Zoran 10-K 2011
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For The Fiscal Year Ended December 31, 2010
For the transition period from to
Commission File Number: 0-27246
(Exact Name of registrant as specified in its charter)
Registrants telephone number, including area code: (408) 523-6500
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
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, as amended (Exchange Act) 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 whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the proceeding 12 months (or for such short period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The aggregate market value of registrants voting stock held by non-affiliates of registrant based upon the closing sale price of the Common Stock on June 30, 2010, as reported on the Nasdaq Global Select Market, was approximately $472,817,187.
Outstanding shares of registrants Common Stock, $0.001 par value, as of March 2, 2011: 49,125,569.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of registrants definitive proxy statement for registrants 2011 Annual Meeting of Stockholders, to be filed with the Commission pursuant to Regulation 14A, are incorporated by reference into Part III of this report where indicated.
ANNUAL REPORT ON FORM 10-K
FOR YEAR ENDED DECEMBER 31, 2010
In this report, Zoran Corporation, the Company, we, us and our refers to Zoran Corporation and subsidiaries unless the context requires otherwise.
Special Note Regarding Forward-Looking Statements
The Business section and other parts of this Annual Report on Form 10-K (Form 10-K) contain forward-looking statements that involve risks and uncertainties. Many of the forward-looking statements are located in Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Forward-looking statements can also be identified by words such as anticipates, believes, estimates, expects, intends, plans, predicts, and similar terms. Forward-looking statements are not guarantees of future performance and the Companys actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in Item 1ARisk Factors set forth below in this Form 10-K. The Company assumes no obligation to revise or update any forward-looking statements for any reason, except as required by law.
Zoran Corporation is a leading provider of digital solutions in the digital entertainment and digital imaging market. Zoran has pioneered high-performance digital audio and video, imaging applications, and Connect Share Entertain technologies for the digital home. We were incorporated in California in December 1981 and reincorporated in Delaware in November 1986.
On November 30, 2010, the Company completed the acquisition of Microtune, Inc. (Microtune) a receiver solutions company that designs and markets advanced radio frequency (RF) and demodulator electronics for worldwide customers based in Plano, Texas. The Company acquired Microtune, among other things, to enhance its position in the core markets it serves and expand its worldwide presence, improving its ability to serve its customers as a single point-of-service provider. Under the terms of the acquisition agreement dated September 7, 2010, the Company acquired all outstanding shares of Microtunes common stock at $2.92 per share for a total payment of $159.2 million in cash. In addition, the Company converted each Microtunes outstanding restricted stock units to 0.42 shares of Zorans restricted stock units. Upon completion of the acquisition, Microtune was integrated into the Companys consumer segment.
We provide integrated circuits, software and platforms for digital televisions, set-top boxes, broadband receivers (silicon tuners) and media players, digital cameras and printers, scanners and related Multi Function Peripherals (MFP).We sell our products to original equipment manufacturers that incorporate them into products for consumer and commercial applications. We also license certain software and other intellectual property. We have two reporting segmentsConsumer and Imaging. The Consumer group provides products for use in multimedia player products, standard and high definition digital televisions, set-top boxes, broadband receiver, digital cameras and multimedia mobile phones. The Imaging group provides products used in digital copiers, laser and inkjet printers, and multifunction peripherals. Our corporate headquarters are located at 1390 Kifer Road, Sunnyvale, California 94086, and our telephone number is (408) 523-6500. Our website can be found at www.zoran.com.
Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to those reports, are available free of charge on our website under Investors / SEC Filings as soon as reasonably practicable after they are filed with the Securities and Exchange Commission. Additionally, these filings may be obtained by visiting the Public Reference Room of the SEC at 100 F Street, NE, Washington, DC 20549 or by calling the SEC at 1-202-551-8090, by sending an electronic message to the SEC at email@example.com or by sending a fax to the SEC at 1-202-777-1027. In addition, the SEC maintains a website (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically.
We provide feature-rich, cost-effective, standards-based solutions for a broad range of digital video, audio and imaging, and cable and satellite communications applications. We were a pioneer in the development of high-performance digital signal processor (DSP) products, and have developed expertise in integrated mixed signal circuit design, mathematical algorithms and software development, as well as proprietary digital signal processing, and video and audio 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 solutions include:
Standards-Plus Methodology We leverage our multi-disciplinary expertise and proprietary digital signal processing and compression technologies to develop what we refer to as standards-plus solutions. We enable original equipment manufacturers (OEMs) to improve image and sound quality and deliver superior products to end users 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 also provide OEMs the ability to include OEM-programmable effects and features, as well as variable compression ratios for video. These standards-plus features is designed to allow our customers to differentiate their products from those of their competitors.
Expandable and Programmable Architectures 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 coresbuilding blocks of integrated circuitsthat 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, designed to accelerate 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 is reduced and they can concentrate on differentiating their products from those of their competitors. For example, our COACH integrated circuit includes most of the electronics of a digital camera on a single chip.
Cost-Effective Products We focus on reducing the size, power requirements and number of integrated circuits necessary to perform required system functions, including compression. This reduces our customers manufacturing costs for products which incorporate our integrated circuits, and also reduces the cost of operating those products so that our products can be used 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 specifications and cost parameters.
Near Production-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 are designed to substantially shorten our customers product design time.
Key elements of our strategy include the following:
Focus on Growth and High Volume Our strategy is to focus on providing cost-effective, high-performance digital video, television, imaging, digital voice and data and mobile solutions for consumer electronics and printing applications. The markets we currently target include: digital televisions, set-top boxes, broadband and media players, digital cameras, and multifunction printing devices. In these markets we strive to introduce increasingly feature-rich products with reduced costs for our customers.
Leverage Existing Technology and Expertise We intend to identify and actively pursue adjacent markets that we believe have high growth potential for our products. Our proprietary digital signal processing, compression, and RF broadband receiver technologies can be used in many emerging markets where there is demand for high-quality digital video products.
Further Penetrate Key International Markets We have offices in China, France, Germany, India, Israel, Japan, Korea, Philippines, Taiwan, the United Kingdom and the United States. At the end of 2010, we had more than 1,500 employees working in various office locations. We believe that by having a presence in regions near our customers we are better able to provide local application support that helps our customers deliver new consumer electronics products to market more quickly.
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, video, and imaging solutions. Using our multi-disciplinary expertise, we have developed new technologies for compression of digital audio, video and imaging formats. Our acquisition of Microtune on November 30, 2010, provides new broadband receiver capabilities for cable and pay satellite markets. We intend to continue to invest in research and development, and to evaluate opportunities to acquire additional technologies when needed to maintain and extend 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 by us with our partners providing technological input and, in selected cases, a portion of the development funding. We have also established long-term relationships with strategic partners that provide manufacturing capacity and we continually seek to develop additional strategic relationships with manufacturers.
Markets and Applications
Our products are currently used in a variety of consumer electronic devices, including the following:
The digital television market represents the most significant technological shift in the consumer electronics market since color televisions were introduced in the late 1950s. Today, digital content providers broadcast programming via satellite, cable or terrestrial (over-the-air) networks. The mix of broadcast networks varies by geographic region. For example, most digital television content in Japan and Korea is broadcast via terrestrial networks, while cable networks currently predominate in the United States. Satellite networks offer an alternative source of content to consumers and are continuing to grow in various regions such as India. Each geographic market is subject to regulations that require compliance with different governmental standards applicable to broadcast technology and content format. In each region, individual broadcasters also have developed their own proprietary standards for content, security and conditional access. This market requires television products, set-top boxes, personal video recorders and other digital consumer appliances that include sophisticated integrated circuits and embedded software that address the emerging requirements of multiple broadcast networks throughout the world. The requirement by the U.S. Federal Communications Commission, or FCC, that all new televisions contain a built-in digital receiver, has accelerated the growth of the digital television market in the U.S.
Broadband Receiver Products
The broadband receiver market includes tuners and demodulators which are used for the reception, tuning and processing of radio frequency (RF) and digital signals for digital television (DTV) products, as well as for the cable and automotive markets. Historically, cable and DTV customers have relied on tuner modules for
the RF front-end, either produced internally by the customer or purchased from a third-party. The cable market has already transitioned to adopt silicon tuner and we are currently shipping products to this market. We expect the same trend we experienced in the cable market to propagate to the DTV manufacturers to transition to silicon tuner technology in the future due to cost, size and performance advantages as compared to tuner modules and expect the complete transition of tuner modules to silicon tuners to take several years.
Set-top Box products
The set-top box market includes system-on a chip with universal support for multiple security systems to serve the worldwide cable and pay satellite markets. With the acquisition of Microtune, we are also able to provide tuners and amplifiers for cable set-top boxes. The cable market is adopting new product categories such as Embedded Multimedia Terminal Adapters (EMTAs) and Digital Transport Adapters in addition to the traditional set-top boxes. Multiple tuners are increasingly implemented in cable set-top boxes to support simultaneous viewing of one channel while recording a second channel using a digital video recorders (DVR), on-demand services and internet access. The Satellite set-top box market is growing rapidly in the emerging markets as the cost to develop the infrastructure is smaller relative to the cable networked market.
Digital cameras enable consumers to capture high resolution images, view, edit and store them on a computer system and transmit them over telephone lines and computer networks. High quality copies of these images can be printed using color printers. Digital cameras have added audio-video capture and compression capabilities enabling them to function as digital video camcorders. Digital cameras can be connected directly to a personal computer (PC) for downloading of pictures or movies and to a television for display.
