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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C.
___________________
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Year Ended December 31, 1997 Commission File No. 0-23596
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
___________________
C-CUBE MICROSYSTEMS INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0192108
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1778 McCarthy Boulevard
Milpitas, California 95035
(Address and zip code of principal executive offices)
Registrant's telephone number, including area code: (408)944-6300
Securities registered pursuant to Section 12(b) of the Act: NONE
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. [X] Yes [ ] 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 Registrant's common stock held by non-
affiliates on March 18, 1998 (based upon the average of the high and low
sales prices of such stock as of such date) was $667,703,366.
As of March 18, 1998, 37,124,074 shares of the Registrant's common stock
were outstanding.
The Registrant's definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on May 8, 1998 (the "Proxy Statement") is
incorporated by reference in Part III of this Form 10-K to the extent
stated herein. Except with respect to information specifically incorporated
by reference in this Form 10-K, the Proxy Statement is not deemed to be
filed as a part hereof.
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C-CUBE MICROSYSTEMS INC.
Form 10-K
For the Year Ended December 31, 1997
Table of Contents
Page
Part I ----
Item 1. Business......................................................... 1
Item 2. Properties....................................................... 18
Item 3. Legal Proceedings................................................ 18
Item 4. Submission of Matters to a Vote of Security Holders.............. 18
Executive Officers of the Registrant...................................... 19
Part II
Item 5. Market for Registrant's Common Stock 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...................................... 24
Item 8. Financial Statements and Supplementary Data...................... 29
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure........................................... 45
Part III
Item 10. Directors and Executive Officers of C-Cube Microsystems Inc...... 46
Item 11. Executive Compensation........................................... 46
Item 12. Security Ownership of Certain Beneficial Owners and Management... 46
Item 13. Certain Relationships and Related Transactions................... 46
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.. 46
Exhibit Index............................................................... 47
Signatures.................................................................. 50
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This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. Actual results could differ materially from those
projected in the forward-looking statements as a result of the risk factors
set forth in or incorporated by reference into this report. The registrant
has attempted to identify forward-looking statements in this report by
placing an asterisk (*) following each sentence containing such statements.
PART I
ITEM 1. Business
C-Cube Microsystems Inc. (referred to herein as "C-Cube" or the
"Company"), established as a California corporation in 1988 and
reincorporated in Delaware in 1994, is a provider of powerful, highly
integrated, standards-based digital video compression solutions. The
Company's innovative encoder, decoder and codec products enable high
quality video to be provided cost-effectively by a broad range of end user
systems. Digital video compression technology has enabled the development
of a significant number of new or enhanced applications in the consumer
electronics, communications and computer markets including video compact
disc (VideoCD) and digital video disk (DVD) players, desktop video
production equipment, Direct Broadcast Satellite (DBS) systems, wireless
cable systems and distributed video networks.
In August 1996, C-Cube completed the acquisition of DiviCom Inc.
(referred to herein as "DiviCom"). C-Cube paid $65.7 million in cash,
issued 2.3 million shares of its common stock, assumed options exercisable
for 264,000 shares of its common stock and incurred $1.35 million in other
costs in exchange for the outstanding shares of DiviCom stock that C-Cube
did not already own. This acquisition was accounted for as a purchase.
DiviCom develops and integrates products and systems that enable the
transmission of digital video, audio and data over networks, allowing its
customers to create "end-to-end" digital video systems. Products include
audio/video encoding and multiplexing systems, integration consulting and
implementation services. Based on the MPEG-2 (Moving Pictures Experts
Group), Digital Video Broadcasting (DVB) and Advanced Television Standards
Committee (ATSC) international standards, DiviCom's products enable digital
video broadcasting over a variety of networks including satellite,
wireless, terrestrial, fiber and cable.
Background
Since the 1930s, video images have been transmitted and stored almost
exclusively using analog formats. Digital video provides several
fundamental benefits over analog video. Unlike analog video, digital video
can be compressed, providing significant storage and transmission
efficiencies, and can be transmitted and reproduced without perceptible
image degradation. In the 1980s, the benefits of digital formats led the
U.S. consumer audio industry to convert from analog long playing records to
digital CDs, resulting in growth in the market for CD players. In the
1990s, the ongoing evolution from analog to digital is transforming the way
in which video is produced, stored, transmitted and viewed.
A significant barrier to the greater market acceptance of digital video
has been the large volume of data required to represent images and video in
a digital format, making storage or transmission economically impractical.
For example, storage of an hour long video program in uncompressed digital
form would require well over 100 CD-ROMs. Through emerging digital
compression techniques, a substantial number of the redundancies inherent
in video data can be detected and eliminated, significantly reducing the
overall amount of data which needs to be retained, without affecting
perceived image quality. These compression techniques allow the same hour
long video program which required 100 CD-ROMs for storage in uncompressed
format to be stored on a single CD-ROM. Similarly, a single uncompressed
digital video program requires as much bandwidth for effective transmission
as 50 compressed video programs, making uncompressed digital video
impractical for markets such as broadcast and cable. As a result of these
limitations, C-Cube believes that the design and deployment of cost-
effective and practical video compression technology is critical to the
development of mass market digital video applications.
The benefits provided by the combination of digital video and
compression technology are enabling the deployment of a large number of new
applications and improving or expanding existing applications. Existing and
potential applications in the consumer electronics, communications and
computer markets include VideoCD players, DVD players, video conferencing
equipment, video editing systems and video networks, including DBS,
wireless cable and switched digital systems.
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Market development for C-Cube's new and expanded applications requires
communication of shared content among various products and across multiple
industries. This interoperability requires the widespread adoption of
international compression standards. In response to the need for standards,
industry leaders in consumer electronics, computers and communications
including AT&T, IBM, JVC, Matsushita Electronics Corporation (MEC), NTT,
Philips, Scientific Atlanta and Sony joined together with C-Cube in various
committees sanctioned by the International Standards Organization (ISO) to
define standards for the compression of still images and digital video for
consumer electronics and broadcast industries. The first standard ISO
adopted was a recommendation from the Joint Photographic Experts Group
(JPEG) committee for the compression of still images. In 1991, the MPEG
committee made a recommendation for a standard for compression of audio and
video to CD-ROM, now commonly known as MPEG-1. MPEG-2, a compression
standard used for audio and video broadcast systems and high density disk
formats (e.g. DVD), was adopted by the ISO in 1994.
The ISO standards stipulate a data format that supports multi-vendor
integration, thereby enabling system-wide transmission and display of
images or video. These standards do not, however, specify the actual
compression methodology and, therefore, do not determine image quality or
compression efficiency. For example, poorly compressed data may comply with
the relevant standard but contain visual artifacts which may result in poor
image quality or loss in efficiency, costing capacity or play time. As a
result, there can be significant differences in overall image quality
between two solutions based on the same standard. Therefore, system
manufacturers can differentiate their products by the quality of the
compression solution which they select.
Applications utilizing compressed digital video require an encoder for
compression and a decoder for decompression. Encoding, the process of
compressing digital images using complex mathematical algorithms to
eliminate redundant information, determines the potential quality of the
resulting image and the achievable degree of compression. Decoding, the
process of reconstructing compressed video, restores a compressed digital
bitstream back into an uncompressed and viewable format. The design and
architecture of encoders and decoders are extremely complex, presenting
significant technical challenges.
C-Cube seeks to differentiate its products from competitors by offering
both encoding and decoding solutions that provide superior image quality
(enhancing the viewing experience), are fully compliant to the MPEG-1 or
MPEG-2 international standards (and therefore interoperable with equipment
from other suppliers), are feature rich and highly integrated. All C-Cube
products are programmable, permitting the incorporation of sophisticated
system-level features, while lessening design time and system cost. The
Company also develops proprietary product extensions and features such as
WideSound (TM) home theater sound enhancement and ClearView (TM) error
correction technology.
The technical challenges of developing real-time digital video
transmission systems are compounded by the complexities of acquiring,
integrating and using a wide variety of sophisticated new system and
network technologies. Because these new technologies are diverse and
complex, providers of digital video services can benefit from integration
services provided by companies, such as DiviCom, that are experienced with
these technologies. To meet the often conflicting goals of
interoperability, reliability and efficiency, nearly all new systems for
broadcasting digital video implement new standards such as MPEG-2, DVB and
(where applicable) Asynchronous Transfer Mode (ATM). In some cases,
companies that have previously provided proprietary analog-based solutions
have developed their own proprietary digital-based solutions (or created
proprietary solutions where there are no standards, such as conditional
access). Increasingly, companies that broadcast digital video realize that
they need to foster interoperability and competition among their equipment
suppliers. Accordingly, adherence to industry standards is a key
requirement for suppliers in this market.
DiviCom offers products based on industry standards that allow its
customers to compress, transmit and receive large quantities of digital
audio and video information. DiviCom products enable its customers to
compress information, scramble the transmission and remultiplex (i.e., add
or delete information or programs such as advertisements), then assist in
transmitting the information.
DiviCom is focused on merging video compression technologies with
network and communications technologies to create innovative products for
producers, distributors and consumers of video and video-enhanced
information. Products include MPEG audio/video encoders, multiplexing and
network management systems, as well as integration services. Based on the
MPEG-2 international standard, DiviCom's products enable digital video
broadcasting over a variety of digital video networks including DBS,
wireless cable (also known as Multichannel Multipoint Distribution Systems
(MMDS) and wired services, including switched digital video services,
digital cable and Hybrid Fiber Coax (HFC).
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Markets and Applications
Products enabled by digital video compression technology can be divided
into three broad markets: video-based consumer electronics, video
communications and video-enabled computers.
Whereas C-Cube sells its products across these markets, DiviCom
currently sells its products and services into several market segments
within the video communications market, including DBS, broadcast, wireless
cable systems and wired digital video networks, such as switched digital
video, HFC and twisted pair.
Consumer Electronics
General. Through the use of MPEG compression, video can be stored,
reproduced and distributed on the same media currently in use for other
types of digital data, such as 5-inch (12 cm) CDs that are commonly used
for digital audio. Emerging applications for digital video capture,
playback and distribution at the consumer level are being advanced by the
rapid adoption of new consumer-oriented media formats such as VideoCD
Players, DVD Players, Recordable DVD and Consumer Digital Video Cameras.
VideoCD Players. A VideoCD player is essentially an audio CD player
with an MPEG-1 decoder and a video output. While adding this functionality
marginally increases the cost to manufacture a typical CD player, these
machines now have the ability to play movies, music videos and other titles
from MPEG-1 encoded CDs. The physical VideoCD disk format is identical to a
standard 12 cm audio CD and is limited to 72 minutes play time with video
quality generally perceived to be comparable to an analog VHS tape. Several
thousand VideoCD titles are now available, including movies, music videos
and karaoke titles. The VideoCD format has thus far received mass market
adoption exclusively in China.
Digital Video Disk (DVD) Players. Unlike the VideoCD standard which is
an adaptation of the audio CD, next generation Digital Video Disks have
recently been defined specifically for the very high quality playback of
feature length movies. This new format, which is now becoming commercially
available, provides 135 minutes average play time (270 minutes for a
double-sided disk) on a high density CD-ROM and provides four times the
image resolution of a standard VideoCD. The Company believes that this
format, which is based on the MPEG-2 standard, will eventually achieve
widespread use worldwide.*
Recordable Digital Video Disk. Thus far, Recordable DVD as a VCR
replacement has been sold in small volumes, primarily to home theater
owners and other early adopters, as is typical for a new consumer
electronic product. It is unlikely that the Recordable DVD will begin to
replace the VCR in large volumes until C-Cube, with its new DVxpert
architecture single-chip codec, is able to deliver a low-cost encoding.*
This will enable a recordable model at prices considered a mass market
value, given the superior quality of DVD's video and audio and its many new
interactive features.
Consumer Digital Video Cameras. Digital video cameras (camcorders) can
offer advantages over today's analog-based home equipment in areas such as
image quality, cost and size. In addition, digital formats may provide
interoperability with other digital home consumer appliances such as DVD
players and home editing equipment. The first tape-based, consumer-grade
products using Discrete Cosine Transform (DCT)-based formats called DV and
DVCpro have been introduced by companies including Sony, JVC and MEC. Other
formats which support recordable disk-based media are currently being
defined. C-Cube does not currently offer products supporting DCT-based
formats but may choose to do so in the future.
Communications
General. Digital video compression is currently enabling a number of
new applications and capabilities in the communications market, including
expanding the capacity and services of DBS networks, wireless cable and
wired networks.
DBS Networks. The first full-scale digital video transmission systems
to achieve full deployment were a series of DBS networks (often called
Direct to Home networks). By combining digital video compression technology
with high-power Ku-band satellites, DBS systems typically provide 100 or
more channels to a large geographical area (e.g. the continental U.S.).
This is accomplished at a relatively low cost per subscriber since the only
incremental investment needed by subscribers is the purchase of a small
dish and a decoder box.
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Wireless Cable or MMDS. MMDS is a local "line-of-sight" broadcast
system which broadcasts video over relatively short distances from a
stationary ground-based antenna directly to small receiving antennas which
are placed in each subscriber's home (or on the roof). Such systems are
initially being deployed in areas where there may not be an existing cable
system or as an alternative to existing cable services in high-density
urban centers. Wireless cable systems have comparatively low fixed costs
and a moderate cost per home. The advantages of MMDS over DBS include the
support of local content and moderate levels of interactivity, such as
Internet support.
Wired Networks. Wired networks, which include such varied
architectures as switched digital video, fiber to the curb (FTTC), HFC and
twisted pair schemes such as ADSL and HDSL, are currently in early trials
and first stage deployments by leading telecommunications suppliers and
digital cable providers. Switched digital networks can provide a much
higher level of interactivity compared to either DBS or MMDS including the
potential for full two-way video communication. However, because of the
significant investment in new infrastructure, the cost per home is high.
Other Communications Applications. Such applications include equipment
which enables digital transmission from remote sites to a studio
(contribution), from studios to cable headends (distribution) and the use
of digital video, audio and data within businesses, educational
institutions and other private networks.
Computer
General. Computer makers and users are increasingly embracing digital
video as the most flexible and feature rich data type for educational,
entertainment, communication and training applications. In the future,
playback of video will be performed using software decoders, which will
increases the number of video-capable computers. In addition, computers are
the primary platform for video editing and video encoding through the
addition of dedicated video-specific hardware.
DVD-ROMs. Currently these are sold into three PC market segments - the
OEM desktop market, the OEM portable market and the PC peripheral after
market. PC OEMs offer DVD-ROMs as add-in board options for their desktop
models. Some OEMs, such as C-Cube's customer Dell, have begun bundling the
DVD-ROM as part of its complete system offerings. While the cost
differential over a CD-ROM for a drive with MPEG-2 playback is currently
above $200, the DVD-ROM offers 7 times the capacity and 24 times the speed
of CD-ROMs. This product appears to be experiencing adoption rates common
to new PC peripherals.*
Besides competition from other decoder suppliers, C-Cube expects to
encounter a growing proportion of DVD decoding and decryption performed by
software in desktop PCs. However, demonstrations of linear movie playback
on 300 MHz PCs with software decoding show video performance inferior to
that of hardware solutions. It appears that a 400 MHz processor is required
to provide comparable quality, and even that may lack the power to provide
a high rate of interactivity, such as will be demanded with MPEG-2 rich
video games and training films. Thus, we believe that for a few years,
hardware solutions will command much of the DVD-PC market.* Furthermore,
the emergence market for under $1,000 PCs will prolong the competitiveness
of hardware solutions, since compromises in processor speed will have to be
made to enable this price segment to meet profit requirements.
New portable PC models are being designed as DVD-ready and some,
including the Toshiba Tecra, are featuring MPEG-2 video playback built
right into the motherboard. The portable PC offers an even longer term
market for hardware solutions because software decoding will drastically
reduce battery life. Microprocessors powerful enough to perform MPEG-2
decoding and decryption dissipate between 8 and 12 watts of power. C-Cube's
ZiVA video RISC microprocessor dissipates less than 1.5 watts.
The third, and to date the largest growing DVD-PC market segment is for
DVD-ROMs as add-in kits sold at retail to owners of PCs who would like to
upgrade their CD-ROM drives. Companies such as Creative Labs, which drove
the CD-ROM after-market, have begun driving this application aggressively.
While the PC may be the first application for DVD decoders and the VCR
the second, in a few years DVD decoders may be incorporated into game
platforms and consumer electronics, including personal computer
"convergence" systems, such as big-screen TVs that have game playing,
internet surfing and digital broadcast receiving capabilities.
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Add-in Cards for Video Capture. A new class of computer peripheral,
MPEG Video Peripherals (MVP), are real-time MPEG encoders that are low-
cost, easy to install and use, and are capable of capturing high-quality
video and still images.
Video Post-Production Systems. Through the addition of appropriate
capture and encoding hardware as well as application software, computers
are commonly used as digital video editing and/or content encoding
equipment. Several manufacturers have introduced MPEG content encoding
equipment in the form of PC or Macintosh add-in boards or complete systems
based on C-Cube solutions. The newest PC application to use C-Cube's DVx
single-chip encoding and decoding codec is non-linear editing of films,
documentaries and advertisements.
Dependence on Emerging Markets
To date, C-Cube has derived a majority of its product revenues from
sales of products for linear video playback (e.g. movies) and karaoke as
well as DBS applications. The Company expects that VideoCD and digital
video networking applications will continue to account for a significant
portion of C-Cube's revenues for the near future.* Over the longer term,
the Company's ability to generate increased revenues will be dependent on
the development of new opportunities for compressed digital video in the
consumer electronics, communications and computer markets.* The potential
size of these new market opportunities and the timing of their development
is uncertain. Substantially all of the growth in the sales of C-Cube's
decoder products over the last year has occurred in the Asia-Pacific
region, which is currently experiencing economic difficulties. See
"International Business Activities." There can be no assurance that such
growth will continue or that other markets for C-Cube's products will
emerge. Further, C-Cube's success in such markets will depend upon whether
system manufacturers select the Company's products for incorporation into
the system manufacturers' products, and upon the successful introduction of
such products. There can be no assurance that demand for VideoCD players or
other existing applications will be sustained or that new markets will
develop as expected by the Company, or at all, or that system manufacturers
developing products for any such markets will design C-Cube's products into
their system products and successfully introduce such system products. The
failure of existing and new markets to develop as expected by the Company
or to be receptive to C-Cube's products would have a material adverse
effect on the Company's business and results of operations.
The emergence of markets for certain digital video applications will be
affected by a variety of factors beyond C-Cube's control. In particular,
certain sectors of the communications market will require the development
and deployment of an extensive and expensive communications
infrastructure.* There can be no assurance that communications providers
will make the necessary investment in such infrastructure or that the
creation of this infrastructure will occur in a timely manner. In addition,
the deployment of such infrastructure will be subject to governmental
regulatory policies, taxes and tariffs.* For example, the U.S. Federal
Communications Commission currently restricts the number of new frequencies
available for deployment of new digital video broadcast networks, such as
wireless cable. In addition, other countries have similar governmental
restrictions. The development of such markets could be delayed or otherwise
adversely affected by new governmental regulations or changes in taxes, or
tariffs, or by the failure of government agencies to adopt changes to
existing regulations necessary to permit new technologies to enter the
market. The emergence of these and other markets is also dependent in part
upon third-party content providers developing and marketing content for end
user products such as VideoCD and DVD players, interactive game consoles,
desktop computers and settop decoders in a format compatible with the
Company's products.* There can be no assurance that these third parties
will develop and introduce such content in a timely fashion, or at all, or
that other factors beyond C-Cube's control will not adversely affect the
development of the digital video applications for which the Company's
products are developed.
