FAROUDJA INC, 424B3, 1998-08-18

FAROUDJA INC
424B3, 1998-08-18
HOUSEHOLD AUDIO & VIDEO EQUIPMENT

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Filed Pursuant to Rule 424(b)(3)
File Number 333-59901

1,680,871 SHARES

FAROUDJA, INC.
COMMON STOCK

ALL OF THE 1,680,871 SHARES OF COMMON STOCK $.001 PAR VALUE (THE "COMMON
STOCK") OF FAROUDJA, INC. ("FAROUDJA" OR THE "COMPANY") OFFERED HEREBY ARE BEING
OFFERED BY THE SELLING STOCKHOLDERS NAMED HEREIN (THE "SELLING STOCKHOLDERS").
SEE "PRINCIPAL AND SELLING STOCKHOLDERS." THE COMPANY WILL NOT RECEIVE ANY OF
THE PROCEEDS FROM THE SALE OF THE COMMON STOCK BEING OFFERED BY THE SELLING
STOCKHOLDERS. THE COMMON STOCK IS TRADED ON THE NASDAQ STOCK MARKET UNDER THE
SYMBOL "FDJA."

The Common Stock may be offered and sold, from time to time, and in amounts to
be determined, by the Selling Stockholders directly, through agents designated
by them from time to time, or through dealers or underwriters also to be so
designated, and on terms to be determined at the time of any sale. The Selling
Stockholders reserve the sole right to accept and, together with their agents
from time to time, to reject in whole or in part any proposed purchase to be
made directly or through agents. Shares of the Common Stock may be offered by
and on behalf of the Selling Stockholders from time to time in and through
transactions or distributions on The Nasdaq Stock Market, in privately
negotiated transactions, or otherwise at prices prevailing in such exchange or
as may be negotiated at the time of sale. See "Principal and Selling
Stockholders" and "Plan of Distribution."

The aggregate proceeds to the Selling Stockholders from the sale of the
Common Stock will be the purchase price of Common Stock sold less the aggregate
agents' commissions and underwriters' discounts, if any, and other expenses of
distribution not borne by the Company. The Company will receive none of the
proceeds from the sale of any of the Common Stock. The Company has agreed to
bear the expenses of registration of the Common Stock under federal and state
securities laws other than commissions, discounts or fees paid to any
underwriter, broker, dealer or other selling agent.

The Selling Stockholders and any broker-dealers, agents or underwriters
that participate with the Selling Stockholders in the distribution of the Common
Stock may be deemed to be "underwriters" within the meaning of the Securities
Act of 1933, as amended (the "Securities Act"), and any discounts, commissions
or concessions received by them and any profit on the resale of the Common Stock
purchased by them may be deemed to be underwriting discounts or commissions
under the Securities Act.

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

THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. SEE "RISK
FACTORS" BEGINNING AT PAGE 3.
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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.

The date of this Prospectus is August 12, 1998

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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
Prospectus 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.

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TABLE OF CONTENTS

PAGE
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SUMMARY ................................................................. 1
RISK FACTORS................................................................ 3
DIVIDEND POLICY............................................................. 11
PRICE RANGE OF COMMON STOCK................................................. 11
SELECTED CONSOLIDATED FINANCIAL DATA........................................ 12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS............................. 14
BUSINESS ................................................................. 20
MANAGEMENT ................................................................. 32
CERTAIN TRANSACTIONS........................................................ 41
PRINCIPAL AND SELLING STOCKHOLDERS.......................................... 44
DESCRIPTION OF CAPITAL STOCK................................................ 48
SHARES ELIGIBLE FOR FUTURE SALE............................................. 51
PLAN OF DISTRIBUTION........................................................ 52
LEGAL MATTERS............................................................... 53
EXPERTS ................................................................. 53
Index to Consolidated Financial Statements................................. F-1
</TABLE>

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FAROUDJA, PICTURE PLUS, PRESENTATION PLUS, DIGITAL FORMAT TRANSLATOR, AND
DIGITAL LIGHT PROCESSING 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 is a trademark of Texas Instruments
Incorporated.

The Company has filed with the Commission a Registration Statement on
Form S-1 (herein together with all amendments and exhibits, referred to as the
"Registration Statement") under the Securities Act with respect to the Common
Stock offered hereby. This Prospectus does not contain all of the information
contained in the Registration Statement and reference is made to the
Registration Statement, certain parts of which are omitted in accordance with
the rules and regulations of the Commission, and the exhibits and schedules
thereto for further information with respect to the Company and the Common Stock
offered hereby. Statements contained herein concerning the provisions of any
documents are not necessarily complete, and in each instance reference is made
to the copy of such document filed as an exhibit to the Registration Statement.
Each such statement is qualified in its entirety by such reference.

The Company is subject to the informational requirements of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in
accordance therewith files reports, proxy statements and other information
with the Securities and Exchange Commission (the "Commission"). Such reports,
proxy statements and other information filed by the Company and 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., Washington, D.C. 20549 and at certain
regional offices of the Commission located at Seven World Trade Center, 13th
Floor, New York, New York 10048 and Northwestern Atrium Center, 500 West
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 Stock Market, Reports Section, 1735 "K" Street, N.W.,
Washington, D.C. 20006.

ii
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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 FACTORS 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 for the high-end home theater, industrial and broadcast markets through
its wholly-owned subsidiary, Faroudja Laboratories, Inc. The Company is
currently seeking to apply its technologies and experience to address
opportunities in the emerging digital television ("DTV") and high definition
television ("HDTV") broadcast and display environments and to facilitate the
convergence of the personal computer ("PC") and the television ("TV").

Video images are pervasive in today's society as sources of entertainment
and information. 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.

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 customers and board level products to original equipment
manufacturer ("OEM") customers.

Faroudja is developing 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 has developed 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 currently commencing production of its first product in this field,
the Digital Format Translator-TM-.

The Company is also developing products and technologies that are intended
to solve the problems associated with the display of high quality TV pictures on
PC screens by significantly reducing the inherent noise and artifacts.

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 primarily sells directly. 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.

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.

1
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SUMMARY CONSOLIDATED FINANCIAL DATA
(in thousands, except per share data)
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THREE MONTHS
YEAR ENDED DECEMBER 31, ENDED MARCH 31,
----------------------------------------------------------- ---------------------------
1993 1994 1995 1996 1997 1997 1998
---- ---- ---- ---- ---- ---- ----
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CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Total revenues........................... $5,684 $8,065 $11,954 $13,126 $17,006 $ 3,585 $ 3,358
Gross profit............................. 3,557 5,067 7,739 8,329 11,745 2,586 2,254
Operating income (loss).................. 1,206 1,859 4,006 2,115 1,570 305 (265)
Net income............................... $1,251 $1,929 $ 4,009 $ 1,511 $ 1,251 $ 249 $ 8

Net income per share(1)
Basic.................................. $0.14 $0.03 $0.00
Diluted................................ $0.13 $0.03 $0.00
Shares used in per share calculation
Basic.................................. 9,041 8,200 12,079
Diluted................................ 9,925 9,054 12,766

PRO FORMA DATA (2):
Pro forma adjustments.................... $(701) $(939) $(192)
Pro forma net income..................... 1,228 3,070 1,319
Pro forma net income per share(1)
Basic.................................. $0.15 $0.43 $0.17
Diluted................................ 0.15 0.43 0.16
Shares used in per share calculation
Basic.................................. 7,979 7,157 7,977
Diluted................................ 7,979 7,176 8,191
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MARCH 31, 1998
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CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments................................................ $ 21,875
Working capital.................................................................................. 27,103
Total assets..................................................................................... 31,720
Total long-term debt............................................................................. ---
Total stockholders' equity....................................................................... 29,463
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(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 assuming the Company had been 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."

RECENT OPERATING RESULTS

On July 23, 1998, Faroudja reported it's second quarter financial
results. Net revenues for the quarter ending June 30, 1998, were $3.4 million
compared to net revenues of $4.3 million in the quarter ended June 30, 1997.
Net revenues for the first six months of 1998, ended on June 30, 1998, were
$6.7 million compared to $7.9 million net revenues for the six months in 1997
ended on June 30, 1997. The Company's net loss in the quarter ended June 30,
1998 was $754,000, or $0.06 per share on a diluted basis, compared to net
income of $285,000, or $0.03 per share on a diluted basis for the quarter
ended June 30, 1997. Net loss for the six months ended June 30, 1998, was
$746,000, or $0.06 per share on a diluted basis compared to net income of
$534,000 or $0.06 per share on a diluted basis for the six months ended June
30, 1997. On both a year-to-year and a sequential comparison, second quarter
1998 revenues and net income were negatively impacted by the absence of major
royalty payments. See "Business--Strategic Relationships and Licensing."
Spending in the second quarter was up significantly over the first quarter,
as the Company focused its development efforts on its line of Digital Format
Translators-TM-. See "Business--Broadcast Products."

2
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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 from
customers and the unexpected loss of key customers. Many of these factors are
beyond the Company's control. 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.

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 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.

3
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RISKS ASSOCIATED WITH NEW MARKETS AND APPLICATIONS; MARKET ACCEPTANCE

A substantial portion of the Company's revenues in 1997 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 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.
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 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 to certain
current broadcast industry standards. There can be no assurance that
manufacturers will continue to follow these standards or that competing
standards will not emerge which will be preferred by manufacturers 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 Federal Communications Commission ("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, 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, to develop new products and features to meet changing
customer requirements and evolving industry standards and to identify and
enter into royalty-generating license agreements with prospective licensees.
The Company anticipates that sales from its line multiplier product lines
will experience limited growth, or may decline, in future periods. The home
theater market has exhibited weakness which the Company believes is
attributable to consumer confusion over HDTV. The Company believes that such
confusion and related market weakness could continue until HDTV broadcast
begins, as currently anticipated, at the end of the third quarter of 1998.
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 products
introduced in 1997 and scheduled to be introduced in 1998. 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

4
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Associated with New Markets and Applications; Market Acceptance." 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 will begin producing products intended
for the digital broadcast market in the third quarter of 1998. There can be
no assurance that the Company's broadcast products will be accepted by the
broadcast market. There can be no assurance as to the amount of royalties,
if any, that the Company will receive going forward under the license
agreement with S3 Incorporated ("S3"). S3 has advised the Company that it
will not make any payments necessary to maintain its exclusive license rights
with respect to any periods after March 31, 1998 and the Company does not
currently have any other license agreements in effect pursuant to which it
expects to receive substantial future royalties. See "Certain
Transactions--License Agreement with S3" for further information relating to
the relationship between the Company and S3.

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.

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 Electronics, Inc. ("DWIN"), Extron
Electronics ("Extron"), NEC Technologies, Inc. USA ("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.

Yves Faroudja, the Company and General Instrument Corporation ("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
the Company's Digital Format Translator-TM- products.

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 GI are licensees which could compete with certain of the Company's
technologies and products.

5
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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 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; Risks of
Third Party Infringement."

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.

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. The Company
depends on CinemaPro Corporation dba Runco International ("Runco") and Vidikron
of America, Inc. ("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. There can be no assurance
that the Company will identify new strategic partners or enter into additional
strategic relationships or 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.

RISKS ASSOCIATED WITH EXPORT SALES AND OPERATIONS

The Company intends to expand its international presence in order to
increase its export sales and believes that export sales will increase as a
percentage of total revenues in future periods. 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, 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

6
<PAGE>
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. 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."

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 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'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.

RELIANCE ON INDEPENDENT FOUNDRIES AND MANUFACTURING

The Company currently relies on independent foundries to manufacture,
assemble and test all of its semiconductor components and products. 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

7
<PAGE>
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. The Company does not have
any long term agreements with its subcontractors and contract manufacturers.
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.

LIMITED PROTECTION OF PROPRIETARY RIGHTS; RISKS OF THIRD PARTY INFRINGEMENT

The Company's future success depends in part upon its ability to protect
its 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. There
can be no assurance that patents will be issued from any pending applications,
be issued in all countries where the Company's products can be sold, or that any
claims allowed from pending applications will be of sufficient scope or strength
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 nonexclusive
right to license his patents and technologies to third parties for use outside
the Company's field of use. 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 affect on the Company's business,
financial condition and operating results. See "Business--Proprietary Rights
and Licenses" and "Certain Transactions--Yves Faroudja License Agreement."

8
<PAGE>
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.

The Company may initiate claims or litigations against third parties for
infringement of the Company's proprietary rights or to establish the validity of
the Company's proprietary rights. 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."

DEPENDENCE ON SENIOR MANAGEMENT AND OTHER KEY EMPLOYEES

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 ("CTO"), 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. Mr. Faroudja has entered into an
agreement with the Company pursuant to which he will serve as the Company's CTO
until a new CTO is identified and hired. Thereafter, Mr. Faroudja will serve as
a Senior Fellow to the Company, advising the Company in a variety of areas, with
time to be devoted at Mr. Faroudja's discretion. 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."

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, 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."

9
<PAGE>

SHARES ELIGIBLE FOR FUTURE SALES

Sales of substantial amounts of Common Stock (including shares issued upon
the exercise of outstanding options) in the public market could materially
adversely affect the market price of the Company's 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. As of March 31, 1998, there were 12,084,557 shares of Common
Stock outstanding. Of this amount, 6,880,632 are freely tradeable without
restriction or further registration under the Securities Act, unless such shares
are held by "affiliates" of the Company as that term is defined in Rule 144
under the Securities Act. Approximately 4,499,513 additional shares will be
available for sale in the public market on the date of this Prospectus and an
additional 704,412 shares will be available on September 5, 1998, subject in
some cases to compliance with the volume and other limitations of Rule 144. In
addition, the Company had 1,607,952 options and 165,152 warrants outstanding
as of March 31, 1998.

CONTROL BY MANAGEMENT AND EXISTING STOCKHOLDERS

After the sale of the securities offered hereby, the current officers,
directors and major stockholders of the Company will own or control
approximately 42.9% of the outstanding shares of Common Stock (including options
and warrants to purchase Common Stock). Accordingly, these stockholders, if
they were to act as a group, would be able to influence the Company's Board of
Directors and otherwise influence 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 Stockholder" and "Description of Capital Stock."

POSSIBLE VOLATILITY OF STOCK PRICE

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. There can be no assurance that the market price of the
Company's Common Stock will not experience significant fluctuations in the
future, including fluctuations that are unrelated to the Company's performance.