Many mobile phones now incorporate digital still camera and camcorder functionality. Photos and video clip files can be immediately sent to another mobile phone or PC via email; downloaded to a printer or PC for printing or storing via wired or wireless technology. With the spread of new technology and decreased manufacturing costs, mobile phones are including high-resolution digital camera capabilities at increasingly lower price points.
Digital Imaging Print Products
The market for Digital Imaging Print Products includes Printers, Scanners and MFPs that print, scan, copy and fax. The market comprises both business and enterprise segments, served primarily by networked laser products and consumer segments served primarily by Ink Jet products.
In the enterprise networked segment, most devices use a Page Description Language (PDL) to transmit the document to be printed from the application to the printer. The embedded controller in the printer or MFP then interprets and renders the file into pixels to be laid down on the paper.
In general, applications are designed to send jobs to printers using one or all of a number of protocols or language families. Print Control Language (PCL), originated as a Hewlett-Packard developed protocol for page printers and has become an industry standard in office environments. Both PCL 5 and PCL XL, or PCL 6, are supported in office printers today. The application may also use the PostScript language originally developed by Adobe. More recently, printers have also offered support for portable digital document formats that are designed to be widely viewed and shared, such as PDF, originally developed by Adobe and XML Paper Specification (XPS), a new format, introduced by Microsoft is also being deployed as a format in printers.
We offer products in five principal product families:
The following table lists our principal integrated circuits currently in production, as well as the most recent versions of our printer software products:
Zoran, the Zoran logo, HDXtreme, Quatro, SupraFRC, SupraHD, SupraTV, SupraXD, Vaddis and VaddisHD are trademarks and/or registered trademarks of Zoran Corporation and/or its subsidiaries in the United States and/or other countries. All other names and brands may be claimed as property of others.
DTV Our DTV products include integrated circuit products for both high definition and standard definition formats for digital televisions, set-top boxes and related applications, including personal video recorders. Our system-on-a-chip products use advanced CPUs for higher performance with lower power consumption. Our highly integrated SupraHD® product line addresses the mainstream market segment as well as high-end and entry-level segments of the digital television and analog-to-digital broadcast transition markets. Our new Supra FRC® (frame rate conversion) processor is designed to deliver superior quality and cost performance for OEMs competing in the 120Hz/240Hz and 3D DTV markets. Our innovative approach to video processing yields outstanding video quality without the common artifacts introduced by current state-of the industry motion estimation motion compensation (MEMC) technologies. Our RF broadband receiver products require levels of performance specific to various industry standards, power efficiency, functionality and integration, which must all be delivered with a low overall solution cost. Our products are designed to address the complex, high-performance RF requirements of broadband transmission and reception and the high performance requirements of video demodulation and decoding of broadcast signals.
In the set-top box domain we are shipping our products to the China cable and Europe free-to-air markets.
Multimedia Players Our Vaddis® processors perform all the audio and video decoding and display requirements of the DVD specifications, including MPEG 2, Dolby Digital, DivX and MLP, on-screen display, and decryption required for copyright protection and presentation of graphic information. The HDXtreme® technology allows video playback and viewing of JPEG pictures on an HDTV with an HDMI interface in a resolution of up to 1080p. Our VaddisHDs® processor ICs integrate a state-of-the art High Definition (HD) video pipeline and enable multi-standard decoding, including support for HD H.264, VC1, MPEG2, MPEG4, and AVS. With an integrated dual processor and dual Audio DSP, it enables the most advanced HD applications, including Java and HDi support for Blu-ray and HD-DVD standards. This IC family also incorporates our latest HDXtreme® video processing and scaling technology in our SupraHD® HDTV processors powering major brand HDTVs.
Mobile Our COACH processors are integrated system-on-a-chip solutions that include most of the electronics of a digital camera, which can be connected directly to a high-resolution CCD or CMOS sensor. The COACH IC processes the video information and compresses the captured image in real time, controls the interface to an LCD, TV or micro display and to all types of flash memory. The COACH products also allow for direct connection to a printer, including color correction and special effects, for the non-PC consumer environment. The COACH product is supplemented by digital camera reference designs, CamON and CamMini, products that shorten the time to market for our customers. The newest COACH processors use MPEG-4 and H.264 codecs to incorporate basic digital camcorder capabilities for displaying video clips on a PC or TV.
Digital Imaging Our Quatro® product line is a family of programmable set-top box systems on a chip (SOCs) solutions for imaging and printing devices, including multifunction and single function color inkjet and color and mono laser devices. IPS printing software is licensed to OEMs, either in conjunction with our Quatro® SOC, or independently to be run on the customers CPU of choice. It incorporates interpreter and render software to support all the PDL streams listed above.
Our customers consist primarily of OEMs, original design manufacturers (ODMs), and resellers in both domestic and international markets. Because we leverage our technologies across different markets, certain of our integrated circuits may be incorporated into equipment used in several markets. Our sales and marketing
teams work closely with our customers to define product features, performance and timing of new products so that the products we are developing meet the needs of our customers. We also employ application engineers to assist our customers in designing, testing and qualifying system designs that incorporate our products. We believe that our commitment to customer service and design support improves our customers time-to-market and fosters relationships that encourage customers to use the next generation of our products.
In 2010, four customers accounted for 13%, 12%, 11% and 11% of our total revenues, respectively. In 2009, three customers accounted for 20%, 12% and 10% of our total revenues, respectively. In 2008, three customers accounted for 13%, 10% and 10% of our total revenue, respectively.
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, video and imaging solutions. Accordingly, we devote a significant portion of our resources to maintaining and upgrading our products to reduce integrated circuit cost, power consumption and the number of integrated circuits required to perform compression and other functions necessary for the evolving digital audio, video and imaging application markets. In addition, we seek to design integrated circuits and cores, as well as near production-ready reference designs that reduce the time needed by manufacturers to integrate our integrated circuits into their products.
Sales and Marketing
Our sales and marketing strategy is to focus on providing solutions to manufacturers seeking to design audio, video and imaging products for existing and emerging high volume consumer applications. We attempt to identify market segments that have the potential for substantial growth. To implement our strategy, we have established a worldwide direct sales force in offices located near our key customers and strategic partners, and a worldwide network of independent sales representatives and resellers. In some cases, our strategic partners also provide sales and marketing support.
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 direct sales staff, field application engineers, and customer service staff located in the United States and internationally. Our United States and United Kingdom sales staffs are primarily responsible for sales in North America, Europe and South America. Sales management and sales operations staff also reside in the United States. Our sales and field application engineers in China, Japan, Korea and Taiwan are responsible for marketing and technical support in their respective regions. In addition, we sell our products indirectly through selected resellers and commissioned sales representatives. To date, we have not experienced material product returns or warranty expense.
We have offices in Shenzhen and Shanghai, China as part of our effort to capture a leadership position in the Chinese digital audio and video markets and offices in Taipei and Hsinchu, Taiwan in an effort to better address the video, imaging and digital camera market. In addition, we operate sales support offices in Hong Kong, India and Korea that provide sales, applications and customer support.
We distribute our products in Japan primarily through resellers. We operate an office in Tokyo to help promote our products in Japan, to assist with the marketing of products not sold through resellers, such as integrated circuit cores and certain digital camera, digital video, digital television, and imaging products, and to provide applications support to some of our customers.
Sales of our products are made pursuant to 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 ability to order products can carry lead times of between four and sixteen weeks; however, most of 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.
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 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. Most of our devices are currently fabricated using standard complementary metal oxide semiconductor process technology with 0.08 micron to 0.18 micron feature sizes. Our broadband receiver products are manufactured using standard and SiGe BiCMOS technology with feature sizes ranging from 0.50 micron to 0.18 micron.
Our primary foundry is Taiwan Semiconductor Manufacturing Company (TSMC), which has manufactured integrated circuits for us since 1987. TSMC and TowerJazz Semiconductor Ltd. are currently manufacturing our multimedia player, DTV, set-top box, multimedia players, imaging and mobile products. LSI Corporation is providing turn-key manufacturing for one high-end laser-printer product. Our primary foundries for our tuner and amplifier products are IBM and TowerJazz Semiconductor. Our independent foundries fabricate products for other companies and may also produce products of their own design. By subcontracting our manufacturing requirements, we can focus our resources on design and test applications where we believe we have greater competitive advantages. This strategy also eliminates the high cost of owning and operating semiconductor wafer fabrication facilities. Most of our semiconductor products are currently being assembled by one of two independent contractors and tested by those contractors or other independent contractors. Our primary services company for assembly and testing is Advanced Semiconductor Engineering Inc. Our operations and quality engineering teams closely manage the interface between manufacturing and design engineering.
We currently purchase products from all of our foundries under individually negotiated purchase orders. We do not currently have a long-term supply contract with TSMC, and therefore TSMC is not obligated to manufacture products for us for any specific period, in any specific quantity or at any specific price, except as may be provided in a particular purchase order.
Our existing and potential competitors include many large domestic and international companies that have substantially greater finance, manufacturing, technology, marketing, personnel and distribution resources than we have.