Products
C-Cube is focused on providing powerful, highly integrated, standards-
based, programmable digital compression solutions that are cost-effective
and capable of delivering high-quality images. The Company has developed
extensive expertise in programmable architectures, algorithms, microcode
development and VLSI circuit design. This expertise has enabled C-Cube to
be a leading innovator in the development of digital video compression
solutions for customers in the consumer electronics, communications and
computer markets.
While broadcast applications continue to be reliant on encoding, the
ability to encode and decode broadcast-quality video in a single processor
opens the doors for significant new market opportunities. Recognizing the
future opportunity for recordable MPEG-2 applications, C-Cube brought to
market the DVxpert architecture, the first single-chip MPEG-2 codec. This
product furthered the Company's lead in digital video encoding by
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developing a processor that integrates both encoding and decoding functions
into a single solution. Supporting all MPEG formats, DVxpert offers a cost
and space effective solution to the PC and consumer electronics market and
will facilitate the adoption of satellite newsgathering and other digital
television applications.* C-Cube's introduction of the DVxpert digital
video architecture has the potential to further stimulate the digital video
industry by providing the first cost-effective platform in which real-time
MPEG-2 encoding can extend into consumer and computer markets.*
Consumer Electronics
C-Cube is a world leader in the supply of MPEG-1 decoders which are
primarily used as the key enabling component for VideoCD players. In 1992,
C-Cube introduced the CL450 MPEG-1 Video Decoder which the Company believes
was the first commercially available MPEG-1 video decoder. The CL450 was
used as the core enabling technology for commercial and professional
digital karaoke players which offered significant capabilities versus
larger, more expensive analog laser disk based systems.
In 1994, C-Cube introduced the CL480 Family of VCD MPEG-1 System
Decoders which enabled the development of high-volume, consumer grade
VideoCD players. The most current member of the family is the CL484 which
offers full VideoCD 1.1 and 2.0 compliance. By utilizing the
programmability of the CL480 family of products, the Company has added
features to enhance the product line over time. The CL484 added ClearView
error concealment technology and FlexView (TM) NTSC to PAL conversion as well
as karaoke features such as key control and on-screen status displays
without significantly increasing system cost. The CL484 also added the
"DiscView" menuing feature and CD-G decoding capability for complete CD
standard support.
In 1996, C-Cube introduced the CL680 Advanced VideoCD Decoder, which
the Company believes is the first VideoCD system decoder to integrate an
NTSC/PAL encoder. In addition to full CL484 compliance, the CL680 also
provides improvements to C-Cube's ClearView error concealment technology
and delivers WideSound (a two channel home theater surround sound
environment), stereo key control, vocal fade and other features previously
provided through the use of expensive external components.
C-Cube's VideoCD branding program, begun in 1996, saw continued success
throughout 1997. Many of the major VideoCD manufacturers located in
C-Cube's largest markets chose C-Cube's VideoCD Decoder technology to use in
their new lines of VideoCD players. The success of C-Cube's VideoCD
branding program is predicated on offering first-to-market technology,
superior feature set video playback quality and a roadmap to higher quality
more feature rich digital video products.*
In February 1997, C-Cube introduced the ZiVA family of DVD products
including decoders and system-level design solutions for consumer and
multimedia OEMs. The ZiVA DVD decoder family incorporates eight critical
DVD functions into a single chip: MPEG-2 video decoding, Dolby Digital
decoding, MPEG audio decoding, sub-picture decoding, on-screen display,
linear PCM audio decoding, demultiplexing and audio/video synchronization.
In March 1997, ZiVA DVD decoders became the first integrated, MPEG-2
audio/video products to be recognized as Dolby Digital 6-channel compliant.
With the unveiling of SecureView (TM) copy protection and decryption technology
in May 1997, they became the first single-chip DVD decoder to incorporate
the DVD Consortium's copy protection scheme known as Content Scramble
System (CSS). The level of security achieved with SecureView ensures
content owners that copyrights will be protected.
Consumer Encoders
In order to create MPEG-1 content for the VideoCD market, sophisticated
encoder systems are required. C-Cube provides the core enabling technology
to OEMs which facilitates the development of low-cost, high quality content
encoding equipment. In 1993, C-Cube announced the VideoRISC architecture,
believed to be the industry's first highly integrated real-time video
encoding engine. This architecture has been improved through three
successive generations, reducing power, cost and chip count. The engine is
fully programmable and supports multiple algorithms including MPEG-1,
MPEG-2 and H.261 for video teleconferencing.
In 1993, C-Cube introduced the CLM4500 MPEG-1 Video Encoder. The
CLM4500 consists of two VideoRISC processors and associated MPEG encoding
microcode incorporating C-Cube's proprietary rate control and masking
algorithms, enabling the encoders to deliver consumer grade video quality
at low bit rates. In 1996, the Company began shipping an improved version
of its MPEG-1 encoder, the CLM4550 Advanced MPEG-1 Video Encoder. The
CLM4550 is a four chip encoder designed to provide extra filtering
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capability to offset noise, graininess or other video artifacts in original
material which often adversely affects the quality of MPEG-1 encoded
bitstreams. This is particularly important in professional applications
such as VideoCD mastering which demand very high quality video encoding.
Communications
C-Cube has pioneered a series of firsts in the digital video industry
including the first real-time MPEG-1 video encoder, as well as the more
complex encoder for the MPEG-2 standard, which the Company believes are
important for the development of the emerging digital video market. Today,
C-Cube is the industry leader in MPEG video encoder chipsets for broadcast,
postproduction and multimedia authoring applications, and C-Cube offers the
broadest range of MPEG encoders.
In August 1996, C-Cube completed its acquisition of DiviCom, a leader
in developing and implementing end-to-end systems for digital video
networks. DiviCom designs system-level solutions for digital video networks
and is also involved with service providers in developing the
infrastructure and consumer interface for these complex networks. DiviCom's
system solutions are designed to address all digital video network
architectures in both encoder systems and settop decoders, including
digital cable, MMDS, switched digital fiber and DBS.
DiviCom has significant expertise in designing settop boxes for digital
video network deployments This generates revenue from the sale of decoder
and demultiplexer devices into these boxes. DiviCom also develops
specialized ASICs for the settop box to enhance its feature-rich design and
optimize the video quality and functionality for numerous applications. See
"DiviCom Products."
Communication Decoders
MPEG-2 decoders are volume-oriented products which are placed into a
variety of communication equipment such as settop decoders for DBS, cable
and telephone company services. C-Cube provides products which support all
common variants of the MPEG-2 standards for audio, video and transport
decoding.
In 1994, C-Cube introduced the CL9100 MPEG-2 video decoder, a single
chip MPEG-2 broadcast video decoder for MPEG-1 and MPEG-2 formats
containing system level features such as error concealment and advanced on-
screen display. In 1995, C-Cube introduced the CL9110 Transport
Demultiplexer which was licensed from DiviCom, a private company at that
time. The CL9110 separates MPEG-2 transport streams into video and audio
components and implements a number of broadcast-specific features,
including a descrambler interface and conditional access functions.
In 1996, the Company introduced the AViA (TM) family of MPEG-2 settop
decoder chipsets comprised of two settop solutions:
The AViA-502 Advanced Audio/Video Settop Decoder with Dolby AC-3 audio,
along with the AViA-GTX Advanced Graphics Transport I/O (GTIO) are designed
for use in highly functional "value-added" settops. These "value-added"
functions include high performance graphics capabilities, interoperability
across both wired and wireless broadcast networks and Dolby AC-3 audio
decoding to deliver a complete home theater experience to consumers.
The AViA-500 MPEG-2 Audio/Video Settop Decoder and the AViA-DMX (TM)
Transport Demultiplexer are designed for use in "basic" settops such as
those typically deployed in DBS applications. This chipset offers advanced
2D graphics display, advanced electronic program guide support as well as
infrared remote control and smart card interfaces.
The two chipsets are pin-for-pin compatible and API upgradable,
allowing one design to be used to provide both a high-end solution as well
as a low-cost solution. This allows OEMs to develop a single settop design
that can be successfully deployed for multiple applications including MMDS,
DBS, switched digital video and HFC networks.
FLARE (TM) (flexible architecture for settop boxes), DiviCom's advanced
settop design, enables consumer electronics manufacturers to rapidly
develop high performance, low-cost decoders using proven technology based
on international standards. DiviCom offers a broad spectrum of designs to
support various applications including DBS, MMDS, cable, ATM/switched
digital video and HFC network interfaces. DiviCom provides the schematics,
7
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software (object code) and documentation necessary to implement a high
quality, full-featured decoder. Decoder designs incorporate a CPU with high
performance graphics, an expansion slot, MPEG-2 stream processing and
software download functions. Various levels of interactivity are available
depending on the specific memory, graphics and networking options chosen.
In August 1997, C-Cube unveiled the DVxpert Digital Video Codec, the
world's first single-chip, MPEG-2 codec. Benefits include improved image
quality, efficient bandwidth utilization and reliability, allowing this new
codec architecture to meet the critical needs of today's broadcast and
authoring markets. In addition, as users begin to realize the inherent
benefits of MPEG-2, the market should include many new applications, among
them nonlinear editing and personal authoring. Ultimately, the architecture
will enable the use of both digital video recording as well as video
playback in consumer devices: a one-to-one use of MPEG compression and
decompression.*
Communication Encoders
The DVxpert product line extends C-Cube's MPEG-2 leadership into new
digital broadcast and professional studio applications and is the first
silicon solution to support HDTV encoding. The DVxpert family will enable
broadcasters and digital video service providers to expand their
entertainment and informational services to the consumer.*
C-Cube's DVxpert 5110 Broadcast Encoder is a single-chip MPEG-2 Main-
Level @ Main Profile encoder. This compact solution provides special
features designed to optimize multichannel broadcast applications while
maintaining high image quality for the viewer. As a result of achieving
high bandwidth efficiency with DVxpert, broadcasters and service providers
can now increase their programming opportunities with more channels and
services. The encoder performs adaptive field/frame (AFF) encoding at
compressed data rates of up to 15 Mbps, and ensures optimal channel
efficiency with statistical multiplexing. C-Cube's patented PerfectView
encoding technology delivers clear image quality with advanced capabilities
such as pre-filtering, error masking and Inverse Telecine.
The DVxpert 6210 Professional Encoder DVxpert 6210 Professional Encoder
can compress video images into either MPEG-2 Main-Level @ 4:2:2 Profile for
video distribution applications, or into MPEG-2 Main Level @ Main Profile
for general broadcast applications. This high-quality encoder handles 4:2:2
video streams from 6 to 50 Mbps with excellent image quality, making it
suitable choice for quality and bandwidth sensitive applications such as
studio-to-studio video distribution. In addition to offering all the
powerful features of the DVxpert 5110, the DVxpert 6210's support for 4:2:2
eliminates generation loss problems which can result from the multiple
encoding and decoding operations typical of video distribution.
C-Cube currently offers two "full-resolution" encoders, the CLM4740
MPEG-2 Broadcast Encoder and the CLM4720 Storage Encoder which are seven
and five chips, respectively. The former encodes broadcast-resolution video
into MPEG-2 Main Level/Main Profile format in real time using adaptive
field/frame encoding techniques and performs statistical multiplexing,
closed captioning and external reference rate control. The latter performs
frame-based encoding using either real time constant bit rate or variable
bit rate (VBR) encoding for improved storage capacity in video servers and
other applications.
The CLM4440 Half D1 Resolution MPEG-2 Video Encoder is a low-cost
2-chip implementation of the MPEG-2 standard which encodes video at half the
horizontal resolution of the full CCIR-601 broadcast standard and is used
in applications such as distance learning, local video networks and ADSL
deployments which benefit from lower data rates or smaller form-factors.
The CLM4200 H.261 Video Conferencing Codec is a two-chip 15 frame per
second full duplex video codec conforming to the H.261 video compression
subset of the H.320 ITU video conferencing standard. The CLM4200 was
developed in cooperation with PictureTel and provides a high quality
solution complete with features such as picture-in-picture and high
resolution still pictures.
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Computer
Computers serve as platforms for creation, editing, compression and
playback of digital video. To achieve the many tasks which can be performed
on such video-enabled platforms, C-Cube offers a wide variety of products
tailored to the computer market.
Computer Decoders
Many of the early implementations of MPEG-1 decoders were PC-based
demonstration systems. The CL450SWA MPEG-1 Video Decoder, while initially
designed for consumer applications, has been used in a variety of add-in
cards for the PC and Macintosh platforms to enable the playback of VideoCDs
and high quality interactive games. The CL450SWA (Software Audio) includes
device drivers that utilize the host CPU to decode the MPEG audio bitstream
in software. The CL480PC MPEG-1 System Decoder is a microcode-based variant
of the consumer-grade CL480 ideally suited for notebook platforms.
Computer Encoders and Codecs
In 1996, the Company introduced the CLM41xx family of MPEG-1 encoders
which consist of the CLM4111 Consumer PC Video Encoder, the CLM4110 Desktop
Editing Encoder and the CLM4120 Professional Authoring Encoder. Like the
consumer and communications encoders, these products are based on the
Company's programmable VideoRISC encoder and are used for applications such
as VideoCD production, video editing for desktop computers and high quality
encoding of video for the Internet.
The CLM4730Z DVD Authoring Encoder provides a complete encoding
solution for DVD content creation. The CLM4730Z uses a real-time
statistical variable bit rate (SVBR) algorithm to maximize image quality
while minimizing encoded file size. Using SVBR, the CLM4730Z can encode a
full two-hour movie in real-time onto a single DVD disc. SVBR reduces
system cost and content creation time by eliminating the need for multipass
encoding.
In June 1997, C-Cube introduced a new category of peripherals for the
mainstream PC market: MVP. These easy-to-install devices connect to a
desktop or notebook PC and allow users to easily capture and record high-
quality video or still images into their computers.
In August 1997, the Company unveiled its revolutionary DVxpert digital
video architecture, the world's first real-time, single-chip MPEG-2 codec.
DVxpert will allow MPEG-2 to penetrate future cost- and space-sensitive
applications, including recordable video applications on the PC.*
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<TABLE>
<CAPTION>
Production
Market Product Name and Function Application Examples Release
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
CL484VCD MPEG-1 Decoder VideoCD players 1Q 96
CL680VCD MPEG-1 Decoder 1Q 97
---------------------------------------------------------------------
ZiVA DS System Decoder DVD players 1Q 97
Consumer ZiVA D6 System Decoder w/ 5.1 1Q 97
Electronics Channel Dolby Audio
---------------------------------------------------------------------
CLM4730Z Authoring Encoder DVD content encoding 1Q 97
---------------------------------------------------------------------
CL9100 MPEG-2 Video Decoder Cable settop decoders 2Q 94
CL9110 MPEG-2 Transport DBS receivers 2Q 94
Demultiplexer Ad insertion equipment
AViA-502 Advanced Audio/Video Multichannel broadcast 3Q 97
Settop Decoder with Dolby Video distribution
AC-3 Audio
Communications AViA-500 Advanced Audio/Video 3Q 97
Settop Decoder
AViA-GTX Advanced Graphics 3Q 97
Transport I/O
AViA-DMC Transport Demultiplexer 3Q 97
DVxpert 5210 Broadcast Encoder 4Q 97
DVxpert 6210 Professional Encoder 4Q 97
---------------------------------------------------------------------
CLM4400 Half D1 Resolution Satellite news 1Q 96
MPEG-2 Encoder gathering
Distance learning
---------------------------------------------------------------------
CLM4700 Broadcast Resolution Cable headends 4Q 94
MPEG-2 Encoders Satellite uplinks
Video servers
Ad insertion equipment
---------------------------------------------------------------------
CLM4110 Multistandard Codec Computer add-in cards 4Q 96
Computer CLM4111 Multistandard Codec 4Q 96
ZiVA DS System Decoder 1Q 97
ZiVA D6 System Decoder w/ 5.1 1Q 97
Channel Dolby Audio
- --------------------------------------------------------------------------------------
</TABLE>
DiviCom Products
DiviCom applies its unique compression algorithms and techniques to
obtain optimal performance from its family of MPEG-2/DVB system-level
products, which include encoding systems (program encoders and MPEG-2 data
injectors) and networking products (for the remultiplexing, grooming and
management of compressed media). DiviCom also offers a full range of
complimentary services including systems integration, consulting, training
and technical support.
Program Encoders and Data Injectors
DiviCom's MediaView (TM) line of program encoders provide compression of
video, audio and data channels in MPEG-2 compliant formats. Using
sophisticated signal pre-processing, noise reduction and encoding
algorithms, the Company's encoders produce high quality video and audio at
a low data rate. Interoperability with other products and systems is
ensured through compliance with the MPEG-2 and DVB standards.
The MediaView MV25 offers exceptional video quality at low bit rates,
and was the first encoder in the industry to integrate the pre-processor
and an advanced video compressor within the same unit. The MV25 is
especially suited to PAL applications and for satellite and cable operators
where compressing as many signals as possible onto a transponder or cable
channel is critical to reducing operational costs.
The MediaView MV10 is targeted for use in cable headends, MMDS direct-
to-home, switched digital video systems and in mobile encoding applications
such as digital satellite news gathering. This encoder is used, in general,
for programming that does not require the advanced adaptive preprocessing
and input/output adapters offered by the MV25.
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The MediaView MV5 is designed to offer an affordable digital video
compression solution for corporate television and distance learning
networks and local access programming.
DiviCom's MPEG Media Toolkit (TM) provides a data injection platform for
applications such as electronic program guides, conditional access streams
and data carousels which require the insertion of high-speed data into
MPEG-2 streams. New applications can also be easily developed for any use
requiring the merging, spooling and packetization of data and video. This
allows for the delivery of a wide range of data applications over all types
of MPEG networks.
Networking Products
DiviCom's MediaNode (TM) MN20 remultiplexes and grooms MPEG-2 compressed
data from various sources into a single MPEG-2 transport stream. This
source could be either DiviCom program encoders and data injectors, or
third-party devices such as satellite integrated receiver/decoders (IRDs)
and near video-on-demand (NVOD) servers. The MN20 Remux is especially
designed for flexible distribution to all types of networks whether through
a modulator to HFC, DTH and MMDS, or directly into an ATM network. The MN20
also provides scrambling and monitoring/decoding capabilities.
DiviCom's MediaView System Controller (TM) SC20 is a an integrated turn-
key product for managing digital video networks. The SC20 allows for the
configuration and management of DiviCom and third-party components, and
through the detection, display and logging of system faults provides for
the ability to properly monitor and maintain system operation. This is done
through an easy-to-use graphical user interface which provides the status,
interconnection maps and context sensitive help necessary for system
troubleshooting.
Professional Services and Customer Support
DiviCom's DiviSys (TM) technology integration group provides consulting
and implementation services to DiviCom customers worldwide. DiviSys draws
upon its expertise in broadcasting television, communications networking
and compression technology to design, integrate and install complete
business solutions. DiviSys offers a broad range of services including
program management, budget analysis, technical design and planning, parts
inventory management, building and site preparation, equipment installation
and integration, end-to-end system testing and comprehensive customer
training.
The DiviSys group also has extensive experience in integrating DiviCom
products with numerous third-party products and services. This includes the
procurement and integration of encoders, multiplexers, system/network
controllers, ATM and TCP/IP network equipment, NVOD servers, modulators,
transmitters, antennas, downlink systems, satellite dishes/IRDs, subscriber
management systems, conditional access systems for pay-per-view, electronic
program guides and diagnostics/quality assurance tools.
DiviTec (TM) is DiviCom's customer service and support organization. The
DiviTec Service Agreement provides for a customized set of services for
ongoing maintenance, support-on-demand and customer training. This service
is designed to meet each customer's specific needs in order to maximize the
benefits they receive from DiviCom products and systems.
