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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
/X/ Annual report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the fiscal year ended
DECEMBER 31, 1999
/ / Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the transition period
from to
COMMISSION FILE NUMBER: 0-27246
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ZORAN CORPORATION
(Exact Name of registrant as specified in its charter)
DELAWARE 94-2794449
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3112 SCOTT BOULEVARD, SANTA CLARA, CALIFORNIA 95054
(Address of principal executive offices) (Zip code)
(408) 919-4111
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EXCHANGE ON WHICH REGISTERED
------------------- ------------------------------------
NONE NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.001 PAR VALUE
(Title of Class)
------------------------
Indicate by check mark whether registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
The aggregate market value of registrant's voting stock held by
non-affiliates of registrant based upon the closing sale price of the Common
Stock on March 17, 2000, as reported on the Nasdaq National Market, was
approximately $778,000,000. Shares of Common Stock held by each officer,
director and holder of 10% or more of the outstanding Common Stock have been
excluded in that such persons may be deemed to be affiliates. This determination
of affiliate status is not necessarily a conclusive determination for other
purposes.
Outstanding shares of registrant's Common Stock, $0.001 par value, as of
March 17, 2000: 14,067,015
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the definitive proxy statement for registrant's 2000 Annual Meeting
of Stockholders to be filed with the Commission pursuant to Regulation 14A not
later than 120 days after the end of the fiscal year covered by this Report are
incorporated by reference into Part III of this Report.
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PART I
THIS REPORT INCLUDES A NUMBER OF FORWARD-LOOKING STATEMENTS WHICH REFLECT
THE COMPANY'S CURRENT VIEWS WITH RESPECT TO FUTURE EVENTS AND FINANCIAL
PERFORMANCE. THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND
UNCERTAINTIES, INCLUDING THOSE DISCUSSED IN "ITEM 7 MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--FUTURE PERFORMANCE
AND RISK FACTORS" AND ELSEWHERE IN THIS REPORT, THAT COULD CAUSE ACTUAL RESULTS
TO DIFFER MATERIALLY FROM HISTORICAL RESULTS OR THOSE ANTICIPATED. IN THIS
REPORT, THE WORDS "ANTICIPATES," "BELIEVES," "EXPECTS," "INTENDS," "FUTURE" AND
SIMILAR EXPRESSIONS IDENTIFY FORWARD-LOOKING STATEMENTS. READERS ARE CAUTIONED
NOT TO PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS, WHICH SPEAK
ONLY AS OF THE DATE HEREOF.
ITEM 1. BUSINESS.
INTRODUCTION
We develop and market integrated circuits, integrated circuit cores and
embedded software used by original equipment manufacturers, or OEMs, in digital
audio and video products for commercial and consumer markets. We also provide
complete, copy-ready system reference designs based on our technology that help
our customers produce commercial and consumer products more quickly and
cost-effectively. Our integrated circuits are used in a variety of products,
including digital versatile disc, or DVD, players, Super Video CD players,
digital speakers and audio systems, filmless digital cameras, and professional
and consumer video editing systems.
INDUSTRY BACKGROUND
Historically, video images and audio soundtracks have been transmitted,
edited and stored almost exclusively using analog formats. More recently,
however, advances in technology have allowed audio and video to be processed and
stored in digital form. Unlike analog formats, which are inherently unstable and
difficult to edit and enhance, digital formats permit the manipulation of audio
and video signals through digital signal processing and offer a number of
fundamental advantages over analog technologies. Through complex digital signal
processing operations, digital audio and video signals may be compressed,
providing significant storage and transmission efficiencies. They also may be
filtered, allowing for noise reduction, and they may be transmitted and
reproduced without perceptible image or sound degradation. Digital formats also
provide users with additional benefits, including random access to data,
superior editing capabilities and enhanced security features such as protection
against unauthorized copying and controlled and secure access.
One of the most significant barriers to the widespread adoption of digital
technology has been the huge amount of data required to represent images and
sounds in a digital format, making cost-effective storage or transmission
impractical. For example, storage of a two-hour movie in uncompressed digital
form would require approximately 200 video CDs. Through digital compression
techniques a substantial number of the redundancies inherent in audio and video
data can be identified and eliminated, significantly reducing the overall amount
of data which needs to be retained. Compression techniques introduced in the
early 1990s allowed the same two-hour movie which required 200 video CDs to be
compressed and stored on only two video CDs with video resolution comparable to
that of a standard VHS tape. More recent techniques allow the storage of a
full-length movie of more than three hours on a single DVD, with substantially
improved audio and video quality and the incorporation of additional data, such
as additional languages, scenes and director and actor commentary. Additionally,
digital compression of video data allows previously unmanageable amounts of data
to be stored in the memory of a standard personal computer, thereby permitting
the data to be accessed and edited easily. Digital audio compression allows
efficient storage and delivery of multi-channel audio, making possible
high-quality special effects such as multi-channel surround sound, virtual
surround sound and wireless audio delivery via two speakers or headphones. In
the field of still photography, digital compression
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allows dozens or hundreds of digital pictures to be stored on a single memory
card, depending on the resolution desired.
To drive the implementation and speed the adoption of products based on
digital formats, industry participants organized committees to define
international compression standards. The principal standards in use today
include:
- The Joint Photographic Experts Group, or JPEG, standard for the high
quality compression of still images and the real-time, low-cost
compression and decompression of moving images;
- The MPEG 1 standard, adopted by the Moving Pictures Experts Group, or
MPEG, for the compression of both audio and video data at the high
compression ratios necessary for the limited storage capacity of the
CD-ROM format;
- The MPEG 2 standard, subsequently adopted by the Motion Pictures Expert
Group, for the compression of both audio and video data, designed to
provide improved quality in broadcast and video playback applications; and
- Dolby AC-3, also known as Dolby Digital, developed by Dolby Laboratories,
an industry standard for the compression of audio for use in multi-channel
digital surround sound systems.
These industry standard techniques have enabled the dramatic growth in a
variety of digital multimedia markets, including:
- DVD PLAYERS. DVD players use MPEG 2 video compression and Dolby Digital
audio technology to provide significantly higher quality playback than is
possible with VCR or video CD technology. According to Understanding &
Solutions, a market research firm, worldwide sales of DVD players are
expected to grow from 2.0 million units in 1998 to 52.4 million units in
2003, a compounded annual growth rate of 92.2%.
- DIGITAL AUDIO SYSTEMS. Dolby Digital and other audio compression
techniques are used in multi-channel surround sound products including
movie theater sound systems, audio/video receivers and digital speakers.
According to Forward Concepts, a market research firm, the demand for
digital audio systems is expected to grow from 1.7 million units in 1998
to 93.3 million units in 2003, a compounded annual growth rate of 122.8%.
- FILMLESS DIGITAL CAMERAS. Filmless digital cameras use JPEG compression
technology to capture high resolution images that can be viewed, edited
and stored on a computer system and transmitted over telephone lines and
computer networks. According to Cahners In-Stat Group, a market research
firm, sales of digital cameras are expected to grow from 3.8 million units
in 1998 to 29.0 million units in 2003, a compounded annual growth rate of
50.1%.
- PC VIDEO SYSTEMS. JPEG-based PC video systems are used to capture and "cut
and paste" video sequences and add special audio and video effects.
According to International Data Corporation, sales of video editing
systems are expected to grow from 964,000 units in 1998 to 9.2 million
units in 2002, a compounded annual growth rate of 75.8%.
Additional products and markets are developing based on these established
compression standards as well as emerging compression technologies such as MLP,
a new standard for DVD audio, and MP3, a compression standard for the download
of audio recordings from the Internet.
These established and emerging compression standards specify data formats in
which compressed data must be presented in order to enable products from
different vendors to interact and permit the capture, transmission, storage and
display of audio and video data in digital format. These standards do not
specify the compression methodologies to be employed or additional functionality
which may be used to enhance or manipulate digital signals. These standards,
therefore, do not determine image or sound quality or compression efficiency.
For example, data compression may comply with relevant
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standards despite being poorly processed and containing artifacts which result
in image degradation in video applications or poor sound quality in audio
applications. As a result there can be significant differences in overall image
or sound quality between two solutions based on the same standard. Therefore,
integrated circuit manufacturers can differentiate their products on the basis
of the quality of their compression solution.
Historically, as system vendors sought compression solutions, the cost,
complexity, and time required to compress and decompress data have imposed
significant limitations on the use of digital compression. Over the last several
years, as cost-effective compression solutions have emerged, product
manufacturers have increasingly sought to design and market lower-cost digital
audio and video systems and products to address high volume consumer
applications. In addition, product manufacturers are facing competitive pressure
to introduce their products more rapidly. To address these issues, OEMs seek to
integrate multiple functions on individual chips in order to reduce their costs,
speed time-to-market and produce smaller products with reduced power
consumption. They also seek solutions that can be easily integrated into their
commercial and consumer products. The current challenge to manufacturers of
compression integrated circuits is, therefore, to provide product manufacturers
with high-quality, cost-effective, standards-based solutions that deliver
flexible control, image enhancement, audio effects and other functions in
addition to high quality compression solutions.
THE ZORAN SOLUTION
We provide feature-rich, cost-effective, standards-based solutions for a
broad range of digital audio and video applications. We were a pioneer in the
development of high performance digital signal processor products, and have
developed expertise in digital signal processing, integrated circuit design,
mathematical algorithms and software development, as well as proprietary digital
signal processing, audio and video compression technologies. We apply our
multi-disciplinary expertise and proprietary technologies to the development of
fully-integrated solutions for high-growth multimedia markets. The key elements
of our solution are:
STANDARDS-PLUS METHODOLOGY. We have leveraged our broad multi-disciplinary
expertise and proprietary digital signal processing and compression technologies
to develop what we refer to as "standards-plus" solutions. We have enabled
OEMs to improve image and sound quality and deliver superior products to
endusers by adding more features around compression standards, such as more
efficient use of memory, processing and communication resources, as well as
audio and image enhancement algorithms. We have also provided OEMs the ability
to include OEM-programmable effects, as well as variable compression ratios for
video. These "standards-plus" features allow our customers to differentiate
their products from those of their competitors.
EXPANDABLE AND PROGRAMMABLE ARCHITECTURE. We design our integrated circuits
to enable easy adaptation for a broad range of specific applications. We can
vary the architecture of our chips by adding or deleting modules, and we can
also modify the software embedded in the chips themselves to address specific
applications. We also license ready-to manufacture "cores"--building blocks of
integrated circuits--that can be integrated into our customers' chips. Combined
with the enhanced functionality of our "standards-plus" technology, our
expandable and programmable architecture facilitates product design, upgrades
and customization, substantially accelerating our customers' time to market with
differentiated products.
INTEGRATED SYSTEM SOLUTIONS. We help our customers meet their total system
requirements by providing integrated products that combine hardware and software
to address required system functions and features on a single integrated circuit
or chip set, reducing the number of integrated circuits, and in some cases
providing a complete solution on a single chip. As a result, our customers'
total system cost can be reduced and they can concentrate on differentiating
their products from those of their competitors. For example, we recently
introduced the Camera On A CHip, or COACH, which includes
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most of the electronics of a filmless digital camera. By delivering a camera on
a chip, we enable our customers to reduce the costs of their products and focus
on providing products that meet the needs of their end users.
COST-EFFECTIVE PRODUCTS. We focus on reducing the feature size, power
requirements and number of integrated circuits necessary to perform required
system functions, including compression functions. This reduces our customers'
manufacturing costs for their products which incorporate our integrated
circuits, and also reduces the operating costs for these products, enabling the
use of our products in a broader range of high volume applications. The modular
nature of our architecture reduces our new product development costs, and
enables our design engineers to meet our customers' new product specification
and cost parameters.
COPY-READY SYSTEM REFERENCE DESIGNS. We provide our customers with a broad
range of engineering reference boards and products complete with device driver
software, embedded software and detailed schematics. These products
substantially shorten our customers' product design time.
STRATEGY
We provide cost-effective, high-performance digital audio and video
solutions addressing selected high-growth applications enabled by compression in
evolving multimedia markets. Key elements of our strategy include:
FOCUS ON HIGH-GROWTH APPLICATIONS. Our strategy is to focus on providing
digital audio and video solutions for emerging high-growth consumer electronics,
PC and communications applications. Our current focus markets include DVD
players and Super Video CD players, digital speakers and audio systems, filmless
digital cameras and professional and consumer video editing systems.
LEVERAGE EXISTING TECHNOLOGY AND EXPERTISE. We intend to continue to
identify those markets that we believe have the highest growth potential for our
products and to actively pursue those markets. Our proprietary digital signal
processing and compression technologies can be used to serve emerging markets
for digital audio and video. Potential markets include Internet audio and video
appliances, digital television and television set-top boxes, as well as personal
digital audio and video devices.
FURTHER PENETRATE KEY INTERNATIONAL MARKETS. During 1998, we opened an
office in Shenzhen, China, and have begun volume shipments of our integrated
circuits to that market. We believe that emerging markets, such as China, Taiwan
and Korea present significant market opportunities for consumer electronic
products, and we intend to further extend our international operations to
address these emerging markets.
EXTEND TECHNOLOGICAL LEADERSHIP. Our years of experience in the fields of
digital signal processing, integrated circuit design, algorithms and software
development have enabled us to become a leader in the development of digital
audio and video solutions enabled by compression. Using our multi-disciplinary
expertise, we have developed new technologies for compression of digital audio
and video. For example, we believe that our proprietary bit rate control
technology has helped us provide reliable and inexpensive JPEG-based video
compression and our proprietary Virtual Multi-Channel Digital, or VMD,
technology enables high-quality surround-sound effects from two low-cost audio
speakers, rather than the four or five speakers required by other technologies.
We intend to continue to invest in research and development in order to maintain
our technological leadership.
EXPAND STRATEGIC PARTNERSHIPS. We work closely in the product development
process with leading manufacturers of products that incorporate our integrated
circuits. We also work closely with key customers and provide them early access
to our technologies. Potential products are designed to meet customer-driven
product requirements defined jointly by us and our partners with the partner
providing technological input and, in selected cases, a portion of the
development funding. This strategy has
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enabled us to develop products with substantial financial and other assistance
while retaining ownership of the technology and ensuring an established customer
for the product once development is completed. In some cases, our strategic
partners also provide sales and marketing support. We have also established
long-term relationships with strategic partners that provide manufacturing
capacity and will seek to develop additional strategic relationships with
manufacturers.
MARKETS AND APPLICATIONS
Our products are currently used in a variety of consumer multimedia and PC
applications.
VIDEO PLAYBACK SYSTEMS
Currently, three types of digital video playback systems are available for
consumer video applications: video CD players, Super Video CD players and DVD
players.
Video CD players are essentially CD audio players with MPEG 1 decoders and a
video output. Video CD players offer video playback of near-VCR quality and
two-channel stereo audio playback. Compression enables 60 to 70 minutes of video
to be stored on a single CD. Video CD players can also play karaoke titles and
are particularly popular in China, which we believe will continue to be the
primary market for these products. We formerly sold MPEG 1-based products to
manufacturers of stand-alone video CD players but are no longer selling these
products for this market.
In 1998, the Chinese government adopted the Super Video CD standard. By
utilizing MPEG 2 compression technology as well as graphics, Super Video CD
offers substantially higher audio and video quality than is possible with a
video CD player. The Super Video CD standard is replacing video CD in China.
DVD players, the latest generation of video playback systems, use MPEG 2
video compression and Dolby Digital or similar audio technology to provide
significantly higher quality playback than is possible with VCRs, Video CD or
Super Video CD players. DVD players are sold as stand-alone products and are
also included in place of CD-ROM drives in some newer PCs, where they are
referred to as DVD-ROMs. DVD-ROMs are also sold as upgrade products. The recent
growth in the DVD market is demonstrated by the rapidly growing sales of DVD
players, the increasing number of models and manufacturers, and the increasing
number of DVD titles available for purchase and rent.
DIGITAL AUDIO SYSTEMS
Digital audio facilitates enhanced audio playback with features such as
multi-channel surround sound and virtual surround sound utilizing two channel
technology. Many standards have emerged for the digital compression of audio.
Current digital audio compression standards in use include Dolby Digital, DTS,
MLP and MP3. Dolby Digital and DTS are competing standards of audio compression
for use in multi-channel digital surround sound systems in movie theaters and at
home. MLP was developed for audio compression in DVD audio. MP3 is one of the
compression standards recognized for the download of audio recordings over the
Internet. Our audio integrated circuits incorporate all of these standards. The
principal products using compressed digital audio in the consumer market are DVD
players, PCs incorporating DVD-ROMs, digital speakers and portable MP3 players.
FILMLESS DIGITAL CAMERAS
Filmless digital cameras allow the capture of high resolution images, the
viewing, editing and storage of such images on a computer system and their
transmission over telephone lines and computer networks. High quality copies of
these images can be printed using color printers. In addition, digital cameras
can be connected directly to a PC for downloading of pictures and to a
television for displaying pictures. The original digital cameras were developed
for the professional market and
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currently sell at prices of $3,000 to $10,000. As technology has advanced and
manufacturing costs have decreased, digital cameras for the consumer market have
been introduced in the $100 to $1,000 price range. Compression technology has
also enabled the development of digital video security cameras and low cost
digital video cameras for use with PCs.
PC VIDEO SYSTEMS
Historically, professional video editing systems have been comprised of
expensive pieces of analog audio and video equipment. Compression technology
allows video images to be stored in a computer's memory in sufficient volume to
enable capture and "cut and paste" editing to be performed through random access
to stored images. As the cost of compression technology has declined, a number
of manufacturers have designed low cost digital video capture and editing
systems that run on PCs, creating a new category of users in the corporate,
education and government markets.
The availability of universal serial bus, or USB, connectors on most PCs
currently being manufactured creates an opportunity for the development of
low-cost external video capture and editing accessories that can be easily
installed by consumers. We believe that enhanced support of the USB port by the
Windows98 operating system and the success of the USB equipped Apple iMac
computer will encourage the development of products of this type.
OTHER APPLICATIONS
Other existing and potential applications for our audio and video
compression technologies include Internet audio and video appliances, digital
television and television set-top boxes, as well as personal digital audio and
video devices.
TECHNOLOGY
IMAGE AND VIDEO TECHNOLOGY
THE JPEG STANDARD. In 1991, the Joint Photographic Experts Group, or JPEG,
Committee of the International Standards Organization completed a technical
specification for a standard to compress individual digitized images which may
consist of still images or consecutive frames of video data. JPEG has been
widely adopted for video editing applications, since each frame in the video is
individually compressed, allowing cutting and pasting of sequences as well as
modification of individual frames. Images are compressed through elimination of
spatial redundancies within an image and the filtering of high frequency areas
to which the eye is less sensitive. Using these techniques, the JPEG compression
standard is able to reduce the data necessary to represent an image without
significant degradation of image quality. Still images or motion video can be
compressed to varying degrees using JPEG, with greater compression resulting in
lower quality. Typically, four-to-one or five-to-one compression yields
broadcast image quality while 20-to-1 compression is similar to VHS quality.