Some of 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. Our principal competitors in the integrated audio and video devices for multimedia player applications include MediaTek Inc. and Sunplus Technology Co. Ltd. In the markets for digital cameras, our principal competitors are in-house solutions developed and used by major Japanese OEMs, as well as products sold by Ambarella, Fujitsu, Novatech, Sunplus and Texas Instruments, Inc. Our principal competitors for digital semiconductor devices in the digital television market include Broadcom Corp., M-Star, Mediatek Inc., ST Microelectronics and Trident. Our competitors in the cable market include Alps, Anadigics, Broadcom, Entropic, Maxlinear, NuTune, NXP Semiconductors and Samsung Electro-Mechanics. Our competitors in the digital television market include Alps, Maxlinear, NuTune, NXP
Semiconductors, Silicon Labs, Xceive, Xuguang, as well as the captive tuner divisions of all the major consumer brands, including Konka, LG, Panasonic, Samsung Electro-Mechanics, Sanyo, Sharp, Sony and Toshiba. Our demodulator competitors in the digital television market include vendors of dedicated silicon demodulators including Altobeam, Guoxin, HDIC, Legend Silicon, LG, MaxScend, NXP Semiconductors, Silicon Labs, SONY, STMicroelectronics and Trident, as well as vendors of DTV or SOCs that integrate silicon demodulator functions inside these SOCs, including Mediatek/MTK, MorningStar/Mstar, Renesas, Sanyo, and STMicroelectronics. Competitors in the printer and multifunction peripheral space include Adobe, Conexant Systems, Inc., Global Graphics, Marvell Semiconductor, Inc., Monotype, Inc. and in-house captive suppliers.
We believe that our ability to compete successfully in the rapidly evolving markets for high performance audio, video and imaging technology depends on a number of factors, including the following:
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.
Historically, average unit selling prices (ASPs) 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 ASPs of our products will continue to be subject to significant pricing pressures. In order to offset expected declines in the ASPs of our products, we seek to continually reduce the cost of our products and continue to integrate additional functions into our ICs. We intend to accomplish this by implementing design changes that integrate additional functionality and lower the cost of manufacturing, assembly and testing by negotiating reduced charges at 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, resellers, customers and potential customers and limit access to our proprietary information. We currently hold 537 issued patents worldwide, and have additional patent applications pending. Our intellectual property rights, if challenged, may not be upheld as 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 or standards bodies that license patents relating to various standards for consumer electronics and digital technology have created uncertainty with respect to the use and enforceability of patents implementing those standards. 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.
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 customers 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. See Item 3Legal Proceedings. We may be subject to additional claims and litigation in the future. In particular, given the uncertainty discussed above regarding patents relating to the consumer electronics or digital technology standards, it is difficult for us to assess the possibility that our activities in these fields 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 on fair or reasonable terms 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 that it uses, we could incur substantial liabilities and be forced to suspend the manufacture of products, or the use by our foundries of certain processes.
We have non-exclusive licenses from various third parties. Some of the licenses are for technologies that are required to develop our products while others allow us to sell our products enabled with the third parties respective technologies. The majority of these agreements do not require us to pay royalties. Under most of our agreements, we may sell such third party enabled products only to customers who are licensees of such third parties. We rely on our customers to enter into license agreements directly with the third parties pursuant to which they pay royalties and or license fees. The failure or refusal of potential customers to enter into license agreement with such third parties in the future could harm our sales.
As of December 31, 2010, we had 1,532 employees, including 672 employees primarily involved in research and development activities, 647 in marketing and sales, 163 in finance, human resources, information systems, legal and administration, and 50 in manufacturing control and quality assurance. We had 380 employees based in Israel, primarily involved in engineering and research and development, 223 employees at our facility in Sunnyvale, California, 132 employees at our facility in Burlington Massachusetts and 96 employees at our facility in Plano, Texas. We had 350 employees in our China office. Other employees are located in our international offices in France, Germany, India, Japan, Korea, Philippines, Taiwan and the United Kingdom. We believe that our future success depends 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.
Item 1A. Risk Factors
Our future business, operating results and financial condition are subject to various risks and uncertainties, including those described below. The following risk factors update and supersede in their entirety the risk factors set forth in our annual report on Form 10-K for the fiscal year ended December 31, 2009 and Part II, Item 1A of our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2010.
Our annual revenues and operating results fluctuate due to a variety of factors, which may result in volatility or a decline in the price of our common stock
Our historical operating results have varied significantly from period to period due to a number of factors, including:
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:
Our operating results could also be harmed by:
These factors are difficult or impossible to forecast. We place orders with independent foundries several months in advance of the scheduled delivery date, often in advance of receiving non-cancelable orders from our customers. This limits our ability to react to fluctuations in demand. If anticipated shipments in any quarter are canceled or do not occur as quickly as expected, or if we fail to foresee a technology or market change that could render our or one of our customers products obsolete, expense and inventory levels could be disproportionately high and we may incur charges for excess inventory, which would harm our gross margins and financial results. If anticipated license revenues in any quarter are canceled, do not occur, or are lower than anticipated, our gross margins and financial results may be harmed.
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 be unable to quickly adjust expenses to levels appropriate for our actual revenues, which could harm our operating results.
Our customers sales fluctuate due to product cycles and seasonality.
Because the markets that our customers serve are characterized by numerous new product introductions and rapid product enhancements and obsolescence, our operating results may vary significantly from quarter to quarter. During the final production of a mature product, our customers typically exhaust their existing inventories of our products. Consequently, orders for our products may decline in those circumstances, even if our products are incorporated into both our customers mature products and replacement products. A delay in a customers 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 second half of the calendar year represents a disproportionate percentage of sales for our customers due to the
holiday shopping period for consumer electronics products, and therefore, a disproportionate percentage of our sales. However, due to our and our customers loss of market share in the DTV market, our revenues for the second half of 2010 were lower than the first half of 2010. Any further or continuing economic slowdown or loss of market share by us or our customers could further decrease our sales for 2011.
Our ability to match production mix with the product mix needed to fill current orders and orders to be delivered in a given quarter may affect our ability to meet that quarters revenue forecast and can lead to excess inventory write-offs. In addition, we manufacture products based on forecasts of customer demand, which are based on multiple assumptions. If we inaccurately forecast customer demand, we may hold inadequate, excess or obsolete inventory causing us to lose revenue or take write-offs that would reduce our profit margins, either of which would harm our results of operations and financial condition.
We derive most of our revenue from sales to a small number of customers, and if we are not able to retain these customers, or they reschedule, reduce or cancel orders, or we are unable to collect from them, our revenues would be reduced and our financial results would suffer.
Our largest customers account for a substantial percentage of our revenues. For the year ended December 31, 2010, four customers accounted for 13%, 12%, 11% and 11% of total revenues while sales to our ten largest customers accounted for 72% of our total revenues. Sales to these large customers have varied significantly from year to year and will continue to fluctuate in the future. These sales may also 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 would harm our sales and financial results. For example, in the third quarter of 2010, we experienced a decline in purchases from one of our customers due to their decision to add a second source supplier resulting in a significant reduction in DTV revenues. In addition, any difficulty in collecting amounts due from one or more key customers could harm our operating results and financial condition. As of December 31, 2010, four customers accounted for approximately 15%, 11%, 11% and 10% of our net accounts receivable balance, respectively.
Our products generally have long sales cycles and implementation periods, which increase our costs in obtaining orders and reduce the predictability of our operating results.
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 processes are 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, depending on our product line, typically range from three to twelve months. Longer sales cycles require us to invest significant resources in attempting to make sales and delay the generation of revenue. We incur costs related to such sales prior to, and even if we do not succeed in, making any sale to a customer.
Long sales cycles also subject us to other risks, including customers budgetary constraints or insolvency, internal acceptance reviews and cancellations. In addition, orders expected in one quarter could shift to another because of the timing of customers purchase decisions, which could harm our financial results.
The time required for our customers to incorporate our products into their own can vary significantly 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. Customers generally purchase our products pursuant to cancelable
short-term purchase orders. We cannot predict whether our current customers will continue to place orders, whether existing orders will be canceled, or whether customers who have ordered products will pay invoices for delivered products. Even when we do enter into a long-term contract, the contract is generally terminable at the convenience of the customer. Termination or reduction in orders by one of our major customers would harm our financial results.
Adverse economic factors have reduced our sales and revenues, increased our expenses and hurt our profitability, results of operations, financial condition and may continue to adversely impact us.
Factors, such as high unemployment levels, inflation, deflation, increased fuel and energy costs, as well as increased consumer debt levels, interest rates and tax rates, may reduce overall consumer spending or shift consumer spending to products other than those offered by our customers. Reduced sales by our customers harm our business by reducing demand for our products. Moreover, if our customers are not successful in generating sufficient revenue or cannot secure financing, they may not be able to pay, or may delay payment of, accounts receivable that are owed to us. Lower net sales of our products and reduced payment capacity of our customers reduces our current and future revenues. In addition, our expenses could increase due to, among other things, fluctuations of the value of the United States dollar, changes in interest and tax rates, decreased inventory turnover, increases in vendor prices, and reduced vendor output. Such reduction of our revenues and increase of our expenses hurts our profitability and harms our results of operations and financial condition. In preparing our financial statements, we are required to make estimates and assumptions that affect amounts reported in our financial statements and accompanying notes, and some of those estimates are based on our forecasts of future results. The current volatility in the global economy increases the risk that our actual results will differ materially from our forecasts, requiring adjustments in future financial statements.
Trends in global credit markets could result in insolvency of our key suppliers or customers, and customer inability to finance purchases of our products.
The credit market crisis, including uncertainties with respect to financial institutions and the global capital markets, and other macro-economic challenges currently affecting the global economy may adversely affect our customers and suppliers. As a result of these conditions, our customers may experience cash flow problems, may not be able to obtain credit to finance their purchases and may modify, delay or cancel plans to purchase our products or lengthen payment terms. If our customers are unable to finance purchases of our products, our sales will be harmed.