Changing Product Mix; Dependence on Decoder Products
While C-Cube offers a number of products for a variety of applications,
beginning in the second quarter of 1995, sales of the Company's CL480
family of products have represented a significant percentage of the
Company's total net revenues. The Company expects that revenues from its
MPEG-1 decoder products including the CL480 and CL680 families of products
will decrease as a percentage of total revenues, but continue to account
for a significant portion of its product revenues in 1998.* C-Cube expects
that price competition will continue to result in declining average selling
prices for this family of products.* The Company has implemented several
programs that have reduced costs associated with these families of
products. In the event that increases in unit sales and other manufacturing
efficiencies of these families of products do not offset decreasing sales
prices in the future, the Company's business and results of operations
would be materially and adversely affected. C-Cube anticipates that overall
gross margin may decrease as a result of a number of factors including
anticipated declines in average selling prices over time.* The timing of
volume shipments and the life cycles of the Company's products are
difficult to predict due in large measure to the emerging nature of the
markets for C-Cube's products, the future effect of product enhancements by
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the Company and its current and future competitors. Declines in demand for
the Company's products, particularly the CL480 and CL680 families of
products, whether as a result of competition, technological change or
otherwise, would have a material adverse effect on C-Cube's business and
results of operations.
Customers
The following table lists certain of the Company's end customers:
<TABLE>
<CAPTION>
Market Customers
- -------------- -----------------------------------------------------
<S> <C> <C>
Idall Malata
Consumer Samsung ChangHong
SAST Xiamin Solid
GI Scientific Atlanta
- -------------- -----------------------------------------------------
Communications NDS NEC
Comsat ABL
Dell Kasan
- -------------- -----------------------------------------------------
Computer Toshiba NEC
Diamond Quadrant International
- -------------- -----------------------------------------------------
</TABLE>
During 1997 one customer accounted for 20% of the Company's net
revenues. During 1996 one customer accounted for 12% of the Company's net
revenues. During 1995 two customers accounted for 14% and 10% of the
Company's net revenues, respectively. There can be no assurance that such
customers will continue to account for a significant percentage of the
Company's revenues in the future.
Research and Development
C-Cube believes that the continued introduction of new products in its
target markets is essential to its growth. As of December 31, 1997, the
Company had 347 full-time employees engaged in research and development.
Expenditures for research and development in 1997, 1996 and 1995 were
approximately $64.2 million, $44.2 million and $14.3 million, respectively.
See "Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations."
The markets for the Company's products are characterized by rapidly
changing technology and evolving industry standards. In addition, markets
for C-Cube's products are characterized by intense price competition. As
the markets for the Company's products develop and competition increases,
C-Cube anticipates that product life cycles will shorten and average
selling prices will decline.* In particular, average selling price and
product gross margin for each of the Company's products will decline as
such products mature and as per order unit volumes for such products
increase.* The Company's operating results will depend to a significant
extent on its ability to continue to successfully introduce new products on
a timely basis and to reduce costs of existing products.* In particular,
C-Cube currently intends to announce several new products over the next
year, including next generation MPEG-1 and MPEG-2 decoders.* There can be
no assurance that these products will be successfully developed or will
achieve market acceptance, and these products are not expected to
contribute significantly to revenues in the first half of 1998. The failure
of any of these products to be successfully introduced and achieve market
acceptance could have a material adverse effect on the Company's business
and results of operations. In addition, the Company continues to sell a
number of earlier generation products; any failure to manage the transition
to new products effectively would have a material adverse effect on the
Company's business and results of operations. The success of new product
introductions is dependent on several factors, including proper new product
definition, product cost, timely completion and introduction of new product
designs, quality of new products, differentiation of new products from
those of the Company's competitors and market acceptance of C-Cube's and
its customers' products. As a result, the Company believes that continued
significant expenditures for research and development will be required in
the future.* Because of the complexity of its products, C-Cube has
experienced delays from time to time in completing development and
introduction of new products, and, as a result, has from time to time not
achieved the market share anticipated for such products. There can be no
assurance that such delays will not be encountered in the development and
introduction of future products, including the products currently expected
to be announced over the next year. There can be no assurance that the
Company will successfully identify new product opportunities and develop
12
<PAGE>
and bring new products to market in a timely manner, that products or
technologies developed by others will not render C-Cube's products or
technologies obsolete or noncompetitive, or that the Company's products
will be selected for design into the products of its targeted customers.
The failure of any of the Company's new product development efforts could
have a material adverse effect on C-Cube's business and results of
operations.
Sales and Marketing
C-Cube's sales and marketing strategy targets markets for which digital
video compression is an enabling technology in order to achieve key design
wins with industry leaders as well as early adopters of digital video
technology. To implement its strategy, the Company has established a direct
sales force and a worldwide network of independent sales representatives
and distributors. In addition, C-Cube has a team of application engineers
who assist customers in designing in the Company's products.
In the United States, the Company sells its products through the direct
sales channel, independent representatives and distributors. The Company
records revenues from product sales to customers at the time of shipment.
Certain of the Company's agreements with its distributors permit limited
stock rotation and provide for price protection. Allowances for returns and
adjustments, including price protection, are provided at the time revenues
from product sales are recorded. Generally, the Company pays its
independent sales representatives on a commission basis. As of December
1997, C-Cube had North American regional sales offices in California,
Georgia and Quebec and international sales offices in the United Kingdom,
France, Korea, China, Hong Kong, Singapore, Taiwan and Japan. In Japan,
C-Cube sells products through the direct sales force of C-Cube Japan, Inc.
(CCJ) and two distributors. CCJ was formed by the Company and Kubota
Corporation in 1988 and is owned 65% by C-Cube and 35% by Kubota. The
primary business of CCJ is the marketing, sales and support of the
Company's products in Japan. Internationally, the Company has commissioned
sales representatives or distributors in Australia, Canada, Denmark,
France, Germany, Great Britain, Hong Kong, Ireland, India, Israel, Italy,
Korea, Malaysia, Scandinavia, Singapore and Taiwan.
International Business Activities
During 1997, 1996 and 1995, international revenues accounted for
approximately 65%, 67% and 70% of the Company's net revenues, respectively,
and C-Cube believes that international revenues will continue to account
for a significant portion of net revenues.* The significant portion of
international revenues in these years is due primarily to sales of MPEG-1
decoder products in Asia. The Company's success will depend in part upon
its ability to manage international marketing and sales operations and
manufacturing relationships. In addition, C-Cube purchases a substantial
portion of its assembly services from foreign suppliers. C-Cube's
international manufacturing and sales are subject to changes in foreign
political and economic conditions and to other risks including currency or
export/import controls, changes in tax laws, tariffs and freight rates and
changes in the ownership and/or leadership of international customers that
may result in delayed or canceled orders. For example, China and Taiwan
comprise substantial markets for consumer electronics products utilizing
the Company's MPEG-1 decoder products, such as VideoCD players. As a
consequence, any political or economic instability in such countries could
significantly reduce demand for products from certain of the Company's
major customers. The Company has made a significant investment in
additional foundry capacity in Taiwan and is subject to the risk of
political instability in Taiwan, including but not limited to the potential
for conflict between Taiwan and the People's Republic of China. The Company
manufactures and sells product to customers in Korea and is subject to the
risk of political instability in Korea, including the potential for
conflict between North and South Korea. In addition, the Company sells
certain of its products in international markets and buys certain products
from its foundries in currencies other than the U.S. dollar and as a
result, currency fluctuations could have a material adverse effect on the
Company's business and results of operations. With respect to international
sales that are denominated in U.S. dollars, increases in the value of the
U.S. dollar relative to foreign currencies can increase the effective price
of and reduce demand for the Company's products relative to competitive
products priced in the local currency. The United States has considered
trade sanctions against Japan and has had disputes with China relating to
trade and human rights issues. If trade sanctions were imposed, Japan or
China could enact trade sanctions in response. Because a number of the
Company's current and prospective customers and suppliers are located in
Japan and China, trade sanctions, if imposed, could have a material adverse
effect on C-Cube's business and results of operations. Similarly,
protectionist trade legislation in either the United States or foreign
countries could have a material adverse effect on the Company's ability to
manufacture or to sell its products in foreign markets.
13
<PAGE>
Manufacturing
C-Cube has chosen to use independent silicon foundries to fabricate its
integrated circuits. Assembly, test and packaging are also subcontracted to
third parties. This approach enables the Company to concentrate its
resources on product design and development, where C-Cube believes it has
greater competitive advantages. The Company continually evaluates
alternative sources for wafer assembly and test capacity.
The Company's devices are currently fabricated using complementary
metal oxide semiconductor (CMOS) process technology with 0.65 micron,
0.5 micron, 0.35 micron and 0.25 micron process feature sizes, using either
three or four layers of metal interconnect. Fabricated wafers are either
tested by the fabrication facility to C-Cube specifications or the Company
takes receipt of untested wafers and works with subcontractor testing
facilities. Once the fully tested and accepted wafers are received by
C-Cube, the die are assembled into packages by subcontractors, primarily
located in Japan, Taiwan, Korea and the United States. The Company utilizes
multiple assembly subcontractors for its products.
In the second quarter of 1996, the Company expanded and formalized its
relationship with Taiwan Semiconductor Manufacturing Co., Ltd. (TSMC) to
provide additional wafer production capacity in the years 1996 to 2001. The
agreement with TSMC provided that TSMC would produce and ship wafers to
C-Cube at specified prices and required C-Cube to make two advance payments
totaling $49 million. An advance payment of $24.5 million was made in June
1996. In May 1997, the Company amended its agreement with TSMC which
resulted in a reduction of the Company's future wafer purchase commitments
and the forgiveness of the second advance payment of $24.5 million. TSMC
will apply the June 1996 prepayment against a portion of the wafer cost as
product is delivered to C-Cube. Accordingly, the prepaid amount, which has
been allocated between current and long-term assets, will be amortized to
inventory as wafers are received. At December 31, 1997, $4.9 million of the
remaining $23.1 million production capacity rights is included in other
current assets.
The Company believes that an increase in the demand for semiconductor
wafers over currently expected levels, or a failure of foundry capacity in
the industry to grow at anticipated rates could result in greater
difficulty in obtaining adequate foundry capacity, increased prices and
increased lead times.* The Company's future operating results depend in
substantial part on its ability to increase the capacity available to it
from its existing or new foundries. In order to secure such capacity, the
Company has considered and will continue to consider various possible
transactions, which could include, without limitation, equity investments
in, prepayments to, non-refundable deposits with or loans to foundries in
exchange for guaranteed capacity, "take or pay" contracts that commit the
Company to purchase specified quantities of wafers over extended periods,
joint ventures or other partnership relationships with foundries.* There
can be no assurance that the Company will be able to make any such
arrangement in a timely fashion or at all, that the Company will not
require additional issuances of equity or debt in order to raise capital
for any such arrangements or that any such financing would be available to
the Company on acceptable terms or at all. If the Company were not able on
a timely basis to obtain additional foundry capacity, its business and
results of operations would be materially and adversely affected.
The Company has entered into an agreement with MEC, JVC and Sharp
whereby they provided assistance in the development of the CL480 family of
products, the CL9100 and the CL680 and currently provide C-Cube with
preferential access to MEC's 0.5 and 0.35 micron manufacturing processes.
As part of the agreement C-Cube provides MEC the right to sell the CL480
family of products and the CL680 to its internal divisions and to a limited
group of VideoCD manufacturers. MEC's right to sell the CL480 has certain
volume limitations and is subject to royalty payments to C-Cube.
C-Cube sources its integrated circuit products from MEC, TSMC and
Yamaha and is in the process of qualifying additional foundries. This
dependence on a small number of foundries subjects the Company to risks
associated with an interruption in supply from these foundries. In
connection with the manufacture of its newer products, C-Cube needs to
continue to evaluate and qualify new foundries that employ advanced
manufacturing and process technologies, which are currently available from
a limited number of foundries. For example, certain of the new products
that the Company intends to introduce require advanced CMOS processes. The
Company has in the past experienced increased costs and delays in
connection with the qualification of new foundries. There can be no
assurance that any delays, cost increases or quality problems resulting
from the qualification of new foundries will not have a material adverse
effect on C-Cube's business and results of operations.
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<PAGE>
The Company's reliance on subcontractors to manufacture and assemble
its products involves significant risks, including: reduced control over
delivery schedules, quality assurance, manufacturing yields and cost; the
potential lack of adequate capacity; and potential misappropriation of
C-Cube intellectual property. The Company obtains foundry capacity through
forecasts that are generated in advance of expected delivery dates. The
Company's ability to obtain the foundry capacity necessary to meet the
future demand for its products is based on its ability to accurately
forecast such future demand. If the Company fails to accurately forecast
such future demand, the Company may be unable to timely obtain an adequate
supply of wafers necessary to manufacture the number of products required
to satisfy the actual demand. There can be no assurance that the Company
will continue to accurately forecast the future demand for its products and
obtain sufficient foundry capacity in the future.
C-Cube has from time to time experienced disruptions in supply,
although none of those disruptions have to date materially adversely
affected results. There can be no assurance that manufacturing or assembly
problems will not occur in the future or that any such disruptions will not
have a material adverse effect upon the Company's results of operations.
Further, there can be no assurance that suppliers who have committed to
provide product will do so, or that the Company will meet all conditions
imposed by such suppliers. Failure to obtain an adequate supply of products
on a timely basis would delay product delivery to C-Cube's customers, which
would have a material adverse effect on the Company's business and results
of operations. In addition, C-Cube's business could also be materially and
adversely affected if the operations of any supplier are interrupted for a
substantial period of time, or if the Company is required, as a result of
capacity constraints in the semiconductor industry or otherwise, to
increase the proportion of wafers or finished goods purchased from higher
cost suppliers in order to obtain adequate product volumes.
The markets into which C-Cube sells its products are subject to extreme
price competition. Thus, the Company expects to continue to experience
declines in the selling prices of its products over the life cycle of each
product.* In order to offset or partially offset declines in the selling
prices of its products, C-Cube must continue to reduce the costs of
products through product design changes, manufacturing process changes,
volume discounts, yield improvements and other savings negotiated with its
manufacturing subcontractors. Since the Company does not operate its own
manufacturing facilities and must make volume commitments to subcontractors
at prices that remain fixed over certain periods of time, it may not be
able to reduce its costs as rapidly as its competitors who perform their
own manufacturing. The failure of the Company to design and introduce, in a
timely manner, lower cost versions of existing products or higher gross
margin new products or to successfully manage its manufacturing
subcontractor relationships would have a material adverse effect on
C-Cube's gross margins.
DiviCom's manufacturing strategy is focused on the rapid transition of
products from engineering development to production. DiviCom makes
extensive use of the services of electronic component suppliers, referred
to as manufacturing distributors, and subcontract assembly houses in order
to minimize inventory risks, obtain competitive pricing and increase supply
flexibility.
DiviCom's manufacturing group establishes relationships with key supply
and subcontract partners. Electronic component distributors are responsible
for the procurement and "kitting" of components in preparation for contract
assemble.
Once a product or subsystem has demonstrated design stability, it is
transitioned from the DiviCom engineering group to the contract partner for
management and full turnkey assembly. The contract partner purchases
components to DiviCom specifications, contracts with the assembly facility
to perform product builds, and ships the completed systems to DiviCom.
DiviCom manages the final integration, system testing, reliability and
quality assurance testing and configuration per customer requirements
Competition
The markets in which C-Cube competes are intensely competitive and are
characterized by declining average selling prices and rapid technology
change. C-Cube believes that it competes favorably in the areas of product
definition, system cost, functionality, time-to-market, reliability and
reputation. C-Cube competes with major domestic and international
companies, most of which have substantially greater financial and other
resources than C-Cube with which to pursue engineering, manufacturing,
marketing and distribution of their products. Some of these companies own
proprietary video compression technology competitive with C-Cube's
standards-based systems. In the consumer electronics market, principal
competitors include ESS Technology, Inc., SGS-Thomson, Zoran, LSI Logic,
Oak Technology, Winbond and UMC as well as several large, integrated
15
<PAGE>
Japanese and Korean consumer electronics companies, such as Sony, MEC,
Toshiba, NEC and Samsung, which have their own semiconductor design and
manufacturing capacity. In the communications market, C-Cube's principal
competitors include SGS-Thomson, LSI Logic, Texas Instruments, VLSI
Technologies, Sony, Phillips and IBM. In the computer market, principal
C-Cube competitors include the increasingly powerful CPUs that are now
available from, among others, Intel and Motorola, as well as hardware
solutions from Zoran, Chromatic Research, LuxSonar and IBM. Graphics chip
manufacturers such as S3 Incorporated and Trident Microsystems, Inc., are
also potential competitors.
In the MPEG-2 encoder market IBM is the principal competitor in the
broadcast communications market, while Sony is the most potent competitor
in the consumer market. C-Cube expects that other companies will introduce
competing encoder products in the future.* Although the timing of the
production availability of such encoders is uncertain, their availability
could have an adverse impact on C-Cube's encoder product revenues and
margins. C-Cube may also face increased competition in the future from new
entrants into its markets. In particular, as the markets for C-Cube's
products develop, competition from large semiconductor companies, such as
SGS-Thomson, Texas Instruments and Phillips, and from vertically integrated
companies such as Sony, MEC, Toshiba and NEC, may increase significantly.
If C-Cube can offer low-cost hardware solutions, then it may continue to
compete with providers of software solutions such as National and AMD, and
manufacturers of CPUs such as Intel and Motorola. The ability of C-Cube to
compete successfully in the rapidly evolving markets for high performance
video compression technology depends on factors both within and outside of
its control, including success in designing and subcontracting the
manufacture of new products that implement new technologies, adequate
sources of raw materials, protection of Company products by effective
utilization of intellectual property laws, product quality, reliability,
price and the efficiency of production, the pace at which customers
incorporate C-Cube's integrated circuits into their products or
technologies, success of competitors' products and general economic
conditions. There can be no assurance that C-Cube will be able to compete
successfully in the future.
A variety of other approaches to digital video compression have been
introduced, including wavelets, fractal image compression, proprietary
compression algorithms and software only solutions. Competitor companies
are designing products around these and other alternative approaches. In
addition, manufacturers of general purpose microprocessors, such as Intel,
and graphics chip manufacturers, such as Chromatics, are positioning their
products as offering digital video compression capability. There can be no
assurance that system manufacturers will not use such processors for video
compression applications. While MPEG has become the accepted standard, any
of the alternative approaches, individually or collectively, could be
adopted on a widespread basis in the emerging video compression market. If
this were to happen, C-Cube's business and results of operations would be
materially and adversely affected.
In the video networking system business, DiviCom competes with
vertically integrated system suppliers including General Instrument,
Scientific Atlanta, NDS, SGS-Thomson and Philips, as well as more
specialized suppliers including the DMV division of News Corp., Nuko and
the TV/Com subsidiary of Hyundai. Many of these competitors have, or have
access to, substantially greater financial resources than does DiviCom.
DiviCom believes that it competes favorably based on its expertise and
focus in the area of digital video network systems and its constituent
components such as digital video compression, digital network and
transmission technology. In addition, DiviCom possesses the practical
knowledge and experience required to design, manufacture, integrate and
support such systems in real-world deployments. Several of these
competitors, including General Instruments, Scientific Atlanta, TV/Com, DMV
(formerly NTL), Philips and Wegener have been established in the analog
technology market for many years. Others, such as Nuko, Tadiran/Scopus and
Tiernan, have come into the market in recent years as the early stages of
digital technology emerged. The only competitor to emerge early with an
MPEG-2 product with a discrete design was DMV.