DEPENDENCE ON ROYALTY REVENUES

There can be no assurance as to the amount of royalties, if any, that
the Company will receive going forward under its license agreement with S3
Incorporated ("S3"). S3 has advised the Company that it will not make any
payments necessary to maintain its exclusive license rights with respect to
any periods after March 31, 1998 and the Company does not currently have any
other license agreements in effect pursuant to which it expects to receive
substantial future royalties. Revenues from S3 accounted for 10.6% of the
Company's total revenues for the year ended December 31, 1997 and 22.3% of
total revenues for the quarter ended March 31, 1998. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
"Business--Strategic Relationships and Licensing", "Certain Transactions --
License Agreement with S3" for further information relating to the
relationship between the Company and S3.

10
<PAGE>
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.

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. 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 sole shareholder, at his 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.

PRICE RANGE OF COMMON STOCK

The Company's Common Stock began trading publicly on The Nasdaq Stock
Market under the symbol "FDJA" on October 30, 1997. Prior to that date, there
was no public market for the Company's Common Stock. The following table
presents, for the periods indicated, the intraday high and low prices for the
Common Stock as reported on The Nasdaq Stock Market.

High Low
---- ---
<S> <C> <C>
Fiscal 1997
-----------
Fourth Quarter (from October 30, 1997)....... $10.50 $5.50

Fiscal 1998
-----------
First Quarter................................ $11.25 $6.44
Second Quarter .............................. $12.38 $7.88
Third Quarter (through August 12, 1998) ....... $ 8.63 $6.63
</TABLE>

On August 12, 1998, the last sale price of the Company's Common Stock as
reported on The Nasdaq Stock Market was $7.13. As of August 12, 1998, there
were approximately 339 holders of record of the Company's Common Stock which
the Company believes represent more than 2,000 beneficial holders.

11
<PAGE>

SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated balance sheet data as of December 31,
1993, 1994, and 1995 and the selected consolidated statement of operations data
for the years ended December 31, 1993 and 1994, have been derived from 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, 1997, and the
related consolidated balance sheet data as of December 31, 1996 and 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 March 31, 1998 and the selected statement of operations data for the three
month periods ended March 31, 1997 and 1998 have been derived from unaudited
consolidated financial statements included elsewhere in this Prospectus. The
quarterly data for each of the eight quarters ended March 31, 1998 have been
derived from unaudited consolidated financial statements not included herein.
The unaudited consolidated financial statements include, in the opinion of
management, all adjustments, consisting only of normal recurring adjustments,
necessary for a fair statement of the results for those periods. The operating
results for the three months ended 1998 are not necessarily indicative of
results that may be expected for the year ending December 31, 1998 or any other
interim period or future fiscal year.

THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED MARCH 31,
-------------------------------------------------------- ---------------------
1993 1994 1995 1996 1997 1997 1998
---- ---- ---- ---- ---- ---- ----
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Revenues:
Product sales.............................. $5,684 $8,065 $11,954 $12,626 $15,506 $2,835 $2,608
License and royalty revenue................ --- --- --- 500 1,500 750 750
------- ---------- ---------- ---------- --------- --------- -------
Total revenues........................... 5,684 8,065 11,954 13,126 17,006 3,585 3,358
Cost of product sales........................ 2,127 2,998 4,215 4,797 5,261 999 1,104
----- ----- ----- ----- ----- --------- -------
Gross profit................................. 3,557 5,067 7,739 8,329 11,745 2,586 2,254
Operating expenses:
Research and development................... 869 1,277 1,484 2,464 4,215 899 1,077
Sales and marketing........................ 525 778 1,070 2,127 3,465 678 752
General and administrative................. 957 1,153 1,179 1,623 2,183 392 690
Financing expenses......................... --- --- --- --- 312 312 ---
------- ------- ------- ------- ------- -------- ------
Total operating expenses................. 2,351 3,208 3,733 6,214 10,175 2,281 2,519
----- ----- ----- ----- ------ ------- -------
Operating income (loss)...................... 1,206 1,859 4,006 2,115 1,570 305 (265)
Other income:
Interest income............................ 39 69 82 83 363 97 278
Other, net................................. 20 14 5 --- 84 -- --
-- ---- --- ------- -------- ------- -----
Income before provision for
income taxes............................... 1,265 1,942 4,093 2,198 2,017 402 13
Provision for income taxes................... 14 13 84 687 766 153 5
---- ---- ---- ------ ------- ------- ------
Net income................................... $1,251 $1,929 $4,009 $1,511 $1,251 $ 249 $ 8
------ ------ ------ ------ ------ ------- -------
------ ------ ------ ------ ------ ------- -------
Net income per share(1):
Basic...................................... $0.14 $0.03 $0.00
Diluted.................................... $0.13 $0.03 $0.00
Shares used in per share calculation:
Basic...................................... 9,041 8,200 12,079
Diluted.................................... 9,925 9,054 12,766
PRO FORMA DATA (UNAUDITED) (2):
Historical income before provision
for income taxes........................... 1,942 4,093 2,198
Pro forma provision for
income taxes............................... 714 1,023 879
----- ----- ------
Pro forma net income......................... $1,228 $3,070 $1,319
----- ----- ------
----- ----- ------
Pro forma net income per share(1):
Basic...................................... $0.15 $0.43 $0.17
Diluted.................................... $0.15 $0.43 $0.16
Shares used in per share calculation:
Basic...................................... 7,979 7,157 7,977
Diluted.................................... 7,979 7,176 8,191
</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 assuming the Company had been 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."

12
<PAGE>

DECEMBER 31, MARCH 31,
----------------------------------------------------------- -------------
1993 1994 1995 1996 1997 1998
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short
term investments......................... $1,455 $1,064 $2,759 $3,083 $23,549 $21,875
Working capital.............................. 2,599 2,223 4,744 5,861 26,987 27,103
Total assets................................. 3,652 3,434 6,734 9,604 33,489 31,720
Total long-term obligations,
less current portion....................... 996 -- -- -- -- --
Stockholders' equity......................... 2,166 2,826 5,515 7,245 29,348 29,463
</TABLE>

QUARTERLY DATA (unaudited)
(in thousands, except per share amounts)
1996 1997 1998
--------------------------- -------------------------------------- --------

June 30 Sept. 30 Dec. 31 March 31 June 30 Sept. 30 Dec. 31 March 31
------- -------- ------- -------- ------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Total revenues................................ $ 2,753 $ 3,663 $ 3,874 $ 3,585 $ 4,279 $ 5,012 $ 4,130 $ 3,358
Gross profit.................................. 1,757 2,390 2,416 2,586 2,992 3,346 2,820 2,254
Net income.................................... 188 385 318 249 285 391 326 8
Net income per share (diluted)................ $0.02 $0.04 $0.04 $0.03 $0.03 $0.04 $0.03 $0.00
</TABLE>

13
<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

Faroudja, Inc. (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.
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 theatre market, a
line multiplier. In 1997 and 1996 sales of products for the home theater and
industrial markets comprised approximately 88% and 80%, 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
1995 through 1997, primarily as a result of the introduction of a number of new
products for the home theater and industrial markets. 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 products
as well as for use in the TV and PC industries. Net income declined in 1997
from 1996 and 1996 from 1995 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, in 1996, 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, introduce enhanced versions of its products, and
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 until such time as royalties, if received, become
a significantly larger percentage of revenues. 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 from the high-end home theater, industrial and broadcast markets. On
an absolute dollar basis, sales and marketing expenses, general and
administrative expenses and research and development expenses are expected to
increase in 1998 over 1997. Consequently, without a corresponding increase in
revenues, net income will be adversely impacted.

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 and product returns or price protection charges from
customers. Many of these factors are beyond the Company's control. 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 has received quarterly prepaid license fees from S3
Incorporated ("S3") to maintain exclusivity under its license agreement with the
Company. S3 has advised the Company that no prepayments will be made with
respect to any periods after March 31, 1998. There can be no assurance as to
the amount of royalties, if any, the Company will receive in the future as the
Company does not have any other license agreements in effect pursuant to which
it expects to receive substantial royalties.

14
<PAGE>
The Company introduced its new family of Digital Format Translators-TM- in
April 1998. There is no assurance as to the eventual demand for this product,
the size of the digital broadcast market, or that the digital broadcast market
will develop in the timeframe currently specified by the FCC.

RECENT OPERATING RESULTS

RESULTS OF OPERATIONS

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

THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED MARCH 31,
-------------------------------- -----------------------
1995 1996 1997 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
REVENUES:
Product sales.............................. 100.0% 96.2% 91.2% 79.1% 77.7%
License and royalty revenues............... -- 3.8 8.8 20.9 22.3
------- ------ ------- ------- -------
Total revenues........................... 100.0 100.0 100.0 100.0 100.0
Cost of product sales........................ 35.3 36.5 30.9 27.9 32.9
------ ------ ------- ------- -------
Gross margin................................. 64.7 63.5 69.1 72.1 67.1
Operating expenses:
Research and development................... 12.3 18.8 24.8 25.1 32.1
Sales and marketing........................ 9.0 16.2 20.4 18.9 22.4
General and administrative................. 9.9 12.4 12.8 10.9 20.5
Financing expense.......................... -- -- 1.8 8.7 --
------- ------ ------- ------- -------
Total operating expenses................. 31.2 47.4 59.8 63.6 75.0
Operating income (loss)...................... 33.5 16.1 9.3 8.5 (7.9)
Other income:
Interests income........................... 0.7 0.6 2.1 2.7 8.2
Other, net................................. -- -- 0.5 -- --
------- ------ ------- ------- -------
Income before provision for income taxes..... 34.2 16.7 11.9 11.2 0.3
Provision for income taxes................... 0.7 5.2 4.5 4.3 0.1
------- ------ ------- ------- -------
Net income................................... 33.5% 11.5% 7.4% 6.9% 0.2%
------- ------ ------- ------- -------
------- ------ ------- ------- -------
</TABLE>

THREE MONTHS ENDED MARCH 31, 1997 AND 1998

TOTAL REVENUES. Total revenues decreases to $3.4 million in first quarter
of 1998 from $3.6 million in the first quarter of 1997 for a 6.5% decline year
to year. The $0.2 million decline was primarily due to reduced sales of line
multiplier products. This was partially offset by increases in shipments of the
VP100 video decoder, DV1000 digital video disk player and the introduction of
the RP4800 rear screen projection system. Revenues from S3 accounted for 23.0%
and 22.3% of total revenues in the first quarter of 1997 and 1998, respectively.
Sales to Vidikron accounted for 13.6% and 5.5% of total revenues in the first
quarter of 1997 and 1998, respectively.

15
<PAGE>

Export sales, consisting primarily of VP400, VP280 and VP250 products
shipped to dealers and distributors in Asia and Europe, represented 6.8% and
17.9% of total revenues in the first quarter of 1997 and 1998, 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. The Company
believes that current economic conditions in Asia might adversely impact any
increase in sales to that region in 1998.

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 line will
experience limited growth, or may decline, in future periods. In the first
quarter of 1998, the home theater market continued to exhibit weakness, which
the Company attributes to consumer confusion over HDTV. The Company believes
that such confusion and related market weakness could continue until HDTV
broadcasting begins on a wide-scale basis, as currently anticipated at the end
of the third quarter of 1998. 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 products introduced in 1997 and scheduled to be introduced in
1998.

GROSS PROFIT. Gross profit as a percentage of total revenues was 72.1% in
the first quarter of 1997 and 67.1% in the first quarter of 1998. The decrease
in gross margin in the first quarter of 1998 compared to 1997 was primarily due
to lower product gross margin. Product gross margin as a percentage of product
sales decreased from 64.8% in 1997 to 57.7% in 1998. This was primarily due to
the sale of products introduced in the second half of 1997, such as the RP4800
rear screen projection system, DV1000 digital video disc ("DVD") player and
VP100 decoder, which have lower margins than the Company's line multiplier
products.

RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased from $899,000 in the first quarter of 1997 to $1.1 million in the
first quarter of 1998. The increases were primarily due to costs 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 increased from 25.1% in the first quarter of 1997 to 32.1% in the first
quarter of 1998 due to the expansion of the VLSI department that occurred
throughout 1997. The Company increased its engineering and management
personnel, and related equipment, 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 broadcast, 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
$678,000 in the first quarter of 1997 to $752,000 in the first quarter of 1998.
Sales and marketing expenses increased as a percentage of total revenues from
18.9% in the first quarter of 1997 to 22.4% in the first quarter of 1998
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 and sales representatives. 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
increased from $392,000 in the first quarter of 1997 to $690,000 in the first
quarter of 1998. General and administrative expenses increased as a percentage
of total revenues from 10.9% in the first quarter of 1997 to 20.5% in the first
quarter of 1998. This was primarily due to expenses associated with being a
public company, additions to the Company's general and administrative staff, and
an increase in legal fees associated with the Company's efforts against alleged
patent infringement. The Company anticipates that it will incur increases in
general and administrative expenses in future periods associated with litigation
to protect the Company's intellectual property and with legal, accounting and
other expenses of being a public company.

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

OTHER INCOME. Interest and other income were $97,000 in the first
quarter of 1997 and $278,000 in the first quarter of 1998. The increase in
1998 from 1997 was due to the investment of the $15.6 million net proceeds of
the Company's initial public offering completed in November 1997, and the $5
million investment by S3 in the Company in June 1997, in short-term, interest
bearing investment grade securities.
16
<PAGE>

PROVISION FOR INCOME TAXES. The Company's effective tax rate was 38% for
the first quarter of both 1997 and 1998. The Company anticipates implementing
certain tax planning strategies to reduce the effective tax rate in 1998 and
future periods.

FISCAL 1995, 1996 AND 1997

TOTAL REVENUES. Total revenues increased 9.8% and 29.5%, respectively, for
1996 and 1997 from their respective prior years. 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. The increase in
1997 was due primarily to increased shipments of line multiplier products for
the home theater market, shipments of new products including the VP100 decoder,
DV1000 DVD player, VP300 line tripler and VP280 frame doubler, and $1.5 million
of license and royalty revenues from S3. These factors offset a reduction in
sales to the broadcast market. Sales to Hughes/JVC Technology Corporation
("Hughes/JVC") accounted for 12.1% of total revenues in 1995. Sales to Vidikron
accounted for 10.5% and 11.1% of total revenues in 1996 and 1997. Revenues from
S3 accounted for 10.6% of total revenues in 1997.

Export sales, consisting primarily of VP400 and LD200 products shipped to
dealers and distributors in Asia and Europe, represented 13.2%, 15.3% and 13.1%
of total revenues in 1995, 1996 and 1997, respectively. All export sales are
denominated in U.S. dollars.