Similarly, current economic and credit conditions may cause our suppliers to increase their prices, tighten payment terms or reduce their output, which could increase our expenses, make it harder or more expensive to obtain required supply and impair our sales. Moreover, if one of our key suppliers becomes insolvent, we may not be able to find a suitable substitute in a timely manner, which could reduce our sales and increase our cost of production. If economic and credit conditions in the United States, Europe and other key markets deteriorate further or do not show improvement, our business and operating results may be harmed.
Our products are characterized by average selling prices that typically 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 will suffer.
Average selling prices for our products typically decline over relatively short time periods, while many of our manufacturing costs are fixed. When our average selling prices decline, our revenues decline unless we are able to sell more units and our gross margins decline unless we are able to reduce our manufacturing costs by a commensurate amount. In addition, we must continue to introduce new products with high average selling prices to compensate for our older products that may have declining average selling prices. Our operating results suffer when gross margins decline. We have experienced these problems, and we expect to continue to experience them in the future, although we cannot predict when they may occur or how severe they will befor example, we experienced significant declines in average selling prices during fiscal 2010 compared to the prior years.
Our operating results may be harmed by cyclical and volatile conditions in the markets we address. As a result, our business, financial condition and results of operations could be harmed.
We operate in the semiconductor industry, which is cyclical and from time to time has experienced significant downturns. Downturns in the semiconductor industry often occur in connection with, or in anticipation of, maturing product cycles for semiconductor companies and their customers, and declines in general economic conditions. These downturns can cause abrupt fluctuations in product demand, production over-capacity and accelerated average selling price declines. The downturn in our industry has harmed our revenue and our results of operations. This downturn may continue and the recovery may be slow, which may continue to harm our revenues, gross margins and results of operations. The semiconductor industry also periodically experiences increased demand and production capacity constraints, which may affect our revenues, market share and relationship with our customers if we are unable to ship enough products to meet customer demand.
Our success depends on our ability to develop and sell new products in new markets. We may experience difficulties in transitioning to smaller geometry process technologies or in achieving higher levels of design integration, which may result in reduced manufacturing yields, delays in product deliveries and increased expenses.
Our future success will depend on our ability to anticipate and adapt to changes in technology and industry standards and our customers changing demands. We sell products in markets that are characterized by rapid technological change, evolving industry standards, frequent new product introductions, short product life cycles and increasing demand for higher levels of integration and smaller process geometries. We must constantly compete to ensure that our products are designed into our customers new products, which are rapidly evolving. Our past sales and profitability have resulted, to a large extent, from our ability to anticipate changes in technology and industry standards and to develop and introduce new and enhanced products incorporating the new standards and technologies. Our ability to adapt to these changes and to anticipate future standards, and the rate of adoption and acceptance of those standards and our products, will be a significant factor in maintaining or improving our competitive position and prospects for growth. If new industry standards emerge, our products or our customers products could become unmarketable or obsolete, and we could lose market share. We may also have to incur substantial unanticipated costs to comply with these new standards.
Our success will also depend on the successful development of new markets and the application and acceptance of new technologies and products in those new markets. For example, our success will depend on the ability of our customers to develop new products and enhance existing products in the digital television and set-top box markets and to introduce and promote those products successfully, as well as our success in obtaining design wins for our products in these markets. These markets may not continue to develop to the extent or in the time periods that we currently anticipate due to factors outside our control. If new markets do not develop as we anticipate, or if our products or those of our customers do not gain widespread acceptance in these markets, our business, financial condition and results of operations could be harmed. 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 this content is not available, manufacturers may not be able to sell products incorporating our products, and our sales would suffer.
Our financial performance is highly dependent on the timely and successful introduction of new and enhanced products.
Our financial performance depends in large part on our ability to successfully develop and market next-generation and new products in a rapidly changing technological environment. If we fail to successfully identify new product opportunities and timely develop and introduce new products, obtain design wins, and achieve market acceptance, we may lose our market share and our future revenues and earnings may suffer.
In the consumer electronics market, our performance has been dependent on our successful development and timely introduction of integrated circuits for multimedia players, digital cameras, digital televisions, set-top boxes and digital imaging products. These markets are characterized by the incorporation of a steadily increasing level of integration and features on a chip at the same or lower system cost, enabling OEMs to continually improve the features or reduce the prices of the systems they sell. If we are unable to continually develop and introduce integrated circuits with increasing levels of integration and new features at competitive prices, our operating results will suffer.
In the Imaging market, our performance has been dependent on our successful development and timely introduction of integrated circuits for printers and multi-function peripherals. These markets are characterized by the incorporation of a steadily increasing level of integration and higher speeds on a chip at the same or lower system cost, enabling OEMs to improve the performance and features or reduce the prices of the systems they sell. If we are unable to develop and introduce integrated circuits with increasing levels of integration, performance and new features at competitive prices, our operating results will suffer. The performance of our imaging software licensing business is dependent on our ability to develop, introduce and sell new releases of our software, incorporating new or enhanced printing and performance standards required by our OEM customers. If we are unable to develop and sell versions of our software supporting required standards and offering enhanced performance, our operating results will be harmed.
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 would decline and our business would be harmed.
The markets in which we compete are intensely competitive and are characterized by rapid technological change, declining average 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 that may be less costly or provide higher performance or more desirable features than our products. Competition typically occurs at the design stage, when customers evaluate alternative design approaches requiring integrated circuits. Because of short product life cycles, there are frequent design win competitions for next-generation systems.
Our existing and potential competitors include many large domestic and international companies that have substantially greater financial, manufacturing, marketing, personnel, technological, market, distribution and other resources. These competitors may also have broader product lines and longer standing relationships with customers and suppliers than we have. Many of our competitors are located in countries where our customers are located, such as China, Japan, Korea and Taiwan, which may give them an advantage in securing business from these customers.
Some of our principal competitors maintain their own semiconductor foundries and may benefit from capacity, cost and technical advantages. Our principal competitors in the integrated audio and video devices for multimedia player applications include MediaTek and Sunplus Technology Co. Ltd. In the digital camera market, our principal competitors are in-house solutions developed and used by major Japanese OEMs, as well as products sold by Ambarella, Fujitsu, Novatech, SunPlus Inc. and Texas Instruments, Inc. In the market for multimedia acceleration for mobile phones, our principal competitors include Broadcom Corp., CoreLogic, MtekVision Co.Ltd., nVidia and Telechips Inc. Our principal competitors for digital semiconductor devices in the digital television market include Broadcom Corp., M-Star, MediaTek, ST Microelectronics and Trident Microsystems, Inc. Competitors in the printer and multifunction peripheral space include Adobe, Conexant Systems, Inc., Global Graphics, Marvell Semiconductor, Inc. and in-house captive suppliers.
The multimedia player market has slowed, and continued competition will lead to further price reductions and reduced profit margins. We also face significant competition in the DTV, set-top box, digital imaging and digital camera markets. The future growth of these markets is highly dependent on OEMs continuing to
outsource chip supply and an increasing portion of their product development work rather than doing it in-house. Many of our existing competitors, as well as OEM customers that are expected to compete with us in the future, have substantially greater financial, manufacturing, technical, marketing, distribution and other resources, broader product lines and longer standing relationships with customers than we have. In addition, much of our future success is dependent on the success of our OEM customers. If we or our OEM customers are unable to compete successfully against current and future competitors, we could experience price reductions, order cancellations and reduced gross margins, any one of which could harm our business.
We rely on independent foundries and contractors for the manufacture, assembly and testing of our integrated circuits and other hardware products, 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 own or operate any assembly, fabrication or test facilities. We rely on independent foundries to manufacture all of our products. These independent foundries fabricate products for other companies and may also produce products of their own design. Availability of foundry capacity has at times in the past been, and may in the future be, reduced due to strong demand. Additionally, due to the recent global economic environment it is possible that our foundry subcontractors could experience financial difficulties that would impede their ability to operate effectively. If we are unable to secure sufficient capacity at our existing foundries, or in the event of a closure at any of these foundries, our product revenue, cost of product revenue and results of operations would be negatively impacted.
We do not have long-term supply contracts with any of our suppliers, including our principal supplier, TSMC, and our principal assembly houses. Therefore, TSMC and our other suppliers are 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:
In addition, TSMC, TowerJazz Semiconductor Ltd and some of our other foundries are located in areas of the world that are subject to natural disasters such as earthquakes. While the 1999 and 2010 earthquakes in Taiwan did not have a material impact on our independent foundries, a similar event centered near TSMCs facility and other foundries could severely reduce TSMCs ability to manufacture our integrated circuits. The loss of any of our manufacturers as a supplier, our inability to obtain increased supply 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 would cause us to have to identify and qualify additional sources of supply, which could be more expensive and could cause delays 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 a limited number of independent contractors for the assembly and testing of our products. 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 financial results.
Because foundry capacity is limited from time to time, 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 be reduced. In order to secure additional foundry capacity, we have considered, and may in the future need to consider, various arrangements with suppliers, which could include, among other things:
We may not be able to make any such arrangement in a timely fashion or at all, and such arrangements, if any, may be expensive and 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. Excess capacity could lead to write downs of excess inventory, which could harm our financial results. Any penalties that we incur 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. Small levels of contaminants in the manufacturing environment, defects in photo masks 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.