DiviCom and C-Cube's consumer settop box technology licensees compete
with traditional cable industry settop box suppliers, such as General
Instruments and Scientific Atlanta, as well as consumer electronics
companies (which may choose to license DiviCom technology or compete with
DiviCom and its licensees) such as Thomson Consumer Electronics, Philips,
Sony, MEC, Mitsubishi, Zenith, Hyundai and Samsung. DiviCom competes by
providing software and system designs that provide more advanced features
more economically than are typically available elsewhere. DiviCom expects
that successful companies in this industry will be those that provide the
deployable, affordable end-to-end solutions that support open-standards and
industry-accepted architectures.* Delivering a low-cost digital settop
decoder or other highly integrated solution as well as the broadcast video,
audio and data systems, is a key factor for successful participation in the
digital television market.*
16
<PAGE>
Intellectual Property and Licenses
The Company attempts to protect its technology through a combination of
patents, copyrights, trade secret laws, confidentiality procedures and
licensing arrangements. The Company has 21 issued United States patents and
61 U.S. patent applications pending and has filed certain corresponding
applications in certain foreign jurisdictions. These patents expire at
various times from 2010 to 2015. The Company intends to continue to seek
patents on its technology where appropriate. Notwithstanding its patent
position, the Company believes that, in view of the rapid pace of
technological change in the semiconductor industry, the technical
experience and creative skills of its engineers and other personnel are the
most important factors in determining the Company's future technological
success.
There can be no assurance that patents will issue from any pending
applications or that any claims allowed from existing or pending patents
will be sufficiently broad to protect the Company's technology. While the
Company intends to protect its intellectual property rights vigorously,
there can be no assurance that any patents held by the Company will not be
challenged, invalidated or circumvented, or that the rights granted
thereunder will provide competitive advantages to the Company. Moreover,
while the Company holds or has applied for patents relating to the design
of its products, the Company's products are based in part on standards,
including MPEG-1, MPEG-2 and JPEG, and the Company does not hold patents or
other intellectual property rights for such standards. The semiconductor
industry is characterized by frequent litigation regarding patent and other
intellectual property rights. While there is currently no pending
intellectual property litigation against the Company, the Company receives
from time to time notices of potential infringement of third-party rights
and there can be no assurance that third parties will not assert claims
against the Company with respect to existing or future products or that
licenses will be available on reasonable terms, or at all, with respect to
any third-party technology including third-party technology which is or may
be embodied in standards. In the event of litigation to determine the
validity of any third-party claims, such litigation could result in
significant expense to the Company and divert the efforts of the Company's
technical and management personnel, whether or not such litigation is
determined in favor of the Company. In the event of an adverse result in
any such litigation, the Company could be required to pay substantial
amounts in damages and to cease selling the infringing product unless and
until the Company is able to develop non-infringing technology or to obtain
licenses to the technology which was the subject of the litigation. There
can be no assurance that the Company would be successful in such
development or that such licenses would be available, and any such
development or license could require expenditure of substantial time and
other resources.
The Company has entered into an agreement with MEC, JVC and Sharp
whereby they provided assistance in the development of the CL480 family of
products, the CL9100 and the CL680 and currently provide C-Cube with
preferential access to MEC's 0.5 and 0.35 micron manufacturing processes.
As part of the agreement C-Cube provides MEC the right to sell the CL480
family of products and the CL680 to its internal divisions and to a limited
group of VideoCD manufacturers. MEC's right to sell the CL480 has certain
volume limitations and is subject to royalty payments to C-Cube.
In February 1992, the Company entered into an agreement providing that
it would deposit into escrow certain technology relating to the CL450,
CL950 and CL4000 to be released to JVC in the event of bankruptcy or
failure to perform development obligations. In the event of such release,
JVC may manufacture such products for its own use, subject to certain
royalties. In June 1993, C-Cube entered into a joint development agreement
with JVC regarding the development of the CL480 pursuant to which JVC paid
the Company a development fee and which provides for payment of royalties
to JVC based on sales of the product.
In order to defray the cost of developing its products and to develop
products with specifications meeting customer requirements, C-Cube
established development relationships with JVC, Philips and Thomson
Consumer Electronics. Under these arrangements, these customers provided
the Company with significant development funding and development assistance
for the CL450, CL950, CLM4500 and CLM4600. In addition, these customers
participated with C-Cube in determining the specifications for the
performance requirements of these products. As a result of these
relationships, the Company believes it has been able to more rapidly
introduce products meeting the demands of these as well as other customers
for similar applications. As consideration for development funding, C-Cube
has agreed to pay certain royalties to such customers and generally retains
ownership of such products.
Employees
As of December 31, 1997, the Company had approximately 750 employees,
347 of whom are engaged in, or directly support, the Company's research and
development, 197 of whom are in sales and marketing, 130 of whom are in
17
<PAGE>
manufacturing and 76 of whom are in administration. C-Cube's employees are
not represented by any collective bargaining agreement, and the Company has
never experienced a work stoppage. C-Cube believes its employee relations
are good.
C-Cube's future success is heavily dependent upon its ability to hire
and retain qualified technical, marketing and management personnel. The
loss of the services of key personnel could have a material adverse effect
on the Company's business. C-Cube is currently seeking certain additional
engineering, marketing and management personnel. The Company's success in
the future will depend in part on the successful assimilation of such new
personnel. C-Cube also obtains assistance from customers whose engineers
participate in development programs at the Company. The continuing
availability of such support is dependent upon a number of factors,
including relationships with customers and the ability of such engineers,
many of whom are foreign residents, to obtain immigration visas. The
competition for such personnel, particularly for engineering personnel, is
intense and the loss of such personnel could have a material adverse effect
on C-Cube.
Acquisitions
On August 28, 1996, the Company acquired DiviCom, a digital video
networking company. C-Cube paid $65.7 million in cash, issued 2.3 million
shares of its common stock, assumed options exercisable for 264,000 shares
of its common stock and incurred $1.35 million in other costs in exchange
for the outstanding shares of DiviCom stock that C-Cube did not already
own.
On November 17, 1995, C-Cube acquired MCT, a privately-held supplier of
digital video processing and video windowing technology for the personal
computer market. The primary motivation behind the acquisition was to have
MCT personnel supplement the Company's capabilities in the area of
reference designs, application software and the development of highly
integrated video solutions that optimize C-Cube's existing product lines.
ITEM 2. Properties
C-Cube's principal facilities consist of approximately 263,000 square
feet of space in six buildings located in Milpitas, California. This space
is leased pursuant to five agreements that expire on various dates through
April 14, 2005. The Company believes its existing facilities and other
available facilities will be adequate to meet its requirements for at least
the next 12 months.
ITEM 3. Legal Proceedings
From time to time the Company is party to certain litigation or legal
claims. Management has reviewed all pending legal matters and believes that
the resolution of such matters will not have a significant adverse effect
on the Company's financial position or results of operations.
ITEM 4. Submission of Matters to a Vote of Security Holders
None.
18
<PAGE>
Executive Officers Of The Registrant
The following table lists the names, ages and positions held with the
Registrant of all executive officers of the Registrant as of March 18,
1998. There are no family relationships between any director or executive
officer and any other director or executive officer of the Registrant.
Executive officers serve at the discretion of the Board of Directors.
<TABLE>
<CAPTION>
Name Age Position
------------------------ ---- ----------------------------------------
<S> <C> <C>
Alexandre A. Balkanski, Ph.D. 37 President, Chief Executive Officer and
Director
Tom Lookabaugh, Ph.D. 36 President - DiviCom
John J. Hagedorn 56 Vice President of Finance and
Administration, Chief Financial
Officer and Assistant Corporate
Secretary
Alexander D. Daly 36 Senior Vice President of Sales and
Corporate Marketing
Mark K. Allen 42 Senior Vice President of Operations
Richard Foreman 43 Vice President, Chief Information Officer
and Corporate Secretary
</TABLE>
Dr. Balkanski co-founded the Company in July 1988 as Vice President. He
served as Executive Vice President and Chief Operating Officer from
February 1994 to July 1995. He has served as President and Chief Executive
Officer since July 1995. He was elected to the Board of Directors in April
1993. Prior to co-founding C-Cube, Dr. Balkanski was the co-founder and
President of Diamond Devices Inc., a semiconductor company specializing in
the development of fast algorithms for signal processing. Dr. Balkanski
currently serves on the board of directors of PMC-Sierra, Inc. and CKS
Group, Inc. Dr. Balkanski holds a B.A. in physics from Harvard College, and
an M.S. in physics and a Ph.D. in business economics from Harvard
University.
Dr. Lookabaugh joined DiviCom as its Vice President of Research and
Business Development in June 1993 and was named Vice President of Marketing
in February 1996. From March 1997 to December 1997, Dr. Lookabaugh served
as Senior Vice President and General Manager. He was appointed President of
DiviCom in December 1997. Prior to joining DiviCom, Dr. Lookabaugh spent
five years with Compression Labs, Inc., where he assumed project management
responsibility on the development of an MPEG-1 decoder for video on demand,
and was Executive Director of Research and New Business Technology.
Dr. Lookabaugh received a Ph.D. in Electrical Engineering, an M.S. in
Statistics, an M.S. in Engineering Management, and an M.S. in Electrical
Engineering from Stanford University and a B.S. in Engineering Physics from
the Colorado School of Mines.
Mr. Hagedorn joined C-Cube in 1997 as Vice President of Finance and
Administration, Chief Financial Officer and Assistant Secretary. He brings
more than twenty years of senior financial management experience, the last
fourteen of which have been in the semiconductor industry. Prior to joining
C-Cube, Mr. Hagedorn held the chief financial officer's positions for IC
WORKS and for Data I/O. After having served as CFO of Pacific Intermountain
Express for a number of years, he began his semiconductor career at Intel
in 1983 and held a number of key positions, including director of finance
and administration for Intel's European subsidiary. In this position, he
served as CFO and oversaw finance, information systems and physical
distribution for a $400 million operation in eleven countries. Mr. Hagedorn
holds a B.S. in Industrial Engineering from Yale University and an MBA from
Harvard University.
Mr. Daly joined the Company in June 1995 as Vice President of
Marketing. In December 1997 he was appointed Senior Vice President of Sales
and Corporate Marketing. From 1990 to 1995, he served at Intel Corporation,
most recently as director of marketing for the mobile computing group.
Mr. Daly currently serves on the board of directors of Vitesse Semiconductor
Corporation. He holds a B.S. degree, cum laude, in electrical engineering
from the University of Miami and an M.B.A. from the University of Dallas.
Mr. Allen joined the Company in February 1995 as Vice President of
Operations. From 1987 to 1993 he was Vice President of Worldwide Operations
for Cypress Semiconductor. From 1993 to 1995, he was a student at the Haas
School of Business at the University of California, Berkeley. Mr. Allen
holds a B.S. in electrical engineering from Purdue University.
19
<PAGE>
Mr. Foreman joined the Company in November 1994 as Director of
Information Technology. In January 1996 he was appointed Vice President and
Chief Information Officer. During 1994, Mr. Foreman was Vice President of
the Intouch Group and an information systems consultant to Sybase
Corporation. From April 1983 to January 1994, Mr. Foreman held management
positions at Cypress Semiconductor, including Corporate Controller and
Director of Information Systems. Mr. Foreman holds a B.S., with honors, in
Mechanical Engineering from Villanova University, an M.S. in Systems
Engineering from the University of Pennsylvania and an M.B.A. from the
Wharton Graduate School.
20
<PAGE>
PART II
ITEM 5. Market For Registrant's Common Stock And Related Stockholder
Matters
The Company's common stock has been included for quotation on the
Nasdaq National Market under the Nasdaq symbol "CUBE" since the Company's
initial public offering in April 1994. The following table sets forth, for
the periods indicated, the high and low closing sale prices for the common
stock on such market.
<TABLE>
<CAPTION>
High Low
--------- ---------
<S> <C> <C>
1996:
First Quarter $71 $42 3/4
Second Quarter 61 1/2 29 3/4
Third Quarter 44 3/4 23 3/8
Fourth Quarter 48 1/2 35 1/8
1997:
First Quarter $39 1/4 $25 1/4
Second Quarter 28 13/16 17 3/8
Third Quarter 34 1/2 17 21/32
Fourth Quarter 33 13/16 16 3/16
</TABLE>
At March 18, 1998, the Company had 1,044 holders of record of its
common stock and 37,124,074 shares outstanding.
The market price of C-Cube's common stock has fluctuated significantly
since its initial public offering in April 1994. The market price of the
common stock could be subject to significant fluctuations in the future
based on factors such as announcements of new products by C-Cube or its
competitors, quarterly fluctuations in C-Cube's financial results or other
semiconductor companies' financial results, changes in analysts' estimates
of C-Cube's financial performance, general conditions in the semiconductor
and digital video networking industries, conditions in the financial
markets and general conditions in the global economy which might adversely
affect consumer purchasing. In addition, the stock market in general has
experienced extreme price and volume fluctuations, which have particularly
affected the market prices for many high technology companies and have
often been unrelated to the operating performance of the specific
companies. The market price of C-Cube's common stock has declined
substantially from its historic highs, and may continue to experience
significant fluctuations in the future.
Dividend Policy
The Company has never paid cash dividends on its common stock. The
Company presently intends to retain all cash for use in the operation and
expansion of the Company's business and does not anticipate paying any cash
dividends in the near future. In addition, the Company's existing bank
credit agreement prohibits the declaration or payment of cash dividends on
its common stock.
21
<PAGE>
ITEM 6. Selected Financial Data
The following selected consolidated financial data for each of the five
years in the period ended December 31, 1997 have been derived from the
audited consolidated financial statements of the Company included herein.
The selected consolidated financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the consolidated financial
statements and notes thereto included elsewhere in this report.
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(In thousands, except percentage and per share amounts)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Net revenues:
Product $337,012 $319,558 $123,190 $42,026 $20,411
Development contracts -- 200 1,412 2,993 3,328
-------- -------- -------- -------- --------
Total 337,012 319,758 124,602 45,019 23,739
-------- -------- -------- -------- --------
Costs and expenses:
Cost of product revenues 151,333 144,985 59,253 19,574 8,304
Research and development 64,204 44,177 14,342 9,774 7,372
Selling, general and 52,732 39,002 19,227 11,283 8,217
administrative
Purchased in-process -- 131,349 3,800 -- --
technology
-------- -------- -------- -------- --------
Total 268,269 359,513 96,622 40,631 23,893
-------- -------- -------- -------- --------
Income (loss) from operations 68,743 (39,755) 27,980 4,388 (154)
Interest income (expense), net (1,757) (28) 2,059 689 (257)
-------- -------- -------- -------- --------
Income (loss) before income
taxes and minority interest 66,986 (39,783) 30,039 5,077 (411)
Income tax expense 22,895 32,944 4,933 69 71
-------- -------- -------- -------- --------
Income (loss) before minority 44,091 (72,727) 25,106 5,008 (482)
interest
Minority interest in net income (248) 318 211 -- --
(loss) of subsidiary
-------- -------- -------- -------- --------
Net income (loss) $ 44,339 $(73,045) $ 24,895 $ 5,008 $ (482)
======== ======== ======== ======== ========
Earnings (loss) per share: (1)
Basic $ 1.21 $(2.15) $ 0.78 $ 0.18 $(0.02)
======== ======== ======== ======== ========
Diluted $ 1.15 $(2.15) $ 0.74 $ 0.16 $(0.02)
======== ======== ======== ======== ========
Shares: (1)
Basic 36,497 33,928 31,819 28,248 25,406
======== ======== ======== ======== ========
Diluted 41,683 33,928 35,000 31,433 25,406
======== ======== ======== ======== ========
Product Gross Margin Data:
Net product revenues $337,012 $319,558 $123,190 $42,026 $20,411
Cost of product revenues 151,333 144,985 59,253 19,574 8,304
-------- -------- -------- -------- --------
Product gross margin $185,679 $174,573 $ 63,937 $22,452 $12,107
======== ======== ======== ======== ========
Product gross margin percentage 55.1% 54.6% 51.9% 53.4% 59.3%
======== ======== ======== ======== ========
Balance Sheet Data:
Cash and short-term investments $166,350 $82,246 $144,089 $43,833 $8,608
Working capital 208,391 124,487 158,577 48,751 7,200
Total assets 304,108 279,515 203,526 67,862 23,925
Short-term debt and current
portion of long-term obligations 608 25,337 3,093 6,908 6,429
Long-term obligations, net of 87,462 87,700 88,010 2,081 2,613
current portion
Stockholders' equity 175,415 118,572 87,535 53,488 10,445
</TABLE>
(1) See Note 1 of Notes to Consolidated Financial Statements for an
explanation of the computation of net income (loss) per share.
22
<PAGE>
<TABLE>
Quarterly Results of Operations (Unaudited)
<CAPTION>
1997 1996
---------------------------------------- ----------------------------------------
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- ------- ------- ------- -------- ------- -------
(In thousands, except per share and percentage amounts)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenues $90,065 $81,717 $71,098 $94,132 $95,520 $83,180 $72,958 $68,100
Costs and expenses:
Cost of product revenues 42,330 36,750 31,278 40,975 42,017 37,428 33,561 31,979
Research and development 16,344 16,798 15,450 15,612 15,327 12,637 9,363 6,850
Selling, general and
administrative 13,767 13,555 12,340 13,070 12,123 10,785 8,294 7,800
Purchased in-process -- -- -- -- -- 131,349 -- --
technology
------- ------- ------- ------- ------- -------- ------- -------
Total 72,441 67,103 59,068 69,657 69,467 192,199 51,218 46,629
------- ------- ------- ------- ------- -------- ------- -------
Income (loss) from
Operations 17,624 14,614 12,030 24,475 26,053 (109,019) 21,740 21,471
Interest income (122) (33) (535) (1,067) (677) (59) 237 471
(expense), net
------- ------- ------- ------- ------- -------- ------- -------
Income (loss) before
income taxes and
minority interest 17,502 14,581 11,495 23,408 23,376 (109,078) 21,977 21,942
Income tax expense 6,030 4,958 3,949 7,958 8,454 8,679 8,131 7,680
------- ------- ------- ------- ------- -------- ------- -------
Income (loss) before
minority interest 11,472 9,623 7,546 15,450 16,922 (117,757) 13,846 14,262
Minority interest in net
income (loss) of
subsidiary (125) (40) (138) 55 (363) -- -- 681
------- ------- ------- ------- ------- ------- ------- -------
Net income (loss) $11,597 $ 9,663 $ 7,684 $15,395 $17,285 $(117,757) $13,846 $13,581
======= ======= ======= ======= ======= ======== ======= =======
Diluted income (loss) per
share (1) $0.30 $0.25 $0.21 $0.40 $0.44 $(3.46) $0.38 $0.37
======= ======= ======= ======= ======= ======== ======= =======
Shares used in 42,023 42,055 40,938 41,209 41,511 39,477 38,488 38,863
computation (1) ======= ======= ======= ======= ======= ======== ======= =======
Gross margin percentage 53.0% 55.0% 56.0% 56.5% 56.0% 55.0% 54.0% 53.0%
======= ======= ======= ======= ======= ======== ======= =======
</TABLE>
(1) See Note 1 of Notes to Consolidated Financial Statements for an
explanation of the computation of net income (loss) per share.
