L.B. from Harvard Law School and a B.A. from the
University of California at Berkeley.

MERV L. ADELSON has served as a director of the Company since September
1996. Mr. Adelson has been Chairman of East-West Capital Associates, Inc., a
private investment banking company, since 1989. Previously, he was Chairman and
Chief Executive Officer of Lorimar Telepictures Corporation, an entertainment
firm. Mr. Adelson has been a director of Time Warner, Inc., a media and
communication corporation, since 1989. Mr. Adelson served as Vice Chairman of
Warner Communications, Inc. from January 1989 through August 1991. Mr. Adelson
is a director of 7th Level, Inc., a video graphics developer. Mr. Adelson has
served as a Managing Member of Adelson Investors, LLC, a private venture capital
fund, since February 1996.

The Company's Certificate of Incorporation provides for a classified Board
of Directors consisting of three classes of directors, each serving staggered
three-year terms. As a result, approximately one-third of the Company's Board of
Directors will be elected each year. Yves Faroudja, Michael Moone and Stuart
Buchalter have been designated Class 1 directors with terms expiring at the 1997
Annual Meeting of Stockholders. Merv Adelson, Kevin Kimberlin and William Turner
have been designated Class 2 directors with terms expiring at the 1998 Annual
Meeting of Stockholders. William Sick and Matthew Miller have been designated as
Class 3 directors with terms expiring at the 1999 Annual Meeting of
Stockholders. See "Description of Capital Stock-- Delaware Law and Certain
Charter and By-Law Provisions."

BOARD COMMITTEES

EXECUTIVE COMMITTEE. The Executive Committee of the Board of Directors
reviews and monitors the Company's annual operating and capital expense budgets,
and acts as the Board of Directors' nominating committee with respect to the
selection of independent directors. Merv Adelson, Matthew Miller and Yves
Faroudja are the members of the Executive Committee and Yves Faroudja is its
chairman.

AUDIT COMMITTEE. The Audit Committee of the Board of Directors (i) reviews
the results and scope of the annual audit and other services provided by the
Company's independent auditors, (ii) reviews and evaluates the Company's
internal audit and control functions and (iii) monitors transactions between the
Company and its

46
<PAGE>
employees, officers and directors. Kevin B. Kimberlin and Stuart D. Buchalter
are the members of the Audit Committee.

COMPENSATION COMMITTEE. The Compensation Committee of the Board of
Directors administers the Company's stock option and stock purchase plans and
designates compensation levels for the Company's executive officers and
directors. William J. Turner and William N. Sick, Jr. are the members of the
Compensation Committee.

BOARD COMPENSATION

Directors received no fees for serving on the Board of Directors during 1996
but were reimbursed for all reasonable expenses incurred by them in attending
Board of Directors and Committee meetings. Commencing in August 1997,
non-employee directors will receive an annual retainer of $7,500, payable in
Common Stock on the day after the annual meeting of stockholders. In addition,
each non-employee director will receive $650 for each Board of Directors meeting
attended and $375 for each Committee meeting attended. Non-employee directors
are also eligible to participate in the Directors Plan. See "--Stock Plans--1997
Non-Employee Directors Stock Option Plan." On August 13, 1997 the Company issued
750 shares of its Common Stock to each of Stuart D. Buchalter, Merv Adelson,
William N. Sick, William J. Turner and Kevin B. Kimberlin as their annual
retainer for serving as directors of the Company. Under a consulting agreement
between the Company and Matthew D. Miller, the Company paid Mr. Miller a
consulting fee of $7,000 per month from July 1997 through August 1997, and will
pay Mr. Miller $5,000 per month for the balance of the term of the agreement.
The Company paid Mr. Miller $35,645 and $14,000 in consulting fees during fiscal
1996 and the six months ended June 30, 1997, respectively. To date, Merv Adelson
has not received any compensation under his consulting agreement with the
Company. See "Certain Transactions--Consulting Agreements."

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

In January 1997, the Compensation Committee of the Board of Directors was
formed, consisting of William N. Sick, Jr. and William J. Turner. No member of
the Compensation Committee was or is an officer or employee of the Company or
any of its subsidiaries. No executive officer of the Company serves as a member
of the Board of Directors or Compensation Committee of any entity which has one
or more executive officers serving as a member of the Company's Board of
Directors or Compensation Committee.

EXECUTIVE COMPENSATION

The following table sets forth all compensation received for services
rendered to the Company and the Company's subsidiaries in all capacities during
the fiscal year ended December 31, 1996 by (i) the Company's

47
<PAGE>
Chief Executive Officer and (ii) the Company's other executive officers whose
total compensation exceeded $100,000 during such fiscal year (together, the
"Named Executive Officers"):

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION(1) -------------
------------------------------------- SECURITIES
OTHER UNDERLYING
ANNUAL OPTIONS ALL OTHER
NAME AND PRINCIPAL POSITION SALARY ($) BONUS COMPENSATION (#)(2) COMPENSATION(3)
- ----------------------------------------- ---------- ---------- ------------- ------------- ---------------
<S> <C> <C> <C> <C> <C>
Michael J. Moone
President, Chief Executive
Officer and Director(4)................ $ 175,000 $ 150,000 -- 528,932 $ 4,750

Michael C. Hoberg
Vice President--Finance and Chief
Financial Officer(5)................... 135,000 -- -- 75,000 --

Yves C. Faroudja
Chief Technical Officer, Secretary and
Director(6)............................ 198,500 -- -- -- 2,464

Donald S. Butler
Vice President--Engineering(7)......... 200,000 30,512 -- 195,964 --
</TABLE>

- ------------------------

(1) Excludes perquisites and other personal benefits which for each Named
Executive Officer did not exceed the lesser of (i) $50,000 or (ii) 10% of
the total annual salary and bonus for such officer. The bonus for each
executive varies annually based on a variety of factors. Accordingly, the
bonus reported for each executive is the actual amount earned in 1996, not
an annualized amount.

(2) These shares are issuable upon exercise of stock options granted under the
1995 Option Plan.

(3) Represents matching contributions by the Company under its 401(k) plan.

(4) Mr. Moone joined the Company in June 1996, and the amount reported
represents his salary in 1996 on an annual basis. Commencing in January
1997, Mr. Moone's base salary was increased to $250,000. Includes a grant of
options to purchase 456,432 shares under the 1995 Option Plan at an exercise
price of $3.83 and a grant of options to purchase 72,500 shares under the
1995 Option Plan at an exercise price of $3.91. The options vest over four
years.

(5) Mr. Hoberg joined the Company in December 1996, and the amount reported
represents his salary on an annual basis. He is eligible for a discretionary
bonus at the end of the year. Includes a grant of options to purchase 75,000
shares under the 1995 Option Plan at an exercise price of $3.91. The options
vest over four years.

(6) Mr. Faroudja served as the Company's President prior to June 1996, and
currently serves as the Company's Chief Technical Officer, Chairman of the
Executive Committee, Secretary and Director of the Board of Directors. Under
his employment agreement, Mr. Faroudja will receive a salary of up to
$200,000 for each of fiscal 1997 and fiscal 1998 depending on the amount of
time he devotes to the Company.

(7) Mr. Butler joined the Company in May 1996 and received an annualized salary
of $200,000. Commencing in May 1997, Mr. Butler's base salary was increased
to $220,000. He is eligible for a discretionary bonus at the end of the
year. Includes a grant of options to purchase 172,964 shares under the 1995
Option Plan at an exercise price of $3.83 and a grant of options to purchase
23,000 shares under the 1995 Option Plan at an exercise price of $3.91. The
options vest over four years.

Kenneth S. Boschwitz joined the Company in June 1997 as its Vice
President--Business Development and General Counsel, and will receive a
pro-rated annual salary of $150,000 in 1997. He is also eligible for a

48
<PAGE>
discretionary bonus at the end of the year. He was granted options to purchase
80,000 shares under the 1997 Option Plan at an exercise price of $7.50. Mr.
Boschwitz's option vests over four years. If Mr. Boschwitz is terminated without
cause during his first year of employment with the Company, he will receive a
severance of $75,000. Thomas A. Harvey joined the Company in June 1997 as its
Vice President--Sales and Marketing and will receive a pro-rated salary of
$200,000 in 1997. In addition, he received a signing bonus of $50,000 in July
1997 and is eligible for a discretionary bonus at the end of the year. He was
granted options to purchase 100,000 shares under the 1997 Option Plan at an
exercise price of $7.50. Mr. Harvey's options vest over four years. If Mr.
Harvey is terminated without cause during his first year of employment with the
Company, he will receive a severance of $125,000 which will be paid over 12
months.

STOCK OPTION GRANTS

The following table provides information relating to stock options awarded
to each of the Named Executive Officers during the fiscal year ended December
31, 1996.

OPTION GRANTS IN LAST FISCAL YEAR

<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
INDIVIDUAL GRANTS(1) ANNUAL RATES OF
---------------------------------------------------------- STOCK PRICE
NUMBER OF % OF TOTAL APPRECIATION FOR
SECURITIES OPTIONS EXERCISE OPTION TERM(2)
UNDERLYING GRANTED PRICE PER EXPIRATION ------------------------
NAME OPTIONS GRANTED TO EMPLOYEES SHARE DATE(4) 5% ($) 10% ($)
- -------------------------------- --------------- --------------- ----------- ----------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C>
Michael J. Moone................ 345,928 27.42% $ 3.83 06/24/06 $ 833,226 $ 2,111,556
Michael J. Moone................ 110,504 8.76 3.83 07/08/06 266,167 674,520
Michael J. Moone................ 72,500 5.75 3.91 12/31/06 178,276 451,786
Michael C. Hoberg............... 75,000 5.95 3.91 12/31/06 184,423 467,365
Donald S. Butler................ 172,964(3) 13.71 3.83 05/06/06 416,613 1,055,778
Donald S. Butler................ 23,000(3) 1.82 3.91 12/31/06 56,557 143,325
</TABLE>

- ------------------------

(1) Each of these options was granted pursuant to the 1995 Option Plan. These
options were granted at an exercise price equal to the fair market value of
the Company's Common Stock as determined by the Board of Directors of the
Company on the date of grant, and vest over a four year period at the rate
of 25% of the shares on the first anniversary of the date of grant and
1/48th of the shares each month thereafter. The term of each option is ten
years.

(2) Potential gains are net of the exercise price but before taxes associated
with the exercise. The 5% and 10% assumed annual rates of compounded stock
appreciation are mandated by the rules of the Securities and Exchange
Commission and do not represent the Company's estimate or projection of the
future Common Stock price. Actual gains, if any, on stock option exercises
are dependent on the future financial performance of the Company, overall
market conditions and the option holders' continued employment through the
vesting period.

(3) Mr. Butler entered into an agreement with the Company on March 6, 1996,
pursuant to which Mr. Butler will receive a bonus of $1.08 per each option
upon exercise of such options, up to an aggregate of 138,370 options, or
$150,000.

(4) Options become exercisable as to 25% of the option shares on the first
anniversary of the date of grant and as to 1/48th of the option shares each
month thereafter, with full vesting occurring on the fourth anniversary of
the date of grant.

49
<PAGE>
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES

There were no stock options exercised by Named Executive Officers during the
year ended December 31, 1996. The following table sets forth certain information
regarding stock options held as of December 31, 1996 by the Named Executive
Officers.

<TABLE>
<CAPTION>
FISCAL YEAR-END OPTION VALUES
--------------------------------------------------------------
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT DECEMBER 31, 1996 IN-THE-MONEY OPTIONS
(#) DECEMBER 31, 1996 ($)
------------------------------ ------------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- --------------------------------- --------------- ------------- --------------- -------------
<S> <C> <C> <C> <C>
Michael J. Moone................. -- 456,432 -- $ 36,515
Michael J. Moone................. -- 72,500(2) -- --
Michael C. Hoberg................ -- 75,000(2) -- --
Donald S. Butler................. -- 172,964 -- 13,837
Donald S. Butler................. -- 23,000(2) -- --
</TABLE>

- ------------------------

(1) Calculated by determining the difference between the exercise price of such
option and the fair market value of the Company's Common Stock at December
31, 1996, multiplied by the total number of shares subject to the option.

(2) These options were granted at an exercise price of $3.91 per share.

The Board of Directors determined that the fair value of the Common Stock at
December 31, 1996 was $3.91 per share, after taking into consideration the
purchase price of $3.83 per share paid by the Investor Group in March 1996 and
assessing operations after that date.

STOCK PLANS

1997 NON-EMPLOYEE DIRECTORS STOCK OPTION PLAN. The Directors Plan provides
for the grant of nonqualified stock options to non-employee directors of the
Company. The Directors Plan was adopted by the Company's Board of Directors in
December 1996 and approved by its stockholders in January 1997, at which time
100,000 shares of Common Stock were authorized for issuance thereunder. Under
the Directors Plan, each non-employee director is eligible to receive options
exercisable for the Company's Common Stock. As of June 30, 1997, there were
options to purchase 45,605 shares of Common Stock outstanding under the
Directors Plan, none of which have been exercised. Unless terminated sooner the
Directors Plan will terminate in 2007.

Options granted under the Directors Plan shall be exercisable in whole or in
part at all times during the period beginning on the date of grant until the
earlier of (i) ten years from the date of grant, and (ii) one year from the date
on which a grantee ceases to be a non-employee director, subject to certain
vesting requirements which may be imposed by the committee designated by the
Board of Directors to administer the Directors Plan or by the Board of Directors
if no such committee has been designated. No director option granted under the
Directors Plan is transferable by the optionee except by will or by the laws of
descent or distribution, and each director option is exercisable during the
lifetime of the optionee only by such optionee. The exercise price of each
director option is equal to the fair market value of the Common Stock on the
date of grant. In the event of a merger of the Company with or into another
corporation, or the sale of substantially all of the assets of the Company, the
Directors Plan shall terminate and each director option issued thereunder shall
become fully exercisable.

1995 STOCK OPTION PLAN. On August 1, 1995, the Company's Board of Directors
and its stockholders approved the 1995 Option Plan to succeed the 1993 Stock
Option Plan. The 1995 Option Plan was amended on August 19, 1996, February 11,
1997, April 30, 1997 and June 13, 1997. The 1995 Option Plan provides for the
grant to employees of the Company of incentive stock options within the meaning
of Section 422 of the Code, and for the grant of nonstatutory stock options to
employees and consultants of the Company. A total of 1,225,000 shares of Common
Stock have been reserved for issuance under the 1995 Option Plan. As of June 30,
1997, 1,217,019 shares were subject to outstanding options, and 7,380 shares had
been issued upon exercise of stock

50
<PAGE>
options granted under the 1995 Option Plan. The exercise price of all incentive
stock options granted under the 1995 Option Plan must be at least equal to the
fair market value of the Common Stock on the date of grant. The exercise price
of all nonstatutory stock options granted under the 1995 Option Plan must be at
least 85% of the fair market value of the Common Stock on the date of grant.
With respect to any participant who owns stock possessing more than 10% of the
voting power of all classes of stock of the Company, the exercise price of any
incentive or nonstatutory stock option granted must equal at least 110% of the
fair market per share value on the grant date and the maximum term of the option
may not exceed five years. The term of all other options granted under the 1995
Option Plan may not exceed ten years. Options granted under the 1995 Option Plan
are not transferable by the optionee except by will or by the laws of descent or
distribution, and are exercisable during the lifetime of the optionee only by
such optionee. As of June 30, 1997, options to purchase 1,217,019 shares of
Common Stock were outstanding. No additional options to purchase Common Stock
will be issued under the 1995 Option Plan.

The 1995 Option Plan is administered by the Board of Directors, or a
committee designated by the Board of Directors, which, among other things,
selects the optionees and interprets and implements the 1995 Option Plan. Most
options vest over three or four years. The 1995 Option Plan may be amended at
any time by the Board of Directors, although certain amendments require
stockholder approval.

In the event of a merger of the Company with or into another corporation, or
the sale of substantially all of the assets of the Company, the 1995 Option Plan
shall terminate and each option issued thereunder shall become fully
exercisable.

