10-Q 1 a10-q.txt 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------------- FORM 10-Q (Mark One) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2000 or ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from__________ to__________ Commission File Number: 0-27246 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) Registrant's telephone number, including area code: (408) 919-4111 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- The number of outstanding shares of the registrant's Common Stock, $.001 par value, as of July 31, 2000 was 14,589,115. ZORAN CORPORATION INDEX
PAGE NO. ------- PART I. FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets June 30, 2000 and December 31, 1999 3 Condensed Consolidated Statements of Operations Three and Six Months Ended June 30, 2000 and 1999 4 Condensed Consolidated Statements of Cash Flows Six Months Ended June 30, 2000 and 1999 5 Notes to Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 3. Quantitative and Qualitative Disclosures About Market Risk 25 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 26 SIGNATURES 27
2 ZORAN CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA) (UNAUDITED)
June 30, December 31, 2000 1999 ---- ---- ASSETS Current assets: Cash and cash equivalents $ 15,418 $ 12,665 Short-term investments 93,200 132,967 Accounts receivable, net 21,734 21,869 Inventory 11,380 7,159 Prepaid expenses and other current assets 3,171 1,946 --------------------- --------------------- Total current assets 144,903 176,606 Property and equipment, net 6,061 5,662 Other investments 41,241 200 Goodwill and other intangibles 18,036 -- --------------------- --------------------- $ 210,241 $ 182,468 ===================== ===================== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 9,711 $ 7,987 Accrued expenses and other liabilities 12,665 11,036 --------------------- --------------------- Total current liabilities 22,376 19,023 --------------------- --------------------- Stockholders' equity: Common Stock, $0.001 par value; 20,000,000 shares authorized; 14,535,945 and 13,919,270 shares issued and outstanding 14 14 Additional paid-in capital 221,408 195,269 Warrants 717 717 Accumulated other comprehensive income 3,478 4,962 Accumulated deficit (37,752) (37,517) --------------------- --------------------- Total stockholders' equity 187,865 163,445 --------------------- --------------------- $ 210,241 $ 182,468 ===================== =====================
The accompanying notes are an integral part of these condensed consolidated financial statements. 3 ZORAN CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
Three Months Ended Six Months Ended June 30, June 30, -------------------------- ------------------------- 2000 1999 2000 1999 ------------- ------------ ------------ ------------ Revenues: Product sales $ 16,389 $ 10,927 $ 30,611 $ 20,209 Software, licensing and development 2,472 2,704 5,892 5,314 ------------- ------------ ------------ ------------ Total revenues 18,861 13,631 36,503 25,523 ------------- ------------ ------------ ------------ Costs and expenses: Cost of product sales 9,069 5,684 17,205 10,777 Research and development 3,976 3,991 7,245 7,515 Selling, general and administrative 4,443 3,302 8,580 6,549 Write-off of acquired in-process research and development 6,769 -- 6,769 -- ------------- ------------ ------------ ------------ Total costs and expenses 24,257 12,977 39,799 24,841 ------------- ------------ ------------ ------------ Operating income (loss) (5,396) 654 (3,296) 682 Interest and other income, net 2,208 878 4,214 977 ------------- ------------ ------------ ------------ Income (loss) before income taxes (3,188) 1,532 918 1,659 Provision for income taxes 537 306 1,153 332 ------------- ------------ ------------ ------------ Net income (loss) $ (3,725) $ 1,226 $ (235) $ 1,327 ============= ============ ============ ============ Basic net income (loss) per share $ (0.26) $ 0.12 $ (0.02) $ 0.13 ============= ============ ============ ============ Diluted net income (loss) per share $ (0.26) $ 0.10 $ (0.02) $ 0.11 ============= ============ ============ ============ Shares used to compute basic net income (loss) per share 14,113 10,436 14,072 10,441 ============= ============ ============ ============ Shares used to compute diluted net income (loss) per share 14,113 11,673 14,072 11,735 ============= ============ ============ ============
The accompanying notes are an integral part of these condensed consolidated financial statements. 4 ZORAN CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