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 2010 and 2009, 93% of our total revenues were derived outside of North America. We anticipate that international sales will continue to account for a substantial majority of our total revenues for the foreseeable future. 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 a variety of risks inherent in doing business internationally, including:
A material amount of our research and development personnel and facilities and a portion of our marketing personnel are located in Israel. Political, economic and military conditions in Israel directly affect our operations. For example, increased violence or armed conflict in Israel or the Palestinian territories may disrupt travel and communications in the region, harming our operations there. Furthermore, some of our employees in Israel are obligated to perform up to 36 days of military reserve duty annually and may be called to active duty in a time of crisis. The absence of these employees for significant periods may cause us to operate inefficiently during these periods.
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 may not be sustained. If Asia, particularly China, fails to continue its recent growth, or even contracts, this could harm our OEM and ODM customers based in Asia and cause them to purchase fewer products from us for shipment to China, the rest of Asia and globally. In addition, Asian consumers may purchase fewer products sold by our OEM customers containing our products, and we may experience disruptions in our operations in Asia, which could harm our business and financial results.
We also maintain offices in France, India, Japan, Korea, Philippines, Taiwan and the United Kingdom, and our operations are subject to the economic and political uncertainties affecting these countries as well.
The significant concentration of our manufacturing activities with third party foundries in Taiwan exposes us to the risk of political instability in Taiwan, including the potential for conflict between Taiwan and China. We have several significant OEM customers in Japan, Korea and other parts of Asia. Adverse economic circumstances in Asia could affect these customers willingness or ability to do business with us in the future or their success in developing and launching devices containing our products.
The complexity of our international operations may increase our operating expenses and disrupt our revenues and business.
We transact business and have operations worldwide. For example, international transactions account for a substantial majority of our sales and our semiconductor products are manufactured, assembled and tested outside of the United States. Our global operations involve significant complexity and difficulties, including:
Managing international operations is expensive and complex. If we are unable to manage the complexity of our global operations successfully and cost effectively, our financial performance and operating results could suffer.
Our ability to compete could be jeopardized if we are unable to protect our intellectual property rights.
Our success and ability to compete depend in large part upon protection of 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 intellectual property 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 or remedies may be difficult to obtain or enforce. 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 or misappropriation 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.
The protection offered by patents is uncertain. For example, our competitors may be able to effectively design around our patents, or our patents may be challenged, invalidated or circumvented. Those competitors may also independently develop technologies that are substantially equivalent or superior to our technology and may obtain patents that restrict our business. Moreover, while we hold, or have applied for, patents relating to the design of our products, some of our products are based in part on standards, for which we do not hold patents or other intellectual property rights.
We have generally limited access to and distribution of the source and object code of our software and other proprietary information. With respect to our page description language software, system-on-a-chip platform firmware and drivers for the digital office market and in limited circumstances with respect to firmware and platforms for our DTV products, we grant licenses that give our customers access to and restricted use of the source code of our software. This access increases the likelihood of misappropriation or misuse of our technology.
Claims and litigation regarding intellectual property rights and breach of contract claims 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, and we have been party to a number of patent-related lawsuits, both as plaintiff and defendant. In 2010, we incurred $1.1 million in legal settlement and in 2009, we incurred $11.8 million in legal settlement cost. We could become subject to additional litigation in the future, either to protect our intellectual property or as a result of allegations that we infringe others intellectual property rights or have breached our contractual obligations to others. Claims that our products infringe proprietary rights or that we have breached contractual obligations would force us to defend ourselves and possibly our customers or manufacturers against the alleged infringement or breach. Future litigation against us, if successful, could subject us to significant liability for damages, restrict or prohibit the sale of our products or invalidate our proprietary rights. These lawsuits, regardless of their success, are time-consuming and expensive to resolve and require significant management time and attention. Our costs and potential liability are increased to the extent we have to indemnify or otherwise defend our customers. Future intellectual property and breach of contract litigation could force us to do one or more of the following:
Although patent disputes in the semiconductor industry have often been settled through cross-licensing arrangements, we may not be able to settle an alleged patent infringement claim through a cross-licensing arrangement. We have a more limited patent portfolio than many of our competitors. If a successful claim is made against us or any of our customers and a license is not made available to us on commercially reasonable terms, we are restricted in or prevented from selling our products or we are required to pay substantial damages or awards, our business, financial condition and results of operations would be materially harmed.
If necessary licenses of third-party technology are not available to us or are 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 on commercially reasonable terms or at all. If we are unable to obtain any third-party license required to develop new products and product enhancements or to continue selling our current products, we may have to obtain substitute technology of lower quality or performance standards or at greater cost or discontinue selling or developing certain products, which could seriously harm the competitiveness of our products.
We rely on licenses to use various technologies that are material to our products. We do not own the patents that underlie these licenses. Our rights to use these technologies and employ the inventions claimed in the licensed patents are subject to our abiding by the terms of the licenses. Under the license agreements we must fulfill confidentiality obligations and pay royalties. If we fail to abide by the terms of the license, we would be unable to sell and market the products under license. In addition, we do not control the prosecution of the patents subject to this license or the strategy for determining when such patents should be enforced. As a result, we are dependent upon our licensor to determine the appropriate strategy for prosecuting and enforcing those patents.
Our business may be impacted by foreign exchange fluctuations.
Foreign currency fluctuations may affect the prices of our products. Prices for our products are currently denominated in United States 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 countrys currency; our products may be less competitive in that country and our revenues may be adversely affected. Also, we cannot be sure that our international customers will continue to be willing to place orders denominated in United States dollars. If they do not, our revenue and operating results will be subject to foreign exchange fluctuations, which we may not be able to successfully manage.
A portion of the cost of our operations, relating mainly to our personnel and facilities is incurred in foreign currencies. As a result, we bear the risk that the rate of inflation in those foreign countries or the decline in value of the United States dollar compared to those foreign currencies will increase our costs as expressed in United States dollars. To date, we have not engaged in hedging transactions. In the future, we may enter into currency hedging transactions designed to decrease the risk of financial exposure from fluctuations in the exchange rate of the United States dollar against foreign currencies. These measures may not adequately protect us from the impact of inflation or currency fluctuation in foreign countries.
Because we have significant operations in Israel, Germany, Japan, Taiwan, the Philippines, China, South Korea and the United Kingdom, our business and future operating results could be adversely affected by events that occur in or otherwise affect these countries.
We conduct a significant portion of our research and development and engineering activities at our design center in Haifa, Israel, a 109,700 square foot facility where we employ approximately 380 people, and in Germany and China, we employee approximately 400 people. We also conduct a portion of our sales and marketing operations at our Haifa facility and have sales offices in Japan, Taiwan, China, South Korea and the United Kingdom.
As a result, our operations are affected by the local conditions in those countries, as well as actions taken by the governments of those countries and, as a result, may hinder our business generally by delaying product development or interfering with global marketing efforts. For example, as a result of the heightened military operations in Gaza, some of our employees were conscripted into the Israeli armed forces for several weeks ending in January 2009. Additional employees may be called to active duty in the future. Extended absences could disrupt our operations and delay product development cycles.
In addition, military conflict or terrorist activities in the Middle East or elsewhere or local economic and political instability in areas in the Far East, in particular in the Philippines, China and South Korea, where there has been political instability in the past, could harm our business as a result of a disruption in commercial activity or a general economic slowdown and reduced demand for consumer electronic products.
In addition, if any country, including the United States, imposes significant import restrictions on our products, our ability to import our products into that country from our international manufacturing and packaging facilities could be diminished or eliminated.
Changes in, or different interpretations of, tax rules and regulations may harm our effective tax rates.
Unanticipated changes in our tax rates could affect our future results of operations. Our future effective tax rates could be harmed by changes in tax laws or the interpretation of tax laws, by unanticipated decreases in the amount of revenue or earnings in countries with low statutory tax rates, by changes in the geography of our income or losses, or by changes in the valuation of our deferred tax assets and liabilities. The ultimate outcomes of any future tax audits are uncertain, and we can give no assurance as to whether an adverse result from one or more of them will have a material effect on our operating results and financial position.
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 loss (NOLs) carryforwards, against taxable income in future periods. Our NOLs totaled approximately $338.0 million for federal, $72.6 million for state and $183.9 million for foreign tax reporting purposes as of December 31, 2010. The Internal Revenue Code contains a number of provisions that limit the use of NOLs under certain circumstances. Changes in federal, state or foreign tax laws may further limit our ability to utilize our NOLs. Any further limitation on our ability to utilize these respective NOLs could 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, our manufacturers and 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, would harm our reputation and would harm our business. Defects, integration issues or other performance problems in our products could result in financial or other damages to customers or could damage market acceptance of such 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.
Regulation of our customers products may slow the process of introducing new products and could impair our ability to compete.
The Federal Communications Commission, or FCC, has broad jurisdiction over our target markets in the digital television and mobile phone business. Various international entities or organizations may also regulate aspects of our business or the business of our customers. Although our products are not directly subject to regulation by any agency, the transmission pipes, as well as much of the equipment into which our products are incorporated, are subject to direct government regulation. For example, before they can be sold in the United States, advanced televisions and emerging interactive displays must be tested and certified by Underwriters Laboratories and meet FCC regulations. Accordingly, the effects of regulation on our customers or the industries in which our customers operate may in turn harm our business. In addition, our digital television and digital camera businesses may also be adversely affected by the imposition of tariffs, duties and other import restrictions on our suppliers or by the imposition of export restrictions on products that we sell internationally. Changes in current laws or regulations or the imposition of new laws or regulations in the United States or elsewhere could harm our business.
Any acquisitions we make could disrupt our business and severely harm our financial condition.