1997 PERFORMANCE STOCK OPTION PLAN. In January 1997, the Company's Board of
Directors adopted and its stockholders approved the 1997 Option Plan to succeed
the 1995 Option Plan. The 1997 Option Plan was amended on June 13, 1997. The
1997 Option Plan provides for the granting to employees (including officers and
employee directors) of incentive stock options within the meaning of Section 422
of the Code, and for the granting to employees (including officers and employee
directors) and consultants of nonstatutory stock options. Unless terminated
sooner, the 1997 Option Plan will terminate automatically in 2007. The Board of
Directors has authority to amend, suspend or terminate the 1997 Option Plan,
provided that no such action may affect any share of Common Stock previously
issued and sold or any option previously granted under the 1997 Option Plan. A
total of 725,000 shares of Common Stock have been reserved for issuance under
the 1997 Option Plan. As of June 30, 1997, there were options to purchase
315,725 shares of Common Stock outstanding under the 1997 Option Plan, none of
which have been exercised.

The 1997 Option Plan may be administered by the Board of Directors or a
committee designated by the Board (the "Administrator"), which committee is
required to be constituted to comply with Section 16(b) of the Securities
Exchange Act of 1934, as amended, and applicable laws. The Administrator has the
power to determine the terms of the options granted, including the exercise
price, the number of shares subject to the option and the exercisability
thereof, and the form of consideration payable upon exercise. Options granted
under the 1997 Option Plan are not transferable except by will or by the laws of
descent and distribution and may only be exercised by the holder of such options
or by the holder's legal representative. Options granted under the 1997 Option
Plan must be exercised within three months of the end of the optionee's status
as an employee or consultant of the Company, or within twelve months after such
optionee's termination by death or disability, but in no event later than the
expiration of the option term. The exercise price of all nonstatutory stock
options granted under the 1997 Option Plan shall be determined by the
Administrator. With respect to any participant who owns stock possessing more
than 10% of the voting power of all classes of the Company's outstanding capital
stock (a "10% Stockholder"), the exercise price of any stock option granted to
such participant must equal at least 110% of the fair market value per share on
the date of grant. The exercise price of incentive stock options for all other
employees shall be no less than 100% of the fair market value per share on the
date of grant and the exercise price of nonstatutory stock options shall be no
less than 85% of the fair market value per share on the date of grant. The
maximum term of an option granted under the 1997 Option Plan may not exceed ten
years from the date of grant (five years in the case of an incentive stock
option granted to a 10% Stockholder).

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<PAGE>
In the event of a merger of the Company with or into another corporation, or
the sale of substantially all of the assets of the Company, the 1997 Option Plan
shall terminate and each option issued thereunder shall become fully
exercisable.

1997 EMPLOYEE STOCK PURCHASE PLAN. The Purchase Plan was approved by the
Company's Board of Directors and stockholders in January 1997. The Purchase Plan
is intended to qualify as an "employee stock purchase plan" under Section 423 of
the Code. An aggregate of 400,000 shares of the Company's Common Stock are
reserved for offering under the Purchase Plan and are available for purchase
thereunder, subject to adjustment in the event of a stock split, stock dividend
or other similar change in the Common Stock or the capital structure of the
Company. Employees are eligible to participate if they are regularly employed by
the Company for at least 20 hours per week and more than five months per
calendar year. As of the date of this Prospectus no shares of the Company's
Common Stock have been purchased pursuant to the Purchase Plan.

Under the Purchase Plan, offering periods will commence on the first trading
day on or after June 15 and December 15 of each year and terminate on the last
trading day in periods ending 24 months later, except that the first offering
period shall begin on the effective date of this Offering and end on the last
trading day in the period ending June 15, 1999. Payroll deductions may be from
1% to 10% (in whole percentage increments) of a participant's compensation. The
per share price at which shares of Common Stock are to be purchased pursuant to
the Purchase Plan is an amount equal to 85% of the fair market value (as
defined) of a share of Common Stock on the first day of any offering period or
on an exercise date, whichever is lower. On the enrollment date of each offering
period, eligible employees are granted an option to purchase every six months
(an exercise date) during such offering period up to a number of shares of
Common Stock determined by dividing such employee's payroll deductions
accumulated prior to such exercise date by the applicable purchase price. In no
event shall an employee be permitted to purchase during each purchase period
more than a number of shares determined by dividing $12,500 by the fair market
value of a share of Common Stock on the enrollment date. In the event the fair
market value at the end of a purchase period is less than the fair market value
at the beginning of the offering period, the participants will be withdrawn from
the current offering period following exercise and will automatically be
re-enrolled in a new offering period. The new offering period will use the lower
fair market value as of the first date of the new offering period to determine
the purchase price for future purchase periods.

In the event of a sale of substantially all of the assets of the Company or
a merger of the Company with or into another corporation, the Purchase Plan
provides that each option under the Purchase Plan be assumed or an equivalent
option substituted by the successor corporation, unless the Board of Directors
decides to shorten the offering period or to cancel each outstanding option and
refund all sums collected from participants during the offering period then in
progress. Unless terminated sooner, the Purchase Plan will terminate ten years
from its effective date. The Board of Directors has authority to amend or
terminate the Purchase Plan, provided, however, no such action may adversely
affect the rights of any participant.

401(k) PLAN. The Company has adopted the Faroudja Laboratories 401(k) Plan
(the "401(k) Plan"), which is intended to qualify under Section 401(k) of the
Code. All employees of the Company and its subsidiaries who have attained 21
years of age and have met the plan's service requirements, including employment
with the Company for at least 1 year, are eligible to participate in the 401(k)
Plan. Each eligible employee may contribute to the 401(k) Plan, through payroll
deductions, up to $9,500 (adjusted annually after 1995 for cost-of-living
increases), subject to statutory limitations imposed by the Internal Revenue
Service. The Company has the discretion to match employee contributions under
the 401(k) Plan. Under Section 401(k) of the Code, contributions by employees or
by the Company to the 401(k) Plan, and income earned on plan contributions, are
not taxable to employees until withdrawn from the 401(k) Plan, and contributions
by the Company will be deductible by the Company when made. On April 19, 1996,
the 401(k) Plan was amended by the Board of Directors of the Company. Pursuant
to such amendment and effective as of January 1, 1996, the Company matches 50%
of employee contributions under the 401(k) Plan, matching contributions made by
the Company vest over 4 years, and the waiting period before which employees
become eligible to participate in the 401(k) Plan was decreased to 1 month.

52
<PAGE>
EMPLOYMENT AGREEMENTS

In March 1996, the Company entered into an employment agreement with Yves C.
Faroudja for a term of two years, pursuant to which Mr. Faroudja is to serve as
Chief Technical Officer of the Company at an annual base salary of $100,000 for
the first year and $66,600 for the second year. Mr. Faroudja is required to
devote at least one-half of his time to the Company during the first year of the
agreement and at least one-third of his time to the Company during the second
year of the agreement. Mr. Faroudja may not engage in any other business
activities that interfere with the performance of his duties under his agreement
with the Company, and the agreement contains a covenant not to compete. Mr.
Faroudja is not currently employed by another company. Mr. Faroudja's annual
base salary is $100,000 for the first year and $66,600 for the second year, but
his salary will increase proportionately if Mr. Faroudja contributes more than
one-half of his time to the Company during the first year and/or more than
one-third of his time to the Company during the second year of his employment
with the Company, with a maximum annual base salary during the first and second
years of $200,000 for each year. Mr. Faroudja is entitled under the agreement to
participate in all insurance and benefit plans generally available to the
employees of the Company. If Mr. Faroudja is terminated without cause (as
defined in the agreement), Mr. Faroudja will be entitled to receive his annual
base salary and continuation of his benefits through the term of the agreement.
If Mr. Faroudja is terminated for any other reason, he will be entitled only to
his accrued and annual unpaid base salary.

On July 8, 1996, the Company entered into an employment agreement with
Michael J. Moone for a term of four years, pursuant to which Mr. Moone is to
serve as President, Chief Executive Officer and a director of the Company at an
annual base salary of $175,000. Effective January 1, 1997, Mr. Moone's annual
base salary was increased to $250,000. Mr. Moone is entitled to receive an
annual bonus of up to 100% of his annual base salary at the discretion of the
Board of Directors. Mr. Moone is entitled to participate in all insurance and
benefit plans generally available to the employees of the Company. Mr. Moone was
granted options under the 1995 Option Plan to purchase 456,432 shares at an
exercise price of $3.83 per share and 72,500 shares at an exercise price of
$3.91 per share. If Mr. Moone's employment is terminated for any reason, he is
entitled to his accrued and unpaid annual base salary and bonus. However, if Mr.
Moone dies and the Company has not obtained life insurance for the benefit of
Mr. Moone's estate, the Company is required to pay his estate three month's
annual base salary and bonus.

LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS

The Company believes that the provisions in its Certificate of Incorporation
and By-Laws and the separate indemnification agreements outlined below are
necessary to attract and retain qualified persons as directors and officers.

The Company's Certificate of Incorporation limits the liability of directors
to the maximum extent permitted by Delaware law. Delaware law provides that
directors of a company will not be personally liable for monetary damages for
breach of their fiduciary duties as directors except for liability (i) for any
breach of their duty of loyalty to the company or its stockholders, (ii) for
acts or omissions not in good faith or which involve intentional misconduct or a
knowing violation of law, (iii) for unlawful payments or dividends or unlawful
stock repurchases or redemptions as provided in Section 174 of the Delaware
General Corporation Law, or (iv) for any transaction from which the director
derived an improper personal benefit.

The Company's By-Laws provide that the Company shall indemnify its officers
and directors and may indemnify its employees and other agents to the fullest
extent permitted under Delaware Law, including in those circumstances where
indemnification would otherwise be discretionary. The Company believes that
indemnification under its By-Laws covers at least negligence and gross
negligence on the part of indemnified parties. The By-Laws authorize the use of
indemnification agreements, and the Company has entered into indemnification
agreements with each of its directors that are in some respects broader than the
specific indemnification provisions contained in Delaware Law. The
indemnification agreements may require the Company, among other things, to
indemnify such directors against certain liabilities that may arise by reason of

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<PAGE>
their status or service as directors (other than liabilities arising from
willful misconduct of a culpable nature) and to advance expenses reasonably
expected to be incurred in defending any proceeding against them for which they
would receive indemnification. The Company also plans to obtain directors and
officers liability insurance with respect to certain matters, including matters
arising under the Securities Act.

At present, there is no pending litigation or proceeding involving any
director, officer, employee or agent of the Company where indemnification will
be required or permitted. The Company is not aware of any threatened litigation
or proceeding which may result in a claim for such indemnification.

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<PAGE>
CERTAIN TRANSACTIONS

1996 FINANCING

In March 1996, (i) the Company issued 1,043,105 shares of Common Stock for
an aggregate purchase price of $4.0 million to the Investor Group, of which
213,642 shares were issued to Adelson, 682,153 shares were issued to Investors
LLC and 147,310 shares were issued to Images, (ii) the Investor Group purchased
a total of 3,569,395 shares of Common Stock from Yves and Isabell Faroudja for
an aggregate purchase price of $14.0 million, of which 731,062 shares were
purchased by Adelson, 2,334,253 shares were purchased by Investors LLC and
504,080 shares were purchased by Images, and (iii) Yves and Isabell Faroudja
granted the Investor Group the Faroudja Option to purchase 1,537,500 shares of
the Company's Common Stock for an aggregate purchase price of $6.0 million or
$3.90 per share, of which Adelson had an option to purchase 486,875 shares of
Common Stock for $1.9 million, Investors LLC had an option to purchase 666,250
shares of Common Stock for $2.6 million and Images had an option to purchase
384,375 shares of Common Stock for $1.5 million. The Faroudja Option was
exercised by the Investor Group on September 5, 1997. The transactions described
in (i) and (ii) above are collectively referred to herein as the "Equity
Purchase."

Kevin Kimberlin, a director of the Company, is a general partner of, and has
a beneficial interest in the shares held by, Images. Kevin Kimberlin Partners,
L.P. provided a secured loan of $1 million to Investors LLC to exercise that
portion of the Faroudja Option that Investors LLC holds. Mr. Kimberlin is the
general partner of Kevin Kimberlin Partners, L.P. Spencer Trask Securities,
Incorporated organized Investors LLC and served as the placement agent for the
Equity Purchase, receiving a fee of $2.1 million. ST Partners, L.P., of which
Kevin Kimberlin is the general partner, is the majority shareholder of Spencer
Trask Holdings, Incorporated, the sole shareholder of Spencer Trask Securities,
Incorporated.

Merv Adelson and Stuart Buchalter, directors of the Company, are,
respectively, the managing member and an officer of Adelson.

As part of the Equity Purchase, the Investor Group received certain
registration rights which provide that 180 days following the completion of an
initial public offering, the Company must file a registration statement under
the Securities Act, to register the shares held by members of the Investor
Group. Under this agreement the Company must pay for all of the expenses
incurred with the registration other than selling commissions and discounts. See
"Description of Capital Stock--Registration Rights."

SUBCHAPTER S DISTRIBUTIONS

One of the Company's predecessor entities, FLI, elected to be taxed as an S
Corporation. Yves Faroudja and Isabell Faroudja, as stockholders of such
predecessor entity, received for 1994, 1995 and 1996 aggregate S Corporation
distributions of $1.5 million, $1.4 million and $4.0 million, respectively.

YVES FAROUDJA LICENSE AGREEMENT

On January 20, 1997 (the "Effective Date"), the Company entered into a
license agreement (the "License Agreement") with Yves Faroudja with respect to
all intellectual property, including all rights in inventions, works of
authorship and designs owned by Mr. Faroudja prior to the Effective Date
(collectively, the "Faroudja Technology"), pursuant to which (1) Mr. Faroudja
granted to the Company a worldwide, perpetual, royalty-free, sublicensable
license to exploit the Faroudja Technology and (2) Yves Faroudja assigned to the
Company his rights to all intellectual property, including all rights in
inventions, works of authorship and designs, first owned by him during the
period commencing on the Effective Date and ending on the date (the "Termination
Date") Yves Faroudja ceases to be an employee of the Company. The Company's
license to the Faroudja Technology in the field of data processing for
electronically displaying images to the human eye (the "Company Field") is
exclusive subject to licenses previously granted by Mr. Faroudja. Mr. Faroudja
has retained the non-exclusive, nontransferrable rights to exploit the Faroudja
Technology outside of the Company Field. Prior to entering into the License
Agreement, Mr. Faroudja had granted licenses to the Faroudja Technology to
approximately 20 other companies for various applications such as video
recorders and players, color TV cameras, broadcast encoders,

55
<PAGE>

and video compression and decompression equipment. Although these licenses are
within the Company Field, the Company believes that such licenses relate to
products and technologies outside of the Company's present and proposed areas of
activity. Yves Faroudja, the Company and GI are parties to a royalty free,
world-wide license agreement dated May 1, 1996 pursuant to which GI licensed
certain patents to the Company and the Company licensed certain patents to GI
relating to video compression and decompression. As a result of that agreement,
GI could produce products in the field of scan conversion of source material
presented to a compression system competitive with certain present or proposed
products of the Company. The Company does not believe these licenses will
materially assist these licensees in producing products competitive with present
or proposed products of the Company, either because the items of Faroudja
Technology licensed to the respective licensees do not represent the current
state of the art of such technology practised by the Company or do not represent
all elements of the technology necessary for the respective licensees to produce
products which compete with the Company's products. During the term of his
employment agreement with the Company, Mr. Faroudja is prohibited from
exploiting non-exclusive rights to the Faroudja Technology in a manner which is
competitive with the Company. After the term of that employment agreement, in
the event that Mr. Faroudja or the Company choose to exploit their non-exclusive
rights outside the Company Field separately, the activities of Mr. Faroudja may
compete with the activities of the Company. The Company enjoys certain other
rights pursuant to the License Agreement, including the rights (1) to control
the preparation, filing, and prosecution of additional patent applications
covering the licensed intellectual property prior to the Termination Date and
(2) to bring actions against third parties that apparently infringe the licensed
intellectual property and to retain the recovery, if any, from such actions,
except that if the Company elects not to enforce an action against an infringer
of its intellectual property whose infringement occurs outside the Company
Field, Yves Faroudja may, beginning nine months after the Company's receipt of
notice of an infringing action, institute an action against such infringer. Mr.
Faroudja enjoys certain other rights pursuant to the License Agreement,
including the non-exclusive right to license his patents and technologies to
third parties for use outside the Company's field of use.

As consideration for the License Agreement, Yves Faroudja was granted a
warrant to purchase 100,000 shares of Common Stock at an exercise price of $7.50
per share. The warrant vests as to 1/36th of the total shares for each full
month after January 20, 1997 provided that Yves Faroudja is then either (i)
employed by the Company (as a full or part-time employee), or (ii) acting as a
member of the Board of Directors of the Company. Certain registration rights and
anti-dilution provisions are provided to Yves Faroudja as contained therein.