23
<PAGE>
ITEM 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Results of Operations
The following table sets forth certain operating data as a percentage
of net revenues for the years ended December 31, 1997, 1996 and 1995:
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Net revenues 100.0% 100.0% 100.0%
Costs and expenses:
Cost of product revenues 44.9 45.3 47.6
Research and development 19.1 13.8 11.5
Selling, general and
administrative 15.6 12.2 15.4
Purchased in-process
technology 0.0 41.1 3.0
------ ------ ------
Total 79.6 112.4 77.5
------ ------ ------
Income (loss) from operations 20.4 (12.4) 22.5
Interest income (expense), net (0.5) 0.0 1.6
------ ------ ------
Income (loss) before income
taxes and minority interest 19.9 (12.4) 24.1
Income tax expense 6.8 10.3 4.0
------ ------ ------
Income (loss) before minority
interest 13.1 (22.7) 20.1
Minority interest in net
income (loss) of subsidiary (0.1) 0.1 0.1
------ ------ ------
Net income (loss) 13.2% (22.8)% 20.0%
====== ====== ======
</TABLE>
Acquisition
On August 28, 1996, the Company acquired DiviCom Inc., a digital video
networking company. C-Cube paid $65.7 million in cash, issued 2.3 million
shares of its common stock, assumed options exercisable for 264,000 shares
of its common stock and incurred $1.35 million in other costs in exchange
for the outstanding shares of DiviCom stock that C-Cube did not already
own. C-Cube assumed net liabilities of $1.9 million, purchased technology
of $14.2 million, which will be amortized over five years, and wrote off
$131.3 million of in-process technology.
The Company incurred acquisition-related charges of $133 million in the
third quarter of 1996, which include the in-process technology write-off
and bonuses paid to DiviCom employees.
The acquisition of DiviCom was accounted for as a purchase and
therefore DiviCom financial results from the date of acquisition,
August 28, 1996, are included in C-Cube's consolidated financial results.
Net Revenues
Net revenues increased 5% to $337.0 million in 1997 compared to
$319.8 million in 1996. Revenue from the Company's family of encoder products
increased primarily due to sales of encoder systems developed by DiviCom,
which was acquired in the third quarter of 1996. See "Acquisition." The
Company also began volume shipments of its MPEG-2 DVD decoder chips used
primarily in DVD-ROMs on PCs. Revenue from MPEG-1 decoder chips used in
VideoCD players which are sold primarily in China, decreased from the prior
year due to price reductions made in response to competition. The decreased
prices for these products were partially offset by unit volumes which
roughly doubled.
1996 revenues increased 157% to $319.8 million compared to
$124.6 million in 1995. Revenue from the VideoCD market increased significantly
due to an increase in volume shipments of MPEG-1 VideoCD system decoders,
led by the CL484VCD MPEG-1 Decoder, which was introduced and began
significant volume shipments in the first quarter of 1996. Revenue from the
Company's family of encoder products increased primarily due to the
acquisition of DiviCom and shipments of its MediaView MV20 program encoder
as well as increased volume shipments of C-Cube's MPEG-2 encoder chips.
Revenue from the digital video broadcast market increased due to increased
volume shipments of the CL9100 MPEG-2 video decoder product and the CL9110
MPEG-2 transport demultiplexer product. The increase in product revenues
noted above was partially offset by a decline in the CL450 MPEG-1 video
decoder product shipments and an increased provision for sales returns
allowance.
24
<PAGE>
The sales returns allowance at December 31, 1997 was $6.7 million, down
from $11.5 million at December 31, 1996. During 1997, provisions to the
sales returns allowance were $3.3 million and deductions were $8.1 million.
The deductions to the allowance were primarily due to price protection
credits given to distributors in the first quarter of 1997 as the Company
significantly reduced the selling prices of its MPEG-1 decoder chips in
response to competitive pressures.
The sales returns allowance increased to $11.5 million at the end of
1996 as compared to $1.8 million at the end of 1995. The increase was due
to the $12.2 million provision to the allowance during 1996, partially
offset by $2.5 million in deductions. The $11.5 million allowance at the
end of 1996 was established to cover price protection credits to
distributors, as selling price reductions on MPEG-1 decoder chips were
anticipated in the first quarter of 1997, and to cover potential returns
for new products shipped in the fourth quarter of 1996.
During 1997 one customer accounted for 20% of net revenues. During 1996
one customer accounted for 12% of net revenues. During 1995 two customers
accounted for 14% and 10% of the Company's net revenues, respectively.
There can be no assurance that such customers will continue to account for
a significant percentage of the Company's revenues in the future.
International revenues accounted for 65%, 67% and 70% of net revenues
in 1997, 1996 and 1995, respectively. International revenues were a
significant portion of total revenues primarily due to volume shipments of
the CL480 and CL680 families of products in Asia for VideoCD players in the
consumer market. The Company sells products and supports customers in Japan
primarily through C-Cube Japan, Inc. (CCJ), the Company's 65% owned joint
venture with Kubota Corporation. The Company expects that international
revenues will continue to represent a significant portion of net revenues.*
C-Cube's international sales and manufacturing are subject to changes in
foreign political and economic conditions and to other risks, including
fluctuations in foreign exchange rates, export/import controls and changes
in tax laws, tariffs and freight rates. See "Item 1. Business -
International Business Activities."
Gross Margin
C-Cube's gross margin percentage increased to 55.1% in 1997 from 54.7%
in 1996. This improvement is due primarily to lower product transition
costs, reduced product costs and a shift in product mix to higher margin
encoder products. The Company has been able to reduce product costs through
the negotiation of lower foundry wafer prices, the adoption of finer
geometry fabrication processes and the redesign of products to reduce die
size. These changes were largely offset by decreases in average selling
prices for the Company's products. C-Cube's gross margin percentage
increased to 54.7% in 1996 from 52.4% in 1995 primarily due to cost
reduction efforts and a shift in product mix whereby the higher margin
encoder products made up a larger portion of sales, due in part to the
acquisition of DiviCom. The increase in gross margin mix was partially
offset by lower margins on end-of-life products in 1996 as compared to
1995.
The markets into which C-Cube sells its products are subject to extreme
price competition. Thus, the Company expects to continue to experience
declines in the selling prices of its products over the life cycle of each
product.* In particular, C-Cube expects to continue to experience
significant price competition in the markets for decoder products.* Due to
an increasing percentage of sales represented by lower margin MPEG-1 and
MPEG-2 decoder products and to decreasing selling prices of certain
products, the Company anticipates that its gross margin percentages may
decrease in the future.* In order to offset or partially offset declines in
the selling prices of its products, C-Cube must continue to reduce the
costs of products through product design changes, manufacturing process
changes, volume discounts, yield improvements and other savings negotiated
with its manufacturing subcontractors. Since the Company does not believe
that it can continually achieve cost reductions which fully offset the
price declines of its products, it expects gross margin percentages to
decline for existing products over their life cycles.*
C-Cube does not operate its own manufacturing facilities and must make
volume commitments to subcontractors at prices that remain fixed over
certain periods of time. Therefore, the Company may not be able to reduce
its costs as rapidly as its competitors who perform their own
manufacturing. Failure of the Company to design and introduce, in a timely
manner, lower cost versions of existing products or higher gross margin new
products or to successfully manage its manufacturing subcontractor
relationships would have a material adverse effect on C-Cube's gross
margins.
25
<PAGE>
Research and Development Expenses
In 1997, research and development expenses were $64.2 million or 19.1%
of net revenues, compared to $44.2 million or 13.8% of net revenues, in
1996. The increase in research and development expenses primarily
represents additional employee-related costs associated with increases in
product engineering staff, reflecting the Company's continuing efforts to
provide industry leading digital video solutions at the chip and systems
levels. In 1996, research and development expenses were $44.2 million or
13.8% of net revenues, compared to $14.3 million or 11.5% of net revenues,
in 1995. The increase in research and development expenses from the prior
year is primarily related to an increase in employee-related costs as well
as increases in depreciation and product start-up costs. The Company
anticipates that absolute levels of research and development expenses will
increase in future periods.*
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $52.7 million
or 15.6% of net revenues in 1997 compared to $39.0 million or 12.2% of net
revenues for 1996. The increase in spending was primarily due to increased
headcount and related expenses, increased travel costs and higher
advertising costs. Selling, general and administrative expenses increased
to $39.0 million or 12.2% of net revenues in 1996 compared to $19.2 million
or 15.4% of net revenues for 1995. The increase in absolute dollars was
primarily due to increased staffing and related expenses and increased
commissions on higher sales levels. The Company expects that absolute
levels of selling, general and administrative expenses will continue to
increase in future periods.*
Other Income (Expense)
Interest income decreased to $4.3 million in 1997 compared to
$5.9 million in 1996 primarily due to lower average balances in cash and
investments in 1997 as compared to 1996. Interest income increased to
$5.9 million in 1996 compared to $3.6 million in 1995 primarily due to higher
average balances in cash and investments in 1996 as compared to 1995.
Interest expense and other remained consistent at $6.0 million in 1997 and
1996. Interest expense and other increased to $6.0 million in 1996 from
$1.6 million in 1995 due primarily to interest paid on the $86.3 million
principal on convertible subordinated notes issued in the fourth quarter of
1995.
Income Tax Expense
The Company provided $22.9 million for income taxes in 1997 on income
before taxes and minority interest of $67.0 million for an effective tax
rate of 34%. In 1996, the Company provided $32.9 million on a loss before
income taxes and minority interest of $39.8 million because the purchased
in-process technology charge in 1996 was not tax deductible. The effective
tax rate in 1996 was 36% excluding the 1996 purchased in-process technology
charge. The effective rates for 1997 and 1996 are less than the combined
federal and state statutory rate primarily due to tax credits and foreign
taxes. The Company's effective tax rate for 1995 of 16.5% was lower than
the federal statutory rate as the Company reduced its valuation allowance
against its deferred tax assets in order to recognize the benefit from
operating loss carryforwards.
Factors that May Affect Future Results
The Company's quarterly and annual operating results have been, and
will continue to be, affected by a wide variety of factors that could have
a material adverse effect on revenues and profitability during any
particular period, including the level of orders which are received and can
be shipped in a quarter, the rescheduling or cancellation of orders by its
customers, competitive pressures on selling prices, changes in product or
customer mix, availability and cost of foundry capacity and raw materials,
fluctuations in yield, loss of any strategic relationships, C-Cube's
ability to introduce new products and technologies on a timely basis,
unanticipated problems in the performance of the Company's next generation
or cost-reduced products, the ability to successfully introduce products in
accordance with OEM design requirements and design cycles, new product
introductions by the Company's competitors, market acceptance of products
of both C-Cube and its customers, supply constraints for other components
incorporated into its customers' products, fluctuations in the Japanese yen
to U.S. dollar exchange rate, and the level of expenditures in
manufacturing, research and development, and sales, general and
administrative functions.
In addition, C-Cube's operating results are subject to fluctuation in
the markets for its customers' products, particularly the consumer
electronics market, which has been extremely volatile in the past, and the
satellite broadcast and wireless cable markets, which are in an early
stage, creating uncertainty with respect to product volume and timing. The
26
<PAGE>
Company has devoted a substantial portion of its research and development
efforts in recent quarters to developing chips used in Digital Video Disk
(DVD) systems. The Company's DVD products are subject to the new product
risks described in the preceding paragraph, including in particular
C-Cube's ability to timely introduce these products and the market's
acceptance of them, which could have a materially adverse affect on its
operating results. Furthermore, to the extent the Company is unable to
fulfill its customers' purchase orders on a timely basis, these orders may
be canceled due to changes in demand in the markets for its customers'
products. Historically, the Company has generally shipped a substantial
portion of its product in the last month of a given quarter. A significant
portion of C-Cube's expenses are fixed in the short term, and the timing of
increases in expenses is based in large part on the Company's forecast of
future revenues. As a result, if revenues do not meet the Company's
expectations, it may be unable to quickly adjust expenses to levels
appropriate to actual revenues, which could have a material adverse effect
on the Company's business and results of operations.
Due to the Company's dependence on the consumer electronics market, the
substantial seasonality of sales in that market could impact the Company's
revenues and net income. In particular, C-Cube believes that there may be
seasonality in the Asia-Pacific region related to the Chinese New Year,
which falls within the first calendar quarter, which could result in
relatively lower product demand from mid-first quarter until mid-third
quarter.* If the future geographic mix of the Company's sales shifts
towards the U.S. and Europe, C-Cube would anticipate higher revenues and
net income in the third and fourth calendar quarters as system
manufacturers in these areas make purchases in preparation for the holiday
season, and comparatively less revenues and net income in the first and
second calendar quarters.*
The economic crisis in Asia has been characterized by increases in idle
production capacity, real estate vacancies, unemployment and bank failures,
and has resulted in currency devaluation, falling consumer spending and
domestic price deflation. Any of these factors could significantly reduce
the demand for the end user goods in which the Company's products are used.
As a result of the foregoing, the Company's operating results and stock
price may be subject to significant volatility, particularly on a quarterly
basis. Any shortfall in net revenues or net income from levels expected by
securities analysts could have an immediate and significant adverse effect
on the trading price of the Company's common stock. See "Concentration of
Credit Risk" and "Product and Geographic Risks" in Note 1 of Notes to
Consolidated Financial Statements.
The market price of C-Cube's common stock has fluctuated significantly
since the initial public offering in April 1994. The market price of the
common stock could be subject to significant fluctuations in the future
based on factors such as announcements of new products by C-Cube or its
competitors, quarterly fluctuations in C-Cube's financial results or other
semiconductor companies' financial results, changes in analysts' estimates
of C-Cube's financial performance, general conditions in the semiconductor
and digital video networking industries, conditions in the financial
markets and general conditions in the global economy which might adversely
affect consumer purchasing. In addition, the stock market in general has
experienced extreme price and volume fluctuations, which have particularly
affected the market prices for many high technology companies and which
have often been unrelated to the operating performance of the specific
companies. The market price of C-Cube's common stock has declined
substantially from historic highs, and may continue to experience
significant fluctuations in the future.
The Company is aware of the issues associated with the programming code
in existing computer systems as the millennium (year 2000) approaches. The
"year 2000" problem is pervasive and complex, as virtually every computer
operation will be affected in the same way by the rollover of the two digit
year value to 00. The issue is whether computer systems will properly
recognize date sensitive information when the year changes to 2000. Systems
that do not properly recognize such information could generate erroneous
data or cause a system to fail. The Company is utilizing both internal and
external resources to identify, correct or reprogram, and test the systems
for year 2000 compliance. It is anticipated that all reprogramming efforts
will be completed by December 31, 1998, allowing adequate time for
testing.* This process includes getting confirmation from the Company's
primary vendors that plans are being developed or are already in place to
address processing of transactions in the year 2000. However, there can be
no assurance that the systems of other companies on which the Company's
systems rely, will also be converted in a timely manner or that any such
failure by another company would not have an adverse effect on the
Company's systems. Management is in the process of completing its
assessment of the year 2000 compliance costs and, based on information to
date (excluding the possible impact of vendor systems), management believes
that total costs of year 2000 related issues will not exceed $500,000.*
These costs will be funded through operating cash flows and will be
expensed as incurred.
27
<PAGE>
Liquidity and Capital Resources
Cash, cash equivalents and short-term investments increased to
$166.4 million at December 31, 1997 from the $82.2 million at the end of 1996.
Working capital increased to $208.4 million at December 31, 1997 from
$124.5 million at the end of 1996.
The Company's operating activities generated cash of $88.6 million in
1997, compared to $15.2 million in 1996 reflecting reduced inventory levels
and various prepaid and production capacity right balances.
C-Cube's investing activities, exclusive of the maturities and
purchases of short-term investments of $14.9 million and $30.0 million,
respectively, used cash of $13.2 million, primarily for capital
expenditures.
Cash provided by financing activities was $8.9 million, primarily
reflecting sales of stock pursuant to employee stock plans of $9.1 million.
At December 31, 1997, the Company had an available bank line of credit
of $30,000,000 which expires May 1, 1999. Borrowings bear interest at LIBOR
plus 1.25% or the bank's prime rate (8.50% at December 31, 1997). The line
of credit agreement requires the Company, among other things, to maintain a
minimum tangible net worth, annual net income (no quarterly loss exceeding
$3,000,000) and certain financial ratios. In addition, the bank agreement
prohibits the payment of cash dividends. At December 31, 1997, the Company
was in compliance with these covenants, and there were no borrowings under
this line.
In the second quarter of 1996, the Company expanded and formalized its
relationship with Taiwan Semiconductor Manufacturing Co., Ltd. (TSMC) to
provide additional wafer production capacity in the years 1996 to 2001. The
agreement with TSMC provided that TSMC would produce and ship wafers to
C-Cube at specified prices and required C-Cube to make two advance payments
totaling $49 million. An advance payment of $24.5 million was made in June
1996. In May 1997, the Company amended its agreement with TSMC which
resulted in a reduction of the Company's future wafer purchase commitments
and the forgiveness of the second advance payment of $24.5 million. TSMC
will apply the June 1996 prepayment against a portion of the wafer cost as
product is delivered to C-Cube. Accordingly, the prepaid amount, which has
been allocated between current and long-term assets, will be amortized to
inventory as wafers are received. At December 31, 1997, $4.9 million of the
remaining $23.1 million production capacity rights is included in other
current assets.
Based on current plans and business conditions, C-Cube expects that its
cash, cash equivalents and short-term investments together with any amounts
generated from operations and available borrowings, will be sufficient to
meet the Company's cash requirements for at least the next 12 months.*
However, there can be no assurance that the Company will not be required to
seek other financing sooner or that such financing, if required, will be
available on terms satisfactory to the Company. In addition, the Company
has considered and will continue to consider various possible transactions
to secure additional foundry capacity, which could include, without
limitation, equity investments in, prepayments to, non-refundable deposits
with or loans to foundries in exchange for guaranteed capacity, "take or
pay" contracts that commit the Company to purchase specified quantities of
wafers over extended periods, joint ventures or other partnership
relationships with foundries.
28
<PAGE>
ITEM 8. Financial Statements and Supplementary Data
Index to Financial Statements and Financial Statement Schedule
- --------------------------------------------------------------
Page
Financial Statements: ----
Independent Auditors' Report.................................................29
Consolidated Balance Sheets at December 31, 1997 and 1996....................30
Consolidated Statements of Operations for the years ended December 31, 1997,
1996 and 1995..............................................................31
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1997, 1996 and 1995...........................................32
Consolidated Statements of Cash Flows for the years ended December 31, 1997,
1996 and 1995..............................................................33
Notes to Consolidated Financial Statements...................................34
Financial Statement Schedule:
Independent Auditors' Report.................................................51
Schedule II-Valuation and Qualifying Accounts and Reserves...................52
All other schedules are omitted because they are not required, are not
applicable, or the information is included in the financial statements or
notes thereto.
[DELOITTE & TOUCHE LLP LOGO APPEARS HERE]
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
C-Cube Microsystems Inc.:
We have audited the accompanying consolidated balance sheets of C-Cube
Microsystems Inc. and subsidiaries as of December 31, 1997 and 1996, and
the related consolidated statements of operations, stockholders' equity and
cash flows for each of the three years in the period ended December 31,
1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly,
in all material respects, the financial position of C-Cube Microsystems
Inc. and subsidiaries at December 31, 1997 and 1996, and the results of
their operations and their cash flows for each of the three years in the
period ended December 31, 1997 in conformity with generally accepted
accounting principles.