SIX MONTHS ENDED JUNE 30, ------------------------------------------- 2000 1999 -------------------- -------------------- Cash flows from operating activities: Net income (loss) $ (235) $ 1,327 Adjustments to reconcile net income (loss) to net cash provided by (used in) operations: Depreciation, amortization and other 1,395 1,213 Write-off of in process research and development 6,769 -- Changes in current assets and liabilities: Accounts receivable 222 (2,173) Inventory (4,100) (4,670) Prepaid expenses and other current assets (1,260) (548) Accounts payable 1,650 2,869 Accrued expenses and other liabilities 1,147 (138) -------------------- -------------------- Net cash provided by (used in) operating activities 5,588 (2,120) -------------------- -------------------- Cash flows from investing activities: Capital expenditures for property and equipment (1,308) (794) Purchases of investments (145,708) (5,806) Sales and maturities of investments 144,953 5,720 Purchases of long-term equity investments (2,250) -- PixelCam acquisition costs net of cash acquired (12) -- -------------------- -------------------- Net cash used in investing activities (4,325) (880) Cash flows from financing activities: Proceeds from issuance of Common Stock, net 1,490 882 -------------------- -------------------- Net cash provided by financing activities 1,490 882 -------------------- -------------------- Net increase (decrease) in cash and cash equivalents 2,753 (2,118) Cash and cash equivalents at beginning of period 12,665 8,221 -------------------- -------------------- Cash and cash equivalents at end of period $ 15,418 $ 6,103 ==================== ==================== Non-cash disclosures of investing activities: Issuance of common stock in exchange for the net assets of PixelCam, Inc. $ 24,649 $ -- ==================== ====================
The accompanying notes are an integral part of these condensed consolidated financial statements. 5 ZORAN CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) which, in the opinion of management, are necessary to present fairly the financial information included therein. While the Company believes that the disclosures are adequate to make the information not misleading, it is suggested that these financial statements be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 1999. Results for the interim periods presented are not necessarily indicative of the results to be expected for the full year. 2. COMPREHENSIVE INCOME In 1998, the Company adopted Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income. The following are the components of comprehensive income (loss) (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------------------- ------------------- 2000 1999 2000 1999 --------- ------- -------- ------- Net income (loss) $ (3,725) $ 1,226 $ (235) $ 1,327 Unrealized gain on short-term investment (1,592) -- $(1,484) -- --------- ------- -------- ------- Comprehensive income (loss) $ (5,317) $ 1,226 $(1,719) $ 1,327 ========= ======= ======== =======
The components of accumulated other comprehensive income are unrealized gain (loss) on short-term investment which was $3.5 million and $5.0 million at the end of June 30, 2000 and December 31, 1999 respectively. 3. BALANCE SHEET COMPONENTS
JUNE 30, DECEMBER 31, 2000 1999 -------------------- -------------------- INVENTORY: Work-in-process $ 4,017 $ 1,135 Finished goods 7,363 6,024 -------------------- -------------------- $ 11,380 $ 7,159 ==================== ====================
4. INCOME TAXES The provision for income taxes reflects the estimated annualized effective tax rate applied to earnings for the interim periods. The effective tax rate differs from the U.S. statutory rate due to utilization of net operating losses and State of Israel tax benefits on foreign earnings. The provision includes primarily taxes on income in excess of net operating loss carryover limitations and foreign withholding taxes. 6 5. EARNINGS PER SHARE A reconciliation of the numerators and the denominators of the basic and diluted per share computation is as follows:
Three Months Ended June 30, 2000 1999 ------------------------------------- ------------------------------------- Income Shares Per Share (Loss) Shares Per Share (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount ----------- ------------- --------- ----------- ------------ --------- Basic EPS: Net income (loss) available to common stockholders $ (3,725) 14,113 $ (0.26) $ 1,226 10,436 $ 0.12 ======== ====== Effects of Dilutive Securities: Stock Options - - - 1,237 --------- ------ ------- ------ Diluted EPS: Income (loss) available to common stockholders $ (3,725) 14,113 $ (0.26) $ 1,226 11,673 $ 0.10 ========= ====== ======== ======= ====== ======
---------------------------------------------------------------------------- Six Months Ended June 30, 2000 1999 ------------------------------------- ------------------------------------- Income Shares Per Share (Loss) Shares Per Share (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount ----------- ------------- --------- ----------- ------------ --------- Basic EPS: Net income (loss) available to common stockholders $ (235) 14,072 $ (0.02) $ 1,327 10,441 $ 0.13 ======== ====== Effects of Dilutive Securities: Stock Options - - - 1,294 -------- ------ ------- ------ Diluted EPS: Income (loss) available to common stockholders $ (235) 14,072 $ (0.02) $ 1,327 11,735 $ 0.11 ======== ====== ======== ======= ====== ======