CONSULTING AGREEMENTS

In September 1994, the Company entered into a six month consulting services
agreement with M-Squared, pursuant to which M-Squared agreed to render
consulting services to the Company in connection with (i) providing advice on
strategic alternatives for the Company, (ii) the preparation of the Company's
business plan, and (iii) other specific projects related to the intellectual
property of the Company. Matthew Miller, a director of the Company, is president
and the sole member of M-Squared. Pursuant to this agreement, (i) the Company
paid M-Squared $50,000 for consulting services, and (ii) Mr. Faroudja is
obligated to pay Mr. Miller the aggregate sum of $120,000, representing 2% of
the exercise price for the Faroudja Option, contingent upon the exercise of such
options.

In July 1997, the Company entered into a consulting services agreement with
Matthew D. Miller, which agreement supersedes all prior existing arrangements
among M-Squared, Mr. Miller and the Company. Pursuant to this agreement, Mr.
Miller agreed to advise the Company on strategic, technology and communications
matters and will provide such assistance and advice related to such matters as
the Company may request. This agreement is for a term of one year, is renewable
upon the mutual consent of Mr. Miller and the Company's Board of Directors and
may be cancelled on four weeks notice if the Company's Board of Directors is not
satisfied with Mr. Miller's performance. Under the agreement, the Company paid
Mr. Miller a consulting fee of $7,000 per month from July 1997 through August
1997, and will pay Mr. Miller $5,000 per month for the balance of the term of
the agreement. Mr. Miller may also receive a performance-based year-end bonus
which shall be determined by the Company's Board of Directors in its sole
discretion. The Company issued to Mr. Miller an option to purchase 50,000 shares
of Common Stock at an exercise price of $9.50 per share (the "Miller Option")

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<PAGE>
under the agreement. The Miller Option has a term of three years and vests as to
1/24th of the option shares each month during the first year after the date of
grant and as to an additional 1/2 of the option shares one year after the date
of grant.

In December 1996, the Company entered into a three year consulting agreement
("Adelson Consulting Agreement") with Merv Adelson, a director of the Company,
pursuant to which Mr. Adelson agreed to provide certain consulting services in
the analysis and implementation of potential strategic alliances ("Proposed
Strategic Alliances") in the specific field of TV signal enhancement for TV,
cable TV, satellite TV and DVDs, including, but not limited to (i) providing the
Company with a list of possible corporate investors, partners, customers,
buyers, lenders and joint ventures ("Proposed Strategic Alliance Partners"),
(ii) coordinating and making approaches to Proposed Strategic Alliance Partners,
and (iv) assisting in the negotiation of the principal forms of Proposed
Strategic Alliances and preparation of all contracts, documents, approvals and
related matters necessary to consummate a Proposed Strategic Alliance with a
Proposed Strategic Alliance Partner. The Company has agreed to compensate Mr.
Adelson for any strategic alliance or combination of strategic alliances during
the term of the agreement in which the Company receives consideration (as
defined in the agreement) of at least $5 million, through the issuance of a
three year warrant to Adelson for the purchase of 65,152 shares of Common Stock
with an exercise price of $0.15 per share ("Adelson Contingent Warrant"). During
the term of the Consulting Agreement, the Company also agreed to use its best
efforts to cause the election to the Board of Directors of Mr. Adelson (or a
designee of Mr. Adelson reasonably acceptable to the Board of Directors) and an
additional designee of Mr. Adelson reasonably acceptable to the Board of
Directors. Mr. Buchalter serves on the Board of Directors as Mr. Adelson's
designee.

LICENSE AGREEMENT WITH S3

On June 30, 1997, the Company issued 526,316 shares of Common Stock to S3
for an aggregate purchase price of $5.0 million. Under the terms of the Stock
Purchase Agreement and an Investor's Rights Agreement, S3 is entitled to certain
anti-dilution and registration rights as described therein. The Stock Purchase
Agreement provides that S3 shall receive additional shares if the Offering price
is less than $9.50 per share. Assuming an Offering price of $9.00, S3 will be
entitled to 29,240 additional shares of Common Stock. See "Description of
Capital Stock--Registration Rights." Moreover, S3 may send an observer to attend
meetings of the Company's Board of Directors and committees thereof and, in this
respect, S3 is entitled to receive copies of all notices, minutes, consents and
other materials that the Company provides to its directors, except that the
Company may exclude the observer from a meeting of the Board of Directors or
portion thereof if (i) such meeting concerns the relationship between the
Company and S3 or (ii) if such attendance would result in disclosure of trade
secrets to S3 or would adversely affect the attorney-client privilege between
the Company and its counsel.

The Company believes that all of the transactions set forth above were made
on terms no less favorable to the Company than could have been obtained from
unaffiliated third parties. All future transactions, including loans, between
the Company and its officers, directors, principal stockholders and their
affiliates will be approved by a majority of the Board of Directors, including a
majority of the independent and disinterested outside directors, and will
continue to be on terms no less favorable to the Company than could be obtained
from unaffiliated third parties.

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<PAGE>

PRINCIPAL AND SELLING STOCKHOLDERS

The following table sets forth certain information known to the Company with
respect to beneficial ownership of the Company's Common Stock as of June 30,
1997 and as adjusted to reflect the sale of shares offered hereby by the Company
for (i) each person known by the Company to own beneficially more than 5% of the
outstanding shares of Common Stock, (ii) each of the Company's directors, (iii)
each Named Executive Officer, (iv) all executive officers and directors as a
group and (v) the stockholder (the "Selling Stockholder") that has granted the
Underwriters an over-allotment option. A total of 8,733,696 shares of the
Company's Common Stock were issued and outstanding. Except as indicated in the
footnotes to the table, the persons named in the table have sole voting and
investment power with respect to all shares of Common Stock shown as
beneficially owned by them, subject to community property laws where applicable.
Except as otherwise indicated, the address of each of the persons in this table
is as follows: c/o Faroudja, Inc., 750 Palomar Avenue, Sunnyvale, California,
94086.

<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP BENEFICIAL OWNERSHIP
BEFORE OFFERING(1) SHARES AFTER OFFERING(1)
----------------------- TO BE -----------------------
BENEFICIAL OWNER SHARES PERCENT SOLD(2) SHARES PERCENT
- ------------------------------------------------------------- ---------- ----------- ------------ ---------- -----------
<S> <C> <C> <C> <C> <C>
Yves C. Faroudja(3).......................................... 2,069,444 23.6% -- 2,069,444 17.6%
Adelson Investors, LLC(4) ................................... 1,431,579 16.4 -- 1,431,579 12.2
10900 Wilshire Boulevard
Los Angeles, CA 90024
Faroudja Images Investors, LLC(5) ........................... 3,682,656 42.2 450,000 3,232,656 27.5
c/o Spencer Trask Securities, Inc.
535 Madison Avenue
New York, New York 10022
Roger K. Baumberger(5)....................................... 3,682,656 42.2 -- 3,232,656 27.5
Images Partners, L.P.(6) .................................... 1,035,765 11.9 -- 1,035,765 8.8
c/o Spencer Trask Securities, Inc.
535 Madison Avenue
New York, New York 10022
Michael J. Moone(7).......................................... 130,824 1.5 -- 130,824 1.1
Michael C. Hoberg(8)......................................... -- -- --
Donald S. Butler(9).......................................... 54,051 * -- 54,051 *
William J. Turner(10)........................................ -- --
Kevin B. Kimberlin(6)........................................ 1,543,698 17.7 -- 1,543,698 13.1
Matthew D. Miller(11)........................................ -- -- --
William N. Sick, Jr.(12)..................................... -- -- --
Merv L. Adelson(4)(13)....................................... 1,431,579 16.4 -- 1,431,579 12.2
Stuart D. Buchalter(14)...................................... 9,447 * -- 9,447 *
S3 Incorporated(15) ......................................... 526,316 6.0 -- 526,316 4.5
2801 Mission College Boulevard
Santa Clara, California 95052
All directors and executive officers as a group (12
persons)(16)............................................... 5,239,043 58.6% 5,239,043 43.8%
</TABLE>

- ------------------------

* Less than 1%

(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission. In computing the number of shares
beneficially owned by a person and the percentage ownership of that person,
shares of Common Stock subject to options held by that person that are
currently exercisable or exercisable within 60 days of June 30, 1997 are
deemed outstanding.

(2) Shares to be offered only if the Underwriters' over-allotment option is
exercised. See "Underwriting."

(3) Mr. Faroudja holds the 2,050,000 shares jointly with Isabell Faroudja, his
wife. Includes 19,444 shares issuable upon exercise of warrants exercisable
within 60 days of June 30, 1997. Does not include rights to receive warrants

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<PAGE>
to purchase 80,556 shares pursuant to the Yves Faroudja Warrant. See
"Certain Transactions--Yves Faroudja License Agreement."

(4) Mr. Adelson is the Managing Member of Adelson Investors, LLC and exercises
sole voting and investment power over the shares held by that entity. Mr.
Buchalter is an officer of Adelson Investors, LLC and has an interest in the
profits of such firm, but does not exercise voting or investment power over
the shares held by the entity. Does not include rights to receive warrants
to purchase 65,152 shares pursuant to the Adelson Contingent Warrant. See
"Certain Transactions--Consulting Agreements."

(5) Roger K. Baumberger is the manager of Faroudja Images Investors, LLC. Mr.
Baumberger exercises voting and investment power over the shares held by
this entity, but disclaims beneficial ownership. Faroudja Images Investors,
LLC has granted the Underwriters an option to purchase up to 450,000 shares
of Common Stock pursuant to the over-allotment option. If the over-allotment
option is exercised in full, such entities will beneficially own 3,232,656
shares, or approximately 27.5% of the then outstanding Common Stock
following this Offering.

(6) Mr. Kimberlin is a general partner of Images and exercises voting and
investment power over the shares held by this entity. He also has a
beneficial interest in Faroudja Images Investors, LLC.

(7) Includes 130,824 shares issuable upon exercise of stock options exercisable
within 60 days of June 30, 1997. Does not include 398,108 shares subject to
options granted to Mr. Moone, which options will be fully vested on December
31, 2000. The options vest over four years, 1/4 after the first year from
the date of grant and 1/48 every month thereafter.

(8) Does not include 75,000 shares subject to options granted to Mr. Hoberg,
which options will be fully vested on December 31, 2000. The options vest
over four years, 1/4 after the first year from the date of grant and 1/48
every month thereafter.

(9) Includes 54,051 shares issuable upon exercise of stock options exercisable
within 60 days of June 30, 1997. Does not include 141,953 shares subject to
options granted to Mr. Butler, which options will be fully vested on
December 31, 2000. The options vest over four years, 1/4 after the first
year from the date of grant and 1/48 every month thereafter.

(10) Mr. Turner is a limited partner of Images but he does not exercise voting
or investment power over the shares held by this entity. Mr. Turner also has
a beneficial interest in Faroudja Images Investors, LLC.

(11) Mr. Miller is a limited partner of Images, but he does not have voting or
investment power over the shares held by this entity. Does not include
56,515 shares subject to options granted to Mr. Miller. 6,515 of these
options will be fully vested on December 31, 1999, vesting over three years,
1/3 after the first year from the date of grant and 1/36 every month
thereafter. 50,000 of these options will be fully vested on July 22, 1998,
vesting over one year, 1/24 each month during the first year from the date
of grant and an additional 1/2 one year after the date of grant.

(12) Mr. Sick is a limited partner of Images, but he does not exercise voting or
investment power over the shares held by this entity. Does not include
26,060 shares subject to options granted to Mr. Sick, which options will be
fully vested on December 31, 1999. The options vest over three years, 1/3
after the first year from the date of grant and 1/36 every month thereafter.
Mr. Sick is the Chairman and Chief Executive Officer of Business Resources
International which has a beneficial interest in Faroudja Images Investors,
LLC.

(13) Does not include 6,515 shares subject to options granted to Mr. Adelson,
which options will be fully vested on December 31, 1999. The options vest
over three years, 1/3 after the first year from the date of grant and 1/36
every month thereafter.

(14) Does not include 6,515 shares subject to options granted to Mr. Buchalter,
which options will be fully vested on December 31, 1999. The options vest
over three years, 1/3 after the first year from the date of grant and 1/36
every month thereafter.

(15) The Stock Purchase Agreement between S3 and the Company provides that S3
shall receive additional shares if the Offering price is less than $9.50.
Assuming an Offering price of $9.00, S3 will be entitled to 29,240
additional shares of Common Stock.

(16) All directors and executive officers as a group hold options and warrants
to purchase 1,029,642 shares of the Company, which options and warrants have
not vested as of the date hereof.

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<PAGE>
DESCRIPTION OF CAPITAL STOCK

GENERAL

Upon the completion of this Offering, the Company will be authorized to
issue 50,000,000 shares of Common Stock, par value $0.001 per share, and
5,000,000 shares of undesignated Preferred Stock, par value $0.001 per share.

COMMON STOCK

As of June 30, 1997, there were 8,733,696 shares of Common Stock
outstanding. As of June 30, 1997, options and warrants to purchase an aggregate
of 1,757,950 shares of Common Stock were also outstanding. See
"Management--Stock Plans."

Holders of Common Stock are entitled to receive such dividends as may from
time to time be declared by the Board of Directors of the Company out of funds
legally available therefor. Holders of Common Stock are entitled to one vote per
share on all matters on which the holders of Common Stock are entitled to vote
and do not have any cumulative voting rights. Holders of Common Stock have no
preemptive, conversion, redemption or sinking fund rights. In the event of a
liquidation, dissolution or winding-up of the Company, holders of Common Stock
are entitled to share equally and ratably in the assets of the Company, if any,
remaining after the payment of all debts and liabilities of the Company and the
liquidation preference of any outstanding Preferred Stock. The outstanding
shares of Common Stock are, and the shares of Common Stock offered by the
Company hereby when issued will be, fully paid and nonassessable. The rights,
preferences and privileges of holders of Common Stock are subject to any series
of Preferred Stock which the Company may issue in the future.

PREFERRED STOCK

The Company's Certificate of Incorporation permits the Company's Board of
Directors, without further vote or action by the stockholders, to issue shares
of the Preferred Stock in one or more series and to determine the designations,
preferences, voting powers, qualifications and special or relative rights or
privileges of the shares of each such series, including the dividend rights,
dividend rate, conversion rights, voting rights, terms of redemption (including
sinking fund provisions), redemption price or prices, liquidation preferences
and the number of shares constituting any series or the designations of such
series. These rights and privileges could limit the voting power of holders of
Common Stock and restrict their rights to receive dividends or liquidation
proceeds.

The Company has granted the Board of Directors authority to issue Preferred
Stock and to determine its rights and preferences, including the right to
eliminate delays associated with a stockholder vote on specific issuances. The
Company believes that this power to issue Preferred Stock will provide
flexibility in connection with possible corporate transactions. It could also
have the effect, however, of making it more difficult for a third party to
acquire, or of discouraging a third party from attempting to acquire, control of
the Company. The Board of Directors could also utilize shares of Preferred Stock
in order to adopt a stockholders' rights plan which would have the effect of
further discouraging or delaying a takeover of the Company. The Company has no
present plans to issue any shares of Preferred Stock. See "Risk
Factors--Potential Anti-Takeover Effects of Charter Documents and Delaware Law."

WARRANTS

Yves Faroudja was granted a warrant to purchase 100,000 shares of Common
Stock at an exercise price of $7.50 per share. The warrant vests as to 1/36th of
the total shares for each full month after January 20, 1997 provided that Yves
Faroudja is then either (i) employed by the Company (as a full or part-time
employee), or (ii) acting as a member of the Board of Directors of the Company.
The warrant expires on January 20, 2002. Certain registration rights and
anti-dilution provisions are provided to Yves Faroudja as contained therein.

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<PAGE>
Adelson was granted a warrant to purchase 65,152 shares of Common Stock at
an exercise price of $0.15 per share. This Adelson Contingent Warrant expires on
December 31, 1999 and is fully exercisable prior to February 9, 1999, if the
Company receives consideration (as defined in the Adelson Consulting Agreement)
of at least $5 million from a strategic alliance or combination of strategic
alliances during the term of the Adelson Consulting Agreement. See "Certain
Transactions--Consulting Agreements." Certain registration rights are provided
to Adelson as contained therein.