ZORAN JPEG TECHNOLOGY. Our JPEG technology incorporates a proprietary bit
rate control algorithm that enables our JPEG-based products to compress any
image to a predetermined size while optimizing video quality using pre-selected
parameters. Without this feature, the JPEG compression process results in
compressed data files of various sizes based on the actual content of the
original image given a constant degree of compression. An image with large
amounts of visual detail will generate a larger data file than that generated
from an image with less detail. Performance of many video applications is
hampered by variability in the size of the compressed images in a video
sequence, which can result in inefficient use of available memory, bus speed or
communication channel capacity or even the loss of images. Our bit rate control
is a "standards-plus" solution that uses real-time digital signal processing
algorithms to optimize video quality based on pre-selected parameters, which can
be programmed by OEMs, without the loss of any image or video frame. Our bit
rate control has been incorporated in our JPEG-based devices that are used in
video editing systems, filmless and tapeless
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digital cameras, color scanners, PC-based security systems, video conferencing
and other applications. Other features of our JPEG-based products include their
ability to handle a wide range of compression ratios, to perform a "lossless"
compression algorithm in the same JPEG device and to rapidly scan or browse a
large number of images. We implement these functions in a single integrated
circuit while we believe most other manufacturers either offer fewer functions
or require multiple chips, resulting in higher manufacturing costs and greater
power consumption.
THE MPEG STANDARDS. In 1991, the Moving Pictures Expert Group, or MPEG,
Committee of the International Standards Organization completed a technical
specification for a standard to compress moving audio and video into a single
data stream. Like JPEG, MPEG 1 removes spatial redundancies from single frames
of video data. MPEG 1 improves on JPEG by also removing redundancies that occur
between consecutive video frames. Because video represents movement, it is
possible to detect and estimate the movement of similar picture elements between
video frames, a process called motion estimation. MPEG motion estimation uses
the content of previous and future frames to predict the content of the current
frame without using its full content. MPEG 1 implements audio compression by
exploiting psycho-acoustic masking, taking advantage of the fact that the ear is
less sensitive to a quiet note at one frequency when a much louder note is
present at a nearby frequency. MPEG 1 often achieves audio compression ratios of
six-to-one and video compression ratios of over 100-to-1. MPEG 1 is particularly
suitable for low-cost CD-ROM applications due to its low-cost implementation.
In 1993, the MPEG 2 video committee completed a technical specification to
address the more stringent requirements of the broadcast industry. MPEG 2
provides more sophisticated prediction techniques, enabling a compression
solution to comprehend video as interlaced fields of data, rather than
individual frames. MPEG 2 also allows for operation at higher resolution and at
higher bit rates than MPEG 1, resulting in improved image quality for high
motion, high detail video. MPEG 2 typically achieves compression ratios of
50-to-1. Because of its higher bit rate, MPEG 2 technology cannot be used in
standard CD-ROM applications, but can be used in DVD players.
ZORAN MPEG TECHNOLOGY. Beginning in 1997, we established ourselves as a
leading provider of MPEG 2 technology for DVD and Super Video CD applications.
We introduced the first DVD decoder device integrating digital video with
multi-channel digital audio and programmable audio effects for use in DVD
players. We also introduced new MPEG compression chip cores that can be
integrated into chips manufactured by OEM customers, enabling these customers to
reduce the cost of custom chip design and accelerate the time-to-market of their
products.
AUDIO TECHNOLOGY
THE DOLBY DIGITAL STANDARD. In 1992, Dolby Laboratories launched Dolby
Digital, an audio compression technique which has emerged as an industry
standard. Dolby Digital was developed as a successor to Dolby's Pro-Logic analog
technique for use in multi-channel digital surround sound systems. It is
currently used in movie theaters comprising over 24,000 screens worldwide and is
also used in home theater and computer multimedia applications. Digital
compression of audio data allows the storage of full quality multi-channel audio
playback in the limited space allocated for audio in video-oriented formats. It
also facilitates the seamless integration of sound with compressed video. The
Dolby Digital audio compression standard is currently the principal audio
compression technique used in DVD players. Dolby Digital has also been adopted
as a standard for use in high-definition television and digital cable systems.
OTHER AUDIO STANDARDS. Other digital audio compression standards currently
in use include DTS, an audio compression standard that competes with Dolby
Digital, MLP, a compression standard for DVD audio, and MP3, used for the
download of audio recordings from the Internet.
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ZORAN AUDIO TECHNOLOGY. Working closely with Dolby Laboratories, we have
developed a programmable audio digital signal processing engine with an
architecture optimized for Dolby Digital and other demanding audio applications
and we were the first to develop a single-chip solution for Dolby Digital
decoding. Zoran's Vaddis DVD decoders and audio processors now incorporate this
engine to allow systems manufacturers to replace system components with software
modules, differentiate their products from their competition, use our
SILICONSOFTWARE library of advanced audio algorithms, and reduce system costs
and time to market. In addition to Dolby Digital, our DVD decoders and audio
processors implement all principal audio compression standards, including DTS,
MLP and MP3. Our integrated circuits also include additional functions such as
Virtual Multi-Channel Digital, surround sound for headphones, High-Definition
CD, karaoke processing and speaker equalization.
PRODUCTS
Our multimedia product line consists of four principal product families:
- DVD/Super Video CD--audio and video decompression products based on MPEG,
Dolby Digital and DTS;
- Digital Audio--audio decompression products for use in products using
MPEG, Dolby Digital, DTS, MLP, MP3 and other audio technologies;
- Filmless Digital Cameras--video compression and decompression products
based on JPEG technology; and
- PC Video--video compression and decompression products based on JPEG
technology.
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The following table lists our principal multimedia integrated circuits
currently in production, including the months in which initial production units
were first made available to customers:
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INITIAL
PRODUCT COMMERCIAL PRINCIPAL
FAMILY PRODUCTS SHIPMENT APPLICATIONS
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DVD and Vaddis DVD decoder December 1997 DVD players
Super Video CD (ZR36700)
Vaddis III Integrated August 1998
DVD decoder
(ZR36710)
Vaddis IV Integrated June 1999
DVD decoder
(ZR36730)
SupraAV I Super Video August 1998 Super Video CD players
CD decoder (ZR36205)
SupraAV II Super Video September 1998
CD decoder (ZR36215)
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Digital Audio 6-channel Dolby December 1994 Home theater
Digital decoder
(ZR38500)
Programmable Digital December 1998 Digital speakers for
audio processor home theater,
(ZR38601) computers and gaming
consoles
Multi-standard December 1998 Audio/video receivers,
Programmable Digital 3D headphones
audio processor
(ZR38650)
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Filmless Digital Filmless digital February 1999 Filmless digital
Cameras camera cameras, security
processor--COACH
(ZR36400)
Filmless digital September 1999
camera
processor--COACH-XL
(ZR36410)
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PC Video JPEG codec (ZR36050) April 1993 PC video editing,
office automation
Integrated converter February 1995 Color scanners and
(ZR36016)* printers
JPEG codec (ZR36060) February 1997 PC video editing,
security
JPEG PCI multimedia September 1997 PC video editing
controller (ZR36067)
PCI multimedia March 1997 PC video capture
controller (ZR36125)
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* Designed and manufactured by a third party and sold by us under our name
pursuant to a non-exclusive license. See "Proprietary Rights and Licenses."
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DVD/SUPER VIDEO CD PRODUCTS. In 1997, we introduced the first member of our
Vaddis line of DVD decoders, the Vaddis I. During 1998, we introduced the Vaddis
II and Vaddis III, and in 1999 we introduced the Vaddis IV. Our Vaddis decoders
perform all the audio and video decoding and display requirements of the DVD
specification, including MPEG 2 audio and video decoding, Dolby Digital, DTS and
MLP audio decoding, on-screen display, decryption required for copyright
protection and presentation of graphic information. The Vaddis has additional
computation power that can be utilized for customer differentiation features.
For example, it can incorporate virtual surround sound algorithms without the
addition of hardware. This allows the user to enjoy the theater-like sound
obtained from six speakers using a system that includes only two speakers and
the Vaddis. The Vaddis IV incorporates a more powerful audio digital signal
processor that enables the support of advanced audio algorithms like MPEG 5.1,
DTS and audio DVD, which are needed in today's DVD player systems. Vaddis
decoders are being used in DVD players manufactured by Sharp, Toshiba and
others. The SupraAV is our single chip solution for the Super Video CD market.
This single chip performs all of the audio and video decoding required by the
Super Video CD standard and also allows additional features, like karaoke, to be
implemented without any additional hardware. We provide a full reference design
of a Super Video CD player, based on the SupraAV ZR36215, that helps our
customers accelerate their time to market for their players.
DIGITAL AUDIO PRODUCTS. The ZR38601, a single-chip digital audio processor
designed to support the growing PC and home theater digital speaker market,
takes advantage of most of the advanced audio algorithms included in our
SILICONSOFTWARE library. Its eight channel output architecture supports the
latest home theater applications, including Dolby Surround EX 6.1 channel sound.
The ZR38601's ability to accept six individual channels of audio input also
makes it the ideal processor for today's four channel Direct Sound computer
games. The ZR38650, a true multi-standard digital audio processor, takes
advantage of our complete SILICONSOFTWARE library. It is designed to support the
large mid and low range audio/video receiver market, while providing features
previously available only on more expensive models.
FILMLESS DIGITAL CAMERA PRODUCTS. Our JPEG technology is used in filmless
digital cameras. In September 1999, we introduced the Camera On A CHip, or
COACH--an integrated system on a chip solution that includes most of the
electronics of a filmless digital camera. The COACH can be connected directly to
a high-resolution (up to 4 mega pixel) CCD or CMOS sensor, process the video
information in real time, compress the captured image in real time to a Flash
memory, interface an LCD or micro display and interface to all types of flash
memory. Among the unique capabilities of the COACH is the ability to transfer in
real-time, over a USB bus, high quality video to the PC and thus serve also as a
PC video camera. The COACH also allows for direct connection to a printer,
including color correction and special effects, for the non-PC consumer
environment. The COACH is supplemented by a full filmless digital camera
reference design, "Cam ON," shortening the time to market for COACH customers.
PC VIDEO PRODUCTS. Our ZR36050 and ZR36060 codecs are
compression/decompression devices used for real time encoding and decoding of
JPEG video for editing applications. They are fully compliant with JPEG
standards. The ZR36050 and ZR36060 utilize our proprietary bit rate control
technology for high quality video capture. The ZR36050 also features a unique,
embedded, "lossless" mode that allows customers to elect to use low compression
ratio techniques that result in no data loss for applications where quality is
the primary consideration. The ZR36050 and ZR36060 can be installed in a chipset
that includes the ZR36067 motion controller for PCI board implementation or pre/
post-processing devices such as the ZR36016 integrated color
space/raster-to-block converter. The ZR36060 integrates the functions of the
ZR36050, ZR36015 and an additional SRAM device in a single chip. The ZR36067 is
a PCI motion JPEG controller targeting consumer-priced but professional quality
desktop PCI video editing systems.
11
INTEGRATED CIRCUIT CORES. We offer multimedia integrated circuit cores
which can be incorporated into our customers' chips. For example, our latest
generation programmable audio digital signal processor engine, the ZR39000,
offers extended processing power and software compatibility with all previous
generations of our digital audio processors, thus allowing it to use our
extensive SILICONSOFTWARE library. The ZR39000 is designed to be integrated into
DVD, television set-top box, home network, and Internet appliance
system-on-a-chip applications. Our video decoder core, the ZR4VD1, can be used
to reformat and process video from television-type analog format to digital
format, enabling video processing by PCs, digital televisions and other video
systems. Our video encoder core, the ZR4VE2, enables the conversion of various
digital video formats for display on televisions and PC monitors, and can be
integrated into graphics integrated circuits, digital televisions, television
set-top boxes and digital cameras.
CUSTOMERS
The following table lists representative customers, as well as other
OEMs who purchase our products through our distributors. Each of these customers
and OEMs has purchased, directly or indirectly, at least $100,000 of our
products from January 1, 1999 through December 31, 1999:
- --------------------------------------------------------------------------------------------------
PRODUCT FAMILY CUSTOMERS OTHER OEMS
- --------------------------------------------------------------------------------------------------
DVD/Super Video CD Cet Optibase Quisheng
Fly Ring Marketa Semiconductor Sharp
Digital Technology Newell Hong Kong Toshiba
Fujifilm Xiaxin
Holy Stone Enterprise
- --------------------------------------------------------------------------------------------------
Digital Audio Acoustic Accessories Dolby Laboratories Denon
Altec Lansing Fujifilm Hitachi
Amega Technology Gallant Computer
Antex Minton Optical Industry
Boston Acoustics Vtech Communications
Creative Technology Xiaxin
- --------------------------------------------------------------------------------------------------
PC Video Alcom Electronics Matrox Avid
Avermedia Technologies Newer Technology Lucent Technologies
Avex Electronics Optibase Silicon Graphics
Edge Electronics Pinnacle Systems Sony
Electronics For Imaging SCI Manufacturing Inc.
Flash Electronics Topas Electronic
Fujifilm Unique Technologies
Leadtek Research Inc.
- --------------------------------------------------------------------------------------------------
Filmless Digital Camera Kinpo Electronics Ltd. Primax Electronics Ltd.
- --------------------------------------------------------------------------------------------------
Fujifilm purchases our products primarily as a distributor and resells these
products, in many cases under its own trade name. Fujifilm acts as our primary
distributor in Japan and accounts for most of our product sales in Japan.
During 1998, sales to Fujifilm accounted for 22.7% of our total revenues,
including 26.5% of product sales, and sales to Pinnacle accounted for 14.3% of
revenues, including 18.8% of product sales. During 1999, sales to Fujifilm
accounted for 37.3% of our total revenues, including 41.0% of product sales.
During 1998, our four largest customers accounted for 45.7% of our revenues, and
during 1999, our four largest customers accounted for approximately 56.9% of our
revenues.
12
RESEARCH AND DEVELOPMENT
We believe that our future success depends on our ability to continue to
enhance our existing products and to develop new products that maintain
technological competitiveness and compliance with new standards in rapidly
evolving consumer-oriented digital audio and video markets. We attempt to
leverage our expertise in the fields of digital signal processing, integrated
circuit design, algorithms and software development to maintain our position as
a leader in the development of digital audio and video solutions enabled by
compression. Accordingly, we devote a significant portion of our resources to
maintaining and upgrading our products to reduce integrated circuit cost,
feature size, power consumption and the number of integrated circuits required
to perform compression and other functions necessary for the evolving digital
audio and video application markets. In addition, we seek to design integrated
circuits and cores, as well as copy-ready reference designs which can reduce the
time needed by manufacturers to integrate our products into their own products.
We have historically generated a significant percentage of our total
revenues from development contracts with our strategic partners. These
development contracts provide that we will receive payments upon reaching
certain development milestones and that we will retain ownership of the
intellectual property developed. Development contracts have enabled us to fund
portions of our product development efforts, to respond to the feature
requirements of our customers, to accelerate the incorporation of our products
into our customers' products and to accelerate the time-to-market of our
customers' products. We are currently developing new integrated circuits based
on MPEG and Dolby Digital compression standards pursuant to a development
contract with Fujifilm, under which Fujifilm is providing a portion of the
development funding. Fujifilm has participated directly in product definition
for these development programs and has the right to sell resulting products in
Japan under its distribution agreement with us. Fujifilm also has the right to
manufacture a portion of our requirements for which it has contributed
significant funding.
We are a party to research and development agreements with the Chief
Scientist in Israel's Ministry of Industry and Trade and the Israel-United
States Binational Industrial Research and Development Foundation. These
organizations fund up to 50% of incurred project costs for approved projects up
to contract maximums. The agreements require us to use our best efforts to
achieve specified results and to pay royalties at rates of 3% to 5% of resulting
product sales and up to 30% of resulting license revenues, up to a maximum of
100% to 150% of the total funding received. Reported research and development
expenses are net of these grants, which fluctuate from period to period. Total
grants earned in 1998 were $851,000 and in 1999 were $484,000. No grants were
earned in 1997. The terms of Israeli Government participation also contain
restrictions on the location of research and development activities, and the
terms of the grants from the Chief Scientist prohibit the transfer of technology
developed pursuant to these grants to any person without the prior written
consent of the Chief Scientist. We are currently engaged in the development of
improvements to our Camera On A CHip, or COACH, technology under grant from the
Chief Scientist. Although we have received grants from the Chief Scientist and
the Foundation in the past, we intend to fund future research and development
efforts for new products primarily from our own funds and through research and
development arrangements with our major OEM customers.
As of December 31, 1999, we had a staff of 75 full-time and 27 part-time
research and development personnel, 98 of whom are based in Israel.
SALES AND MARKETING
Our sales and marketing strategy is to focus on providing compression
solutions for manufacturers seeking to design audio and video products for
emerging high volume consumer applications. In cooperation with leading
manufacturers of audio and video equipment in the commercial and consumer
markets, we attempt to identify market segments which have the potential for
substantial growth. To implement our strategy, we have established a direct
sales force located at several sales and marketing
13
offices, and a worldwide network of independent sales representatives and
distributors. In some cases, our strategic partners also provide sales and
marketing support.
We work closely in the product development process with strategic partners
to incorporate our integrated circuits and software into their products.
Potential products are designed to meet customer-specific product requirements
defined jointly by us and our strategic partners with our partners providing
technological input, and in some cases, a portion of the development funding.
This strategy has permitted us to develop products with substantial financial
and other assistance, while retaining ownership of the technology and ensuring
an established customer for the product once development is completed. In
addition, our application engineers assist customers in designing their products
to incorporate our integrated circuits.
Our sales are generally made pursuant to purchase orders received between
one and six months prior to the scheduled delivery date. We sell our products
primarily through our 12-person direct sales staff, of whom nine are located in
the United States and three are located in Israel. Our United States sales staff
is primarily responsible for sales in North America, South America and Asia, and
our Israeli sales staff is primarily responsible for sales in Europe and the
Middle East. In addition, we sell our products indirectly through 23
commissioned sales representatives as well as selected distributors. We
typically warrant our products for a 12-month period. To date, we have not
experienced material product returns or warranty expense.
During 1998, we opened an office in Shenzhen, China as part of our effort to
capture a leadership position in the Chinese digital audio and video markets. As
of December 31, 1999, we had a staff of 18 employees in our China office,
including sales, applications and customer support employees.
We distribute our integrated circuit products in Japan primarily under an
agreement with Fujifilm. Under this agreement, Fujifilm acts as the primary
distributor in Japan of products developed by us under development contracts
with Fujifilm. Fujifilm also sells some of these products in Japan under its own
name. We may sell these products directly in Japan only to specified customers
and must first buy the products from Fujifilm. Fujifilm also has a nonexclusive
license to distribute most of our products outside of Japan. During 1997, we
opened a representative office in Tokyo to help promote our products in Japan
and to manage the sale of products not sold through Fujifilm, such as integrated
circuit cores and certain JPEG products.
We sell our Dolby Digital-based products under a perpetual, non-exclusive
license from Dolby to sell products that incorporate the Dolby Digital
algorithm. We are not required to pay license fees or royalties to Dolby under
this agreement. Our customers enter into license agreements directly with Dolby,
pursuant to which they pay royalties to Dolby. Under our agreement with Dolby,
we may sell our Dolby Digital-based products only to customers who are licensees
of Dolby. To date, most potential customers for our Dolby Digital-based products
are licensees of Dolby. However, the failure or refusal of potential customers
to enter into license agreements with Dolby in the future could harm our sales.