GROSS PROFIT. Gross profit as a percentage of total revenues was 64.7% in
1995, 63.5% in 1996 and 69.1% in 1997. Product gross margin declined in 1996 to
62.0% from 64.7% in 1995 primarily due to an increased proportion of sales to
distributors and OEM customers, 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 increase in
gross margin in 1997 compared to 1996 was primarily due to license and royalty
revenues. Product gross margin as a percentage of product sales increased to
66.1% in 1997 from 62.01% in 1996, primarily due to product cost reduction
efforts.

RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased from $1.5 million in 1995 and $2.5 million in 1996 to $4.2 million in
1997. The increases were primarily due to costs incurred by the Company for the
development of ASIC components used in the full range of the Company's products.
Research and development expenses increased as a percentage of total revenues to
18.8% in 1996 due to the establishment in 1996 of the VLSI design department.
Research and development expenses as a percentage of total revenues increased to
24.8% in 1997 due to expansion of the VLSI department.

SALES AND MARKETING EXPENSES. Sales and marketing expenses increased from
$1.1 million in 1995 and $2.1 million in 1996 to $3.5 million in 1997. Sales
and marketing expenses increased as a percentage of total revenues to 20.4% in
1997 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 and sales representatives.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased from $1.2 million in 1995 and $1.6 million in 1996 to $2.2 million in
1997. General and administrative expenses increased as a percentage of total
revenues to 12.4% in 1996 and 12.8% in 1997, primarily due to additions to the
Company's general and administrative staff, including the hiring of a new chief
executive officer, chief financial officer and general counsel, and an increase
in professional fees.

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

17
<PAGE>

OTHER INCOME. Interest and other income was $87,000 in 1995, $83,000 in
1996 and $447,000 in 1997. The increase in 1997 from 1996 was due to investment
of the $15.6 million net proceeds of the Company's initial public offering
completed in November 1997, and the $5 million investment by S3 in the Company
in June 1997, in short-term interest bearing investment grade securities.
Accordingly, the Company anticipates that interest income will increase
significantly in 1998 from 1997.

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
1995 consisted solely of a California franchise fee. FRE was a C Corporation
since its inception. The Company has incurred minimal foreign taxes. The pro
forma provision for income taxes, calculated assuming FLI's S Corporation status
terminated January 1, 1994, reflects an effective tax rate for the years ended
December 31, 1995 and 1996 of 25% and 40%, respectively. The Company's
effective tax rate for 1997 was 38%. The Company anticipates implementing
certain tax planning strategies to reduce the effective tax rate in future
periods.

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 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 $642,000 increase in accounts
receivable and (ii) a $793,000 increase in inventory.

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 (i) a $1.2 million increase in accounts receivable
primarily attributable to $1.0 million due from a licensee under an agreement
completed in December, 1996, (ii) a $96,000 increase in inventory and (iii) an
increase in deferred tax assets of $462,000.

In 1997, net cash provided by operating activities was $1,106,000,
primarily composed of (i) $1.3 million of net income, (ii) $561,000 of
depreciation and amortization, (iii) a $716,000 increase in accounts payable,
(iv) a $545,000 increase in accrued compensation, (v) a $756,000 increase in
income taxes payable and (vi) a $265,000 increase in other accrued liabilities.
These were primarily offset by (i) a $330,000 increase in accounts receivable,
(ii) a $1.3 million increase in inventory, (iii) a $481,000 increase in deferred
tax assets, (iv) a $372,000 increase in other current assets and (v) a $500,000
decrease in deferred revenues.

In the first quarter of 1998, net cash used in operating activities was
$1.6 million, primarily composed of (i) a $772,000 decrease in accounts payable,
(ii) a $692,000 decrease in accrued compensation, (iii) a $198,000 decrease in
income taxes payable, (iv) a $222,000 decrease in other accrued liabilities, and
(v) a $180,000 increase in inventory. These were partially offset by a $197,000
decrease in other current assets.

INVESTING ACTIVITIES. Capital equipment purchases in 1995, 1996 and 1997
were $392,000, $967,000 and $1.2 million, respectively, and $168,000 in the
first quarter of 1998, primarily for computer hardware and software used in
research and development engineering test equipment and furniture and fixtures.

FINANCING ACTIVITIES. In connection with its status as a Subchapter S
Corporation, the Company distributed $1.5 million, and $4.0 million 1995 and
1996 respectively. In 1996, the Company raised $4.0 million through the
issuance of its Common Stock. In June 1997, the Company also received $5.0
million from a private placement with S3. The Company effected its initial
public offering in October 1997. Net proceeds, after underwriting discounts
and commissions and expenses associated with the offering, were $15.6
million. In the first quarter of 1998, the Company received $90,000 from
stock purchases under the employee stock purchase plan.

18
<PAGE>

LIQUIDITY. At March 31, 1998, the Company's principal sources of liquidity
consisted of cash, cash equivalents and short-term investments totaling $21.9
million, and a bank credit facility for $2.0 million. The Company's working
capital at March 31, 1998 was $27.1 million. On April 1, 1998, the Company
renewed its bank revolving line of credit which now expires on April 5, 1999.
The line of credit is secured by substantially all of the Company's tangible
assets. Borrowings are limited to defined percentages of eligible accounts
receivable. In addition, the Company must satisfy certain financial covenants.

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 will be sufficient to support the Company's planned activities
through at least the next twelve months.

YEAR 2000. The Company has determined that its present internal management
information systems are not compliant with Year 2000 requirements and has
implemented plans to upgrade both its software and hardware in the normal course
of business during 1998. It will also be initiating discussions with its
significant suppliers, customers and financial institutions to ensure that their
systems are Year 2000 compliant. The Company expects the total costs of these
upgrades to be less than $500,000 and is scheduled to complete its upgrades by
the end of 1998. It does not anticipate the cost of such upgrade to have a
significant impact on its operations or financial position.

19
<PAGE>
BUSINESS
OVERVIEW

Faroudja designs, develops and markets a range of video image enhancement
products for the high-end home theater, industrial and broadcast markets through
its wholly-owned subsidiary, Faroudja Laboratories, Inc. The Company is
currently seeking to apply its technologies and experience to address
opportunities in the DTV and HDTV broadcast and display environments 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.

BACKGROUND

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 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 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. To date, the interlace/progressive
conversion, along with other steps in the conversion of the TV signal, have
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.

20
<PAGE>

FAROUDJA SOLUTIONS

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

Faroudja is developing 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 currently beginning to produce its first product in this field, the
Digital Format Translator-TM-.

The Company is also developing products and technology that are intended to
solve the problems associated with the display of high quality pictures on PC
screens by significantly reducing the inherent noise and artifacts.

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, DTV display 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 targeting 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 broadcast and display
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 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.

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

21
<PAGE>

relationships with customers serving international markets, such as Hughes/JVC,
Vidikron, Runco and NEC, and product development that incorporates various
international specifications.

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:

Market Product Description
- ----------------------- ------------- ---------------------------------------------------------------------------------------
<S> <C> <C>
TV-Image VP401 Line quadrupler and video processor for large screen high resolution video
Enhancement/ VP401U projection systems
Line Multiplying
VP301 Line tripler and video processor for large screen high resolution video projection
systems

VP201 Line doubler and video processor for large screen high resolution video projection
VP201U systems
VP251
VP281FD

VP100 Video decoder with detail and color enhancement
VP100P

Computer Monitor VP600 Line multiplier and scaling product for high resolution video computer monitors
Enhancement

Rear Screen RP4800 Rear screen projection system with line doubler
System

TV-Source DV1000 DVD/CD player with detail and color enhancement
Players LD1000 Laser disc player with audio enhancement

Broadcast DFD-U Low noise video decoder/frame synchronizer with video adjustments

CFD-SN Very low noise video decoder with video adjustments

DFT1000 Format translator for translating digital component video into 480p video with frame
synchronization

DFT2000 Format translator for translating digital component video into 480p,
720p and 1080i video formats with full aspect ratio control and frame
synchronization.

DFT5000 Format translator for translating analog composite, analog component,
digital composite, digital component and S-Video inputs into 480p, 720p and
1080i video formats with full aspect ratio control, frame synchronization,
digital noise reduction and system control software
</TABLE>

TV PRODUCTS

LINE QUADRUPLERS (VP401 AND VP401U). Faroudja line quadrupler video
processors produce cinemalike 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 projection TV systems. The

22
<PAGE>

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 TRIPLING VIDEO PROCESSORS (VP301). The Company's line tripling video
processors utilize certain of the same technologies as the Company's line
quadruplers, and deliver similar results for smaller direct-view or projection
TV systems.

LINE DOUBLING VIDEO PROCESSORS (VP201, VP201U, VP251, VP281FD). 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 projection TV systems.

VP100 TV ENHANCER AND VP100P. The VP100 and VP100P 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 increase
image detail and depth. These products offer consumers a moderately priced
video enhancement technology that plugs directly into the TV unit.

REAR PROJECTION SYSTEM (RP4800). The Company's 48 inch wide rear screen
projection system incorporates a VP250 line doubling video processor. This
display system is designed for customers with space, remodeling or lighting
constraints, provides HDTV quality images from analog sources and is HDTV
compatible.

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 1995, 1996 and 1997
were 80%, 80% and 88%, respectively.

BROADCAST PRODUCTS

DFD-U 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-SN. 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.

The Company's Digital Format Translator-TM- products, used in conjunction
with existing NTSC production equipment at post-production, network or network
affiliate studios, provide broadcasters with the ability to produce programming
in various DTV and HDTV video formats. In addition to translating standard
resolution video into higher resolution formats, certain of the Digital Format
Translator-TM- products enable broadcasters to transform standard source
material (4:3 aspect ratio) into a wide screen (16:9 aspect ratio) format. The
products provide user-friendly means for studio engineers to control a broad
range of factors which ultimately contribute to superior image quality.

DFT1000 -DIGITAL FORMAT TRANSLATOR. The DFT1000 utilizes Faroudja
technology to translate 525 line interlace digital component video into the 480
line progressive DTV video format. The device includes frame synchronization
capability.

23
<PAGE>

DFT2000 -DIGITAL FORMAT TRANSLATOR. The DFT2000 utilizes Faroudja
technology to translate 525 line interlace digital component video into 480 line
progressive, 720 line progressive and 1080 line interlace video formats with the
ability to fully control the aspect ratio of the displayed images. The device
also includes frame synchronization capability.

DFT5000 -DIGITAL FORMAT TRANSLATOR. The DFT5000 has all of the features of
the DFT2000 and additional capabilities including analog composite, analog
component, digital composite and S-Video inputs, time base correction, digital
noise reduction and Window's NT-based control software which allows highest
level of user control over system features.

Broadcast product sales as a percentage of total revenues for 1995, 1996
and 1997 were 20%, 16% and 2%, 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.

COMPUTER PRODUCTS

The Company has designed and developed the VP600 Presentation Plus-TM-
product, a line multiplier and scaling product for high resolution video
computer monitors that incorporates time base correction, image enhancement and
video synchronization. To date, sales from this product have not been material.

RESEARCH AND DEVELOPMENT; NEW PRODUCTS

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. As of March 31, 1998, the Company had a staff of 27
full-time research and development personnel. During 1995, 1996 and 1997, the
Company's research and development expenses were approximately $1.5 million,
$2.5 million and $4.2 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 system ("DLP")
products and a video processor for less demanding industrial applications. The
Company is also developing a 58 inch wide rear screen projection TV system
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.

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.

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<PAGE>

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. 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. There can be no assurance that the Company's broadcast products
will be accepted by the broadcast market. There can be no assurance as to
the amount of royalties, if any, that the Company will receive in the future
as S3 has advised the Company that it will not make any payments necessary to
maintain its exclusive license rights with respect to any periods after March
31, 1998 and the Company does not currently have any other license agreements
in effect pursuant to which it expects to receive substantial royalties.

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-filtering 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."

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<PAGE>

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, DVD 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 make 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 odd lines of the picture, the second the even 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.

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.

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<PAGE>

STRATEGIC RELATIONSHIPS AND LICENSING

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,
which allows S3 to incorporate certain of the Company's technologies,
including line doubling, detail enhancement, cross-color suppression, motion
tracking and compensation and digital compression filtering, in S3's advanced
graphics accelerator products for mainstream multimedia PC systems. To the
extent that S3 incorporates the Company's technologies in S3 products, the
Company will receive royalties. The license agreement was exclusive for
certain markets, provided that certain conditions, including the payment of
minimum quarterly license fees, were satisfied. S3 has advised the Company
that it will not make payments necessary to maintain its exclusive rights
with respect to any periods after March 31, 1998. S3 has not shipped any
products that incorporate the Company's technology and there can be no
assurance that S3 will develop products or pay any future royalties under the
license agreement.

The patented technologies which the Company uses to produce standalone
products for home theater and broadcast applications may also be used in other
applications, such as digital television sets and digital set-top boxes, for
improving the image quality displayed from standard definition video sources.
The Company may offer to license these technologies, such as decoding, line
multiplication, detail enhancement, motion tracking, motion compensation, time
base correction and scaling, to strategic partners such as semiconductor chip
manufacturers, for wide scale deployment. The Company is not currently a party
to any such license agreements. There can be no assurance that the Company will
identify strategic partners or enter into additional license agreements for the
uses described or any other uses, or that any such relationships or agreements
will result in substantial revenues to the Company. See "Risk
Factors--Dependence on Strategic Relationships."

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
March 31, 1998, the Company maintained a sales and marketing staff of nine
persons at its headquarters in Sunnyvale, California, and three employees in
regional offices. The Company's marketing programs include trade shows,
training seminars, public relations and advertising. 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 10.6% and 11.1% respectively, of total revenues in 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, three
regional managers, one field training manager, independent sales representatives
and a customer service department.

The Company services industrial applications, such as corporate boardrooms,
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 three regional managers.

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

The Company has OEM relationships with Runco, Vidikron and Ampro
Corporation ("Ampro"). Vidikron is also integrating the VP100 decoder into
certain of its projection systems, including the new Helios I projector based
on Texas Instrument Incorporated's ("TI") 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.

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<PAGE>

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 DLP product. There can be
no assurance that the Company will continue to receive any revenues from any
of these arrangements.

In 1995, 1996 and 1997, the Company generated approximately 13.1%, 15.3%,
and 13.2%, respectively, of its total revenues from export sales. The decrease
in the percentage of total revenues generated from export sales in 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 increase its export sales and intends to hire
a sales manager in 1998 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 nonexclusive
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.

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.

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'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, except for rear
projection systems, 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, Inc. ("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, Inc. ("DC Electronics") which
builds all of the Company's wire and cable harnesses.