DELOITTE & TOUCHE LLP
San Jose, California
January 21, 1998
29
<PAGE>
<TABLE>
CONSOLIDATED BALANCE SHEETS
(In thousands, except par value amounts)
<CAPTION>
December 31, December 31,
1997 1996
-------- --------
<S> <C> <C>
ASSETS
Current assets:
Cash and equivalents $145,034 $ 76,241
Short-term investments 21,316 6,005
Accounts receivable, net of 40,606 40,706
allowances: 1997 -- $10,175,
1996 -- $14,092
Inventories 15,270 28,056
Deferred income taxes 11,496 18,423
Other current assets 14,666 23,246
-------- --------
Total current assets 248,388 192,677
Property and equipment - net 23,561 22,653
Production capacity rights 18,200 46,200
Distribution rights - net 1,648 1,812
Purchased technology - net 9,408 12,895
Other assets 2,903 3,278
-------- --------
Total $304,108 $279,515
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable $ -- $ 24,500
Accounts payable 9,221 18,320
Accrued compensation and benefits 9,639 10,243
Other accrued liabilities 14,167 7,260
Income taxes payable 2,467 320
Deferred contract revenue 3,895 6,710
Current portion of long-term 608 837
obligations
-------- --------
Total current liabilities 39,997 68,190
Long-term obligations 87,462 87,700
Deferred income taxes 869 4,440
-------- --------
Total liabilities 128,328 160,330
-------- --------
Minority interest in subsidiary 365 613
Stockholders' equity:
Preferred stock, $0.001 par value, -- --
5,000 shares authorized
Common stock, $0.001 par value,
50,000 shares authorized; shares
outstanding: 1997 - 36,787, 203,728 191,044
1996 - 36,013
Deferred stock compensation -- (250)
Notes receivable from stockholders -- (305)
Accumulated translation adjustments (1,969) (1,238)
Unrealized loss on investments (17) (13)
Accumulated deficit (26,327) (70,666)
-------- --------
Total stockholders' equity 175,415 118,572
-------- --------
Total $304,108 $279,515
======== ========
</TABLE>
See notes to consolidated financial statements.
30
<PAGE>
<TABLE>
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
<CAPTION>
Years Ended December 31,
--------------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Net revenues $337,012 $319,758 $124,602
Costs and expenses:
Cost of product revenues 151,333 144,985 59,253
Research and development 64,204 44,177 14,342
Selling, general and administrative 52,732 39,002 19,227
Purchased in-process technology -- 131,349 3,800
-------- -------- --------
Total 268,269 359,513 96,622
-------- -------- --------
Income (loss) from operations 68,743 (39,755) 27,980
Other income (expense):
Interest income and other 4,291 5,934 3,637
Interest expense and other (6,048) (5,962) (1,578)
-------- -------- --------
Total (1,757) (28) 2,059
-------- -------- --------
Income (loss) before income taxes and 66,986 (39,783) 30,039
minority interest
Income tax expense 22,895 32,944 4,933
-------- -------- --------
Income (loss) before minority interest 44,091 (72,727) 25,106
Minority interest in net income (loss) of
subsidiary (248) 318 211
-------- -------- --------
Net income (loss) $ 44,339 $(73,045) $ 24,895
======== ======== ========
Earnings (loss) per share:
Basic $ 1.21 $ (2.15) $ 0.78
======== ======== ========
Diluted $ 1.15 $ (2.15) $ 0.74
======== ======== ========
Shares:
Basic 36,497 33,928 31,819
======== ======== ========
Diluted 41,683 33,928 35,000
======== ======== ========
</TABLE>
See notes to consolidated financial statements.
31
<PAGE>
<TABLE>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)
<CAPTION>
Notes
Common Stock Deferred Receivable Accumulated Unrealized Retained Total
----------------- Stock From Translation Loss on Earnings Stockholders
Shares Amount Compensation Stockholders Adjustments Investments (Deficit) Equity
-------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCES,
JANUARY 1, 1995 30,792 $ 78,482 $(1,065) $(506) $ (826) $(81) $(22,516) $ 53,488
Common stock issued
under stock plans 1,571 1,967 1,967
Tax benefit from
employee stock
transactions 5,907 5,907
Amortization of
deferred stock
compensation 430 430
Collection of notes
receivable from
stockholders 47 47
Accumulated
translation
adjustments (34) (34)
Unrealized gain on
investments 67 67
Capital activity of
subsidiary 768 768
Net income 24,895 24,895
-------------------------------------------------------------------------------------------
BALANCES,
DECEMBER 31, 1995 32,363 87,124 (635) (459) (860) (14) 2,379 87,535
Common stock issued
under stock plans 1,359 7,302 7,302
Common stock issued
and stock options
assumed in
connection with
business
acquisition 2,291 76,580 76,580
Tax benefit from
employee stock
transactions 20,038 20,038
Amortization of
deferred stock
compensation 385 385
Collection of notes
receivable from
stockholders 154 154
Accumulated
translation
adjustments (378) (378)
Unrealized gain on
investments 1 1
Net loss (73,045) (73,045)
-------------------------------------------------------------------------------------------
BALANCES,
DECEMBER 31, 1996 36,013 191,044 (250) (305) (1,238) (13) (70,666) 118,572
Common stock issued
under stock plans 774 9,111 9,111
Tax benefit from
employee stock
transactions 3,573 3,573
Amortization of
deferred stock
compensation 250 250
Collection of notes
receivable from
stockholders 305 305
Accumulated
translation
adjustments (731) (731)
Unrealized loss on
investments (4) (4)
Net income 44,339 44,339
-------------------------------------------------------------------------------------------
BALANCES,
DECEMBER 31, 1997 36,787 $203,728 $ -- $ -- $(1,969) $(17) $(26,327) $175,415
===========================================================================================
</TABLE>
See notes to consolidated financial statements.
32
<PAGE>
<TABLE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<CAPTION>
Years Ended December 31,
----------------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 44,339 $(73,045) $ 24,895
Adjustments to reconcile net income
(loss) to net cash provided
by operating activities:
Minority interest in subsidiary (248) 318 295
Depreciation and amortization 17,396 7,728 3,073
Deferred income taxes 3,356 (9,007) (5,224)
Purchased in-process technology -- 131,349 3,800
Changes in assets and liabilities:
Receivables (146) (890) (13,627)
Inventories 12,712 (6,751) (7,138)
Production capacity rights -- (24,500) --
Prepaids and other assets 10,956 (455) (244)
Accounts payable (8,993) (6,685) 7,312
Accrued liabilities 9,258 (2,841) 15,707
-------- -------- --------
Net cash provided by operating
activities 88,630 15,221 28,849
-------- -------- --------
Cash flows from investing activities:
Maturities of short-term investments 14,850 54,701 49,700
Purchases of short-term investments (29,956) (49,297) (29,758)
Capital expenditures (13,572) (17,141) (5,389)
Acquisition of business (net of $8.4
million cash acquired in 1996) -- (58,568) (4,818)
Other assets 368 (126) (264)
-------- -------- --------
Net cash provided by (used in) investing
activities (28,310) (70,431) 9,471
-------- -------- --------
Cash flows from financing activities:
Bank term loan borrowings (repayments)
-- net -- -- (694)
Notes payable -- net -- (8,836) (3,596)
Repayments of capital lease obligations (467) (626) (1,078)
Issuance of convertible subordinated
notes -- -- 83,662
Sale of common stock, net of notes
receivable 9,111 7,302 2,735
Collection of stockholder notes
receivable 305 154 47
-------- -------- --------
Net cash provided by (used in) financing
activities 8,949 (2,006) 81,076
-------- -------- --------
Exchange rate impact on cash and
equivalents (476) 43 344
-------- -------- --------
Net increase (decrease) in cash and
equivalents 68,793 (57,173) 119,740
Cash and equivalents, beginning of period 76,241 133,414 13,674
-------- -------- --------
Cash and equivalents, end of period $145,034 $ 76,241 $133,414
======== ======== ========
Supplemental schedule of noncash investing
and financing activities:
Unrealized gain (loss) on investments $ (4) $ 1 $ 67
Purchase of production capacity rights
for note payable -- (24,500) --
Forgiveness of note payable for
production capacity rights 24,500 -- --
Supplemental disclosure of cash flow
information --
Cash paid during the period for:
Interest $ 5,609 $ 5,852 $ 519
Income taxes 11,473 38,127 133
</TABLE>
See notes to consolidated financial statements.
33
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 1997, 1996 and 1995
Note 1. Organization and Significant Accounting Policies
Organization
C-Cube Microsystems Inc. (the "Company" or "C-Cube") was founded in July
1988. The Company operates in one industry as a leading provider of both
digital video semiconductor solutions which implement international
standards for digital video, including MPEG-1 and MPEG-2, and digital video
networks for broadcast communications applications.
Consolidation
The consolidated financial statements include the Company, its wholly
owned subsidiaries and C-Cube Japan, Inc. (a 65% owned Japanese subsidiary)
after elimination of intercompany accounts and transactions.
Cash and Equivalents and Short-term Investments
All highly liquid debt instruments purchased with a remaining maturity of
three months or less are classified as cash equivalents.
Management determines the classification of debt and equity securities at
the time of purchase and reevaluates the classification at each balance
sheet date. Debt securities are classified as available-for-sale when the
Company generally has the ability and intent to hold such securities to
maturity, but, in certain circumstances, may potentially dispose of such
securities prior to their maturity. Securities available-for-sale are
reported at fair value with unrealized gains and losses reported as a
separate component of stockholders' equity. All available-for-sale
securities are classified as current assets.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or
market. Cost is computed on a currently adjusted standard basis (which
approximates actual cost on a current average or first-in, first-out
basis).
Property and Equipment
Property and equipment are stated at cost. Depreciation is provided using
the straight-line method over estimated useful lives of three years.
Equipment under capital lease and leasehold improvements is amortized over
the shorter of their estimated useful lives, generally three years, or the
lease term.
Investments in Companies
Investments in 20% to 50% owned companies are accounted for using the
equity method. Investments in less than 20% owned companies are accounted
for using the cost method unless the Company can exercise significant
influence or the investee is economically dependent upon the Company, in
which case the equity method is used. Such investments are included in
other assets.
Production Capacity Rights
Production capacity rights are allocated between current and long-term
assets and are amortized to inventory as wafers are received.
Revenue Recognition
The Company records product sales to customers and distributors at the
time of shipment. Certain of the Company's agreements with its distributors
permit limited stock rotation and provide for price protection. Allowances
for returns and adjustments, including price protection, are provided at
the time sales are recorded.
34
<PAGE>
Revenue from product development agreements is recognized using the
percentage of completion method. Estimates are reviewed and revised
periodically throughout the lives of the contracts. Any revisions are
recorded in the accounting period in which the revisions are made.
Research and Development
Research and development expenses include costs and expenses associated
with the development of the Company's design methodology and the design and
development of new products, including initial nonrecurring engineering and
product verification charges from foundries. Research and development is
expensed as incurred.
Income Taxes
The accounting for income taxes requires an asset and liability approach
and requires recognition of deferred tax liabilities and assets for the
expected future tax consequences of temporary differences between the
financial statement carrying amounts and the tax bases of assets and
liabilities and net operating loss and tax credit carryforwards.
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect reported amounts of assets, liabilities, revenues
and expenses as of the dates and for the periods presented. Actual results
could differ from those estimates.
Fair Value of Financial Instruments
Financial instruments include cash equivalents, short-term investments, a
promissory note and convertible subordinated notes. Cash equivalents and
short-term investments are stated at fair value based on quoted market
prices. Fair value of convertible subordinated notes is determined using
market information and valuation methodologies considered to be
appropriate. The estimated fair value of the Company's convertible
subordinated notes was $70 million and $111 million at December 31, 1997
and 1996, respectively. The estimated fair value of all other financial
instruments at December 31, 1997 and 1996 was not materially different from
the values presented in the consolidated balance sheets.
Concentration of Credit Risk
Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of cash equivalents, short-
term investments, accounts receivable and financial instruments used in
hedging transactions. By policy, the Company places its investments only
with financial institutions meeting its credit guidelines and, other than
U.S. Government Treasury instruments, limits the amounts invested in any
one institution or in any type of instrument. Almost all of the Company's
accounts receivable are derived from sales to manufacturers and
distributors in the consumer electronics, computer and communications
markets. The Company performs ongoing credit evaluations of its customers'
financial condition and manages its exposure to losses from bad debts by
limiting the amount of credit extended whenever deemed necessary and
generally does not require collateral.
The Company is subject to credit risks related to sales made into Asia,
where an economic crisis, which resulted in several countries sharply
devaluing their currencies in the second half of 1997, is reducing the cash
flows and the access to credit of some of the Company's major customers.
Approximately 55% of the Company's sales in 1997 were into Asia. The
Company is requiring letters of credit for substantially all of its sales
into Asia, except for those made into Japan and Taiwan. Nevertheless, banks
have failed in many of these countries in recent months, and it is possible
that there will be more such failures before the crisis is settled. Bank
failures could cause the letters of credit upon which the Company is
relying on not to be paid or to be paid much later than is called for in
the contract. To reduce this risk, the Company is requiring its customers
in Asia to obtain letters of credit from only the largest banks in the
customer's country, or in the case of China, the largest banks in Hong Kong
and China. However, there can be no assurance that the largest banks in
these countries will not fail, causing defaults against letters of credit.
Product and Geographic Risks
Beginning in the second quarter of 1995, sales of the Company's MPEG-1
system decoders have represented a significant percentage of the Company's
total net revenues. The Company expects that revenues from its MPEG-1
35
<PAGE>
system decoders will account for a significant portion of its product
revenues in 1998. Declines in demand for these products, whether as a
result of competition, technological change or otherwise, would have a
material adverse effect on the Company's business and results of
operations.
The Asian consumer electronics markets accounted for approximately 55% of
total Company sales in 1997 and are expected to continue to account for a
substantial, though declining, percentage of sales in the future.* As a
percent of total 1997 sales, China represented 37%, Japan 7%, Singapore and
Korea each 4%, and Taiwan and Thailand 3% combined. The economic crisis in
Asia has been characterized by increases in idle production capacity, real
estate vacancies, unemployment and bank failures, and has resulted in
currency devaluation, falling consumer spending and domestic price
deflation. Any of these factors could significantly reduce the demand for
the end user goods in which the Company's products are used. In 1997, most
of the Company's sales in Asia were of its MPEG-1 decoder chips, which are
used in VideoCD players. VideoCD players generally sell in Asia for the
equivalent of between $90 and $300 U.S. dollars. At these prices, purchases
of VideoCD players are not as likely to be deferred as are purchases of
expensive consumer durables and production equipment, which have
dramatically impacted U.S. export sales.* However, there can be no
assurance that the Company will not experience reduced sales of its
products into Asia because of declining consumer spending or because of
increasing difficulty of its customers in obtaining letters of credit which
the Company requires prior to shipment.
Foreign Currency Translation
The functional currency of C-Cube Japan is the Japanese yen. Accordingly
all assets and liabilities of C-Cube Japan are translated at the current
exchange rate at the end of the period and revenues and costs at average
exchange rates in effect during the period. Gains and losses from foreign
currency translation are recorded as a separate component of stockholders'
equity.
Forward Exchange Contracts
In the normal course of business, the Company has exposure to foreign
currency fluctuations arising from foreign currency purchases and
intercompany sales, among other things. The Company enters into forward
exchange contracts to neutralize the short-term impact of foreign currency
fluctuations on assets and liabilities. All foreign exchange contracts are
designated as and effective as hedges. Gains and losses on forward exchange
contracts are deferred and recognized in income when the related
transactions being hedged are recognized. The costs of entering into such
contracts are not material to the Company's financial results. The fair
value of exchange contracts is determined by obtaining quoted market prices
of comparable contracts at the balance sheet date, adjusted by
interpolation where necessary for maturity differences.
At December 31, 1997, the Company had $13.4 million of outstanding
foreign exchange contracts to buy Japanese yen and $1.3 million of
outstanding foreign exchange contracts to sell Japanese yen. The net
carrying value of contracts at December 31, 1997 was $12.1 million and
estimated fair value of these contracts was $11.7 million. These contracts
mature through April 1998. Unrealized losses on forward exchange contracts
at December 31, 1997 were $0.4 million. The Company's risk in these
contracts is the cost of replacing, at current market rates, these
contracts in the event of default by the other party. These contracts are
executed with credit worthy financial institutions and are denominated in
the currency of major industrial nations. Prior to 1997, the Company held
no foreign exchange contracts.
Amortization of Distribution Rights
As a result of the Company increasing its ownership interest in C-Cube
Japan to 65% at December 31, 1992, the Company capitalized $2,471,000 as
distribution rights and amortizes this intangible asset over its expected
useful life of 15 years. Accumulated amortization was $823,000 and $659,000
at December 31, 1997 and 1996, respectively. The Company evaluates the
recoverability of this and other long-lived assets on a regular basis based
on estimated future undiscounted cash flows.
During 1995, the Company and Kubota Corporation contributed additional
equity to C-Cube Japan and the Company recorded a $768,000 adjustment to
paid-in capital to reflect subsidiary losses previously recognized.
36
<PAGE>
Earnings (Loss) Per Share
During the fourth quarter of 1997, the Company adopted Statement of
Financial Accounting Standards No. 128, "Earnings per Share" (SFAS 128)
which replaces the previously reported primary and fully diluted earnings
per share with basic and diluted earnings per share ("Basic EPS" and
"Diluted EPS"), and requires a dual presentation of basic and diluted EPS.
Basic EPS excludes dilution and is computed by dividing net income by the
weighted average of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that would occur if securities or other
contracts to issue common stock were exercised or converted into common
stock. Earnings per share amounts for all periods have been restated to
conform to SFAS 128.
Stock-Based Compensation
The Company accounts for stock-based awards to employees using the
intrinsic value method in accordance with Accounting Principles Board No.
25, "Accounting for Stock Issued to Employees."
Recently Issued Accounting Standards
In June 1997, the Financial Accounting Standards Board issued Statements
of Financial Accounting Standard No. 130, "Reporting Comprehensive Income,"
which requires that an enterprise report, by major components and a single
total, the change in its net assets during the period from nonowner
sources; and No. 131, "Disclosures about Segments of an Enterprise and
Related Information," which establishes annual and interim reporting
standards for an enterprise's business segments and related disclosures
about its products, services, geographic areas and major customers. Both
statements are effective for fiscal years beginning after December 15,
1997, with earlier adoption permitted. Adoption of these standards will not
impact the Company's consolidated financial position, results of operations
or cash flows.
Reclassifications
Certain prior year amounts have been reclassified to conform to the
current year presentation. These reclassifications had no effect on net
income, net loss or stockholders' equity.
Note 2. Acquisitions
On August 28, 1996, the Company acquired DiviCom Inc., a digital video
networking company. C-Cube paid $65.7 million in cash, issued 2.3 million
shares of its common stock valued at $69.6 million, assumed options
exercisable for 264,000 shares of its common stock valued at $7.0 million
and incurred $1.35 million in other costs in exchange for the outstanding
shares of DiviCom stock that C-Cube did not already own. The purchase price
was allocated on the basis of the estimated fair value of the assets
acquired and liabilities assumed as follows (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Fair value of tangible assets
acquired (including cash of $8,448) $ 53,741
Purchased technology 14,159
In-process technology 131,349
Liabilities assumed (including
deferred tax liabilities of $5,239) (55,653)
--------
Purchase consideration $143,596
========
</TABLE>
The purchased technology is being amortized over 5 years. The Company
incurred acquisition-related charges of $133 million, which include the
in-process technology write-off and bonuses paid to DiviCom employees.
The acquisition of DiviCom was accounted for as a purchase and therefore
DiviCom financial results from the date of acquisition, August 28, 1996,
are included in C-Cube's consolidated financial results.
Excluding the one-time charge of $133 million, intercompany sales and
cost of sales, and including amortization of purchased technology, pro
forma revenue, net income and diluted earnings per share would be
$354 million, $49 million and $1.27, respectively for the year ended
December 31, 1996, and $155 million, $21 million and $0.57, respectively for
the year ended December 31, 1995 assuming DiviCom had been acquired at the
37
<PAGE>
beginning of the respective periods. The pro forma results are not
necessarily indicative of what actually would have occurred if the
acquisition had been in effect for the entire periods presented or of
future operations of the combined companies.
