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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
COMMISSION FILE NUMBER 0-23107
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FAROUDJA, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 77-0444978
(State or other jurisdiction of
incorporation and organization) (I.R.S. Employer Identification No.)
750 PALOMAR AVENUE, SUNNYVALE, CA 94086
(Address of principal executive offices, including zip code)
(408) 735-1492
(Registrant's telephone number)
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.001 PER SHARE
(Title of class)
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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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates
of the Registrant, based on the closing price of the Common Stock on March 1,
2000, as reported on the NASDAQ National Market, was approximately $77.7
million. Shares of Common Stock held by each officer and director and by each
person who owns 5% or more of the outstanding Common Stock have been excluded
from this computation in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
As of March 1, 2000 the Registrant had outstanding 12,422,557 shares of
Common Stock.
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FAROUDJA, INC.
FORM 10-K
DECEMBER 31, 1999
INDEX
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PAGE
NO.
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PART I
Item 1. BUSINESS.................................................................................................. 3
EXECUTIVE OFFICERS OF THE COMPANY......................................................................... 19
Item 2. PROPERTIES................................................................................................ 20
Item 3. LEGAL PROCEEDINGS......................................................................................... 20
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS....................................................... 20
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS..................................... 21
Item 6. SELECTED FINANCIAL DATA................................................................................... 22
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS..................... 22
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK................................................ 27
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA............................................................... 28
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE...................... 44
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT........................................................ 44
Item 11. EXECUTIVE COMPENSATION.................................................................................... 45
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT............................................ 53
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................................................ 54
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.......................................... 56
SIGNATURES .......................................................................................................... 57
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THIS FORM 10-K CONTAINS FORWARD LOOKING STATEMENTS WITHIN THE MEANING OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 CONCERNING THE COMPANY'S FUTURE
PRODUCTS, EXPENSES, REVENUE, LIQUIDITY AND CASH NEEDS AS WELL AS THE COMPANY'S
PLANS AND STRATEGIES. SUCH FORWARD-LOOKING STATEMENTS INVOLVE KNOWN AND UNKNOWN
RISKS AND UNCERTAINTIES. THESE FORWARD-LOOKING STATEMENTS ARE BASED ON CURRENT
EXPECTATIONS. THE COMPANY'S ACTUAL RESULTS AND TIMING OF CERTAIN EVENTS COULD
DIFFER MATERIALLY FROM THE DESCRIPTIONS IN THESE FORWARD-LOOKING STATEMENTS. FOR
A DISCUSSION OF VARIOUS RISKS AND UNCERTAINTIES AFFECTING THE COMPANY'S FUTURE
OPERATIONS SEE "FACTORS AFFECTING FUTURE OPERATING RESULTS." 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.
PART I
ITEM 1. BUSINESS
GENERAL
Faroudja, Inc. (the "Company") designs, develops and markets a range of video
processing and video image enhancement products for the home theater, commercial
presentation and broadcast markets. These products include system level products
for consumer and commercial end-users and application specific integrated
circuits, referred to as "ASICs", that other manufacturers can incorporate into
their products. The Company is currently seeking to sell its ASICs into markets
for new digital display devices such as digital televisions, liquid crystal
display ("LCD") monitors, plasma displays, digital cathode ray tube ("CRT")
displays, and LCD and Digital Light Processing-TM- ("DLP") projectors, and
seeking to address opportunities in the emerging high definition television
("HDTV") broadcast market.
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. Thereafter, FRE was
merged into FLI with FLI surviving the merger. FLI was subsequently merged into
a newly-formed, wholly-owned subsidiary of the Company.
Disclosures in this Form 10-K regarding the Company's business and strategy
are based on the Company continuing as an independent entity. On February 18,
2000, Faroudja and Sage, Inc. ("Sage") entered into a definitive agreement to
merge Faroudja into a wholly owned subsidiary of Sage. The agreement provides
for each share of Faroudja common stock, $.001 par value, to be converted
into .285 shares of Sage common stock. Sage will assume all outstanding
options and warrants. Completion of the merger requires the approval of the
stockholders of Sage and the stockholders of Faroudja and satisfaction of
other conditions. Under the merger agreement Faroudja is obligated to carry
on its business in substantially the same way it is currently being
conducted. The agreement contains customary provisions that significantly
limit a variety of possible company activities, such as entering into joint
ventures or strategic partnerships or licensing any technology, without
Sage's consent. Among the risks that should be considered are:
- - There can be no assurance that the merger will be consummated.
- - If the merger is not consummated there can be no assurance that the costs
associated with the transaction and the management attention diverted to
the transaction will not have a material adverse affect on the Company.
- - If the merger is consummated there can be no assurance that the business
and strategy of the combined entity will not differ materially from the
current business of the Company or that the integration of the businesses
of Sage and Faroudja will not have a material adverse effect on the
combined entity.
- - Because the exchange ratio is fixed, the market value of Faroudja common
stock may vary with the market value of Sage and be unrelated to the
business, operations or prospects of Faroudja.
These issues associated with the merger should be considered along with the
issues discussed in "Factors Affecting Future Operating Results."
BACKGROUND
Video images are pervasive in today's society as sources of entertainment and
information. These video images are displayed on a variety of electronic media
including color TVs, projection systems and PC monitors. Historically, there has
been a substantial difference between the quality of video images and the
quality of cinema displayed in movie theaters. 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 large screen TVs, projection systems, PCs and new digital displays.
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With U.S. households owning approximately 250 million television sets, TV is the
dominant medium for viewing video images. TV signals are produced in accordance
with a standard developed more than 40 years ago and contain image-degrading
imperfections, known as artifacts, because of technical choices made back then.
Additionally, analog transmission introduces noise in the TV image. While these
imperfections are always present they are not that obvious on screens less than
25 inches in size from normal viewing distances. As TV screen sizes increase, or
as viewing distances decrease, as is the case with PC monitors, impairments in
the image, such as low resolution, artifacts and noise, become more apparent and
annoying.
PCs are increasingly being used for multi-media applications such as viewing
DVDs and video over the Internet. Since video typically uses an interlaced
scanning format and PCs use a progressive scanning display format, video must be
converted before being displayed on a PC. The interlace/progressive conversion,
along with other steps in the conversion process, cause color distortion, motion
artifacts, noise and other imperfections, and result in poor video quality on
the PC. Image problems become even more apparent on a PC, because users sit
relatively close to their screens and PC monitors have higher resolution than
most TVs.
The Company believes that the trends toward larger and higher resolution
displays, the availability of new digital display technologies and devices, the
use of PCs for multi-media applications and the introduction of HDTV will result
in increasing demand for high quality video.
HDTV images incorporate cinema-like image quality in a wider screen format. The
Federal Communications Commission ("FCC") has established standards and a
schedule for broadcasters' gradual replacement of analog television with digital
television ("DTV") in the United States. The FCC has targeted the eventual
phase-out of analog broadcasting by the year 2006. Current analog broadcasting
equipment is not compatible with the new DTV standards. In order to transmit
digital signals that comply with the new DTV standards, broadcasters will need
to spend millions of dollars to acquire new equipment. Broadcasters are seeking
to reduce the costs of transitioning from analog to digital broadcasting through
strategies that allow them to continue using some of their existing equipment
and legacy video footage.
FAROUDJA SOLUTIONS
The Company has pioneered video image enhancement technologies and designs,
develops and markets a variety of video image enhancement products incorporating
these technologies. These technologies and products dramatically improve image
quality, producing cinema quality images on a wide variety of displays.
The Company's products substantially reduce the imperfections inherent in
standard TV signals, which become increasingly apparent on large screen and high
resolution 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 products
for the home theater and commercial presentation market include standalone
system-level products, and video processing ASICs that original equipment
manufacturers can incorporate into their own products. The Company is currently
seeking to sell its ASICs into markets for new digital display devices such as
digital televisions, LCD monitors, plasma displays, digital CRTs, LCD and DLP
projectors and PC multimedia applications.
The Company has also developed products that support the transition from analog
to DTV/HDTV broadcasting. As broadcasters make significant investments to
satisfy regulatory requirements, the Company believes that product solutions
that enable broadcasters to continue using some of their current studio
equipment and source material will help broadcasters minimize transition costs
and maintain flexibility in responding to evolving regulatory and market
requirements. The Company believes that its Digital Format Translator-TM-
("DFT") upconversion products will enable broadcasters to use equipment present
in their existing studios to produce programming in various DTV/HDTV video
formats.
STRATEGY
The Company's objective is to maintain and expand its position as the industry
standard of excellence for high quality video processing. Key elements of the
Company's strategy to achieve this objective include:
MAINTAIN AND EXTEND TECHNOLOGY LEADERSHIP. The Company intends to maintain high
levels of investment in research and development to build upon its technology
leadership in video image processing. These efforts will focus on developing
patentable technologies and innovative products for the video display and
broadcast markets. The Company intends to leverage its image enhancement
expertise in the high end home theater and commercial presentation markets into
markets for digital televisions, other new digital display devices and
broadcast.
PENETRATE BROADER MARKET SEGMENTS. The Company has historically sold products
that address the needs of the home theater and commercial presentation markets.
The Company is seeking product opportunities in new and broader market segments,
such as emerging
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digital video displays, computer/television convergence and DTV/HDTV
broadcast. The Company's emphasis on incorporating its technologies into
reasonably priced, highly integrated, high performance ASICs, will facilitate
entry into the digital television and new digital display markets.
BUILD AND LEVERAGE STRATEGIC RELATIONSHIPS. The Company intends to establish and
maintain strategic relationships with companies whose technology, products and
distribution strategies complement those of the Company in order to increase
market penetration and recognition of the Company's capabilities in markets
currently served and to facilitate migration into new markets. In July 1999, the
Company entered into a license and joint development agreement with Sage, Inc.
to leverage Sage's capabilities as a supplier of display controller chips for
flat panel displays and other digital display devices.
INCREASE BRAND NAME AWARENESS. The Company has established a reputation for
excellence in video processing and video image enhancement in the home
theater, commercial presentation, broadcast and consumer electronics markets.
The Company intends to increase brand name awareness through advertising, the
marketing of stand alone image enhancement and display products carrying the
Company's trademarks, co-branding agreements with OEM customers and greater
emphasis on Internet marketing through its web site. The distribution of
Company-branded and co-branded products in new and broader market segments is
also intended to increase Faroudja-Registered Trademark- brand awareness. In
February 2000, the Company's collaboration with MadOnion.com (formerly
Futuremark Corporation), a leading provider of PC performance and upgrade
information, resulted in the release of the Video2000 video benchmark.
Video2000 objectively measures the video quality, features and performance of
desktop video streams. Involvement with a video benchmarking effort and
prominent display of Faroudja's trademark on MadOnion.com's frequently
visited website are intended to increase recognition of the preeminence of
the Company's video processing technology and expertise and increase
awareness of the Faroudja brand in general.
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 home theater and
commercial presentation products, OEM ASIC products and products for the
broadcast market:
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MARKET PRODUCT DESCRIPTION
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Image Enhancement/ DVP2200 Video processor/scaler for large screen
Line Multiplying/ high-resolution CRT, DLP, LCD and Plasma
Scaling Processors video projection and display systems. Scan
for Projection and rate scaling from 480i to computer SVGA
Direct View Display and DTV rate of 480p. Aspect ratio control
Systems for letterbox, anamorphic and 4:3 video
sources.
DVP2220 In addition to the capabilities of the
DVP2200 the DVP2220 can optimize display
of PAL sources by scan rate scaling from
576i to 576p and doubling the refresh rate
of PAL sources from 50Hz to 100Hz ("frame
doubling"), removing flicker and
increasing light output.
DVP3000 Video processor/scaler for large screen
high-resolution CRT, DLP, LCD and Plasma
video projection and display systems. Scan
rate scaling from 480i to computer VGA,
SVGA, XGA and SXGA rates and to DTV/HDTV
rates of 480p, 1080i, 720p, 960p and
1080p. Aspect ratio control for
letterbox, anamorphic and 4:3 video
sources.
VS50 NTSC/PAL low noise video decoder and image
processor for large screen standard
resolution displays and video production.
Large Screen Multimedia RP5800 HDTV rear screen multimedia projection
Display Systems system with built-in line doubler and
video processor.
LS700 LCD-based front projection system with
line doubler and video processor.
Broadcast DFD U NTSC/PAL video decoder/frame synchronizer
with 10-bit processing, time base
correction, patented 2D adaptive comb
filter produces artifact-free digital D1
parallel and serial outputs.
A2D1F Low noise video decoder/frame synchronizer
with video adjustments and D1 output.
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DFT Format translator products with modular
design that allow custom configurations
ranging from base functionality to full
feature suite including upconverting a
full range of NTSC signals through
patented 2D decoding, analog component and
serial digital inputs to ATSC 480p, 720p
and 1080i DTV/HDTV video formats, full
aspect ratio control, standard and high
definition frame synchronization, digital
color correction, digital noise reduction,
advanced video enhancement, HD-SDI and
analog outputs, and System Control
Software.
ASICs FLI2000 Single chip broadcast quality NTSC/PAL
adaptive comb filter video decoder with
10-bit processing and time base correction
produces separate and enhanced luminance
and chrominance signals for high-end
consumer or commercial product
applications.
FLI9000 Eight chip set (including the FLI2000)
incorporating Faroudja's basic
decoding, line doubling and enhancement
path to provide clearer, sharper video
signals compatible with progressively
scanned displays and large screen
projection systems.
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HOME THEATER AND COMMERCIAL PRESENTATION PRODUCTS
DVP2200. The DVP2200 was introduced in 1999 to replace the the VP251 line
doubling video processors and VP301 line tripling video processors. These
digital video processor/scalers produce cinema-like images for large screen
high-resolution CRT, DLP, LCD and Plasma video projection and display systems.
The processors accept input from sources formatted for conventional 525-line or
625-line TV standards, and perform scan rate conversion to the computer SVGA
scan rate and to the DTV scan rate of 480p and aspect ratio conversion (to
letterbox, anamorphic or 4:3) necessary to optimize the image produced by the
projection system or display device being used. The processors are precision
instruments employing three complex digital signal processes utilizing patented
technology in the fields of decoding, scan conversion and detail enhancement.
These products substantially reduce color blurring, rainbow patterns, dot crawl
and visible scan lines, and deliver sharp image details.
DVP2220. In addition to having the capabilities of the DVP2200, the DVP2220 can
optimize the display of PAL sources by scan rate scaling from 576i to 576p and
doubling the refresh rate of PAL sources from 50Hz to 100Hz ("frame doubling").
This removes flicker and increases light output.
DVP3000. The DVP3000 was introduced in 1999 as the Company's premier line of
digital video processor/scalers to replace the VP401 line quadruplers. In
addition to having all the features and capabilities of the DVP2200, the DVP3000
can convert conventional 525-line or 625-line TV standards into additional scan
rates: computer VGA, XGA and SXGA rates and HDTV rates of 1080i, 720p, 960p and
1080p. Greater flexibility and the higher level of performance allows the
DVP3000 to be used with a broader variety of projection and display devices and
to optimize the image produced by even the most high-performance projection and
display systems.
VS50 CHROMA DECODER. The VS50 decodes NTSC and PAL signals into high quality,
artifact-free components to greatly improve image quality for high quality
standard scan rate displays and video production.
REAR PROJECTION MULTIMEDIA DISPLAY SYSTEM (RP5800). The Company's 58 inch wide,
HDTV rear screen multimedia projection system incorporates the Company's line
doubling video processing technology. This display system is designed for
customers with space, remodeling or lighting constraints and provides HDTV
quality images.
LS-TM- 700 LCD PROJECTOR. The LS700 is an LCD-based front projection system
produced by In Focus Systems, Inc. ("In Focus-Registered Trademark-"),
incorporating line doubling and video processing ASICs of the Company. This
product combines the image quality for which the Company is recognized with
the compact form factor, ease-of-use, reliability and low cost of ownership
of an LCD projector.
Home theater and industrial product sales as a percentage of total revenues for
fiscal 1999, 1998 and 1997 were 81%, 84% and 88%, respectively.
The Company co-brands certain of its standalone video processing products with
Vidikron of America, Inc. ("Vidikron").
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.
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A2D1F. The A2D1F 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 and digital video compression.
DIGITAL FORMAT TRANSLATOR. The Company's Digital Format Translator-TM- ("DFT")
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 DFT 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 that ultimately contribute to superior image quality.
The translators have a modular design and can be configured to suit particular
customer's needs. Examples of configurations are the DFT3 and DFT3A described
below.
DFT3 - DIGITAL FORMAT TRANSLATOR. The DFT3 base model translator uses patented
Faroudja technologies to translate 525 line interlace serial digital component
video into the customer's choice of either the ATSC 720 line progressive or 1080
line interlace HDTV video formats. The product includes the ability to choose
from among multiple preset aspect ratios, standard and high definition frame
synchronization, digital color correction and HD-SDI outputs.