The Company's RP4800 Rear Projection System utilizes a projector chassis
provided by Audio Video Source, Inc. ("AVS") and modified to the Company's
specifications. AVS also manufactures the RP4800 for the Company on a contract
basis including integrating, assembling and testing the various components of
the system.

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

28
<PAGE>

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 Microelectronics,
Inc. ("SGS-Thomson"). In addition, Micro Devices Technology, Inc. ("MDT") and
TEMIC North America, Inc. ("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 reliance on independent foundries and
assembly and testing houses involves a number of risks.

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.

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 the Company's Digital Format
Translator-TM-.

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."

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<PAGE>

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. At present, the Company
believes that S3 and GI are licensees which could compete with certain of the
Company's technologies and products.

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 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, be issued in all countries where the
Company's products can be sold, or that any claims allowed from pending
applications will be of sufficient scope or strength 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 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. 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. See "Risk Factors--Limited Protection of Proprietary
Rights; Risk of Third Party Infringement" and "--Litigation."

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 "Risk Factors--Limited Protection of
Proprietary Rights; Risks of Third Party Infringement;" and "--Litigation."

EMPLOYEES

As of March 31, 1998, the Company had 70 full-time and three part-time
and contract employees, including 27 full-time employees primarily involved
in research and development activities, 12 in marketing and sales, 10 in
finance and administration and 21 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 collective
bargaining unit

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<PAGE>

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 expand its employee base in 1998,
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.

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 10,000 square feet to expand its headquarters in Sunnyvale,
California which expires in September 2003 and 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 $186,000 in 1996 and $289,000 in 1997, and the Company estimates
that this amount will increase to approximately $431,000 in 1998.

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 (the "596 Patent"), 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, including assertions 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
judgments that all of the claims of the patent are invalid and/or that the 596
Patent has not been infringed. They are also seeking recovery of their
respective attorneys' fees and costs. Discovery has commenced in both matters.
On February 18, 1998, the court in the Snell & Wilcox action granted the
Company's motion for leave to amend its complaint against Snell & Wilcox to add
claims of infringement of U.S. Patent Number 4,998,287 (the "287 Patent") and
U.S. Patent Number 4,881,125 (the "125 Patent"), and to name additional Snell &
Wilcox products as being within the category of infringing products. The 287
Patent, which was issued on March 5, 1991, and the 125 Patent, which was issued
on November 14, 1989, are owned by GI and licensed to the Company pursuant to a
license agreement dated May 1, 1996. By order dated May 1, 1998, the court
granted Snell & Wilcox's motion for summary judgment as to the 596 Patent on the
basis of noninfringement. The action will continue with respect to the 125
Patent and the 287 Patent. The Company's management believes that a finding
that all of the claims of the patents at issue in these cases are invalid or
have not been infringed, in one or both actions, would not have a material
adverse effect on the Company because the Company's products and business are
protected by a variety of patents and the Company will remain competitive even
in the absence of the protection afforded by the respective patents.

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<PAGE>

MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

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

NAME AGE POSITION(S)
---- --- -----------
<S> <C> <C>
Michael J. Moone.................. 52 President, Chief Executive Officer
and Director
Yves Faroudja (1)................. 64 Chief Technical Officer, Director
and Chairman of the Executive
Committee
Robert A. Sheffield............... 49 Vice President-Finance and Chief
Financial Officer
Donald S. Butler.................. 52 Vice President-Engineering
Kenneth S. Boschwitz.............. 44 Vice President-Business
Development, General Counsel and
Secretary
Thomas A. Harvey.................. 49 Vice President-Sales and Marketing
William J. Turner (2)............. 54 Chairman of the Board of Directors
Kevin B. Kimberlin (3)............ 45 Director
Matthew D. Miller (1)............. 51 Director
William N. Sick, Jr. (2).......... 63 Director
Stuart D. Buchalter (3)........... 60 Director
Merv L. Adelson (1)............... 68 Director
</TABLE>

- --------------------
(1) Member of the Executive Committee
(2) Member of the Compensation Committee
(3) Member of the Audit 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. Prior
thereto, he co-founded Kid One, Inc., a developer of electronic toys and games,
where from June 1993 to February 1995 he served as its Chief Executive Officer
and a director. In 1985, Mr. Moone founded Merchantec International, a credit
card processing company, and from May 1985 to May 1993 served as its President,
Chief Executive Officer and a director. In 1983 he founded Electronic
Publishing Systems Inc., a software development and marketing company, and from
April 1983 to May 1985 served as its President. 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.

YVES 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
("CTO") since July 1996 and is currently Chairman of its Executive Committee of
the Board of Directors. Mr. Faroudja has entered into an agreement with the
Company pursuant to which he will serve as the Company's CTO until a new CTO is
identified and hired.

ROBERT A. SHEFFIELD joined the Company in July 1998 as Vice President
- -Finance and Chief Financial Officer. From 1996 to June 1998, Mr. Sheffield
was the Vice President - Finance and Chief Financial Officer of Asante
Technologies, a leading designer, manufacturer and supplier of local area
networking products. From 1994 to 1995, Mr. Sheffield was the Vice President
of New Business Development for Time Warner/Atari Games ("Time Warner

32
<PAGE>

Interactive"), a leader in video arcade and consumer video entertainment
software, and from 1988 to 1994, Mr. Sheffield was Time Warner Interactive's
Vice President - Finance and Chief Financial Officer. Mr. Sheffield also
served as the Vice President - Finance and Chief Financial Officer of
Televideo Systems, Inc., a manufacturer of video display terminals, personal
computers and networks from 1985 to 1988 and of Gill Management Services,
Inc., a computer services and software development firm from 1984 to 1985.

DONALD BUTLER joined the Company in May 1996 as Vice President and
General Manager of the VLSI Division. In October 1996, as Vice President of
Engineering, he assumed responsibility for all engineering functions. 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.

KENNETH S. BOSCHWITZ joined the Company in June 1997 as Vice
President-Business Development and General Counsel. In June 1998, he became
Secretary of the Company. From May 1984 to September 1996, Mr. Boschwitz held
various legal and management positions with GI, including Vice President &
General Counsel of the Communications Division of GI.

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.

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.

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
each of the Ciena Corporation, Myriad Genetics and The Immune Response
Corporation. He has been a director of The Immune Response Corporation since
1986.

MATTHEW D. MILLER has served as a director of the Company since December
1995. Since December 1997, Dr. Miller has served as President and Chief
Executive Officer of Sarnoff Digital Communications, a fabless chip company
which designs chips for high speed digital communications, including broadcast
digital television, cable modems and digital set-top boxes. Since July 1994,
Dr. 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, Dr. Miller served
as Chairman of the Center for Advanced Television 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., a media and communications company. 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 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.

33
<PAGE>

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. He has
been an officer of East-West Capital Associates, Inc., a private investment
banking firm, since February 1996. From August 1980 to June 1993, he served as
Chairman of the Board 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, 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.

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. 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. Previously, he was Chairman and Chief Executive
Officer of Lorimar Telepictures Corporation, an entertainment firm. 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 Restated 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 their
terms expiring at the 2000 Annual Meeting of Stockholders. Merv Adelson, Kevin
Kimberlin and William Turner have been designated Class 2 directors with their
terms expiring at the 2001 Annual Meeting of Stockholders. William Sick and
Matthew Miller have been designated as Class 3 directors with their 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's 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 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

Prior to August 1997, directors received no fees for serving on the Board
of Directors but were reimbursed for reasonable expenses incurred by them in
attending Board of Directors and Committee meetings. Commencing in August 1997,
each non-employee director receives 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 receives $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 1997 Non-Employee Directors Stock Option
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 to August 1997 and $5,000 per month for the remainder of the fiscal
year ended December 31, 1997. On December 17, 1997, the Board of Directors made
a warrant issued to

<PAGE>

Merv Adelson under his consulting agreement with the Company currently
exercisable with respect to 21,718 shares of Common Stock. See "Certain
Transactions--Consulting Agreements." On July 31, 1998 the Company issued
732 shares of its Common Stock to each of Stuart D. Buchalter, Merv Adelson,
William N. Sick, William J. Turner, Matthew D. Miller and Kevin B. Kimberlin
as their annual retainer for serving as directors of the Company.

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 summarizes the compensation paid by the Company for the
year ended December 31, 1997 to the Chief Executive Officer and to those persons
who were, at December 31, 1997, the Company's four most highly compensated
executive officers other than the Chief Executive Officer (collectively, the
"Named Executive Officers").

SUMMARY COMPENSATION TABLE

Long-Term
Annual Compensation(1) Compensation
---------------------------------------------- ------------
Other Securities
Annual Underlying All Other
Name and Principal Position Year Salary ($) Bonus Compensation Options (#) Compensation(2)
--------------------------- ---- ---------- ----- ------------ ----------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Michael J. Moone
President, Chief Executive 1997 $247,913 $200,000 -- -- $ 4,740
Officer and Director(3)............... 1996 73,904 150,000 -- 528,932(4) 4,750

Yves C. Faroudja
Chief Technical Officer, 1997 196,787 -- -- -- 4,620
Secretary and Director(5)............. 1996 198,500 -- -- -- 2,464

Michael C. Hoberg
Vice President--Finance and 1997 129,164 45,000 -- -- 4,750
Chief Financial Officer(6)............ 1996 -- -- -- 75,000(4) --

Donald S. Butler 1997 211,684 55,000 -- -- 2,750
Vice President--Engineering(7)........ 1996 125,564 30,512 -- 195,964(4) --

Thomas A. Harvey
Vice President--Sales and
Marketing(8).......................... 1997 77,177 68,000 -- 100,000(9) --
</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.

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

(3) Mr. Moone joined the Company in June 1996, and the amount reported
represents his salary in 1996 on a pro-rated basis. See "--Employment
Agreements."

(4) These shares are issuable upon exercise of stock options granted under the
1995 Employee Stock Option Plan (the "1995 Option Plan").

(5) 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 of the Board of Directors, Secretary and Director. See
"--Employment Agreements."

35
<PAGE>

(6) Mr. Hoberg joined the Company in December 1996 and did not receive a salary
payment in 1996. For Fiscal 1997, Mr. Hoberg's salary on an annualized
basis was $135,000. Includes a grant of options in 1996 to purchase 75,000
shares under the 1995 Option Plan at an exercise price of $3.91. The
options vest over four years. In July 1998, Mr. Hoberg's position with the
Company changed to advisor to the President.

(7) Mr. Butler joined the Company in May 1996 and the amount reported
represents his salary on a pro-rated basis based on an annual salary of
$200,000. Commencing in May 1997, Mr. Butler's base salary was increased
to $220,000. Includes a grant of options in 1996 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.

(8) Mr. Harvey joined the Company in June 1997, and the amount reported
represents his salary in 1997 on a pro-rated basis based on an annual
salary of $200,000. Includes a grant of options in 1997 to purchase
100,000 shares under the 1997 Performance Stock Option Plan at an exercise
price of $7.50. The options vest over four years.

(9) These shares are issuable upon exercise of stock options granted under the
1997 Performance Stock Option Plan.

STOCK OPTION GRANTS

The following table sets forth information with respect to options granted
to each Named Executive Officer during the fiscal year ended December 31, 1997.

Potential Realized
Value at Assumed
Annual Rates of
Stock Appreciation
Individual Grants for Option Term(1)
---------------------------------------------------------------- ------------------

Percent of
Number of Total Options
Securities Granted to Exercise Price
Options Employees Per Share Expiration
Name Granted(#)(1) Fiscal 1997(1) ($/Share)(2) Date 5%($) 10%($)
- ---- ------------- -------------- ------------ ---- ----- ------
<S> <C> <C> <C> <C> <C> <C>
Michael J. Moone........ -- -- -- -- -- --

Michael C. Hoberg....... -- -- -- -- -- --

Yves C. Faroudja........ -- -- -- -- -- --

Donald S. Butler........ -- -- -- -- -- --

Thomas A. Harvey........ 100,000 24.21% $ 7.50 6/10/07 $471,671 $1,195,307
</TABLE>

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

(1) As suggested by the rules of the Securities and Exchange Commission, the
Company used assumed rates of the Company's stock price appreciation in
calculating the potential realizable value of executive stock options
(calculated based upon a 10-year option term, with compounded appreciation
at 5% and 10% rates). The actual value, if any, an executive may realize
will depend on the excess of the stock price on the date the option is
exercised over the option's exercise price so that there is no assurance
the value realized by an executive will be at or near the values estimated
above. The Company does not advocate or necessarily agree that the stated
assumed annual rates of appreciation properly determine the value of the
options. 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.

(2) 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.

(3) These options were granted pursuant to the Company's 1997 Performance Stock
Option Plan. The options vest 1/4 after the first anniversary of the date
of the grant and 1/48th each month thereafter.

36
<PAGE>

AGGREGATE OPTION EXERCISES IN THE LAST FISCAL YEAR AND FISCAL YEAR END OPTION
VALUES

There were no stock options exercised by the Named Executive Officers
during the year ended December 31, 1997. The following table sets forth certain
information regarding stock options held as of December 31, 1997 by the Named
Executive Officers.

Fiscal Year-End Option Values
--------------------------------------------------------------------------
Number of Unexercised Value of Unexercised
Options Held at In-the-Money Options
Fiscal Year End(#) At Fiscal Year End($)(1)
--------------------- ------------------------

Name Exercisable Unexercisable Exercisable Unexercisable
- ---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Michael J. Moone(2)........... 186,985 341,947 $1,223,302 $2,235,403

Yves C. Faroudja.............. -0- -0- -0- -0-

Michael C. Hoberg(2).......... 18,750 56,250 121,313 363,938

Donald S. Butler(2)........... 74,215 121,749 485,642 796,083

Thomas A. Harvey(3)........... -0- 100,000 -0- 288,000
</TABLE>

- ----------------
(1) Represents the difference between the closing price of the Company's Common
Stock as reported on The Nasdaq Stock Market on December 31, 1997 and the
exercise price of the options.

(2) 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 on the
date of grant, and vest over a four year period, at the rate of 1/4 on the
first anniversary of the date of grant and 1/48th of the shares each month
thereafter.

(3) Each of these options was granted pursuant to the 1997 Performance Stock
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 on the date of grant, and vest over a four year period, at the
rate of 1/4 on the first anniversary of the date of grant and 1/48th of the
shares each month thereafter.