On November 17, 1995, the Company acquired all of the outstanding capital
stock of Media Computer Technologies, Inc. (MCT), a fabless semiconductor
company marketing video based products, for cash of $6.35 million,
including $100,000 of acquisition costs. The Company withheld $1,125,000 of
the purchase price which is included in long-term obligations as of
December 31, 1997 and 1996. The acquisition was accounted for using the
purchase method of accounting. Accordingly, the purchase price was
allocated on the basis of the estimated fair value of the assets acquired
and liabilities assumed. Purchased technology of $1.7 million and goodwill
of $1.6 million are each being amortized over 5 years. Approximately
$3.8 million of the total purchase price represented the value of in-process
technology that had not yet reached technological feasibility and had no
alternative future use and was charged to the Company's operations in the
fourth quarter of fiscal 1995.
Note 3. Production Capacity Rights
In the second quarter of 1996, the Company expanded and formalized its
relationship with Taiwan Semiconductor Manufacturing Co., Ltd. (TSMC) to
provide additional wafer production capacity in the years 1996 to 2001. The
agreement with TSMC provided that TSMC would produce and ship wafers to
C-Cube at specified prices and required C-Cube to make two advance payments
totaling $49 million. An advance payment of $24.5 million was made in June
1996. In May 1997, the Company amended its agreement with TSMC which
resulted in a reduction of the Company's future wafer purchase commitments
and the forgiveness of the second advance payment of $24.5 million. TSMC
will apply the June 1996 prepayment against a portion of the wafer cost as
product is delivered to C-Cube. Accordingly, the prepaid amount, which has
been allocated between current and long-term assets, will be amortized to
inventory as wafers are received. At December 31, 1997, $4.9 million of the
remaining $23.1 million production capacity rights is included in other
current assets.
Note 4. Short-Term Investments
Short-term investments include the following debt securities as of
December 31, 1997 and 1996:
<TABLE>
<CAPTION>
Unrealized Unrealized
Amortized Market Holding Holding
Cost Value Gains Losses
--------- -------- ---------- ----------
(in thousands)
<S> <C> <C> <C> <C>
Available-for-sale corporate
debt securities:
December 31, 1997 $21,333 $21,316 $ -- $ 17
========= ======== ========== ==========
December 31, 1996 $ 6,018 $ 6,005 $ -- $ 13
========= ======== ========== ==========
</TABLE>
There were no gains or losses on the sale of investments in 1997, 1996 or
1995.
Note 5. Inventories
Inventories consist of:
<TABLE>
<CAPTION>
December 31,
-------------------
1997 1996
-------- --------
(in thousands)
<S> <C> <C>
Finished goods $ 9,158 $ 22,817
Work-in-process 3,852 2,898
Raw materials 2,260 2,341
-------- --------
Total $ 15,270 $ 28,056
======== ========
</TABLE>
38
<PAGE>
Note 6. Property and Equipment
Property and equipment consist of:
<TABLE>
<CAPTION>
December 31,
------------------
1997 1996
------- --------
(in thousands)
<S> <C> <C>
Equipment under capital lease $ 2,834 $ 3,647
Machinery and equipment --
principally computers 44,307 34,113
Furniture and fixtures 3,559 3,068
Leasehold improvements 4,727 2,449
------- -------
Total 55,427 43,277
Accumulated depreciation and
amortization (31,866) (20,624)
------- -------
Property and equipment -- net $23,561 $22,653
======= =======
</TABLE>
Note 7. Line of Credit and Notes Payable to Banks
At December 31, 1997, the Company had an available bank line of credit
of $30,000,000 which expires May 1, 1999. Borrowings bear interest at LIBOR
plus 1.25% or the bank's prime rate (8.50% at December 31, 1997). The line
of credit agreement requires the Company, among other things, to maintain a
minimum tangible net worth, annual net income (no quarterly loss exceeding
$3,000,000) and certain financial ratios. In addition, the bank agreement
prohibits the payment of cash dividends. At December 31, 1997, the Company
was in compliance with these covenants, and there were no borrowings under
this line.
Note 8. Long-term Obligations
Long-term obligations consist of the following:
<TABLE>
<CAPTION>
December 31,
-----------------------
1997 1996
-------- --------
(in thousands)
<S> <C> <C>
Convertible notes (see below) $86,250 $86,250
Purchase consideration (see Note 2) 1,125 1,125
Capital lease obligations (see Note 9) 225 903
Other long-term obligations 470 259
-------- --------
88,070 88,537
Current portion (608) (837)
-------- --------
Long-term portion $87,462 $87,700
======== ========
</TABLE>
In November 1995, the Company completed a public debt offering of
$86,250,000 aggregate principal amount of convertible subordinated notes.
The notes mature in 2005. Interest is payable semi-annually at 5.875% per
annum. The notes are convertible at the option of the note holders into the
Company's common stock at an initial conversion price of $30.70 per share,
subject to adjustment. Beginning in November 1997, the notes are redeemable
at the option of the Company at an initial redemption price of 104.7% of
the principal amount. The Company has reserved 2,809,446 shares of common
stock for the conversion of these notes. Offering costs of $2,853,000 are
included in other assets and are amortized on a straight-line basis as an
adjustment to interest expense over the term of the notes.
Note 9. Lease Commitments
Fully depreciated equipment with a cost of $2,834,000 ($3,647,000 cost
and $3,380,000 accumulated depreciation at December 31, 1996) has been
leased under capital leases. In addition, the Company rents office and
research facilities under operating lease agreements which expire through
April 2005.
39
<PAGE>
Future minimum annual operating and capital lease commitments at
December 31, 1997 are as follows:
<TABLE>
<CAPTION>
Operating Capital
--------- ---------
(in thousands)
<S> <C> <C>
1998 $4,203 $240
1999 4,226 --
2000 2,904 --
2001 2,737 --
2002 2,067 --
Thereafter 3,122 --
--------- ---------
Total minimum lease payments $19,259 240
Amount representing interest (15)
--------- ---------
Present value of minimum
lease payments 225
Current portion (225)
---------
Long-term portion $ --
=========
</TABLE>
Rent expense for operating leases was approximately $3,385,000,
$2,048,000 and $857,000 for the years ended December 31, 1997, 1996 and
1995, respectively.
Note 10. Stockholders' Equity
Preferred Stock
The number of shares of preferred stock authorized to be issued is
5,000,000 with a par value of $0.001 per share. Preferred stock may be
issued from time to time in one or more series. The Board of Directors is
authorized to provide for the rights, preferences, privileges and
restrictions of the shares of such series. As of December 31, 1997, no
shares of preferred stock had been issued.
Common Stock
The Company has authorized 26,295,803 shares of its common stock for
issuance to founders, employees and others as designated by the Board of
Directors through the Company's stock option plans or through stock
purchase agreements. Notes receivable from stockholders were fully repaid
in 1997.
Employee Stock Option Plans
The Company's stock option plans (the "Plans") authorize the issuance of
23,446,803 shares of common stock (included in the 26,295,803 authorized
shares discussed above) for the grant of incentive or nonstatutory stock
options and the direct award or sale of shares to employees, directors,
contractors and consultants. Under the Plans, options are generally granted
at fair value at the date of grant. Such options become exercisable over
periods of one to five years and expire up to 10 years from the grant date.
Upon the acquisition of DiviCom in August 1996, 268,285 outstanding
options under DiviCom's Stock Option Plan at an average exercise price of
$7.75 were assumed by C-Cube. These options retained their original terms.
The Company repriced 6,429,078 options to $19.94, the market price on
July 14, 1997, and 3,532,716 options to $38.13, the market price on
September 11, 1996. The repriced shares are treated as canceled and
regranted, however, the vesting terms on the 1997 regrants were extended
six months. The 1996 regrants retained their original vesting terms.
40
<PAGE>
Option activity under the Plans was as follows:
<TABLE>
<CAPTION>
Weighted
Number Average
of Shares Exercise Price
---------- ---------
<S> <C> <C>
Outstanding, January 1, 1995 (1,515,018
exercisable at a weighted average price 3,770,180 $ 2.20
of $1.26)
Granted (weighted average fair value of $10.39) 3,985,106 17.11
Exercised (1,432,941) 0.78
Canceled (308,527) 6.66
----------
Outstanding, December 31, 1995 (1,316,523
exercisable at a weighted average price
of $4.16) 6,013,818 12.20
Granted (weighted average fair value of $17.87) 8,076,424 40.57
Exercised (1,189,523) 4.56
Canceled (3,899,002) 44.38
----------
Outstanding, December 31, 1996 (2,301,108
exercisable at a weighted average price
of $9.36) 9,001,717 24.63
Granted (weighted average fair value of $13.02) 11,025,405 21.38
Exercised (570,164) (8.47)
Canceled (7,542,412) (31.90)
----------
Outstanding, December 31, 1997 11,914,546 $17.80
========== =========
</TABLE>
Additional information regarding options outstanding as of December 31,
1997 is as follows:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------ -----------------------------
Weighted
Average
Remaining Weighted Weighted
Range of Number Contractual Average Number Average
Exercise Prices Outstanding Life (years) Exercise Price Exercisable Exercise Price
----------------- ----------- ------------ -------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
$ 0.14 - $ 3.00 693,198 4.72 $ 1.25 691,490 $ 1.25
6.00 - 13.00 1,970,560 7.40 8.86 1,296,567 8.73
14.34 - 19.88 1,729,127 9.06 17.79 405,035 16.99
19.94 - 19.94 6,079,140 8.67 19.94 1,144,911 19.94
20.00 - 63.00 1,442,521 9.25 28.97 161,652 36.64
----------------- ----------- ------------ -------------- ----------- --------------
$ 0.14 - $63.00 11,914,546 8.35 $17.80 3,699,655 $12.93
================= =========== ============ ============== =========== ==============
</TABLE>
At December 31, 1997, 4,663,048 shares were available for future grants.
Employee Stock Purchase Plan
The Company has an employee stock purchase plan, under which eligible
employees may authorize payroll deductions of up to 10% of their
compensation (as defined in the plan) to purchase common stock at a price
equal to 85% of the lower of the fair market values as of the beginning or
the end of the offering period. Stock issued under the plan was 211,000,
171,000 and 138,000 shares in 1997, 1996 and 1995 at weighted average
prices of $20.52, $11.07 and $6.51, respectively. The weighted average fair
value of the 1997, 1996 and 1995 awards was $9.46, $10.39 and $2.05,
respectively. At December 31, 1997, 223,000 shares of common stock were
available for issuance under this plan.
Additional Stock Plan Information
As discussed in Note 1, the Company continues to account for its stock-
based awards using the intrinsic value method in accordance with Accounting
Principles Board No. 25, "Accounting for Stock Issued to Employees" and its
related interpretations. Accordingly, no compensation expense has been
recognized in the financial statements for employee stock arrangements
which are granted with exercise prices equal to the fair market value at
grant date.
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," (SFAS 123) requires the disclosure of pro forma
net income and earnings per share had the Company adopted the fair value
method as of the beginning of fiscal 1995. Under SFAS 123, the fair value
of stock-based awards to employees is calculated through the use of option
pricing models, even though such models were developed to estimate the fair
value of freely tradable, fully transferable options without vesting
restrictions, which significantly differ from the Company's stock option
awards. These models also require subjective assumptions, including future
stock price volatility and expected time to exercise, which greatly affect
41
<PAGE>
the calculated values. The Company's calculations were made using the Black-
Scholes option pricing model with the following weighted average
assumptions: expected life, 5.50 years in 1997, 6.25 years in 1996 and
5.25 years in 1995; stock volatility, 63% in 1997, 66% in 1996 and 58% in
1995; risk free interest rates, 6.09% in 1997, 6.12% in 1996 and 6.62% in
1995; and no dividends during the expected term. The Company's calculations
are based on a single option valuation approach and forfeitures are
recognized as they occur. If the computed fair values of the 1997, 1996 and
1995 awards had been amortized to expense over the vesting period of the
awards, pro forma net income would have been $18.0 million ($0.54 per
share) in 1997, net loss would have been $85.6 million ($2.52 per share) in
1996 and net income would have been $22.4 million ($0.67 per share) in
1995. However, the impact of outstanding non-vested stock options granted
prior to 1995 has been excluded from the pro forma calculation;
accordingly, the 1997, 1996 and 1995 pro forma adjustments are not
indicative of future period pro forma adjustments, when the calculation
will apply to all applicable stock options. Per share amounts above
represent diluted earnings per share under SFAS 128 (see Note 1).
Deferred Stock Compensation
In connection with the grants of certain stock options to employees in
1994 and 1993, the Company recorded deferred stock compensation for the
difference between the deemed fair value for accounting purposes and the
option price as determined by the Board at the grant dates. Deferred stock
compensation was amortized over the vesting period of the related stock
options and was fully amortized by December 31, 1997.
Note 11. Earnings (Loss) Per Share
The following table sets forth the computation of basic and diluted
earnings per share (in thousands, except per share amounts):
<TABLE>
<CAPTION>
Quarter Ended Year Ended
--------------------- ----------------------------------
Dec. 31, Dec. 31, Dec. 31, Dec. 31, Dec. 31,
1997 1996 1997 1996 1995
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Numerator:
Net income (loss) -
numerator for basic
earnings (loss per share) $11,597 $17,285 $44,339 $(73,045) $24,895
Addback interest income
after tax related to
convertible shares 883 893 3,532 n/a 920
-------- -------- -------- -------- --------
Numerator for diluted
earnings (loss) per share $12,480 $18,178 $47,871 $(73,045) $25,815
Denominator:
Weighted-average shares -
denominator for basic
earnings (loss) per share 36,738 35,821 36,497 33,928 31,819
Convertible shares 2,809 2,809 2,809 n/a 573
Dilutive common stock
equivalents, using
treasury stock method 2,476 2,881 2,377 n/a 2,608
-------- -------- -------- -------- --------
Denominator for diluted
earnings (loss) per share 42,023 41,511 41,683 33,928 35,000
======== ======== ======== ======== ========
Basic earnings (loss) per share $ 0.32 $ 0.48 $ 1.21 $(2.15) $ 0.78
======== ======== ======== ======== ========
Diluted earnings (loss) per share $ 0.30 $ 0.44 $ 1.15 $(2.15) $ 0.74
======== ======== ======== ======== ========
</TABLE>
42
<PAGE>
Note 12. Income Taxes
The provision for income taxes is as follows:
<TABLE>
<CAPTION>
December 31,
------------------
1997 1996
-------- --------
(in thousands)
<S> <C> <C>
Current:
Federal $14,336 $37,087
State 2,938 4,686
Foreign 2,265 170
-------- --------
Total 19,539 41,943
Deferred:
Federal 3,105 (6,660)
State (899) (1,189)
Foreign 1,150 (1,150)
-------- --------
Total 3,356 (8,999)
-------- --------
Total $22,895 $32,944
======== ========
</TABLE>
The tax benefit associated with dispositions from employee stock plans
reduced taxes currently payable by $3,573,000 and $20,038,000 for 1997 and
1996, respectively.
Income tax expense differs from the amount computed by applying the
federal statutory income tax rate to income before taxes as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------
1997 1996 1995
------- ------- -------
(in thousands)
<S> <C> <C> <C>
Tax expense (benefit) computed
at federal statutory rate $23,445 $(14,035) $10,514
State income taxes, net of
federal effect 1,248 (1,865) 947
Foreign withholding taxes 73 170 88
Tax credits (2,646) (4,710) (892)
Change in valuation allowance -- (1,324) (2,149)
Purchased in-process technology -- 52,080 --
Foreign operations taxed at
different rates 995 1,069 --
Other (220) 1,559 (3,575)
------- ------- -------
Income tax expense $22,895 $32,944 $ 4,933
======= ======= =======
</TABLE>
The components of the net deferred tax asset as of December 31 were as
follows:
<TABLE>
<CAPTION>
1997 1996
-------- --------
(in thousands)
<S> <C> <C>
Deferred tax assets:
Accruals and reserves recognized in
different periods $11,603 $14,985
Net operating loss carryforwards 289 2,302
Tax credit carryforwards 1,607 --
Capitalized research and development 65 188
Tax basis depreciation 990 1,163
Other 907 2,045
-------- --------
Total 15,461 20,683
Valuation allowance (218) (1,152)
-------- --------
Net 15,243 19,531
Deferred tax liabilities:
Purchased technology (4,616) (5,548)
-------- --------
Net deferred tax assets $10,627 $13,983
======== ========
</TABLE>
At December 31, 1997, the Company has foreign net operating loss
carryforwards of approximately $556,000 expiring through 2002.
43
<PAGE>
U.S. income taxes were not provided for on a cumulative total of
approximately $13 million of undistributed earnings for certain foreign
subsidiaries. The Company intends to reinvest these earnings indefinitely
in foreign operations.
Note 13. Employee Benefit Plan
The Company has a 401(k) tax-deferred savings plan under which
participants may contribute up to 20% of their compensation, subject to
certain Internal Revenue Service limitations. The Company is not required
to contribute and has not contributed to the plan to date.
Note 14. Development Agreements
The Company enters into development agreements with other companies for
which it receives development fees with certain payments contingent upon
attaining contract milestones. The Company generally retains ownership of
the products developed under the agreements; however, some agreements limit
the product markets in which the Company may sell the developed product. In
addition, under certain of the agreements, the Company is required to pay
royalties based on a percentage of the net sales of the products developed
under the agreements. Royalty expense was $1,960,000 in 1997, $1,860,000 in
1996 and $574,000 in 1995.
Note 15. Geographic and Customer Information
Information concerning the Company's operations by geographic area as of
and for the years ended December 31, is as follows:
<TABLE>
Geographic Region Information
<CAPTION>
1997 1996 1995
-------- -------- --------
(in thousands)
<S> <C> <C> <C>
Net revenues from unaffiliated customers
by geographic region:
United States $162,020 $241,239 $107,341
Bermuda 157,147 39,813 --
Japan 17,845 38,706 17,261
-------- -------- --------
Net revenues $337,012 $319,758 $124,602
======== ======== ========
Revenues from affiliates (eliminated
in consolidation) by geographic
region:
United States $ 35,788 $ 77,268 $ 13,406
Bermuda 70,376 5,442 --
Other Areas 7,470 2,925 --
-------- -------- --------
Total revenues from affiliates $113,634 $ 85,635 $ 13,406
======== ======== ========
Income (loss) from operations by
geographic region:
United States $ 38,087 $(23,134) $ 26,574
Bermuda 37,386 (2,229) --
Japan (20) 1,243 2,048
Other Areas 787 190 --
Transfers between geographic areas (7,497) (15,825) (642)
-------- -------- --------
Income (loss) from operations $ 68,743 $(39,755) $ 27,980
======== ======== ========
Identifiable assets by geographic region:
United States $182,896 $335,114 $202,862
Bermuda 164,654 88,000 --
Japan 3,779 17,970 6,614
Other Areas 1,084 1,371 --
Eliminations (48,305) (162,940) (5,950)
-------- -------- --------
Total assets $304,108 $279,515 $203,526
======== ======== ========
</TABLE>
44
<PAGE>
The Company sells its products primarily in Asia, the U.S. and Western
Europe. Export revenues for the years ended December 31, consisted of the
following:
<TABLE>
<CAPTION>
1997 1996 1995
------- -------- --------
(in thousands)
<S> <C> <C> <C>
Asia $ 19,659 $123,745 $ 63,469
Europe 18,990 14,258 5,435
-------- -------- --------
Total export revenues $ 38,649 $138,003 $ 68,904
======== ======== ========
</TABLE>
International revenues as a percentage of net revenues were 65% in 1997,
67% in 1996 and 70% in 1995. During 1997, one customer accounted for 20% of
net revenues. During 1996, one customer accounted for 12% of net revenues.