DFT3A - DIGITAL FORMAT TRANSLATOR. The DFT3A is a fully featured DFT3. It
contains all features of the DFT3 and Faroudja's patented adaptive comb filter
decoding for upconverting the full range of NTSC signals (analog, composite and
digital) into the full range of ATSC DTV and HDTV video formats: 480 line
progressive, 720 line progressive and 1080 line interlace. Digital noise
reduction and a variety of analog monitoring options are also added to round out
the DFT3A and make it the most advanced and feature rich product in its class.
Broadcast product sales as a percentage of total revenues for fiscal 1999, 1998
and 1997 were 13%, 10% and 2%, respectively.
ASIC PRODUCTS AND LICENSING
The Company has designed and developed ASIC products incorporating the Company's
technologies for the display and broadcast OEM markets including the FLI2000
chip and the FLI9000 chip set.
FLI2000. The FLI 2000 is a broadcast quality NTSC/PAL decoder ASIC, with time
base correction and detail enhancement. It can be incorporated into consumer or
commercial projection and display devices or into broadcast products.
FLI9000. The FLI9000 set of eight proprietary ASICs includes the FLI2000 and
additional ASICs that provide deinterlacing and enhancement functionality.
The chip set provides much of the functionality of the DVP2200. The FLI9000
chip set was incorporated by In Focus-Registered Trademark- into the LS700
projector and is being incorporated by Mitsubishi Electric Corporation into
video processors primarily being sold in conjunction with Mitusbishi's
high-end projection systems.
In July 1999, Faroudja entered into a license, joint development and equity
purchase agreement with Sage, Inc. ("Sage"), a leading supplier of controller
chips to the flat panel display industry. The agreement provided for the
transfer of certain of Faroudja's video processing technologies to Sage and
granted Sage rights to incorporate those technologies into Sage chips. The
combination of Sage and Faroudja technologies will enable the development of
complete, high quality, cost-effective ASIC solutions for flat panel and other
digital display systems. In addition to receiving shares of Sage common stock
for granting the license rights and transferring the technology, Faroudja is
entitled to receive royalties on the sales of Sage chips incorporating Faroudja
technology and was granted rights to purchase Sage chips incorporating Faroudja
technology for resale. On February 18, 2000, Faroudja and Sage entered into a
definitive agreement for Faroudja to be merged into a wholly owned subsidiary of
Sage. The merger transaction, if consummated, is expected to accelerate the
execution of both parties' ASIC development strategies. See "General."
ASIC sales represented 6% of total revenues for fiscal 1999 and were not
significant in prior years.
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. As of
December 31, 1999, the Company had a staff of 21 full-time research and
development personnel. During 1999, 1998 and 1997 the Company's research and
development expenses were approximately $4.2 million, $4.8 million and $4.2
million, respectively. The Company anticipates that its research and development
expenses will increase in absolute dollars for the foreseeable future.
A number of products are in development with introductions planned during the
next several years. For the home theater and commercial presentation markets,
the Company introduced the DVP5000 digital video processor/scaler in early 2000
and plans to have the product in production by the end of the first quarter of
2000. In addition to features shared with the DVP3000, the DVP5000 upconverts
1080i
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HDTV signals to 1080p, and unconverts 480p DTV signals to 960p. These video
processor/scalers will optimize the performance of very large, high
performance, projection systems and displays devices. For the broadcast
market the Company is continuing to develop and cost-reduce its DFT products
to respond to the needs of the emerging DTV/HDTV market. The Company is also
developing additional ASICs that include enhanced capabilities, integrate
more of the Company's video processing technologies and use denser chip
geometries. The introduction of these new ASICs will enable the Company to
make its technologies available on a more cost-effective basis for higher
volume applications. In 2000 the Company expects to introduce a new ASIC that
incorporates the Company's enhancement technology and a new ASIC that
incorporates the Company's deinterlacing technology. The combination of these
two ASICs and the FLI2000 will enable the Company to provide a three chip set
with functionality exceeding that of its present FLI9000 eight chip set at
lower cost.
Other planned research products include expanded development of line multipliers
and compression pre-processors for broadcast products which include noise
reduction to increase compressor efficiency.
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, develop new
products and features to meet changing customer requirements and evolving
industry standards, and enter into royalty-bearing licenses. Sales of the
Company's line multiplier products to the home theater and commercial
presentation markets increased in 1999 due to the introduction of new products
with superior performance and enhanced feature sets. The Company anticipates
that sales of such products will experience limited growth, or decline, in
future periods due to increased competition, pricing pressure and consumer
confusion over HDTV. The Company believes that the confusion resulting from HDTV
and related market weakness could continue until HDTV broadcast begins on a
wide-scale basis. The Company does not expect a material portion of its revenues
in 2000 to come from sales of recently introduced products or products which the
Company is developing for introduction in 2000. The success of new products
depends on a number of factors, including proper selection and timely
introduction, successful and timely completion of product development, accurate
estimation of demand, 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
ASIC products, and future 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 widely 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.
Incorporating 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
be chosen to supply ASIC products for incorporation into OEMs' products 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. See "Factors Affecting
Future Operating Results - DEPENDENCE ON NEW PRODUCT DEVELOPMENT AND RISK OF
TECHNOLOGICAL CHANGE."
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 crispness. Digital adaptive
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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 the artifact known as "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 readily apparent with large, highly saturated,
stationary graphics such as titles and credits.
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 multiplied 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.
LINE MULTIPLIER TECHNOLOGY. The line multiplier technology reduces scan line
visibility resulting from utilizing a 525 line interlaced broadcast standard on
today's large screen TVs by changing the interlaced video signal to a
progressively scanned signal. The Company's line multiplier technology detects
motion and interpolates correctly to "fill in the blanks." This technology can
detect the difference between a film image that has been transferred to video or
a video image that emanates from a video camera. After detecting the image type,
the line multiplier technology selects its algorithm to compensate accordingly.
This is critical because today's home theaters are primarily used to show films
that were transferred to video, whether on tape, laser disc, 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. Common sources
such as broadcast or VHS tapes are noticeably deficient. The problem is
compounded when scan lines are multiplied 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. Through the
use of non-linear processing 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. This technique also expands the apparent 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 an
image that gives a greater feeling of depth.
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 that are transmitted from a broadcast studio
or by a satellite or cable TV headend 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 and display technologies emerge, the need to
reformat the video picture by scaling in both the horizontal and vertical
domains becomes more important. The Company's digital video processor/scalers
and DFT products scale the picture by non-integer ratios to convert traditional
video sources to the new DTV and HDTV formats. This capability is required for
PC interface products, and LCD and DLP-TM- based products, all of which have
finite numbers of pixels in their display format. When pixel based displays are
used to display video, the video source should be scaled to convert the original
number of lines to the number of lines in the display device to avoid the
creation of video artifacts.
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.
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Yves Faroudja, the Company and General Instrument Corporation ("GI") are
parties to a 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. The licenses
are royalty-free so neither party is obligated to pay, nor entitled to
receive, license fees from the other party. The agreement grants exclusive
rights to each company in defined fields of use, includes the right to grant
sublicenses and extends until the last to expire of the licensed patents. 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 upconverter products.
In March 1997, the Company entered into a license agreement with S3
Incorporated ("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.
In December 1998, the Company entered into a manufacturing, sales and
distribution agreement with In Focus, pursuant to which In Focus agreed to
incorporate the Company's line doubling and video processing circuitry into
an In Focus LCD projector to be known as the "LS-TM- 700." The agreement
granted to the Company the exclusive right to sell the LS700 in the home
theater market. The Company also agreed that until May 30, 1999 it would not
allow any company other than In Focus to offer or sell any front-screen
LCD-based home theater projection devices incorporating the Company's
proprietary ASICs. Shipments of LS700s to the Company's home theater
customers began in January 1999.
In July 1999, Faroudja entered into a license, joint development and equity
purchase agreement with Sage, Inc. ("Sage"). The agreement provided for the
transfer of certain of Faroudja's video processing technologies, including
video decoding, enhancement and deinterlacing, to Sage for incorporation into
Sage chips. Faroudja agreed not to transfer the technology to certain
companies that make products similar to the products produced by Sage until
after October 27, 2000. The Company received 375,000 shares of Sage common
stock in exchange for, among other things, granting the license rights,
transferring the technology and a $500,000 payment to Sage. To the extent
that Sage incorporates Faroudja technologies in Sage products, Faroudja will
receive royalties on the sales of those products. Faroudja was also granted
rights to purchase Sage chips incorporating Faroudja technology for resale.
Sage has not shipped any products that incorporate the Company's technology
and there can be no assurance that Sage will develop products or pay any
future royalties under the agreement. On February 18, 2000, Faroudja and Sage
entered into a definitive agreement for Faroudja to be merged into a wholly
owned subsidiary of Sage. The merger transaction, if consummated, is expected
to accelerate the execution of both parties' ASIC development strategies.
The patented technologies which the Company uses to produce standalone
products for home theater, commercial presentation 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. With Sage's consent (see "General"), 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. There can be no assurance that
the Company will identify additional strategic partners or enter into
additional license agreements for the uses described or any other uses, that
Sage will consent to any such agreements or that any such relationships or
agreements will result in substantial revenues to the Company. See "Factors
Affecting Future Operating Results - DEPENDENCE ON STRATEGIC RELATIONSHIPS."
SALES AND MARKETING
Faroudja markets its products for the home theater and commercial presentation
markets through a network of home theater, industrial and commercial dealers,
representatives, as well as OEM customers. As of December 31, 1999, the Company
maintained a sales force of seven persons at its headquarters in Sunnyvale,
California, and four employees in regional offices. The Company's marketing
programs include trade shows, training seminars, public relations and
advertising. The Company also uses its web site (www.faroudja.com) for
marketing, and intends to place greater emphasis on Internet marketing in the
future. Revenues from S3 and Vidikron accounted for 10.6% and 11.1%,
respectively, of total revenues in 1997. Revenues from Vidikron accounted for
10% of total revenues in 1998. No customer accounted for 10% or more of total
revenues in 1999.
The Company currently distributes its home theater products through
approximately 350 home theater dealers throughout the United States. This
distribution channel is managed by a Company national sales manager, two
regional managers, one field training manager, independent sales representatives
and a customer service department.
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The Company also sells its products to the industrial market for uses such as
corporate boardrooms, executive conference centers and auditoriums, through a
network of more than 100 industrial dealers. These dealers typically provide
installation, product integration, on site training and customer support.
This network is managed directly by the national sales manager and two
regional managers that manage home theater distribution and by independent
industrial sales representatives.
For the broadcast market, the Company relies primarily on direct sales and
marketing. The Company has two employees who sell directly to the broadcast
market and a technical support engineer. In 1999 the Company entered into
reseller arrangements with Thomcast Communications Inc.'s Comark Division,
Harris Corporation's Broadcast Division, Communications Engineering, Inc. and
Philips Digital Video Systems Company, systems integrators of broadcast
equipment, to support growth in this area.
The Company has OEM and/or co-branding relationships with Vidikron, In Focus
and Mitsubishi Electric Corporation. There can be no assurance that the
Company will continue to receive any revenues from continuing relationships
or that it will be successful in developing additional OEM relationships.
Export sales represented approximately 15.4%, 18.6% and 13.1% of the
Company's total revenues in 1999, 1998 and1997, respectively. Export sales
decreased in 1999 in absolute dollars and as a percentage of total revenues
from the prior year, primarily due to declining economic conditions in Asia.
The Company has a non-exclusive worldwide distribution arrangement with
Vidikron pursuant to which Vidikron distributes the Company's digital video
processor/scalers. In addition, the Company has distributors or dealers in
over 35 countries worldwide. Export sales to international customers entail a
number of risks, including unexpected changes in, or impositions of,
legislative or regulatory requirements, delays resulting from difficulty in
obtaining export licenses for certain technology, tariffs, quotas and other
trade barriers and restrictions, longer payment cycles, greater difficulty in
accounts receivable collection, potential adverse taxes, currency exchange
fluctuations, the burdens of complying with a variety of foreign laws and
other factors beyond the Company's control. See "Factors Affecting Future
Operating Results - RISKS ASSOCIATED WITH EXPORT SALES AND OPERATIONS."
The Company's future success will depend, in large part, on the continued
efforts of its network of direct and indirect distributors and dealers. The
loss of, or reduction in sales to, any of the Company's key customers could
have a material adverse effect on the Company's operating results. See
"Factors Affecting Future Operating Results - DISTRIBUTION RISKS;
DIVERSIFICATION OF SALES CHANNELS."
The Company's business is characterized by short lead times and quick delivery
schedules. As a result, the Company does not believe that backlog at any given
time is a meaningful indication of future sales.
MANUFACTURING
VIDEO PROCESSOR/SCALERS 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 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 RP5800 Rear Projection System utilizes a projector chassis
purchased from Barco, Inc. The RP5800 is manufactured for the Company on a
contract basis by Visual Structures, Inc. Visual Structures integrates,
assembles and tests the various components of the system, including the
Company's video processors.
The LS700 projector was manufactured by In Focus incorporating ASICs provided
by the Company. The projector is co-branded with the names of both In Focus
and the Company.
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.
WAFER FABRICATION. The Company contracts all of its wafer fabrication,
assembly and testing to independent foundries and contractors, which enables
the Company to focus on its design strengths, minimize fixed costs and
capital expenditures and gain access to advanced manufacturing facilities. As
the Company continues to develop ASIC products, it will continue to outsource
its wafer production. The Company's engineers work closely with the Company's
foundries and subcontractors to increase yields, lower manufacturing costs
and
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assure quality. The Company's primary foundry is ST Microelectronics, Inc.
("ST"). Most of the Company's devices are currently fabricated using
complementary metal oxide semiconductor ("CMOS") process technology with 0.5
and 0.8 micron feature sizes. New devices are being designed in 0.25 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 have long-term supply contracts 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.
See "Factors Affecting Future Operating Results - RELIANCE ON INDEPENDENT
FOUNDRIES AND MANUFACTURING."
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. For example, during the year ended December 31, 1999,
the low end of the Company's video processor/scaler family faced heavy
competition from other line processor manufacturers and from certain
projector manufacturers that included built-in line multipliers in their
projectors. These trends are expected to continue. 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 video processors, the Company's principal competitors are
CinemaPro Corporation dba Runco International ("Runco"), Communications
Specialties, Inc., DWIN Electronics, Inc. ("DWIN"), Extron Electronics
("Extron"), Miranda Techologies Inc. ("Miranda"), NEC Technologies, Inc., RGB
Spectrum, Snell & Wilcox, Inc. ("Snell & Wilcox"), Sony Corporation ("Sony")
and Yamashita Engineering Manufacturing, Inc. ("YEM"). DVDO, Inc. ("DVDO")
and Genesis Microchip Inc. ("Genesis"), have recently emerged as competitors
with chip solutions. In the market for broadcast products, the Company's
principal competitors are Leitch Incorporated ("Leitch"), Miranda, Panasonic
Broadcast & Television Systems Company ("Panasonic"), Snell & Wilcox and
TeraNex. 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 upconverter.
The Company has licensed and, subject to obtaining Sage's consent (see
"General"), intends to continue to license its technologies and intellectual
property. The Company also offers for sale ASIC 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 that compete with the
Company's technologies and products. At present, the Company believes that
S3, Sage and GI are licensees which could compete with certain of the
Company's technologies and products. While the Company may sell ASIC 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.
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, form factor 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 "Factors Affecting
Future Operating Results - COMPETITION."
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PROPRIETARY RIGHTS AND LICENSES
The Company's future success depends, in part, on its ability to protect its
proprietary technology and information. Although the Company relies on a
combination of 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. The Company holds
or is the exclusive licensee of 44 U.S. and 16 foreign patents, and 5 U.S.
and 25 foreign patent applications. The Company depends on these patents for
the enhancement of its current products and the development of future
products. Most of these patents and patent applications are owned by Yves
Faroudja, the Company's founder and Chief Technical Officer. Mr. Faroudja has
granted the Company an exclusive perpetual, royalty-free, license to use
patented and unpatented technologies developed by him prior to January 20,
1997. As the Company is a licensee of such patents and applications, it is
subject to risks not generally faced by other companies that own the
intellectual property upon which their businesses rely. There can be no
assurance that patents will issue from any pending applications or that any
claims allowed from pending applications will be of sufficient scope or
strength, or be issued in all countries necessary 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 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 "Factors Affecting Future Operating
Results - LIMITED PROTECTION OF INTELLECTUAL PROPERTY RIGHTS; RISK OF THIRD
PARTY INFRINGEMENT."
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 certain
patents.
EMPLOYEES
As of December 31, 1999, the Company had 52 full-time employees, including 21
full-time employees primarily involved in research and development
activities, 11 in marketing and sales, 7 in finance and administration and 13
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 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 2000, primarily
in research and development, and believes that its future success will depend
largely on its ability to attract and retain highly-skilled engineering
personnel. Competition for such personnel is intense. The Company's future
success will depend to a significant extent upon the continued services of
members of senior management and other key employees of the Company. The loss
of the service of any of these individuals could have a material adverse
effect on the Company. See "Item 2. Legal Proceedings."