We have made investments in, and acquisitions of other complementary companies, products and technologies, and we may acquire additional businesses, products or technologies in the future. In the event of any future acquisitions, we could:
Our operation of acquired business will also involve numerous risks, including:
In the fourth quarter of 2010, we completed the acquisition of Microtune. If we are unable to successfully integrate Microtunes business and personnel and develop these businesses to realize financial growth, we may
not realize the expected benefits of such acquisition or achieve our intended return of investment and our financial results could be harmed.
Our acquisition activities, including the Microtune acquisition, may present financial, managerial and operational risks, including diversion of managements attention from existing core businesses, difficulties integrating in-process products, technologies or personnel, harm to our existing business relationships with suppliers and customers, inaccurate estimates of fair value made in the accounting for acquisitions and amortization of acquired intangible assets which would reduce future reported earnings, potential loss of customers or key employees of acquired businesses, and indemnities and potential disputes with the sellers. Any of these activities could disrupt our business, cause us to not achieve the intended benefits of the acquisition, and seriously harm our financial condition.
If we fail to manage our future growth, if any, our business would be harmed.
If we were able to attain future growth, we may need to recruit and hire new engineering, managerial, sales and marketing personnel. Our ability to manage growth successfully may also require us to expand and improve administrative, operational, management and financial systems and controls. Many of our key functions, including a material portion of our research and development, product operations and a significant portion of our marketing, 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 manage growth effectively. If we are unable to manage any future growth effectively, our business will be harmed.
We are exposed to fluctuations in the market values of our portfolio investments and in interest rates.
At December 31, 2010, we had $261.3 million in cash, cash equivalents and short-term investments. We invest our cash in a variety of financial instruments, consisting principally of investments in certificate of deposits insured by Federal Deposit Insurance Corporation (FDIC), commercial paper, money market funds and highly liquid debt securities of corporations, municipalities and the United States government and its agencies. These investments are denominated in U.S. dollars.
Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate debt securities may have their market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or if the decline in fair value of our publicly traded equity investments and debt instruments is judged to be other-than-temporary. We may suffer losses in principal if we are forced to sell securities that decline in market value due to changes in interest rates. However, because any debt securities we hold are classified as available-for-sale, generally no gains or losses are recognized due to changes in interest rates unless such securities are sold prior to maturity.
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. We do not have employment contracts with any of our key employees. Management and other employees may voluntarily terminate their employment with us at any time upon short or no notice. The loss of key personnel could delay product development cycles or otherwise harm our business. 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, located in the United States and overseas. A portion of our employee compensation is in the form of equity compensation, which is directly tied to our stock price. Our employees
continue to hold a substantial number of equity incentive awards that are underwater, and as a result, a portion of our equity compensation has little or no retention value. Failure to attract, integrate and retain key personnel could harm our ability to carry out our business strategy and compete with other companies.
We could face adverse consequences as a result of the actions of activist stockholders.
An activist stockholder group, the Ramius Group, is seeking a change in control of Zoran by removing, without cause, six of the seven current members of the Board of Directors and filling the vacancies with a slate of individuals selected by Ramius. Ramius commenced a consent solicitation, and on May 3, 2010 announced that it had delivered consents by stockholders owning more than 50% of our outstanding shares to remove directors Uzia Galil, James D. Meindl and Philip M. Young, and to elect Ramius nominees Jon S. Castor, Dale Fuller and Jeffrey C. Smith. Ramius announcement also stated that these proposals took effect upon Ramius delivery of the consents to us on March 3, 2011. Ramius has also nominated its slate of individuals for election to replace our Board of Directors at the 2011 annual stockholders meeting. Our business could be materially adversely affected by Ramius actions because:
These actions, and future announcements related to current or future actions by Ramius or other activist stockholders, could also cause our stock price to fluctuate.
Provisions in our charter documents and Delaware law could prevent or delay a change in control of Zoran.
Our certificate of incorporation and bylaws and Delaware law contain provisions that could make it more difficult or expensive for a third party to acquire us, even if doing so would be beneficial to our stockholders. These include provisions:
Our proposed acquisition by CSR is subject to a number of conditions that must be satisfied prior to the closing of the merger. If we are unable to satisfy these conditions, the merger may not occur. Should the merger fail to close for any reason, our business, financial condition, results of operations and cash flows may be harmed. During the pendency of the merger our business may be harmed and our stock price may be subject to significant fluctuations.
The merger Agreement contains a number of conditions that must be satisfied before the closing of the merger can occur. Many of these conditions are described under Note 13 If one or more of these conditions is not
satisfied, and as a result, we do not complete the merger, or in the event the proposed merger is not completed or delayed for any other reason, our business may be harmed because:
Our stock price may also fluctuate significantly based on announcements by CSR, Ramius, us or other third-parties regarding the proposed merger and/or Ramius ongoing consent solicitation to replace certain of our directors, or based on market perceptions of the likely outcomes of these events. Such announcements may lead to perceptions in the market that the merger may not be completed, which could cause our stock price to fluctuate or decline.
The merger agreement generally requires us to operate our business in the ordinary course pending consummation of the proposed merger, and it restricts us, without CSRs prior written consent, from taking certain specified actions until the merger is completed or the merger agreement is terminated. These restrictions may prevent us from pursuing attractive business opportunities that may arise prior to the completion of the merger with CSR that could be favorable to us and our stockholders. Further, we risk losing key employees due to the uncertainty posed by the proposed merger and the Ramius consent solicitation. Efforts are needed by our employees to ensure that during the pendency of the proposed merger we continue to execute on our business plan and strategy, including research and development work on new products; sales and marketing efforts relating to current marketed products, as well as the launch of new products; and management of relationships with important customers, suppliers and other stakeholders to avoid disruption in our business. Moreover, our customers, suppliers and vendors could reduce or eliminate their business with us due to the merger, which could harm our business, particularly if the merger is not completed.
Any of these events could harm our results of operations and financial condition and could cause a decline in the price of our common stock, particularly if the merger does not close.
Our officers and directors have certain interests in the merger that are different from, or in addition to, interests of our stockholders.
Our officers and directors have certain interests in the merger that are different from, or in addition to, interests of our stockholders. These interests include:
Our stockholders should be aware of these interests when considering our Board of Directors recommendation to adopt the merger agreement.
In certain instances, the merger agreement requires us to pay a termination fee to CSR. This potential payment could affect the decisions of a third party considering making an alternative acquisition proposal to the merger.
Under the terms of the merger agreement, we will be required to pay to CSR a termination fee of $12,200,000 if the merger agreement is terminated under certain circumstances. In addition, if we terminate the merger agreement prior to obtaining the approval of our stockholders to enter into a contract providing for a superior proposal in which all the consideration payable to our stockholders or Zoran is cash, we must pay CSR a termination fee of $18,000,000. These potential payments, as well as related provisions of the merger agreement regulating our conduct in connection with alternative acquisition proposals, could affect the structure, pricing and terms proposed by a third party seeking to acquire or merge with us or could deter a third party from making a competing acquisition proposal. In addition, if we were required to pay CSR a termination fee, our business, financial condition, results of operations and cash flows would be harmed.
Purported stockholder class action lawsuits have been filed against us and members of our Board of Directors challenging the merger, and such lawsuits could prevent or delay the consummation of the merger, result in substantial costs, or both.
Purported class action lawsuits are frequently filed in response to merger announcements. We and our Board of Directors are currently defending against several lawsuits in Delaware related to the proposed merger with CSR. See Item 3Legal proceedings below.
Several plaintiffs law firms have announced investigations of our company concerning possible breaches of fiduciary duty and other violations of law, and it is possible that one or more of these or other law firms could initiate additional litigation against us and/or our Board of Directors. These lawsuits may require us to incur substantial legal fees and expenses, could create additional uncertainty relating to the proposed merger and could be distracting to management.
For more information on each of the above risk factors related to the merger, stockholders are encouraged to review the merger agreement, which is filed as an exhibit to the Current Report on Form 8-K that we filed with the SEC on February 22, 2011
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, 2010 and December 31, 2010, the sale prices of our common stock, as reported on the Nasdaq Global Selected Market, ranged from a low of $6.18 to a high of $12.23. The market price of our common stock may be subject to significant fluctuations in the future in response to a variety of factors, including:
From time to time, the stock market experiences 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 also reduce the future market price of our common stock.
Our executive offices and principal marketing, sales and product development operations are located in approximately 89,000 square feet of leased space in Sunnyvale, California, under a lease that expires in September 2016. A significant portion of our research and development and engineering facilities and our administration operations are currently located in approximately 109,700 square feet of leased space in an industrial park in Haifa, Israel under a lease expiring in November 2016. We also lease facilities, primarily for sales, product development, and technical support, in Shenzhen, Shanghai and Hong Kong, China; Paris, France; Ingolstadt, Germany; Tokyo, Japan; Seoul, Korea; Burlington, Massachusetts; Taipei, Taiwan, Plano, Texas and Manchester, United Kingdom;. We believe that our current facilities are adequate for our needs for the foreseeable future and that, should it be needed, suitable additional space in each of the locations where we operate will be available to accommodate expansion of our operations on commercially reasonable terms.
Item 3Legal Proceedings
See Note 7, Commitments and contingencies to Consolidated Financial Statements of this Form 10-K included in Item 8 of this report.
Item 5Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on the Nasdaq Global Select Market under the symbol ZRAN.
The following table sets forth the high and low sales prices of our common stock, based on the last daily sale, as reported on The Nasdaq Global Select Market for the periods indicated:
As of December 31, 2010, there were 276 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.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
We repurchased 3,376,203 shares of our equity securities in 2010. The following is a summary of stock repurchase activities during 2010 (in thousands except per share amounts):
Item 6Selected 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.
Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations
We provide integrated circuits, software and platforms for digital televisions, set-top boxes, broadband receivers (silicon tuners) and media players, digital cameras and printers, scanners and related Multi Function Peripherals (MFP). We sell our products to original equipment manufacturers that incorporate them into products for consumer and commercial applications
In 2009, our revenues were harmed by the poor macroeconomic environment which had the effect of reducing consumer spending. As a result of those macroeconomic conditions, we continued several cost containment programs including realigning our resources to focus on our key priorities, reducing investments in certain areas and scaling back travel, as well as other measures. In addition, we continued our focus on maintaining a strong balance sheet, and in particular, managing our cash and inventory balances very closely.
While the global economic downturn continues to affect consumer spending, we are seeing some indications that it may be stabilizing. In 2010, we saw growth in our digital camera product line as a result of increased demand for low to mid-range models. However, we also saw a significant reduction in the demand for our DTV and multimedia player products primarily due to loss of market share by our key customers resulting in reduced orders of our products. We were also impacted by one of our customers decision to add a second supplier, causing additional market share loss for us. As a result of these developments, we have taken certain restructuring activities such as discontinuing further investment in our multimedia player products and closing our Sweden office to reduce our operating expenses to right size the business and maintain a strong balance sheet.
We derive most of our revenues from the sale of our integrated circuit and system-on-a-chip (SOC) products. Historically, average selling prices for our products, consistent with average selling prices for products in the semiconductor industry generally, have decreased over time. Average selling prices for our products have fluctuated substantially from period to period, reflecting changes in our mix of product sold and transitions from low-volume to high-volume production. In the past, we have periodically 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.
We also derive revenues from licensing our software and other intellectual property. Licensing revenues include one-time license fees and royalties based on the number of units sold by the licensee. Quarterly licensing revenues can be significantly affected by the timing of a small number of licensing transactions, each accounting for substantial revenues. Accordingly, licensing revenues have fluctuated, and will continue to fluctuate, on a quarterly basis. Our software license agreements typically include obligations to provide maintenance and other support over a fixed term and allow for renewal of maintenance services on an annual basis. We recognize maintenance and support revenue ratably over the term of the arrangement. We also receive royalty revenues based on per unit shipments of products that include our software, which we recognize upon receipt of a royalty report from the customer, typically one quarter after the sales are made by our licensee.
We also generate a portion of our revenues from development contracts, primarily with key customers. Revenues from development contracts are generally recognized as the services are performed based on the specific deliverables outlined in each contract. Amounts received in advance of performance under contracts are recorded as deferred revenue and are generally recognized within one year from receipt.
Cost of Hardware Product Revenues
Our cost of hardware product revenues consists primarily of fabrication costs, assembly and test costs, the cost of materials and overhead from operations and allocable facilities costs. If we are unable to reduce our cost of hardware product revenues to offset anticipated decreases in average selling prices, our product gross margins will decrease. We expect both product and customer mix to continue to fluctuate in future periods, causing fluctuations in margins.
Research and Development
Our research and development expenses consist of salaries and related costs of employees engaged in ongoing research, design and development activities, costs of engineering materials and supplies and allocable facilities costs. 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.
Selling, General and Administrative
Our selling, general and administrative expenses consist primarily of employee-related expenses, sales commissions, product promotion, other professional services and allocable facilities costs.
Our global effective tax rate is highly dependent upon the geographic distribution of our worldwide earnings or losses as our statutory tax rate varies significantly by jurisdiction. Our current tax expense reflects taxes expected to be owed in our profitable jurisdictions. Our 2010 tax expense also includes the cost of recording a valuation allowance on our California deferred tax assets as it is no longer more likely than not that we will receive a future benefit from those assets. In addition, in certain foreign jurisdictions, we continue to record a valuation allowance on the portion of those deferred tax assets for which future income is uncertain. The determination of when to record or remove a valuation allowance is decided for each jurisdiction separately. We rely primarily on an analysis of cumulative earnings or losses and projected future earnings or losses. It is possible that we will remove or record a valuation allowance in the near future dependent primarily on the actual and projected results in each jurisdiction.
Our Israeli subsidiary is 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 2017 and 2029, and the benefits from our subsidiarys Approved Enterprise status expire at various times beginning in 2012.
On November 30, 2010 (the closing date), we completed the acquisition of Microtune, a receiver solutions company that designs and markets advanced radio frequency (RF) and demodulator electronics for worldwide customers based in Plano, Texas. We acquired Microtune, among other things, to enhance its position in the core markets it serves and expand its worldwide presence, improving its ability to serve its customers as a single point-of-service provider. Under the terms of the acquisition agreement dated September 7, 2010, we acquired all outstanding shares of Microtunes common stock at $2.92 per share for a total payment of $159.2 million in cash. In addition, we converted each outstanding Microtunes restricted stock units to 0.42 shares of our restricted stock units. Upon completion of the acquisition, Microtune was integrated into our consumer segment.
The transaction is accounted for consistent with the provisions of ASC 805 Business Combinations. We retained an independent appraiser to assist management in determining the fair value of assets and liabilities
acquired. The estimated fair values are preliminary and represent managements best estimate of fair value as of the closing date. The consideration of $161.2 million paid by us exceeds the estimated fair value of the acquired net assets of $145.3 million, resulting in goodwill of $15.9 million.
Following the completion of the acquisition, results of operations of Microtune have been included in our consolidated financial statements. Accordingly, our results of operations for the year ended December 31, 2010 reflect Microtunes operations since December 1, 2010 while our results of operations for the years ended December 31, 2009 and 2008 reflected only Zorans historical operations.
Our products consist of application-specific integrated circuits, or ASICs and SOC products. We also license certain software and other intellectual property. We have two reporting segmentsConsumer and Imaging. The Consumer group provides products for use in multimedia player products, standard and high definition digital televisions, set-top boxes, digital cameras and multimedia mobile phones. The Imaging group provides products used in digital copiers, laser and inkjet printers, and multifunction peripherals.
Critical Accounting Policies and Estimates
This discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including bad debt, inventories, investments, intangible assets and income taxes. We base these estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following critical accounting policies require our most significant judgments and estimates used in the preparation of our consolidated financial statements:
The Company has two reportable segmentsConsumer and Imaging. Impairment is tested at the reporting unit level which is one level below the reportable segments. The first step (Step 1) is performed by comparing the reporting units carrying amount, including goodwill and intangible assets, to the fair value of the reporting unit. If the carrying amount of the reporting unit exceeds its fair value, goodwill and intangible assets is considered impaired and a second step (Step 2) is performed to measure the amount of impairment loss, if any. Step 2 is performed by calculating the implied fair value of goodwill and intangible assets and comparing the implied fair value to the carrying amount of goodwill and intangible assets. If the implied fair value of goodwill and intangible assets is lower than the carrying amount, an impairment loss is recognized equal to the difference.
In 2008, we determined that goodwill and intangible assets related to our reporting units in the Consumer segment were fully impaired and recorded a $167.6 million impairment charge. In 2010 and 2009, we performed our annual goodwill and intangible assets impairment analysis as of September 30, 2010 and 2009, respectively. Based on the analyses, we have determined that the fair value of the Imagining segment exceeded its carrying amount and concluded that goodwill and intangible assets were not impaired at that date. On November 30, 2010, we completed the acquisition of Microtune which resulted in an increase of goodwill of $15.9 million and an increase in purchased intangible assets of $33.8 million. See Note 6 to Consolidated Financial Statements for a detailed description.
We had no assets or liabilities utilizing Level 3 inputs as of December 31, 2010 and had utilized Level 3 inputs for the Auction Rate Securities (ARS) held as of December 31, 2009.
We recorded $0, $302,000 and $0 other-than-temporary impairment (OTTI) charges on our available-for-sale securities in 2010, 2009 and 2008, respectively. As of December 31, 2010 and 2009, our cumulative unrealized gains, net of tax, related to our investments classified as available-for-sale was approximately $1.5 million and $2.6 million, respectively. These unrecognized gains could be recognized in the future if our other-than-temporary assessment changes.
Results of Operations
The following table sets forth certain consolidated statement of operations data as a percentage of total revenues for the periods indicated:
The following table summarizes selected consolidated statement of operations data and changes from period to period (dollars in thousands, except for percentages):
Year Ended December 31, 2010 Compared to Year Ended December 31, 2009
Hardware product revenues for 2010 were $312.1 million compared to $334.9 million for 2009. Hardware product revenues decreased $27.9 million, or 8.6%, in the Consumer segment, partially offset by an increase of $5.2 million, or 44.2%, in the Imaging segment. Within the Consumer segment, hardware product revenues for DTV products decreased by $51.3 million, or 37.4%, and hardware product revenues for Multimedia Player products decreased by $16.2 million, or 30.4%. The decrease was partially offset by an increase of $34.2 million, or 25.7%, in hardware product revenue for Mobile products and $5.4 million in hardware product revenue we acquired through the Microtune acquisition. Total units shipped for DTV products decreased by 15.0% compared to the prior year. The decrease was due to loss of market share by our key customers and softness in the U.S. DTV market in the second half of the year. We were also impacted by the decision of one of our customers to add a second source supplier, causing additional market share loss for us. In addition, there continues to be price erosion in the DTV market. As a result, average selling prices for DTV products decreased by 26.4% in 2010 compared to 2009. Total units shipped for Multimedia Player products decreased by 32.4% compared to the prior year. Due to the weakening demand and the poor industry fundamentals, we have discontinued further investments in Multimedia Player products and reduced our headcount, which should enable us to harvest end-of-life revenues and be profitable in this business segment in 2011. Our strategy to address all ranges of the mobile market from the value segment to the very high end, including DVC, has resulted in an increase of 36.5% in total units shipped for Mobile products in 2010 compared to 2009. The increase in Imaging product revenue was primarily due to a 16.5% increase in total units shipped in 2010 compared to 2009 and 23.7% increase in average selling price due to product mix shift.