During 1995, two customers accounted for 14% and 10% of net revenues,
respectively. At December 31, 1997, two customers represented 20% and 11%
of accounts receivable, respectively. At December 31, 1996, three customers
represented 15%, 12% and 12% of accounts receivable, respectively.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
45
<PAGE>
PART III
ITEM 10. Directors and Executive Officers of C-Cube Microsystems Inc.
The information required by Item 10 of Form 10-K with respect to
identification of directors is incorporated by reference to the information
contained in the section captioned "Proposal No. 1: Election of Directors"
in C-Cube's definitive Proxy Statement for the Annual Meeting of
Stockholders to be held May 8, 1998 (the "Proxy Statement"), a copy of
which has been filed with the Securities and Exchange Commission. For
information with respect to the executive officers of the Registrant, see
"Executive Officers of the Registrant" at the end of Part I of this report.
ITEM 11. Executive Compensation
The information required by Item 11 of Form 10-K is incorporated by
reference to the information contained in the section captioned "Executive
Compensation and Other Matters" in the Proxy Statement.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management
The information required by Item 12 of Form 10-K is incorporated by
reference to the information contained in the section captioned "Stock
Ownership of Certain Beneficial Owners and Management" in the Proxy
Statement.
ITEM 13. Certain Relationships and Related Transactions
The information required by Item 13 of Form 10-K is incorporated by
reference to the information contained in the section captioned "Executive
Compensation and Other Matters-Certain Relationships and Related
Transactions" in the Proxy Statement.
PART IV
ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)(1)Financial Statements - See Index to Consolidated Financial
Statements and Financial Statement Schedule at page 29 of this Form
10-K.
(2)Financial Statement Schedule - See Index to Consolidated Financial
Statements and Financial Statement Schedule at page 29 of this Form
10-K.
(3)Exhibits-See Exhibit Index at page 47 of this Form 10-K.
(b) The Registrant did not file any reports on Form 8-K during the
fourth quarter of 1997.
46
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description
- ------ -----------
3.1 Restated Certificate of Incorporation filed June 30, 1994. (3)
3.2 By-Laws (1)
4.1 Specimen of Common Stock Certificate. (1)
4.2 Restated Registration Rights and Shareholder Rights Agreement
dated December 18, 1992. (1)
10.1 Form of Indemnity Agreement for directors and officers. (1)
10.2 1994 Employee Stock Plan and form of agreement thereunder. (1)
10.3 1994 Outside Directors Stock Option Plan and form of agreement
thereunder. (1)
10.4 1994 Employee Stock Purchase Plan. (1)
10.5 1990 Stock Plan and forms of agreements thereunder. (1)
10.6 Employee Stock Option Plan and form of agreements thereunder. (1)
10.7 Series A Preferred Stock Purchase Agreement dated July 25, 1988
and January 20, 1989. (1)
10.8 Series B Preferred Stock Purchase Agreement Dated October 1989,
January 26, 1990 and May 30, 1990. (1)
10.9 Series C Preferred Stock Purchase Plan Agreements dated March 15,
1991, December 16, 1991 and December 18, 1992. (1)
10.10 Common Stock Purchase Agreement dated December 18, 1992. (1)
10.11 Loan and Security Agreement and Promissory Note with Comerica Bank-
-California dated December 27, 1993. (1)
10.12 Joint Venture Agreement dated July 11, 1990 and First Amendment to
and Restatement of Joint Venture Agreement dated December 18, 1992
with Kubota Corporation. (1)
10.13 Strategic Relationship Agreement dated July 5, 1988, First
Amendment to and Restatement of Strategic Relationship Agreement
dated July 11, 1990 and Second Amendment to and Restatement of
Strategic Relationship Agreement dated December 18, 1992 with
Kubota Corporation and Kubota C-Cube, Inc. (1)
10.14 Stock Exchange Agreement and License and Purchase Agreement each
dated December 18, 1992, with Kubota Corporation and Kubota
C-Cube, Inc. (1)
10.15 Warrant Agreement dated December 18, 1992 with Kubota Corporation. (1)
10.16 Financial Support Agreement dated December 18, 1992 and form of
Amendment to Financial Support Agreement with Kubota Corporation
and Kubota C-Cube, Inc. (1)
10.17 Agreement Regarding Collateral dated December 20, 1993 with Kubota
Corporation. (1)
10.18(2)Letter of Intent dated December 15, 1992 with Advanced Micro
Devices, Inc. (1)
10.19(2)Technology License and Wafer Foundry Agreement dated December 22,
1992 with Texas Instruments Incorporated. (1)
10.20(2)Development Agreement and Agreement on CL450A Procurement, each
dated June 30, 1993 and Amended Agreement on CL450A Procurement
dated September 1, 1993 with Victor Company of Japan, Limited. (1)
10.21 Secured Promissory Note dated February 17, 1993 by William J.
O'Meara. (1)
10.22 Secured Promissory Note dated October 21, 1993 by James G. Burke.
(1)
10.23 Standard Industrial Lease -- Multi-Tenant dated August 1991 with
San Bernardino County Employees Retirement Association, as amended
October 19, 1992, January 8, 1993, June 15, 1993 and December 9,
1993. (1)
10.24 Oxford Financial Services Corporation Master Lease Agreement dated
as of May 31, 1994. (3)
10.25 Agreement dated June 29, 1994 with Donald T. Valentine. (3)
47
<PAGE>
10.26 Revolving Credit Loan Agreement with Comerica Bank-California
dated August 18, 1994. (4)
10.27(2)Manufacturing and Sales Agreement between C-Cube Microsystems Inc.
and Matsushita Electronics Corporation. (6)
10.28 Sublease agreement with Atari Games Corporation dated October 4,
1995. (7)
10.29 Agreement and Plan of Merger By and Among C-Cube Microsystems
Inc., MCT Acquisition Corporation, Media Computer Technologies,
Inc., Dhimant Bhayani and Hemant Bhayani dated November 17, 1995.
(8)
10.30 Supplemental Stock Option Plan. (9)
10.31 Amendment to Revolving Credit Loan Agreement dated January 3,
1996. (9)
10.32(2)Option Agreement dated May 18, 1996 with Taiwan Semiconductor
Manufacturing Co., Ltd. (10)
10.33 Form of Affiliate Agreement among C-Cube Microsystems, Inc., SAGEM
S.A., SAGEM International S.A., Tregor Electronique S.A., and Iena
International S.A. dated as of May 28, 1996. (11)
10.34 Form of Affiliate Agreement among C-Cube Microsystems Inc.,
DiviCom Inc. and certain stockholders of DiviCom Inc. (11)
10.35 Form of Voting Agreement among C-Cube Microsystems Inc., SAGEM
S.A, SAGEM International S.A. Tregor Electronique S.A. and Iena
International S.A. dated as of May 28, 1996. (11)
10.36 Lease agreement with Callahan-Pentz Properties dated July 9, 1996.
(12)
10.37 Sublease agreement with LSI Logic Corporation dated January 8,
1997. (13)
10.38 Amendment to Option Agreement dated May 30, 1997 with Taiwan
Semiconductor
Manufacturing Co., Ltd. (14)
10.39 Amendment to Lease Agreement with APT-IND/APTS Realty, Inc. dated
September 2, 1997. (15)
10.40 Amendment to Loan Agreement with Comerica Bank-California dated
October 10, 1997. (15)
21.1 Principal Subsidiaries.
23.1 Independent Auditors' Consent.
27.1 Financial Data Schedule.
27.2 Financial Data Schedule - 1995 & 1996 Revised.
27.3 Financial Data Schedule - 1997 Revised.
____________________________________________________________________
(1) Incorporated by reference to the corresponding Exhibit previously
filed as an Exhibit to Registrant's Registration Statement on Form
S-1 filed March 4, 1994, as amended (File No. 33-76082)
(2) Confidential treatment has been granted as to a portion of this
Exhibit.
(3) Incorporated by reference to the corresponding Exhibit previously
filed as an Exhibit to Registrant's Form 10-Q filed August 5, 1994
(File No. 0-23596)
(4) Incorporated by reference to the corresponding Exhibit previously
filed as an Exhibit to Registrant's Form 10-Q filed October 28,
1994 (File No. 0-23596)
(5) Confidential treatment has been requested as to a portion of this
Exhibit.
(6) Incorporated by reference to the corresponding Exhibit previously
filed as an Exhibit to Registrant's Form 10-K filed March 21, 1995
(File No. 0-23596)
(7) Incorporated by reference to the corresponding Exhibit previously
filed as an Exhibit to Registrant's Form 8-K filed November 14,
1995 (File No. 0-23596)
(8) Incorporated by reference to the corresponding Exhibit previously
filed as an Exhibit to Registrant's Form 10-K filed March 15, 1996
(File No. 0-23596)
(9) Incorporated by reference to the corresponding Exhibit previously
filed as an Exhibit to Registrant's Form 10-Q filed May 10, 1996
(File No. 0-23596)
(10) Incorporated by reference to the corresponding Exhibit previously
filed as an Exhibit to Registrant's Form 10-Q filed August 9, 1996
(File No. 0-23596)
48
<PAGE>
(11) Incorporated by reference to the corresponding Exhibit previously
filed as an Exhibit to Registrant's Registration Statement on Form
S-4 filed August 8, 1996, as amended (File No. 33-06653)
(12) Incorporated by reference to the corresponding Exhibit previously
filed as an Exhibit to Registrant's Form 10-Q filed November 13,
1996 (File No. 0-23596)
(13) Incorporated by reference to the corresponding Exhibit previously
filed as an Exhibit to Registrant's Form 10-Q filed May 15, 1997
(File No. 0-23596)
(14) Incorporated by reference to the corresponding Exhibit previously
filed as an Exhibit to Registrant's Form 10-Q filed October 14,
1997, as amended (File No. 0-23596)
(15) Incorporated by reference to the corresponding Exhibit previously
filed as an Exhibit to Registrant's Form 10-Q filed November 14,
1997 (File No. 0-23596)
49
<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.
C-Cube Microsystems Inc.
(Registrant)
Dated: March 26, 1998 By: /s/ Alexandre A. Balkanski, Ph.D.
----------------------------------
Alexandre A. Balkanski, Ph.D.
President and Chief Executive Officer
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>
/s/ Donald T. Valentine Director and
- ---------------------------------- Chairman of the Board March 26, 1998
(Donald T. Valentine)
President,
/s/ Alexandre A. Balkanski, Ph.D. Chief Executive Officer
- ---------------------------------- and Director
(Alexandre A. Balkanski, Ph.D.) (Principal Executive Officer) March 26, 1998
/s/ John J. Hagedorn Vice President of Finance and
- ---------------------------------- Administration, Chief Financial Officer
(John J. Hagedorn) and Assistant Secretary
(Principal Financial and
Accounting Officer) March 26, 1998
/s/ Gregorio Reyes Director March 26, 1998
- ----------------------------------
(Gregorio Reyes)
/s/ T.J. Rodgers Director March 26, 1998
- ----------------------------------
(T.J. Rodgers)
/s/ Baryn S. Futa Director March 26, 1998
- ----------------------------------
(Baryn S. Futa)
/s/ Donald McKinney Director March 26, 1998
- ----------------------------------
(Donald McKinney)
</TABLE>
50
<PAGE>
[DELOITTE & TOUCHE LLP LOGO APPEARS HERE]
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
C-Cube Microsystems Inc.:
We have audited the consolidated financial statements of C-Cube
Microsystems Inc. as of December 31, 1997 and 1996, and for each of the
three years in the period ended December 31, 1997, and have issued our
report thereon dated January 21, 1998. Our audits also included the
consolidated financial statement schedule of C-Cube Microsystems Inc.,
listed in the Index at Item 14(a)(2). This consolidated financial statement
schedule is the responsibility of the Company's management. Our
responsibility is to express an opinion based on our audits. In our
opinion, such consolidated financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
DELOITTE & TOUCHE LLP
San Jose, California
January 21, 1998
51
<PAGE>
SCHEDULE II
<TABLE>
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
For the Years Ended December 31, 1997, 1996 and 1995
(in thousands)
<CAPTION>
Additions
Balance at Charged to Charged to Deductions Balance
Beginning Costs and Other From at End
of Period Expenses Accounts Reserves of Period
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1997:
Sales returns allowance $11,529 $ 3,297 $ -- $8,086 $6,740
Allowance for doubtful accounts 2,563 1,010 -- 138 3,435
Warranty 1,859 547 -- 833 1,573
YEAR ENDED DECEMBER 31, 1996:
Sales returns allowance $ 1,800 $12,188 $ -- $2,459 $11,529
Allowance for doubtful accounts 987 900 707 (1) 31 2,563
Warranty 567 919 1,467 (1) 1,094 1,859
YEAR ENDED DECEMBER 31, 1995:
Sales returns allowance $ 848 $ 2,846 $ -- $1,894 $1,800
Allowance for doubtful accounts 443 574 -- 30 987
Warranty 238 889 -- 560 567
</TABLE>
(1) Adjustments relating to purchased business.
52
<PAGE>
EXHIBIT 21-1
LIST OF SUBSIDIARIES OF THE REGISTRANT:
DiviCom Inc. (incorporated in Delaware)
DiviCom Limited (organized under the laws of Barbados), a subsidiary of
DiviCom Inc.
C-Cube U.S. Inc. (incorporated in Delaware)
C-Cube Microsystems International Ltd. (organized under the laws of
Bermuda)
C-Cube International Limited (organized under the laws of the Hong Kong
Special Administrative Region of the People's Republic of China), a
subsidiary of C-Cube Microsystems International Ltd.
DiviCom Europe SAS (organized under the laws of France), a subsidiary of
C-Cube Microsystems International Ltd.
C-Cube Microsystems (Asia Pacific) Limited (organized under the laws of the
Hong Kong Special Administrative Region of the People's Republic of China)
C-Cube Japan, Inc. (organized under the laws of Japan)
*Media Computer Technologies, Inc. (incorporated in California)
*Discontinued operation
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration
Statements No. 33-81718, 33-89474, 333-19777, 333-14799,
333-03877, 333-03881, 333-03677 and 333-02812 of C-Cube Microsystems
Inc. on Form S-8 of our reports dated January 21, 1998, appearing
in this Annual Report on Form 10-K of C-Cube Microsystems Inc.
for the year ended December 31, 1997.
/s/ DELOITTE & TOUCHE LLP
DELOITTE & TOUCHE LLP
San Jose, California
March 20, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 145,034
<SECURITIES> 21,316
<RECEIVABLES> 40,606
<ALLOWANCES> 10,175
<INVENTORY> 15,270
<CURRENT-ASSETS> 248,388
<PP&E> 55,427
<DEPRECIATION> 31,866
<TOTAL-ASSETS> 304,108
<CURRENT-LIABILITIES> 39,997
<BONDS> 0
0
0
<COMMON> 203,728
<OTHER-SE> (28,313)
<TOTAL-LIABILITY-AND-EQUITY> 304,108
<SALES> 337,012
<TOTAL-REVENUES> 337,012
<CGS> 151,333
<TOTAL-COSTS> 151,333
<OTHER-EXPENSES> 116,936
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6,048
<INCOME-PRETAX> 66,986
<INCOME-TAX> 22,895
<INCOME-CONTINUING> 44,339
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 44,339
<EPS-PRIMARY> 1.21
<EPS-DILUTED> 1.15
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C> <C>
<C>
<PERIOD-TYPE> 12-MOS 12-MOS 3-MOS 6-MOS
9-MOS
<FISCAL-YEAR-END> DEC-31-1995 DEC-31-1996 DEC-31-1996 DEC-31-1996
DEC-31-1996
<PERIOD-END> DEC-31-1995 DEC-31-1996 MAR-31-1996 JUN-30-1996
SEP-30-1996
<CASH> 133,414 76,241 113,935 107,115
54,456
<SECURITIES> 10,675 6,005 38,596 35,003
21,341
<RECEIVABLES> 24,421 40,706 37,893 35,940
55,841
<ALLOWANCES> 2,787 14,092 0 0
0
<INVENTORY> 11,871 28,056 11,184 23,249
31,907
<CURRENT-ASSETS> 186,263 192,677 207,060 214,337
200,381
<PP&E> 17,564 43,277 22,697 27,312
38,412
<DEPRECIATION> 10,342 20,624 11,175 12,759
18,108
<TOTAL-ASSETS> 203,526 279,515 228,466 285,666
288,556
<CURRENT-LIABILITIES> 27,686 68,190 29,448 70,617
111,070
<BONDS> 0 0 0 0
0
0 0 0 0
0
0 0 0 0
0
<COMMON> 87,124 191,044 96,095 98,391
177,805
<OTHER-SE> (411) (72,472) 14,044 27,866
(89,826)
<TOTAL-LIABILITY-AND-EQUITY> 203,526 279,515 228,466 285,666
288,556
<SALES> 123,190 319,558 67,900 140,858
224,038
<TOTAL-REVENUES> 124,602 319,758 68,100 141,058
224,238
<CGS> 59,253 144,985 31,979 65,540
102,968
<TOTAL-COSTS> 59,253 144,985 31,979 65,540
102,968
<OTHER-EXPENSES> 37,369 214,528 14,650 32,307
187,078
<LOSS-PROVISION> 0 0 0 0
0
<INTEREST-EXPENSE> 1,578 5,962 0 0
0
<INCOME-PRETAX> 30,039 (39,783) 21,942 43,919
(65,159)
<INCOME-TAX> 4,933 32,944 7,680 15,811
24,490
<INCOME-CONTINUING> 24,895 (73,045) 13,581 27,427
(90,330)
<DISCONTINUED> 0 0 0 0
0
<EXTRAORDINARY> 0 0 0 0
0
<CHANGES> 0 0 0 0
0
<NET-INCOME> 24,895 (73,045) 13,581 27,427
(90,330)
<EPS-PRIMARY> 0.78 (2.15) 0.41 0.83
(2.71)
<EPS-DILUTED> 0.74 (2.15) 0.37 0.75
(2.71)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997 DEC-31-1997
<PERIOD-END> MAR-31-1997 JUN-30-1997 SEP-30-1997
<CASH> 103,731 117,129 136,911
<SECURITIES> 4,985 9,513 4,835
<RECEIVABLES> 54,856 42,871 45,004
<ALLOWANCES> 0 0 0
<INVENTORY> 19,607 21,471 26,912
<CURRENT-ASSETS> 214,533 226,398 242,517
<PP&E> 46,863 51,236 53,554
<DEPRECIATION> 22,762 25,784 29,166
<TOTAL-ASSETS> 300,778 288,505 304,502
<CURRENT-LIABILITIES> 68,105 46,645 48,508
<BONDS> 0 0 0
0 0 0
0 0 0
<COMMON> 196,432 198,181 202,105
<OTHER-SE> (56,845) (48,966) (39,445)
<TOTAL-LIABILITY-AND-EQUITY> 300,778 288,505 304,502
<SALES> 94,132 165,230 246,947
<TOTAL-REVENUES> 94,132 165,230 246,947
<CGS> 40,975 72,253 109,003
<TOTAL-COSTS> 40,975 72,253 109,003
<OTHER-EXPENSES> 28,682 56,472 86,825
<LOSS-PROVISION> 0 0 0
<INTEREST-EXPENSE> 1,067 1,602 1,635
<INCOME-PRETAX> 23,408 34,903 49,484
<INCOME-TAX> 7,958 11,907 16,865
<INCOME-CONTINUING> 15,395 23,079 32,742
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 15,395 23,079 32,742
<EPS-PRIMARY> 0.43 0.64 0.90
<EPS-DILUTED> 0.40 0.60 0.85
</TABLE>