BACKLOG
Sales of our products are made pursuant to firm purchase orders. However,
sometimes we allow customers to cancel or reschedule deliveries. In addition,
purchase orders are subject to price renegotiations and to changes in quantities
of products ordered as a result of changes in customers' requirements and
manufacturing availability. Our business is characterized by short lead times
and quick delivery schedules. As a result of these factors, we do not believe
that backlog at any given time is a meaningful indicator of future sales.
MANUFACTURING
We contract our wafer fabrication, assembly and testing to independent
foundries and contractors, which enables us to focus on our design strengths,
minimize fixed costs and capital expenditures and
14
gain access to advanced manufacturing facilities. Our engineers work closely
with our foundry partners and subcontractors to increase yields, lower
manufacturing costs and assure quality.
Our primary foundry is Taiwan Semiconductor Manufacturing Company, or TSMC,
which has manufactured integrated circuits for us since 1987. TSMC is currently
manufacturing our DVD, audio and JPEG products. In addition, Fujifilm and
Samsung manufacture some integrated circuit products for us. Fujifilm is
currently manufacturing our JPEG codec, our JPEG-based converter products and
our MPEG 1 decoder. Samsung is currently manufacturing our COACH products. Our
independent foundries fabricate products for other companies and may also
produce products of their own design.
All of our devices are currently fabricated using standard complementary
metal oxide semiconductor process technology with 0.25 micron to 0.8 micron
feature sizes. All of our semiconductor products are currently being assembled
by one of three independent contractors, ASE, Amkor or ASAT, and tested by those
contractors or other independent contractors.
Our ZR36050 JPEG codec was developed jointly with Fujifilm and is currently
manufactured by Fujifilm pursuant to an agreement that grants Fujifilm the right
to manufacture up to 80% of our requirements for this product subject to
Fujifilm's ability to manufacture the product on substantially the same or
better terms and conditions as we could obtain from a third party. This
agreement also grants Fujifilm marketing rights in Japan with respect to these
products. See "Sales and Marketing."
We currently purchase products from all of our foundries under individually
negotiated purchase orders. Our agreement with Fujifilm entitles us to obtain
wafer foundry services from Fujifilm on most favored pricing and availability
terms, subject to Fujifilm's technological capabilities and reasonable
limitations as to quality and delivery terms requested by us.
We do not currently have a long-term supply contract with TSMC or Samsung,
and therefore neither TSMC nor Samsung is obligated to manufacture products for
us for any specific period, in any specific quantity or at any specified price,
except as may be provided in a particular purchase order.
COMPETITION
Our existing and potential competitors include many large domestic and
international companies that have substantially greater resources in the areas
of:
- finance;
- manufacturing;
- technology;
- marketing; and
- distribution.
These competitors also have broader product lines and longer standing
relationships with customers than we do. Some of our principal competitors
maintain their own semiconductor foundries and may therefore benefit from
capacity, cost and technical advantages. In the market for JPEG-based products
for desktop video editing applications, our principal competitors are C-Cube
Microsystems and LSI Logic. Cirrus Logic (Crystal Semiconductor), Fujitsu,
Motorola, STMicroelectronics and Yamaha are currently shipping Dolby
Digital-based audio compression products. C-Cube, ESS, LSI Logic, LuxSonor,
Matsushita, National Semiconductor, Oak Technology, STMicroelectronics, Sony and
Winbond have introduced integrated audio and video devices for DVD and Super
video CD applications. These manufacturers, as well as others, are licensed by
Dolby to incorporate Dolby Digital technology in their products. In addition,
some manufacturers, including Sony, incorporate compression technologies other
than Dolby Digital in audio products that compete with products using our
integrated circuits. In the markets for JPEG-based products for use in filmless
digital cameras, our
15
principal competitors are in-house solutions developed and used by major
Japanese OEMs. LSI Logic and Ricoh are providing system-on-a-chip solutions for
filmless digital cameras to third parties. In the market for MPEG-based chip
core products, our principal competitors are David Sarnoff Research Center and
SICAN Microelectronics.
We believe that our ability to compete successfully in the rapidly evolving
markets for high performance audio and video compression technology depends on a
number of factors, including:
- price, quality, performance and features of our products;
- the timing and success of new product introductions by us, our customers
and our competitors;
- the emergence of new industry standards;
- our ability to obtain adequate foundry capacity;
- the number and nature of our competitors in a given market; and
- general market and economic conditions.
The markets in which we compete are intensely competitive and are
characterized by rapid technological change, declining average unit selling
prices and rapid product obsolescence. We expect competition to increase in the
future from existing competitors and from other companies that may enter our
existing or future markets with solutions which may be less costly or provide
higher performance or more desirable features than our products.
The DVD market is just emerging, and additional competitors are expected to
enter the market for integrated circuits used in DVD players. We believe that
several large Japanese consumer electronics companies may be planning to enter
this market and may attempt to develop MPEG 2 hardware or software to compete
with our products. Some of these potential competitors may develop captive
implementations for use only with their own PC and commercial and consumer
electronics products. This increased competition may result in price reductions,
reduced profit margins and loss of market share.
Historically, average unit selling prices in the semiconductor industry in
general, and for our products in particular, have decreased over the life of a
particular product. We expect that the average unit selling prices of our
products will continue to be subject to significant pricing pressures. In order
to offset expected declines in the average unit selling prices of our products,
we will likely need to reduce the cost of our products. We intend to accomplish
this by implementing design changes that lower the cost of manufacture, assembly
and testing, by negotiating reduced charges by our foundries as and if volumes
increase, and by successfully managing our manufacturing and subcontracting
relationships. Since we do not operate our own manufacturing, assembly or
testing facilities, we may not be able to reduce our costs as rapidly as
companies that operate their own facilities. If we fail to introduce lower cost
versions of our products in a timely manner or to successfully manage our
manufacturing, assembly and testing relationships our business would be harmed.
PROPRIETARY RIGHTS AND LICENSES
Our ability to compete successfully is dependent in part upon our ability to
protect our proprietary technology and information. Although we rely on a
combination of patents, copyrights, trademarks, trade secret laws and licensing
arrangements to protect some of our intellectual property, we believe that
factors such as the technological and creative skills of our personnel and the
success of our ongoing product development efforts are more important in
maintaining our competitive position. We generally enter into confidentiality or
license agreements with our employees, distributors, customers and potential
customers and limit access to our proprietary information. We currently hold
several U.S. patents, and have additional patent applications pending, that
pertain to technologies and processes relating to our current business. Our
intellectual property rights, if challenged, may not be upheld as
16
valid, may not be adequate to prevent misappropriation of our technology or may
not prevent the development of competitive products. Additionally, we may not be
able to obtain patents or other intellectual property protection in the future.
In particular, the existence of several consortiums that license patents
relating to the MPEG standard has created uncertainty with respect to the use
and enforceability of patents implementing that standard. Furthermore, the laws
of certain foreign countries in which our products are or may be developed,
manufactured or sold, including various countries in Asia, may not protect our
products or intellectual property rights to the same extent as do the laws of
the United States and thus make the possibility of piracy of our technology and
products more likely in these countries.
We sell our Dolby Digital-based products under a perpetual non-exclusive
license from Dolby which permits us to incorporate the Dolby Digital algorithm
into our products. Our customers enter into license agreements with Dolby
pursuant to which they pay royalties directly to Dolby. Under our agreement with
Dolby, we may sell our Dolby Digital-based products only to customers who are
licensees of Dolby. To date, most potential customers for our Dolby
Digital-based products are licensees of Dolby. However, the failure or refusal
of potential customers to enter into license agreements with Dolby in the future
could harm our business.
The semiconductor industry is characterized by vigorous protection and
pursuit of intellectual property rights, which have resulted in significant and
often protracted and expensive litigation. We or our foundries from time to time
are notified of claims that we may be infringing patents or other intellectual
property rights owned by third parties. We have been subject to intellectual
property claims and litigation in the past and we may be subject to additional
claims in the future. In particular, given the uncertainty discussed above
regarding patents relating to the MPEG standard, it is difficult for us to
assess the possibility that our activities in the MPEG field may give rise to
future patent infringement claims. Litigation by or against us relating to
patent infringement or other intellectual property matters could result in
significant expense to us and divert the efforts of our technical and management
personnel, whether or not such litigation results in a determination favorable
to us. In the event of an adverse result in any such litigation, we could be
required to pay substantial damages, cease the manufacture, use and sale of
infringing products, expend significant resources to develop non-infringing
technology, discontinue the use of certain processes or obtain licenses to the
infringing technology. Licenses may not be offered or the terms of any offered
licenses may not be acceptable to us. If we fail to obtain a license from a
third party for technology used by us we could incur substantial liabilities and
to suspend the manufacture of products, or the use by our foundries of certain
processes.
EMPLOYEES
As of December 31, 1999, we had 152 full-time and 37 part-time and contract
employees, including 75 full-time and 27 part-time and contract employees
primarily involved in research and development activities, 53 in marketing and
sales, 24 in finance and administration and 10 in manufacturing control and
quality assurance. We have 88 full-time employees and 29 part-time and contract
employees based in Israel, including 98 employees who are primarily involved in
engineering and research and development. There are 48 individuals at our
facilities in Santa Clara, California. The remaining employees are located in
our international offices in Canada, Japan and China. We believe that our future
success will depend in large part on our ability to attract and retain
highly-skilled, engineering, managerial, sales and marketing personnel.
Competition for such personnel is intense. Our employees are not represented by
any collective bargaining unit, and we have never experienced a work stoppage.
We believe that our employee relations are good.
17
ITEM 2. PROPERTIES.
Our executive offices, our principal administration, marketing and sales
operations and a portion of our research and development operations are located
in approximately 24,000 square feet of leased space in Santa Clara, California
under a lease expiring in March 2000. We have completed negotiating a renewal of
this lease that will expire in March 2003. Our principal research and
development and engineering facilities and the balance of our administration,
marketing and sales operations are located in approximately 20,000 square feet
of leased space in an industrial park in Haifa, Israel under a lease expiring in
2004. The aggregate annual gross rent for our facilities was approximately
$1,010,000 in 1999. We also lease sales offices in Tokyo, Japan and Shenzhen,
China. See Note 7 of Notes to Consolidated Financial Statements. We believe that
our current facilities are adequate for our needs for the foreseeable future and
that, should it be needed, suitable additional space will be available to
accommodate expansion of our operations on commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS.
We are not a party to any pending legal proceedings which we believe will
materially affect our financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
We did not submit any matters to a vote of security holders during the
fourth quarter of the year ended December 31, 1999.
EXECUTIVE OFFICERS
The names of our executive officers and their ages as of December 31, 1999
are as follows:
NAME AGE POSITION
- ---- -------- ------------------------------------------------------------
Levy Gerzberg, Ph.D............ 54 President, Chief Executive Officer and Director
Aharon Aharon.................. 46 Senior Vice President and Chief Operating Officer
Isaac Shenberg, Ph.D........... 49 Senior Vice President, Business and Strategic Development
Bruce Renouard................. 39 Vice President, Worldwide Sales
Paul R. Goldberg............... 54 Vice President, Audio Products and Intellectual Properties
Karl Schneider................. 45 Vice President, Finance and Chief Financial Officer
Shmuel Farkash, Ph.D........... 43 Vice President, Video Products
Alon Ironi..................... 36 Vice President, Engineering, General Manager, Israel
LEVY GERZBERG was a co-founder of Zoran in 1981 and has served as our
President and Chief Executive Officer since December 1988 and as a director
since 1981. Dr. Gerzberg also served as our President from 1981 to 1984 and as
our Executive Vice President and Chief Technical Officer from 1985 to 1988.
Prior to co-founding Zoran, Dr. Gerzberg was Associate Director of Stanford
University's Electronics Laboratory. Dr. Gerzberg holds a Ph.D. in Electrical
Engineering from Stanford University and an M.S. in Medical Electronics and a
B.S. in Electrical Engineering from the Technion-Israel Institute of Technology
in Haifa, Israel.
AHARON AHARON joined Zoran as Vice President, Engineering--Haifa Operations
in February 1997 and was elected Vice President, Engineering in August 1997 and
Senior Vice President and Chief Operating Officer in October 1998. From 1983 to
February 1997, Mr. Aharon was employed by IBM in a variety of engineering and
management positions, including Senior Manager of VLSI Design Tools from 1993 to
February 1997 and Design Automation Manager from 1989 to 1993. Mr. Aharon holds
a B.S. and M.S. in Electrical Engineering from the Technion.
18
ISAAC SHENBERG has served as Vice President, Sales and Marketing of Zoran
since January 1995 and as Senior Vice President, Business and Strategic
Development since October 1998. From August 1990 to January 1995, Dr. Shenberg
served as our Product Line Business Manager. Dr. Shenberg holds a Ph.D. in
Electrical Engineering from Stanford University and a B.S. and M.S. in
Electrical Engineering from the Technion.
BRUCE RENOUARD joined Zoran as Vice President, Worldwide Sales in
September 1999. From August 1997 to September 1999, Mr. Renouard served as
Director of Worldwide Market Development for IDT/Centour, a semiconductor
company. From December 1995 to August 1997, Mr. Renouard served as National
Distribution Sales Manager of Cyrix Corporation, a semiconducter company. From
April 1993 to December 1995, Mr. Renouard served as District Sales Manager for
Cyrix. Mr. Renouard holds a B.S.E.E. in Electrical Engineering from Southern
Methodist University.
PAUL R. GOLDBERG joined Zoran as Vice President, Systems Solutions in
June 1996 and was elected Vice President, Audio Products in October 1998. From
April 1991 to June 1996, Mr. Goldberg was employed as film products group leader
at Dolby Laboratories, Inc. From 1988 to 1990, Mr. Goldberg was Director of the
Tandy Electronic Research Center. From 1979 to 1988, Mr. Goldberg was employed
by Wavetek Incorporated and its spin-off, Advanced Image Data, most recently as
Vice President of Research and Development and Market Development of AID. Prior
thereto, Mr. Goldberg was employed by Smith Kline Instruments, most recently as
Director of Biomedical Research and Development. Mr. Goldberg holds a B.S. in
Electrical Engineering from the University of Minnesota.
KARL SCHNEIDER joined Zoran as Corporate Controller in January 1998 and was
elected Vice President, Finance and Chief Financial Officer in July 1998. From
September 1996 through 1997, Mr. Schneider served as Controller for the Film
Measurement and Robotics and Integrated Technologies divisions of KLA-Tencor, a
semiconductor equipment company. Mr. Schneider served as the Corporate
Controller for SCM Microsystems, Inc. from October 1995 to September 1996,
Controller for Reply Corporation from January 1994 to September 1995, Director
of Finance for Digital F/X from October 1992 to January 1994 and Controller for
Flextronics from September 1987 through June 1991. Mr. Schneider holds a B.S. in
Business Administration from San Diego State University.
SHMUEL FARKASH joined Zoran in March 1992 as a senior research and
development engineer. In February 1994 Dr. Farkash became our marketing and
sales manager for Europe. In June 1996 Dr. Farkash became Director of Marketing
for the JPEG product line. In July 1998, Dr. Farkash was elected Vice President,
Video Products, with responsibilities for the JPEG and DVD product lines.
Dr. Farkash holds a Ph.D., M.S., and a B.S. in Electrical Engineering from the
Technion.
ALON IRONI joined Zoran as a system engineer in March 1993. Mr. Ironi
subsequently served as our Manager, System Engineering and Manager, Architecture
and Algorithms. Mr. Ironi was elected Vice President, Engineering, Israel in
January 1999. From March 1990 to March 1993, Mr. Ironi served as a DSP software
engineer for the DSP Group. Mr. Ironi holds a B.S. in Electrical Engineering
from the Technion.
19
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS.
We effected our initial public offering of our common stock on December 15,
1995. Since that date, our common stock has been quoted on the Nasdaq National
Market under the symbol "ZRAN." The following table sets forth the high and low
closing sales price of our common stock as reported as The Nasdaq National
Market for the periods indicated:
HIGH LOW
-------- --------
1999:
First Quarter............................................... $20.00 $11.88
Second Quarter.............................................. $17.50 $ 8.88
Third Quarter............................................... $35.81 $17.06
Fourth Quarter.............................................. $55.75 $21.00
1998:
First Quarter............................................... $18.25 $12.50
Second Quarter.............................................. $14.75 $ 9.50
Third Quarter............................................... $12.06 $ 5.88
Fourth Quarter.............................................. $18.00 $ 5.19
As of December 31, 1999, there were 271 holders of record of our common
stock.
We have never paid cash dividends on our capital stock. It is our present
policy to retain earnings to finance the growth and development of our business
and, therefore, we do not anticipate paying any cash dividends in the
foreseeable future.
20
ITEM 6. SELECTED FINANCIAL DATA.
The following selected consolidated financial data should be read in
conjunction with the consolidated financial statements and the notes thereto
included elsewhere herein.
YEAR ENDED DECEMBER 31,
----------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
(In thousands, except per share data)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues:
Product sales................................ $52,887 $33,465 $32,717 $35,503 $18,086
Software, licensing and development.......... 8,787 10,760 12,210 8,606 5,378
------- ------- ------- ------- -------
Total revenues............................. 61,674 44,225 44,927 44,109 23,464
------- ------- ------- ------- -------
Costs and expenses:
Cost of product sales........................ 28,523 19,036 16,032 20,262 9,306
Research and development..................... 12,651 13,548 13,787 8,954 5,916
Selling, general and administrative.......... 14,251 11,551 11,209 10,739 6,748
Merger and related........................... -- -- -- 2,153 --
------- ------- ------- ------- -------
Total costs and expenses................... 55,425 44,135 41,028 42,108 21,970
------- ------- ------- ------- -------
Operating income............................... 6,249 90 3,899 2,001 1,494
Interest and other income (expense), net....... 1,585 1,071 1,258 1,027 (147)
------- ------- ------- ------- -------
Income before income taxes..................... 7,834 1,161 5,157 3,028 1,347
Provision for income taxes..................... 1,175 232 928 665 399
------- ------- ------- ------- -------
Net income..................................... $ 6,659 $ 929 $ 4,229 $ 2,363 $ 948
======= ======= ======= ======= =======
Basic net income per share(1).................. $ 0.61 $ 0.09 $ 0.45 $ 0.27 $ 0.35
======= ======= ======= ======= =======
Diluted net income per share(1)................ $ 0.54 $ 0.08 $ 0.38 $ 0.22 $ 0.11
======= ======= ======= ======= =======
Shares used to compute basic net income per
share(1)..................................... 10,844 10,042 9,412 8,802 2,391
======= ======= ======= ======= =======
Shares used to compute diluted net income per
share(1)..................................... 12,249 11,119 11,072 10,661 8,397
======= ======= ======= ======= =======
DECEMBER 31,
----------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
(In thousands)
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term
investments.............................. $145,632 $ 19,175 $ 22,376 $ 23,419 $ 21,438
Working capital............................ 157,583 30,830 28,582 24,673 19,753
Total assets............................... 182,468 49,170 50,944 41,382 31,264
Long-term debt, less current portion....... -- -- -- -- 601
Accumulated deficit........................ (37,517) (44,176) (45,105) (49,334) (51,697)
Total stockholders' equity................. 163,445 36,186 34,286 28,530 20,917
- ------------------------
(1) See Note 2 of Notes to Consolidated Financial Statements for a description
of the computation of the number of shares and net income per share.
