<PAGE>
- -------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 1998
Or
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______to______
Commission File Number 0-23107
FAROUDJA, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 77-0444978
(State or other jurisdiction (I.R.S. employer
of incorporation or organization) identification number)
750 PALOMAR AVENUE, SUNNYVALE, CA 94086
(Address of Principal Executive Offices, including zip code)
(408) 735-1492
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90
days. Yes X No .
---- ----
As of November 12, 1998, there were 12,174,026 shares of Common Stock
($.001 par value per share) outstanding.
- -------------------------------------------------------------------------------
<PAGE>
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION . . . . . . . . . . . . . . . . . . . . . . . .1
ITEM 1. FINANCIAL STATEMENTS. . . . . . . . . . . . . . . . . . . . . . . .1
CONDENSED CONSOLIDATED BALANCE SHEETS . . . . . . . . . . . . . . . . . . . .1
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) . . . . . . . . . . .2
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) . . . . . . . . .3
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. . . . . . . . . . . . .4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . .7
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK . . . . 12
PART II. OTHER INFORMATION . . . . . . . . . . . . . . . . . . . . . . . . 13
ITEM 1. LEGAL PROCEEDINGS . . . . . . . . . . . . . . . . . . . . . . . . 13
ITEM 2. CHANGES IN SECURITIES . . . . . . . . . . . . . . . . . . . . . . 13
ITEM 3. DEFAULTS UPON SENIOR SECURITIES . . . . . . . . . . . . . . . . . 13
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS . . . . . . . 13
ITEM 5. OTHER INFORMATION . . . . . . . . . . . . . . . . . . . . . . . . 14
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. . . . . . . . . . . . . . . . . 15
SIGNATURES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
<PAGE>
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FAROUDJA, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
(Unaudited) (Note)
-------------- ---------------
<S> <C> <C>
Assets
Current assets:
Cash, cash equivalents $20,948 $23,272
Short-term investments - 277
Accounts receivable, net 2,375 3,098
Inventories 3,445 2,943
Deferred tax assets 942 942
Prepaid expenses and other current assets 359 596
-------------- ---------------
Total current assets 28,069 31,128
Property and equipment, net 1,892 2,026
Other assets 267 335
-------------- ---------------
Total assets $30,228 $33,489
-------------- ---------------
-------------- ---------------
Liabilities and stockholders' equity
Current liabilities
Accounts payable $1,186 $1,445
Accrued compensation & benefits 1,061 1,217
Income tax payable 201 872
Other current liabilities 397 607
-------------- ---------------
Total current liabilities 2,845 4,141
Commitments
Stockholders' equity
Preferred Stock, par value $0.001 per share:
Authorized - 5,000 shares; none issued and
outstanding - -
Common Stock, par value $0.001 per share:
Authorized - 50,000 shares;
Issued and outstanding - 12,174 shares at
September 30, 1998 and 12,059 shares at
December 31, 1997 12 12
Additional paid-in capital 30,024 28,978
Deferred compensation (187) (238)
Retained earnings (accumulated deficit) (2,466) 596
-------------- ---------------
Total stockholders' equity 27,383 29,348
-------------- ---------------
Total liabilities and stockholders' equity $30,228 $33,489
-------------- ---------------
-------------- ---------------
</TABLE>
Note - The balance sheet at December 31, 1997 has been derived from the audited
financial statements at that date.
See notes to condensed consolidated financial statements.
1
<PAGE>
FAROUDJA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
---------- ----------- ----------- ----------
<S> <C> <C> <C> <C>
Revenues:
Product sales $3,005 $4,762 $8,966 $11,626
License and royalty revenues - 250 750 1,250
---------- ----------- ----------- ----------
Total revenues 3,005 5,012 9,716 12,876
Cost of product sales 1,643 1,666 4,160 3,952
---------- ----------- ----------- ----------
Gross profit 1,362 3,346 5,556 8,924
Operating expenses:
Research and development 1,338 1,137 3,826 2,977
Sales and marketing 1,051 1,069 2,853 2,862
General and administrative 1,083 638 2,780 1,504
Financing expenses - - - 312
---------- ----------- ----------- ----------
Total operating expenses 3,472 2,844 9,459 7,655
---------- ----------- ----------- ----------
Operating (loss) income (2,110) 502 (3,903) 1,269
Other income (expense), net 289 128 879 223
---------- ----------- ----------- ----------
(Loss) income before provision for
income taxes (1,821) 630 (3,024) 1,492
(Provision)/Benefit for income taxes - (239) 457 (567)
---------- ----------- ----------- ----------
Net (loss) income ($1,821) $391 ($2,567) $925
---------- ----------- ----------- ----------
---------- ----------- ----------- ----------
Net (loss) income per share:
Per share computation:
Basic ($0.15) $0.04 ($0.21) $0.11
Diluted ($0.15) $0.04 ($0.21) $0.10
Number of shares used in per share
computation:
Basic 12,173 8,742 12,126 8,382
Diluted 12,173 9,759 12,126 9,365
</TABLE>
See notes to condensed consolidated financial statements.