6. RECENTLY ISSUED ACCOUNTING STANDARD 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. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin: No. 101 "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 summarizes certain of the Staff's views in applying generally accepted accounting principles to revenue recognition in financial statements. In June 2000 the SEC issued SAB No. 101B to defer the effective date of the implementation of SAB No. 101 until the fourth quarter of fiscal 2000. The Company does not expect the adoption of SAB 101 to have a material effect on its financial position or results of operations. In March 2000, the Financial Accounting Standards Board issued Interpretation No. 44 ("FIN 44") "Accounting for Certain Transactions involving Stock Compensation," an interpretation of APB Opinion No. 25. FIN 44 clarifies the application of Opinion 25 for (a) the definition of employee for purposes of applying Opinion 25, (b) the criteria for determining whether a plan qualifies as a noncompensatory plan, (c) the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. FIN 44 is effective July 1, 2000, but certain conclusions cover specific events that occur after either December 15, 1998, or January 12, 2000. The adoption of FIN 44 has not had a material effect. 7 7. ACQUISITION OR DISPOSITION OF ASSETS On June 29, 2000, the Company acquired PixelCam, Inc. ("PixelCam"), a manufacturer of megapixel CMOS image sensors and integrated lens/sensor modules, in exchange for 370,832 shares of Zoran common stock and options to purchase 4,168 shares of Zoran common stock with an aggregate value of $24.6 million. The common stock issued includes 123,612 shares of restricted stock subject to repurchase by the Company exchanged for restricted stock of PixelCam. The restrictions and vesting periods of the PixelCam shares was maintained and will apply to the converted shares of the Company. The agreement also includes shares that are contingently issuable to former PixelCam shareholders upon achievement of certain milestones. Any contingent consideration will be valued and recorded as of the date the lifting of the contingency becomes probable. The acquisition was accounted for under the purchase method of accounting. The Company had a valuation performed of the in-process research and development and the intangible assets acquired. The allocation of the purchase price based on independent appraisal and estimates of fair value and including acquisition costs of $575,000, is as follows (in thousands): Net tangible assets $ 419 In-process research and development 6,769 Goodwill and other intangible assets: Goodwill 15,956 Covenant not to compete 800 Patents 900 Acquired employees 380 ---------- $18,036 ---------- Net assets acquired $25,224 ==========
The net tangible assets acquired were comprised primarily of property and equipment, inventory, and cash offset by accrued liabilities. The acquired in-process research and development was written-off in the second quarter of 2000. The estimated weighted average useful life of the intangible assets for purchased technology, covenant not to compete, acquired employees, patents and residual goodwill, created as a result of the acquisition of PixelCam, is approximately three years. Assuming the business combination had taken place as of January 1, 1999, amortization of goodwill and other intangibles would have been $3.0 million for each of the six month periods ended June 30, 2000 and June 30, 1999. The Company will disclose further pro forma financial information in a subsequent filing on Form 8-K/A. The allocation of $6.8 million of the purchase price to the acquired in-process research and development has been determined by identifying the research project which technological feasibility had not been established and no alternative future uses existed. The value was determined by estimating the expected cash flows from the project once commercially viable, discounting the net cash flows back to their present value, and then applying a percentage of completion to the calculated value as defined below. NET CASH FLOWS. The net cash flows from the identified project was based on estimates of revenues, cost of sales, research and development costs, selling, general and administrative costs, and income taxes from the project. These estimates were based on the assumptions discussed below. The research and development costs excluded costs to bring the acquired in-process project to technological feasibility. The estimated revenues were based on management projections of the acquired in-process project. The business projections were compared with and found to be in line with industry analysts' forecasts of growth in substantially all of the relevant markets. Estimated total revenues from the acquired in-process research and development product are expected to peak in fiscal 2002 and decline in fiscal 2003 as other new products are expected to become available. These projections were based on estimates of market size and growth, expected trends in technology, and the nature and expected timing of new product introductions by the Company and its competitors. Projected gross margins as well as selling, general and administrative costs were based on management's estimates. 