21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
From our inception in 1981 through 1991, we derived the substantial majority
of our revenue from digital filter processors and vector signal processors used
principally in military, industrial and medical applications. In 1989, we
repositioned our business to develop and market data compression products for
the evolving multimedia markets and discontinued development of digital filter
processor and vector signal processor products. In 1994, we discontinued
production of these products. Our current lines of digital audio and video
products include integrated circuits and related products used in digital
versatile disc players, movie and home theater systems, filmless digital cameras
and video editing systems.
In December 1996, we expanded our compression based product offerings
through the acquisition of CompCore Multimedia, a provider of software-based
compression products and cores for audio and video decoder integrated circuits.
We derive most of our revenues from the sale of our integrated circuit
products. Historically, average selling prices in the semiconductor industry in
general, and for our products in particular, have decreased over the life of a
particular product. Average selling prices for our hardware products have
fluctuated substantially from period to period, primarily as a result of changes
in our customer mix of original equipment manufacturer, or OEM, sales versus
sales to distributors and the transition from low-volume to high-volume
production. During 1997 and 1998, we reduced the prices of some of our products
in order to better penetrate the consumer market. We believe that, as our
product lines continue to mature and competitive markets evolve, we are likely
to experience further declines in the average selling prices of our products,
although we cannot predict the timing and amount of such future changes with any
certainty.
Our cost of product sales consists primarily of fabrication costs, assembly
and test costs, and the cost of materials and overhead from operations. If we
are unable to reduce our cost of product sales to offset anticipated decreases
in average selling prices, our product gross margins will decrease. Our product
gross margin is also dependent on product mix and on the percentage of products
sold directly to our OEM customers versus indirectly through our marketing
partners who purchase our products at lower prices but absorb most of the
associated marketing and sales support expenses, maintain inventories and
provide customer support and training. Lower gross margins on sales to
distributors are partially offset by reduced selling and marketing expenses
related to such sales. Product sales in Japan are primarily made through
Fujifilm, our strategic partner and distributor in Japan. Fujifilm provides more
sales and marketing support than our other distributors. We expect both product
and customer mix to continue to fluctuate in future periods, causing further
fluctuations in margins.
We also derive revenue from licensing our software and other intellectual
property. Licensing revenue includes one-time license fees and royalties based
on the number of units distributed by the licensee. In addition, we have
historically generated a significant percentage of our total revenues from
development contracts, primarily with key customers, although development
revenue has declined as a percentage of total revenues over the past several
years. These development contracts have provided us with partial funding for the
development of some of our products. These development contracts provide for
license and milestone payments which are recorded as development revenue. We
classify all development costs, including costs related to these development
contracts, as research and development expenses. We retain ownership of the
intellectual property developed by us under these development contracts. While
we intend to continue to enter into development contracts with certain strategic
partners, we expect development revenue to continue to decline as a percentage
of total revenues.
Our research and development expenses consist of salaries and related costs
of employees engaged in ongoing research, design and development activities and
costs of engineering materials and supplies. We are also a party to research and
development agreements with the Chief Scientist in Israel's
22
Ministry of Industry and Trade and the Israel-United States Binational
Industrial Research and Development Foundation, which fund up to 50% of incurred
project costs for approved products up to specified contract maximums. These
agreements require us to use our best efforts to achieve specified results and
require us to pay royalties at rates of 3% to 5% of resulting product sales, and
up to 30% of resulting license revenues, up to a maximum of 100% to 150% of
total funding received. Reported research and development expenses are net of
these grants, which fluctuate from period to period. We believe that significant
investments in research and development are required for us to remain
competitive and we expect to continue to devote significant resources to product
development, although such expenses as a percentage of total revenues may
fluctuate.
Our selling, general and administrative expenses consist primarily of
employee-related expenses, royalties, sales commissions, product promotion and
other professional services. We expect that selling, general and administrative
expenses will continue to increase to support our anticipated growth.
We conduct a substantial portion of our research and development and certain
sales and marketing and administrative operations in Israel through our
wholly-owned Israeli subsidiary. As a result, some of our expenses are incurred
in New Israeli Shekels. To date, substantially all of our product sales and our
development and licensing revenue have been denominated in U.S. dollars and most
costs of product sales have been incurred in U.S. dollars. We expect that most
of our sales and costs of sales will continue to be denominated and incurred in
U.S. dollars for the foreseeable future. We have not experienced material losses
or gains as a result of currency exchange rate fluctuations and have not engaged
in hedging transactions to reduce our exposure to such fluctuations. We may in
the future elect to take appropriate action to reduce our foreign exchange risk.
Our effective income tax rate has benefited from the availability of net
operating losses which we have utilized to reduce taxable income for U.S.
federal income tax purposes and by our Israeli subsidiary's status as an
"Approved Enterprise" under Israeli law, which provides a ten-year tax holiday
for income attributable to a portion of our operations in Israel. Our U.S.
federal net operating losses expire at various times between 2000 and 2009, and
the benefits from our subsidiary's Approved Enterprise status expire at various
times beginning in 2003.
In June 1999, we sold to MGI Software of Canada the intellectual property
related to our SoftDVD product line and transferred to MGI certain related
software development and support resources in exchange for cash, MGI common
stock and future royalties. Our results for the second quarter of 1999 include a
$732,000 gain realized from this transaction which is reported as part of
interest and other income or expense. In connection with this transaction, we
also recorded a charge that reduced software, licensing and development revenue
for the quarter by $517,000 for possible issues related to receivables
associated with the SoftDVD product line. The net impact of the MGI transaction
on our operating results was an after-tax gain of $172,000, or $0.01 per share
on a diluted basis. This gain does not reflect the potential future economic
benefit that may be derived from this transaction and realized in future periods
in the form of royalties. We do not currently expect, however, that these
royalties will have a material impact on quarterly revenues for the foreseeable
future. In addition, the shares of MGI stock received by us as part of this
transaction are subject to future appreciation or depreciation. Our software
revenues have declined significantly as a result of the sale of the SoftDVD
product line.
23
RESULTS OF OPERATIONS
The following table sets forth certain consolidated statement of operations
data as a percentage of total revenues for the periods indicated:
YEAR ENDED DECEMBER 31,
------------------------------------
1999 1998 1997
-------- -------- --------
Revenues:
Product sales...................................... 85.8% 75.7% 72.8%
Software, licensing and development................ 14.2 24.3 27.2
----- ----- -----
Total revenues................................... 100.0 100.0 100.0
----- ----- -----
Costs and expenses:
Cost of product sales.............................. 46.3 43.0 35.7
Research and development........................... 20.5 30.7 30.7
Selling, general and administrative................ 23.1 26.1 24.9
----- ----- -----
Total costs and expenses......................... 89.9 99.8 91.3
----- ----- -----
Operating income..................................... 10.1 0.2 8.7
Interest and other income (expense), net............. 2.6 2.4 2.8
Income before income taxes........................... 12.7 2.6 11.5
Provision for income taxes........................... 1.9 0.5 2.1
----- ----- -----
Net income........................................... 10.8% 2.1% 9.4%
===== ===== =====
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
REVENUES. Total revenues increased by 39.5% to $61.7 million in 1999 from
$44.2 million in 1998. Product sales increased by 58.0% to $52.9 million in 1999
from $33.5 million in 1998. The increase in product sales resulted primarily
from increased unit sales of DVD and Super Video CD products. Software,
licensing and development revenues decreased by 18.3% to $8.8 million in 1999
from $10.8 million in 1998. This decrease was principally due to a decline in
software licensing revenues following the sale of our SoftDVD product line in
June 1999 and, to a lesser degree, a decline in development revenue. These
decreases were partially offset by increased revenues from licenses of our
integrated circuit cores.
PRODUCT GROSS MARGIN. Product gross margin increased to 46.1% for 1999
compared to 43.1% for 1998. The increase was due to a shift in product mix to a
higher percentage of higher-margin products, a shift in customer mix to a
greater percentage of direct sales to OEM customers and lower per-unit
manufacturing costs as a result of increased unit sales.
RESEARCH AND DEVELOPMENT. Research and development ("R&D") expenses
decreased by 6.6% to $12.7 million in 1999 from $13.5 million in 1998. R&D
expenses in 1999 were net of reimbursements in the amounts of $484,000 under
product development agreements with the Chief Scientist. For 1998, Chief
Scientist reimbursements were $851,000. Gross R&D expenses decreased as a result
of a decline in software development activities in the second half of the year
following the sale of our SoftDVD product line in June 1999. R&D expenses
decreased as a percentage of total revenues to 20.5% in 1999, compared to 30.6%
in 1998.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
("SG&A") expenses increased by 23.4% to $14.3 million in 1999 from
$11.5 million in 1998. The increase was primarily due to increased sales and
marketing expenses related to product market development and to support planned
revenue growth in China.
24
INTEREST AND OTHER INCOME (EXPENSE), NET. Net interest and other income
increased by 48.0% to $1.6 million in 1999 from $1.1 million in 1998. The
increase resulted primarily from a $732,000 gain realized from the sale of our
SoftDVD product line in the second quarter of 1999.
PROVISION FOR INCOME TAXES. Our estimated effective tax rate decreased to
15.0% for 1999 from 20.0% in 1998. The decrease reflects our income tax
expectation going forward based on increasing foreign operations taxed at lower
rates.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
REVENUES. Total revenues decreased by 1.6% to $44.2 million in 1998 from
$44.9 million in 1997. Product sales increased by 2.3% to $33.5 million in 1998
from $32.7 million in 1997. The increase in product sales resulted primarily
from increased unit sales of DVD and Super Video CD products. Software,
licensing and development revenues decreased by 11.9% to $10.8 million in 1998
from $12.2 million in 1997. This decrease was due to a reduction in royalties
from our SoftPEG product.
PRODUCT GROSS PROFIT. Product gross margin decreased by 15.5% to 43.1% in
1998, compared to 51.0% in 1997. The decrease was due to a product sales mix
that included an increased percentage of lower margin products, and higher
manufacturing costs during 1998.
RESEARCH AND DEVELOPMENT. R&D expenses decreased by 1.7% to $13.5 million
in 1998 from $13.8 million in 1997. R&D expenses in 1998 were net of
reimbursements in the amounts of $851,000 under product development agreements
with the Chief Scientist. There were no such reimbursements during 1997. Gross
R&D expenses increased as a result of our planned enhancement to our technology
and development capabilities. R&D expenses decreased as a percentage of total
revenues to 30.6% in 1998, compared to 30.7% in 1997.
SELLING, GENERAL AND ADMINISTRATIVE. SG&A expenses increased by 3.1% to
$11.5 million in 1998 from $11.2 million in 1997. The increase was primarily due
to increased sales and marketing expenses related to product market development
and to support planned revenue growth in China.
INTEREST AND OTHER INCOME (EXPENSE), NET. Net interest and other income
decreased by 14.9% to $1.1 million in 1998 from $1.3 million in 1997. The
decrease resulted primarily from decreased interest income as a result of lower
balances of cash, cash equivalents and short-term investments.
PROVISION FOR INCOME TAXES. Our estimated effective tax rate increased to
20.0% for 1998 from 18.0% in 1997.
LIQUIDITY AND CAPITAL RESOURCES
During 1999 and 1998, our capital requirements were satisfied primarily by
cash flows from operations. In December 1999, we received net proceeds of
$112.9 million from a public offering of our common stock. At December 31, 1999,
we had $12.7 million of cash and cash equivalents, $133.0 million of short-term
investments and $157.6 million of working capital.
Our operating activities provided cash of $7.0 million during the twelve
months ended December 31, 1999, primarily due to net income. An increase in
accounts receivable, due to the increase in revenues during 1999, was offset by
increases in accrued expenses, accounts payable and by the non-cash impact of
depreciation and amortization.
Cash used in investing activities was $118.2 million during the twelve
months ended December 31, 1999. Capital equipment expenditures accounted for
$2.8 million of the cash used while the purchase of short-term investments used
$115.4 million.
25
Cash provided by financing activities was $115.6 million for the twelve
months ended December 31, 1999 and primarily consisted of net proceeds of
$112.9 million from our public offering of common stock in December 1999. Net
proceeds are what we received after paying the underwriting discount and other
expenses for this offering. Cash provided by financing activities also consisted
of proceeds from the issuance of common stock under our incentive stock option
and employee stock purchase plans.
We believe that our current balances of cash, cash equivalents and
short-term investments, and anticipated cash flow from operations, will satisfy
our anticipated working capital and capital expenditure requirements at least
through 2000. Nonetheless, our future capital requirements may vary materially
from those now planned and will depend on many factors including, but not
limited to:
- the levels at which we maintain inventory and accounts receivable;
- the market acceptance of our products;
- the levels of promotion and advertising required to launch our new
products or to enter markets and attain a competitive position in the
marketplace;
- our business, product, capital expenditure and research and development
plans and technology roadmap;
- volume pricing concessions;
- capital improvements to new and existing facilities;
- technological advances;
- the response of competitors to our products; and
- our relationships with our suppliers and customers.
In addition, we may require an increase in the level of working capital to
accommodate planned growth, hiring and infrastructure needs. Additional capital
may also be required for consummation of any acquisitions of businesses,
products or technologies.
To the extent that our existing resources and cash generated from
operations, are insufficient to fund our future activities, we may need to raise
additional funds through public or private financings or borrowings. If
additional funds are raised through the issuance of debt securities, these
securities could have rights, preferences and privileges senior to holders of
common stock, and the terms of this debt could impose restrictions on our
operations. The sale of additional equity or convertible debt securities could
result in additional dilution to our stockholders. We cannot be certain that
additional financing will be available in amounts or on terms acceptable to us,
if at all. If we are unable to obtain this additional financing, we may be
required to reduce the scope of our planned product development and sales and
marketing efforts, which could harm our business, financial condition and
operating results.
STOCK OPTION REPRICING
In August 1998, our employees were offered the opportunity to reprice their
options. Repricing was conditional on employees accepting the restart of their
vesting schedule. The vesting schedule would however, revert back to the
original schedule if we meet significant performance goals. At the end of 1999,
the Company did, in fact, meet these performance goals and vesting schedules of
the repriced stock options reverted to their original vesting timetable.
Substantially all options with an exercise price in excess of $5.94 were
cancelled and replaced with new options having an exercise price of $5.94, the
market price on the date that the employees accepted the repricing. A total of
924,164 shares were repriced.
26
FUTURE PERFORMANCE AND RISK FACTORS
Our future business operating results and financial condition are subject to
various risks and uncertainties, including those described below:
OUR QUARTERLY REVENUES AND OPERATING RESULTS FLUCTUATE DUE TO A VARIETY OF
FACTORS, WHICH MAY RESULT IN VOLATILITY OR A DECLINE IN THE PRICE OF OUR STOCK.
Our quarterly operating results have varied significantly due to a number of
factors, including:
- fluctuation in demand for our products;
- the timing of new product introductions by us and our competitors;
- the level of market acceptance of new and enhanced versions of our
products and our customers' products;
- the timing of large customer orders;
- the length and variability of the sales cycle for our products;
- the cyclical nature of the semiconductor industry;
- the availability of development funding and the timing of development
revenue;
- changes in the mix of products sold;
- seasonality in demand for our products;
- competitive pricing pressures; and
- the evolving and unpredictable nature of the markets for products
incorporating our integrated circuits and embedded software.
We expect that our operating results will continue to fluctuate in the
future as a result of these factors and a variety of other factors, including:
- the cost and availability of adequate foundry capacity;
- fluctuations in manufacturing yields;
- the emergence of new industry standards;
- product obsolescence; and
- the amount of research and development expenses associated with new
product introductions.
Our operating results could also be harmed by:
- economic conditions generally or in various geographic areas where we or
our customers do business;
- other conditions affecting the timing of customer orders; or
- a downturn in the markets for our customers' products, particularly the
consumer electronics market.
These factors are difficult or impossible to forecast. We place orders to
purchase our products from independent foundries several months in advance of
the scheduled delivery date, often in advance of receiving non-cancelable orders
from our customers. If anticipated shipments in any quarter are canceled or do
not occur as quickly as expected, expense and inventory levels could be
disproportionately high. If anticipated license revenues in any quarter are
canceled or do not occur, gross margins may be reduced. A significant portion of
our expenses are relatively fixed, and the timing
27
of increases in expenses is based in large part on our forecast of future
revenues. As a result, if revenues do not meet our expectations we may be unable
to quickly adjust expenses to levels appropriate to actual revenues, which could
harm our operating results.
As a result of these factors, our operating results may vary significantly
from quarter to quarter. Any shortfall in revenues or net income from levels
expected by securities analysts could cause a decline in the trading price of
our stock.
OUR SUCCESS FOR THE FORESEEABLE FUTURE WILL BE DEPENDENT ON GROWTH IN DEMAND FOR
INTEGRATED CIRCUITS FOR DIGITAL VERSATILE DISC, OR DVD, SUPER VIDEO CD, DIGITAL
AUDIO, VIDEO EDITING AND FILMLESS DIGITAL CAMERA APPLICATIONS AND OUR ABILITY TO
MARKET AND SELL OUR PRODUCTS TO MANUFACTURERS WHO INCORPORATE THOSE TYPES OF
INTEGRATED CIRCUITS INTO THEIR PRODUCTS.
In 1999, we derived a majority of our product revenues from the sale of
integrated circuits for DVD and Super Video CD applications. We expect that
sales of our products for DVD and Super Video CD applications, digital audio
applications and video editing applications will continue to account for a
significant portion of our revenues for the near future. Our ability to sell our
recently introduced products for filmless digital camera applications will also
have a significant impact on our financial performance for the foreseeable
future. If the markets for these products and applications decline or fail to
develop as expected, or we are not successful in our efforts to market and sell
our products to manufacturers who incorporate integrated circuits into these
products, our financial results will be harmed.
OUR CUSTOMERS EXPERIENCE FLUCTUATING PRODUCT CYCLES AND SEASONALITY, WHICH
CAUSES OUR SALES TO FLUCTUATE.
Because the markets our customers serve are characterized by numerous new
product introductions and rapid product enhancements, our operating results may
vary significantly from quarter to quarter. During the final production of a
mature product, our customers typically exhaust their existing inventory of our
products. Consequently, orders for our products may decline in those
circumstances, even if our products are incorporated into both mature products
and replacement products. A delay in the customer's transition to commercial
production of a replacement product would delay our ability to recover the lost
sales from the discontinuation of the related mature product. Our customers also
experience significant seasonality in the sales of their consumer products,
which affects their orders of our products. Typically, the fourth calendar
quarter represents a disproportionate percentage of sales for our customers due
to the holiday period, and therefore a disproportionate percentage of our sales.
We expect these sales fluctuations to continue for the foreseeable future.
PRODUCT SUPPLY AND DEMAND IN THE SEMICONDUCTOR INDUSTRY IS SUBJECT TO CYCLICAL
VARIATIONS.
The semiconductor industry is subject to cyclical variations in product
supply and demand. Downturns in the industry often occur in connection with, or
anticipation of, maturing product cycles for both semiconductor companies and
their customers and declines in general economic conditions. These downturns
have been characterized by abrupt fluctuations in product demand, production
over-capacity and accelerated decline of average selling prices. In some cases,
these downturns have lasted more than one year. A downturn in the semiconductor
industry could harm our sales and revenues if demand drops or our gross margins
if average selling prices decline.