2
<PAGE>
FAROUDJA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
1998 1997
------------- ------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net (loss) income (2,567) 925
Adjustment to reconcile net (loss) income to net cash
used in operating activities:
Depreciation and amortization 619 231
Amortization of deferred compensation 51 -
Loss on disposal of equipment - 17
Gain on sale of short term investments - (83)
Changes in operating assets and liabilities:
Accounts receivable 723 (552)
Inventories (502) (951)
Deferred tax assets - (183)
Prepaid expenses and other current assets 237 (517)
Accounts payable (259) 527
Accrued compensation and benefits (156) 487
Income tax payable (671) 252
Other accrued liabilities (210) 196
Deferred revenue - (500)
------------- ------------
Net cash used in operating activities (2,735) (151)
Cash Flows from Investing Activities
Intangible assets - (50)
Purchases of equipment (417) (740)
Maturities of short-term investments 277 -
Sales of short term investments - 1,613
Net cash provided by (used in) investing activities (140) 823
Cash Flows from Financing Activities:
Issuance of Common Stock 551 5,047
------------- ------------
Net cash provided by financing activities 551 5,047
(Decrease) increase in cash and cash equivalents (2,324) 5,719
Cash and cash equivalents at beginning of period 23,272 1,215
------------- ------------
Cash and cash equivalents at end of period 20,948 6,934
------------- ------------
------------- ------------
</TABLE>
3
<PAGE>
FAROUDJA, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
NOTE A - BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
only of normal recurring adjustments) considered necessary for a fair
presentation have been included. Operating results for the three and nine
months ended September 30, 1998, are not necessarily indicative of the results
that may be expected for the year ended December 31, 1998. For further
information, reference is made to the consolidated financial statements and
footnotes thereto included in the Company's Annual Report on Form 10-K for the
year ended December 31, 1997 and other filings.
NOTE B - INVENTORIES
Inventory is valued at the lower of cost (first-in, first-out method) or
market. The components of inventory consist of the following (in thousands):
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
------------------ -----------------
<S> <C> <C>
Raw materials $ 872 $ 770
Work-in-process 1,660 1,508
Finished goods 913 665
---------- ---------
$ 3,445 $ 2,943
---------- ---------
---------- ---------
</TABLE>
4
<PAGE>
NOTE C - NET INCOME (LOSS) PER SHARE
As of December 31, 1997, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128").
All prior periods have been restated to reflect the adoption of SFAS 128.
Under the provisions of SFAS 128, basic net income per share is computed
using the weighted average number of shares of Common Stock outstanding
during the period. Diluted net income per share also gives effect to the
dilutive effect of stock options and warrants (using the treasury stock
method). A reconciliation of shares used in the calculation follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
----------------------- --------------------------
<S> <C> <C> <C> <C>
Weighted average shares outstanding 12,173 8,742 12,126 8,382
Dilutive effect of stock options and warrants - 1,017 - 983
--------- -------- -------- ---------
Weighted average shares used in diluted
net income per share 12,173 9,759 12,126 9,365
--------- -------- -------- ---------
--------- -------- -------- ---------
</TABLE>
Options and warrants to purchase 1,758,529 shares of the Company's common stock
would have been anti-dilutive for the three and nine month periods ended
September 30, 1998 and were, therefore, excluded from the diluted calculation in
those periods.
NOTE D - INCOME TAXES
The estimated annual benefit for income taxes was 0% and 15.1% for the three and
nine months ended September 30, 1998, respectively, compared to tax provisions
for income taxes of 38% for the same periods of 1997. The 1998 rate reflects the
estimated benefit of refundable taxes related to the company's overall loss
position and realization of deferred tax assets based on the reversal of taxable
temporary differences and projected future income. The third quarter of 1998 was
impacted by a cumulative adjustment to record the revised lower estimated tax
rate of 15.1% for the year as a result of revised estimated pretax losses for
the fiscal year. The tax provisions for 1997 differed from the federal statutory
rate primarily due to the utilization of research and development tax credits
offset by state taxes.