FACTORS AFFECTING FUTURE OPERATING RESULTS
POTENTIAL FLUCTUATIONS IN FUTURE OPERATING RESULTS; SEASONALITY. The
Company's period to period operating results have varied in the past and are
likely to vary significantly in the future as a result of a number of
factors, including the volume and timing of orders received during the
period, the amount and timing of 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 and other manufacturing problems,
changes in product or distribution channel mix, product returns, 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 life cycles of the Company's products, the Company's failure to
consistently introduce new, competitive products in a timely manner could
have a material adverse affect on operating results for one or more product
cycles.
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Gross margins may vary from period to period as a result of various factors,
including the volume of sales, the mix of products sold, new product
introductions, fluctuations in the receipt of royalty revenues, the mix of
distribution channels and adjusting prices to meet competition. 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, introduce
enhanced versions of existing products and continuously reduce the cost of
its products. The Company anticipates that it will incur lower overall gross
margins in future periods as it introduces lower margin products for consumer
markets and as price competition increases for all products.
Customers generally do not order the Company's products in advance of their
needs. As a result, the Company does not have meaningful backlog. Even though
backlogs are small and future sales are difficult to forecast, the Company
must undertake development projects, initiate sales and marketing activities,
stock inventory, plan production, order components and make other commitments
months in advance of receiving orders for its products. A shortfall in
revenues in a given quarter may adversely impact the Company's operating
results due to its inability to make a corresponding adjustment to expenses
during that quarter.
The Company currently derives a substantial portion of its total revenues
from the sale of a relatively low unit volume 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 new orders for products to be
shipped in the same quarter. On occasion, a significant amount of the
Company's quarterly sales are attributable to a limited number of customers.
These factors combine to make the volume and timing of orders received by the
Company during a quarter difficult to forecast.
A disproportionate percentage of the Company's total revenues result from
sales made 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. This sales cycle may also increase the impact of a delay
in shipment near the end of a particular quarter, due for example, to
shipment rescheduling or cancellation, or manufacturing difficulties
experienced by the Company or its suppliers. Either an unexpected shortfall
in sales late in a quarter or a delay in shipment 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
that quarter.
The Company's industry is subject to a high degree of seasonality. Demand for
the Company's products has historically been highest in the third and fourth
quarters of each calendar year. As a result, sales are typically highest in
these quarters and may be lower in following quarters.
RISKS ASSOCIATED WITH NEW MARKETS AND APPLICATIONS; MARKET ACCEPTANCE. A
substantial portion of the Company's revenues in 1999 were derived from sales
of products that address the home theater and commercial presentation
markets. Certain of the Company's current products and future product plans
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. There can
be no assurance that these markets will become substantial commercial markets
or that the Company's products will achieve market acceptance in those
markets. The Company also intends to exploit new digital display technologies
and what it believes will be the convergence of the TV and PC markets. There
can be no assurance that these new display technologies will be successful or
that the TV and PC markets will converge, that these new market will present
substantial commercial opportunities, or that the Company's products will
adequately address these markets in a timely manner. The Company has
experienced, and expects to continue to experience, technological and pricing
constraints that may interfere with its development of products that address
emerging markets. For example, price has been an issue for certain OEMs that
considered incorporating the Company's current ASICs into their products. In
addition, certain prospective development partners have deferred or abandoned
joint development plans for reasons including market uncertainties regarding
which technologies should be bundled on highly integrated chips. 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, if 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 technologies or
products.
RISKS ASSOCIATED WITH CHANGING TV STANDARDS. The Company is developing
products that are designed to conform with certain current industry broadcast
standards. However, there can be no assurance that manufacturers will
continue to follow these standards or that more desirable standards will not
emerge. The acceptance of the Company's products also depends in part upon
content providers developing and marketing content for end user systems, such
as video and audio playback systems, in a format compatible with the
Company's products. There can be no assurance that these or other factors
beyond the Company's control will not adversely affect the development of
markets for the Company's products.
The FCC has required broadcasters to begin broadcasting DTV signals in May 1999,
targeting the eventual phase out of the current analog
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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 home theater and commercial
presentation or broadcast products will continue following the introduction
of DTV or if competing standards or technologies will 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
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, all of which are 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 on its ability 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 decline in future periods due to increased competition,
pricing pressure and consumer confusion over HDTV. The confusion associated
with HDTV broadcast is expected to continue until HDTV broadcast begins on a
wide-scale basis. The Company believes that the introduction of new products
in 1999 and 2000, and increased emphasis on ASICs, will improve its
competitive position. The success of new products depends on a number of
factors, including proper selection and timely introduction, successful and
timely completion of product development, accurate estimation of demand,
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 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 ASIC products
and future licensing 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 widely 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.
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 be chosen to supply ASIC products for incorporation into OEMs' products
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. During 1999 competition in
the home theater and commercial presentation markets increased at the low end
from manufacturers of less expensive line multipliers, from projector
manufacturers building line multipliers into their projectors and from
companies offering relatively inexpensive chips performing functions
analogous to functions performed by 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 video processors, the Company's principal
competitors are Communications Specialties, DWIN, Extron, Miranda, NEC, RGB
Spectrum, Runco, Snell & Wilcox, Sony and YEM. DVDO and Genesis are
competitors with chip solutions. In the market for broadcast products, the
Company's principal competitors are Leitch, Miranda, Panasonic, Snell &
Wilcox, and TeraNex. 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- 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 that compete with the
Company's
-15-
<PAGE>
technologies and products. At present, the Company believes that S3, Sage and
GI are licensees which could compete with certain of the Company's
technologies and products.
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 Company's failure or
inability to introduce cost-reduced 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 processing technology depends on
a number of factors, including protection of its intellectual property, 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.
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 companies like Vidikron to
sell, and Mitsubishi to manufacture, products that incorporate the Company's
technology, and a failure by these companies to do so 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.
The Company has licensed and, subject to obtaining Sage's consent (see
"General"), intends to continue to license its technologies and intellectual
property. The Company also offers for sale ASIC products that 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 that compete with the Company's technologies
and products. While the Company may sell ASIC products to 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.
RISKS ASSOCIATED WITH EXPORT SALES AND OPERATIONS. The Company intends to expand
its international presence in order to increase its export sales. 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 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.
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 this 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
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
-16-
<PAGE>
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 distributors or
direct sales personnel, or that such distributors will continue to recommend,
or devote sufficient resources to market and provide customer support for the
Company's 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 will be required to reallocate
production among its other existing foundries or identify and qualify acceptable
alternatives. 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, the
inability of the Company to obtain additional production in a period of
increased demand, or the Company's inability to obtain timely and adequate
deliveries from its 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 all or part of the manufacturing of its broadcast, home
theater and commercial presentation and ASIC 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 INTELLECTUAL PROPERTY RIGHTS; RISK 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 issue from any pending
applications, or that any claims allowed from pending applications will be of
sufficient scope or strength, or be issued in all countries necessary to provide
meaningful protection or 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. 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.
-17-
<PAGE>
Substantially all of the intellectual property used by the Company is
licensed to the Company by Yves Faroudja. The Company faces certain risks
because the Company is a licensee and not the owner of such intellectual
property rights. Under his agreement with the Company, Mr. Faroudja retains
the non-exclusive right to license his patents and technologies to third
parties for use outside the Company's field of use. 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 could have a material
adverse affect on the Company's business, financial condition and operating
results.
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.
The Company may initiate claims or litigation against third parties for
infringement of the Company's proprietary rights, like the suits it filed
against DWIN and Snell & Wilcox, 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 determination favorable to the Company. Such
diversion could have a material adverse effect on the Company's business,
financial condition and operating results. In addition, litigation initiated
by the Company could result in the assertion of counterclaims 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. The Company could also be ordered to cease infringing a third
party's intellectual property rights (including, marketing, using, selling
and importing infringing products, and employing infringing methods or
processes). An adverse determination could also result in the Company
expending 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, if at all. 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.
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. The loss
of the service of any of these individuals could have a material adverse
effect on the Company.
Yves Faroudja, the Company's founder, is co-chairman of the Company's Board
of Directors, Chairman of the Executive Committee of the Board and serves as
the Company's Chief Technical Officer. Mr. Faroudja terminated the agreement
with the Company pursuant to which he rendered advisory services on June 30,
1999. The Company does not know how much time, if any, Mr. Faroudja will
devote to the Company's affairs in the future.
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. During 1998
and 1999 a number of VLSI engineers left the Company. Some of those engineers
have been replaced and the Company has retained certain of the engineers as
consultants on an interim basis to complete projects in progress. The Company
has ongoing recruiting efforts, but there can be no assurance that the
Company will be successful in attracting or retaining qualified replacements
for these VLSI engineers or other personnel that may leave the Company. The
failure to attract or retain such replacements could have a material adverse
effect on the Company's business, financial condition and operating results.
Competition for skilled executive, technical, management, sales, marketing,
consulting and other 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.
DEPENDENCE ON ROYALTY REVENUES. Royalty revenues have contributed to the
Company's growth historically and are expected to represent a significant
portion of the Company's revenues in 2000. There can be no assurance as to
the amount of additional royalties, if any, that the Company will receive in
the future under its license agreement with S3 or Sage. S3 has not made any
payments necessary to maintain its exclusive license rights with respect to
any periods after March 31, 1998 and Sage has not yet produced any products
incorporating the Company's technology. Revenues from S3 accounted for 10.6%
of the Company's total
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<PAGE>
revenues for the year ended December 31, 1997 and 6.1% of total revenues for
the year ended December 31, 1998.
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, the market served by the Company's customers or the
economy as a whole, 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 decline
substantially, or otherwise experience significant fluctuations in the
future, including fluctuations that are unrelated to the Company's
performance.
EXECUTIVE OFFICERS OF THE COMPANY
Set forth below is the name, age and office held with the Company of each of
the executive officers of the Company as of March 30, 1999 and such executive
officers' other business experience during the past five years. Except as
otherwise indicated, each such executive officer was elected at the meeting
of the Board of Directors held after the annual meeting of stockholders held
on June 10, 1999. The term of office for each executive officer extends until
the next meeting of the Board of Directors for the election of officers and
until their respective successors are duly elected.
GLENN W. MARSCHEL, JR. (age 53) has served as President, Chief Executive
Officer and Co-Chairman of the Board of Directors since joining the Company
in October 1998. He has served as Chairman of the Board of Directors of
Additech, Inc., a petrochemicals marketing company, since October 1997. From
December 1995 to August 1997 Mr. Marschel was President and Chief Executive
Officer of Paging Network, Inc., a telecommunications company, and from April
1995 to November 1995 he served as Vice Chairman of First Financial
Management Company, a company in the credit card transaction processing
business. Prior thereto, from January 1972 to December 1994, Mr. Marschel
held positions of increasing responsibility at Automatic Data Processing,
Inc., an information systems company, last serving as President of ADP's
Employer Services Group. Mr. Marschel is also a director of Sabre Group
Holdings, Inc. and Travelocity.com.
YVES C. FAROUDJA (age 66) 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 and has been the Company's
Chief Technical Officer since July 1996. Mr. Faroudja has served as
Co-Chairman of the Board of Directors since October 1998 and is Chairman of
the Board's Executive Committee.
DONALD S. BUTLER (age 54) joined the Company in May 1996 as Vice President
and General Manager of the VLSI Division. In October 1996, as Vice
President-Engineering, he assumed responsibility for all engineering
functions, and in July 1998 he was promoted to the position of Senior Vice
President -Engineering. Prior to joining the Company, from 1989 to May 1996,
Mr. Butler was Vice President of Engineering at the Integrated Systems Center
of General Instrument Corporation, a manufacturer of cable and satellite TV
equipment. From 1974 to 1989, he held several engineering and engineering
management positions within GI's Microelectronics Division.
NIKHIL BALRAM, PH.D. (age 37) joined the Company in January 1999 as Vice
President-Advanced Technology. From July 1997 to January 1999, Dr. Balram was
Director of Systems Architecture and Manager of the Video Group at S3
Incorporated, a manufacturer of multimedia integrated circuits. From January
1995 to July 1997, Dr. Balram held various research and development positions
at Kaiser Electronics, a manufacturer of military avionics display systems,
last serving as Staff Scientist. From June 1994 to January 1995, Dr. Balram
did marketing and engineering at the multimedia business unit of
Rexon/Tecmar, Inc., a data storage company. From March 1992 to June 1994, Dr.
Balram was a staff engineer with the Video/Graphics VLSI Development group of
IBM Corporation, a computer company.
ITA GEVA (age 46) joined the Company in 1989 as Accounting Manager, was
promoted to Controller in 1996, and became the Company's interim Chief
Financial Officer in September 1999.
THOMAS A. HARVEY (age 51) 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.
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<PAGE>
KENNETH S. BOSCHWITZ (age 46) 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 General Instrument Corporation, a
manufacturer of cable and satellite TV equipment, including Vice President
and General Counsel of GI's Communications Division.
ITEM 2. PROPERTIES
The Company occupies approximately 20,000 square feet of space in Sunnyvale,
California pursuant to a lease that extends until September 30, 2003. In
1997, the Company leased an additional 10,000 square feet of space in
Sunnyvale, California for a term that extends until September 2003, and
leased a 2,000 square foot facility in Phoenix, Arizona for a research and
development facility. The Company determined that leased space exceeded its
needs and terminated the Phoenix lease on October 31, 1998 and subleased the
additional 10,000 square feet in Sunnyvale in April 1999 for the balance of
that lease term. The aggregate annual gross rent for the Company's facilities
(less rent received from a sublessee) was approximately $465,000 in 1998,
approximately $392,000 in 1999, and will be approximately $252,000 in 2000.
ITEM 3. LEGAL PROCEEDINGS
In January 1997 the Company filed an action against DWIN seeking injunctive
relief and unspecified monetary damages for the infringement of US Patent
Number 4,876,596 (the "596 Patent"). The action was filed in the United
States District Court, Northern District of California, San Jose Division.
The case against DWIN is Civil Action No. C-97 20010 SW (PVT). The 596 Patent
was issued on October 24, 1989, is owned by Yves Faroudja and is licensed to
the Company. DWIN raised defenses and counterclaims that the 596 Patent is
invalid and not infringed. They also sought to recover attorneys' fees and
costs.
In the DWIN action the Company amended its complaint to add claims of
infringement of U.S. Patent Number 4,998,287 (the "287 Patent") on August 17,
1998. The 287 patent, which was issued on March 5, 1991, is owned by General
Instrument and licensed to the Company. On February 24, 1999, the court in
the DWIN action granted DWIN's motion for summary judgment as to the 596
Patent on the basis of non-infringement. On March 13, 2000 the parties
entered into an agreement settling the action, subject to the Court granting
Faroudja's unopposed motion to vacate the Court's summary judgment order as
to the 596 Patent. The Court has not yet ruled on Faroudja's motion and there
can be no assurance that the motion will be granted. If the motion is not
granted, the case, which is in the discovery stage, will continue.
The Company's management believes that a finding that all of the claims of
the patents are invalid or that the patents have not been infringed in the
DWIN action will 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 patents which are involved in that litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
PRICE RANGE OF COMMON STOCK
The Company's Common Stock (Nasdaq symbol "FDJA") is publicly traded on the
Nasdaq Stock Market. The follow table presents, for the last two fiscal years,
the intraday high and low sale prices for the Common Stock as reported by the
Nasdaq Stock Market.
<TABLE>
<CAPTION>
Fiscal 1998 High Low
- ---------------------------------------------------------------------------------
<S> <C> <C>
First Quarter $11.13 $6.44
Second Quarter $12.38 $8.50
Third Quarter $8.63 $3.69
Fourth Quarter $4.31 $2.31
Fiscal 1999 High Low
- ---------------------------------------------------------------------------------
First Quarter $4.31 $2.13
Second Quarter $3.63 $2.63
Third Quarter $4.25 $2.75
Fourth Quarter $6.44 $2.75
</TABLE>
As of March 1, 2000, there were approximately 300 holders of record of the
Company's Common Stock, which the Company believes represent more than 3,000
beneficial holders. The Company has not paid cash dividends on its Common Stock
and presently intends to retain any earnings for investment in its business.
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<PAGE>
ITEM 6. SELECTED FINANCIAL DATA.
SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
Year Ended December 31
- -------------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1999 1998 1997 1996 1995
--------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Total revenues $13,476 $12,270 $17,006 $13,126 $11,954
Net (loss) income (2,099) (3,469) 1,251 N/A N/A
Pro forma net (loss) income (1) N/A N/A N/A 1,319 (1) 3,070 (1)
Net (loss) income per share (diluted) ($0.17) ($0.29) $0.13 N/A N/A
Pro forma net (loss) income per share (diluted)(1) N/A N/A N/A $0.16 (1) $0.43 (1)
Shares used in diluted per share computation 12,272 12,146 9,925 8,191 7,176
- -------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and available-for-sale
investments $19,916 $20,419 $23,549 $3,083 $2,759
Working capital 20,526 24,487 26,987 5,861 4,744
Total assets 34,567 28,721 33,489 9,604 6,734
Total long-term debt - - - - -
Total stockholders'
equity 29,083 26,498 29,348 7,245 5,515
- -------------------------------------------------------------------------------------------------------------------------
QUARTERLY DATA:
1999 1998
-----------------------------------------------------------------------------------------------
4th 3rd 2nd 1st 4th 3rd 2nd 1st
-----------------------------------------------------------------------------------------------
Total revenues $3,876 $3,856 $3,309 $2,435 $2,554 $3,005 $3,353 $3358
Gross profit 2,164 2,382 1,770 850 1,215 1,362 1,940 2,254
Net (loss) income 77 23 (721) $1,478) (903) (1,821) (754) 8
Net (loss) income per share
(diluted) $0.01 ($0.00) ($0.06) ($0.12) ($0.08) ($0.15) ($0.06) ($0.00)
</TABLE>
(1) Reflects the pro forma effect of the Company being treated as a C
Corporation rather than an S Corporation for federal and state income tax
purposes from January 1, 1994.
(2) See Note 1 of Notes to Consolidated Financial Statements for an
explanation of the basis used to calculate net (loss) income per share.
- ------------------------------------------------------------------------------
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION.
THIS DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 CONCERNING THE COMPANY'S FUTURE
PRODUCTS, EXPENSES, REVENUE, LIQUIDITY AND CASH NEEDS AS WELL AS THE COMPANY'S
PLANS AND STRATEGIES. SUCH FORWARD-LOOKING STATEMENTS INVOLVE KNOWN AND UNKNOWN
RISKS AND UNCERTAINTIES. THESE FORWARD-LOOKING STATEMENTS ARE BASED UPON CURRENT
EXPECTATIONS. THE COMPANY'S ACTUAL RESULTS AND TIMING OF CERTAIN EVENTS COULD
DIFFER MATERIALLY FROM THE DESCRIPTIONS IN THESE FORWARD-LOOKING STATEMENTS AS A
RESULT OF VARIOUS FACTORS, INCLUDING THOSE SET FORTH BELOW. 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.
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 home theater and commercial presentation markets - a
video processor referred to as a "line multiplier."
- 22 -
<PAGE>
In 1999, 1998, and 1997, sales of home theater and commercial presentation
markets comprised approximately 81%, 84% and 88%, respectively, of the Company's
total revenues. The decrease in home theater and commercial presentation market
sales as a percentage of total Company sales in 1999 over 1998, and 1998 over
1997, reflects the change in sales mix due to increased sales of ASIC chips in
1999 and growth in broadcast sales in 1999 and 1998 resulting from the Company's
re-entry into the broadcast market in the second half of 1998 with the
introduction of the Digital Format Translator(TM) ("DFT"), an upconverter that
supports television broadcasters' transition from analog to digital television.
The Company's revenues increased in 1999 over 1998 as a result of increased
sales in all areas: line multiplier products, broadcast products and ASIC
products, partially offset by the absence of licensing revenue. Revenues in 1998
were lower than revenues in 1997 primarily due to a decline in sales of line
multiplier products.
Increased revenues, the introduction of new, higher margin products and lower
expenses resulted in a lower net loss for 1999 as compared to 1998. The
Company's net loss in 1998, following a profitable 1997, was primarily due to
a substantial drop in line multiplier product sales and higher operating
expenses.
To maintain favorable margin levels on product sales, the Company must introduce
new products, introduce enhanced versions of existing products, and continue
cost reduction efforts. Significant efforts in these areas in 1998 and in the
first half of 1999 resulted in the introduction of DFTs in 1998 and a completely
new line of line multipliers in 1999, with corresponding improvements in product
revenues and margins.
In 1999 the Company reduced expenses throughout the organization, with modest
decreases in research and development and sales and marketing expenses and a
more significant decrease in general and administrative expenses. In 1998 the
Company dedicated increased research and development resources to the
development of the DFT and ASIC products. Sales and marketing expenses also
increased slightly in 1998 due to efforts to launch the DFT and reenter the
broadcast market. General and administrative expenses increased significantly
in 1998 over 1997 due to a variety of factors such as litigation expenses,
one time charges for management changes and expenses associated with being a
public company. In 2000 the Company expects to increase research and
development expenses in an effort to introduce new ASIC products. Sales and
marketing and general and administrative expenses are expected to remain at
comparable levels.
The Company's quarterly 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.
In March 1997, the Company entered into a license agreement with S3,
Incorporated ("S3") pursuant to which significant royalty payments were received
for use of certain Company technology. No royalty payments have been made by S3
with respect to any periods after March 31, 1998.
In July 1999, the Company entered into a license, joint development and equity
purchase agreement with Sage, Inc. ("Sage") pursuant to which the Company
received, among other things, Sage common stock and the right to receive
royalties on the sale of Sage chips incorporating the technology licensed from
Faroudja. Recognition of revenues associated with the license of the Company's
technology was deferred until the completion of the Company's delivery and
performance obligations under the agreement. The Company does not expect any
royalty-bearing Sage chips to be shipped until the second half of 2000 and there
can be no assurance that Sage will develop any royalty-bearing products or pay
any royalties under the license agreement. Royalty revenues have contributed to
the Company's growth historically and are expected to represent a significant
portion of the Company's revenues in 2000. There can be no assurance that the
Company will receive additional royalties, if any, from S3 or Sage under the
Company's existing license agreements, or that the Company will enter into any
future license agreements that result in the payment of royalties.
In February 2000, the Company signed a definitive agreement with Sage for a
stock-for-stock merger, following which the Company would become a wholly owned
subsidiary of Sage. Each share of Faroudja common stock will be converted into
0.285 shares of Sage common stock and Sage will assume all outstanding warrants
and options. The transaction has been unanimously approved by the boards of
directors of both companies and is expected to close in the quarter ending June
30, 2000, subject to approval by each company's shareholders. The merger is
expected to be accounted for as a purchase transaction by Sage.
- 23 -
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth certain items from the Company's consolidated
statements of operations expressed as a percentage of total revenues for the
periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------
1999 1998 1997
-------------------------------------------
<S> <C> <C> <C>
Revenues:
Product sales 100% 93.9% 91.2%
License and royalty revenues - 6.1 8.8
-------------------------------------------
Total revenues 100.0 100.0 100.0
Cost of sales 46.8 44.8 30.9
-------------------------------------------
Gross margin 53.2 55.2 69.1
Operating expenses:
Research and development 31.0 39.3 24.8
Sales and marketing 24.9 28.9 20.4
General and administrative 19.7 28.2 12.8
Financing expense - - 1.8
-------------------------------------------
Total operating expenses 75.6 96.4 59.8
-------------------------------------------
Operating (loss) income (22.4) (41.2) 9.3
Other income:
Interest income 6.8 9.2 2.1
Other, net - - 0.5
-------------------------------------------
(Loss) income before provision for income taxes (15.6) (32.0) 11.9
Benefit (provision) for income taxes - 3.7 (4.5)
-------------------------------------------
Net (loss) income (15.6)% (28.3)% 7.4%
===========================================
</TABLE>
TOTAL REVENUES
Total revenues in 1999 increased by $1.2 million or 9.8% from revenue in 1998.
Revenues in 1998 decreased by $4.7 million or 27.8% from revenues in 1997
The increase in revenues in 1999 over 1998 was primarily attributable to three
factors: a $.5 million increase in home theater products attributable to new
line multipliers introduced in the second quarter of 1999, an increase of $.6
million in sales of DFT products introduced in 1998 to support broadcasters'
roll out of digital TV services, and an increase of $.8 million in sales of ASIC
products. Licensing revenue decreased by $.8 million in 1999 from 1998,
primarily due to the discontinuance of royalty payments from S3 after March 31,
1998. Sales to one customer accounted for 10% of total Company revenues in 1998.
No customer accounted for 10% or more of total revenues in 1999.
Export sales, consisting primarily of line multiplier products shipped to
dealers and distributors in Asia, Europe and Canada, represented 13.1%, 18.6%
and 13.1% of total revenues in 1999, 1998, and 1997, respectively. In absolute
dollars, total export sales for 1999 were slightly lower than in 1998. All
export sales are denominated in U.S. dollars. The Company has not experienced
nor does it anticipate to experience exposure to any foreign currency exchange
fluctuation. 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 continue to adversely impact sales to that region in 2000.
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.
Sales of line multiplier products to the home theater and commercial
presentation markets increased in 1999 due to the introduction of new products
with superior performance and an enhanced feature set. The Company anticipates
that sales of such products will experience limited growth, or decline, in
future periods due to increased competition, pricing pressure and consumer
confusion over HDTV. The Company believes that the confusion resulting from HDTV
and related market weakness could continue until HDTV broadcasting begins on a
wide-scale basis. With the continuing rollout of HDTV in 2000, the Company
anticipates that sales of its broadcast products, and specifically the DFT, will
increase in 2000 and for the next several years.
- 24 -
<PAGE>
GROSS PROFIT
Gross profit as a percentage of total revenues was 53.2% in 1999, 55.2% in 1998
and 69.1% in 1997. The 2% decrease in gross margin in 1999 from 1998 was due to
the absence in 1999 of high gross margin licensing revenues corresponding to
last royalty payments received from S3 in the first quarter of 1998, offset in
part by higher margins on new line multiplier products and increased sales of
high margin DFTs. The 13.9% decrease in gross margin in 1998 from 1997 was due
to price reductions for certain line multiplier products, a significant decrease
in licensing revenues from S3, the write down of certain excess and obsolete
inventory items to their net realizable value, and only $1.0 million revenue
from DFTs during their first year of sales. The Company anticipates that it
will incur lower overall gross margins in future periods as it introduces
lower margin products for consumer markets and as price competition increases
for all products.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses were $4.2 million in 1999, $4.8 million in
1998 and $4.2 million 1997. The decrease in 1999 is primarily due to a reduction
in purchases of the prototype parts that were heavily used in 1998 developing
the DFT. Research and development expenses as a percentage of total revenues
decreased in 1999 to 31.0% due to a decrease of $.6 million in 1999 from 1998
levels coupled with an increase in total revenue in 1999.
In 1998 the increase in research and development expenses were primarily due to
costs incurred by the Company for the development of the DFT and the development
of ASICs. Research and development expenses as a percentage of total revenues
increased to 39.3% in 1998 from 1997 due to increased spending of $.6 million in
1998 from 1997 levels coupled with the decline in total revenues in 1998 from
1997. The Company intends to increase its research and development efforts in
2000, primarily in the design and development of board and ASIC products, and
therefore expects that research and development expenses will increase in
absolute dollars.
SALES AND MARKETING EXPENSES
Sales and marketing expenses decreased to $3.4 million in 1999 from $3.6 million
in 1998 and from $3.5 million in 1997. The decrease is primarily related to
decreases in consulting fees, advertising, printing and representative
commissions, which were partially offset by an increase in travel expenses.
Sales and marketing expenses as a percentage of total revenues decreased in 1999
to 24.9% due to the spending reduction of $.2 million in absolute dollars and
the increase of total revenue in 1999.
Sales and marketing expenses increased as a percentage of total revenues to
28.9% in 1998 from the prior year primarily due to the decline in revenues in
1998 from 1997. Expenses in 1998 were slightly higher than in 1997 due to an
increase in trade shows and advertising expenses partially offset by the decline
in commissions to outside sales representatives in 1998. The Company expects its
sales and marketing expenses in 2000 to be similar to 1999 spending levels.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses decreased to $2.6 million in 1999 from $3.5
million in 1998 due to reductions in legal, public relations and litigation
expenses along with the absence of one time charges for management changes.
General and administrative expenses in 1998 increased from $2.2 million in 1997,
primarily due to the costs and professional fees associated with being a public
company, legal expenses incurred in patent litigation and one time charges for
management changes.
General and administrative expenses decreased as a percentage of total revenues
to 19.7% in 1999 from 28.2% in 1998, primarily due to decreases in spending and
increases in total revenue in 1999. As a percentage of total revenues, general
and administrative expenses increased in 1998 from 12.8% in 1997 due to
increases in spending accompanied by a decline in total revenues in 1998.
The Company expects that 2000 general and administrative expenses, both in
absolute dollars and as a percentage of total revenues, will remain similar to
1999 spending levels.
FINANCING EXPENSE
In 1997 the Company expensed $.3 million in the first quarter related to
financing activities. There were no financing expenses in either 1999 or 1998.
OTHER INCOME
Interest and other income decreased to $917,000 in 1999 from $1.1 million in
1998. Interest income was lower in 1999 than 1998 because cash used in operating
activities and for an investment in Sage common stock resulted in a decrease in
the Company's investments in interest bearing securities. The increase in
interest and other income in 1998 from $447,000 in 1997 was due to the
- 25 -
<PAGE>
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. The Company anticipates that interest income will decrease
in 2000.
PROVISION FOR INCOME TAXES
The Company made no provision for income taxes in 1999 and recorded a benefit of
$457,000 in 1998 and a provision of $766,000 in 1997. The 1999 tax rate reflects
the full valuation allowance for net deferred tax assets. The 1998 tax rate
reflects the benefit of refundable taxes offset by state taxes and the valuation
allowance for certain deferred tax assets.
Under the 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 including current and projected losses, the Company
has provided a full valuation allowance against its net deferred tax assets for
1999. The Company will continue to evaluate the realization of the deferred tax
assets on a quarterly basis.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically funded its capital requirements with 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 1999, net cash used by operating activities was $139,000, consisting
primarily of (i) $2.1 million of net loss, and (ii) a $1.7 million increase in
accounts receivable, offset by (i) a $1.1 million decrease in inventory, (ii)
receipt of a $1.3 million tax refund, (iii) a $.3 million increase in other
accrued liabilities and (iv) $.8 million of depreciation and amortization.
In 1998, net cash used by operating activities was $3.2 million, primarily
composed (i) $3.5 million of net loss, (ii) a $.9 million decrease in accrued
income taxes payable, (iii) a $.7 million increase in income taxes receivable,
(iv) a $.6 million decrease in accrued compensation and benefits, (v) a $.4
million increase in inventories and (vi) a $.3 million decrease in accounts
payable. These were offset by (i) a $1.3 million decrease in accounts
receivable, (ii) a $.9 million decrease in deferred tax assets and (iii) $.9
million of depreciation and amortization.
In 1997, net cash provided by operating activities was $1.1 million, primarily
composed of (i) $1.3 million of net income, (ii) $.6 million of depreciation and
amortization, (iii) a $.7 million increase in accounts payable, (iv) a $.5
million increase in accrued compensation, (v) a $.8 million increase in income
taxes payable and (vi) a $.3 million increase in other accrued liabilities.
These were primarily offset by (i) a $.3 million increase in accounts
receivable, (ii) a $1.3 million increase in inventory, (iii) a $.5 million
increase in deferred tax assets, (iv) a $.4 million increase in other current
assets and (v) a $.5 million decrease in deferred revenues.
INVESTING ACTIVITIES
Capital equipment purchases in 1999, 1998 and 1997 were $.1 million, $.5 million
and $1.2 million, respectively, primarily for computer hardware and software
used in research and development, research and development test equipment and
furniture and fixtures. In 1999, the Company also paid $.5 million as part of
its investment in Sage.
FINANCING ACTIVITIES
In October 1997, the Company effected its initial public offering. Net proceeds,
after underwriting discounts and commissions and expenses associated with the
offering, were $15.6 million. In June 1997, the Company also received $5.0
million from a private placement of Common Stock to S3.
- 26 -
<PAGE>
LIQUIDITY
At December 31, 1999, the Company principal sources of liquidity consisted of
cash, cash equivalents and short term investments totaling $19.9 million and
working capital of approximately $20.5 million.
Cash and cash equivalents are predominantly held in three types of investments.
These investments are obligations issued by U.S. federal agencies, money market
funds that 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 December 31, 1999 declined
by $.5 million or 2.5% from the balances at December 31, 1998. The most
significant reasons for the cash decrease were the $.5 million investment in
Sage and increase of accounts receivable balances, partially offset by receipt
of an income tax refund and reduction in inventory.
The Company's future capital requirements are expected to include (i) supporting
the expansion of research and development, (ii) funding the acquisition of
capital equipment, primarily for research and development and consisting of such
items as research and development equipment, computers and furniture, and (iii)
funding the growth of working capital items such as receivables and inventory.
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.
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.