8 DISCOUNT RATE. Discounting the net cash flows back to their present value was based on the cost of capital for well managed venture capital funds which typically have similar risks and returns on investments. The cost of capital used in discounting the net cash flows from acquired in-process research was 25%. PERCENTAGE OF COMPLETION. The percentage of completion was determined using costs incurred by PixelCam prior to the acquisition date compared to the remaining research and development to be completed to bring the project to technological feasibility. The Company estimated, as of the acquisition date, the project was 62% complete and the estimated costs to complete the project were approximately $4.1 million. The Company expects to complete the project within 12 months from the acquisition date. However, development of this project remains a significant risk to the Company due to the remaining effort to achieve technical feasibility, rapidly changing customer markets and significant competitive threats from numerous companies. Failure to bring these products to market in a timely manner could adversely impact sales and profitability of the Company in the future. Additionally, the value of the intangible assets acquired may become impaired. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO THE COMPANY'S FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CURRENTLY ANTICIPATED DEPENDING UPON A VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED BELOW UNDER THE SUB-HEADING, "FUTURE PERFORMANCE AND RISK FACTORS" AND DISCUSSED MORE FULLY IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1999. 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. 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. In the past, 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 10 also 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, 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. 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. RESULTS OF OPERATIONS REVENUES Total revenues were $18.9 million and $36.5 million for the three and six month periods ended June 30, 2000, compared to $13.6 million and $25.5 million for the same periods of 1999, representing increases of 38.4% and 43.0% for the respective periods. For the three and six month periods ended June 30, 2000, product revenues were $16.4 million and $30.6 million, compared to $10.9 million and $20.2 million for the same periods in 1999, increases of 50.0% and 51.5%, respectively. Fueling the growth in product revenue were the DVD and audio product lines. Software, licensing and development revenues were $2.5 million and $5.9 million for the three and six month periods ended June 30, 2000, compared to $2.7 million and $5.3 million for the same periods of 1999, representing a decrease of 8.6% and an increase of 10.9% for the respective periods. These changes were primarily due to the timing of significant new licensing contracts, as well as the timing of revenue recognition on development contracts. PRODUCT GROSS MARGIN Product gross margins were 44.7% and 43.8% of product revenues for the three and six month periods ended June 30, 2000, compared to 48.0% and 46.7% for the same periods of 1999. The decreases were due 11 to a product sales mix that included a decreased percentage of higher-margin products and a lower percentage of products sold directly to OEM customers. RESEARCH AND DEVELOPMENT Research and development ("R&D") expenses were $4.0 million and $7.2 million for the three and six month periods ended June 30, 2000, compared to $4.0 million and $7.5 million for the same periods of 1999. As a percentage of revenues, R&D expenses decreased to 21.1% and 19.8% for the three and six month periods ended June 30, 2000, compared to 29.3% and 29.4% for the same periods of 1999. The decrease in R&D expenses as a percentage of revenues for the current quarter compared to the same period in 1999 was due to increased revenues in 2000. SELLING, GENERAL AND ADMINISTRATIVE Selling, general and administrative ("SG&A") expenses were $4.4 million and $8.6 million for the three and six month periods ended June 30, 2000, compared to $3.3 million and $6.5 million for the same periods of 1999. The increase was primarily due to increased efforts in the development of the China market and greater commission expense related to increased sales volume. As a percentage of revenues, SG&A expenses were 23.6% and 23.5% for the three and six month periods ended June 30, 2000, compared to 24.2% and 25.7% for the same periods of 1999. The decrease as a percent of revenues, quarter to quarter, was due to the increase in revenues in 2000. WRITE-OFF OF ACQUIRED IN-PROCESS TECHNOLOGY On June 29, 2000, the Company acquired PixelCam, Inc. ("PixelCam"), a manufacturer of megapixel CMOS image sensors and integrated lens/sensor modules, in exchange for 370,832 shares of Zoran common stock and options to purchase 4,168 shares of Zoran common stock with an aggregate value of $24.6 million. The common stock issued includes 123,612 shares of restricted stock subject to