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 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 March 31, 1998, there were options to
purchase 58,635 shares of Common Stock outstanding under the Directors Plan.
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 granted under the Directors Plan 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 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 and its
shareholders approved the 1995 Option Plan to succeed the 1993 Stock Option
Plan. The 1995 Option Plan was amended on August 19, 1996,

37
<PAGE>
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 Internal Revenue Code of 1986, as
amended (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
March 31, 1998, 1,171,275 shares were subject to outstanding options and 17,682
shares had been issued upon exercise of stock options granted under the 1995
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 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 generally 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. No
additional options to purchase Common Stock will be issued under the 1995 Option
Plan.

The 1995 Option Plan is administered by the Board, or a committee
designated by the Board, 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,
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 and June 10, 1998. 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 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. As of June 30, 1998, a total
of 1,125,000 shares of Common Stock are reserved for issuance under the 1997
Option Plan. As of March 31, 1998, there were options to purchase 378,042
shares of Common Stock outstanding under the 1997 Option Plan.

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 incentive stock option
granted must equal at least 110% of the fair market value 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).

38
<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 thereunder shall become fully exercisable.

EMPLOYEE STOCK PURCHASE PLAN. The Purchase Plan was approved by the
Company's Board of Directors and stockholders in January 1997 and was amended on
August 12, 1997 and September 30, 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 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
March 31, 1998, 15,253 shares of 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 February 1 and August 1 of each year and terminate
on the last trading day in periods ending 24 months later, except that the
first offering period began on October 29, 1997 and will end on the last
trading day in the period ending August 1, 1999. Payroll deductions may be
from 1% to 10% (in whole percentage increments) of a participants
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
employees 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 employees become eligible to participate in the 401(k) Plan was decreased
to 1 month.

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 was to
serve as the CTO of the Company at an annual base salary of $100,000 for

39
<PAGE>

the first year and $66,600 for the second year (the "Faroudja Employment
Agreement"). Mr. Faroudja was required to devote at least one-half of his time
to the Company during the first year of the Faroudja Employment Agreement and at
least one-third of his time to the Company during the second year of the
Faroudja Employment Agreement. Mr. Faroudja could not engage in any other
business activities that interfered with the performance of his duties under the
Faroudja Employment Agreement with the Company, and the Faroudja Employment
Agreement contained a covenant not to compete. Mr. Faroudja's annual base
salary was to increase proportionately if Mr. Faroudja contributed 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 was entitled under the Faroudja
Employment Agreement to participate in all insurance and benefit plans generally
available to the employees of the Company.

The Faroudja Employment Agreement was superseded on March 8, 1998 by an
agreement entered into between the Company and Mr. Faroudja for a term of three
years pursuant to which Mr. Faroudja will serve as the Company's CTO until a new
CTO is identified and hired (the "Advisory Agreement"). Thereafter,
Mr. Faroudja will serve as a Senior Fellow to the Company, advising the Company
in a variety of areas, with time to be devoted at Mr. Faroudja's discretion.
Under the Advisory Agreement, Mr. Faroudja will be paid a fee of $150,000 per
year and was granted a five year option to purchase an aggregate of 22,500
shares of Common Stock. Mr. Faroudja is entitled to the use of a Company
automobile and medical insurance to be paid for by the Company in an amount not
to exceed $13,680 per year. The Advisory Agreement may only be terminated by
the Company for cause (as defined in the Advisory Agreement). If the Advisory
Agreement is terminated due to Mr. Faroudja's disability, he will be entitled to
his annual base salary for an additional six months. Mr. Faroudja may terminate
the Advisory Agreement upon six months notice to the Company.

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 Corporations 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 authorize the use of indemnification
agreements, and the Company has entered into indemnification agreements with
each of its directors and officers that are in some respects broader that the
specific indemnification provisions contained in Delaware Law. The
indemnification agreements may require the Company, among other things, to
indemnify such directors and officers against certain liabilities that may arise
by reason of their status or service as directors and/or officers (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

40
<PAGE>

has obtained 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 preceding 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 litigation.

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 million to Adelson Investors, LLC, a
predecessor of Faroudja Images Investors, LLC ("Investors LLC") and Images
Partners, L.P. ("Images") (collectively the "Investor Group"), of which 213,642
shares were issued to Adelson Investors, LLC, 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 sold to Adelson Investors, LLC, 2,334,253 shares were sold to Investors LLC
and 504,080 shares were sold to 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 million (the
"Faroudja Option"), of which Adelson Investors, LLC 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 $1.0 million to Investors LLC to
assist in the exercise of 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 Investors, LLC.

The Company filed the registration statement of which this Prospectus is
part pursuant to an agreement between the Company and the Investor Group. As
part of the Equity Purchase, the Investor Group received certain registration
rights which provide that 180 days following the completion of the Company's
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 will pay for all of the expenses
associated 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 elected to be taxed as an "S"
corporation. Yves and Isabell Faroudja, as sole 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

41
<PAGE>
to exploit the Faroudja Technology and (2) Mr. 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, nontransferable rights to exploit the Faroudja Technology outside
of the Company Field. The License Agreement remains in effect during the term
of the Advisory Agreement between Mr. Faroudja and the Company. See
"Management--Employment Agreement." The Company's right to use the Faroudja
Technology and rights to enforce rights granted thereunder survive the
termination of the License Agreement.

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 July 1997, the Company entered into a consulting services agreement with
Matthew D. Miller. Pursuant to this agreement, Mr. Miller, a director of the
Company, agreed to advise the Company on strategic, technology and
communications matters and to provide such assistance and advice related to such
matters as the Company may request. This agreement was for a term of one year,
was renewable upon the mutual consent of Mr. Miller and the Company's Board of
Directors and could 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 paid Mr. Miller $5,000 for the remaining months of the
fiscal year ended December 31, 1997. 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") under the agreement. The Miller Option had a term
of three years and vested 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. On December 17, 1997, the Company and
Mr. Miller agreed to cancel the Consulting Agreement effective as of
December 22, 1997. Accordingly, the Miller Option was cancelled as to any
options that had not vested by December 22, 1997.

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 (iii) 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. On December 17, 1997, the
Adelson Consulting Agreement, which had provided that the Company shall
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 amendment to the agreement) of at least $5
million, through the issuance of a three year warrant to Mr. Adelson for the
purchase of 65,152 shares of Common Stock with an exercise price of $0.15 per
share ("Adelson Warrant"), was amended. The Adelson Consulting Agreement was
amended to compensate Mr. Adelson for services valued at less than $5 million by
providing that the number of shares for which the Adelson Warrant may be
exercised currently to be determined by the Company's Board of Directors, from
time to time, based upon the level of consideration received by the Company as a
result of Mr. Adelson's services. On December 17, 1997, the Board of Directors
made the Adelson Warrant currently exercisable with respect to 21,718 shares of
Common Stock as of that date. During the term of the Adelson 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.

42
<PAGE>

LICENSE AGREEMENT WITH S3

In March 1997, the Company entered into a license agreement with S3 to
develop integrated circuits incorporating the Company's video processing
technologies for use in PCs. Portions of the license were exclusive for certain
markets for a period of five years provided that performance criteria, including
minimum license fees were satisfied. S3 has advised the Company that it will no
longer make the minimum license payments necessary to maintain its exclusive
rights with respect to any periods after March 31, 1998. No director, officer
or affiliate of S3 is an affiliate of the Company.

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 anti-dilution
provisions of the Stock Purchase Agreement provided that S3 was entitled to
receive additional shares if the Company's initial public offering was less than
$9.50 per share. Based on the Company's initial public offering price of $6.00,
the Company issued 307,018 additional shares of Common Stock to S3. Under the
purchase agreement, S3 has the right to have an observer attend meetings of the
Company's Board of Directors and committees thereof, 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. See "Description of Capital Stock - Registration Rights."

OTHER

Mr. Buchalter is Of Counsel to the California law firm of Buchalter, Nemer,
Fields and Younger, which from time to time provides legal services to the
Company.

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.

<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 May 15,
1998 and as adjusted to reflect the sale of shares offered hereby by the Selling
Stockholders 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) each Selling Stockholder. 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 Company's directors,
each person known by the Company to own beneficially more than 5% of the
outstanding shares of Common Stock and Named Executive Officers in this table is
as follows: c/o Faroudja, Inc., 750 Palomar Avenue, Sunnyvale, California,
94086.

BENEFICIAL OWNERSHIP SHARES TO BENEFICIAL OWNERSHIP
PRIOR TO OFFERING(1) BE SOLD AFTER OFFERING(1)
------------------- ------- ----------------
BENEFICIAL OWNER SHARES PERCENT SHARES PERCENT
- ---------------- ------ ------- ------ -------
<S> <C> <C> <C> <C> <C>
Yves C. Faroudja(2).................................... 1,929,722 15.9% -- 1,929,722 15.9%
Merv L. Adelson(3)(4).................................. 1,487,305 12.3 -- 1,487,305 12.3
Adelson Investors, LLC(3).............................. 1,431,579 11.9 -- 1,431,579 11.9
10900 Wilshire Boulevard
Los Angeles, California 90024
Kevin B. Kimberlin(5).................................. 1,145,923 9.5 293,556 852,367 7.1
S3 Incorporated........................................ 833,334 6.9 833,334 -- ---
2801 Mission College Boulevard
Santa Clara, California 95052
Oshkim Limited Partners, L.P.(5)....................... 789,205 6.5 257,184 532,021 4.4
c/o Spencer Trask
535 Madison Avenue, 18th Fl.
New York, NY 10022
Spencer F. Segura...................................... 352,307 2.9 100,602 251,705 2.1
c/o Spencer Trask
535 Madison Avenue, 18th Fl.
New York, NY 10022
Michael J. Moone(6).................................... 254,326 2.0 -- 254,326 2.0
Spencer Trask Holdings, Inc.(5)........................ 165,846 1.4 33,091 132,755 1.1
William J. Turner(7)................................... 162,297 1.3 54,352 107,945 *
William N. Sick, Jr.(8)................................ 137,451 1.1 30,750 106,701 *
Donald S. Butler(9).................................... 98,925 * -- 98,925 *
Matthew D. Miller(10).................................. 79,186 * 16,626 62,560 *
Stuart D. Buchalter(3)(11)............................. 13,455 * -- 13,455 *
Michael C. Hoberg(12).................................. 8,786 * -- 8,786 *
Thomas A. Harvey(13)................................... 490 * -- 490 *
Sal Caravetta.......................................... 57,500 * 4,922 52,578 *
Tournier Investment Limited............................ 48,092 * 10,434 37,658 *
George L. Argyros...................................... 45,366 * 9,843 35,523 *
Tissera Overseas Fund N.V.............................. 41,761 * 12,159 29,602 *
Lewis Rudin............................................ 40,000 * 6,562 33,438 *
J. Michael Wolfe....................................... 37,805 * 8,203 29,602 *
MRS Investments, Inc................................... 37,805 * 8,203 29,602 *
Windsor Road Limited Partnership....................... 35,840 * 10,969 24,871 *
Bostar A/S............................................. 33,079 * 7,177 25,902 *
4601 Investors Inc..................................... 30,244 * 6,562 23,682 *
James E. Foreman....................................... 30,244 * 6,562 23,682 *

</TABLE>

44
<PAGE>

<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP SHARES TO BENEFICIAL OWNERSHIP
PRIOR TO OFFERING(1) BE SOLD AFTER OFFERING(1)
------------------- ------- ----------------
BENEFICIAL OWNER SHARES PERCENT SHARES PERCENT
- ---------------- ------ ------- ------ -------
<S> <C> <C> <C> <C> <C>
Raymond E. Ozzie....................................... 30,244 * 6,562 23,682 *
Edward B. Grier III.................................... 26,333 * 6,889 19,444 *
RehCam Investments L.P. ............................... 25,244 * 6,562 18,682 *
Glenn W. Marschel, Jr.................................. 22,683 * 4,922 17,761 *
James F. Holden........................................ 22,683 * 4,922 17,761 *
Richard Hausman........................................ 22,683 * 4,922 17,761 *
William Kapner(14)..................................... 22,683 * 3,281 11,841 *
Bradley Resources Company.............................. 20,122 * 3,281 16,841 *
John T. Woodruff....................................... 18,615 * 3,579 15,036 *
Clarence G. Olson...................................... 18,398 * 5,250 13,148 *
Chelsea Holdings Ltd................................... 16,370 * 3,552 12,818 *
John H. Styles......................................... 15,244 * 6,562 8,682 *
Rodrigo L. Gabuya and Aurora P. Gabuya(15)............. 15,123 * 3,281 11,842 *
ALCE Partners, LP...................................... 15,122 * 3,281 11,841 *
Allan Jacobson......................................... 15,122 * 3,281 11,841 *
Dadourian Family General Partnership................... 15,122 * 3,281 11,841 *
Donald A. Weiss........................................ 15,122 * 3,281 11,841 *
James E. Forrest....................................... 15,122 * 3,281 11,841 *
Kimberlin Family Partners(5)........................... 15,122 * 3,281 11,841 *
Lawrence J. Corneck.................................... 15,122 * 3,281 11,841 *
Marcos Anszelowicz..................................... 15,122 * 3,281 11,841 *
Morgan Steel, Ltd...................................... 15,122 * 3,281 11,841 *
Richard Gibbs.......................................... 15,122 * 3,281 11,841 *
Robert Bruce Brown..................................... 15,122 * 3,281 11,841 *
Robert Elston Cawthorn................................. 15,122 * 3,281 11,841 *
Robert F. Johnston..................................... 15,122 * 3,281 11,841 *
Schaffer Family General Partnership ................... 15,122 * 3,281 11,841 *
Thomas J. Bruch........................................ 15,122 * 3,281 11,841 *
Victor M. Goldberg..................................... 15,122 * 3,281 11,841 *
WisdomTree Associates, L.P............................. 15,122 * 3,281 11,841 *
John Sie............................................... 14,449 * 14,449 0 --
Chillington Corporation N.V............................ 14,110 * 2,815 11,295 *
Interlex Trust Corporation
Trust A/C 4762....................................... 12,854 * 2,789 10,065 *
James G. Dinan......................................... 12,820 * 2,756 10,064 *
Fred W. Goldman........................................ 12,341 * 2,461 9,880 *
Eric Rosenfeld......................................... 11,941 * 11,941 0 --
Laura M. McNamara(16).................................. 11,746 * 1,538 10,208 *
Alan J. Rubin.......................................... 11,342 * 2,461 8,881 *
James Jordan Bullard................................... 11,342 * 2,461 8,881 *
Joseph P. Kazickas..................................... 11,342 * 2,461 8,881 *
Mary F. Hauser......................................... 11,342 * 2,461 8,881 *
Robert H. Elman........................................ 11,342 * 2,461 8,881 *
Rodrigo L. Gabuya IRA(15).............................. 11,342 * 2,461 8,881 *
D. Gerald Bing, Jr..................................... 11,341 * 2,461 8,880 *
George E. Bisnett...................................... 11,341 * 2,461 8,880 *
Peter V. Sperling...................................... 11,341 * 2,461 8,880 *
Richard G. David....................................... 11,341 * 2,461 8,880 *
Richard M. Hoffman..................................... 11,341 * 2,461 8,880 *
Robert P. Hauptfuhrer Family Partnership............... 11,341 * 2,461 8,880 *
Robert R. Belliveau Trust.............................. 11,341 * 2,461 8,880 *