YEAR 2000
Prior to January 1, 2000, the Company completed remediation and testing of its
computer systems. As a result of those planning and implementation efforts, the
Company did not experience any significant disruptions to its operations. The
Company had no material expenses in 1999 in connection with remediating its
systems. The Company is not aware of any material problems resulting from Year
2000 issues, either with its products, its internal systems, or products and
services of third parties. However, there can be no assurance that the Company
will not experience problems in the future. Any such problems could result in
the Company experiencing a business interruption which could have a material
adverse impact on the Company's business, results of operations and financial
condition.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Financial Instruments and for Hedging Activities" ("SFAS 133")
which provides a comprehensive and consistent standard for the recognition
and measurement of derivatives and hedging activities. In June 1999, FASB
issued Statement of Financial Accounting Standards No. 137, which defers the
effective date of SFAS 133 to years beginning after June 15, 2000. The
Company does not anticipate SFAS 133 to have a material impact on the
Company's results of operations or financial condition when adopted.
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin 101, "Revenue Recognition in Financial Statements" ("SAB
101"), which provides guidance related to revenue recognition based on
interpretations and practices followed by the SEC. SAB 101 is effective the
first quarter of fiscal years beginning after December 15, 1999 and requires
companies to report any changes in revenue recognition as a cumulative change
in accounting principle at the time of implementation in accordance with APB
Opinion No. 20 "Accounting Changes". The Company believes that its current
revenue recognition policy complies with SAB101 and therefore does not expect
the adoption of SAB101 to have a material effect on results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS.
INTEREST RATE RISK. The Company's exposure to interest rate risk relates
primarily to its investment portfolio. Fixed rate securities may have their fair
market value adversely impacted by a rise in interest rates, while floating rate
securities may produce less income than expected if interest rates fall. Due in
part to these factors, the Company's future investment income may fall short of
expectations due to changes in interest rates or the Company may suffer losses
in principal if forced to sell securities which have declined in market value
due to changes in interest rates.
The Company invests its excess cash in debt instruments of the U.S. Government
and its agencies, and in high-quality corporate issuers. Due to the short-term
nature of all of the Company's investments in 1999 (average portfolio duration
and contractual maturity of investments were three months) the Company has
assessed that there is no material exposure risk arising from its investments.
- 27 -
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
<TABLE>
<CAPTION>
Financial Statements: Page
<S> <C>
Consolidated Balance Sheets as of December 31, 1999 and 1998........................... 29
Consolidated Statements of Operations for the years ended December 31, 1999, 1998 and
1997................................................................................ 30
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1999,
1998 and 1997 ...................................................................... 31
Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 1998 and 1997.................................................. 32
Notes to Consolidated Financial Statements............................................. 33
Report of Ernst & Young LLP, Independent Auditors...................................... 43
Financial Statement Schedule:
Schedule II: Valuation and Qualifying Accounts......................................... 58
All other schedules are omitted because they are not applicable or not
required or because the required information is included in the Consolidated
Financial Statements or the Notes thereto.
</TABLE>
- 28 -
<PAGE>
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
December 31,
1999 1998
-------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 12,998 $ 20,419
Available-for-sale securities 6,918 -
Trade accounts receivable, less allowance for doubtful
accounts of $342 in 1999 and $136 in 1998 3,418 1,764
Inventories 2,222 3,348
Income taxes receivable - 738
Prepaid expenses and other current assets 454 441
-------------------------------
Total current assets 26,010 26,710
Property and equipment, net 1,104 1,778
Other investments 7,266 -
Other assets 187 233
-------------------------------
TOTAL ASSETS $ 34,567 $ 28,721
===============================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 957 $ 1,125
Accrued compensation and benefits 609 587
Income taxes payable 670 -
Deferred revenue 2,425 -
Other accrued liabilities 823 511
-------------------------------
Total current liabilities 5,484 2,223
Commitments
Stockholders' equity:
Preferred Stock $0.001 par value; 5,000,000 shares
authorized, none issued and outstanding - -
Common Stock $0.001 par value; 50,000,000 shares
authorized; 12,310,556, and 12,205,147 shares
issued and outstanding in 1999 and 1998, respectively 12 12
Additional paid-in capital 30,322 30,027
Deferred compensation (125) (173)
Accumulated other comprehensive income 4,341 -
Accumulated deficit (5,467) (3,368)
-------------------------------
Total stockholders' equity 29,083 26,498
-------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 34,567 $ 28,721
===============================
</TABLE>
See accompanying notes.
-29-
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
Year Ended December 31,
1999 1998 1997
---------------------------------------
<S> <C> <C> <C>
Revenues:
Product sales $ 13,476 $ 11,520 $ 15,506
License and royalty revenues - 750 1,500
---------------------------------------
Total revenues 13,476 12,270 17,006
Cost of product sales 6,310 5,499 5,262
---------------------------------------
Gross profit 7,166 6,771 11,744
Operating expenses:
Research and development 4,175 4,822 4,215
Sales and marketing 3,359 3,551 3,465
General and administrative 2,648 3,458 2,182
Financing expenses - - 312
---------------------------------------
Total operating expenses 10,182 11,831 10,174
---------------------------------------
Operating (loss) income (3,016) (5,060) 1,570
Other income:
Interest income 917 1,134 364
Other, net - - 83
---------------------------------------
(Loss) income before income taxes (2,099) (3,926) 2,017
Benefit/(Provision) for income taxes - 457 (766)
---------------------------------------
Net (loss) income $ (2,099) $ (3,469) $ 1,251
=======================================
Per share data:
Net (loss) income per share Basic ($0.17) ($0.29) $0.14
Diluted ($0.17) ($0.29) $0.13
=======================================
Shares used in per share
computations Basic 12,272 12,146 9,041
Diluted 12,272 12,146 9,925
=======================================
</TABLE>
See accompanying notes.
-30-
<PAGE>
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY
(In thousands, except share data)
<TABLE>
<CAPTION>
Retained
Common Stock Additional Earnings Other
----------------- Paid-In Deferred (Accumulated Comprehensive
Shares Amount Capital Compensation Deficit) Income Total
------ ------ ---------- ------------ ------------ -------------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996 8,200,000 $ 8 $ 7,825 $ - $ (655) $ 67 $ 7,245
Net income - - - - 1,251 - 1,251
Reclassification adjustment for
Gains included in net income
of $67 - - - - - (67) (67)
--------
Comprehensive income 1,184
--------
Sale of Common Stock
net of issue costs 3,833,334 4 20,532 - - - 20,536
Issuance of Common
Stock for services and
Upon exercise of
Option and warrants 25,579 - 99 - - - 99
Issuance of warrants to
Purchase Common Stock
for technology acquired - - 250 - - - 250
Deferred compensation
on employee stock
Option grants - - 272 (272) - - -
Amortization of deferred
Compensation - - - 34 - - 34
---------- ---- -------- ------- ------- ------- --------
Balance at December 31, 1997 12,058,913 12 28,978 (238) 596 - 29,348
Net loss - - - - (3,469) - (3,469)
Comprehensive loss (3,469)
Issuance of Common Stock
for cash upon exercise
of options and employee
stock purchase plan 146,234 - 554 - - - 554
Reclassification of undistributed
Retained earnings - - 495 - (495) - -
Amortization of
deferred compensation - - - 65 - - 65
---------- ---- -------- ------- ------- ------- --------
Balance at December 31, 1998 12,205,147 12 30,027 (173) (3,368) - 26,498
Net loss - - - - (2,099) - (2,099)
Unrealized gain on investments
of $4,341 4,341 4,341
--------
Comprehensive income 2,242
--------
Issuance of Common Stock
for cash upon exercise
of options and employee
stock purchase plan 91,017 - 252 - - - 252
Issuance of common stock for
services rendered 14,392 - 43 - - - 43
Amortization of -
deferred compensation - - - 48 - - 48
---------- ---- -------- ------- ------- ------- --------
Balance at December 31, 1999 12,310,556 $ 12 $ 30,322 $ (125) $(5,467) $ 4,341 $ 29,083
---------- ---- -------- ------- ------- ------- --------
---------- ---- -------- ------- ------- ------- --------
</TABLE>
See accompanying notes.
-31-
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net (loss) income $ (2,099) $ (3,469) $ 1,251
Adjustments to reconcile net (loss) income to net cash
provided by (used in) operating activities:
Depreciation and amortization 846 921 561
Amortization of deferred compensation 48 65 34
Issuance of common stock for services 43 - -
Gain on sales of short-term investments - - (83)
Changes in operating assets and liabilities:
Trade accounts receivable (1,654) 1,334 (330)
Inventories 1,126 (405) (1,260)
Deferred tax assets - 942 (482)
Income taxes receivable 738 (738) -
Prepaid expenses and other current assets (23) 81 (372)
Accounts payable (168) (320) 716
Accrued compensation and benefits 22 (630) 545
Income taxes payable 670 (872) 756
Other accrued liabilities 312 (96) 265
Deferred revenue - - (500)
--------- --------- --------
Net cash provided by (used in) operating activities (139) (3,187) 1,101
--------- --------- --------
INVESTING ACTIVITIES
Purchases of equipment (116) (497) (1,195)
Proceeds from sale of equipment - - 13
Other assets - - (110)
Purchases of short-term investments (6,918) - -
Sales of short-term investments - - 1,612
Maturities of short-term investments - 277 -
Other investments (500) - -
--------- --------- --------
Net cash provided by (used in) investing activities (7,534) (220) 320
--------- --------- --------
FINANCING ACTIVITIES
Issuance of Common Stock 252 554 20,635
Distribution to stockholders - - -
--------- --------- --------
Net cash provided by (used in) financing activities 252 554 20,635
--------- --------- --------
(Decrease) increase in cash and cash equivalents (7,421) (2,853) 22,056
Cash and cash equivalents at beginning of year 20,419 23,272 1,216
--------- --------- --------
Cash and cash equivalents at end of year $ 12,998 $ 20,419 $ 23,272
--------- --------- --------
--------- --------- --------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for income taxes $ - $ 225 $ 465
--------- --------- --------
--------- --------- --------
SUPPLEMENTAL DISCLOSURES OF NONCASH FINANCING ACTIVITIES
Issuance of warrants to acquire Common Stock for
technology acquired $ - $ - $ 250
--------- --------- --------
--------- --------- --------
Transfer of technology in exchange for shares of common
stock in Sage, Inc. $ 2,425 $ - $ -
--------- --------- --------
--------- --------- --------
</TABLE>
See accompanying notes.
-32-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 theater and commercial
presentation, 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 chip level products for applications in the television,
digital display and 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
for $14,000,000 and newly issued FLI shares for $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.
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.
SOURCES OF SUPPLY
The Company currently relies on a limited number of independent foundries to
manufacture, assemble and test all of its semiconductor components and
products. In addition, the Company subcontracts the manufacturing of its
broadcast and television products with two principal suppliers. While
alternate sources of supply exist, in the event of the discontinuance of any
of the above supplier relationships, the Company would be required to locate
and qualify new suppliers, which could take several months.
CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of less
than three month when purchased, to be cash equivalents. Cash equivalents
consist primarily of deposits in banks, money market accounts, commercial
paper and discount notes.
INVESTMENTS
The Company accounts for its 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.
-33-
<PAGE>
At December 31, 1999 and 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 part of accumulated
other comprehensive income in 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, 1999, no single customer accounted for more than 10% of the
Company's ending accounts receivable balance.
At December 31, 1998, one customer accounted for 22% of the accounts
receivable balance.
INVENTORIES
Raw materials, work-in-process and finished goods inventories are stated at
the lower of standard cost (which approximates actual cost) or market value.
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 $790,000, $745,000 and $540,000 for 1999, 1998 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 there are no customer acceptance provisions in the Company's
normal sales. 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 $312,000, $374,000 and $430,000 in 1999, 1998 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.
Options granted to non-employees are accounted for using the Black-Scholes
method prescribed by SFAS 123 and, in accordance with Emerging Issues Task
Force Consensus No. 96-18, the options are subject to periodic re-valuation
over their vesting terms.
-34-
<PAGE>
NET INCOME (LOSS) PER SHARE
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). A reconciliation of shares
used in the calculation follows (in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
------------------------------------------------
<S> <C> <C>
Weighted average shares outstanding 12,272 12,146 9,041
Dilutive effect of stock options and warrants - - 834
------------------------------------------------
Shares used in computation of diluted net (loss) income
per share 12,272 12,146 9,875
================================================
</TABLE>
Options and warrants to purchase 1,950,288, 1,991,905 and 445,200 shares of
the Company's common stock would have been anti-dilutive in 1999, 1998 and
1997 respectively and were, therefore, excluded from the respective diluted
calculation.
COMPREHENSIVE INCOME (LOSS)
Statement of Financial Accounting Standard No. 130, Reporting Comprehensive
Income ("SFAS 130) requires unrealized gains or losses on the Company's
investments to be included in comprehensive income. Total comprehensive
income has been disclosed in the Consolidated Statement of Stockholder's
Equity.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Financial Instruments and for Hedging Activities" ("SFAS 133")
which provides a comprehensive and consistent standard for the recognition
and measurement of derivatives and hedging activities. In June 1999, FASB
issued Statement of Financial Accounting Standards No. 137, which defers the
effective date of SFAS 133 to years beginning after June 15, 2000. The
Company does not anticipate SFAS 133 to have a material impact on the
Company's results of operations or financial condition when adopted.
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin 101, "Revenue Recognition in Financial Statements" ("SAB
101"), which provides guidance related to revenue recognition based on
interpretations and practices followed by the SEC. SAB 101 is effective the
first quarter of fiscal years beginning after December 15, 1999 and requires
companies to report any changes in revenue recognition as a cumulative change
in accounting principle at the time of implementation in accordance with APB
Opinion No. 20 "Accounting Changes". The Company believes that its current
revenue recognition policy complies with SAB101 and therefore does not expect
the adoption of SAB101 to have a material effect on results of operations.
2. AVAILABLE-FOR-SALE SECURITIES
The following is a summary of available-for-sale debt securities at December
31, 1999 and 1998 (in thousands):
<TABLE>
<CAPTION>
Cost and
Fair Market
Value
------------
<S> <C>
At December 31, 1999:
Commercial paper $ 5,749
Government agency discount notes 10,977
------------
$ 16,276
============
Reported as:
Cash equivalents $ 9,808
Available-for-sale securities 6,918
------------
$ 16,276
============
At December 31, 1998:
Commercial paper $ 6,977
Government agency discount notes 10,844
------------
$ 17,821
============
Reported as:
Cash equivalents $ 17,821
============
</TABLE>
-35-
<PAGE>
The estimated fair value amounts discussed above have been determined by the
Company using available market information. The investments are held in
commercial paper of U.S. corporations with A1/P1 credit ratings and U.S.
federal agency discount obligations.
As of December 31, 1999, the average portfolio duration and contractual
maturity of the investments were approximately six months.
There were no material realized or unrealized gains or losses from these
investments in 1999, 1998 and 1997.
The Company's equity investment is disclosed in Note 3.
3. LICENSE AGREEMENT
In July 1999, the Company entered into a license, joint development and
equity purchase agreement with Sage, Inc. ("Sage") for the transfer of
certain of the Company's video processing technologies to Sage. In exchange
for the license rights, the transfer of the technology and a $500,000 payment
to Sage, the Company received 375,000 shares of Sage common stock. To the
extent that Sage incorporates the Company's technology into Sage products,
the Company will also receive royalties on the sales of those products.
The license and technology transfer was valued at $2.4 million and at
December 31, 1999, this has been recorded as deferred revenue, subject to
completion of the Company's performance obligations under the agreement. The
shares of Sage common stock have been accounted for as available-for-sale
securities and marked to market. At December 31, 1999, the Company recorded
an unrealized gain of $4.3 million. (See Note 12 - Subsequent Events).
4. INVENTORIES
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
1999 1998
------------ ------------
<S> <C> <C>
Raw materials $ 668 $1,072
Work-in-process 513 1,048
Finished goods 1,041 1,228
------------ ------------
$ 2,222 $3,348
============ ============
</TABLE>
5. PROPERTY AND EQUIPMENT
Property and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
1999 1998
------------ ------------
<S> <C> <C>
Machinery and equipment $ 2,893 $ 2,782
Purchased computer software 956 952
Furniture, fixtures and equipment 314 314
Vehicles 84 84
Leasehold improvements 228 227
------------ ------------
4,475 4,359
Accumulated depreciation (3,371) (2,581)
------------ ------------
$ 1,104 $ 1,778
============ ============
</TABLE>
-36-
<PAGE>
6. 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 on one lease and increase $.60 per square
foot per year under the other lease. At December 31, 1999, future estimated
minimum payments under these leases are approximately as follows (in
thousands):
<TABLE>
<S> <C>
2000 $ 435
2001 451
2002 467
2003 360
---------------
Total minimum lease payments $ 1,713
===============
</TABLE>
In May 1999 the Company entered into a sublease agreement for one of its
facilities for the remaining term of that lease. Rental income received in
1999 was $144,000.
Rent expense under operating leases amounted to $536,000, $465,000 and
$289,000 in 1999, 1998 and 1997, respectively.
7. 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.