repurchase by the Company exchanged for restricted stock of PixelCam. The restrictions and vesting periods of the PixelCam shares was maintained and will apply to the converted shares of the Company. The agreement also includes shares that are contingently issuable to former PixelCam shareholders upon achievement of certain milestones. Any contingent consideration will be valued and recorded as of the date the lifting of the contingency becomes probable. The acquisition was accounted for under the purchase method of accounting. The Company had a valuation performed of the in-process research and development and the intangible assets acquired. The allocation of the purchase price based on independent appraisal and estimates of fair value and including acquisition costs of $575,000, is as follows (in thousands): Net tangible assets $ 419 In-process research and development 6,769 Goodwill and other intangible assets: Goodwill 15,956 Covenant not to compete 800 Patents 900 Acquired employees 380 ---------- $18,036 ---------- Net assets acquired $25,224 ==========
The net tangible assets acquired were comprised primarily of property and equipment, inventory, and cash offset by accrued liabilities. The acquired in-process research and development was written-off in the second quarter of 2000. The estimated weighted average useful life of the intangible assets for purchased technology, covenant not to compete, acquired employees, patents and residual goodwill, created as a result of the acquisition of PixelCam, is approximately three years. Assuming the business combination had taken place as of January 1, 1999, amortization of goodwill and other intangibles would have been $3.0 million for each of the six month periods ended June 30, 2000 and June 30, 1999. The Company will disclose further pro forma financial information in a subsequent filing on Form 8-K/A. 12 The allocation of $6.8 million of the purchase price to the acquired in-process research and development has been determined by identifying the research project which technological feasibility had not been established and no alternative future uses existed. The value was determined by estimating the expected cash flows from the project once commercially viable, discounting the net cash flows back to their present value, and then applying a percentage of completion to the calculated value as defined below. NET CASH FLOWS. The net cash flows from the identified project was based on estimates of revenues, cost of sales, research and development costs, selling, general and administrative costs, and income taxes from the project. These estimates were based on the assumptions discussed below. The research and development costs excluded costs to bring the acquired in-process project to technological feasibility. The estimated revenues were based on management projections of the acquired in-process project. The business projections were compared with and found to be in line with industry analysts' forecasts of growth in substantially all of the relevant markets. Estimated total revenues from the acquired in-process research and development product are expected to peak in fiscal 2002 and decline in fiscal 2003 as other new products are expected to become available. These projections were based on estimates of market size and growth, expected trends in technology, and the nature and expected timing of new product introductions by the Company and its competitors. Projected gross margins as well as selling, general and administrative costs were based on management's estimates. DISCOUNT RATE. Discounting the net cash flows back to their present value was based on the cost of capital for well managed venture capital funds which typically have similar risks and returns on investments. The cost of capital used in discounting the net cash flows from acquired in-process research was 25%. PERCENTAGE OF COMPLETION. The percentage of completion was determined using costs incurred by PixelCam prior to the acquisition date compared to the remaining research and development to be completed to bring the project to technological feasibility. The Company estimated, as of the acquisition date, the project was 62% complete and the estimated costs to complete the project were approximately $4.1 million. The Company expects to complete the project within 12 months from the acquisition date. However, development of this project remains a significant risk to the Company due to the remaining effort to achieve technical feasibility, rapidly changing customer markets and significant competitive threats from numerous companies. Failure to bring these products to market in a timely manner could adversely impact sales and profitability of the Company in the future. Additionally, the value of the intangible assets acquired may become impaired. INTEREST AND OTHER INCOME, NET Net interest and other income for the three and six month periods ended June 30, 2000 was $2.2 million and $4.2 million, respectively, an increase of 151.5% and 331.3% compared to the same periods in 1999. The increase resulted primarily from increased