REGISTRATION RIGHTS

Under the terms of the registration rights agreements entered into by each
of Adelson Investors, LLC, Images, Roger K. Baumberger as Liquidating Trustee of
Faroudja Images, Inc. and Faroudja Images Investors LLC (collectively the
"Holders" and individually referred to as a "Holder") and the Company, if the
Company registers its securities under the Securities Act prior to March 8, 1999
("Initial Registration"), the Company shall prepare and file, not later than 180
days after the closing date of such Initial Registration, a registration
statement under the Securities Act to permit resales of up to 4,612,500 shares
of Common Stock owned by the Holders; provided, however, that a Holder may elect
to exclude such Holder's shares of Common Stock from such registration. In
addition, if the Company does not register its securities prior to March 8,
1999, a majority of the Holders can demand that the Company file a registration
statement under the Securities Act to permit resales of up to 4,612,500 shares
of Common Stock owned by the Holders. However, the Holders may require the
Company on not more than one occasion to file a registration statement under the
Securities Act with respect to their shares.

Under the terms of the registration and stockholders' rights agreements
entered into by and among Yves Faroudja and Isabell Faroudja, Adelson Investors,
LLC, Images, Faroudja Images Investors LLC and the Company, if the Company
registers its securities under the Securities Act during the five-year period
commencing six months after the Initial Registration and any of the stockholders
of the Company are permitted to sell stock in such registered public offering,
Yves Faroudja and Isabell Faroudja, or any successor who purchases such shares
(including purchasers of the Faroudja Option), shall have the right to include
in such registration up to 3,587,500 shares of Common Stock that they own,
subject to certain limitations. Additionally, if any officers or directors are
permitted to sell any shares of Common Stock in the Initial Registration, Yves
Faroudja and Isabell Faroudja, or any successor who purchases such shares
(including purchasers of the Faroudja Option), will have the right to sell up to
3,587,500 shares of Common Stock that they own on the same basis.

Under the terms of the investor's rights agreements entered into by and
between S3 and the Company, if S3 owns at least 100,000 shares of Common Stock,
at any time after 12 months after the effective date of the Initial
Registration, S3 shall have the right to require the Company to file, not more
than twice, a registration statement under the Securities Act to permit resales
of up to 526,316 shares of Common Stock that it owns, subject to certain
limitations, and S3 shall have the right to require the Company to file a
registration statement not more than once on Form S-3 under the Securities Act
to permit resales of up to 526,316 shares of Common Stock that it owns, subject
to certain limitations. Further, if at any time after 12 months after the
Initial Registration the Company registers any of its Common Stock under the
Securities Act, S3 shall have the right to sell all of its 526,316 shares of
Common Stock pursuant to such registration, subject to certain limitations.
Also, under this agreement, there are indemnification provisions pursuant to
which the Company has agreed to indemnify S3 and the Company's underwriters.

DELAWARE LAW AND CERTAIN CHARTER AND BY-LAW PROVISIONS

Upon the consummation of the Offering made hereby, the Company will be
subject to the provisions of Section 203 of the Delaware General Corporation
Law. In general, Section 203 prohibits certain publicly-held Delaware
corporations from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the date of the transaction in
which the person or entity became an interested stockholder, unless, among other
exceptions, (i) prior to the date the interested stockholder attained such
status the Board of Directors approved either the business combination or the
transaction which resulted in the stockholder

61
<PAGE>
becoming an interested stockholder, (ii) the holder of two-thirds of the
outstanding voting stock not owned by the interested stockholder approved the
business combination, or (iii) the interested stockholder acquired 85% or more
of the outstanding voting stock of the corporation in the same transaction that
makes it an interested stockholder (excluding shares owned by persons who are
both officers and directors of the corporation, and shares held by certain
employee stock ownership plans). For purposes of Section 203, a "business
combination" is defined broadly to include mergers, asset sales and other
transactions resulting in a financial benefit to the interested stockholder.
Subject to certain exceptions, an "interested stockholder" is a person or entity
who, together with affiliates and associates, owns, or within the three
immediately preceding years of a business combination did own, 15% or more of
the corporation's outstanding voting stock.

The Company's Certificate of Incorporation limits the liability of directors
to the maximum extent permitted by the Delaware General Corporations Law.
Delaware law provides that the directors of a corporation will not be personally
liable to such corporation or its stockholders for monetary damages for breach
of fiduciary duties as directors, except for liability (i) for any breach of
their duty of loyalty to the corporation or its stockholders; (ii) for acts or
omissions not in good faith or which involve intentional misconduct or a knowing
violation of law; (iii) for unlawful payments of dividends or unlawful stock
repurchases or redemptions as provided in Section 174 of the Delaware General
Corporation Law; or (iv) for any transaction from which the director derives an
improper personal benefit. The Company's Certificate of Incorporation and
By-Laws provide that the Company shall indemnify its directors and officers to
the fullest extent permitted by Delaware law and permit the Company to advance
expenses to such directors and officers to defend any action for which rights of
indemnification are provided in the By-Laws. The Company believes that these
provisions will assist the Company in attracting and retaining qualified
individuals to serve as directors and officers.

The Company's Board of Directors is classified into three classes, with the
initial terms of each class expiring at the 1997, 1998 and 1999 annual
stockholders' meetings, respectively. After the expiration of each initial term,
the directors in each class will be elected for three year terms. See
"Management." The Board of Directors is authorized to create new directorships
and to fill such positions so created. After the classification of the Board of
Directors, the Board of Directors will be permitted to specify to which class
such new position is assigned and the person filling such position will serve
for the term applicable to that class. The Board of Directors (or its remaining
members (even though less than a quorum)) is also empowered to fill vacancies on
the Board of Directors occurring for any reason for the remainder of the term of
the class of directors in which the vacancy occurred. The Company's Certificate
of Incorporation provides that directors may be removed with cause by the vote
of the holders of at least 66.66% of the voting power of the outstanding stock
of the Company. The likely effect of these provisions is that they will increase
the time required for the stockholders to change the composition of the Board of
Directors. For example, in general, at least two annual meetings of the
stockholders will be necessary for stockholders to effect a change in a majority
of the members of the Board of Directors.

The Company's By-Laws provide that for nominations for the Board of
Directors or for other business to be properly brought by a stockholder before a
meeting of stockholders, the stockholder must first have given timely notice
thereof in writing to the Secretary of the Company. To be timely, a
stockholder's notice generally must be delivered not less than 60 days nor more
than 90 days prior to the annual meeting. If the meeting is not an annual
meeting, the notice must generally be delivered not more than ninety days prior
to the special meeting and not later than the later of 60 days prior to the
special meeting or ten days following the day on which public announcement of
the meeting is first made by the Company. The notice must contain, among other
things, certain information about the stockholder delivering the notice and, as
applicable, background about the nominee or a description of the proposed
business to be brought before the meeting.

The Company's Certificate of Incorporation and By-Laws provide that any
action required or permitted to be taken by the stockholders of the Company
shall be taken only at a duly called annual or special meeting of the
stockholders and may not be taken by written consent. Special meetings may only
be called by the Board of Directors, the Chairman of the Board of Directors or
the President of the Company. These provisions could have the effect of
delaying, until the next annual stockholders' meeting, stockholder actions which
are favored by the holders of a majority of the outstanding voting securities of
the Company. These provisions may also discourage

62
<PAGE>
another person or entity from making a tender offer for the Company's Common
Stock, because such person or entity, even if it acquired a majority of the
outstanding voting securities of the Company, would be able to take action as a
stockholder (such as electing new directors or approving a merger) only at a
duly called stockholders' meeting, and not by written consent.

The affirmative vote of the holders of at least 66.66% of the outstanding
voting stock of the Company is required to amend or repeal any of the foregoing
provisions in the Company's Restated Certificate of Incorporation, and to reduce
the number of authorized shares of Common Stock and Preferred Stock. Such 66.66%
vote is also required to amend or repeal the Company's By-Laws. The By-Laws may
also be amended or repealed by a majority vote of the Board of Directors. Such
66.66% stockholder vote would be in addition to any separate class vote that
might in the future be required pursuant to the terms of any Preferred Stock
that might be outstanding at the time any such amendments are submitted to the
stockholders.

OTHER ATTRIBUTES OF THE STOCK OF THE COMPANY

The Company is a corporation organized under the laws of Delaware and
generally the laws of the state of incorporation govern the corporate operations
of a corporation and the right of its stockholders. Certain provisions of the
California Corporations Code become applicable to a corporation incorporated
outside of California, however, if (i) the corporation transacts intrastate
business in California and the average of its California property, payroll and
sales factors (as defined in the California Revenue and Taxation Code) with
respect to it is more than 50% during its latest fiscal year, (ii) more than
one-half of its outstanding voting securities are held of record by persons
having addresses in California and (iii) the corporation is not otherwise
exempt. An exemption is provided if the corporation has outstanding securities
(x) listed on the New York Stock Exchange or the American Stock Exchange or (y)
qualified for trading as a national market security on the National Association
of Securities Dealers Automated Quotation System if such corporation has at
least 800 holders of its equity securities as of the record date of its most
recent annual meeting of stockholders (a "Listed Corporation").

Since approximately 50% of the Company's activities occur in California,
certain provisions of California corporate law may apply to the Company, as
described above.

Except as discussed herein, provisions of California law which could be
applicable to the Company if the Company meets these tests and is not exempt
include, without limitation, those provisions relating to the stockholders'
right to remove a director without cause (under California law, no director may
be removed without cause when the votes cast against removal would be sufficient
to elect the director if voted cumulatively), provide for a classified Board of
Directors (only a Listed Corporation may have a classified Board of Directors
under California law), call special meetings (under California law, the holders
of shares entitled to cast not less than 10 percent of the votes at the meeting
may call such a meeting; however, under Delaware law, stockholders may not call
a special meeting unless provided for in the certificate of incorporation or the
bylaws), cumulative votes in elections of directors (cumulative voting is
mandatory under California law), and the Company's ability to indemnify its
officers, directors and employees (which is more limited in California than in
Delaware). Notwithstanding the foregoing, a corporation may provide for a
classified Board of Directors, eliminate cumulative voting or both, if it is a
Listed Corporation.

LISTING

The Company has made an application for listing the Company's Common Stock
on The Nasdaq National Market, subject to completion of the Offering, under the
symbol FDJA.

TRANSFER AGENT AND REGISTRAR

The transfer agent and registrar for the Company's Common Stock is U.S.
Stock Transfer Corporation.

63
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE

Upon completion of this Offering, the Company will have 11,751,895 shares of
Common Stock outstanding assuming no exercise of stock options. Of this amount,
the 3,000,000 shares offered hereby will be freely tradeable without restriction
or further registration under the Securities Act, unless such shares are
purchased by "affiliates" of the Company as that term is defined in Rule 144
under the Securities Act. No additional shares will be available for sale in the
public market on the date of this Prospectus and approximately 8,207,380
additional shares will be available for sale in the public market following the
expiration of 180-day lockup agreements with the Representatives of the
Underwriters or the Company, subject in some cases to compliance with the volume
and other limitations of Rule 144.

In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated) who has beneficially owned shares for at least one
year is entitled to sell within any three-month period commencing 90 days after
the date of this Prospectus a number of shares that does not exceed the greater
of (i) 1% of the then outstanding shares of Common Stock or (ii) the average
weekly trading volume during the four calendar weeks preceding such sale,
subject to the filing of a Form 144 with respect to such sale. Sales under Rule
144 are also subject to certain manner of sale provisions and notice
requirements and to the availability of current public information about the
Company. A person (or persons whose shares are aggregated) who is not deemed to
have been an "affiliate" of the Company at any time during the 90 days
immediately preceding the sale and who has beneficially owned his or her shares
for at least two years is entitled to sell such shares pursuant to Rule 144(k)
without regard to the limitations described above. Therefore, unless otherwise
restricted, "144(k)" shares may be sold immediately upon completion of this
Offering. Persons deemed to be "affiliates" must always sell pursuant to Rule
144, even after the applicable holding periods have been satisfied. The Company
is unable to estimate the number of shares that will be sold under Rule 144,
since this will depend on the market price for the Common Stock of the Company,
the personal circumstances of the sellers and other factors.

The Company, certain stockholders of the Company, and all executive officers
and directors of the Company have agreed that they will not directly or
indirectly, offer, sell, contract to sell, grant any option to purchase or
otherwise dispose of any shares of Common Stock or any securities convertible
into or exercisable or exchangeable for such Common Stock or, in any manner,
transfer all or a portion of the economic consequences associated with the
ownership of the Common Stock, without the prior written consent of BancAmerica
Robertson Stephens, for a period of 180 days from the date of this Prospectus
(the "Lockup Period"), except that the Company may, without such consent, grant
options and sell shares pursuant to the 1995 Option Plan, the 1997 Option Plan,
the Directors Plan and the Purchase Plan. BancAmerica Robertson Stephens may, in
its sole discretion and at any time without notice, release all or any portion
of the securities subject to lock-up agreements. BancAmerica Robertson Stephens
currently has no plans to release any of the securities subject to lock-up
agreements.

Any employee or consultant to the Company who purchased his or her shares
pursuant to a written compensatory plan or contract is entitled to rely on the
resale provisions of Rule 701, which permit nonaffiliates to sell their Rule 701
shares without having to comply with the public information, holding period,
volume limitation or notice provisions of Rule 144 and permit "affiliates" to
sell their Rule 701 shares without having to comply with the Rule 144 holding
period restrictions, in each case, subject to the contractual lock-up
restrictions described above, commencing 90 days after the date of this
Prospectus.

As of June 30, 1997, options to purchase a total of 1,217,019 shares of
Common Stock pursuant to the 1995 Option Plan were outstanding. As of June 30,
1997, options to purchase a total of 45,605 shares of Common Stock pursuant to
the Directors Plan were outstanding. As of June 30, 1997, options to purchase a
total of 315,725 shares of Common Stock pursuant to the 1997 Option Plan were
outstanding. An additional 409,275, 54,395 and 400,000 shares of Common Stock
are available for future option grants under the 1997 Option Plan, the Directors
Plan, and the Purchase Plan, respectively. No more options will be granted under
the 1995 Option Plan, even though 601 shares of Common Stock remain reserved
under the 1995 Option Plan. See "Management--Stock Plans."

64
<PAGE>
The Company intends to file a registration statement on Form S-8 under the
Securities Act to register shares of Common Stock reserved for issuance under
the 1995 Stock Plan, the 1997 Stock Plan, the Directors Plan and the Purchase
Plan within 90 days after the date of this Offering, thus permitting the resale
of shares issued pursuant to such plans by nonaffiliates in the public market
without restriction under the Securities Act.

Prior to this Offering, there has been no market for the Common Stock of the
Company. Therefore, future sales of substantial amounts of Common Stock in the
public market could materially adversely affect market prices prevailing from
time to time. Furthermore, since only a limited number of shares will be
available for sale shortly after this Offering because of certain contractual
and legal restrictions on resale (as described above), sales of a substantial
amount of Common Stock in the public market after the restrictions lapse could
materially adversely affect the prevailing market price and the ability of the
Company to raise equity capital in the future.

65
<PAGE>
UNDERWRITING

The Underwriters named below, acting through their representatives,
BancAmerica Robertson Stephens and Volpe Brown Whelan and Company, LLC (the
"Representatives"), have severally agreed, subject to the terms and conditions
of the Underwriting Agreement, to purchase from the Company the number of shares
of Common Stock set forth opposite their names below. The Underwriters are
committed to purchase and pay for all such shares if any are purchased.

<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
- ---------------------------------------------------------------------------------- ----------
<S> <C>
BancAmerica Robertson Stephens....................................................
Volpe Brown Whelan & Company, LLC.................................................

----------
Total........................................................................... 3,000,000
----------
----------
</TABLE>

The Company has been advised by the Representatives that the Underwriters
propose to offer the shares of Common Stock to the public at the initial public
offering price set forth on the cover page of this Prospectus and to certain
dealers at such price less a concession not in excess of $ per share of which
$ may be reallowed to other dealers. After the initial public offering, the
public offering price, concession and reallowance to dealers may be reduced by
the Representatives. No such reduction shall change the amount of proceeds to be
received by the Company as set forth on the cover page of this Prospectus.