WARRANTS
In 1996, the Company issued a warrant to purchase 65,152 shares of Common
Stock at an exercise price of $0.15 to a limited liability company in which a
member of the Company's Board of Directors has a substantial interest. The
warrant was issued in exchange for services to be performed by the director.
The warrant was exercised for all shares on January 13, 2000. The Company
expensed $222,000, the value of the warrant, over the related service period.
In 1997, one of the Founders granted to the Company an exclusive (excluding
certain rights retained by the Founder), worldwide, perpetual, irrevocable
and royalty-free right and license to patents owned by him. The Founder has a
nonexclusive, nontransferable right to the patents for applications and uses
outside of the Company's business as defined in the license agreement. In
exchange for rights granted, the Founder received a warrant to purchase
100,000 shares of Common Stock at $7.50 per 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, June 1998 and June 1999 the
stockholders approved amendments to the 1997 Plan increasing the number of
shares reserved for issuance by 250,000 shares, 400,000 shares and 500,000
shares, respectively. 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
-37-
<PAGE>
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. Payroll deductions are at the election of the employee
subject to a maximum of 10% of the employee's salary. In 1999 and 1998,
71,977 shares and 41,223 shares, respectively, were issued under the purchase
plan. There were no shares issued in 1997.
In 1998, the Company granted 118,750 options to one officer outside of any of
the Company's option plans.
A summary of the Company's stock option activity, and related information
follows:
<TABLE>
<CAPTION>
Years Ended December 31
-----------------------------------------------------------------------------------------
Weighted - Weighted- Weighted-
Average Average Average
1999 Exercise 1998 Exercise 1997 Exercise
Options Price Options Price Options Price
------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of period 1,826,753 $4.49 1,659,190 $4.48 1,441,988 $3.46
Granted 669,000 3.07 670,950 4.72 432,570 7.55
Exercised (19,040) 3.64 (105,013) 3.27 (7,380) 1.68
Canceled (691,577) 4.89 (398,374) 5.33 (207,988) 3.90
-------------- -------------- --------------
Outstanding at end of period 1,785,136 $3.81 1,826,753 $4.49 1,659,190 $4.48
============== ============== ==============
Weighted-average fair value of
options granted during the period $2.36 $2.50 $2.19
</TABLE>
<TABLE>
<CAPTION>
December 31, 1999
- -------------------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
- ------------------------------------------------------------------------ ----------------------------
Weighted-
Average Weighted- Weighted-
Remaining Average Average
Range of Number of Contractual Exercise Number of Exercise
Exercise Prices Options Life Price Options Price
<S> <C> <C> <C> <C> <C>
$1.16-$2.63 259,546 6.87 $ 1.74 196,395 $1.48
$2.88-$3.75 955,850 8.91 $ 3.41 232,836 $3.75
$3.83-$3.91 333,123 6.62 $ 3.85 284,578 $3.85
$7.00-$8.12 222,500 6.99 $ 7.53 139,307 $7.52
$8.50-$10.38 14,117 2.62 $ 9.52 11,818 $9.51
------------- -------------
1,785,136 7.90 $ 3.81 864,934 $3.95
============= =============
</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
-38-
<PAGE>
aggregate exercise price of such options. The total deferred compensation
expense of $272,000 is being amortized over the vesting period of such
options.
RESERVED SHARES
The Company has reserved shares of Common Stock for future issuance as
follows:
<TABLE>
<CAPTION>
December 31,
1999
----------------
<S> <C>
Warrants 165,152
Stock purchase plan 286,800
Stock option plans:
Outstanding options 1,785,136
Reserved for future grants 1,152,181
----------------
3,389,269
================
</TABLE>
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 (in thousands except per share data):
<TABLE>
<CAPTION>
December 31,
1999 1998 1997
----------------------------------------------
<S> <C> <C> <C>
Net income (loss)-as reported ($2,099) ($3,469) $1,251
Net income (loss)-pro forma (3,264) (4,210) 868
Basic net income per share-as reported ($0.17) ($0.29) $0.14
Basic net income per share-pro forma ($0.27) ($0.35) $0.10
</TABLE>
The pro forma net loss is not necessarily indicative of potential pro forma
effects on results for future years.
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: a risk free interest rate of 5.63%, an expected
option life of 72 months and no dividends. The value of options granted
following the initial public offering in 1997 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. The value of options
granted in 1998 and 1999 were determined using the Black-Scholes method and
the weighted average assumptions were as follows: an expected volatility
factor of 0.66 and 1.10 respectively, a risk free interest rate of 5.46% and
6.56%, respectively, an expected option life of 48 months and no dividends.
-39-
<PAGE>
8. INCOME TAXES
The provision (benefit) for income taxes computed under Statement of
Financial Accounting Standards, No.109, "Accounting for Income Taxes,"
consists of the following (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Federal:
Current $ - $(1,386) $1,059
Deferred (-) 808 (369)
--------- --------- ---------
$ (578) $ 690
State:
Current - (13) 143
Deferred (-) 134 (67)
--------- --------- ---------
121 76
--------- --------- ---------
Provision (benefit) for Income Taxes $ - $ (457) $ 766
========= ========= =========
</TABLE>
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 (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Tax at U.S. statutory rate $ (714) ($1,335) $ 686
State income taxes, net of federal benefit - 120 30
Research & development tax credits - - (137)
Unbenefited net operating
losses and timing differences 714 632 -
Other - 126 187
--------- --------- ---------
Benefit/(provision) for income taxes $ 0 $ (457) $ 766
========= ========= =========
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's deferred tax liabilities and assets are as
follows (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
Deferred tax assets: 1999 1998
-------- --------
<S> <C> <C>
Reserves and accruals not currently deductible $ 781 $ 591
Tax credits 279 151
Net operating losses 606 107
Other, net 155 172
--------
Total gross deferred tax assets 1,821 1,021
Less: valuation allowance (1,523) (822)
-------- --------
Net deferred tax assets 298 199
Deferred tax liabilities:
Depreciation of property and equipment (298) (199)
-------- --------
Total net deferred tax assets/(liabilities) $ - $ -
======== ========
</TABLE>
As of December 31, 1999, the Company had federal and state tax loss
carryforwards of approximately $1,350,000 and $2,500,000,
-40-
<PAGE>
respectively. As of December 31, 1999, the Company also had federal tax
credit carryforwards of approximately $279,000. The loss carryforwards will
begin to expire in 2003, and the federal tax credit carryforwards will begin
to expire in 2018, if not utilized. Because of the change in ownership
provisions of the Internal Revenue Code, a portion of the Company's net
operating loss and tax credit carryforwards may be subject to annual
limitations. The annual limitations may result in the expiration of net
operating loss and tax credit carryforwards before utilization.
Realization of deferred tax assets is dependent on future earnings, if any,
the timing and the amount of which are uncertain. Accordingly, a valuation
allowance, in an amount equal to the net deferred tax asset as of December
31, 1999 has been established to reflect these uncertainties. The valuation
allowance increased by approximately $701,000, $822,000 and none during the
fiscal years ended December 31, 1999, 1998 and 1997. The Company will
continue to evaluate the realization of the deferred tax assets on a
quarterly basis.
9. MARKET SALES, EXPORT SALES AND SIGNIFICANT CUSTOMERS
The Company has determined that, under the definition in Statement of
Financial Accounting Standards No. 131, it operates only in one segment.
The Company had product sales by market as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Home theater/industrial $ 10,857 $ 10,229 $ 15,199
Broadcast 1,770 1,209 307
ASIC 849 82 -
------------ ------------ ------------
Total product sales $ 13,476 $ 11,520 $ 15,506
============ ============ ============
</TABLE>
The Company had product sales by region as follows (in thousands):
<TABLE>
<CAPTION>
December 31,
1999 1998 1997
-------------------- ---------------------- ---------------------
<S> <C> <C> <C>
Revenues to customers:
U.S.A $ 11,402 $ 9,241 $ 13,285
Asia 855 1,080 1,182
Europe 672 521 345
Canada 241 478 269
Latin America and other 306 200 425
-------------------- ---------------------- ---------------------
$ 13,476 $ 11,520 $ 15,506
==================== ====================== =====================
</TABLE>
In 1999, no customer accounted for 10% or more of total revenues. In 1998,
sales to one customer accounted for 10% of total revenues. In 1997, sales to
two customers accounted for 11% of total revenues
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 $92,000 in 1999, $166,000 in 1998 and $147,000 in 1997.
11. SUBSEQUENT EVENTS (UNAUDITED)
In February 2000, the Company signed a definitive agreement with Sage for a
stock-for-stock merger, following which the Company would become a wholly
owned subsidiary of Sage. Each share of Faroudja common stock will be
converted into 0.285 shares of Sage common stock and Sage will assume all
outstanding warrants and options. The transaction has been unanimously
approved by the boards of directors of both companies and is expected to
close in the quarter ending June 30, 2000, subject to approval by each
company's shareholders. The merger is expected to be accounted for as a
purchase transaction by Sage.
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<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, 1999 and 1998, and the related consolidated
statements of income, stockholders' equity and cash flows for each of the three
years in the period ended December 31, 1999. Our audits also included the
financial statement schedule listed in the Index as Item 14(a). These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Faroudja, Inc. at December 31, 1999 and 1998 and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements taken as
a whole, present fairly in all material respects the information set forth
therein.
/S/ ERNST & YOUNG LLP
Palo Alto, California
January 25, 2000
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<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The Company's Bylaws, as amended, provide for a classified Board of Directors
with no fewer than six and no more than nine directors, consisting of three
classes of directors with each director serving a three-year term. Yves
Faroudja and Stuart Buchalter are serving as directors for terms expiring at
the 2000 Annual Meeting of Stockholders. Kevin Kimberlin and William Turner
are serving as directors for terms expiring at the 2001 Annual Meeting of
Stockholders. Glenn Marschel is serving as a director with a term expiring at
the 2002 Annual Meeting of Stockholders. At each annual meeting of
stockholders, directors are elected for a full term of three years to succeed
directors whose terms are expiring. Officers are elected annually by the
Board of Directors and serve at the discretion of the Board of Directors.
BOARD OF DIRECTORS
GLENN W. MARSCHEL, JR. (age 53) has served as President, Chief Executive
Officer and Co-Chairman of the Board of Directors since joining the Company
in October 1998. He has served as Chairman of the Board of Directors of
Additech, Inc., a petrochemicals marketing company, since October 1997. From
December 1995 to August 1997 Mr. Marschel was President and Chief Executive
Officer of Paging Network, Inc., a telecommunications company, and from April
1995 to November 1995 he served as Vice Chairman of First Financial
Management Company, a company in the credit card transaction processing
business. Prior thereto, from January 1972 to December 1994, Mr. Marschel
held positions of increasing responsibility at Automatic Data Processing,
Inc., an information systems company, last serving as President of ADP's
Employer Services Group. Mr. Marschel is also a director of Sabre Group
Holdings, Inc. and Travelocity.com.
YVES C. FAROUDJA (age 66) 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 and has been the Company's
Chief Technical Officer since July 1996. Mr. Faroudja has served as
Co-Chairman of the Board of Directors since October 1998 and is Chairman of
the Board's Executive Committee.
STUART D. BUCHALTER (age 62) has served as a director of the Company since
April 1996. Mr. Buchalter has been Of Counsel with the California law firm of
Buchalter, Nemer, Fields & Younger, a Professional Corporation, since August
1980. He has been an officer of East-West Capital Associates, Inc. since
February 1996. From August 1980 to June 1993, he served as Chairman of the
Board of Directors and Chief Executive Officer of Standard Brands Paint
Company, a paint retailer and manufacturer. Mr. Buchalter is a director of
Authentic Fitness Corp., an athletic apparel manufacturer, City National
Corp., the holding company for City National Bank, Earl Scheib, Inc., an
automotive painting company, and e4L, Inc. (formerly National Media
Corporation), a direct response marketing company. He is also Vice-Chairman
of the Board of Trustees of Otis College of Art and Design.
KEVIN B. KIMBERLIN (age 47) has served as a director of the Company since
December 1995. Since 1991, Mr. Kimberlin has been Chairman of Spencer Trask
Holdings, Inc., an investment banking firm. Mr. Kimberlin is a co-founder of
Ciena Corporation, Myriad Genetics and The Immune Response Corporation. He
has been a director of The Immune Response Corporation since 1986.
WILLIAM J. TURNER (age 56) served as Chairman of the Board of Directors of
the Company from December 1995 to October 1998 and continues to serve as a
director of the Company. 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, Inc., a computer and information
services firm. Mr. Turner is currently a director of Federal Home Loan
Mortgage Corporation.
COMPLIANCE WITH REPORTING REQUIREMENTS OF SECTION 16 OF THE EXCHANGE ACT
Under Section 16(a) of the Exchange Act, the Company's directors, executive
officers and any persons holding ten percent or more of the
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<PAGE>
Company's Common Stock are required to report their ownership of Common Stock
and any changes in that ownership to the Securities and Exchange Commission
(the "SEC") and to furnish the Company with copies of such reports. Specific
due dates for these reports have been established and the Company is required
to report in this Proxy Statement any failure to file on a timely basis by
such persons. Based solely upon a review of copies of reports filed with the
SEC during 1999, all persons subject to the reporting requirements of Section
16(a) filed all required reports on a timely basis.
EXECUTIVE OFFICERS
Information concerning the executive officers of the Registrant is included
in Part I, page 19, of this annual report on Form 10-K.
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<PAGE>
ITEM 11. EXECUTIVE COMPENSATION.
The following table summarizes the compensation paid by the Company during
1999 to the Company's Chief Executive Officer and those persons who were, at
December 31, 1999, the Company's four most highly compensated executive
officers other than the Chief Executive Officer.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
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>
Glenn W. Marschel, Jr.............. 1999 $238,320 -- $35,843(4) -- 5,000
President, Chief Executive 1998 51,846(3) -- 8,649(4) 400,000 5,000
Officer and Director
Donald S. Butler..................... 1999 237,783 55,000 -- 90,000(7) 5,000
Senior Vice President - Engineering 1998 228,626 69,000(6) -- -- 5,000
1997 212,196(5) 55,000 -- -- 2,750
Thomas A. Harvey.................. 1999 202,423 43,000 40,000(9) --
Vice President - Sales 1998 200,000 5,000 -- -- --
And Marketing 1997 77,177(8) 68,000 -- 100,000(10) --
Kenneth S. Boschwitz............... 1999 163,127 27,000 -- 40,000(9) 5,000
Vice President - Business 1998 155,570 5,000 -- -- 5,000
Development, General Counsel 1997 84,099(11) 25,000 80,000(10)
& Secretary
Robert A. Sheffield 1999 143,548 -- -- 40,000(9) --
Former Vice President Finance and 1998 88,692(12) 2,000 -- 125,000(13) --
Chief Financial Officer
Nikhil Balram 1999 136,058 33,000 -- 125,000(15) 4,424
Vice President -
Advanced Technology(14)
</TABLE>
(1) Excludes perquisites and other personal benefits that did not exceed the
lesser of (i) $50,000 or (ii) 10% of the total annual salary and bonus for
the officer named. 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. Marschel joined the Company in October 1998 and the amount reported
represents his salary on a pro-rated basis based on an annual salary of
$240,000. Includes a grant of options in 1998 to purchase 281,250 shares
under the 1997 Performance Stock Option Plan ("1997 Option Plan") at an
exercise price of $3.75, which vest over three years. In addition, Mr.
Marschel was granted options to purchase 118,750 shares at an exercise
price of $3.75, of which options to purchase 100,000 shares vested
immediately and the balance vest over three years.
(4) Comprised of $7,817 for use of a Company leased automobile and $28,026 for
temporary housing expenses in 1999 and $1,954 for use of a Company leased
automobile and $6,695 for temporary housing expenses in 1998.
(5) 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. 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.
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<PAGE>
(6) Includes $54,000 received under an agreement with the Company dated March
6, 1996, pursuant to which Mr. Butler will receive a bonus of $1.08 per
option upon exercise of his first 138,370 options granted under the 1995
Option Plan.
(7) These shares are issuable upon exercise of stock options granted under the
1997 Option Plan. These options vest over a three year period at an
exercise price of $3.125.
(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.
(9) These shares are issuable upon exercise of stock options granted under the
1997 Option Plan at an exercise price of $3.125 and vest on the first
anniversary of the date of grant.
(10) These shares are issuable upon exercise of stock options granted under the
1997 Option Plan at an exercise price of $7.50 and vest over four years.
(11) Mr. Boschwitz joined the Company in June 1997, and the amount reported for
that year represents his salary in 1997 on a pro-rated basis based on an
annual salary of $150,000.
(12) Mr. Sheffield joined the Company in July 1998, and the amount reported for
that year represents his salary in 1998 on a pro-rated basis based on an
annual salary of $185,000. Mr. Sheffield left the Company on September 9,
1999.