</TABLE>

45
<PAGE>

<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP SHARES TO BENEFICIAL OWNERSHIP
PRIOR TO OFFERING(1) BE SOLD AFTER OFFERING(1)
------------------- ------- ----------------
BENEFICIAL OWNER SHARES PERCENT SHARES PERCENT
- ---------------- ------ ------- ------ -------
<S> <C> <C> <C> <C> <C>
Sechs Limited Partnership.............................. 11,341 * 2,461 8,880 *
Steinberg, Steinberg & Plush........................... 11,341 * 2,461 8,880 *
Brad Danforth.......................................... 9,829 * 2,133 7,696 *
Louis Aronson Part B Trust............................. 8,506 * 1,846 6,660 *
Barbara & Joseph Cordani............................... 7,561 * 1,641 5,920 *
Bushnell Corporation................................... 7,561 * 1,641 5,920 *
David C. Brown......................................... 7,561 * 1,641 5,920 *
Frank M. Drendel....................................... 7,561 * 1,641 5,920 *
Joi Dell & Harry Hurd Trust............................ 7,561 * 1,641 5,920 *
Joyalyn D. Zaidan & James R. Zaidan JTWROS............. 7,561 * 1,641 5,920 *
Kenneth L. Naiff....................................... 7,561 * 1,641 5,920 *
Kent Hamilton.......................................... 7,561 * 1,641 5,920 *
Richard A. Taddonio IRA................................ 7,561 * 1,641 5,920 *
William Kapner DDS PC Pension Trust(14)................ 7,561 * 1,641 5,920 *
Scott F. Schulte....................................... 7,279 * 1,452 5,827 *
James L. Faust......................................... 6,202 * 1,641 4,561 *
Robert E. Fulton....................................... 6,049 * 1,312 4,737 *
Donald L. Sears........................................ 5,671 * 1,230 4,441 *
Kurt Penner............................................ 5,671 * 1,230 4,441 *
Michael Stargel........................................ 5,671 * 1,230 4,441 *
Robert Whitby.......................................... 5,671 * 1,230 4,441 *
Lawrence A. Cook....................................... 5,482 * 1,189 4,293 *
Gary H. Anderson....................................... 4,561 * 1,641 2,920 *
Gilbert S. Omenn....................................... 4,561 * 1,641 2,920 *
James D. Robinson III.................................. 4,537 * 984 3,553 *
Jeremy M. Jacobs, Sr................................... 4,537 * 984 3,553 *
Linda Gosden Robinson.................................. 4,537 * 984 3,553 *
R. Carlton Browne II................................... 4,537 * 984 3,553 *
Synteke Demonteverde and Lilia Demonteverde............ 4,537 * 985 3,552 *
Scott Davidson......................................... 3,940 * 3,940 0 --
Charles Nash........................................... 3,781 * 820 2,961 *
David L. Schlotterback Trust........................... 3,781 * 820 2,961 *
Jerome F. Snyder &
Diane R. Snyder JTWROS................................. 3,781 * 820 2,961 *
Joe B. Massey.......................................... 3,781 * 820 2,961 *
Peter Laqueur.......................................... 3,781 * 820 2,961 *
Richard J. Mish........................................ 3,733 * 745 2,988 *
Richard Gould.......................................... 3,671 * 1,230 2,441 *
Ronald Nash(17)........................................ 3,579 * 3,579 0 --
Melham Inc............................................. 3,311 * 3,281 30 *
Larry Abrams........................................... 3,281 * 3,281 0 *
Ronald Nash IRA R/O(17)................................ 3,281 * 3,281 0 --
Rose Marie and Victor Melnichuk(18).................... 3,219 * 656 2,563 *
A. Eugene Kohn......................................... 3,024 * 656 2,368 *
Beverly J. Rento....................................... 3,024 * 656 2,368 *
Gregory Judge.......................................... 3,024 * 656 2,368 *
Henry Kolpan........................................... 3,024 * 656 2,368 *
Robert F. Koehler Secur. Def. Emp. Pen. Pl.
Dtd 10/31/97......................................... 3,024 * 656 2,368 *
Rodrigo P. Gabuya, Jr.................................. 3,024 * 656 2,368 *
Todd Larson............................................ 3,024 * 656 2,368 *
</TABLE>

46
<PAGE>

</TABLE>

- --------------------------------
* Less than 1%

(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. 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 or warrants held by that
person that are currently exercisable or exercisable within 60 days of
March 31, 1998 are deemed outstanding.

(2) Mr. Faroudja holds 1,882,500 shares jointly with Isabell Faroudja, his
wife. Includes 47,222 shares issuable upon exercise of warrants.

(3) 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.

(4) Includes 3,077 shares issuable upon exercise of stock options exercisable
within 60 days of May 15, 1998 and 21,718 shares issuable upon exercise of
a warrant granted to Mr. Adelson under a consulting agreement (the "Adelson
Warrant"). Does not include 3,257 shares subject to options granted to
Mr. Adelson or 43,434 shares subject to the Adelson Warrant that are not
currently exercisable.

(5) Mr. Kimberlin is the general partner of Oshkim Limited Partners, L.P. and
exercises voting and investment power over the shares held by this entity.
Includes 15,122 shares owned by Kimberlin Family Partners, L.P, of which
Mr. Kimberlin is the general partner, 165,846 shares owned by Spencer Trask
Holdings, Inc. in which Mr. Kimberlin is the Chairman and 175,000 shares
owned by Kevin Kimberlin Partners, L.P. of which Mr. Kimberlin is the
general partner.

(6) Includes 253,101 shares issuable upon exercise of stock options exercisable
within 60 days of May 15, 1998. Does not include 275,831 shares subject to
options granted to Mr. Moone that are not currently exercisable.

(7) Includes 11,109 shares held jointly with Mr. Turner's spouse.

(8) Includes 12,487 shares issuable upon exercise of stock options exercisable
within 60 days of May 15, 1998. Does not include 13,573 shares subject to
options granted to Mr. Sick that are not currently exercisable. Includes
11,342 shares held by Business Resources International where Mr. Sick is
the Chairman and Chief Executive Officer.

(9) Includes 98,710 shares issuable upon exercise of stock options exercisable
within 60 days of May 15, 1998. Does not include 97,254 shares subject to
options granted to Mr. Butler that are not currently exercisable.

(10) Includes 13,675 shares issuable upon exercise of stock options exercisable
within 60 days of May 15, 1998. Does not include 3,257 shares subject to
options granted to Mr. Miller that are not currently exercisable.

47
<PAGE>

(11) Includes 3,258 shares issuable upon exercise of stock options exercisable
within 60 days of May 15, 1998 granted to Mr. Buchalter. Does not include
3,257 shares subject to an option granted to Mr. Buchalter that are not
currently exercisable.

(12) Includes 28,125 shares issuable upon exercise of stock options exercisable
within 60 days of May 15, 1998 granted to Mr. Hoberg. Does not include
46,875 shares subject to options granted to Mr. Hoberg that are not
currently exercisable.

(13) Does not include 100,000 shares subject to options granted to Mr. Harvey
that are not currently exercisable.

(14) Includes 7,561 shares held by the William Kapner DDS Pension Trust in which
Mr. Kapner exercises voting and investment power over the shares held by
this entity and the 1,641 shares to be sold by this entity.

(15) Includes 11,342 shares held by the Rodrigo L. Gabuya IRA in which
Mr. Gabuya exercises voting and investment power over the shares held by
this entity and the 2,461 shares to be sold by this entity.

(16) Includes 7,563 shares that Ms. McNamara has the right to acquire within 60
days of May 15, 1998.

(17) Includes 3,281 shares held by the Ronald Nash IRA R/O in which Mr. Nash
exercises voting and investment power over the shares held by this entity
and 3,281 shares to be sold by this entity.

(18) Includes 195 shares that Rose Marie Melnichuk has the right to acquire
within 60 days of May 15, 1998.

(19) Includes 1,303 shares that Mr. Stein has the right to acquire within
60 days of May 15, 1998

(20) All directors and executive officers as a group hold options and warrants
to purchase 481,554 shares of Common Stock, which options and warrants will
vest within 60 days of May 15, 1998 and options and warrants to purchase
719,516 shares of the Company, which options and warrants will not have
vested within 60 days of March 31, 1998.

DESCRIPTION OF CAPITAL STOCK

The authorized capital stock of the Company consists of 50,000,000 shares
of Common Stock, par value $0.001 per share, and 5,000,000 shares of Preferred
Stock, par value $0.001 per share.

COMMON STOCK

As of March 31, 1998, there were 12,084,557 shares of Common Stock
outstanding. As of March 31, 1998, options and warrants to purchase an
aggregate of 1,773,104 shares of Common Stock were also outstanding.

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 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 Restated 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

48
<PAGE>
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.

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 1/36 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.

Merv Adelson was granted the Adelson Warrant to purchase 65,152 shares of
Common Stock at an exercise price of $0.15 per share. The number of shares for
which the Adelson Warrant may be exercised is to be determined by the Company's
Board of Directors, from time to time, based upon the level of consideration
received by the Company as a result of Mr. Adelson's services. On December 17,
1997, the Board of Directors made the Adelson Warrant currently exercisable with
respect to 21,718 shares of Common Stock as of that date. See "Certain
Transactions--Consulting Agreements."

REGISTRATION RIGHTS

Under the terms of the registration and shareholders rights agreements
entered into by and between 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 October 30, 1997, the Company's first
underwritten public offering of its securities (the "Initial Registration") and
any of the shareholders 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 the 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 the 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 October 30, 1997, 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 833,334 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 833,334 shares of Common
Stock that it owns, subject to certain limitations. Further, if at any time
after twelve months after the Initial Registration the Company registers any of
its stock under the Securities Act, S3 shall have the right to sell all of its
833,334 shares of Common Stock pursuant to such registration, subject to certain
limitations. Also, under this agreement, the Company has agreed to indemnify S3
and the Company's underwriters.

DELAWARE LAW AND CERTAIN CHARTER AND BY-LAW PROVISIONS

The Company is 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 becoming an
interested stockholder, (ii) the holder of two-thirds of the outstanding voting
stock not owned by the interest 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

49
<PAGE>

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 Restated 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
terms of each class expiring at the 1999 and 2001 annual stockholders' meetings,
respectively. After the expiration of each 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 sixty days nor
more than ninety 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 sixty 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, not by written consent. Special meetings may be called only 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 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 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

50
<PAGE>

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 ("NASDAQ") 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, provide for a classified board of
directors, call special meetings, 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. As of March 31, 1998, the Company had over
1,600 holders of record. Accordingly, the provisions of California described
above do not currently apply to the Company.

TRANSFER AGENT AND REGISTRAR

The transfer agent and registrar for the Company's Common Stock is
U.S. Trust Company of California, N.A.

SHARES ELIGIBLE FOR FUTURE SALE

As of March 31, 1998, the Company had 12,084,557 shares of Common Stock
outstanding. Of this amount, 6,880,632 are freely tradeable without
restriction or further registration under the Securities Act, unless such
shares are held by "affiliates" of the Company as that term is defined in
Rule 144 under the Securities Act. Approximately 4,499,513 additional shares
will be available for sale in the public market on the date of this
Prospectus and an additional 704,412 shares will be available on September 5,
1998, subject in some cases to compliance with the volume and other
limitations of Rule 144. In addition, the Company had 1,607,952 options and
165,152 warrants outstanding as of March 31, 1998.

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 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. 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.

51
<PAGE>

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.

On April 23, 1998, the Company filed a registration statement on Form S-8
(Reg. No. 333-50811) 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, thus permitting the resale of shares
issued pursuant to such plans by nonaffiliates in the public market without
restriction under the Securities Act.

PLAN OF DISTRIBUTION

The Common Stock may be offered and sold, from time to time, and in
amounts to be determined, by the Selling Stockholders directly, through
agents designated by them from time to time, or through dealers or
underwriters also to be so designated, and on terms to be determined at the
time of any sale. The Selling Stockholders reserve the sole right to accept
and, together with their agents from time to time, to reject in whole or in
part any proposed purchase to be made directly or through agents. Shares of
the Common Stock may be offered by and on behalf of the Selling Stockholders
from time to time in and through transactions or distributions on The Nasdaq
Stock Market, in privately negotiated transactions, or otherwise at prices
prevailing in such exchange or as may be negotiated at the time of sale. See
"Principal and Selling Stockholders."

The aggregate proceeds to the Selling Stockholders from the sale of the
Common Stock will be the purchase price of Common Stock sold less the
aggregate agents' commissions and underwriters' discounts, if any, and other
expenses of distribution not borne by the Company. The Company will receive
none of the proceeds from the sale of any of the Common Stock. The Company
has agreed to bear all of the expenses of registration of the Common Stock
under federal and state securities laws other than commissions, discounts or
fees paid to any underwriter, broker, dealer or other selling agent.

The Selling Stockholders and any broker-dealers, agents or underwriters
that participate with the Selling Stockholders in the distribution of the
Common Stock may be deemed to be "underwriters" within the meaning of the
Securities Act of 1933, as amended (the "Securities Act"), and any discounts,
commissions or concessions received by them and any profit on the resale of
the Common Stock purchased by them may be deemed to be underwriting discounts
or commissions under the Securities Act.

52
<PAGE>

LEGAL MATTERS

The validity of the Common Stock offered hereby will be passed upon for the
Selling Stockholders by Buchalter, Nemer, Fields & Younger, a Professional
Corporation, Los Angeles, 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 Faroudja, Inc. as of
December 31, 1996 and 1997, and for each of the three years in the period ended
December 31, 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.

53
<PAGE>

FAROUDJA, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
<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, 1996 and 1997, and related consolidated statements of income,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 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, 1996 and 1997, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended December 31,
1997, in conformity with generally accepted accounting principles.