Under Statement of Financial Accounting Standards No. 109 (FAS 109), deferred
tax assets and liabilities are determined based on differences between financial
reporting and tax bases of assets and liabilities and are measured using the
enacted tax rates and laws that will be in effect when the differences are
expected to reverse. FAS 109 provides for the recognition of deferred tax assets
if realization of such assets is more likely than not. Based on the weight of
available evidence, the Company has provided a valuation allowance against
certain deferred tax assets for 1998. The Company will continue to evaluate the
realizability of the deferred tax assets on a quarterly basis.
5
<PAGE>
NOTE E - SIGNIFICANT CUSTOMERS
Total revenues from two customers accounted for 16% and 22% of revenues for the
nine months ended September 30, 1998 and 1997, respectively.
Revenue from S3 Incorporated (S3) accounted for 8% and 11% of revenues for the
nine months ended September 30, 1998 and 1997, respectively. S3 revenues mostly
represented pre-paid non-refundable royalty payments in order to maintain
exclusive rights to license certain technology. No prepayments will be made by
S3 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. Sales to Vidikron of
America, Inc. accounted for 8% and 11% of revenues for the nine months ended
September 30, 1998 and 1997, respectively.
NOTE F - COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted SFAS 130, REPORTING COMPREHENSIVE
INCOME. Statement 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. Statement
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 Statement 130.
There was no difference between net loss and total comprehensive loss for the
three and nine month periods ended September 30, 1998. Total comprehensive
income for the three and nine months ended September 30, 1997 was $391,000 and
$858,000, respectively.
NOTE G - RECLASSIFICATION
In accordance with SAB 4.B., the Company reclassified $495,000 from retained
earnings to paid-in capital to reflect the undistributed accumulated earnings of
Faroudja Laboratories, Inc. Faroudja Laboratories, Inc., which was an S
Corporation for income tax purposes, was merged with another company, and the
resulting entity was merged with a wholly owned subsidiary of the Company. There
was no impact on total stockholders' equity as a result of this
reclassification.
6
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This discussion, other than the historical financial information, may consist of
forward-looking statements that involve risks and uncertainties, including
quarterly fluctuations in results, the timely availability of new products
including line multipliers and HDTV/DTV products, consumer acceptance of new
HDTV standards, the impact of competitive products and pricing, and the other
risks set forth from time to time in the Company's SEC reports, including this
report on Form 10-Q for the quarter ended September 30, 1998 and the Company's
Annual Report on Form 10-K for the year ended December 31, 1997. Actual results
may vary significantly.
The Company undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events, or otherwise.
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 Ended
Revenues: September 30, September 30,
------------- -------------
1998 1998
---- ----
<S> <C> <C>
Product sales 100% 95%
License and royalty revenues - 5
------------- -------------
Total revenues 100 100
Cost of product sales 55 33
------------- -------------
Gross margin 45 67
Operating expenses:
Research and development 45 23
Sales and marketing 35 21
General and administrative 36 13
------------- -------------
Total operating expenses 116 57
------------- -------------
Operating income (loss) (70) 10
Other income 10 3
------------- -------------
Income (loss) before provision for income taxes (61) 13
Provision for income taxes - 5
------------- -------------
Net Income (loss) (61)% 8%
------------- -------------
</TABLE>
Total revenues for the third quarter of 1998 were approximately $3.0 million, a
decrease of approximately $2.0 million, or 40%, from total revenues of
approximately $5.0 million for the third quarter of 1997. Total revenues for
the first nine months of 1998 decreased by approximately 25% to $9.7 million
compared to $12.9 million in the first nine months of 1997. This revenue
decrease for the quarter and year to date as compared to the prior year was due
primarily to two factors. First, softness in revenues of line multiplier
products in the home theater industry. Specifically, the low end of the line
multiplier product family, line doublers, faced heavy competition from other
line processor manufacturers and from certain manufacturers
7
<PAGE>
that included built-in line doublers in their projectors. Sales for the
higher end of the line multiplier family, line triplers and line quadruplers,
remained strong and grew year over year, resulting in a nine month year over
year decline of 28% in total line multiplier sales. Second, due to S3's
decision to discontinue making royalty payments necessary to maintain S3's
exclusive license rights with respect to any periods after March 31, 1998,
for the first nine months of 1998 royalty revenues declined by $0.5 million.