The Selling Stockholder has granted to the Underwriters an option,
exercisable during the 30-day period after the date of this Prospectus, to
purchase up to 450,000 additional shares of Common Stock at the same price per
share as the Company will receive for the 3,000,000 shares that the Underwriters
have agreed to purchase. To the extent that the Underwriters exercise such
option, each of the Underwriters will have a firm commitment to purchase
approximately the same percentage of such additional shares that the number of
shares of Common Stock to be purchased by it shown in the above table represents
as a percentage of the 3,000,000 shares offered hereby. If purchased, such
additional shares will be sold by the Underwriters on the same terms as those on
which the 3,000,000 shares are being sold.

The Underwriting Agreement contains certain covenants of indemnity among the
Underwriters, the Company and the Selling Stockholder against certain
liabilities, including liabilities under the Securities Act.

Each executive officer and director of the Company and the holders of
approximately 8,748,145 shares of Common Stock of the Company have agreed with
the Underwriters for a period of 180 days from the date of this Prospectus,
subject to certain limited exceptions, not to offer to sell, contract to sell,
or otherwise sell, dispose of, loan, pledge or grant any rights with respect to
any shares of Common Stock, any options or warrants to purchase any shares of
Common Stock, or any securities convertible into or exchangeable for shares of
Common Stock now owned or hereafter acquired directly by such holders or with
respect to which they have or hereafter acquire the power of disposition,
without the prior written consent of BancAmerica Robertson Stephens which may,
in its sole discretion for any reason and at any time or from time to time,
without notice, release all or any portion of the securities subject to lock-up
agreements ("Lock-Up Agreements"). If the Lock-Up Agreements are waived, the
Company would issue a press release announcing any such waiver. In addition, the
Company has agreed that during the lock-up period, the Company will not, without
the prior written consent of BancAmerica Robertson Stephens, subject to certain
exceptions, issue, sell, contract to sell or otherwise dispose of any shares of
Common Stock, any options or warrants to purchase any shares of Common Stock or
any securities convertible into, exercisable for or exchangeable for shares of
Common Stock other than the issuance of Common Stock upon the exercise of
outstanding options and under the existing employee stock purchase plan and the
Company's issuance of options under existing employee stock option plans.

66
<PAGE>
Prior to this Offering, there has been no public market for the Common Stock
of the Company. Consequently, the initial public offering price for the Common
Stock offered hereby was determined by negotiations among the Company and the
Representatives. Among the factors considered in such negotiations were
prevailing market conditions, certain financial information of the Company,
market valuations of other companies that the Company and the Representatives
believe to be comparable to the Company, estimates of the business potential of
the Company, the present state of the Company's development and other factors
deemed relevant.

Until the distribution of the Common Stock is completed, the rules of the
Securities and Exchange Commission may limit the ability of the Underwriters and
certain selling group members to bid for and purchase the Common Stock. As an
exception to these rules, the Representatives are permitted to engage in certain
transactions that stabilize the price of the Common Stock. Such transactions
consist of bids or purchases for the purpose of pegging, fixing or maintaining
the price of the Common Stock.

If the Underwriters create a short position in the Common Stock in
connection with the Offering (i.e., if they sell more Common Stock than are set
forth on the cover page of this Prospectus) the Representatives may reduce that
short position by purchasing Common Stock in the open market. The
Representatives may also elect to reduce any short position by exercising all or
part of the over-allotment option described above.

The Representatives may also impose a penalty bid on certain Underwriters
and selling group members. This means that if the Representatives purchase
Common Stock in the open market to reduce the Underwriters' short position or to
stabilize the price of the Common Stock, they may reclaim the amount of the
selling concession from the Underwriters and selling group members who sold
those shares as part of the Offering.

In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of such purchases. The imposition of a penalty bid
might also have an effect on the price of a security to the extent that it
discourages resales of the security.

Neither the Company nor any of the Underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above might have on the price of the Common Stock. In addition,
neither the Company nor any of the Underwriters makes any representation that
the Representative will engage in such transactions or that such transactions,
once commenced, will not be discontinued without notice.

The Representatives have informed the Company that neither they, nor any
other member of the National Association of Securities Dealers, Inc.
participating in the distribution of this Offering, will make sales of the
Common Stock offered hereby to accounts over which they exercise discretionary
authority without the prior specific written approval of the customer.

LEGAL MATTERS

The validity of the Common Stock offered hereby will be passed upon for the
Company by Buchalter, Nemer, Fields & Younger, a Professional Corporation, Los
Angeles, California. Certain legal matters relating to this Offering will be
passed upon for the Underwriters by Wilson Sonsini Goodrich & Rosati,
Professional Corporation, Palo Alto, California. Stuart D. Buchalter, of counsel
to Buchalter, Nemer, Fields & Younger, is one of the Company's directors and
beneficially owns 10,197 shares of Common Stock and options to purchase 6,515
shares of Common Stock granted pursuant to the Directors Plan.

EXPERTS

The consolidated financial statements of the Company as of December 31, 1995
and 1996 and June 30, 1997, and for the years ended December 31, 1994, 1995 and
1996 and the six-month period ended June 30, 1997, appearing in this Prospectus
and Registration Statement have been audited by Ernst & Young LLP, independent
auditors, as set forth in their report thereon appearing elsewhere herein, and
are included in reliance upon such report given upon the authority of such firm
as experts in accounting and auditing.

67
<PAGE>
AVAILABLE INFORMATION

The Company has filed with the Securities and Exchange Commission (the
"Commission") in Washington, D.C. a Registration Statement on Form S-1 (the
"Registration Statement") under the Securities Act with respect to the shares
offered hereby. As used herein, the term "Registration Statement" means the
initial Registration Statement and any and all amendments thereto. This
Prospectus does not contain all of the information set forth in the Registration
Statement and the exhibits and schedules thereto. For further information with
respect to the Company and the Shares, reference is hereby made to such
Registration Statement and the exhibits and schedules thereto. Statements
contained in this Prospectus as to the contents of any contract or other
document are not necessarily complete and in each instance, reference is made to
the copy of such contract or documents filed as an exhibit to the Registration
Statement, each such statement being qualified in all respects by such
reference. The Registration Statement, including the exhibits and schedules
thereto, may be inspected and copied at the public reference facilities
maintained by the Commission at 450 Fifth Street, N.W., Room 1024, Washington,
D.C. 20549 and at certain regional offices of the Commission located at 75 Park
Place, 14th Floor, New York, New York 1007 and Northwest Atrium Center, 500
Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of such materials
can be obtained from the Public Reference Section of the Commission at 450 Fifth
Street, N.W., Room 1025, Washington, D.C. 20549, at prescribed rates. The
Commission maintains a World Wide Web site at http://www.sec.gov that contains
reports, proxy and information statements and other information regarding
registrants that filed electronically with the Commission. Information
concerning the Company is also available for inspection at the offices of the
Nasdaq National Market, Reports Section, 1735 "K" Street, N.W., Washington, D.C.
20006.

Upon completion of the this Offering, the Company will be subject to the
informational requirements of the Securities Exchange Act of 1934 and, in
accordance therewith, will file reports with the Commission. The Company intends
to furnish to its stockholders annual reports containing audited financial
statements of the Company audited by its independent accountants and quarterly
reports containing unaudited condensed financial statements for each of the
first three quarters of the fiscal year.

68
<PAGE>
FAROUDJA, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<S> <C>
Report of Ernst & Young LLP, Independent Auditors..................................... F-2
Consolidated Balance Sheets........................................................... F-3
Consolidated Statements of Income..................................................... F-4
Consolidated Statement of Stockholders' Equity........................................ F-5
Consolidated Statements of Cash Flows................................................. F-6
Notes to Consolidated Financial Statements............................................ F-7
</TABLE>

F-1
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders

Faroudja, Inc.

We have audited the accompanying consolidated balance sheets of Faroudja,
Inc. as of December 31, 1995 and 1996 and June 30, 1997, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended December 31, 1996 and for the six-month
period ended June 30, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Faroudja, Inc.
at December 31, 1995 and 1996 and June 30, 1997, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1996 and for the six-month period ended June 30, 1997, in
conformity with generally accepted accounting principles.

ERNST & YOUNG LLP

San Jose, California
July 18, 1997, except for Note 12
as to which the date is July 22, 1997

F-2
<PAGE>
FAROUDJA, INC.

CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------- JUNE 30,
1995 1996 1997
------------ ------------ -------------
<S> <C> <C> <C>
ASSETS

Current assets:
Cash and cash equivalents............................................ $ 1,522,756 $ 1,215,591 $ 7,520,481
Short-term investments............................................... 1,235,960 1,867,896 272,227
Trade accounts receivable, less allowance for doubtful accounts of
$10,000 in 1995, $110,000 in 1996, and $181,000 in 1997............ 1,573,866 2,767,331 2,644,616
Inventories.......................................................... 1,587,070 1,683,550 2,093,922
Deferred tax assets.................................................. -- 461,519 600,048
Other current assets................................................. 43,252 224,426 355,160
------------ ------------ -------------
Total current assets................................................... 5,962,904 8,220,313 13,486,454

Property and equipment, net............................................ 771,053 1,383,807 1,503,404
Other assets........................................................... -- -- 235,137
------------ ------------ -------------
$ 6,733,957 $ 9,604,120 $ 15,224,995
------------ ------------ -------------
------------ ------------ -------------

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Accounts payable..................................................... $ 601,206 $ 729,320 $ 695,068
Accrued compensation and benefits.................................... 485,936 671,863 765,217
Income taxes payable................................................. 48,593 116,602 368,187
Other accrued liabilities............................................ 83,069 341,444 473,433
Deferred revenue..................................................... -- 500,000 --
------------ ------------ -------------
Total current liabilities.............................................. 1,218,804 2,359,229 2,301,905

Commitments

Stockholders' equity:
Preferred Stock--$0.001 par value; 2,000,000 shares authorized, none
issued and outstanding............................................. -- -- --
Common Stock--$0.001 par value; 18,000,000 shares authorized;
7,156,895, 8,200,000, and 8,733,696 shares issued and outstanding
in 1995, 1996, and 1997, respectively.............................. 3,611,023 8,200 8,734
Additional paid-in capital........................................... -- 7,824,823 13,306,417
Unrealized gains on available-for-sale securities, net of tax
effect............................................................. 34,885 66,737 --
Deferred compensation................................................ -- -- (271,500)
Retained earnings (deficit).......................................... 1,869,245 (654,869) (120,561)
------------ ------------ -------------
Total stockholders' equity............................................. 5,515,153 7,244,891 12,923,090
------------ ------------ -------------
$ 6,733,957 $ 9,604,120 $ 15,224,995
------------ ------------ -------------
------------ ------------ -------------
</TABLE>

See accompanying notes.

F-3
<PAGE>
FAROUDJA, INC.

CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
------------------------------------------ --------------------------
1994 1995 1996 1996 1997
------------ ------------- ------------- ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues:
Product sales.......................... $ 8,064,603 $ 11,953,658 $ 12,626,183 $ 5,589,570 $ 6,863,531
License and royalty revenues........... -- -- 500,000 -- 1,000,000
------------ ------------- ------------- ------------ ------------
Total revenues........................... 8,064,603 11,953,658 13,126,183 5,589,570 7,863,531
Cost of product sales.................... 2,998,262 4,214,753 4,797,516 2,066,843 2,285,785
------------ ------------- ------------- ------------ ------------
Gross profit............................. 5,066,341 7,738,905 8,328,667 3,522,727 5,577,746

Operating expenses:
Research and development............... 1,277,053 1,483,388 2,463,838 990,183 1,839,878
Sales and marketing.................... 777,643 1,070,045 2,126,686 880,150 1,793,062
General and administrative............. 1,152,968 1,178,990 1,623,453 664,149 866,565
Financing expense...................... -- -- -- -- 311,572
------------ ------------- ------------- ------------ ------------
Total operating expenses................. 3,207,664 3,732,423 6,213,977 2,534,482 4,811,077
------------ ------------- ------------- ------------ ------------

Operating income......................... 1,858,677 4,006,482 2,114,690 988,245 766,669

Other income:
Interest income........................ 69,118 81,746 83,179 38,522 48,299
Other, net............................. 14,391 4,986 -- -- 46,812
------------ ------------- ------------- ------------ ------------
Income before provision for income
taxes.................................. 1,942,186 4,093,214 2,197,869 1,026,767 861,780
Provision for income taxes............... 13,450 83,981 687,054 218,593 327,472
------------ ------------- ------------- ------------ ------------
Net income............................... $ 1,928,736 $ 4,009,233 $ 1,510,815 $ 808,174 $ 534,308
------------ ------------- ------------- ------------ ------------
------------ ------------- ------------- ------------ ------------
Pro forma data (unaudited):
Historical income before provision for
income taxes......................... $ 1,942,186 $ 4,093,214 $ 2,197,869 $ 1,026,767
Pro forma provision for income taxes... 714,155 1,023,188 879,148 410,800
------------ ------------- ------------- ------------
Pro forma net income..................... $ 1,228,031 $ 3,070,026 $ 1,318,721 $ 615,967
------------ ------------- ------------- ------------
------------ ------------- ------------- ------------

Income per share data:
Net income per share................... $ 0.05
------------
------------
Pro forma net income per share
(unaudited).......................... $ 0.15 $ 0.38 $ 0.15 $ 0.07
------------ ------------- ------------- ------------
------------ ------------- ------------- ------------
Shares used in per share
computations......................... 7,978,926 7,998,146 9,011,961 8,783,921 9,729,653
------------ ------------- ------------- ------------ ------------
------------ ------------- ------------- ------------ ------------
</TABLE>

See accompanying notes.

F-4
<PAGE>
FAROUDJA, INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
UNREALIZED
GAINS ON
COMMON STOCK ADDITIONAL AVAILABLE- RETAINED TOTAL
---------------------- PAID-IN FOR-SALE DEFERRED EARNINGS STOCKHOLDERS'
SHARES AMOUNTS CAPITAL SECURITIES COMPENSATION (DEFICIT) EQUITY
--------- ----------- ----------- ------------- ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1993........................ 7,156,895 $ 3,611,023 $ -- $ -- $ -- $(1,228,778) $ 2,382,245
Net income.................... -- -- -- -- -- 1,928,736 1,928,736
Distribution to
stockholders................ -- -- -- -- -- (1,484,946) (1,484,946)
--------- ----------- ----------- ------------- ------------ ----------- -------------
Balance at December 31,
1994........................ 7,156,895 3,611,023 -- -- -- (784,988) 2,826,035
Net income.................... -- -- -- -- -- 4,009,233 4,009,233
Unrealized gain on
available-for-sale
securities.................. -- -- -- 34,885 -- -- 34,885
Distribution to
stockholders................ -- -- -- -- -- (1,355,000) (1,355,000)
--------- ----------- ----------- ------------- ------------ ----------- -------------
Balance at December 31,
1995........................ 7,156,895 3,611,023 -- 34,885 -- 1,869,245 5,515,153
Sale of Common Stock.......... 1,043,105 4,000,000 -- -- -- -- 4,000,000
Issuance of warrants to
purchase Common Stock for
future services............. -- -- 222,000 -- -- -- 222,000
Reincorporation in Delaware... -- (7,602,823) 7,602,823 -- -- -- --
Net income.................... -- -- -- -- -- 1,510,815 1,510,815
Change in unrealized gain on
available-for-sale
securities, net of tax...... -- -- -- 31,852 -- -- 31,852
Distributions to
stockholders................ -- -- -- -- -- (4,034,929) (4,034,929)
--------- ----------- ----------- ------------- ------------ ----------- -------------
Balance at December 31,
1996........................ 8,200,000 8,200 7,824,823 66,737 -- (654,869) 7,244,891
Sale of Common Stock, net of
issue costs................. 533,696 534 4,960,094 -- -- -- 4,960,628
Issuance of warrants to
purchase Common Stock for
technology acquired......... -- -- 250,000 -- -- -- 250,000
Deferred compensation on
employee stock option
grants...................... -- -- 271,500 -- (271,500) -- --
Net income.................... -- -- -- -- -- 534,308 534,308
Change in unrealized gain on
available for sale
securities, net of tax...... -- -- -- (66,737) -- -- (66,737)
--------- ----------- ----------- ------------- ------------ ----------- -------------
Balance at June 30, 1997...... 8,733,696 $ 8,734 $13,306,417 $ -- $(271,500) $ (120,561) $12,923,090
--------- ----------- ----------- ------------- ------------ ----------- -------------
--------- ----------- ----------- ------------- ------------ ----------- -------------
</TABLE>

See accompanying notes.