28
THE DEVELOPMENT AND EVOLUTION OF MARKETS FOR OUR INTEGRATED CIRCUITS IS
DEPENDENT ON FACTORS SUCH AS INDUSTRY STANDARDS, OVER WHICH WE HAVE NO CONTROL;
FOR EXAMPLE, IF MANUFACTURERS ADOPT NEW OR COMPETING INDUSTRY STANDARDS WITH
WHICH OUR PRODUCTS ARE NOT COMPATIBLE, OUR EXISTING PRODUCTS WOULD BECOME LESS
DESIRABLE TO THE MANUFACTURERS AND OUR SALES WOULD SUFFER.
The emergence of markets for our products is affected by a variety of
factors beyond our control. In particular, our products are designed to conform
to current specific industry standards. Manufacturers may not continue to follow
these standards, which would make our products less desirable to manufacturers
and reduce our sales. Also, competing standards may emerge that are preferred by
manufacturers, which could also reduce our sales and require us to make
significant expenditures to develop new products. The emergence of new markets
for our products is also dependent in part upon third parties developing and
marketing content in a format compatible with commercial and consumer products
that incorporate our products. If content compatible with commercial and
consumer products that incorporate our products is not available, manufacturers
may not be able to sell products incorporating our integrated circuits, and our
sales to manufacturers would suffer.
WE RELY ON INDEPENDENT FOUNDRIES AND CONTRACTORS FOR THE MANUFACTURE, ASSEMBLY
AND TESTING OF OUR INTEGRATED CIRCUITS, AND THE FAILURE OF ANY OF THESE THIRD
PARTIES TO DELIVER PRODUCTS OR OTHERWISE PERFORM AS REQUESTED COULD DAMAGE OUR
RELATIONSHIPS WITH OUR CUSTOMERS AND HARM OUR SALES AND FINANCIAL RESULTS.
We do not operate any manufacturing facilities, and we rely on independent
foundries to manufacture substantially all of our products. These independent
foundries fabricate products for other companies and may also produce products
of their own design. From time to time there are manufacturing capacity
shortages in the semiconductor industry. We do not have long-term supply
contracts with any of our suppliers, including our principal supplier, Taiwan
Semiconductor Manufacturing Company, or TSMC. Therefore, TSMC is not obligated
to manufacture products for us for any specific period, in any specific quantity
or at any specified price, except as may be provided in a particular purchase
order.
Our reliance on independent foundries involves a number of risks, including:
- the inability to obtain adequate manufacturing capacity;
- the unavailability of or interruption in access to certain process
technologies necessary for manufacture of our products;
- reduced control over delivery schedules;
- reduced control over quality assurance;
- reduced control over manufacturing yields and cost; and
- potential misappropriation of our intellectual property.
In addition, TSMC and some of our other foundries are located in areas of
the world which are subject to natural disasters such as earthquakes. While the
recent earthquake in Taiwan did not have a material impact on our independent
foundries, a similar event centered near TSMC's facility could severely reduce
TSMC's ability to manufacture our integrated circuits. The loss of any of our
manufacturers as a supplier, our inability to expand the supply of our products
in response to increased demand, or our inability to obtain timely and adequate
deliveries from our current or future suppliers due to a natural disaster or any
other reason could delay or reduce shipments of our products. Any of these
circumstances could damage our relationships with current and prospective
customers and harm our sales and financial results.
29
We also rely on independent contractors for the assembly and testing of our
products. At present, all of our semiconductor products are assembled by one of
three independent contractors: ASE, Amkor or ASAT. Our semiconductor products
are tested by these contractors or other independent contractors. Our reliance
on independent assembly and testing houses limits our control over delivery
schedules, quality assurance and product cost. Disruptions in the services
provided by our assembly or testing houses or other circumstances that would
require us to seek alternative sources of assembly or testing could lead to
supply constraints or delays in the delivery of our products. These constraints
or delays could damage our relationships with current and prospective customers
and harm our sales and financial results.
BECAUSE FOUNDRY CAPACITY IS LIMITED WE MAY BE REQUIRED TO ENTER INTO COSTLY
LONG-TERM SUPPLY ARRANGEMENTS TO SECURE FOUNDRY CAPACITY.
If we are not able to obtain additional foundry capacity as required, our
relationships with our customers would be harmed and our sales would likely be
reduced. In order to secure additional foundry capacity, we have considered and
will continue to consider various arrangements with suppliers, which could
include, among others:
- option payments or other prepayments to a foundry;
- nonrefundable deposits with or loans to foundries in exchange for capacity
commitments;
- contracts that commit us to purchase specified quantities of silicon
wafers over extended periods;
- issuance of our equity securities to a foundry;
- investment in a foundry;
- joint ventures; or
- other partnership relationships with foundries.
We may not be able to make any such arrangement in a timely fashion or at
all, and such arrangements, if any, may not be on terms favorable to us.
Moreover, if we are able to secure foundry capacity, we may be obligated to
utilize all of that capacity or incur penalties. Such penalties may be expensive
and could harm our financial results.
IF OUR INDEPENDENT FOUNDRIES DO NOT ACHIEVE SATISFACTORY YIELDS, OUR
RELATIONSHIPS WITH OUR CUSTOMERS MAY BE HARMED.
The fabrication of silicon wafers is a complex process. Minute levels of
contaminants in the manufacturing environment, defects in photomasks used to
print circuits on a wafer, difficulties in the fabrication process or other
factors can cause a substantial portion of the integrated circuits on a wafer to
be non-functional. Many of these problems are difficult to detect at an early
stage of the manufacturing process and may be time consuming and expensive to
correct. As a result, foundries often experience problems achieving acceptable
yields, which are represented by the number of good integrated circuits as a
proportion of the number of total integrated circuits on any particular wafer.
Poor yields from our independent foundries would reduce our ability to deliver
our products to customers, harm our relationships with our customers, and harm
our business.
TO BE SUCCESSFUL, WE MUST EFFICIENTLY DEVELOP NEW AND ENHANCED PRODUCTS TO MEET
RAPIDLY CHANGING CUSTOMER REQUIREMENTS AND INDUSTRY STANDARDS.
The markets for our products are characterized by:
- rapidly changing technologies;
30
- evolving industry standards;
- frequent new product introductions; and
- short product life cycles.
We expect to increase our product development expenses, and our future
success will depend to a substantial degree upon our ability to develop and
introduce, on a timely and cost-effective basis, new and enhanced products that
meet rapidly changing customer requirements and industry standards. We may not
successfully develop, introduce or manage the transition to new products. Delays
in the introduction or shipment of new or enhanced products, lack of market
acceptance for such products or problems associated with new product transitions
could harm our sales and financial results.
WE FACE COMPETITION OR POTENTIAL COMPETITION FROM COMPANIES WITH GREATER
RESOURCES THAN OURS, AND IF WE ARE UNABLE TO COMPETE EFFECTIVELY WITH THESE
COMPANIES, OUR MARKET SHARE MAY DECLINE AND OUR BUSINESS COULD BE HARMED.
Competition in the compression technology market has historically been
dominated by large companies such as STMicroelectronics and companies that
develop and use their own integrated circuits, such as Sony. As this market
continues to develop, we face competition from other large semiconductor
vendors, including:
- C-Cube Microsystems;
- LSI Logic;
- Cirrus Logic (Crystal Semiconductor);
- Fujitsu; and
- Motorola.
For example, in the markets for JPEG-based products for use in filmless
digital cameras, LSI Logic and Ricoh are providing system-on-a-chip solutions to
third parties. We also face competition from internally-developed solutions
developed and used by major Japanese original equipment manufacturers, who may
also be our customers.
Many of our existing and potential competitors have substantially greater
resources than ours in many areas, including:
- finances;
- manufacturing;
- technology;
- marketing; and
- distribution.
Many of our competitors have broader product lines and longer standing
relationships with customers than we do. Moreover, our competitors may foresee
the course of market developments more accurately than we do and could in the
future develop new technologies that compete with our products or even render
our products obsolete. In addition, a number of private companies have announced
plans for new products to address the same digital multimedia compression
problems that our products address. If we are unable to compete successfully
against our current and future competitors, we could experience price
reductions, order cancellations and reduced gross margins, any one of which
could harm our business.
31
The DVD market is just emerging, and additional competitors are expected to
enter the market for DVD players and software. We believe that several large
Japanese consumer electronics companies may be planning to enter this market and
may, accordingly, attempt to develop MPEG 2 hardware or software that may be
competitive with our products. Some of these potential competitors may develop
captive implementations for use only with their own PC and consumer electronics
products. It is also possible that application software vendors, such as
Microsoft, may attempt to enter the DVD application market in the future. This
increased competition may result in price reductions, reduced profit margins and
loss of market share.
OUR PRODUCTS ARE CHARACTERIZED BY AVERAGE SELLING PRICES THAT DECLINE OVER
RELATIVELY SHORT TIME PERIODS; IF WE ARE UNABLE TO REDUCE OUR COSTS OR INTRODUCE
NEW PRODUCTS WITH HIGHER AVERAGE SELLING PRICES, OUR FINANCIAL RESULTS WOULD
SUFFER.
Average selling prices for our products decline over relatively short time
periods. Many of our manufacturing costs are fixed. When our average selling
prices decline, our revenues decline unless we sell more units, and our gross
margins decline unless we are able to reduce our manufacturing costs by a
commensurate amount. Our operating results suffer when gross margins decline. We
may experience these problems in the future and cannot predict when they may
occur or their severity.
WE DERIVE MOST OF OUR REVENUE FROM SALES TO A SMALL NUMBER OF LARGE CUSTOMERS,
AND IF WE ARE NOT ABLE TO RETAIN THESE CUSTOMERS, OR THEY RESCHEDULE, REDUCE OR
CANCEL ORDERS, OUR REVENUES WOULD BE REDUCED AND OUR FINANCIAL RESULTS WOULD
SUFFER.
Our largest customers account for a substantial percentage of our revenues.
In 1999, sales to Fujifilm accounted for 37.3% of our total revenues and 41.0%
of our product sales. Our four largest customers in 1999 accounted for
approximately 56.9% of our total revenues. During 1998, our four largest
customers accounted for approximately 45.7% of our revenues with Fujifilm
accounting for 22.7% and Pinnacle 14.3%. Sales to these large customers have
varied significantly from year to year and will continue to fluctuate in the
future. These sales also may fluctuate significantly from quarter to quarter. We
may not be able to retain our key customers or these customers may cancel
purchase orders or reschedule or decrease their level of purchases from us. Any
substantial decrease or delay in sales to one or more of our key customers could
harm our sales and financial results. In addition, any difficulty in collecting
amounts due from one or more key customers could harm our financial results.
WE ARE DEPENDENT ON OUR RELATIONSHIP WITH FUJIFILM FOR A SIGNIFICANT PERCENTAGE
OF OUR PRODUCT SALES, AND IF THIS RELATIONSHIP WERE TERMINATED, OUR BUSINESS
WOULD BE HARMED.
Fujifilm has been our largest customer in three of the last five years.
Fujifilm purchases our products primarily as a distributor. Under our
arrangement with Fujifilm, Fujifilm acts as the primary distributor in Japan of
products developed by us under development contracts with Fujifilm. Fujifilm
also sells some of these products in Japan under its own name. We may sell these
products directly in Japan only to specified customers and must first buy the
products from Fujifilm. Fujifilm provides more sales and marketing support than
our other distributors. Fujifilm also has a nonexclusive license to distribute
most of our products outside of Japan. Fujifilm has provided wafer manufacturing
services on a most-favored terms basis to us since 1993 and has also provided
funding to support our development efforts. If our relationship with Fujifilm
were terminated, our business would be harmed.
OUR PRODUCTS GENERALLY HAVE LONG SALES CYCLES AND IMPLEMENTATION PERIODS, WHICH
INCREASES OUR COSTS IN OBTAINING ORDERS AND REDUCES THE PREDICTABILITY OF OUR
EARNINGS.
Our products are technologically complex. Prospective customers generally
must make a significant commitment of resources to test and evaluate our
products and to integrate them into larger systems. As a result, our sales
process is often subject to delays associated with lengthy approval processes
that
32
typically accompany the design and testing of new products. The sales cycles of
our products often last for many months or even years. Longer sales cycles
require us to invest significant resources in attempting to make sales and delay
the generation of revenue.
Long sales cycles also subject us to other risks, including customers'
budgetary constraints, internal acceptance reviews and cancellations. In
addition, orders expected in one quarter could shift to another because of the
timing of customers' purchase decisions. The time required for our customers to
incorporate our products into their own can vary significantly with the needs of
our customers and generally exceeds several months, which further complicates
our planning processes and reduces the predictability of our operating results.
WE ARE NOT PROTECTED BY LONG-TERM CONTRACTS WITH OUR CUSTOMERS.
We generally do not enter into long-term purchase contracts with our
customers, and we cannot be certain as to future order levels from our
customers. When we do enter into a long-term contract, the contract is generally
terminable at the convenience of the customer. In the event of an early
termination by one of our major customers, it is unlikely that we will be able
to rapidly replace that revenue source, which would harm our financial results.
WE ARE DEPENDENT UPON OUR INTERNATIONAL SALES AND OPERATIONS; ECONOMIC,
POLITICAL OR MILITARY EVENTS IN A COUNTRY WHERE WE MAKE SIGNIFICANT SALES OR
HAVE SIGNIFICANT OPERATIONS COULD INTERFERE WITH OUR SUCCESS OR OPERATIONS THERE
AND HARM OUR BUSINESS.
During 1999, 79.5% of our total revenues were derived from international
sales. We anticipate that international sales will continue to represent a
significant portion of our total revenues for the foreseeable future. In
addition, substantially all of our semiconductor products are manufactured,
assembled and tested outside of the United States by independent foundries and
subcontractors.
We are subject to the risks inherent in doing business internationally,
including:
- unexpected changes in regulatory requirements;
- fluctuations in exchange rates;
- political and economic instability;
- imposition of tariffs and other barriers and restrictions; and
- the burdens of complying with a variety of foreign laws.
The majority of our research and development personnel and facilities and a
significant portion of our sales personnel are located in Israel. Political,
economic and military conditions in Israel directly affect our operations. Some
of our officers and employees in Israel are obligated to perform up to 39 days
of military reserve duty annually. The absence of these employees for
significant periods during the work week may cause us to operate inefficiently
during these periods.
During 1998, we opened an office in Shenzhen, China. Our operations in China
will be subject to the economic and political uncertainties affecting that
country. For example, the Chinese economy has experienced significant growth in
the past decade, but such growth has been uneven across geographic and economic
sectors and has recently been slowing. This growth may continue to decrease and
any slowdown may have a negative effect on our business. The Chinese economy is
also experiencing deflation which may continue in the future. This deflation
could result in devaluation of the Chinese Yuan, which could reduce our sales to
the Chinese market.
33
THE PRICES OF OUR PRODUCTS MAY BECOME LESS COMPETITIVE DUE TO FOREIGN EXCHANGE
FLUCTUATIONS.
Foreign currency fluctuations may affect the prices of our products. Prices
for our products are currently denominated in U.S. dollars for sales to our
customers throughout the world. If there is a significant devaluation of the
currency in a specific country, the prices of our products will increase
relative to that country's currency and our products may be less competitive in
that country. Also, we cannot be sure that our international customers will
continue to be willing to place orders denominated in U.S. dollars. If they do
not, our revenue and operating results will be subject to foreign exchange
fluctuations.
OUR ABILITY TO COMPETE COULD BE JEOPARDIZED IF WE ARE UNABLE TO PROTECT OUR
INTELLECTUAL PROPERTY RIGHTS FROM CHALLENGES BY THIRD PARTIES.
Our success and ability to compete depend in large part upon protecting our
proprietary technology. We rely on a combination of patent, trade secret,
copyright and trademark laws, non-disclosure and other contractual agreements
and technical measures to protect our proprietary rights. These agreements and
measures may not be sufficient to protect our technology from third-party
infringement, or to protect us from the claims of others. Monitoring
unauthorized use of our products is difficult and we cannot be certain that the
steps we have taken will prevent unauthorized use of our technology,
particularly in foreign countries where the laws may not protect our proprietary
rights as fully as in the United States. The laws of certain foreign countries
in which our products are or may be developed, manufactured or sold, including
various countries in Asia, may not protect our products or intellectual property
rights to the same extent as do the laws of the United States and thus make the
possibility of piracy of our technology and products more likely in these
countries. If competitors are able to use our technology, our ability to compete
effectively could be harmed.
WE COULD BECOME SUBJECT TO CLAIMS AND LITIGATION REGARDING INTELLECTUAL PROPERTY
RIGHTS, WHICH COULD SERIOUSLY HARM OUR BUSINESS AND REQUIRE US TO INCUR
SIGNIFICANT COSTS.
In recent years, there has been significant litigation in the United States
involving patents and other intellectual property rights. In the past, we have
been subject to claims and litigation regarding alleged infringement of other
parties' intellectual property rights. We could become subject to litigation in
the future either to protect our intellectual property or as a result of
allegations that we infringe others' intellectual property rights. Claims that
our products infringe proprietary rights would force us to defend ourselves and
possibly our customers or manufacturers against the alleged infringement. These
claims and any resulting lawsuit, if successful, could subject us to significant
liability for damages and invalidation of our proprietary rights. These
lawsuits, regardless of their success, would likely be time-consuming and
expensive to resolve and would divert management time and attention. Any
potential intellectual property litigation could force us to do one or more of
the following:
- stop selling our products that incorporate the challenged intellectual
property;
- obtain from the owner of the infringed intellectual property right a
license to sell or use the relevant technology, which license may not be
available on reasonable terms or at all;
- pay damages; or
- redesign those products that use such technology.
If we are forced to take any of the foregoing actions, our business could be
severely harmed.
34
IF NECESSARY LICENSES OF THIRD-PARTY TECHNOLOGY ARE NOT AVAILABLE TO US OR ARE
VERY EXPENSIVE, OUR PRODUCTS COULD BECOME OBSOLETE.
From time to time we may be required to license technology from third
parties to develop new products or product enhancements. Third party licenses
may not be available to us on commercially reasonable terms, if at all. If we
are unable to obtain any third-party license required to develop new products
and product enhancements, we may have to obtain substitute technology of lower
quality or performance standards or at greater cost, either of which could
seriously harm the competitiveness of our products.
IF WE ARE NOT ABLE TO APPLY OUR NET OPERATING LOSSES AGAINST TAXABLE INCOME IN
FUTURE PERIODS, OUR FINANCIAL RESULTS WILL BE HARMED.
Our future net income and cash flow will be affected by our ability to apply
our net operating losses, which totaled approximately $48.0 million for federal
tax reporting purposes as of December 31, 1999, against taxable income in future
periods. Our net operating losses incurred prior to the consummation of our
initial public offering in 1995 that we can use to reduce future taxable income
for federal tax purposes are limited to approximately $3.0 million per year.
Changes in tax laws in the United States may further limit our ability to
utilize our net operating losses. Any further limitation on our ability to
utilize our net operating losses could harm our financial condition. See Note 9
of Notes to Consolidated Financial Statements.
ANY ACQUISITIONS WE MAKE COULD DISRUPT OUR BUSINESS AND SEVERELY HARM OUR
FINANCIAL CONDITION.
We intend to consider investments in complementary companies, products or
technologies. While we have no current agreements to do so, we may acquire
businesses, products or technologies in the future. In the event of any future
acquisitions, we could:
- issue stock that would dilute our current stockholders' percentage
ownership;
- incur debt;
- assume liabilities;
- incur amortization expenses related to goodwill and other intangible
assets; or
- incur large and immediate write-offs.