While there were no S3 revenues in the second and third quarters of 1998, in
the first nine months of 1998 and 1997, respectively, revenues from S3
accounted for 8% and 11% of total revenues.
The Company anticipates that sales of home theater line multiplier products
will increase slightly in absolute numbers, but represent a lower percentage
of total sales in the last quarter of 1998. Sales of broadcast equipment are
expected to increase as a result of the introduction of the Digital Format
Translator products during the third quarter. The Company continues to pursue
new licensing opportunities, but there can be no assurance that the Company
will enter into additional license agreements.
Sales outside the United States accounted for approximately 20% of net product
sales for the third quarter of 1998 and 21% for the first nine months of 1998.
These percentages compare to 15% for the third quarter of 1997 and 13% for the
first nine months of 1997. 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. All sales are denominated in U.S.
dollars. However, the Company's export sales are subject to risk in the event of
changes in currency exchange rates, which may result in the Company's products
being less price competitive.
The Company's gross margin as a percentage of net sales decreased to 45% of
sales for the third quarter of 1998 from 67% in the third quarter of 1997. The
third quarter margin was negatively affected by both the lack of high margin
licensing revenue and by price reductions in the Company's line multiplier
products. In addition the Company had one-time write-offs of obsolete and
surplus inventory. For the first nine months of 1998, the gross profit
percentage decreased to approximately 57% from 69% for the first nine months of
1997, due primarily to the decline in royalty revenue, price declines in the
Company's line multiplier, DVD and laser disc products, and higher sales volumes
of home theater rear screen projection systems that are sold at lower gross
margins. The Company expects its gross margins as a percentage of sales to
increase in the future due to the improved mix of high margin broadcast product
sales.
Research and development expenses increased by approximately $0.2 million, or
18%, in the third quarter of 1998 compared to the third quarter of 1997, and
expenses increased by approximately $0.8 million in the first nine months of
1998 compared with the first nine months of 1997. The year over year increase
was due to increases in prototype materials and use of outside consulting
services. The higher spending in these areas resulted from increased product
development activities for the Company's recently introduced Digital Format
Translator products for the broadcast industry. The Company expects that
research and development expenses will decline slightly for the remainder of
fiscal 1998.
Sales and marketing expenses remained at the same levels for both the third
quarter and the first nine months of 1998 compared to the respective periods of
1997. The Company believes that
8
<PAGE>
sales and marketing expenses overall will decrease in absolute dollars during
the remainder of fiscal 1998.
General and administrative expenses increased by approximately $0.4 million, or
70%, in the third quarter of 1998 compared to the third quarter of 1997 and
increased by approximately $1.3 million in the first nine months of 1998
compared with the first nine months of 1997. The increase in general and
administrative expenses in 1998 is related to several factors: the preparation
of a Registration Statement on Form S-1 covering the sale of shares by selling
stockholders which was filed in July 1998, expenses for the 1997 Annual Report
to Shareholders that was published in 1998, legal expenses for two lawsuits
brought by the Company for patent infringement and one time compensation charges
relating to changes in senior management. The Company expects that
administrative expenses will decrease in absolute dollars during the remainder
of fiscal 1998.
In 1997 the Company also spent $0.3 million in the first quarter related to
financing activity. There were no such expenses in 1998.
Interest and other income/expense was $0.3 million in the third quarter of 1998
compared to $0.1 million in the third quarter of 1997. The increase in
interest income in 1998 over 1997 is derived from investments in short-term,
interest bearing investment grade securities as a result of two investments made
into the Company in 1997. They include the investment of the $15.6 million net
proceeds from the Company's initial public offering completed in October 1997,
and the $5 million investment by S3 in the Company in June 1997. As a result of
such increased investments, the Company anticipates that 1998 interest income
will continue to be higher than 1997.
The Company provided a valuation allowance against the deferred tax benefit
which resulted from the loss in the quarter ended September 30, 1998. Management
continues to believe that it is probable that the remaining deferred tax asset
will be realized through future profitable operation. The effective tax rate for
the third quarter of 1997 was 38%.
FACTORS AFFECTING FUTURE OPERATING RESULTS
The Company develops, manufactures and sells consumer and commercial products
designed to bring HDTV-quality images to the digital broadcast, display,
PC/TV-convergence and home-theater markets. The Company's target customers
include home theater dealers, broadcasters, TV and projector manufacturers, PC
manufacturers, semiconductor manufacturers, and other suppliers to the PC
industry and the TV industry. Due to the relative size of the customers in some
of these markets, particularly the broadcast and PC/TV convergence markets,
sales in any one market could fluctuate dramatically on a quarter to quarter
basis.