/s/Ernst & Young LLP

Palo Alto, California
January 29, 1998

F-2
<PAGE>

FAROUDJA, INC.

CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>

DECEMBER 31, MARCH 31,
------------ ---------
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents...................................... $1,215,591 $23,272,300 $21,595,097
Short-term investments......................................... 1,867,896 276,605 279,586
Trade accounts receivable, less allowance for doubtful
accounts of $110,000 in 1996, $166,681 in 1997 and
$165,335 in 1998............................................. 2,767,331 3,097,709 3,021,102
Inventories.................................................... 1,683,550 2,943,471 3,122,903
Deferred tax assets............................................ 461,519 942,255 942,255
Prepaid expenses and other current assets...................... 224,426 596,060 398,506
---------- ----------- -----------
Total current assets............................................. 8,220,313 31,128,400 29,359,449

Property and equipment, net...................................... 1,383,807 2,025,910 2,039,153
Other assets .................................................... -- 334,722 320,973
---------- ----------- -----------
$9,604,120 $33,489,032 $31,719,575
---------- ----------- -----------
---------- ----------- -----------

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................... $729,320 $1,445,361 $ 672,520
Accrued compensation and benefits.............................. 671,863 1,216,433 524,763
Income taxes payable........................................... 116,602 872,393 674,800
Other accrued liabilities...................................... 341,444 606,818 384,656
Deferred revenue............................................... 500,000 -- --
---------- ----------- -----------
Total current liabilities........................................ 2,359,229 4,141,005 2,256,739

Commitments

Stockholders' equity:
Preferred Stock - $0.001 par value; 5,000,000 shares
authorized (2,000,000 in 1996), none issued and outstanding
Common stock - $0.001 par value; 50,000,000 shares
authorized (18,000,000 in 1996) 8,200,000, 12,058,913, and
12,084,577 shares issued and outstanding at December 31, 1996
and 1997 and March 31, 1998, respectively..................... 8,200 12,059 12,084
Additional paid-in capital..................................... 7,824,823 28,977,725 29,067,883
Unrealized gains on available-for-sale securities, net of
tax effect.................................................... 66,737 -- --
Deferred compensation.......................................... (237,564) (220,597)
Retained earnings (deficit).................................... (654,869) 595,807 603,466
---------- ----------- -----------
Total stockholders' equity....................................... 7,244,891 29,348,027 29,462,836
---------- ----------- -----------
$9,604,120 $33,489,032 $31,719,575
---------- ----------- -----------
---------- ----------- -----------
</TABLE>

See accompanying notes

F-3
<PAGE>

FAROUDJA, INC.

CONSOLIDATED STATEMENTS OF INCOME

THREE MONTHS
ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
--------------------------------------------------- ------------------------------
1995 1996 1997 1997 1998
---- ---- ---- ---- ----
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues:
Product sales......................... $11,953,658 $12,626,183 $15,506,498 $2,834,859 $2,608,385
License and royalty revenues.......... -- 500,000 1,500,000 750,000 750,000
----------- ----------- ----------- ---------- ----------
Total revenues.......................... 11,953,658 13,126,183 17,006,498 3,584,859 3,358,385
Cost of product sales................... 4,214,753 4,797,516 5,261,664 998,510 1,104,854
----------- ----------- ----------- ---------- ----------
Gross profit............................ 7,738,905 8,328,667 11,744,834 2,586,349 2,253,531
Operating expenses:
Research and development.............. 1,483,388 2,463,838 4,215,346 899,464 1,076,902
Sales and marketing................... 1,070,045 2,126,686 3,465,025 677,934 752,153
General and administrative............ 1,178,990 1,623,453 2,182,641 392,281 689,684
Financing expenses.................... -- -- 311,572 311,572 --
----------- ----------- ----------- ---------- ----------
Total operating expenses.......... 3,732,423 6,213,977 10,174,584 2,281,251 2,518,739
----------- ----------- ----------- ---------- ----------
Operating income (loss)................. 4,006,482 2,114,690 1,570,250 305,098 (265,208)

Other income:
Interest income....................... 81,746 83,179 363,490 97,357 277,563
Other, net............................ 4,986 -- 83,456 -- --
----------- ----------- ----------- ---------- ----------
Income before provision for income
taxes................................. 4,093,214 2,197,869 2,017,196 402,455 12,355
Provision for income taxes.............. 83,981 687,054 766,520 152,928 4,696
----------- ----------- ----------- ---------- ----------
Net income.............................. $4,009,233 $1,510,815 $1,250,676 $249,527 $ 7,659
----------- ----------- ----------- ---------- ----------
----------- ----------- ----------- ---------- ----------

Pro forma data (unaudited):
Historical income before provision
for income taxes.................. $4,093,214 $2,197,869
Pro forma provision for income
taxes............................. 1,023,188 879,148
----------- -----------
Pro forma net income.................... $3,070,026 $1,318,721
----------- -----------
----------- -----------

Per share data:
Net income per share
Basic............................... $ 0.14 $ 0.03 $ 0.00
Diluted............................. $ 0.13 $ 0.03 $ 0.00

Pro forma net income
per share (unaudited)
Basic........................... $ 0.43 $ 0.17
Diluted......................... $ 0.43 $ 0.16
Shares used in per share
computations
Basic........................... 7,156,895 7,976,892 9,040,616 8,200,000 12,079,272
Diluted......................... 7,176,115 8,191,303 9,924,558 9,053,794 12,766,327

</TABLE>

See accompanying notes

F-4
<PAGE>

FAROUDJA, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

Accumulated
Common Stock Additional Retained Other
----------------------- Paid-In Deferred Earnings Comprehensive
Shares Amount Capital Compensation (Deficit) Income Total
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
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 of $34,885............ -- -- -- -- -- 34,885 34,885
-------------
Comprehensive income............... -- -- -- -- -- -- 4,644,118
-------------
Distribution to
Stockholders..................... -- -- -- -- (1,355,000) -- (1,355,000)
------------------------------------------------------------------------------------------------
Balance at December 31, 1995....... 7,156,895 3,611,023 -- -- 1,869,245 34,885 5,515,153
Net income......................... -- -- -- -- 1,510,815 -- 1,510,815
Unrealized gain on
available-for-sale
securities of $31,852............ -- -- -- -- -- 31,852 31,852
------------
Comprehensive Income............... -- -- -- -- -- -- 1,542,667
------------
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 -- -- -- --
Distribution to
stockholders..................... -- -- -- -- (4,034,929) -- (4,034,929)
------------------------------------------------------------------------------------------------
Balance at
December 31, 1996................ 8,200,000 8,200 7,824,823 -- (654,869) 66,737 7,244,891
Net Income......................... -- -- -- -- 1,250,675 -- 1,250,675
Reclassification adjustment for
gains included in net income
of $66,737....................... -- -- -- -- -- (66,737) (66,737)
------------
Comprehensive income............... -- -- -- -- -- -- 1,183,938
------------
Sale of Common Stock
net of issue costs............... 3,833,334 3,833 20,532,373 -- -- -- 20,536,206
Issuance of Common
Stock for services and
upon exercise of
option and warrants.............. 25,579 26 99,029 -- -- -- 99,055
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) -- -- --
Amortization of deferred
compensation..................... -- -- -- 33,936 -- -- 33,936
------------------------------------------------------------------------------------------------
Balance at
December 31, 1997................ 12,058,913 12,059 28,977,725 (237,564) 595,806 29,348,026
Net Income (unaudited)............. -- -- -- -- 7,659 -- 7,659
------------
Comprehensive income (unaudited)... -- -- -- -- -- -- 7,659
------------
Issuance of Common Stock
for cash upon exercise
of options and employee
stock purchase plan (unaudited).. 25,664 25 90,158 -- -- -- 90,183
Amortization of
deferred compensation (unaudited) -- -- -- 16,968 -- -- 16,968
------------------------------------------------------------------------------------------------
Balance at March 31, 1998
(unaudited)...................... 12,084,577 $ 12,084 $ 29,067,883 $ (220,596) $ 603,465 $ --- $ 29,462,836
------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------

</TABLE>

See accompanying notes.

F-5
<PAGE>

FAROUDJA, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>

THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
--------------------------------------- ---------------------------
1995 1996 1997 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
(UNAUDITED) (UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income............................................ $ 4,009,233 $ 1,510,815 $ 1,250,676 $ 249,527 $ 7,659
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization........................ 223,988 422,376 560,974 69,800 154,836
Amortization of deferred compensation................ -- -- 33,936 -- 16,968
Loss on disposal of equipment........................ -- -- 5,178 -- --
Gain on sales of short-term investments.............. -- -- (83,456) (94,382) --

Changes in operating assets and liabilities:
Trade accounts receivable............................ (642,490) (1,193,465) (330,378) 995,786 76,607
Inventories.......................................... (793,149) (96,480) (1,259,921) (97,245) (179,432)
Deferred tax assets.................................. -- (461,519) (480,736) -- --
Other current assets................................. (1,513) (27,174) (371,634) (34,829) 197,554
Accounts payable..................................... 417,306 128,114 716,041 (217,523) (772,841)
Accrued compensation and benefits.................... 118,135 185,927 544,570 (115,948) (691,670)
Income taxes payable................................. 46,574 68,009 755,791 190,800 (197,593)
Other accrued liabilities............................ 29,058 258,375 265,374 250,309 (222,162)
Deferred revenue..................................... 500,000 (500,000) (500,000) --
----------- ----------- ----------- ----------- ------------
Net cash provided by (used in) operating activities... 3,407,142 1,294,978 1,106,415 696,295 (1,610,074)
----------- ----------- ----------- ----------- ------------

CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of equipment............................... (391,907) (967,130) (1,200,219) (173,913) (168,079)
Proceeds from sale of equipment...................... -- -- 12,864 -- --
Other assets......................................... -- -- (110,000) -- 13,749
Purchases of short-term investments.................. (1,751,075) (1,061,000) -- -- (2,981)
Sales of short-term investments...................... -- -- 1,612,388 1,498,623 --
Maturities of short-term investments................. 750,000 460,916 -- -- --
----------- ----------- ----------- ----------- ------------
Net cash provided by (used in) investing activities... (1,392,982) (1,567,214) 315,033 1,324,710 (157,311)
----------- ----------- ----------- ----------- ------------

CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of Common Stock............................. -- 4,000,000 20,635,261 1 90,182
Repayment of loan payable............................ -- -- -- -- --
Distribution to stockholders......................... (1,355,000) (4,034,929) -- -- --
----------- ----------- ----------- ----------- ------------
Net cash provided by (used in) financing activities.. (1,355,000) (34,929) 20,635,261 1 90,182
----------- ----------- ----------- ----------- ------------
Increase (decrease) in cash and cash equivalents..... 659,160 (307,165) 22,056,709 2,021,006 (1,677,203)
Cash and cash equivalents at beginning of period..... 863,596 1,522,756 1,215,591 1,215,591 23,272,300
----------- ----------- ----------- ----------- ------------
Cash and cash equivalents at end of period........... $ 1,522,756 $ 1,215,591 $23,272,300 $ 3,236,597 $ 21,595,097
----------- ----------- ----------- ----------- ------------
----------- ----------- ----------- ----------- ------------

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period of income taxes.......... $ 32,157 $ 1,116,656 $ 465,119 $ -- $ 196,507
----------- ----------- ----------- ----------- ------------
----------- ----------- ----------- ----------- ------------

SUPPLEMENTAL DISCLOSURES OF NONCASH
FINANCING ACTIVITIES
Issuance of warrants to acquire Common Stock
for future services................................ $ -- $ 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 (CONTINUED)
(INFORMATION AT MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 IS UNAUDITED)

1. BUSINESS AND 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.

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 was exercised on 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 at March 31, 1998 and for the three months
ended March 31, 1998 and 1997 is unaudited, but, in the opinion of management,
has been prepared on the same basis as the annual financial statements and
includes all adjustments (consisting only of normal recurring adjustments) that
the Company considers necessary for a fair presentation of the financial
position at such date and the operating results and cash flows for such periods.
Results for the interim period are not necessarily indicative of the results to
be expected for the entire year.

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)
(INFORMATION AT MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 IS UNAUDITED)

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 three 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 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 deposits in banks, money market accounts, commercial paper
and government agency discount notes.

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, 1996 and 1997 and March 31, 1998, 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, dealers 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, 1996 two customers accounted for 48% of the accounts
receivable balance. At December 31, 1997, four customers accounted for 45% of
the accounts receivable balance. No other single customer accounted for more
than 10% of the Company's ending accounts receivable balances.

INVENTORIES

Raw materials, work-in-process and finished goods inventories are
stated at the lower of standard cost (which approximates actual cost on a
first-in, first-out cost method) or market value.

F-8
<PAGE>

FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 IS UNAUDITED)

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. Depreciation expense was $207,092, $248,758 and $540,074 for 1995,
1996 and 1997, respectively.

REVENUE RECOGNITION

Sales revenue is recognized upon shipment of products to customers net
of discounts, rebates and allowances. The Company does not grant rights of
return and customarily does not provide price protection to distributors.
Non-refundable 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 $204,155, $394,578 and $429,817 in the years ended 1995,
1996 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.

F-9
<PAGE>

FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 IS UNAUDITED)

NET INCOME PER SHARE

In 1997, the Company adopted the provisions of Statement of Financial
Accounting Standards No. 128, "Earnings per Share" ("SFAS 128") and Staff
Accounting Bulletin No. 98 ("SAB 98"), and restated all prior periods. Under the
provisions of SFAS 128, basic earnings per share is calculated based on the
weighted average number of common shares outstanding during the period. Diluted
earnings per share also gives effect to the dilutive effect of stock options and
warrants (calculated based on the treasury stock method). SAB 98 eliminated
certain dilutive issuances which were included in the calculation for periods
prior to the Company's initial public offering. A reconciliation of shares used
in the calculation follows:

Three-Months Ended
Years Ended December 31, March 31,
----------------------------------- -----------------------
1995 1996 1997 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Weighted average shares outstanding 7,156,895 7,976,892 9,040,616 8,200,000 12,079,272
Dilutive effect of stock options and warrants 19,220 214,411 883,942 853,794 687,055
--------- --------- --------- --------- ----------
Shares used in computation of diluted net
income per share 7,176,115 8,191,303 9,924,558 9,053,794 12,766,327
--------- --------- --------- --------- ----------
--------- --------- --------- --------- ----------
</TABLE>

Options and warrants to purchase 445,200 shares of the Company's
common stock would have been anti-dilutive in 1997 and were, therefore, excluded
from the 1997 diluted calculation.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 131, "Disclosures about Segments
of an Enterprise and Related Information" ("SFAS 131"). SFAS 131 establishes
standards for annual and interim disclosures of operating segments, products and
services, geographic areas and major customers, and will be adopted in the
Company's annual financial statements for the year ended December 31, 1998. The
Company is in the process of evaluating the disclosure requirements of the new
standards, the adoption of which will have no impact on Faroudja's results of
operations or financial condition.