Our operation of any acquired business will also involve numerous risks,
including:
- problems combining the purchased operations, technologies or products;
- unanticipated costs;
- diversion of management's attention from our core business;
- adverse effects on existing business relationships with customers;
- risks associated with entering markets in which we have no or limited
prior experience; and
- potential loss of key employees, particularly those of the purchased
organizations.
We may not be able to successfully integrate any businesses, products or
technologies or personnel that we might acquire in the future and any failure to
do so could disrupt our business and seriously harm our financial condition.
35
OUR PRODUCTS COULD CONTAIN DEFECTS, WHICH COULD REDUCE SALES OF THOSE PRODUCTS
OR RESULT IN CLAIMS AGAINST US.
We develop complex and evolving products. Despite testing by us and our
customers, errors may be found in existing or new products. This could result
in, among other things, a delay in recognition or loss of revenues, loss of
market share or failure to achieve market acceptance. These defects may cause us
to incur significant warranty, support and repair costs, divert the attention of
our engineering personnel from our product development efforts and harm our
relationships with our customers. The occurrence of these problems could result
in the delay or loss of market acceptance of our products and would likely harm
our business. Defects, integration issues or other performance problems in our
products could result in financial or other damages to our customers or could
damage market acceptance of our products. Our customers could also seek damages
from us for their losses. A product liability claim brought against us, even if
unsuccessful, would likely be time consuming and costly to defend.
IF WE DO NOT MAINTAIN OUR CURRENT DEVELOPMENT CONTRACTS OR ARE UNABLE TO ENTER
INTO NEW DEVELOPMENT CONTRACTS, OUR BUSINESS COULD BE HARMED.
We historically have generated a significant percentage of our total
revenues from development contracts, primarily with key customers. These
development contracts have provided us with partial funding for the development
of some of our products. Under these contracts, we receive payments upon
reaching certain development milestones. If we fail to achieve the milestones
specified in our existing development contracts, if our existing contracts are
terminated or we are unable to secure future development contracts, our ability
to cost-effectively develop new products would be reduced and our business would
be harmed.
WE MAY NEED ADDITIONAL FUNDS TO EXECUTE OUR BUSINESS PLAN, AND IF WE ARE UNABLE
TO OBTAIN SUCH FUNDS, WE WILL NOT BE ABLE TO EXPAND OUR BUSINESS AS PLANNED.
We may require substantial additional capital to finance our future growth,
secure additional foundry capacity and fund our ongoing research and development
activities beyond 2000. Our capital requirements will depend on many factors,
including:
- acceptance of and demand for our products;
- the types of arrangements that we may enter into with our independent
foundries; and
- the extent to which we invest in new technology and research and
development projects.
To the extent that our existing sources of liquidity and cash flow from
operations are insufficient to fund our activities, we may need to raise
additional funds. If we raise additional funds through the issuance of equity
securities, the percentage ownership of our existing stockholders would be
reduced. Further, such equity securities may have rights, preferences or
privileges senior to those of our common stock. Additional financing may not be
available to us when needed or, if available, it may not be available on terms
favorable to us.
IF WE FAIL TO MANAGE OUR FUTURE GROWTH, IF ANY, OUR BUSINESS WOULD BE HARMED.
We anticipate that our future growth, if any, will require us to recruit and
hire a substantial number of new engineering, managerial, sales and marketing
personnel. Our ability to manage our growth successfully will also require us to
expand and improve our administrative, operational, management and financial
systems and controls. Many of our key operations, including the major portion of
our research and development operations and a significant portion of our sales
and administrative operations, are located in Israel. A majority of our sales
and marketing and certain of our research and development and administrative
personnel, including our President and Chief
36
Executive Officer and other officers, are based in the United States. The
geographic separation of these operations places additional strain on our
resources and our ability to effectively manage our growth. If we are unable to
manage growth effectively, our business would be harmed.
WE RELY ON THE SERVICES OF OUR EXECUTIVE OFFICERS AND OTHER KEY PERSONNEL, WHOSE
KNOWLEDGE OF OUR BUSINESS AND INDUSTRY WOULD BE EXTREMELY DIFFICULT TO REPLACE.
Our success depends to a significant degree upon the continuing
contributions of our senior management. The loss of key management personnel
could delay product development cycles or otherwise harm our business. We may
not be able to retain the services of any of our key employees. We believe that
our future success will also depend in large part on our ability to attract,
integrate and retain highly-skilled engineering, managerial, sales and marketing
personnel, both in the United States and in Israel. Competition for such
personnel is intense, and we may not be successful in attracting, integrating
and retaining such personnel. Failure to attract, integrate and retain key
personnel could harm our ability to carry out our business strategy and compete
with other companies.
THE ISRAELI RATE OF INFLATION MAY NEGATIVELY IMPACT OUR COSTS IF IT EXCEEDS THE
RATE OF DEVALUATION OF THE NEW ISRAELI SHEKEL AGAINST THE U.S. DOLLAR.
A portion of the cost of our operations, relating mainly to our personnel
and facilities in Israel, is incurred in New Israeli Shekels. As a result, we
bear the risk that the rate of inflation in Israel will exceed the rate of
devaluation of the New Israeli Shekel in relation to the dollar, which will
increase our costs as expressed in dollars. To date, we have not engaged in
hedging transactions. In the future, we may enter into currency hedging
transactions to decrease the risk of financial exposure from fluctuations in the
exchange rate of the U.S. dollar against the New Israeli Shekel. These measures
may not adequately protect us from the impact of inflation in Israel.
THE GOVERNMENT PROGRAMS WE PARTICIPATE IN AND TAX BENEFITS WE RECEIVE REQUIRE US
TO MEET SEVERAL CONDITIONS AND MAY BE TERMINATED OR REDUCED IN THE FUTURE, WHICH
WOULD INCREASE OUR COSTS.
In the year ended December 31, 1999, we received an aggregate of $484,000 in
grants for research and development from the Chief Scientist in Israel's
Ministry of Industry and Trade. To continue to be eligible for these grants, our
development projects must be approved by the Chief Scientist on a case-by-case
basis. If our development projects are not approved by the Chief Scientist, we
will not receive grants to fund these projects, which would increase our
research and development costs. We also receive tax benefits, in particular
exemptions and reductions as a result of the "Approved Enterprise" status of our
existing operations in Israel. To be eligible for these tax benefits, we must
maintain our Approved Enterprise status by meeting conditions, including making
specified investments in fixed assets located in Israel and investing additional
equity in our Israeli subsidiary. If we fail to meet these conditions in the
future, the tax benefits would be canceled and we could be required to refund
the tax benefits already received. These tax benefits may not be continued in
the future at their current levels or at any level. Israeli governmental
authorities have indicated that the government may reduce or eliminate these
benefits in the future, which would harm our business.
WE HAVE ANTI-TAKEOVER PROVISIONS IN OUR CHARTER DOCUMENTS AND THERE ARE
PROVISIONS OF DELAWARE LAW THAT COULD PREVENT OR DELAY A CHANGE IN CONTROL OF
OUR COMPANY.
Our certificate of incorporation, our bylaws and Delaware law contain
provisions that could make it more difficult for a third party to acquire us,
even if doing so would be beneficial to our stockholders. These include
provisions:
- prohibiting a merger with a party that has acquired control of 15% or more
of our outstanding common stock, such as a party that has completed a
successful tender offer, until three years after that party acquired
control of 15% of our outstanding common stock;
37
- authorizing the issuance of up to 3,000,000 shares of "blank check"
preferred stock;
- eliminating stockholders' rights to call a special meeting of
stockholders; and
- requiring advance notice of any stockholder nominations of candidates for
election to our board of directors.
OUR STOCK PRICE HAS FLUCTUATED AND MAY CONTINUE TO FLUCTUATE WIDELY.
The market price of our common stock has fluctuated significantly since our
initial public offering in 1995. Between January 1, 1999 and December 31, 1999,
the sale price of our common stock, as reported on the Nasdaq National Market,
ranged from a low of $8.875 to a high of $55.75. The market price of our common
stock is subject to significant fluctuations in the future in response to a
variety of factors, including:
- announcements concerning our business or that of our competitors or
customers;
- quarterly variations in operating results;
- announcements of technological innovations;
- the introduction of new products or changes in product pricing policies by
us or our competitors;
- proprietary rights or other litigation;
- changes in analysts' earnings estimates;
- general conditions in the semiconductor industry; and
- developments in the financial markets.
In addition, the stock market has, from time to time, experienced extreme
price and volume fluctuations that have particularly affected the market prices
for semiconductor companies or technology companies generally and which have
been unrelated to the operating performance of the affected companies. Broad
market fluctuations of this type may reduce the future market price of our
common stock.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS.
We are exposed to financial market risks including changes in interest rates
and foreign currency exchange rates.
The fair value of our investment portfolio or related income would not be
significantly impacted by either a 10% increase or decrease in interest rates
due mainly to the short-term nature of the major portion of our investment
portfolio.
A majority of our revenue and capital spending is transacted in U.S.
dollars, although a portion of the cost of our operations, relating mainly to
our personnel and facilities in Israel, is incurred in New Israeli Shekels. We
have not engaged in hedging transactions to reduce our exposure to fluctuations
that may arise from changes in foreign exchange rates. Based on our overall
currency rate exposure at December 31, 1999 a near-term 10% appreciation or
depreciation of the New Israeli Shekel would have an immaterial affect on our
financial condition.
38
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
--------
Report of Independent Accountants........................... 40
Consolidated Balance Sheets as of December 31, 1999 and
1998...................................................... 41
Consolidated Statements of Operations for the three years
ended
December 31, 1999......................................... 42
Consolidated Statements of Stockholders' Equity for the
three years ended
December 31, 1999......................................... 43
Consolidated Statements of Cash Flows for the three years
ended
December 31, 1999......................................... 44
Notes to Consolidated Financial Statements.................. 45
Supplemental Data: Selected Quarterly Financial Information
(Unaudited)............................................... 60
39
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Zoran Corporation
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of stockholders' equity and of cash flows
present fairly, in all material respects, the financial position of Zoran
Corporation and its subsidiaries at December 31, 1999 and 1998, and the results
of its operations and its cash flows for each of the three years in the period
ended December 31, 1999, in conformity with accounting principles generally
accepted in the United States. 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 of these
statements in accordance with auditing standards generally accepted in the
United States, which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
San Jose, California
January 25, 2000
40
ZORAN COPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
DECEMBER 31,
--------------------
1999 1998
--------- --------
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 12,665 $ 8,221
Short-term investments.................................... 132,967 10,954
Accounts receivable, net.................................. 21,869 15,558
Inventory................................................. 7,159 7,063
Prepaid expenses and other current assets................. 1,946 2,018
--------- --------
Total current assets.................................. 176,606 43,814
Property and equipment, net................................. 5,662 5,356
Other....................................................... 200 --
--------- --------
$ 182,468 $ 49,170
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable.......................................... $ 7,987 $ 6,530
Accrued expenses and other liabilities.................... 11,036 6,454
--------- --------
Total current liabilities............................. 19,023 12,984
--------- --------
Commitments and Contingencies (Note 6)
Stockholders' Equity:
Common Stock: $0.001 par value; 20,000,000 shares
authorized; 13,919,270 and 10,213,394 shares issued and
outstanding............................................. 14 10
Additional paid-in capital................................ 195,269 79,635
Warrants.................................................. 717 717
Accumulated other comprehensive income.................... 4,962 --
Accumulated deficit....................................... (37,517) (44,176)
--------- --------
Total stockholders' equity............................ 163,445 36,186
--------- --------
$ 182,468 $ 49,170
========= ========
The accompanying notes are an integral part of these consolidated financial
statements.
41
ZORAN COPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
Revenues:
Product sales............................................. $52,887 $33,465 $32,717
Software, licensing and development....................... 8,787 10,760 12,210
------- ------- -------
Total revenues........................................ 61,674 44,225 44,927
------- ------- -------
Costs and expenses:
Cost of product sales..................................... 28,523 19,036 16,032
Research and development.................................. 12,651 13,548 13,787
Selling, general and administrative....................... 14,251 11,551 11,209
------- ------- -------
Total costs and expenses.............................. 55,425 44,135 41,028
------- ------- -------
Operating income............................................ 6,249 90 3,899
Interest and other income, net.............................. 1,585 1,071 1,258
------- ------- -------
Income before income taxes.................................. 7,834 1,161 5,157
Provision for income taxes.................................. 1,175 232 928
------- ------- -------
Net income.................................................. $ 6,659 $ 929 $ 4,229
======= ======= =======
Basic net income per share.................................. $ 0.61 $ 0.09 $ 0.45
======= ======= =======
Diluted net income per share................................ $ 0.54 $ 0.08 $ 0.38
======= ======= =======
Shares used to compute basic net income per share........... 10,844 10,042 9,412
======= ======= =======
Shares used to compute diluted net income per share......... 12,249 11,119 11,072
======= ======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
42
ZORAN CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
------------------- PAID-IN COMPREHENSIVE ACCUMULATED
SHARES AMOUNT CAPITAL WARRANTS INCOME DEFICIT TOTAL
-------- -------- ---------- -------- ------------- ----------- --------
Balance at December 31, 1996........ 9,029 $ 9 $ 77,855 $ -- $ -- $(49,334) $ 28,530
Issuance of Common Stock, net....... 772 1 769 -- -- -- 770
Issuance of Warrant................. -- -- -- 717 -- -- 717
Amortization of deferred
compensation...................... -- -- 40 -- -- -- 40
Net income.......................... -- -- -- -- -- 4,229 4,229
------ --- -------- ---- ------ -------- --------
Balance at December 31, 1997........ 9,801 10 78,664 717 -- (45,105) 34,286
Issuance of Common Stock, net....... 412 -- 971 -- -- -- 971
Net income.......................... -- -- -- -- -- 929 929
------ --- -------- ---- ------ -------- --------
Balance at December 31, 1998........ 10,213 10 79,635 717 -- (44,176) 36,186
Issuance of Common Stock, net....... 3,706 4 115,634 -- -- -- 115,638
Unrealized gain on securities
available for sale................ -- -- -- -- 4,962 -- 4,962
Net income.......................... -- -- -- -- -- 6,659 6,659
------ --- -------- ---- ------ -------- --------
Balance at December 31, 1999........ 13,919 $14 $195,269 $717 $4,962 $(37,517) $163,445
====== === ======== ==== ====== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
43
ZORAN CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
YEAR ENDED DECEMBER 31,
-------------------------------
1999 1998 1997
--------- -------- --------
Cash flows from operating activities:
Net income................................................ $ 6,659 $ 929 $ 4,229
Adjustments:
Depreciation, amortization and other.................... 2,166 2,306 1,862
Amortization of deferred compensation................... -- -- 40
Changes in current assets and liabilities:
Accounts receivable................................... (6,828) 951 (5,421)
Deferred revenue...................................... 699 (112) 121
Inventory............................................. (96) (2,940) (2,324)
Prepaid expenses and other current assets............. (108) 214 (356)
Accounts payable...................................... 1,457 (3,042) 3,151
Accrued expenses and other liabilities................ 3,007 (700) 534
--------- ------- -------
Net cash provided by (used in) operating
activities........................................ 6,956 (2,394) 1,836
--------- ------- -------
Cash flows from investing activities:
Capital expenditures for property and equipment........... (2,775) (1,778) (3,649)
Sales (Purchases) of short-term investments, net.......... (115,175) 1,519 (230)
Purchases of long term investments........................ (200) -- --
--------- ------- -------
Net cash used in investing activities............... (118,150) (259) (3,879)
--------- ------- -------
Cash flows from financing activities:
Proceeds from issuance of Common Stock, net............... 115,638 971 770
--------- ------- -------
Net cash provided by financing activities........... 115,638 971 770
--------- ------- -------
Net increase (decrease) in cash and cash equivalents........ 4,444 (1,682) (1,273)
Cash and cash equivalents at beginning of year.............. 8,221 9,903 11,176
--------- ------- -------
Cash and cash equivalents at end of year.................... $ 12,665 $ 8,221 $ 9,903
========= ======= =======
Supplemental disclosures:
Income taxes paid......................................... $ 506 $ -- $ 368
========= ======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
44
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--THE COMPANY:
Zoran Corporation ("Zoran" or the "Company") was incorporated in California
in December 1981 and reincorporated in Delaware in November 1986. Zoran develops
and markets integrated circuits and software products for digital video and
audio applications enabled by compression. The Company's integrated circuits and
software products are used in a variety of video and audio products addressing
PC and consumer multimedia markets. Current applications incorporating Zoran's
products and IP include professional and consumer video editing systems,
filmless digital cameras, standalone and PC-based DVD players, Super VCD
players, digital speakers and audio systems. The Company operates predominantly
in one industry segment.
The Company performs research and development and generates a substantial
portion of its sales from its operations located in the State of Israel. A
significant number of the Company's full-time employees are located in Israel,
including a majority of the Company's research and development personnel.
Therefore, the Company is directly affected by the political, economic and
military conditions to which that country is subject.
The semiconductor business is highly cyclical and has been subject to
significant downturns at various times that have been characterized by
diminished product demand, production, overcapacity, and accelerated erosion of
average selling prices. As such, the selling price that the Company is able to
command for its products is highly dependent on industry-wide production
capacity and demand. Both of these factors could result in rapid deviations in
product pricing and therefore could adversely effect the Company's operating
results.
PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Zoran and all
of its subsidiaries. Intercompany transactions and balances have been eliminated
in consolidation.
NOTE 2--SIGNIFICANT ACCOUNTING POLICIES:
Zoran has adopted accounting policies which are generally accepted in the
industry in which it operates. The following is a summary of the Company's
significant accounting policies.
USE OF ESTIMATES
The preparation of these financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates, although
such differences are not expected to be material to the consolidated financial
statements.
TRANSLATION OF FOREIGN CURRENCIES
ZML, an Israeli subsidiary, treats the U.S. dollar as its functional
currency. In accordance with Statement of Financial Accounting Standards No. 52
("SFAS 52"), gains and losses resulting from translation of accounts designated
in other than the functional currency are reflected in results of operations and
to date have been insignificant.
To date, substantially all of the Company's product sales have been
denominated in U.S. dollars and most costs of product sales have been incurred
in U.S. dollars. The Company has not experienced material losses or gains as a
result of currency exchange rate fluctuations and has not engaged in
45
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
hedging transactions to reduce its exposure to such fluctuations. The Company
may take action in the future to reduce its foreign exchange risk.
REVENUE RECOGNITION
Revenue from product sales is generally recognized upon shipment. A
provision for estimated future returns and potential warranty liability is
recorded at the time revenue is recognized. Development revenue under
development contracts is recognized on the percentage-of-completion method.
Under the percentage-of-completion method, revenue recognized is that portion of
the total contract price equal to the ratio of costs expended to date to the
anticipated final total costs, based on current estimates of the costs to
complete the project. Amounts received in advance of performance under contracts
are recorded as deferred revenue and are generally recognized within one year
from receipt. 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. Costs associated with development revenues are
included primarily in research and development expenses. Revenue resulting from
the licensing of the Company's technology is recognized when significant
contractual obligations have been fulfilled and the customer has indicated
acceptance. The Company does not provide customers with product return or
exchange rights in connection with the sale of software licenses. Periodic
service and maintenance fees provide customers access to technical support and
minor enhancements to licensed releases are recognized ratably over the service
or maintenance period. Royalty revenue is recognized in the period licensed
sales are reported to the Company.