F-5
<PAGE>
FAROUDJA, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE
YEAR ENDED DECEMBER 31, 30,
---------------------------------- ---------------------
1994 1995 1996 1996 1997
---------- ---------- ---------- ---------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income................................ $1,928,736 $4,009,233 $1,510,815 $ 808,174 $ 534,308
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization........... 172,412 223,988 422,376 152,455 224,263
Loss on disposal of equipment........... -- -- -- -- 17,204
Gain on sales of short-term
investments........................... -- -- -- -- (83,456)
Changes in operating assets and
liabilities:
Trade accounts receivable............... (358,639) (642,490) (1,193,465) 558,910 122,715
Inventories............................. 50,111 (793,149) (96,480) (412,422) (410,372)
Deferred tax assets..................... -- -- (461,519) (148,993) (138,529)
Other current assets.................... (8,173) (1,513) (27,174) (74,552) (130,734)
Accounts payable........................ (118,969) 417,306 128,114 355,928 (34,252)
Accrued compensation and benefits....... 165,192 118,135 185,927 (32,895) 93,354
Income taxes payable.................... (5,012) 46,574 68,009 197,795 251,585
Other accrued liabilities............... (99,825) 29,058 258,375 (61,088) 131,989
Deferred revenue........................ -- -- 500,000 -- (500,000)
---------- ---------- ---------- ---------- ---------
Net cash provided by operating
activities.............................. 1,725,833 3,407,142 1,294,978 1,343,312 78,075
---------- ---------- ---------- ---------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of equipment.................... (211,920) (391,907) (967,130) (347,148) (346,687)
Proceeds from sale of equipment........... -- -- -- -- 486
Purchases of short-term investments....... (200,000) (1,751,075) (1,061,000) (356,300) --
Sales of short-term investments........... -- -- -- -- 1,612,388
Maturities of short-term investments...... -- 750,000 460,916 -- --
---------- ---------- ---------- ---------- ---------
Net cash provided by (used in) investing
activities.............................. (411,920) (1,392,982) (1,567,214) (703,448) 1,266,187
---------- ---------- ---------- ---------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of Common Stock.................. -- -- 4,000,000 4,000,000 4,960,628
Repayment of loan payable................. (420,000) -- -- -- --
Distribution to stockholders.............. (1,484,946) (1,355,000) (4,034,929) (4,000,000) --
---------- ---------- ---------- ---------- ---------
Net cash provided by (used in) financing
activities.............................. (1,904,946) (1,355,000) (34,929) -- 4,960,628
---------- ---------- ---------- ---------- ---------
Increase (decrease) in cash and cash
equivalents............................. (591,033) 659,160 (307,165) 639,864 6,304,890
Cash and cash equivalents at beginning of
period.................................. 1,454,629 863,596 1,522,756 1,522,756 1,215,591
---------- ---------- ---------- ---------- ---------
Cash and cash equivalents at end of
period.................................. $ 863,596 $1,522,756 $1,215,591 $2,162,620 $7,520,481
---------- ---------- ---------- ---------- ---------
---------- ---------- ---------- ---------- ---------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION
Cash paid during the period for income
taxes................................... $ 17,531 $ 32,157 $1,116,656 $ 200,000 $ 226,600
---------- ---------- ---------- ---------- ---------
---------- ---------- ---------- ---------- ---------
SUPPLEMENTAL DISCLOSURES OF NONCASH
FINANCING ACTIVITIES
Issuance of warrants to acquire Common
Stock for future services............... $ -- $ -- $ 222,000 $ 222,000 $ --
---------- ---------- ---------- ---------- ---------
---------- ---------- ---------- ---------- ---------
Issuance of warrants to acquire Common
Stock for technology acquired........... $ -- $ -- $ -- $ -- $ 250,000
---------- ---------- ---------- ---------- ---------
---------- ---------- ---------- ---------- ---------
</TABLE>

See accompanying notes.

F-6
<PAGE>
FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SIGNIFICANT ACCOUNTING POLICIES

BUSINESS AND BASIS OF PRESENTATION

Faroudja, Inc. (the "Company") designs, develops and sells a range of video
image enhancement products and technology for the home television, professional
broadcast and personal computer markets. Although traditional business has been
directed to sales of complete subsystem units, the Company has recently expanded
its activities to include the design and development of board and chip level
products for applications in the television as well as the personal computer
markets.

The accompanying financial statements reflect the operations of Faroudja
Laboratories, Inc. ("FLI") and Faroudja Research Enterprises, Inc. ("FRE"), both
of which were California corporations. FLI and FRE, which were owned by common
stockholders, were merged in December 1996, with FLI surviving the merger.
Subsequently, in order to effect a reverse stock split and a reincorporation in
Delaware, FLI merged with a wholly owned subsidiary of a newly formed Delaware
corporation, Faroudja, Inc. In this transaction, the FLI stockholders received
0.69185 shares of the Company's Common Stock for each share of FLI Common Stock
held by them. All outstanding stock options and warrants to purchase FLI Common
Stock were assumed by the Company at the same exchange ratio. The effect of this
exchange on Common Stock, stock options and warrants has been reflected in the
accompanying financial statements on a retroactive basis. All intercompany
balances and transactions between the Company and FLI have been eliminated.

On December 30, 1996, FLI and FRE were merged through the exchange of
0.21258 shares of FLI Common Stock for each outstanding share of FRE Common
Stock. As the outstanding shares of both entities were held in the same
percentage by identical stockholders prior to the merger, this transaction was
accounted for as if it were a pooling-of-interests. Accordingly, the financial
statements have been retroactively restated to give effect to this transaction
as of the beginning of the earliest period presented.

Prior to March 1996, FRE and FLI were each owned 100% by two individuals
(the "Founders"). In March 1996, new investors acquired a 56.25% ownership
interest in both entities through the purchase of shares held by the Founders
($14,000,000) and newly issued FLI shares ($4,000,000). Simultaneous with this
transaction, the Founders received a distribution from FLI in the amount of
$4,000,000. The new investors also acquired an option from the Founders to
acquire an additional 1,537,500 shares held by the Founders for a total of
$6,000,000. Such option expires upon the earlier of (i) upon the close of an
initial public offering by the Company or (ii) September 5, 1997. Prior to the
March 1996 transaction, FLI had elected to be treated as an S Corporation for
income tax purposes. FRE was a C Corporation for income tax purposes.

INTERIM FINANCIAL INFORMATION

The financial information for the six months ended June 30, 1996 is
unaudited, but includes all adjustments (consisting only of normal recurring
adjustments) that the Company considers necessary for a fair presentation of the
operating results and cash flows for such period.

USE OF ESTIMATES

The preparation of 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 these estimates.

F-7
<PAGE>
FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SOURCES OF SUPPLY

The Company currently relies on a limited number of independent foundries to
manufacture, assemble and test all of its semiconductor components and products.
In addition, the Company subcontracts the manufacturing of its broadcast and
television products with two principal suppliers. While alternate sources of
supply exist, in the event of the discontinuance of any of the above supplier
relationships, the Company would be required to locate and qualify new
suppliers, which could take up to several months.

CASH EQUIVALENTS

The Company considers all highly liquid investments with a maturity of three
months or less, when purchased, to be cash equivalents. Cash equivalents consist
primarily of bank deposits, money market account, and, in 1995, a U.S. Treasury
Bill.

SHORT-TERM INVESTMENTS

The Company accounts for its short-term investments in accordance with
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" ("SFAS 115").

Under SFAS 115, all affected debt and equity securities must be stated at
fair value and classified as held-to-maturity, trading or available-for-sale.
Management determines the appropriate classification of securities at the time
of purchase and reevaluates such designation as of each balance sheet date.

At December 31, 1995 and 1996 and June 30, 1997, all debt and equity
securities were designated as available-for-sale. Available-for-sale securities
are carried at fair value, with unrealized gains and losses reported net of tax
as a separate component of stockholders' equity. Realized gains and losses and
declines in value judged to be other-than-temporary, if any, on
available-for-sale securities are included in other income. The cost of
securities sold is based on the specific identification method. Interest on
securities classified as available-for-sale is included in interest income.

CONCENTRATION OF CREDIT RISK

The Company sells its products primarily through a network of distributors
and through original equipment manufacturing ("OEM") arrangements. The Company
performs ongoing credit evaluations of its customers and generally does not
require collateral. Uncollectible accounts receivable have not been significant
in any period presented.

At December 31, 1995, three customers accounted for 50% of the accounts
receivable balance. At December 31, 1996, two customers accounted for 48% of the
accounts receivable balance. At June 30, 1997, four customers accounted for 52%
of the accounts receivable balance. No other single customer accounted for more
than 10% of the Company's ending accounts receivable balances.

INVENTORIES

Inventories are carried at the lower of cost (determined on a first-in,
first-out basis) or market.

F-8
<PAGE>
FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY AND EQUIPMENT

Property and equipment are recorded at cost. Depreciation and amortization
are provided using the straight-line method over the estimated useful lives of
the assets (ranging from three to seven years). Leasehold improvements are
amortized over the shorter of the lease term or the estimated useful life.

REVENUE RECOGNITION

Sales revenue is recognized upon shipment of products to customers. The
Company does not grant rights of return and customarily does not provide price
protection to distributors. Nonrefundable minimum royalties are recognized as
revenue in the period to which they relate.

ADVERTISING COSTS

The Company expenses advertising costs as incurred. Advertising expense
amounted to $165,000, $204,155 and $394,578 in the years ended 1994, 1995 and
1996, respectively, and $233,339 and $233,936 in the six months ended June 30,
1996 (unaudited) and 1997, respectively.

FINANCING EXPENSE

In 1997, the Company incurred and expensed approximately $312,000 of
expenses related to financing activities.

STOCK-BASED COMPENSATION

As permitted by Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123"), the Company has elected
to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" ("APB 25") and related interpretations in accounting for
its employee and director stock option and purchase plans. Under APB 25, if the
exercise price of the Company's employee stock options is not less than the
market price of the underlying stock on the date of grant, no compensation
expense is recognized.

NET INCOME PER SHARE

Net income per share and pro forma net income per share were calculated by
dividing net income or pro forma net income by the weighted average number of
shares of Common Stock outstanding for the respective periods, adjusted for the
dilutive effect of common stock equivalents, which consist of stock options and
warrants, using the treasury stock method. Pursuant to the requirements of the
Securities and Exchange Commission ("SEC"), Common Stock and common stock
equivalents issued by the Company during the 12 months immediately preceding the
Company's proposed initial public offering have been included in the calculation
as if they were outstanding for all periods presented (using the treasury stock
method for common stock equivalents).

In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"),
which is required to be adopted on December 31, 1997. At that time, the Company
will be required to change the method currently used to compute earnings per
share and to restate all prior periods. Under the new requirements for
calculating basic earnings per share, the dilutive effect of stock options and
warrants will be excluded. The impact is expected to increase the income per
share

F-9
<PAGE>
FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
amounts reported on the accompanying statements of income for the year ended
December 31, 1996, and the six-month period ended June 30, 1997 to $0.15 and
$0.06 per share, respectively (including common shares and equivalents mandated
by the SEC as discussed above). There will be no impact on the six-months ended
June 30, 1996 income per share as reported. The impact of SFAS 128 on the
calculation of fully diluted earnings per share for these years is not expected
to be material.

2. SHORT-TERM INVESTMENTS

The following is a summary of available-for-sale securities at December 31,
1995 and 1996 and June 30, 1997:

<TABLE>
<CAPTION>
UNREALIZED FAIR
GAINS MARKET
COST (LOSSES) VALUE
------------ ----------- ------------
<S> <C> <C> <C>
At December 31, 1995:
Mutual funds--principally emerging growth equities...................... $ 552,331 $ 15,825 $ 568,156
Other mutual funds...................................................... 400,000 16,727 416,727
Certificate of deposit.................................................. 250,000 1,077 251,077
U.S. Treasury Bill...................................................... 198,744 1,256 200,000
------------ ----------- ------------
$ 1,401,075 $ 34,885 $ 1,435,960
------------ ----------- ------------
------------ ----------- ------------
Reported as:
Cash equivalents........................................................ $ 198,744 $ 1,256 $ 200,000
Short-term investments.................................................. 1,202,331 33,629 1,235,960
------------ ----------- ------------
$ 1,401,075 $ 34,885 $ 1,435,960
------------ ----------- ------------
------------ ----------- ------------
At December 31, 1996:
Mutual funds--principally emerging growth equities...................... $ 900,000 $ 107,980 $ 1,007,980
Other mutual funds...................................................... 400,000 (3,084) 396,916
Certificate of deposit.................................................. 263,000 -- 263,000
U.S. Treasury Bill...................................................... 193,973 6,027 200,000
------------ ----------- ------------
$ 1,756,973 $ 110,923 $ 1,867,896
------------ ----------- ------------
------------ ----------- ------------
Reported as:
Short-term investments.................................................. $ 1,756,973 $ 110,923 $ 1,867,896
------------ ----------- ------------
------------ ----------- ------------
At June 30, 1997:
Certificate of deposit (reported as short-term investments)............. $ 272,227 $ -- $ 272,227
------------ ----------- ------------
------------ ----------- ------------
</TABLE>

F-10
<PAGE>
FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

2. SHORT-TERM INVESTMENTS (CONTINUED)

The estimated fair value amounts discussed above have been determined by the
Company using available market information and appropriate valuation
methodologies. Gross unrealized losses were not material and thus have not been
presented separately in the above table.

During the years ended December 31, 1995 and 1996, there were no gross
realized gains or losses. During the six months ended June 30, 1997, there were
$83,456 of net realized gains. As of December 31, 1996, the average portfolio
duration is approximately three months and the contractual maturity of the
investments does not exceed one year. At June 30, 1997 the average portfolio
duration is approximately three months and the contractual maturity of the
investments does not exceed six months.

3. INVENTORIES

Inventories consist of the following:

<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
-------------------------- ------------
1995 1996 1997
------------ ------------ ------------
<S> <C> <C> <C>
Raw materials....................................... $ 596,049 $ 615,865 $ 678,282
Work-in-process..................................... 724,577 630,630 948,040
Finished goods...................................... 266,444 437,055 467,600
------------ ------------ ------------
$ 1,587,070 $ 1,683,550 $ 2,093,922
------------ ------------ ------------
------------ ------------ ------------
</TABLE>

4. PROPERTY AND EQUIPMENT

Property and equipment consist of the following:

<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
-------------------------- ------------
1995 1996 1997
------------ ------------ ------------
<S> <C> <C> <C>
Machinery and equipment........................... $ 1,377,953 $ 1,705,845 $ 1,970,375
Purchased computer software....................... -- 492,471 496,042
Office equipment.................................. 25,528 25,528 25,528
Furniture and fixtures............................ 160,510 209,448 251,219
Vehicles.......................................... 241,802 241,802 148,644
Leasehold improvements............................ 45,679 143,508 181,072
------------ ------------ ------------
1,851,472 2,818,602 3,072,880
Accumulated depreciation.......................... (1,080,419) (1,434,795) (1,569,476)
------------ ------------ ------------
$ 771,053 $ 1,383,807 $ 1,503,404
------------ ------------ ------------
------------ ------------ ------------
</TABLE>

5. OPERATING LEASES

The Company leases its main facility under a lease agreement expiring
September 30, 2003. The lease agreement is cancelable at the Company's option
upon four months' notice. Payments are adjusted annually

F-11
<PAGE>
FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

5. OPERATING LEASES (CONTINUED)
based on changes in the Consumer Price Index. At June 30, 1997, future estimated
minimum payments under this and other leases are approximately as follows:

<TABLE>
<CAPTION>
PERIOD ENDING
DECEMBER 31,
-------------
<S> <C>
1997 (July 1 to December 31)................................................... $ 103,568
1998........................................................................... 207,088
1999........................................................................... 191,588
2000........................................................................... 176,088
2001........................................................................... 176,088
2002........................................................................... 176,088
Thereafter..................................................................... 132,066
-------------
Total minimum lease payments................................................... $ 1,162,574
-------------
-------------
</TABLE>

Rent expense under operating leases amounted to $167,997, $168,948 and
$185,709 in 1994, 1995 and 1996, respectively; and $110,669 for the six months
ended June 30, 1997.

6. STOCKHOLDERS' EQUITY

WARRANTS

In April 1992, the Company issued three warrants to purchase a total of
14,449 shares of common stock at a price of $3.40 per share to a consultant. The
warrants are fully exercisable and expire upon the consummation of the Company's
initial public offering a sale of the Company or ten years from the date of
issuance. The Company has reserved 14,449 shares of common stock for issuance
upon exercise of the warrants.