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, if
achieved, competitive products and technologies, 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
9
<PAGE>
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 introduced its new family of Digital Format Translators 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 mandated by the Federal
Communications Commission.
The Company received quarterly prepaid license fees from S3 to maintain
exclusivity under its license agreement with the Company through March 31, 1998.
No prepayments will be made by S3 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.
The Company's success depends in part on its ability to enhance existing
products and introduce new high technology products. The Company must also
bring its products to market at competitive price levels. Unexpected changes in
technical standards, customer demand and pricing of competitive products could
adversely affect the Company's operating results if the Company is unable to
effectively and timely respond to such changes. The industry is also dependent
to a large extent on proprietary intellectual property rights. From time to time
the Company is subject to legal proceedings and claims in the ordinary course of
business, including claims of alleged infringement of patents, trademarks and
other intellectual property rights. Consequently, from time to time, the
Company will be required to prosecute or defend against alleged infringements of
such rights.
The Company intends to increase both engineering and sales and marketing efforts
in the design, development and sale of board and chip level products while
continuing the sale of stand-alone products for the high-end home theater,
industrial and broadcast markets. 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 success also depends to a significant extent upon the
contributions of key sales, marketing, engineering, manufacturing, and
administrative employees, and on the Company's ability to attract and retain
highly qualified personnel, who are in great demand. Unless personnel vacancies
are promptly filled, the loss of current key employees or the Company's
inability to attract and retain other qualified employees in the future could
have a material adverse effect on the Company's business, financial condition
and results of operations.
Year 2000
Certain computers, software and equipment with embedded computing capability
recognize only the last two, rather than all four digits of the year in any
date. As a result they may fail to recognize and properly process date
information or otherwise malfunction unless they are reprogrammed or replaced at
the turn of the century (the "Year 2000 Problem"). The Company,
10
<PAGE>
which is dependent upon computers, software and equipment with embedded
computing capability for all phases of its operations including production,
distribution and accounting, is in the early stages of developing a
comprehensive plan to determine the impact of the Year 2000 Problem on its
operations. This plan will include an assessment of internal and external
Year 2000 Problems, formal contacts with the Company's significant suppliers,
customers, financial organizations, service providers and others to determine
their Year 2000 readiness, remediation of problems where found, and a
contingency plan for problems which cannot be solved on a timely or
cost-effective basis.
The Company has completed an assessment of its products and believes that the
performance and functionality of such products will not be affected by Year 2000
Problems.
The Company is currently evaluating business computer systems to replace a
substantial majority of its existing systems and plans to complete this
system upgrade during the first half of 1999. The system selected will be
Year 2000 compliant, and, if implemented, is expected to eliminate most of
the Company's internal Year 2000 Problems. The Company will also develop a
contingency plan by the end of the first quarter of 1999, to be deployed if
this system upgrade does not take place or is not completed on a timely
basis. While it is not presently possible to precisely quantify the overall
cost of this work, the Company does not believe that the cost of addressing
the Year 2000 Problem, as it relates to the Company's internal systems, will
have a material adverse effect on the Company's financial position, liquidity
or results of operations.
In addition to the Company's own systems and equipment, the Company relies,
directly and indirectly, on the systems and equipment of its suppliers,
distributors, customers, creditors, financial organizations, utility
companies, telecommunication service companies and other service providers.
Some of these third parties may have Year 2000 Problems outside of the
Company's control that could adversely affect the Company.
There can be no assurance that the Company will identify all of its Year 2000
Problems, resolve its internal Year 2000 Problems on a timely or
cost-effective basis, or be successful in avoiding the impact of business
disruptions which may be experienced by the Company's suppliers, service
providers and other third parties as a result of Year 2000 Problems. Failure
by the Company or third parties doing business with the Company to identify
and resolve internal Year 2000 problems on a timely basis could have a
material adverse effect on the Company's financial position, liquidity or
results of operations.
In summary, the Company's net sales and operating results in any particular
quarter may fluctuate as a result of a number of factors, including competition
in the markets for the Company's products, delays in new product introductions
by the Company, market acceptance of new products such as the Digital Format
Translator, changes in product pricing, material costs or customer discounts,
the size and timing of customer orders, dealer and end-user purchasing cycles,
variations in the mix of product sales, manufacturing delays or disruptions in
sources of supply, economic conditions and seasonal purchasing patterns specific
to the broadcast, display, PC and home theater industries, and risk associated
with year 2000 Problems. The Company's future operating results will depend, to
a large extent, on its ability to anticipate and successfully react to these and
other factors.