RESEARCH AND DEVELOPMENT COSTS
Costs related to the conceptual formation and design of internally developed
software are expensed as research and development as incurred. It is the
Company's policy that certain internal software development costs incurred after
technological feasibility has been demonstrated and which meet recoverability
tests are capitalized and amortized over the estimated economic life of the
product. To date, the Company has incurred no significant internal software
development costs which meet the criteria for capitalization.
FAIR VALUE OF FINANCIAL INSTRUMENTS
For certain of Zoran's financial instruments, including cash and cash
equivalents, accounts receivable, accounts payable, accrued expenses and other
current liabilities, the carrying values approximate their fair values due to
the relatively short maturity of these items.
CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
All highly liquid investments purchased with an original maturity of
90 days or less are considered to be cash and cash equivalents.
All of Zoran's investment portfolio is classified as available-for-sale and,
therefore, is reported at fair value with unrealized gains and losses, net of
related tax, if any, included as other comprehensive income, a component of
stockholders' equity. Gains and losses on realized upon sales of all such
securities are reported in interest and other income and have not been
significant to date.
46
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
At December 31, 1999, the Company's investment portfolio consisted primarily
of commercial paper with maturities of less than one year and the stock acquired
as a result of the MGI transaction (see Note 12). The unrealized gain on
securities available for sale of $4,962,000 included in comprehensive income
represents the unrealized gain on the stock at December 31, 1999.
CONCENTRATION OF CREDIT RISK OF FINANCIAL INSTRUMENTS
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash and cash equivalents,
short-term investments and trade accounts receivable. The Company places its
cash in banks and cash equivalents primarily in auction rate preferred,
certificates of deposit and commercial paper. The Company, by policy, limits the
amount of credit exposure through diversification and highly-rated securities.
The Company has not experienced any significant losses on its cash
equivalents or short-term investments.
The Company markets integrated circuits and technology to manufacturers and
distributors of electronic equipment primarily in North America, Europe and the
Pacific Rim. The Company performs ongoing credit evaluations of its customers'
financial condition and limits the amount of credit extended when deemed
necessary, but generally does not require collateral. Management believes that
any risk of loss is significantly reduced due to the diversity of its customers
and geographic sales areas. The Company maintains a provision for potential
credit losses, and write-offs of accounts receivable were insignificant in each
of the three years in the period ended December 31, 1999. As of December 31,
1999, three customers accounted for approximately 33%, 12%, and 9% of the
accounts receivable balance. As of December 31, 1998, five customers accounted
for approximately 20%, 14%, 7%, 7%, and 5% of the accounts receivable balance.
INVENTORY
Inventories are stated at the lower of standard cost (which approximates
actual cost on a first-in, first-out basis) or market. Market is based on
estimated net realizable value.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of three to five years.
Leasehold improvements are amortized on a straight-line basis over the shorter
of the estimated useful lives of the assets or the remaining term of the lease.
INCOME TAXES
The Company follows the liability method of accounting for income taxes
which requires recognition of deferred tax liabilities and assets for the
expected future tax consequence of temporary differences between the financial
statement carrying amounts and the tax bases of assets and liabilities.
For the twelve month periods ended December 31, 1999 and 1998 the provision
for income taxes reflects the estimated annualized effective tax rate applied to
earnings for the periods. The effective tax rate differs from the U.S. statutory
rate due to utilization of net operating losses and State of Israel tax
47
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
benefits on foreign earnings. The provision includes primarily taxes on income
in excess of net operating loss carryover limitations and foreign withholding
taxes.
EARNINGS PER SHARE
In accordance with Statement of Financial Accounting Standards No. 128
("SFAS 128") Zoran reports Earnings per Share ("EPS"), both basic and diluted,
on the statement of operations. Basic EPS is based upon the weighted average
number of common shares outstanding. Diluted EPS is computed using the weighted
average common shares outstanding plus any potential common stock, except when
their effect is anti-dilutive. Potential common stock includes stock options and
warrants. See Note 8.
STOCK COMPENSATION
The Company accounts for stock-based compensation using the intrinsic value
method prescribed in Accounting Principles Board Opinion No. 25 ("APB 25"),
"Accounting for Stock Issued to Employees" and related interpretations. Under
APB No.25, compensation expense is recognized based on the difference, if any,
on the date of grant between the fair value of the Company's stock and the
amount an employee must pay to acquire the stock. The compensation expense is
recognized over the periods the employee performs the related services,
generally the vesting period of four years, consistent with the multiple option
method described in FASB Interpretation No. 28 ("FIN28"). The Company provides
additional pro forma disclosures as required under Statement of Financial
Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based
Compensation." See Note 7.
SEGMENT REPORTING
In 1998, the Company adopted Statement of Financial Accounting Standards
No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related
Information." SFAS 131 supersedes SFAS 14 "Financial Reporting for Segments of a
Business Enterprise," replacing the "Industry Segment" approach with the
"Management" approach. The management approach designates the internal
organization that is used by management for making operating decisions and
assessing performance as the source of the Company's reportable segments.
SFAS 131 also requires disclosures about products and services, geographic
areas, and major customers. The Company operates in one industry segment
comprising the development and marketing of integrated circuits and software
products for use in a variety of video and audio products addressing PC and
consumer multimedia markets.
COMPREHENSIVE INCOME
In 1998, the Company adopted Statement of Financial Accounting Standards
No. 130 ("SFAS 130"), "reporting Comprehensive Income.
48
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
The following are the components of comprehensive income (in thousands):
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
Net income.......................................... $ 6,659 $929 $4,229
Unrealized gain on short-term investment............ 4,962 -- --
------- ---- ------
Comprehensive income................................ $11,621 $929 $4,229
======= ==== ======
The components of accumulated other comprehensive income are as follows (in
thousands):
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
Unrealized gain on short term-investment............ $4,962 -- --
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 establishes a new model for
accounting for derivatives and hedging activities and supercedes and amends a
number of existing accounting standards. SFAS 133 requires that all derivatives
be recognized in the balance sheet at their fair market value, and the
corresponding derivative gains or losses be either reported in the statement of
operations or as a deferred item depending on the type of hedge relationship
that exists with respect to such derivative. Adopting the provisions of
SFAS 133, which will be effective for the Company's fiscal year 2000, are
not expected to have a material effect on the Company's consolidated financial
statements.
In July 1999, the Financial Accounting' Standards Board issued Statement of
Financial Accounting Standards No. 137, "Accounting for Derivative Instruments
and Hedging Activities--Deferral of the Effective Date of SFAS 133"
("SFAS 137"). SFAS 137 defers the effective date of SFAS 133 to fiscal quarters
and years beginning after June 15, 2000. Adopting the provisions of SFAS 133 is
not expected to have a material effect on the Company's consolidated financial
statements.
NOTE 3--BALANCE SHEET COMPONENTS (In thousands):
DECEMBER 31,
-------------------
1999 1998
-------- --------
ACCOUNTS RECEIVABLE, NET:
Trade................................................... $22,367 $14,486
Unbilled................................................ 550 1,871
------- -------
22,917 16,357
Less: allowance......................................... (1,048) (799)
------- -------
$21,869 $15,558
======= =======
49
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--BALANCE SHEET COMPONENTS (In thousands): (CONTINUED)
Unbilled accounts receivable consists of both development revenue
recognized, but not yet billed and research and development funding not yet
received. Unbilled development revenue represents revenue recognized under the
percentage-of-completion method prior to achievement of the related contract
milestones. The Company bills development revenue when contract milestones are
achieved. The Company recognizes research and development funding as
reimbursable expenses, under research and development agreements, as incurred.
This funding is offset against research and development expenses.
DECEMBER 31,
-------------------
1999 1998
-------- --------
INVENTORY:
Work-in-process......................................... $ 1,135 $ 1,781
Finished goods.......................................... 6,024 5,282
------- -------
$ 7,159 $ 7,063
======= =======
PROPERTY AND EQUIPMENT:
Computer equipment...................................... $10,265 $ 9,573
Office equipment and furniture.......................... 729 706
Machinery and equipment................................. 1,391 860
Leasehold improvements.................................. 567 544
------- -------
12,952 11,683
Less: accumulated depreciation and amortization......... (7,290) (6,327)
------- -------
$ 5,662 $ 5,356
======= =======
ACCRUED EXPENSES AND OTHER LIABILITIES:
Accrued payroll and related expenses.................... $ 2,880 $ 1,910
Accrued royalties....................................... 673 808
Taxes payable........................................... 3,682 1,592
Deferred revenue........................................ 1,051 352
Other accrued liabilities............................... 2,750 1,792
------- -------
$11,036 $ 6,454
======= =======
NOTE 4--RESEARCH AND DEVELOPMENT ARRANGEMENTS:
The Company is a party to certain research and development agreements with
the Chief Scientist in Israel's Ministry of Industry and Trade Department (the
"Chief Scientist") and the Israel-United States Binational Industrial Research
and Development Foundation ("BIRDF"), which fund up to 50% of incurred project
costs for approved products up to specified contract maximums. The Company is
not obligated to repay funding regardless of the outcome of its development
efforts; however, these agreements require the Company to use its best efforts
to achieve specified results and require the Company to pay royalties at rates
of 3% to 5% of resulting products sales, and up to 30% of resulting license
revenues, up to a maximum of 100% to 150% of the total funding received.
Reported research and development expenses are net of these grants, which
fluctuate from period to period.
50
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--RESEARCH AND DEVELOPMENT ARRANGEMENTS: (CONTINUED)
Gross research and development expenses and the related grants are as
follows:
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
(IN THOUSANDS)
Research and development expenses:
Gross research and development expenses........ $13,135 $14,399 $13,787
Less: grants earned............................ (484) (851) --
------- ------- -------
$12,651 $13,548 $13,787
======= ======= =======
Royalty expenses related to these grants were $5,000, $196,000, and $301,000
in 1999, 1998 and 1997, respectively.
NOTE 5--DEVELOPMENT CONTRACTS:
The Company has generated a portion of its total revenues from development
contracts, primarily with key customers. These development contracts have
provided the Company with partial funding for the development of certain of its
products. The Company classifies costs related to these development contracts as
research and development expenses. The Company is not obligated to repay funding
regardless of the outcome of its development efforts; however, the agreements
require the Company to use its best efforts to achieve specified results as per
the agreements. The Company retains ownership of the intellectual property
developed under the contracts; however, some contracts limit the product markets
in which the Company may directly sell the developed product. Revenues generated
under these contracts were $1,185,000, $2,960,000 and $1,752,000 in 1999, 1998
and 1997, respectively.
NOTE 6--COMMITMENTS AND CONTINGENCIES:
From time to time, the Company may have certain contingent liabilities that
arise in the ordinary course of its business activities. The Company accrues
contingent liabilities when it is probable that future expenditures will be made
and such expenditures ca be reasonably estimated. In the opinion of management,
there are no pending claims of which the outcome is expected to result in a
material adverse effect in the financial position or results of operations of
the Company.
LEASE COMMITMENTS
The Company rents facilities and equipment under various lease agreements
expiring through 2004. Rent expense for 1999, 1998 and 1997 totaled
approximately $1,010,000, $887,000 and $748,000
51
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--COMMITMENTS AND CONTINGENCIES: (CONTINUED)
respectively. Future minimum lease payments required under noncancelable leases
at December 31, 1999 are as follows:
YEAR ENDING DECEMBER 31,
- ------------------------
2000........................................................ $1,010,000
2001........................................................ 1,018,000
2002........................................................ 1,042,000
2003........................................................ 570,000
2004........................................................ 410,000
----------
Total minimum lease payments................................ $4,050,000
==========
NOTE 7--STOCKHOLDERS' EQUITY:
COMMON STOCK
In December 1995, the Company issued shares of Common Stock in conjunction
with the Company's initial public offering ("IPO"). In January 1996, the
underwriters exercised their over-allotment option to purchase additional shares
of Common Stock. In December 1999, the Company issued 2,917,800 shares of Common
Stock in conjunction with a follow-on public offering that also included
underwriters' exercise of their over-allotment option. Gross proceeds from this
offering were $119.6 million with underwriters' discount and offering expenses
of $6.7 million.
We expect to use the net proceeds of the 1999 offering for working capital
and general corporate purposes, which may include the purchase of equipment and
the expansion of facilities. We also may use a portion of the net proceeds to
acquire or invest in businesses, technologies, products or services that are
complementary to our business. From time to time we have discussed potential
strategic acquisitions and investments with third parties. Pending our uses of
the proceeds, the net proceeds have been invested primarily in short-term,
investment-grade, interest-bearing instruments.
WARRANTS
In September 1997, in connection with a software license agreement, the
Company issued a warrant to purchase 75,000 shares of its Common Stock at an
exercise price of $24.31 per share. The warrant is exercisable for a period of
four years from a date beginning one year after the issuance date of the
warrant. The $717,000 estimated value of the warrant, is being amortized over
the four-year period of the license agreement. The unamortized balance at
December 31, 1999 of $297,000 is included in prepaid expenses and other current
assets.
STOCK OPTION PLANS
1993 STOCK OPTION PLAN
The Company's 1993 Stock Option Plan (the "1993 Option Plan") was adopted by
the Board of Directors of the Company and approved by the stockholders of the
Company in July 1993. A total of 2,940,000 shares of Common Stock have been
reserved for issuance under the 1993 Option Plan. The 1993 Option Plan provides
for grants of options to employees, non-employee directors and consultants. The
1993 Option Plan is currently being administered by the Compensation Committee
of the Board of
52
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--STOCKHOLDERS' EQUITY: (CONTINUED)
Directors of the Company, which determines the optionees and the terms of the
options granted, including the exercise price, number of shares subject to the
option plan and the exercisability thereof. The option price for shares granted
under the 1993 Option Plan is typically equal to the fair market value of the
common stock at the date of grant. The 1993 Option Plan will terminate in
July 2003, unless terminated sooner by the Board of Directors.
Generally, options granted under the 1993 Option Plan are fully exercisable
on and after the date of grant, subject to the Company's right to repurchase
from an optionee, at the optionee's original per share exercise price, any
unvested shares which the optionee has purchased and holds in the event of the
termination of the Optionee's employment, with or without cause. The Company's
right lapses as shares subject to the option become vested. Such shares
generally vest in monthly installments over two or four years following the date
of grant (as determined by the Compensation Committee of the Board of
Directors), subject to the optionee's continuous service. Options expire ten
years from the date of grant and an option shall generally terminate three
months after termination of employment.
In August 1998, substantially all options with an exercise price in excess
of $5.94 were cancelled and replaced with new options having an exercise price
of $5.94, the market price on the date that the employees accepted the
repricing. A total of 924,164 shares were repriced.
At December 31, 1999, shares available for grant under this plan were
133,000.
1995 OUTSIDE DIRECTORS STOCK OPTION PLAN
The Company's Outside Directors Stock Option Plan (the "Directors Plan") was
adopted by the Company's Board of Directors in October 1995, and was approved by
its stockholders in December 1995. A total of 200,000 shares of Common Stock
have been reserved for issuance under the Directors Plan. The Directors Plan
provides for the grant of nonstatutory stock options to nonemployee directors of
the Company. The Directors Plan provides that each new nonemployee director will
automatically be granted an option to purchase 20,000 shares on the date the
optionee first becomes a nonemployee director (the "Initial Grant"). Thereafter,
on the date immediately following each annual stockholders' meeting, each
nonemployee director who is reelected at the meeting to an additional term shall
be granted an additional option to purchase 4,800 shares of Common Stock if, on
such date, he or she shall have served on the Company's Board of Directors for
at least six months (the "Annual Grant"). The Initial Grant is exercisable in
four equal annual installments, and each Annual Grant shall become exercisable
in full one year after the date of grant, subject to the director's continuous
service. The exercise price of all stock options granted under the Directors
Plan is equal to the fair market value of the Company's Common Stock on the date
of grant. Options granted under the Directors Plan have a term of ten years.
At December 31, 1999 shares available for future issuance under this plan
was 35,000.
53
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--STOCKHOLDERS' EQUITY: (CONTINUED)
The following table summarizes the Company's stock option activity for the
years ended December 31, 1999, 1998 and 1997. The weighted average exercise
price for each category presented is also shown in the table below:
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------
1999 1998 1997
-------------------- --------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- -------- ---------- -------- --------- --------
Outstanding at beginning of
period......................... 2,226,265 $ 5.11 2,053,171 $ 8.62 2,164,208 $ 2.30
Granted.......................... 698,803 20.49 1,665,491 7.23 771,890 18.86
Exercised........................ (700,854) 2.87 (329,963) 0.56 (727,882) 0.39
Canceled......................... (291,658) 6.43 (1,162,434) 15.64 (155,045) 10.01
--------- ---------- ---------
Options outstanding at period
end............................ 1,932,556 11.22 2,226,265 5.11 2,053,171 8.62
========= ========== =========
Options exercisable at period
end............................ 1,926,549
=========
Significant option groups outstanding as of December 31, 1999 and the
related weighted average exercise price and contractual life information, are as
follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE CONTRACTUAL
EXERCISE PRICE NUMBER PRICE NUMBER PRICE LIFE (YEARS)
- -------------- --------- -------- --------- -------- ------------
$ 0.13 - $ 0.60 199,778 $ 0.15 199,778 $ 0.15 4.8
$ 1.57 - $ 4.69 25,542 4.49 19,535 4.43 6.5
$ 5.94 - $ 5.94 854,726 5.94 854,726 5.94 7.6
$ 8.50 - $20.38 653,110 17.66 653,110 17.66 8.9
$21.00 - $45.00 199,400 24.72 199,400 24.72 9.3
--------- ---------
1,932,556 11.22 1,926,549 11.24 7.9
========= =========
The weighted average grant date fair value of options granted during the
years ended December 31, 1999, 1998 and 1997 as defined by SFAS 123, were
$17.05, $3.41 and $9.19 per share, respectively.
1995 EMPLOYEE STOCK PURCHASE PLAN
The Company's 1995 Employee Stock Purchase Plan ("ESPP") was adopted by the
Company's Board of Directors in October 1995, and approved by its stockholders
in December 1995. The ESPP enables employees to purchase shares through payroll
deductions at approximately 85% of the lesser of the fair value of Common Stock
at the beginning of a 24-month offering period or the end of each six-month
segment within such offering period. The ESPP is intended to qualify as an
"employee stock purchase plan" under Section 423 of the U.S. Internal Revenue
Code. During the years ended December 31, 1999 and 1998, 87,222 and 84,354
shares were purchased by employees under the terms
54
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--STOCKHOLDERS' EQUITY: (CONTINUED)
of the plan agreements at a weighted average price of $8.73 and $9.57 per share,
respectively. At December 31, 1999, 161,558 shares were reserved and available
for issuance under this plan.
The weighted average grant date fair value of rights granted during the year
ended December 31, 1999, 1998 and 1997 as defined by SFAS 123, was $3.91, $3.55
and $3.64 per share, respectively.
FAIR VALUE DISCLOSURES
Had compensation cost for the Company's option and stock purchase plans been
determined based on the fair value at the grant dates, as prescribed in
FAS 123, the Company's net income (loss) and net income (loss) per share for
each of the three years ended December 31, 1999 would have been as follows (in
thousands, except per share data):
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
Net income (loss)
As reported..................................... $ 6,659 $ 929 $4,229
Pro forma....................................... $ 1,212 $(4,144) $ 547
Net income (loss) per share:
As reported
Basic......................................... $ 0.61 $ 0.09 $ 0.45
Diluted....................................... $ 0.54 $ 0.08 $ 0.38
Pro forma
Basic......................................... $ 0.11 $ (0.41) $ 0.06
Diluted....................................... $ 0.10 $ (0.41) $ 0.05
The fair value of each option grant is estimated on the date of grant using
the Black Scholes model with the following assumptions used for options and
purchase grants during the applicable period.