In 1996, the Company issued a warrant to purchase 65,152 shares of common
stock at an exercise price of $0.15 to a limited liability company in which a
member of the Company's Board of Directors has a substantial interest. The
warrant was issued in exchange for services to be performed by the Board of
Directors member. The warrant will be exercisable upon the occurrence of certain
defined events prior to February 1999. The warrant expires on December 31, 1999.
The Company is recognizing $222,000, the value of the warrant, over the related
service period.

In 1997, one of the Founders granted to the Company an exclusive (excluding
certain rights retained by the Founder), worldwide, perpetual, irrevocable and
royalty-free right and license to patents owned by him. The Founder has a
nonexclusive, nontransferable right to the patents for applications and uses
outside of the Company's business as defined in the license agreement. In
exchange for rights granted, the Founder received a warrant to purchase 100,000
shares of Common Stock at $7.50 a share. The warrant vests over a three-year
period and expires in January 2002. The Company is amortizing $250,000, the
value of the warrant, over the estimated useful economic life of the patents.

STOCK OPTION PLANS

In 1995, the Company adopted the 1995 Stock Option Plan (the "1995 Plan"),
which superseded a 1993 stock option plan under which no options had been
granted. A total of 1,700,000 shares of Common Stock were reserved for issuance
under the 1995 Plan. Under the terms of the 1995 Plan, the Board of Directors
may grant options to directors, employees and consultants. Options may be either
incentive stock options or nonstatutory

F-12
<PAGE>
FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

6. STOCKHOLDERS' EQUITY (CONTINUED)
stock options, at the discretion of the Board of Directors. Incentive stock
options may be granted to employees with exercise prices of no less than the
fair value, and nonstatutory options may be granted to employees, directors, and
consultants with exercise prices of no less than 85% of the fair value, of the
common stock on the date of grant, as determined by the Board of Directors. If,
at the time of grant, the optionee owns stock possessing 10% or more of the
voting power of all classes of stock, the option price shall be at least 110% of
the fair value, and the option shall not be exercised more than five years after
the date of grant. Except as noted above, options expire ten years after the
date of grant, or earlier if employment or service is terminated. Options become
exercisable as determined by the Board of Directors. Options generally vest over
three or four years.

In December 1996, the Board of Directors adopted, and in 1997 the
stockholders approved, the 1997 Non-Employee Directors Stock Option Plan (the
"Directors Plan"). A total of 100,000 shares of Common Stock were reserved for
issuance pursuant to the terms of the Directors Plan, which provides for the
grant of nonqualified stock options to nonemployee directors of the Company. In
January 1997, the Board of Directors adopted, and the stockholders approved, the
1997 Employee Stock Purchase Plan (the "Purchase Plan") and the 1997 Performance
Stock Option Plan (the "1997 Plan"). The 1997 Plan succeeds the 1995 Plan and
has terms similar to that Plan. No additional options will be granted under the
1995 Plan and shares reserved for future option grants thereunder are available
for grant under the terms of the 1997 Plan. In June 1997, the Board of Directors
adopted an amendment to the 1997 Plan increasing the number of shares reserved
for issuance for the 1997 Plan by 250,000 shares, subject to stockholders'
approval. A total of 400,000 shares were reserved for future issuance under the
Purchase Plan. The Purchase Plan permits eligible employees to purchase common
stock through payroll deductions at a price equal to the lower of 85% of the
fair value of the Company's common stock at the beginning or end of the
applicable offering period. No shares have been issued under the Purchase Plan.

During 1996, the Company adopted SFAS 123. In accordance with the Statement,
the Company applies APB 25 in accounting for option grants to employees under
the Plan and, accordingly, does not recognize compensation expense for options
granted to employees at fair value on the date of grant. The effect of applying
the minimum value method of valuing options to options granted in 1995 and 1996
pursuant to SFAS 123 resulted in pro forma net income (after the effect of the
pro forma tax adjustment) of $1,168,364, or $0.13 per share, for the year ended
December 31, 1996 and pro forma net income of $325,519, or $0.03 per share, for
the six months ended June 30, 1997. The pro forma impact in reported results for
the year ended December 31, 1995 was not significant and has not been presented
herein. The minimum value method was applied using the following
weighted-average assumptions for 1995, 1996 and 1997, respectively: risk-free
interest rates of 6.09%, 6.35% and 6.17%; an expected option life of 72 months;
and no dividends. Future pro forma results of operations may be materially
different from actual amounts reported.

F-13
<PAGE>
FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

6. STOCKHOLDERS' EQUITY (CONTINUED)

A summary of the Company's stock option activity, and related information
follows:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, SIX MONTHS ENDED
----------------------------------------------- -----------------------
1995 1996 JUNE 30, 1997
---------------------- ----------------------- -----------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
--------- ----------- ---------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at January 1............... -- $ -- 180,576 $ 1.16 1,441,988 $ 3.46
Granted................................ 180,576 1.16 1,261,412 3.79 338,770 7.24
Exercised.............................. -- -- -- -- (7,380) 1.68
Canceled............................... -- -- -- -- (195,029) 3.79
--------- ----- ---------- ----- ---------- -----
Outstanding at end of period........... 180,576 $ 1.16 1,441,988 $ 3.46 1,578,349 $ 4.24
--------- ----- ---------- ----- ---------- -----
--------- ----- ---------- ----- ---------- -----
Weighted-average fair value of options
granted during the period............ .36 .23 .07
</TABLE>

Exercise prices of options outstanding and options exercisable were as
follows:

JUNE 30, 1997

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
- --------------------------------------------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED- ------------------------
AVERAGE WEIGHTED- WEIGHTED-
REMAINING AVERAGE AVERAGE
NUMBER OF CONTRACTUAL EXERCISE NUMBER OF EXERCISE
RANGE OF EXERCISE PRICES OPTIONS LIFE PRICE OPTIONS PRICE
- ------------------------------------------ --------- ------------- ----------- ----------- -----------
(IN YEARS)
<S> <C> <C> <C> <C> <C>
$1.16-$2.02............................... 204,791 8.29 $ 1.29 136,516 $ 1.26
$3.83-$3.91............................... 1,059,558 9.12 3.85 149,439 3.83
$7.00-$7.50............................... 314,000 9.89 7.46 -- --
--------- -----------
1,578,349 9.16 4.24 285,955 2.60
--------- -----------
--------- -----------
</TABLE>

DECEMBER 31, 1996

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
- --------------------------------------------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED- ------------------------
AVERAGE WEIGHTED- WEIGHTED-
REMAINING AVERAGE AVERAGE
NUMBER OF CONTRACTUAL EXERCISE NUMBER OF EXERCISE
RANGE OF EXERCISE PRICES OPTIONS LIFE PRICE OPTIONS PRICE
- ------------------------------------------ --------- ------------- ----------- ----------- -----------
(IN YEARS)
<S> <C> <C> <C> <C> <C>
$1.16..................................... 180,576 8.75 $ 1.16 95,165 $ 1.16
$2.02..................................... 41,512 9.08 2.02 -- --
$3.83-$3.91............................... 1,219,900 9.58 3.85 -- --
--------- -----------
1,441,988 9.50 3.46 95,165 1.16
--------- -----------
--------- -----------
</TABLE>

F-14
<PAGE>
FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

6. STOCKHOLDERS' EQUITY (CONTINUED)
At December 31, 1995, options to purchase 51,024 shares of Common Stock were
exercisable at a weighted-average exercise price of $1.16 per share.

Pursuant to APB 25, for certain options granted in June 1997, the Company
recognized as deferred compensation expense the excess of the deemed value for
financial reporting purposes of the common stock issuable upon the exercise of
such options over the aggregate exercise price of such options. The total
deferred compensation expense of $271,500 is being amortized over the vesting
period of such options.

RESERVED SHARES

As of June 30, 1997, the Company has reserved shares of common stock for
future issuance as follows:

<TABLE>
<S> <C>
Warrants......................................................... 179,601
Stock purchase plan.............................................. 400,000
Stock option plans:
Outstanding options............................................ 1,578,349
Reserved for future grants..................................... 464,271
---------
2,622,221
---------
---------
</TABLE>

7. LICENSE AGREEMENT

In March 1997, the Company entered into a license agreement with S3
Incorporated ("S3"), a leading supplier of advanced graphics accelerators for
use in mainstream multimedia PC systems. Under the terms of the agreement, the
Company and S3 are working jointly to develop integrated circuits incorporating
the Company's video processing technologies for use in PCs. The Company granted
to S3 a worldwide license to certain technology, including line doubling, detail
enhancement, cross-color suppression, motion tracking and compensation, and
digital compression filtering technology. Portions of such license are exclusive
for certain markets for a period of five years provided that performance
criteria, including minimum license fees are satisfied. The Company is obligated
to negotiate with S3 to extend the five year period. The Company is to receive
certain per unit royalties for products sold incorporating the Company's
technology. If royalties on product sales do not reach the minimum levels
necessary to maintain exclusivity, S3 may elect to pay the required minimum
amount. Such payments may be offset against future royalties otherwise due.

In December 1996, S3 paid the Company $1 million, $500,000 of which was
refundable if a definitive license agreement between the parties was not
consummated. Accordingly, the Company recognized $500,000 of license and royalty
revenue in 1996 and the remaining $500,000 of license and royalty revenue in
March 1997.

On June 30, 1997, the Company sold a total of 526,316 shares of its Common
Stock to S3 pursuant to a Stock Purchase Agreement for $4,948,201, net of
expenses associated with the transaction. S3 is entitled to certain
anti-dilution, registration and other rights as set forth in the Stock Purchase
Agreement. This agreement provides that S3 shall receive additional shares if
the Offering price is less than $9.50.

F-15
<PAGE>
FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

8. INCOME TAXES

The provision for income taxes computed under Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes," consists of the
following:

<TABLE>
<CAPTION>
PRO FORMA
SIX-MONTHS SIX-MONTHS SIX-MONTHS
DECEMBER 31, PRO FORMA DECEMBER 31, ENDED ENDED ENDED
------------------------------- ------------------------------- JUNE 30, JUNE 30, JUNE 30,
1994 1995 1996 1994 1995 1996 1996 1996 1997
--------- --------- --------- --------- --------- --------- --------- --------- ---------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Federal:
Current........ $ -- $ 23,000 $ 991,744 $ 571,682 $ 885,687 $1,157,285 $ 315,534 $ 540,765 $ 394,450
Deferred....... -- -- (439,614) 59,083 5,463 (455,627) (139,868) (212,901) (120,185)
--------- --------- --------- --------- --------- --------- --------- --------- ---------
-- 23,000 552,130 630,765 891,150 701,658 175,666 327,864 274,625
State:
Current........ 13,450 60,981 201,016 83,390 151,242 247,312 63,955 115,562 71,551
Deferred....... -- -- (66,092) -- (19,204) (69,822) (21,028) (32,626) (18,344)
--------- --------- --------- --------- --------- --------- --------- --------- ---------
13,450 60,981 134,924 83,390 132,038 177,490 42,927 82,936 53,207
--------- --------- --------- --------- --------- --------- --------- --------- ---------
$ 13,450 $ 83,981 $ 687,054 $ 714,155 $1,023,188 $ 879,148 $ 218,593 $ 410,800 $ 327,472
--------- --------- --------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- --------- --------- ---------
</TABLE>

The following table reconciles the expected federal corporate income tax
expense (computed by multiplying the Company's income before taxes by the
federal statutory rate of 34%) to the Company's income tax expense for the
following periods ended:

<TABLE>
<CAPTION>
PRO FORMA
SIX-MONTHS SIX-MONTHS SIX-MONTHS
DECEMBER 31, PRO FORMA DECEMBER 31, ENDED ENDED ENDED
------------------------------- ------------------------------- JUNE 30, JUNE 30, JUNE 30,
1994 1995 1996 1994 1995 1996 1996 1996 1997
--------- --------- --------- --------- --------- --------- --------- --------- ---------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Tax at U.S.
Statutory
rate........ $ 660,343 $1,391,693 $ 747,275 $ 660,343 $1,391,693 $ 747,275 $ 349,100 $ 349,100 $ 293,005
State income
taxes, net
of federal
benefit..... 13,450 60,981 78,615 83,390 132,088 106,709 36,726 49,851 31,766
S Corporation
earnings
prior to
change in
tax
status...... (630,765) (868,150) (251,758) -- -- -- (251,758) -- --
Deferred taxes
recorded due
to change in
tax
status...... -- -- (148,993) -- -- -- (148,993) -- --
Net operating
losses
utilized.... (29,578) (500,543) -- (29,578) (500,543) -- -- -- --
Other......... -- -- 261,915 -- -- 25,164 233,518 11,849 2,701
--------- --------- --------- --------- --------- --------- --------- --------- ---------
$ 13,450 $ 83,981 $ 687,054 $ 714,155 $1,023,188 $ 879,148 $ 218,593 $ 410,800 $ 327,472
--------- --------- --------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- --------- --------- ---------
</TABLE>

The pro forma provisions for income taxes reflect the additional tax expense
which would have been incurred had FLI's status as an S Corporation terminated
on January 1, 1994, exclusive of the effects of the establishment of deferred
tax assets and liabilities at that date.

F-16
<PAGE>
FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

8. INCOME TAXES (CONTINUED)
The provision for income taxes for the six months ended June 30, 1997 is
based on the estimated annual effective tax rate for the year.

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax liabilities and assets as of December 31, 1996 and
June 30, 1997 are as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
--------------------- JUNE 30,
1995 1996 1997
--------- ---------- ----------
<S> <C> <C> <C>
Deferred tax assets:
Accrued liabilities......................................................... $ -- $ 354,284 $ 513,274
Other, net.................................................................. 11,992 208,954 175,863
Deferred tax liabilities:
Depreciation of property and equipment...................................... (11,992) (57,533) (89,089)
Valuation of investment portfolio........................................... -- (44,186) --
--------- ---------- ----------
Net deferred tax assets....................................................... $ -- $ 461,519 $ 600,048
--------- ---------- ----------
--------- ---------- ----------
</TABLE>

Management has concluded that a valuation allowance for deferred tax assets
is not required based on its assessment that current levels of taxable income
and the reversal of taxable temporary differences will be sufficient to realize
the tax benefit.

9. EXPORT SALES AND SIGNIFICANT CUSTOMERS

The Company had export sales by region as follows:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SIX MONTHS ENDED
---------------------------------------- JUNE 30,
1994 1995 1996 1997
------------ ------------ ------------ ----------------
<S> <C> <C> <C> <C>
Revenues to customers:
Asia............................................... $ 878,000 $ 986,000 $ 1,115,000 $ 403,000
Europe............................................. 227,000 263,000 479,000 104,000
Canada............................................. 150,000 138,000 200,000 70,000
Latin America and other............................ 111,000 190,000 220,000 169,000
------------ ------------ ------------ --------
$ 1,366,000 $ 1,577,000 $ 2,014,000 $ 746,000
------------ ------------ ------------ --------
------------ ------------ ------------ --------
</TABLE>

In 1994, sales to one customer accounted for 19% of total revenues. In 1995,
sales to one customer accounted for 12% of total revenues. In 1996, sales to one
customer accounted for 11% of total revenues. In the six months ended June 30,
1997, sales to two customers accounted for 15% and 11% of total revenues,
respectively.

10. 401(k) PLAN

During 1994, the Company adopted a defined contribution retirement plan
under Internal Revenue Service Code Section 401(k). Employees are eligible,
following one month of employment, to contribute a specified percentage of their
salary, not to exceed the statutory limit, to the plan. The Company matches a

F-17
<PAGE>
FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

10. 401(k) PLAN (CONTINUED)
percentage of employee contributions. The Company's contributions were
insignificant during the years ended December 31, 1994, 1995 and 1996, and were
$66,192 for the six months ended June 30, 1997.

11. CREDIT FACILITIES

In March 1997, the Company established a revolving line of credit with a
bank for borrowings of up to $1,000,000. In May 1997, the line was increased to
$2,000,000, including secured letters of credit. The line of credit agreement,
which includes certain financial covenants, expires on April 4, 1998. Borrowings
under the line of credit are collaterized by substantially all of the Company's
tangible assets and contract rights. Borrowings are limited to a defined
percentage of eligible accounts receivable. In June 1997, the Company also
established a $500,000 equipment loan facility secured by fixed assets. The
Company can draw against this line to December 1997 and to the extent drawn down
the loan must be fully repaid by December 2000. Borrowings against the line of
credit and the equipment loan bear interest at prime plus 1.5% (10.0% at June
30, 1997). At June 30, 1997, there were no borrowings against either the line of
credit or the fixed asset line, and the aggregate amount available under the
revolving line of credit was $1,886,000.