(13) These shares are issuable upon exercise of stock options granted under the
1997 Option Plan at an exercise price of $8.50 and vest over four years.
(14) Dr. Balram joined the Company in January 1999, and the amount reported
for that year represents his salary in 1999 on a pro-rated basis based on
an annual salary of $150,000.
(15) These shares are issuable upon exercise of stock options granted under
the 1997 Option Plan at an exercise price of $3.125 and vest over four
years.
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth information with respect to options granted
during 1999 to the Company's Chief Executive Officer and those persons who were,
at December 31, 1999, the Company's four most highly compensated executive
officers other than the Chief Executive Officer.
<TABLE>
<CAPTION>
Potential Realized
Value at Assumed
Annual Rates of
Stock Appreciation
Individual Grants for Option Term(1)
--------------------------------------------------------- --------------------
Percent of
Number of Total Options Exercise
Securities Granted to Price
Options Employees in Per Share Expiration
Name Granted(#) Fiscal 1999 ($/Share)(2) Date 5%($) 10%($)
- ---- ---------- ----------- ------------ ---------- ----- ------
<S> <C> <C> <C> <C> <C> <C>
Glenn W. Marschel, Jr.......... -- -- -- -- -- --
Donald S. Butler............... 90,000(3) 14.1% $3.125 1/14/09 $176,877 $448,240
Thomas A. Harvey............... 40,000(4) 6.3% $3.125 1/14/09 78,612 199,218
Kenneth S. Boschwitz........... 40,000(4) 6.3% $3.125 1/14/09 78,612 199,218
Robert A. Sheffield............ 40,000(4) 6.3% $3.125 1/14/09 78,612 199,218
Nikhil Balram.................. 125,000(5) 19.6% $3.125 1/14/09 245,662 622,556
</TABLE>
- ---------------------------
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<PAGE>
(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 holder's continued employment through the vesting period.
(2) These options were granted pursuant to the Company's 1997 Performance
Stock Option Plan at an exercise price equal to the fair market value of
the Company's Common Stock on the date of grant, as determined by the
Board of Directors of the Company.
(3) These options vest over a three year period, with 18,000 options vesting
on the first anniversary of the date of grant, 3,500 options vesting each
month for the next 12 months, and 2,500 options vesting each month for the
final 12 months.
(4) These options vest on the first anniversary of the date of grant.
(5) These options vest1/4after the first anniversary of the date of grant and
1/48th each month thereafter.
AGGREGATE OPTION EXERCISES IN THE LAST FISCAL YEAR AND FISCAL YEAR END OPTION
VALUES
The following table sets forth certain information regarding the exercise of
stock options during 1999 and stock options held as of December 31, 1999 by
the Company's Chief Executive Officer and those persons who were, at December
31, 1999, the Company's four most highly compensated executive officers other
than the Chief Executive Officer.
<TABLE>
<CAPTION>
Fiscal Year-End Option Values
-----------------------------
Number of Unexercised Value of Unexercised
Options Held at In-the-Money Options at
Option Exercises Fiscal Year End(#)(1) Fiscal Year End($)(2)
---------------- --------------------- -----------------------
Shares Value
Acquired on Realized
Name Exercise(#) ($) Exercisable Unexercisable Exercisable Unexercisable
- ---- ------------ --- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Glenn W. Marschel, Jr. ........... -- -- 216,667 183,334 $277,549 $234,851
Donald S. Butler.................. -- -- 122,196 113,768 145,377 199,625
Thomas A. Harvey.................. -- -- 62,500 77,500 -- 76,240
Kenneth S. Boschwitz.............. -- -- 50,000 70,000 -- 76,240
Nikhil Balram..................... -- -- -- 125,000 -- 238,250
</TABLE>
(1) These options were granted pursuant to the 1995 Option Plan or 1997
Option Plan, except for 118,750 of the options granted to Mr. Marschel.
All options were granted at an exercise price equal to the fair market
value of the Company's Common Stock on the date of grant, as determined
by the Board of Directors.
(2) Based upon the closing price of the Company's Common Stock as reported
on the Nasdaq Stock Market on December 31, 1999, $5.031.
EMPLOYMENT AGREEMENTS
In March 1998, the Company entered into an agreement with Yves C. Faroudja (the
"Advisory Agreement") that superceded his previous
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<PAGE>
employment agreement. The Advisory Agreement had a three year term and
provided for Mr. Faroudja's service as the Company's CTO until a new CTO is
identified and hired. Thereafter, the agreement provided that Mr. Faroudja
would 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 was 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 could only be terminated by the
Company for cause (as defined in the Advisory Agreement) or by Mr. Faroudja
with six months notice. The agreement was terminated on June 30, 1999
following notice from Mr. Faroudja.
Glenn W. Marschel, Jr. joined the Company on October 6, 1998 assuming the
positions of President, Chief Executive Officer and Co-Chairman of the Board
of Directors. His annual base salary is $240,000. On his hire date Mr.
Marschel was granted options under the 1997 Option Plan to purchase 281,250
shares at an exercise price of $3.75, which vest monthly over a three year
period. In addition, Mr. Marschel was granted options to purchase 118,750
shares at an exercise price of $3.75, of which options to purchase100,000
shares vested immediately and the balance vest monthly over three years.
In February 2000 the Board of Directors approved a salary adjustment and
bonuses for Mr. Marschel recommended by the Board's Compensation Committee.
Mr. Marschel's salary was raised to $350,000 effective January 1, 2000.
Unless Mr. Marschel is terminated for cause, he will continue to be paid at
that level for at least 12 months. Mr. Marschel was awarded a bonus equal to
10% of the $2.4 million of revenue associated with the license fee paid by
Sage under the license, joint development and equity purchase agreement. The
Company will recognize the revenue during the quarter ending March 31, 2000
and the $240,000 bonus is payable within 30 days after the revenue is
recognized. Mr. Marschel will also be entitled to a performance bonus in the
amount of $240,000, contingent and payable upon the availability of the first
production units of the Company's new enhancer ASIC, known within the Company
as the FLI2200. In addition, a stock price performance bonus program was
adopted entitling Mr. Marschel to earn a $70,000 bonus in each month in which
the closing price of the Company's common stock reached predetermined target
levels for at least three consecutive trading days. These bonuses, which may
not exceed an aggregate of $350,000, are payable at the end of each quarter,
or within 10 days after Mr. Marschel's last day of employment, if he ceases
to be employed by the Company. The Company's common stock reached the target
levels for three or more consecutive trading days in January, February and
March 2000.
REPORT OF THE COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS ON EXECUTIVE
COMPENSATION
The report of the Compensation Committee shall not be deemed
incorporated by reference to any general statement incorporating by reference
this Form 10-K into any filing under the Securities Act of 1933 or under the
Securities Exchange Act of 1934, except to the extent that the Company
specifically incorporates this information by reference, and shall not
otherwise be deemed filed under such Acts.
OVERVIEW AND PHILOSOPHY
The Compensation Committee of the Board of Directors (the "Committee") is
composed entirely of outside directors and is responsible for developing and
making recommendations to the Board with respect to the Company's executive
compensation policies. In addition, the Committee, pursuant to authority
delegated by the Board, determines the compensation to be paid to the
Company's executive officers and directors. The Committee is responsible for
setting and administering the policies which govern annual compensation, the
Company's 1997 Non-Employee Directors Stock Plan, the 1997 Performance Stock
Option Plan, the 1997 Employee Stock Purchase Plan, and the 1995 Stock Option
Plan.
There are three elements in the Company's executive compensation program, all
determined by individual and corporate performance:
- Annual base salary compensation.
- Annual incentive compensation.
- Long-term incentive compensation.
In designing its compensation programs, the Company believes that compensation
should reflect the value created for stockholders and support the Company's
strategic goals. Specifically, the objectives of the program are as follows:
- Attract and retain key executives critical to the long-term
success of the Company.
- Reflect and promote the Company's values, and reward
executives for outstanding contributions to the Company's success.
- Reward executives for long-term strategic management and the
enhancement of stockholder value by providing opportunities for
ownership in the Company.
- Provide incentives for performance, not only with respect to the
achievement of the Company's goals, but also the Company's
performance relative to that of its peers in the technology
industry.
- Align the interests of the Company's executive officers with
those of the Company's stockholders through participation in
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<PAGE>
stock-based incentive plans.
EXECUTIVE OFFICER COMPENSATION PROGRAM
ANNUAL BASE SALARY
In reviewing the annual base compensation of executive officers, the
Compensation Committee considers the individual executive's performance for
the year, the Company's overall performance for the year, the compensation
for executives at competing companies in the technology industry, current
market conditions, and the recommendations of the Company's Chief Executive
Officer. The Company's general approach to annual base salary compensation is
to pay annual salaries which are competitive with salaries paid to executives
of similarly situated companies in the technology industry, after considering
the individual executive's experience and prior and potential contributions
to the Company. The Committee determined that an annual base salary for 1999
of $240,000 was appropriate for Glenn Marschel, the Company's President and
Chief Executive Officer, but has reevaluated Mr. Marschel's compensation
package for 2000, as described below. The Committee believes the annual base
salary for the Company's four Vice Presidents are commensurate with the
current incumbents' level of experience and prior and potential future
contributions to the Company.
ANNUAL INCENTIVE COMPENSATION
The Committee generally believes that, at higher executive levels, a greater
percentage of an individual's total annual cash compensation opportunity
should consist of variable compensation tied to the Company's performance.
The Committee's practice with regard to awarding annual bonuses to executive
officers is to establish measures of performance that the Committee
determines to be appropriate under the circumstances and to assign relative
weight to any such factors. The Committee focuses particularly on such
factors as growth in earnings and increased market share in the Company's
products, as well as discretionary factors in determining whether or not
bonuses are paid. In making such determinations, the Committee takes into
consideration and gives significant weight to the recommendations of the
Chief Executive Officer with respect to the bonuses of executive officers
other than himself.
STOCK EQUITY BASED COMPENSATION
The Company believes that stock ownership is a significant incentive for the
improvement of the long-term performance of the Company by aligning the
interests of the executive officers and stockholders which, in turn, will
help build stockholder wealth. The Company also recognizes that a stock
incentive program is a necessary element of a competitive compensation
package for its employees. In January 1997, the Company adopted the 1997
Performance Stock Option Plan (the "1997 Option Plan") to succeed the earlier
1995 Stock Option Plan. The 1997 Option Plan is applicable to the employees
of the Company (including inside directors and officers) and authorizes the
Compensation Committee to determine the terms of the options granted,
including the exercise price, the number of shares subject to the option and
exercisability thereofb. In making its determination to grant options under
the 1997 Option Plan, the Committee analyzes, among other things, the
executive's level of responsibility and the role in positively influencing
future results.
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<PAGE>
COMPENSATION OF GLENN W. MARSCHEL, JR., THE CHIEF EXECUTIVE OFFICER
Following a review of the compensation of Glenn Marschel, President, Chief
Executive Officer and Co-Chairman of the Board of Directors, the Committee
recommended and the Board of Directors approved, a salary adjustment and
program of performance based bonuses for Mr. Marschel for 2000 tied to
objectives that the Compensation Committee and the Board determined to be
essential to the Company's success. Mr. Marschel's salary was raised to
$350,000 effective January 1, 2000. Unless Mr. Marschel is terminated for
cause, he will continue to be paid at that level for at least 12 months. The
Committee determined that this annual base salary was appropriate based on
the same executive compensation policy exercised above with respect to
executive officers of the Company.
Mr. Marschel was awarded a bonus equal to 10% of the $2.4 million of revenue
associated with the license fee paid by Sage under the license, joint
development and equity purchase agreement. The bonus is payable within 30
days after the revenue from such license fee is recognized by the Company.
Mr. Marschel will also be entitled to a performance bonus in the amount of
$240,000, contingent and payable upon the availability of the first
production units of the Company's new enhancer ASIC, the FLI2200. In
addition, a stock price performance bonus program was adopted entitling Mr.
Marschel to earn a $70,000 bonus in each month in which the closing price of
the Company's common stock reached predetermined target levels for at least
three consecutive trading days. The stock price performance bonuses, which
may not exceed an aggregate of $350,000, are payable at the end of each
quarter, or within 10 days after Mr. Marschel's last day of employment, if he
ceases to be employed by the Company.
Factors the Compensation Committee considered in determining that Mr.
Marschel's salary and bonus compensation were reasonable included personal
qualifications and experience of Mr. Marschel, the Company's anticipated
executive requirements and compensation levels at similar technology
companies.
Compensation Committee
William J. Turner
Kevin B. Kimberlin
PRICE PERFORMANCE GRAPH
Set forth below is a line graph comparing the Company's total stockholder
return on Common Stock with the Nasdaq Stock Market Index ("NASDAQ") and the
Hambrecht & Quist Technology Index, from the Company's initial public
offering on October 30, 1997 through the end of Fiscal 1999. The measurement
points utilized in the graph consist of the last day in each calendar quarter.
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<PAGE>
COMPARISON OF 26 MONTH CUMULATIVE TOTAL RETURN*
AMONG FAROUDJA, INC., THE NASDAQ STOCK MARKET (U.S.) INDEX
AND THE HAMBRECHT & QUIST TECHNOLOGY INDEX
<TABLE>
<CAPTION>
10/30/1997 12/97 12/98 12/99
---------- ----- ----- -----
(Dollars)
<S> <C> <C> <C> <C>
Faroudja, Inc. 100 173 52 84
Nasdaq Stock Market (U.S.) 100 100 141 262
Hambrecht & Quist Technology 100 97 151 337
</TABLE>
* $100 INVESTED ON 10/30/97 IN STOCK OR INDEX -
INCLUDING REINVESTMENT OF DIVIDENDS.
FISCAL YEAR ENDING DECEMBER 31.
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<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth certain information known to the Company
with respect to beneficial ownership of the Company's Common Stock as of
March 1, 1999 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) the Chief Executive Officer and those persons who
were, at December 31, 1999, the Company's four most highly compensated
executive officers other than the Chief Executive Officer (collectively, the
"Named Executive Officers") and (iv) all executive officers and directors as
a group. As of March 1, 1999, a total of 12,242,597 shares of the Company's
Common Stock were issued and outstanding. Except as indicated in the
footnotes to the table, the persons named in the table have sole voting and
investment power with respect to all shares of Common Stock shown as
beneficially owned by them, subject to community property laws, where
applicable. Except as otherwise indicated, the address of each of the persons
in this table is as follows: c/o Faroudja, Inc., 750 Palomar Avenue,
Sunnyvale, California 94086.
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP(1)
-----------------------
BENEFICIAL OWNER SHARES PERCENT
---------------- ------ -------
<S> <C> <C>
Yves C. Faroudja(2)................................... 1,848,550 13.9%
Kevin B. Kimberlin(3)................................. 1,146,655 8.7
Merv L. Adelson(4)(5)................................. 989,183 7.5
Adelson Investors, LLC(4)............................. 949,832 7.2
10900 Wilshire Boulevard
Los Angeles, California 90024
S3 Incorporated....................................... 833,334 6.3
2801 Mission College Boulevard
Santa Clara, California 95052
Oshkim Limited Partners, L.P.(3)...................... 789,205 6.0
Glenn W. Marschel(6).................................. 336,602 2.5
William J. Turner(7).................................. 202,279 1.5
Donald S. Butler(8)................................... 170,542 1.3
Thomas A. Harvey(9)................................... 118,389 *
Kenneth S. Boschwitz(10).............................. 109,661 *
Ita Geva(11).......................................... 45,785 *
Nikhil Balram(12)..................................... 45,241 *
Stuart D. Buchalter(4)(13)............................ 19,759 *
All directors and executive officers as a group
(10 persons)(14)..................................... 4,043,463 30.5%
</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 1, 2000 are deemed outstanding.
(2) Mr. Faroudja holds 1,732,925 shares jointly with his spouse. Includes
100,000 shares issuable upon exercise of warrants and 15,625 shares
issuable upon the exercise of stock options exercisable within 60 days
of March 1, 2000.
(3) 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.
(4) Mr. Adelson is the Managing Member of Adelson Investors, LLC and
exercises sole voting and investment power over the shares held by
that entity. Mr. Buchalter is an officer of Adelson Investors, LLC and
has an interest in the profits of such firm, but does not exercise
voting or investment power over the shares held by the entity.
(5) Includes 5,429 shares issuable upon exercise of stock options
exercisable within 60 days of March 1, 2000 and 53,618 shares that Mr.
Adelson holds jointly with his spouse.
(6) Includes 250,000 shares issuable upon exercise of stock options
exercisable within 60 days of March 1, 2000. Does not include 150,000
shares subject to options granted to Mr. Marschel that are not
currently exercisable.
(7) Includes 11,109 shares held jointly with Mr. Turner's spouse.
-52-
<PAGE>
(8) Includes 167,025 shares issuable upon exercise of stock options
exercisable within 60 days of March 1, 2000. Does not include 68,939
shares subject to options granted to Mr. Butler that are not currently
exercisable.