YEAR ENDED DECEMBER 31,
------------------------------------------
1999 1997 1997
------------ ------------ ------------
Dividend rate.................... 0.0% 0.0% 0.0%
Risk-free interest rates......... 4.6% to 6.2% 4.2% to 5.6% 5.1% to 6.3%
Volatility....................... 93.0% 61.0% 67.0%
Expected life
Option plans................... 5 years 5 years 5 years
Purchase plan.................. 0.5 years 0.5 years 0.5 years
The pro forma amounts reflect compensation expense related to stock options
and purchase rights granted during the years ended December 31, 1999, 1998 and
1997.
55
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8--EARNINGS PER SHARE:
A reconciliation of the numerators and the denominators of the basic and
diluted per share computation are as follows (in thousands):
1999 1998 1997
---------------------------------- ---------------------------------- ----------------------------------
PER PER PER
INCOME SHARES SHARE INCOME SHARES SHARE INCOME SHARES SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ------ ----------- ------------- ------ ----------- ------------- ------
Basic EPS:
Net income........ $6,659 10,844 $0.61 $929 10,042 $0.09 $4,229 9,412 $0.45
===== ===== =====
Effects of Dilutive
Securities:
Stock Options..... -- 1,405 -- 1,064 -- 1,539
Warrants.......... -- -- -- 13 -- 121
Diluted EPS:
------ ------ ---- ------ ------ ------
Net income........ $6,659 12,249 $0.54 $929 11,119 $0.08 $4,229 11,072 $0.38
====== ====== ===== ==== ====== ===== ====== ====== =====
NOTE 9--INCOME TAXES:
The components of income before income taxes are as follows:
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
(In thousands)
U.S................................................. $2,156 $ 475 $1,925
Foreign............................................. 5,678 686 3,232
------ ------ ------
$7,834 $1,161 $5,157
====== ====== ======
The components of the provision for income taxes are as follows:
YEAR ENDED DECEMBER 31,
------------------------------------
1999 1998 1997
-------- -------- --------
(In thousands)
Current:
U.S................................................ $ 50 $106 $360
State.............................................. 454 26 98
Foreign............................................ 671 100 470
------ ---- ----
Total current.................................... 1,175 232 928
Deferred........................................... -- -- --
------ ---- ----
Total........................................ $1,175 $232 $928
====== ==== ====
The tax provision differs from the amounts obtained by applying the
statutory U.S. Federal Income Tax Rate to income taxes as shown below.
56
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9--INCOME TAXES: (CONTINUED)
TAX PROVISION DIFFERENCE
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
(In thousands)
Tax at U.S. statutory rate.......................... $ 2,663 $ 395 $1,753
Utilization of net operating loss carryovers........ (856) (35) (856)
Foreign Earnings.................................... (1,612) (156) (213)
State taxes net of federal benefit.................. 302 -- 65
Other differences not benefited..................... 513 -- --
Permanent differences............................... 85 -- --
Alternative minimum tax............................. 50 -- 50
Other............................................... 30 28 129
------- ----- ------
$ 1,175 $ 232 $ 928
======= ===== ======
Deferred income tax assets comprise the following:
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
(In thousands)
Federal and state net operating loss
carryforwards................................ $ 16,417 $ 12,279 $ 12,286
Capitalized research and development
expenses..................................... 497 372 216
Nondeductible reserves and accruals............ 1,653 951 886
-------- -------- --------
Total deferred tax assets...................... 18,567 13,602 13,388
Deferred tax liabilities....................... -- -- --
-------- -------- --------
Net deferred tax assets........................ 18,567 13,602 13,388
Valuation allowance............................ (18,567) (13,602) (13,388)
-------- -------- --------
$ -- $ -- $ --
======== ======== ========
As of December 31, 1999, the Company has NOLs of approximately $48 million
for federal tax reporting purposes. The federal NOLs expire on various dates
between 2000 and 2009. Management has recorded a full valuation allowance
against all U.S. deferred tax assets on the basis that significant uncertainty
exists regarding the realizability of the assets.
Pursuant to the Tax Reform Act of 1986, the amounts of and the benefit from
NOLs that can be carried forward may be impaired or limited in certain
circumstances, including a cumulative stock ownership change of more than 50%
over a three-year period. The Company's IPO resulted in a cumulative change of
ownership of greater than 50%. Accordingly, the Company's NOLs incurred prior to
the completion of the IPO that can be utilized to reduce future taxable income
for federal tax purposes will be limited to approximately $3.0 million per year.
The Company's Israeli subsidiary has been granted the status of an "Approved
Enterprise" pursuant to the Israeli law for the Encouragement of Capital
Investments, 1959, as amended. The Company has four approved programs pursuant
to this law. The first program was approved in 1984.
57
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9--INCOME TAXES: (CONTINUED)
Income subject to this program is taxed at an annual rate of 10% from the first
year in which the enterprise generates taxable income (net of NOLs). Benefits
under the first program expired in 1997. The second program was approved in
1991. Income subject to this program is exempt from tax for two years from the
first year in which the Company has taxable income (net of NOLs) and is taxed at
a rate of 10% thereafter. Benefits under the second program expire in 2003. The
third program was approved in 1995. Income subject to this program is exempt
from tax for four years from the first year in which the Company has taxable
income (net of NOLs) and is taxed at a rate of 10% during the remaining period
of six years. The fourth program was approved in 1997. Income subject to this
program is exempt from tax for two years from the first year in which the
Company has taxable income (net of NOLs) and is taxed at a rate of 10% during
the remaining period of eight years. Benefits under the third and the fourth
program are limited to fourteen years from approval or twelve years from
commencement of production. The net impact of the tax holidays was an increase
in net income of $1.6 million in fiscal 1999 and an increase in net income per
share of $0.13.
NOTE 10--SEGMENT REPORTING:
The Company operates in one industry segment comprising the design,
development, manufacture and sale of integrated circuits. The following is a
summary of the Company's operations:
Sales to customers located in:
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
(In thousands)
United States.................................... $12,671 $17,935 $25,480
Pacific Rim...................................... 41,870 15,850 9,825
Europe........................................... 7,133 10,440 9,622
------- ------- -------
$61,674 $44,225 $44,927
======= ======= =======
DECEMBER 31,
-------------------
1999 1998
-------- --------
(In thousands)
Identifiable assets:
U.S.................................................... $157,374 $38,509
Israel................................................. 25,094 10,661
-------- -------
Total................................................ $182,468 $49,170
======== =======
58
ZORAN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--SEGMENT REPORTING: (CONTINUED)
Significant customers are as follows:
YEAR ENDED
DECEMBER 31,
------------------------------------
1999 1998 1998
-------- -------- --------
Customers comprising 10% or more of the Company's total
revenues for the period indicated:
A................................................... 37% 23% --
B................................................... -- -- 15%
C................................................... -- 14% 15%
D................................................... -- -- 15%
NOTE 11--SALE OF CERTAIN ASSETS:
In June 1999, the Company sold to MGI Software of Canada the intellectual
property related to its SoftDVD product line and transferred to MGI certain
related software development and support resources in exchange for cash, MGI
common stock and future royalties. The Company's results for the second quarter
of 1999 include a $732,000 gain realized from this transaction which is reported
as part of interest and other income or expense. In connection with this
transaction, the Company also recorded a charge that reduced software, licensing
and development revenue for the quarter by $517,000 for possible issues related
to receivables associated with the SoftDVD product line. The net impact of the
MGI transaction on the Company's results was an after-tax gain of $172,000, or
$0.01 per share on a diluted basis. This gain does not reflect the potential
future economic benefit that may be derived from this transaction and realized
in future periods in the form of royalties. The Company does not currently
expect, however, that these royalties will have a material impact on quarterly
revenues for the foreseeable future. In addition, the shares of MGI stock
received by the Company as part of this transaction are subject to future
appreciation or depreciation. The Company believes that its software revenues
will decline significantly as a result of the sale of the SoftDVD product line.
NOTE 12--RELATED-PARTY TRANSACTIONS:
In January 1996, the Company spun off its wholly-owned subsidiary, Oren
Semiconductor, to the Company's stockholders. Two of the Company's directors are
also members of Oren's board of directors. The Company has no ownership interest
in Oren.
In March 1999, the Company entered into a technology license agreement with
Oren. Under the license arrangement Oren agreed to pay to the Company license
and maintenance fees totalling $400,000 and royalties and maintenance fees based
on related products sold by Oren. License fees of approximately $360,000 were
recognized in the first quarter of 1999.
In April 1999, the company loaned Oren $350,000. The loan plus interest,
computed at 7% per year, was repaid by Oren in July 1999. The Company has no
commitments or plans to loan additional amounts to Oren.
59
ZORAN CORPORATION
SELECTED QUARTERLY FINANCIAL INFORMATION
(UNAUDITED)
QUARTERS ENDED
---------------------------------------------------------------------------------------
DEC 31, SEPT 30, JUNE 30, MARCH 31, DEC 31, SEPT 30, JUNE 30, MARCH 31,
1999 1999 1999 1999 1998 1998 1998 1998
-------- -------- -------- --------- -------- -------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenues:
Product sales......................... $18,159 $14,519 $10,927 $ 9,282 $11,235 $ 8,986 $ 4,610 $ 8,634
Software, licensing and development... 1,896 1,577 2,704 2,610 2,901 2,860 2,465 2,534
------- ------- ------- ------- ------- ------- ------- -------
Total revenues.................... 20,055 16,096 13,631 11,892 14,136 11,846 7,075 11,168
------- ------- ------- ------- ------- ------- ------- -------
Cost and expenses:
Cost of product sales................. 10,026 7,720 5,684 5,093 6,286 5,153 2,940 4,657
Research and development.............. 2,706 2,430 3,991 3,524 3,894 3,476 2,944 3,234
Selling, general and administrative... 4,019 3,683 3,302 3,247 3,240 2,877 2,686 2,748
------- ------- ------- ------- ------- ------- ------- -------
Total costs and expenses.......... 16,751 13,833 12,977 11,864 13,420 11,506 8,570 10,639
------- ------- ------- ------- ------- ------- ------- -------
Operating income (loss)................. 3,304 2,263 654 28 716 340 (1,495) 529
Interest and other income (expense),
net................................... 359 249 878 99 375 176 275 245
------- ------- ------- ------- ------- ------- ------- -------
Income (loss) before taxes.............. 3,663 2,512 1,532 127 1,091 516 (1,220) 774
Provision (benefit) for income taxes.... 342 502 306 25 218 103 (244) 155
------- ------- ------- ------- ------- ------- ------- -------
Net income (loss)....................... $ 3,321 $ 2,010 $ 1,226 $ 102 $ 873 $ 413 $ (976) $ 619
======= ======= ======= ======= ======= ======= ======= =======
Net income (loss) per share:
Basic................................. $ 0.29 $ 0.19 $ 0.12 $ 0.01 $ 0.09 $ 0.04 $ (0.10) $ 0.06
======= ======= ======= ======= ======= ======= ======= =======
Diluted............................... $ 0.26 $ 0.17 $ 0.10 $ 0.01 $ 0.08 $ 0.04 $ (0.10) $ 0.06
======= ======= ======= ======= ======= ======= ======= =======
Shares used to compute basic net income
(loss) per share...................... 11,404 10,681 10,436 10,278 10,154 10,064 9,975 9,856
======= ======= ======= ======= ======= ======= ======= =======
Shares used to compute diluted net
income (loss) per share............... 12,853 12,083 11,673 11,776 11,469 10,941 9,975 10,952
======= ======= ======= ======= ======= ======= ======= =======
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
60
PART III
Certain information required by Part III is omitted from this report in that
the Company intends to file its definitive proxy statement pursuant to
Regulation 14A (the "Proxy Statement") not later than 120 days after the end of
the fiscal year covered by this report and certain information therein is
incorporated herein by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this Item is incorporated by reference to
information set forth in the Proxy Statement under the heading "Proposal
No. 1--Election of Directors" and in Part I of this Report under the heading
"Executive Officers of the Registrant."
The information required by this Item with respect to compliance with
Section 16(a) of the Securities Exchange Act of 1934 is incorporated by
reference to information set forth in the Proxy Statement under the heading
"Section 16(a) Beneficial Ownership Reporting Compliance."
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item is incorporated by reference to
information set forth in the Proxy Statement under the heading "Executive
Compensation."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item is incorporated by reference to
information set forth in the Proxy Statement under the heading "Principal
Stockholders and Share Ownership by Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item is incorporated by reference to
information set forth in the Proxy Statement under the heading "Certain
Transactions."
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as a part of this report:
(1) Financial Statements:
See Index to Consolidated Financial Statements at page 39 of this report.
(2) Financial Statement Schedules:
All financial statement schedules are omitted because they are not
applicable or not required, or because the required information is
included in the Consolidated Financial Statements and Notes thereto which
are included herein.
(3) Exhibits:
The exhibits listed on the accompanying Exhibit Index are filed as part
of, or are incorporated by reference into, this report.
(b) Reports on Form 8-K during the quarter ended December 31, 1999:
None
61
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.
Dated: March 30, 2000 ZORAN CORPORATION
By: /s/ LEVY GERZBERG
------------------------------------------
Levy Gerzberg,
PRESIDENT AND
CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Security Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ LEVY GERZBERG President, Chief Executive
-------------------------------------- Officer and Director March 30, 2000
Levy Gerzberg (Principal Executive Officer)
Vice President, Finance and
/s/ KARL SCHNEIDER Chief Financial Officer
-------------------------------------- (Principal Financial and March 30, 2000
Karl Schneider Accounting Officer)
/s/ UZIA GALIL
-------------------------------------- Chairman of the Board of March 30, 2000
Uzia Galil Directors
/s/ GEORGE T. HABER
-------------------------------------- Director March 30, 2000
George T. Haber
/s/ JAMES D. MEINDL
-------------------------------------- Director March 30, 2000
James D. Meindl
/s/ ARTHUR B. STABENOW
-------------------------------------- Director March 30, 2000
Arthur B. Stabenow
/s/ PHILIP M. YOUNG
-------------------------------------- Director March 30, 2000
Philip M. Young
62
EXHIBIT INDEX
EXHIBIT
NUMBER EXHIBIT TITLE
- --------------------- -------------
3.1(1) Form of Restated Certificate of Incorporation of the
Registrant.
3.2(2) Amended Bylaws of the Registrant.
4.1(3) Amended and Restated Stock Rights Agreement dated July 30,
1993 among the Registrant and certain of its stockholders,
as amended.
*10.1(3) 1993 Stock Option Plan, as amended.
*10.2(3) 1995 Outside Directors Stock Option Plan.
*10.3(4) Amended and Restated 1995 Employee Stock Purchase Plan.
*10.4(3) Form of Indemnity Agreement for officers and directors.
+10.5(3) Agreement dated June 28, 1991 between the Registrant and
Fujifilm Microdevices Co., Ltd. ("Fujifilm"), as amended.
+10.6(3) Agreement dated July 27, 1992 between the Registrant and
Fujifilm.
10.7(3) Letter Agreement dated December 16, 1991 between the
Registrant and Dolby Laboratories Licensing Corporation, as
amended.
10.11(3) Lease Agreement dated October 1, 1992 between the
Registrant's subsidiary, Zoran Microelectronics Ltd.
("ZML"), and Matam-Haifa Scientific Industries Center Ltd.
("Matam")
+10.12(3) License Agreement for ZR33891 Digital Filter Processor dated
June 8, 1995 between the Registrant and Atmel Corporation
("Atmel").
+10.13(3) License Agreement for ZR34325 Vector Signal Processor dated
June 8, 1995 between the Registrant and Atmel.
+10.14(3) Cooperation and Project Funding Agreement dated June 16,
1991 between ZML and the Israel-United States Binational
Industrial Research and Development Foundation ("BIRDF").
+10.15(3) Cooperation and Project Funding Agreement dated June 9, 1992
between ZML and BIRDF.
10.16(3) Note of Approval No. 17391 dated September 5, 1994 issued to
ZML by the Office of Chief Scientist, Head of the Industrial
Research and Development Administration of the Israeli
Ministry of Industry and Trade (the "Chief Scientist"),
together with ZML's Letter of Undertaking dated September 4,
1994.
10.17(3) Note of Approval No. 17337 dated September 5, 1994 issued to
ZML by the Chief Scientist, together with ZML's Letter of
Undertaking dated September 4, 1994.
10.18(3) Loan Agreements dated July 25, 1995, August 1, 1995, August
15, 1995, August 31, 1995 and November 1, 1995 between ZML
and the Israel Discount Bank.
10.29(5) Summary of Discussion dated April 23, 1996 between ZML and
Matam regarding Lease Agreement dated October 1, 1992
between ZML and Matam.
10.30(6) Memorandum of Understanding Dated April 23, 1996 between ZML
and IBM Israel Ltd. regarding Lease Agreement dated October
1, 1992 between ZML and Matam.
10.33(7) Sub-Sublease dated April 1, 1997 between the Registrant and
Integrated Silicon Solutions, Inc.
63
EXHIBIT
NUMBER EXHIBIT TITLE
- --------------------- -------------
*10.34(8) Confidential Separation Agreement dated August 4, 1997
between the Registrant and George T. Haber.
10.35(9) Agreement for Purchase and Sale of Assets between the
Registrant and MGI Software Corp. dated June 15, 1999
10.36 Unprotected Tenancy Agreement dated September 16, 1997
between ZML and Matam together with Appendix Addendum to
Unprotected Tenancy Agreement of 16.9.97.
21.1 List of subsidiaries of the Registrant.
23.1 Consent of PricewaterhouseCoopers LLP.
27 Financial Data Schedule.
- ------------------------
* Constitutes a management contact or compensatory plan required to be filed
pursuant to Item 14(c) of Form 10-K.
+ Confidential treatment has been granted as to a portion of this Exhibit.
(1) Incorporated by reference to Exhibit 3.2 to Registrant's Form SB-2
Registration Statement (No. 33-98630-LA), which became effective on
December 14, 1995 (the "1995 Registration Statement").
(2) Incorporated by reference to Exhibit 3.3 to Registrant's Form 10-Q Quarterly
Report for the quarter ended September 30, 1998.
(3) Incorporated by reference to identically numbered exhibit to the 1995
Registration Statement.
(4) Incorporated by reference to identically numbered exhibit to Registrant's
Form 10-K Annual Report for the year ended December 31, 1995.
(5) Incorporated by reference to Exhibit 10.1 to the Registrant's Form 10-Q
Quarterly Report for the quarter ended June 30, 1996 (the "June 1996 Form
10-Q").
(6) Incorporated by reference to Exhibit 10.2 to the June 1996 Form 10-Q.
(7) Incorporated by reference to identically numbered exhibit to Registrant's
Form 10-Q Quarterly Report for the quarter ended March 31, 1997.
(8) Incorporated by reference to Exhibit 10.34 to Registrant's Form 10-K Annual
Report for the year ended December 31, 1997.
(9) Incorporated by reference to identically numbered exhibit to Registrant's
Form 10-Q Quarterly Report for the quarter ended June 30, 1999.
64