11
<PAGE>
Successfully addressing the factors discussed above, which are subject to
various risks discussed in this report, the Company's Annual Report on Form 10-K
for the year ended December 31, 1997, and other SEC filings, as well as other
factors which generally affect the market for stocks of high technology
companies, will affect the price of the Company's stock and could cause such
stock price to fluctuate over relatively short periods of time.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1998, the Company had approximately $20.9 million of cash and
cash equivalents, and working capital of approximately $25.2 million.
The cash and cash equivalents are predominantly held in three types of cash
investments. These investments are obligations issued by U.S. federal agencies,
money market funds which subject the Company to limited interest rate or credit
risk, and commercial paper of U.S. corporations with A1/P1 credit ratings.
Cash, cash equivalents and short-term investments at September 30, 1998 declined
by $2.6 million or 11% from the balances at December 31, 1997. Cash was used in
purchasing both engineering test equipment and product inventory, and reducing
the accounts payable balances. The decline in cash, cash equivalents and
short-term investments was partially offset by strong customer collections that
reduced accounts receivable balances.
In April 1998, the Company renewed its bank line of credit. Covenants under the
Company's line of credit require the Company to maintain certain minimum levels
of liquidity, net worth, and financial ratios. As of September 30, 1998, the
Company was not in default under any such covenants. No borrowings were made
under the line of credit agreement in either 1998 or 1997.
The Company believes that current cash and cash equivalents and available
borrowings are sufficient to fund its operations and meet anticipated capital
requirements for at least the next twelve months.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not applicable.
12
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In January 1997 and May 1997, the Company filed actions against DWIN
Electronics, Inc. ("DWIN") and Snell & Wilcox, Inc. ("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 General Instrument Corporation 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. A similar motion for summary judgment was recently
filed in the DWIN case but has not yet been ruled upon. 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.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
13
<PAGE>
ITEM 5. OTHER INFORMATION
On October 6, 1998 Glenn W. Marschel, Jr. was named President, Chief Executive
Officer and Co-Chairman of the Board of Directors of the Company. Mr. Marschel
succeeded Michael J. Moone, who resigned his positions with the Company to
pursue other interests. Yves Faroudja, Founder and Chief Technical Officer of
the Company also assumed the position of Co-Chairman at that time. William J.
Turner stepped down from his position as Chairman of the Board but continued as
a director of the Company.
Mr. Marschel (age 52) has served as Chairman of the Board of Additech, Inc., a
petrochemicals company, since September 1997. He served as CEO and President of
Paging Network, Inc., a telecommunications company, from December 1995 to August
1997, Vice Chairman of First Financial Management Group, a credit reporting and
collections company, from April 1995 to November 1995, and held positions of
increasing responsibility over more than twenty years at Automatic Data
Processing, Inc., an information systems company, last serving as President of
its Employer Services Group. Mr. Marschel is a director of Sabre Group
Holdings, Inc.
14
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K.
The Company did not file any reports on Form 8-K during the three
months ended June 30, 1998.
15
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FAROUDJA, INC.
(Registrant)
By: /s/ R.A. Sheffield
--------------------------
R.A. Sheffield, Vice President of Finance and Chief Financial Officer
(Duly Authorized Officer and Principal Financial Officer)
Date: November 12, 1998
-------------------------
16
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL(S) STATEMENT INCLUDED IN ITEM 1 OF FORM 10Q DATED SEPTEMBER 30,
1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 20,948
<SECURITIES> 0
<RECEIVABLES> 2,470
<ALLOWANCES> 95
<INVENTORY> 3,445
<CURRENT-ASSETS> 28,069
<PP&E> 4,279
<DEPRECIATION> 2,387
<TOTAL-ASSETS> 30,228
<CURRENT-LIABILITIES> 2,845
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0
0
<COMMON> 12
<OTHER-SE> 27,371
<TOTAL-LIABILITY-AND-EQUITY> 30,228
<SALES> 8,966
<TOTAL-REVENUES> 9,716
<CGS> 4,160
<TOTAL-COSTS> 4,160
<OTHER-EXPENSES> 3,826
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (3,024)
<INCOME-TAX> 457
<INCOME-CONTINUING> (2,567)
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<EXTRAORDINARY> 0
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<NET-INCOME> (2,567)
<EPS-PRIMARY> (0.21)
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