As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standard No. 130, Reporting Comprehensive Income ("SFAS 130"). SFAS
130 establishes new rules for the reporting and display of comprehensive income
and its components; however, the adoption of this Statement had no impact on the
Company's net income or stockholders' equity. SFAS 130 requires unrealized
gains or losses on the Company's available-for-sale securities and foreign
currency translation adjustments, which prior to adoption were reported
separately in stockholders' equity, to be included in comprehensive income.
Prior year financial statements have been reclassified to conform to the
requirement of SFAS 130.

During the first quarter of 1997 and 1998, total comprehensive income
amounted to $155,000 and $8,000, respectively.

F-10
<PAGE>
FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 IS UNAUDITED)

2. SHORT TERM INVESTMENTS

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

Unrealized Fair
Gains Market
Cost (Losses) Value
---- ---------- --------
<S> <C> <C> <C>
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

Certificates 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 December 31, 1997

Certificates of deposit....................... $ 276,605 $ -- $ 2,76,605

Commercial paper.............................. 5,106,171 -- 5,106,171

Discount notes................................ 11,779,873 -- 11,779,873
----------- ---------- -----------

$17,162,649 -- $17,162,649
----------- ---------- -----------

Reported as:

Cash equivalents.............................. $16,886,044 $ -- $16,886,044

Government agency short-term --
investments................................... 276,605 276,605
----------- ---------- -----------

$17,162,649 $ -- $17,162,649
----------- ---------- -----------
----------- ---------- -----------
</TABLE>

The estimated fair value amounts discussed above have been determined
by the Company using available market information and appropriate valuation
methodologies. There were no unrealized gains or losses in 1997. In 1996, gross
unrealized losses were not material and thus have not been presented separately
in the above table.

There were no realized gains or losses for the year ended December 31,
1996. Realized gains and losses for the year ended December 31, 1997 were
$185,309 and $101,853, respectively. As of December 31, 1997, the average
portfolio duration is approximately three months and the contractual maturity of
the investments does not exceed one year.

F-11
<PAGE>

FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 IS UNAUDITED)

3. INVENTORIES

Inventories consist of the following:

December 31 March 31
------------- --------

1996 1997 1998
---------- ---------- ----------
<S> <C> <C> <C>
Raw materials.................. $615,865 $769,749 $ 645,545

Work in process................ 630,630 1,508,461 1,652,655

Finished goods................. 437,055 665,261 824,703
---------- ---------- ----------

$1,683,550 $2,943,471 $3,122,903
---------- ---------- ----------
---------- ---------- ----------
</TABLE>

4. PROPERTY AND EQUIPMENT

Property and equipment consist of the following:

<TABLE>
<CAPTION>
December 31
---------------------------
1996 1997
---------- ----------
<S> <C> <C>
Machinery and equipment............ $1,705,845 $2,372,918

Purchased computer software........ 492,471 915,041

Furniture, fixtures and equipment.. 234,976 289,998

Vehicles........................... 241,802 84,448

Leasehold improvements............. 143,508 199,812
---------- ----------

2,818,602 3,862,217

Accumulated depreciation........... (1,434,795) (1,836,307)
---------- ----------

$1,383,807 $2,025,910
---------- ----------
---------- ----------
</TABLE>

F-12

<PAGE>

FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 IS UNAUDITED)

5. OPERATING LEASES

The Company leases its main facilities in Sunnyvale, California under
two lease agreements from the same landlord expiring September 30, 2003. The
lease agreement for the primary facility is cancelable at the Company's option
upon four months' notice. Payments are adjusted annually based on changes in
the Consumer Price Index. At December 31, 1997, future estimated minimum
payments under these and other leases are approximately as follows:

<TABLE>
<S> <C>
1988 . . . . . . . . . . . . . . . $431,041
1999 . . . . . . . . . . . . . . . 421,591
2000 . . . . . . . . . . . . . . . 411,091
2001 . . . . . . . . . . . . . . . 417,091
2002 . . . . . . . . . . . . . . . 423,591
Thereafter . . . . . . . . . . . . 321,568
----------
Total minimum lease payments . . . $2,425,973
----------
----------
</TABLE>

Rent expense under operating leases amounted to $288,740, $185,709 and
$168,948 in 1997, 1996 and 1995, respectively.

PURCHASE COMMITMENTS

In 1997, the Company entered into an agreement for the development,
manufacture and sale of a rear screen projection system. Under the agreement,
the Company is committed to purchase a specified number of units over the
two-year period of the contract. As of December 31, 1997, the Company had an
outstanding purchase commitment of $998,600.

6. STOCKHOLDERS' EQUITY

INITIAL PUBLIC OFFERING

In October 1997 the Company sold a total of 3,000,000 shares of Common
Stock at $6.00 per share through its initial public offering. Net proceeds,
after underwriters' discounts, commissions and fees, and other costs associated
with the offering, totaled $15,588,006. In connection with the offering, S3
Incorporated ("S3") received an additional 307,018 shares of Common Stock
pursuant to certain anti-dilution provisions which the Company had granted under
a Stock Purchase Agreement (see Note 7).

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 were exercised in August 1997.

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 director.
As of December 31, 1997, 21,718 shares under the warrant were exercisable. The
remaining 43,434 shares will become exercisable if certain defined events occur
prior to February 1999. The warrant expires on December 31, 1999. The Company is
expensing $222,000, the value of the warrant, over the related service period.

F-13
<PAGE>

FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 IS UNAUDITED)

6. STOCKHOLDERS' EQUITY (CONTINUED)

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 PLANS

In 1995, the Company adopted the 1995 Stock Option Plan (the "1995
Plan"). A total of 1,700,000 shares of Common Stock were reserved for issuance
under the 1995 Plan. In January 1997, the Board of Directors adopted, and the
stockholders approved, 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 and the stockholders'
approved an amendment to the 1997 Plan increasing the number of shares reserved
for issuance by 250,000 shares. Under the terms of the 1997 Plan, the Board of
Directors may grant options to directors, employees and consultants. Options may
be either incentive stock options or nonstatutory 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"). 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.

F-14
<PAGE>

FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 IS UNAUDITED)

6. STOCKHOLDERS' EQUITY (CONTINUED)

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

Years Ended December 31,
---------------------------------------------------------------------
1995 1996 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 3.79 432,570 7.55

Exercised............................... -- -- -- -- (7,380) 1.68

Canceled................................ -- -- -- -- (207,988) 3.90
------- --------- ---------

Outstanding at end of period............ 180,576 1.16 1,441,988 3.46 1,659,190 4.48
------- --------- ---------
------- --------- ---------

Weighted average fair
value of options granted
during the period....................... $0.36 $1.23 $2.19

</TABLE>

DECEMBER 31,

Options Outstanding Options Exercisable
- ---------------------------------------------------------------------- -----------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Number of Contractual Exercise Number of Exercise
Range of Exercise Price Options Life Price Options Price
- ------------------------- --------- ----------- -------- --------- --------
(In Years)
<S> <C> <C> <C> <C> <C>

$1.16.................... 170,198 7.72 1.16 170,198 1.16

$2.02.................... 31,134 8.03 2.02 31,134 2.02

$3.83-$3.91.............. 1,059,558 8.61 3.85 1,006,073 3.5

$7.00-$7.50.............. 335,600 9.46 7.42 -- --

$9.50.................... 62,700 3.97 9.50 10,416 9.50
--------- ---------

1,659,190 8.50 4.48 1,217,821 3.47
--------- ---------
--------- ---------
</TABLE>

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.

F-15
<PAGE>

FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 IS UNAUDITED)

6. STOCKHOLDERS' EQUITY (CONTINUED)

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 with exercise prices of not less than
fair value on the date of grant.

Had the Company valued its stock options granted to employees
according to the provisions of SFAS 123, pro forma net income and basic net
income per share would have been as follows for the years ended December 31:

<TABLE>
<CAPTION>
1996 1997
---- ----
<S> <C> <C>
Net income as reported (includes impact of
pro forma tax adjustment in 1996).............. $1,318,721 $1,250,676

Net Income pro forma.......................... 1,168,364 867,735

Basic net income per share as reported........ $0.17 $0.14

Basic net income per share pro forma.......... $0.15 $0.10

</TABLE>

The pro forma impact on reported results for the year ended December
31, 1995 was not significant and has not been presented herein. The value of
options granted prior to the Company's initial public offering were determined
using the minimum value method using the following weighted average assumptions
in 1997 and 1996, respectively: risk free interest rate of 5.63% and 6.35%, an
expected option life of 72 months and no dividends. The value of options granted
following the initial public offering were determined using the Black Scholes
method and the weighted average assumptions were as follows: an expected
volatility factor of 0.7764, a risk free interest rate of 5.63%, an expected
option life of 72 months and no dividends.

RESERVED SHARES

The Company has reserved shares of Common Stock for future issuance as
follows:

<TABLE>
<CAPTION>
December 31,
1997
---------
<S> <C>
Warrants....................... 165,152

Stock purchase plan............ 400,000

Stock option plans:

Outstanding options.......... 1,659,190

Reserved for future grants... 383,430
---------

2,607,772
---------
---------
</TABLE>

F-16
<PAGE>

FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 IS UNAUDITED)

7. LICENSE AGREEMENT

In March 1997, the Company licensed certain of its technology to S3, a
leading supplier of advanced graphics accelerators for use in mainstream
multimedia personal computer ("PC") systems. 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 in March 1997. S3 has advised the Company that it will no longer make
the minimum license payments necessary to maintain its exclusive rights with
respect to any periods after March 31, 1998.

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 $4,948,200, 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. As a result of the anti-dilution rights, S3 received an additional
307,018 shares of Common Stock upon completion of the Company's initial public
offering in October 1997.

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 for the years ended December 31:

<TABLE>
<CAPTION>
December 31, Pro Forma December 31,
------------------------------------ --------------------------
1995 1996 1997 1995 1996
------- -------- ---------- ---------- ----------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C> <C>

Federal:

Current.................. $23,000 $991,744 $1,058,623 $ 885,687 $1,157,285

Deferred................. -- (439,614) (368,801) 5,463 (455,627)
------- -------- ---------- ---------- ----------

$23,000 552,130 689,822 891,150 701,658

State:

Current................... 60,981 201,016 144,447 151,242 247,312

Deferred.................. -- (66,092) (67,749) (19,204) (69,822)
------- -------- ---------- ---------- ----------

60,981 134,924 76,698 132,038 177,490
------- -------- ---------- ---------- ----------

$83,981 $687,054 $766,520 $1,023,238 $ 879,148
------- -------- ---------- ---------- ----------
------- -------- ---------- ---------- ----------
</TABLE>

F-17
<PAGE>

FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 IS UNAUDITED)

8. INCOME TAXES (CONTINUED)

The provision for income taxes differs from the amount computed by
applying the statutory federal income tax rate to income before taxes. The
sources and tax effects of the differences are as follows for the years ended
December 31:

<TABLE>
<CAPTION>
December 31, Pro Forma December 31,
------------------------------------ -------------------------
1995 1996 1997 1995 1996
---------- -------- -------- ---------- --------
<S> <C> <C> <C> <C> <C>
(Unaudited) (Unaudited)

Tax at U.S. statutory rate...... $1,391,693 $747,275 $685,847 $1,391,693 $747,275

State income taxes, net of
federal benefit................. 60,981 78,615 31,239 132,088 106,709

S Corporation earnings prior
to change in tax status......... (868,150) (251,758) -- -- --

Deferred taxes recorded due
to change in tax status......... -- (148,993) -- -- --

Research and development
tax credits..................... -- (8,725) (137,736) -- --

Net operating losses utilized... (500,543) -- -- (500,543) --

Other........................... -- 270,640 187,170 -- 25,164
--------- -------- -------- ---------- --------

$ 83,981 $687,054 $766,520 $1,023,188 $879,148
--------- -------- -------- ---------- --------
--------- -------- -------- ---------- --------
</TABLE>

The pro forma provision for income taxes in 1996 and 1995 reflects the
additional tax expense which would have been incurred had FLI's status as an S
Corporation terminated on January 1, 1995, exclusive of the effects of the
establishment of deferred tax assets and liabilities at that date.

F-18
<PAGE>

FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 IS UNAUDITED)

8. INCOME TAXES (CONTINUED)

Deferred income taxes reflect the net 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 are as follows at December 31:

<TABLE>
<CAPTION>
December 31,
----------------------
1996 1997
---- ----
<S> <C> <C>
Deferred Tax Assets:

Accrued liabilities.................... $354,284 $686,370

Other, net............................. 208,954 323,840

Deferred tax liabilities:

Depreciation of property and equipment. (57,533) (67,955)

Valuation of investment portfolio...... (44,186) --
-------- --------

Total deferred taxes................... $461,519 $942,255
-------- --------
-------- --------
</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 for the years ended
December 31:

<TABLE>
<CAPTION>
Three Months
Year ended December 31, Ended March 31,
--------------------------------------- ---------------
1995 1996 1997 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue to customers:

Asia...................... $986,000 $1,115,000 $1,182,000 $335,544

Europe.................... 263,000 479,000 345,000 94,179

Canada.................... 138,000 200,000 269,000 100,226

Latin America and other... 190,000 220,000 425,000 69,774
---------- ---------- ---------- --------

$1,577,000 $2,014,000 $2,221,000 $559,723
---------- ---------- ---------- --------
---------- ---------- ---------- --------
</TABLE>

In 1997, sales to two customers accounted for 11% of total revenues. In
1996, sales to one customer accounted for 11% of total revenues. In 1995, sales
to a different customer accounted for 12% of total revenues.

F-19
<PAGE>

FAROUDJA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AT MARCH 31, 1998 AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 IS UNAUDITED)

10. 401K 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
percentage of employee contributions. The Company's contributions were $147,015
in 1997 and were insignificant during 1996 and 1995.

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 collateralized by substantially all of
the Company's tangible assets and contract rights are limited to a defined
percentage of eligible accounts receivable. Borrowings against the line of
credit bear interest at prime plus 1.5% (8.5% at December 31, 1997). At December
31, 1997, there were no borrowings against the line of credit, and the aggregate
amount available under the revolving line of credit was $2,000,000.

F-20