(9) Includes 110,833 shares issuable upon exercise of stock options
exercisable within 60 days of March 1, 2000. Does not include 29,167
shares subject to options granted to Mr. Harvey that are not currently
exercisable.
(10) Includes 96,666 shares issuable upon exercise of stock options
exercisable within 60 days of March 1, 2000. Does not include 23,334
shares subject to options granted to Mr. Boschwitz that are not
currently exercisable. Includes 1,000 shares held by Mr. Boschwitz in
trust for his nieces, as to which shares Mr. Boschwitz disclaims
beneficial ownership.
(11) Includes 41,264 shares issuable upon exercise of stock options
exercisable within 60 days of March 1, 2000. Does not include 9,706
shares subject to options granted to Ms Geva that are not currently
exercisable.
(12) Includes 39,062 shares issuable upon exercise of stock options
exercisable within 60 days of March 1, 2000. Does not include 85,938
shares subject to options granted to Dr. Balram that are not currently
exercisable.
(13) Includes 6,515 shares issuable upon exercise of stock options
exercisable within 60 days of March 1, 2000 granted to Mr. Buchalter.
(14) All directors and executive officers as a group hold options and
warrants to purchase 832,419 shares of Common Stock, which options and
warrants will vest within 60 days of March 1, 2000 and options and
warrants to purchase 373,959 shares of the Company, which options and
warrants will not have vested within 60 days of March 1, 2000.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
MARSCHEL COMPENSATION
In February 2000 the Board of Directors approved a salary adjustment and
bonuses for Mr. Marschel recommended by the Board's Compensation Committee.
Mr. Marschel's salary was raised to $350,000 effective January 1, 2000.
Unless Mr. Marschel is terminated for cause, he will continue to be paid at
that level for at least 12 months. Mr. Marschel was awarded a bonus equal to
10% of the $2.4 million of revenue associated with the license fee paid by
Sage under the license, joint development and equity purchase agreement. The
Company will recognize the revenue during the quarter ending March 31, 2000
and the $240,000 bonus is payable within 30 days after the revenue is
recognized. Mr. Marschel will also be entitled to a performance bonus in the
amount of $240,000, contingent and payable upon the availability of the first
production units of the Company's new enhancer ASIC, known within the Company
as the FLI2200. In addition, a stock price performance bonus program was
adopted entitling Mr. Marschel to earn a $70,000 bonus in each month in which
the closing price of the Company's common stock reached predetermined target
levels for at least three consecutive trading days. These bonuses, which may
not exceed an aggregate of $350,000, are payable at the end of each quarter,
or within 10 days after Mr. Marschel's last day of employment, if he ceases
to be employed by the Company. The Company's common stock reached the target
levels for three or more consecutive trading days in January, February and
March 2000.
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 Mr. Faroudja (1)
granted to the Company a worldwide, perpetual, royalty-free, sublicensable
license to exploit the Faroudja Technology, and (2) 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") he 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
"Executive Compensation - 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, Mr. 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
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<PAGE>
that Mr. 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 Mr. Faroudja as contained therein.
Mr. Faroudja, the Company and General Instrument Corporation ("GI") are
parties to a 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. The licenses
are royalty-free so neither party is obligated to pay, nor entitled to
receive, license fees from the other party. The agreement grants exclusive
rights to each company in defined fields of use, includes the right to grant
sublicenses and extends until the last to expire of the licensed patents. 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 upconverter products.
REGISTRATION RIGHTS AGREEMENT
The Company and Yves Faroudja and Isabell Faroudja are parties to a
Registration and Shareholders Rights Agreement dated March 7, 1997, which
grants to Mr. and Mrs. Faroudja certain rights to include their Company stock
in Company registered public offerings, subject to certain limitations. In
connection with the Company's Registration Statement on Form S-1 declared
effective on August 12, 1998, a disagreement arose between Mr. and Mrs.
Faroudja and the Company with regard to whether they had received appropriate
notice and opportunity to exercise their registration rights and participate
in the offering described therein. In order to resolve the disagreement in an
amicable and mutually beneficial manner, by letter dated January 28, 1999,
the Company agreed that if requested by the Faroudja's it would, on one
occasion, use its reasonable efforts, at Company expense, to register the
offer and sale of the Faroudjas' stock. This undertaking is subject to
registration on Form S-3, or an equivalent SEC form, being available for the
securities to be registered and allows the Company to defer such registration
if filing such a registration would be seriously detrimental to the Company.
CONSULTING AGREEMENTS
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 would 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 for the immediate
issuance of the Adelson Warrant, with the number of shares for which the
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 determined that consideration expected to be received
by the Company as a result of Mr. Adelson's services was $1,666,666 and made
the Adelson Warrant currently exercisable with respect to 21,718 shares of
Common Stock as of that date. The Board of Directors made the Adelson Warrant
currently exercisable with respect to 21,717 shares of Common Stock at a June
10, 1999 Board meeting and made the Adelson Warrant currently exercisable
with respect to 21,717 shares of Common Stock at a Board of Directors meeting
held on October 12 and 13, 1999. During the term of the Consulting Agreement,
the Company also agreed to use its best efforts to cause the election to the
Board of Directors of Mr. Adelson (or a designee of Mr. Adelson reasonably
acceptable to the Board of Directors) and an additional designee of Mr.
Adelson reasonably acceptable to the Board of Directors. Mr. Buchalter serves
on the Board of Directors as Mr. Adelson's designee. The Adelson Consulting
Agreement, as extended, expired on February 9, 2000. The warrant was
exercised for all shares on January 13, 2000.
LICENSE AGREEMENT WITH S3
In March 1997, the Company entered into a license agreement with S3
Incorporated ("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 not made 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
-54-
<PAGE>
additional shares if the Company's initial public offering was at a price of
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) 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.
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.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM
8-K.
(a) (1) Financial Statements - see Index to Financial Statements
and Financial Statement Schedules at page 28 of this Form
10-K.
(2) Financial Statement Schedules - see Index to Financial
Statements and Financial Statement Schedules at page 28 of
this Form 10-K.
(3) Exhibits - see Exhibit Index at page 59 of this Form 10-K.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the last quarter of
1999.
-55-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.
FAROUDJA, INC.
By: /S/ GLENN W. MARSCHEL, JR.
-------------------------------------
Glenn W. Marschel, Jr.
PRESIDENT AND CHIEF EXECUTIVE OFFICER
Date: March 29, 2000
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below hereby constitutes and appoints Glenn W. Marschel, Jr. and Ita
Geva his true and lawful attorneys-in-fact and agents, each with full power
of substitution, for him in his true name, place and stead, in any and all
capacities, to sign this Form 10-K and all amendments hereto, and to file the
same, with exhibits thereto and other documents in connection therewith, with
the Securities and Exchange Commission, granting unto said attorneys-in-fact
and agents full power and authority to do and perform each and every act and
thing requisite and necessary to be done in and about the premises, as fully
to all intents and purposes as he might or could do in person, hereby
ratifying and confirming all that said attorneys-in-fact and agents, or their
substitute or substitutes, may lawfully do or cause to be done by virtue
hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------- ----- ----
<S> <C> <C>
Chief Executive Officer, President and Director
/S/ GLENN W. MARSCHEL, JR. (Principal Executive Officer) March 29, 2000
- --------------------------------
Glenn W. Marschel, Jr.
Vice President of Finance and Chief Financial Officer
/S/ ITA GEVA (Principal Financial and Accounting Officer) March 29, 2000
- --------------------------------
Ita Geva
Chief Technical Officer, Director and Chairman of the
/S/ YVES C. FAROUDJA Executive Committee March 29, 2000
- --------------------------------
Yves C. Faroudja
/S/ STUART D. BUCHALTER Director March 29, 2000
- --------------------------------
Stuart D. Buchalter
/S/ KEVIN B. KIMBERLIN Director March 29, 2000
- --------------------------------
Kevin B. Kimberlin
/S/ WILLIAM J. TURNER Director March 29, 2000
- --------------------------------
William J. Turner
</TABLE>
-56-
<PAGE>
FAROUDJA, INC.
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO CHARGED TO BALANCE
BEGINNING COSTS AND OTHER END OF
OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS(1) PERIOD
---------- ---------- ---------- ------------- --------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1999 deducted from asset
accounts:
Allowance for doubtful accounts................... $136 $261 $ - $55 $342
---------- ---------- ----------- ------------- --------
Year ended December 31, 1998 deducted from asset
accounts:
Allowance for doubtful accounts................... $167 $17 $ - $48 $136
---------- ---------- ----------- ------------- --------
Year ended December 31, 1997 deducted from asset
account:
Allowance for doubtful accounts................... $ 110 $101 $ - $44 $167
---------- ---------- ----------- ------------- --------
</TABLE>
- -----------
(1) Uncollectible accounts written off, net of recoveries.
-57-
<PAGE>
FAROUDJA, INC.
INDEX TO EXHIBITS
(ITEM 14(C))
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
<S> <C>
3.1 The Company's Restated Certificate of Incorporation, as amended on
August 12, 1997. (1)
3.2 The Company's By-Laws. (1)
4.1 Warrant, dated January 20, 1997, for the purchase of Common Stock
issued to Yves Faroudja. (1)
4.2 Warrant, dated December 17, 1997, for the purchase of Common Stock
issued to Adelson Investors, LLC. (1)
4.3 Specimen of Common Stock Certificate. (1)
10.1 Letter Agreement, dated December 31, 1996, between the Company and
Merv L. Adelson for certain consulting services. (1)
10.2 Amendment to Letter Agreement, dated December 17, 1997, between the
Company and Merv L. Adelson. (2)
10.3 Letter Agreement, dated November 13, 1995, by and among certain
stockholders of the Company listed therein and Spencer Trask
Holdings, Inc. (1)
10.4 Amendment to Letter Agreement, dated February 9, 1996, among certain
stockholders of the Company listed therein and Spencer Trask
Holdings, Inc. (1)
10.5 Lease Agreement, dated August 27, 1997, by and among the Company and
the Landlords listed therein. (1)
10.6 The Company's 1995 Stock Option Plan, dated August 1, 1995 and
amended on August 19, 1996, February 11, 1997, April 30, 1997 and
June 13, 1997. (1)
10.7 The Company's 1997 Non-Employee Directors Stock Option Plan, dated
January 2, 1997. (1)
10.8 The Company's 1997 Performance Stock Option Plan, dated January 2,
1997 and amended on June 13, 1997. (1)
10.9 The Company's Amended 1997 Employee Stock Purchase Plan, dated
January 2, 1997 and amended on August 12, 1997 and September
30, 1997. (1)
10.10 Employment Agreement, dated as of July 8, 1996, between the Company
and Michael J. Moone. (1)
10.11 Employment Agreement, dated March 8, 1996, between the Company and
Yves C. Faroudja. (1)
10.12 Registration and Shareholders' Rights Agreement, dated March 7, 1997,
among the Company and Yves & Isabell Faroudja and certain
Stockholders of the Company. (1)
10.13 Three (3) Registration Rights Agreements, dated December 31, 1996
among the Company and each of Adelson Investors, LLC, Images
Partners, LP and Roger K. Baumberger as Liquidating Trustee for
Faroudja Images, Inc. (1)
10.14 Registration Rights Agreement, dated March 7, 1997 among the Company
and Faroudja Images Investors, LLC. (1)
10.15 Agreement, dated January 20, 1997 among Yves Faroudja and the
Company for the transfer of intellectual property to the Company. (1)
10.16 License Agreement, dated March 31, 1997, between the Company and S3
Incorporated. (1) (3)
10.17 Stock Purchase Agreement, dated June 30, 1997, between the Company
and S3 Incorporated. (1)
10.18 Investor's Rights Agreement, dated June 30, 1997, between the
Company and S3 Incorporated. (1)
10.19 Business Loan Agreement, dated April 5, 1997, between the Company
and Silicon Valley Bank. (1)
10.20 Commercial Guaranty, dated April 5, 1997, by the Company for the
benefit of Silicon Valley Bank. (1)
10.21 Commercial Security Agreement, dated April 5, 1997, by the Company
for the benefit of Silicon Valley Bank. (1)
10.22 Promissory Note, dated April 5, 1997, by the Company for the benefit
of Silicon Valley Bank. (1)
10.23 Promissory Note, dated June 6, 1997, by the Company for the benefit
of Silicon Valley Bank. (1)
10.24 Loan Modification Agreement, dated June 6, 1997, by and between the
Company and Silicon Valley Bank. (1)
10.25 Three (3) Amended and Restated Options to Purchase Shares of Common
Stock of the Company, dated March 7, 1997 among the Company,
Yves Faroudja and Isabell Faroudja, Faroudja Images, Inc. and
each of Adelson Investors, LLC, Faroudja Images Investors, LLC and
Images Partners, LP. (1)
10.26 Amended and Restated Option to Purchase Shares of Common Stock of
the Company, dated December 31, 1996 among the Company,
Yves Faroudja and Isabell Faroudja, Faroudja Images, Inc. and
Roger K. Baumberger as Liquidating Trustee of Faroudja Images,
Inc. (1)
10.27 Consulting Services Agreement, dated July 22, 1997, between the
Company and Matthew D. Miller. (1)
10.29 Purchase Agreement dated December 18, 1997, between the Company and
Audio Video Source, Inc. (3)
10.30 Agreement, dated March 8, 1998, between the Company and Yves
Faroudja for advisory services. (2)
10.31 Loan Modification Agreement, dated April 1, 1998 between the Company
and Silicon Valley Bank (4)
10.32 Amendment to the Company's 1997 Performance Stock Option Plan dated
June 10, 1998.(5)
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<PAGE>
10.33 Letter Agreement, dated June 30, 1998, between the Company and
Michael C. Hoberg.(5)
10.34 Letter Agreement, dated November 30, 1998, between the Company and
Michael J. Moone.(5)
10.35 Letter Agreement, dated January 28, 1999, among the Company and
Yves Faroudja and Isabell Faroudja amending the Registration and
Shareholders' Rights Agreement, dated March 7, 1997, among the
Company and Yves & Isabell Faroudja.(5)
10.36 Letter Agreement, dated January 13, 1999, between the Company and
Nikhil Balram.(5)
10.37 Joint Development and License Agreement, dated July 27, 1999,
between Sage, Inc. and the Company(6)
10.38 Investor's Rights Agreement dated July 27, 1999, between Sage, Inc.
and the Company(7)
21.1 List of the Subsidiaries of the Company. (1)
23 Consent of Ernst & Young LLP, Independent Auditors.
24 Power of Attorney (included on page 56 of this Form 10-K)
27 Financial Data Schedules.
</TABLE>
- -----------
(1) Filed as an exhibit to the Company's Registration Statement on Form
S-1, File No. 333-32375, and incorporated herein by reference.
(2) Filed as an exhibit to the Company's Annual Report on Form 10-K for the
year ended December 31, 1997, and incorporated herein by reference.
(3) Confidential treatment has been granted. Non-public information has
been omitted and filed separately with Commission.
(4) Filed as an exhibit to the Company's Registration Statement on Form
S-1, File No. 333-59901, and incorporated herein by reference.
(5) Filed as an exhibit to the Company's Annual Report on Form 10-K for
the year ended December 31, 1998, and incorporated herein by
reference.
(6) Filed as Exhibit 10.3 to the Sage, Inc. Registration Statement on Form
S-1, File No. 333-83665, and incorporated herein by reference.
Confidential treatment of certain portions of the exhibit has been
requested.
(7) Filed as Exhibit 4.4 to the Sage, Inc. Registration Statement on Form
S-1, File No. 333-83665, and incorporated herein by reference.
-59-
<PAGE>
EXHIBIT 23
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 333-50811), pertaining to the 1995 Stock Option Plan, the 1997
Performance Stock Option Plan, the 1997 Non-Employee Directors Option Plan
and the 1997 Amended Employee Stock Purchase Plan of Faroudja, Inc., of our
report dated January 25, 2000, with respect to the consolidated financial
statements and schedule of Faroudja, Inc. included in this Annual Report
(Form 10-K) for the year ended December 31, 1999.
/S/ ERNST & YOUNG LLP
Palo Alto, California
March 29,2000
-60-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
THE AUDITED CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED
DECEMBER 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 12,998
<SECURITIES> 6,918
<RECEIVABLES> 3,418
<ALLOWANCES> 342
<INVENTORY> 2,222
<CURRENT-ASSETS> 26,010
<PP&E> 1,104
<DEPRECIATION> 3,371
<TOTAL-ASSETS> 34,567
<CURRENT-LIABILITIES> 5,484
<BONDS> 0
0
0
<COMMON> 12
<OTHER-SE> 29,071
<TOTAL-LIABILITY-AND-EQUITY> 29,083
<SALES> 13,476
<TOTAL-REVENUES> 13,476
<CGS> 6,310
<TOTAL-COSTS> 6,310
<OTHER-EXPENSES> 4,175
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (2,099)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,099)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,099)
<EPS-BASIC> (0.17)
<EPS-DILUTED> (0.17)
</TABLE>