12. PROPOSED INITIAL PUBLIC OFFERING AND RELATED MATTERS

On July 22, 1997, the Board of Directors of the Company authorized
management to file a registration statement with the Securities and Exchange
Commission for the sale of Common Stock to the public. On the same date the
Board of Directors also approved an increase in the number of authorized shares
of common stock to 50,000,000 and an increase in the number of authorized shares
of Preferred Stock to 5,000,000.

F-18
<PAGE>
Inside Back Cover

1. Diagram with "Faroudja" in the center and lines from "Faroudja to the
following:

"HDTV," "Home Theater," "PCTV," "Digital TV," "Digital Light
Processing-TM-," "High-End Display," "Broadcast," and "DVD."

2. TEXT

FAROUDJA

When high quality video

images are required
<PAGE>
[LOGO]
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.

The estimated expenses in connection with the Offering are as follows:

<TABLE>
<CAPTION>
EXPENSE AMOUNT
- ---------------------------------------------------------------------------------- ----------
<S> <C>
The Commission's Registration Fee................................................. $ 10,455
NASD Filing Fee................................................................... 3,950
NASDAQ Listing Application........................................................ 1,000
Blue Sky Fees and Expenses........................................................ 5,000
Printing Expenses................................................................. 125,000
Legal Fees and Expenses........................................................... 225,000
Accounting Fees and Expense....................................................... 190,000
Transfer Agent Fees............................................................... 5,000
Miscellaneous Expenses............................................................ 184,595
----------
Total........................................................................... $ 750,000
----------
----------
</TABLE>

ITEM 14. INDEMNIFICATION OF OFFICERS AND DIRECTORS.

The Certificate of Incorporation of the Company eliminates the liability of
the Company's directors for monetary damages arising from a breach of their
fiduciary duties to the Company and its stockholders, to the extent permitted by
the Delaware General Corporation Law. Such limitation of liability does not
affect the availability of equitable remedies such as injunctive relief or
rescission.

The Company's By-Laws provide that the Company shall indemnify its directors
and officers to the fullest extent permitted by applicable law. The Company has
entered into indemnification agreements with its directors and executive
officers containing provisions which are in some respects broader than the
specific indemnification provisions contained in the Delaware General
Corporation Law. Such agreements require the Company, among other things, (i) to
indemnify its officers and directors against certain liabilities that may arise
by reason of their status or service as directors or officers provided such
persons acted in good faith and in a manner reasonably believed to be in the
best interests of the Company and, with respect to any criminal action, had no
cause to believe their conduct was unlawful; (ii) to advance the expenses
actually and reasonably incurred by its officers and directors as a result of
any proceeding against them as to which they could be indemnified; and (iii) to
obtain directors' and officers' insurance if available on reasonable terms.
There is no action or proceeding pending or, to the knowledge of the Company,
threatened which may result in a claim for indemnification by any director,
officer, employee or agent of the Company.

ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES

In March 1996, (i) the Company issued 1,043,105 shares of Common Stock for
an aggregate purchase price of $4 million to the Investor Group, of which
213,642 shares were issued to Adelson, 682,153 shares were issued to Investors
LLC and 147,310 shares were issued to Images, (ii) the Investor Group purchased
a total of 3,569,395 shares of Common Stock from Yves and Isabell Faroudja for
an aggregate purchase price of $14 million, of which 731,062 shares were
purchased by Adelson, 2,334,253 shares were purchased by Investors LLC and
504,080 shares were purchased by Images, and (iii) Yves and Isabell Faroudja
granted the Investor Group the Faroudja Option to purchase 1,537,500 shares of
the Company's Common Stock for an aggregate purchase price of $6 million or
$3.90 per share, of which Adelson had an option to purchase 486,875 shares of
Common Stock for $1.9 million, Investors LLC had an option to purchase 666,250
shares of Common Stock for $2.6 million and Images had an option to purchase
384,375 shares of Common Stock for $1.5 million. The Faroudja

II-1
<PAGE>

Option was exercised by the Investor Group on September 5, 1997. The
transactions described in (i) and (ii) above are collectively referred to herein
as the "Equity Purchase." The Company believes that because the Equity Purchase
and the exercise of the Faroudja Option were made to sophisticated persons
without the means of a general solicitation, these offerings were exempt from
registration under Section 4(2) of the Securities Act, and Regulation D
promulgated thereunder.

As of June 30, 1997 the Company had issued 1,217,019 and 315,725 options
under its 1995 Option Plan and its 1997 Option Plan, respectively, to qualified
employees, to purchase the Company's Common Stock. No consideration was received
for such grants, except that 7,380 options under the 1995 Option Plan were
exercised in May, 1997, 4,497 options at an exercise price of $2.02 per share
and 2,883 options at an exercise price of $1.16 per share. The Company believes
that the grant of options and their exercise pursuant to the terms of these
plans is exempt from registration under Rule 701 promulgated under the
Securities Act.

On June 30, 1997 the Company issued 526,316 shares of Common Stock to S3 for
$5.0 million. The Company believes that because the offering was made to a
sophisticated investor without the means of a general solicitation, the Company
was exempt from registration under Section 4(2) of the Securities Act.

As of June 30, 1997 the Company had issued 45,605 options to purchase Common
Stock pursuant to its Director Plan to its directors. No consideration was
received for such grants. The Company believes the grant of option and their
exercise under this plan is exempt from registration under Rule 701 promulgated
under the Securities Act.

On August 13, 1997 the Company issued 750 shares of its Common Stock to each
of Stuart D. Buchalter, Merv Adelson, William N. Sick, William J. Turner and
Kevin B. Kimberlin as consideration for their serving as directors of the
Company. The Company believes that because these offerings were made to
sophisticated investors without the means of a general solicitation, the Company
was exempt from registration under Section 4(2) of the Securities Act.

ITEM 16. EXHIBITS

(a) Exhibits

3.1* The Company's Restated Certificate of Incorporation, as amended on August 12, 1997.

3.2* The Company's By-Laws.

4.1* Warrants (1-3), dated July 16, 1993, for the purchase of Common Stock issued to John Sie.

4.2* Warrant, dated January 20, 1997, for the purchase of Common Stock issued to Yves Faroudja.

4.3* Warrant, dated December 31, 1996, for the purchase of Common Stock issued to Adelson Investors, LLC.

4.4* Specimen of Common Stock Certificate.

5.1 Opinion of Buchalter, Nemer, Fields & Younger, a Professional Corporation, as to the validity of the
shares of Common Stock offered hereby.

10.1* Consulting Services Agreement, dated September 21, 1994, between the Company and M-Squared and
Technology L.L.C.

10.2* Letter Agreement, dated December 31, 1996, between the Company and Merv L. Adelson for certain
consulting services.

10.3* Letter Agreement, dated November 13, 1995, by and among certain stockholders of the Company listed
therein and Spencer Trask Holdings, Inc.
</TABLE>

II-2
<PAGE>

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------- -------------------------------------------------------------------------------------------------------
<C> <S>
10.4* Amendment to Letter Agreement, dated February 9, 1996, among certain stockholders of the Company listed
therein and Spencer Trask Holdings, Inc.

10.5* Lease Agreement, dated August 2, 1993, by and among the Company and the Landlords listed therein.

10.6* The Company's 1995 Stock Option Plan, dated August 1, 1995 and amended on August 19, 1996, February 11,
1997, April 30, 1997 and June 13, 1997.

10.7* The Company's 1997 Non-Employee Directors Stock Option Plan, dated January 2, 1997.

10.8* The Company's 1997 Performance Stock Option Plan, dated January 2, 1997 and amended on June 13, 1997.

10.9 The Company's 1997 Employee Stock Purchase Plan, dated Janaury 2, 1997 and amended on August 12, 1997
and September 30, 1997.

10.10* Employment Agreement, dated as of July 8, 1996, between the Company and Michael J. Moone.

10.11* Employment Agreement, dated March 8, 1996, between the Company and Yves C. Faroudja.

10.12* Registration and Shareholders' Rights Agreement, dated March 7, 1997, among the Company and Yves &
Isabell Faroudja and certain Stockholders of the Company.

10.13* Three (3) Registration Rights Agreements, dated December 31, 1996 among the Company and each of Adelson
Investors, LLC, Images Partners, LP and Roger K. Baumberger as Liquidating Trustee for Faroudja
Images, Inc.

10.14* Registration Rights Agreement, dated March 7, 1997 among the Company and Faroudja Images Investors,
LLC.

10.15* Agreement, dated January 20, 1997 among Yves Faroudja and the Company for the transfer of intellectual
property to the Company.

10.16** License Agreement, dated March 31, 1997, between the Company and S3 Incorporated.

10.17* Stock Purchase Agreement, dated June 30, 1997, between the Company and S3 Incorporated.

10.18* Investor's Rights Agreement, dated June 30, 1997, between the Company and S3 Incorporated.

10.19* Business Loan Agreement, dated April 5, 1997, between the Company and Silicon Valley Bank.

10.20* Commercial Guaranty, dated April 5, 1997, by the Company for the benefit of Silicon Valley Bank.

10.21* Commercial Security Agreement, dated April 5, 1997, by the Company for the benefit of Silicon Valley
Bank.

10.22* Promissory Note, dated April 5, 1997, by the Company for the benefit of Silicon Valley Bank.

10.23* Promissory Note, dated June 6, 1997, by the Company for the benefit of Silicon Valley Bank.

10.24* Loan Modification Agreement, dated June 6, 1997, by and between the Company and Silicon Valley Bank.

10.25* Three (3) Amended and Restated Options to Purchase Shares of Common Stock of the Company, dated March
7, 1997 among the Company, Yves Faroudja and Isabell Faroudja, Faroudja Images, Inc. and each of
Adelson Investors, LLC, Faroudja Images Investors, LLC and Images Partners, LP.

10.26* Amended and Restated Option to Purchase Shares of Common Stock of the Company, dated December 31, 1996
among the Company, Yves Faroudja and Isabell Faroudja, Faroudja Images, Inc. and Roger K. Baumberger
as Liquidating Trustee of Faroudja Images, Inc.

10.27* Consulting Services Agreement, dated July 22, 1997, between the Company and Matthew D. Miller.

10.28** License Agreement, dated May 1, 1996 between the Company, Yves Faroudja and General Instrument
Corporation of Delaware.
</TABLE>

II-3

<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------- -------------------------------------------------------------------------------------------------------
<C> <S>
11.1 Statement of Computation of Net Income per share.

21.1* List of the Subsidiaries of the Company.

23.1 Consent of Ernst & Young LLP, Independent Auditors.

23.2 Consent of Buchalter, Nemer, Fields & Younger, a Professional Corporation (included in Exhibit 5.1).

24.1* Power of Attorney (included on page II-5).

27.1* Financial Data Schedule.
</TABLE>

- ------------------------
* Previously filed
** Confidential treatment has been requested

(b) Financial Statement Schedules

Schedule II -- Valuation and Qualifying Accounts

Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the
Consolidated Financial Statements or Notes thereto.

ITEM 17. UNDERTAKINGS.

17.1 The undersigned registrant hereby undertakes to provide to the
underwriter at the closing specified in the underwriting agreements,
certificates in such denominations and registered in such names as required by
the underwriter to permit prompt delivery to each purchaser.

17.2 Insofar as indemnification for liabilities arising out of the
Securities Act may be permitted to directors, officers and controlling persons
of the registrant pursuant to the foregoing provisions or otherwise, the
registrant has been advised that, in the opinion of the Commission, such
indemnification is against public policy as expressed in the Securities Act and
is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by registrant of expenses
incurred or paid by a director, officer or controlling person of the registrant
in the successful defense in any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.

17.3 The undersigned registrant hereby undertakes that:

(1) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part
of this registration statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4)
or 497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.

(2) For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.

II-4
<PAGE>
SIGNATURES AND POWER OF ATTORNEY

Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Sunnyvale,
State of California on this 30th day of September, 1997.

FAROUDJA, INC.

By: /s/ MICHAEL J. MOONE
---------------------------------
Michael J. Moone
PRESIDENT

<TABLE>
<CAPTION>
NAME TITLE DATE
- ------------------------------------------------ --------------------------------------- ----------------------

<C> <S> <C>
/s/ MICHAEL J. MOONE Chief Executive Officer, President and
-------------------------------------- Director [Principal Executive September 30, 1997
Michael J. Moone Officer]

/s/ MICHAEL C. HOBERG Vice President--Finance and Chief
-------------------------------------- Financial Officer [Principal September 30, 1997
Michael C. Hoberg Financial and Accounting Officer]

/s/ YVES C. FAROUDJA* Chief Technical Officer, Director and
-------------------------------------- Chairman of the Executive Committee, September 30, 1997
Yves C. Faroudja Secretary

/s/ MERV L. ADELSON*
-------------------------------------- Director September 30, 1997
Merv L. Adelson

/s/ STUART D. BUCHALTER*
-------------------------------------- Director September 30, 1997
Stuart D. Buchalter

/s/ KEVIN B. KIMBERLIN*
-------------------------------------- Director September 30, 1997
Kevin B. Kimberlin

/s/ MATTHEW D. MILLER*
-------------------------------------- Director September 30, 1997
Matthew D. Miller

/s/ WILLIAM N. SICK*
-------------------------------------- Director September 30, 1997
William N. Sick

/s/ WILLIAM J. TURNER*
-------------------------------------- Director September 30, 1997
William J. Turner
</TABLE>

*By: /s/ MICHAEL C. HOBERG
-------------------------
Michael C. Hoberg
Attorney-in-fact

II-5
<PAGE>
FAROUDJA, INC.

SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS

(IN THOUSANDS)

<TABLE>
<CAPTION>
ADDITIONS
--------------------------
BALANCE AT CHARGED TO CHARGE TO
BEGINNING OF COSTS AND OTHER BALANCE AT
PERIOD EXPENSES ACCOUNTS DEDUCTIONS(1) END OF PERIOD
------------- ------------- ----------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
Six-months ended June 30, 1997 deducted from
asset account:
Allowance for doubtful accounts............... $ 110 $ 71 $ -- $ -- $ 181
--- --- --- --- ---
--- --- --- --- ---
Year ended December 31, 1996 deducted from asset
account:
Allowance for doubtful accounts............... $ 10 $ 143 $ -- $ 43 $ 110
--- --- --- --- ---
--- --- --- --- ---
Year ended December 31, 1995 deducted from asset
account:
Allowance for doubtful account................ $ 10 $ -- $ -- $ -- $ 10
--- --- --- --- ---
--- --- --- --- ---
Year ended December 31, 1994 deducted from asset
account:
Allowance for doubtful accounts............... $ 10 $ -- $ -- $ -- $ 10
--- --- --- --- ---
--- --- --- --- ---
</TABLE>

- ------------------------

(1) Uncollectible accounts written off, net of recoveries.

S-1
<PAGE>
EXHIBIT INDEX

3.1* The Company's Restated Certificate of Incorporation, as amended on August 12, 1997.

3.2* The Company's By-Laws.

4.1* Warrants (1-3), dated July 16, 1993, for the purchase of Common Stock issued to John Sie.

4.2* Warrant, dated January 20, 1997, for the purchase of Common Stock issued to Yves Faroudja.

4.3* Warrant, dated December 31, 1996, for the purchase of Common Stock issued to Adelson Investors, LLC.

4.4* Specimen of Common Stock Certificate.

5.1 Opinion of Buchalter, Nemer, Fields & Younger, a Professional Corporation, as to the validity of the
shares of Common Stock offered hereby.

10.1* Consulting Services Agreement, dated September 21, 1994, between the Company and M-Squared and
Technology L.L.C.

10.2* Letter Agreement, dated December 31, 1996, between the Company and Merv L. Adelson for certain
consulting services.

10.3* Letter Agreement, dated November 13, 1995, by and among certain stockholders of the Company listed
therein and Spencer Trask Holdings, Inc.

10.4* Amendment to Letter Agreement, dated February 9, 1996, among certain stockholders of the Company listed
therein and Spencer Trask Holdings, Inc.