interest income on higher cash balances following our follow-on public offering of common stock in December 1999. PROVISION FOR INCOME TAXES The Company's estimated effective tax rate remained at 15% for the current quarter, the same as last year's effective tax rate. LIQUIDITY AND CAPITAL RESOURCES During the first six months of 2000, our capital requirements were satisfied primarily by cash flows from operations. At June 30, 2000, we had $15.4 million of cash and cash equivalents, $93.2 million of short-term 13 investments and $122.5 million of working capital. In addition, we had $38.8 million of long-term investments in marketable securities at June 30, 2000. Our operating activities provided cash of $6.4 million during the six months ended June 30, 2000, primarily due to net income adjusted for the non-cash impact of depreciation and amortization and the one-time charge of $6.8 million for the write-off of purchased in-process research and development. An increase of inventory and prepaid expenses was partially offset by an increase of accounts payable and accrued expenses. Cash used in investing activities was $5.0 million during the six months ended June 30, 2000, principally reflecting purchases of long-term equity investments and capital equipment. Cash provided by financing activities was $1.3 million for the six months ended June 30, 2000 and consisted substantially of proceeds from the issuance of common stock under our incentive stock option plan and employee stock purchase plan. 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 the balance of 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 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. FUTURE PERFORMANCE AND RISK FACTORS The Company's future business, operating results and financial condition are subject to various risks and uncertainties, including those described below. 14 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 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 15 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 and the first six months of 2000, 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. 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 16 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 1999 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. 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. 17 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; - 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. 18 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. The DVD market is growing, 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 19 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 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 the first six months of 2000, 84% 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. 20 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 are 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. 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 21 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. 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. 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. We have recently acquired PixelCam, a privately-held manufacturer of CMOS sensors and integrated lens/sensor modules, and we may acquire additional 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 PixelCam and any other business that we may acquire 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. 22 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. 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 23 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 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. 24 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; - 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 June 30, 2000, 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 $74.3125. During the first six months of 2000 the sale price ranged from a low of $33.50 to a high of $74.3125. 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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 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 June 30, 2000, a near-term 10% appreciation or depreciation of the New Israeli Shekel would have an immaterial affect on our financial condition. 25 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 2.1(1) Agreement and Plan of Reorganization dated June 28, 2000 among Zoran Corporation, Grape Acquisition Corp. and PixelCam, Inc. 27 Financial Data Schedule. (b) Reports on Form 8-K No reports on Form 8-K were filed during the three months ended June 30, 2000. -------------------------------------------------------------------------------------------------------------------
(1) Incorporated by reference to identically numbered exhibit to Registrant's Form 8-K Current Report dated July 10, 2000. 26 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ZORAN CORPORATION Date: August 15, 2000 /s/ Karl Schneider ----------------------------------- Karl Schneider Vice President of Finance And Chief Financial Officer (Principal Financial and Accounting Officer) 27