Software and other revenues remained consistent with the prior year as we maintained a consistent customer base.
Cost of Hardware Product Revenues
Cost of hardware product as a percentage of hardware revenues decreased to 54.9% for 2010 from 58.7% for 2009. This decrease was primarily due to a change in overall product mix, including a reduction in the sale of lower margin DTV products compared to higher margin camera and imaging products, as well as improved costs for certain products.
Research and Development
Research and development expenses were $115.7 million for 2010 compared to $112.2 million for 2009. The increase of $3.5 million or 3.1% was primarily due to a $1.9 million increase resulting from the inclusion of Microtunes operations beginning December 1, 2010, $1.4 million charge related to closing our Sweden office and our ongoing investments in research and development activities across various segments. Our research and development expense also fluctuates based on timing of mask sets and engineering wafers.
Selling, General and Administrative
Selling, general and administrative expenses were $110.3 million for 2010 compared to $107.7 million for 2009, resulting in an increase of $2.5 million or 2.3%. The increase was primarily due to various non-recurring expenses incurred in 2010 such as the acquisition of Microtune, restructuring and dissenting shareholder activities. The 2009 expense included an $11.8 million charge for the settlement of non-recurring intellectual property disputes.
Amortization of Intangible Assets
Amortization expense was $0.7 million for 2010 compared to $0.4 million in 2009. The increase was primarily due to amortization related to intangible assets acquired through the Microtune acquisition. At
December 31, 2010, we had approximately $33.7 million in net intangible assets acquired through the Microtune and Let It Wave acquisition, which we will continue to amortize through 2019.
Interest and Other Income, net
Interest and other income was $7.3 million for 2010 compared to $9.4 million for 2009. Interest income decreased by $2.7 million compared to the prior year. The decrease was primarily due to a lower investment balance compared to the prior year as a result of the Microtune acquisition and cash used in operating activities during 2010.
Provision for Income Taxes
The tax provision for the twelve months ended December 31, 2010 and 2009 was $14.3 million and $5.6 million, respectively. The tax provision for 2010 reflects the sum of the estimated tax expense in each of our profitable jurisdictions for their year to date profits, plus a deferred tax expense of $8.3 million for the recognition of a valuation allowance on our California deferred tax assets. Discrete items for 2010 were primarily benefits related to the filing of the 2009 domestic tax returns. The tax provision for 2009 reflects the estimated annual tax rate applied to the year to date net income for our profitable jurisdictions, adjusted for discrete items which are fully recognized in the period they occur.
Year Ended December 31, 2009 Compared to Year Ended December 31, 2008
Hardware product revenues for 2009 were $334.9 million, compared to $379.8 million for 2008. Hardware product revenues decreased $32.6 million or 9.2% in the Consumer segment and $12.3 million or 51.3% in the Imaging segment. Total units shipped for products in the Consumer segment decreased by 6.5% and the average selling price decreased by 2.9% compared to prior year. Within the Consumer segment, hardware product revenues for Mobile products decreased by $34.5 million or 20.6% and hardware product revenue for Multimedia Player products decreased by $12.7 million or 19.3%. Total units shipped for Mobile products decreased by 10.2% and average selling price decreased by 11.5% compared to prior year. Total units shipped for Multimedia Player products decreased by 9.6% and average selling price decreased by 10.7% compared to prior year. Partially offsetting the decrease in hardware product revenues for Mobile and Multimedia Player products was an increase in revenues for DTV products. Hardware product revenues for DTV products increased by $14.6 million or 11.9%. Total DTV product units shipped increased by 10.0% and the average selling price increased by 1.7% compared to 2008. The decrease in Imaging hardware product revenues was primarily due to a 60.6% decrease in unit shipments attributable to a decline in our Ink Jet business as well as an overall decline in demand as a result of the economic downturn. We believe that the recent worldwide recession has adversely affected the markets that our customers serve resulting in reduced unit shipments for some of our products during 2009 as indicated above. As the economy begins to improve, we believe that our revenue will grow in 2010 although there is uncertainty regarding the level of recovery that will occur in the near future.
Software and other revenues were $45.2 million in 2009 compared to $58.7 million in 2008. Software and other revenues decreased by $8.5 million in the Imaging segment and $5.0 million in the Consumer segment. The decrease in the Consumer segment was primarily a result of the decrease in royalty revenues from the Mediatek settlement, which ended in the fourth quarter of 2008. The decrease in the Imaging segment was primarily due to a decrease in royalty revenues due to decreased unit shipments of products that include our software as a result of the current economic slow down.
Cost of Hardware Product Revenues
Cost of hardware product revenues were $196.5 million in 2009 compared to $229.0 million in 2008. The decrease in cost of hardware product revenues of $32.5 million or 14.2% was primarily due to a decrease in total
units shipped of 9.7%. Cost of hardware product revenues as percentage of hardware product revenues remained fairly consistent in 2009 compared to 2008.
Research and Development
Research and development expenses were $112.2 million in 2009 compared to $117.9 million in 2008. The decrease in costs by $5.7 million or 4.9% was primarily a result of our cost reduction efforts and the closing of our facilities in Netanya, Israel and Toronto, Canada.
Selling, General and Administrative
Selling, general and administrative expenses increased to $107.7 million in 2009 from $94.6 million in 2008, representing a 13.9% increase. This fluctuation in spending was primarily due to $11.8 million of IP licensing settlement expenses recorded in 2009 and the timing of legal expenses associated with our ongoing litigation matters.
Amortization of Intangible Assets
Amortization expense decreased to $0.4 million in 2009 from $23.1 million in 2008, a decrease of $22.7 million or 98.1% as a portion of our intangible assets became fully amortized during 2008. At December 31, 2009, we had approximately $0.6 million in net intangible assets acquired through the Let It Wave acquisition, which we will continue to amortize on a straight line basis through 2011.
Impairment of Goodwill and Intangible Assets
In 2008, as a result of our annual impairment test, we determined that the carrying amount of certain reporting units exceeded their fair value resulting in an impairment charge of $164.5 million related to goodwill recorded in our Consumer business segment and $3.1 million related to intangible assets in our Consumer business segment. There were no charges recorded for impairment of goodwill and intangible assets in 2009.
In-Process Research and Development
In 2008, we recorded an in-process research and development expense of $22.4 million as part of the June 2008 acquisition of Let It Wave. There were no charges recorded for in-process research and development in 2009.
Interest and Other Income
Interest and other income was $9.4 million in 2009 compared to $12.6 million in 2008. The decrease was primarily due to lower average interest earned on our cash and short term investment balances by $4.3 million due to declines in prevailing interest rates. The decrease was partially offset by a decrease in foreign currency remeasurement losses in 2009 compared to 2008.
Provision for Income Taxes
We recorded a tax provision of $5.6 million in 2009 and $12.3 million in 2008. The 2009 provision is primarily for the accrual of taxes we expect to owe in our profitable jurisdictions. The tax expense for the year ended December 31, 2008 was primarily for the accrual of taxes we expected to owe in our profitable jurisdictions offset by an expense of $8.7 million associated with a valuation allowance in foreign jurisdictions where it was no longer more likely than not that we would fully utilize our deferred taxes. In addition, due to statute of limitation lapses, there was a release of our accrued liabilities of $1.3 million.
The income tax provision for these periods was affected by the geographic distribution of our worldwide earnings and losses, the impact of recording or removing the valuation allowance relating to deferred tax assets, non-deductible expenses such as ASC 718 Compensation-Stock Compensation, as well as the accrual of liabilities associated with unrecognized tax benefits. Our Israel based subsidiary is an Approved Enterprise under Israeli law, which provides a ten-year tax holiday for income attributable to a portion of our operations in Israel.
Liquidity and Capital Resources
At December 31, 2010, we had $81.1 million of cash and cash equivalents and $180.2 million of short-term investments and $287.2 million of working capital.
Cash used in operating activities was $32.0 million during 2010. While we recorded a net loss of $47.6 million, this loss included non-cash items such as amortization of intangible assets of $0.7 million, depreciation of $6.1 million, stock-based compensation expense of $10.4 million and deferred income taxes of $13.6 million resulting in our net loss adjusted for non-cash items totaling $16.8 million. Cash flow from changes in assets and liabilities was due to increases in inventory by $9.4 million due to decrease in sales, prepaid expenses, other current assets and other assets by $3.3 million due to the timing of payments made and decrease in accounts payable, accrued expenses and other liabilities totaling $9.4 million due to timing of payments. These changes were partially offset by a decrease in accounts receivable of $8.2 million due to the timing of collections
Our investing activities generated cash of $46.1 million during 2010. Proceeds from sales and maturities of investments, net of purchases, of $178.5 million were offset by $125.8 million used for the acquisition of Microtune and $6.6 million used for purchases of property and equipment.
Cash used in financing activities was $22.3 million during 2010. Repurchases of common stock of $28.9 million under our Stock Repurchase Program was offset by $6.6 million of proceeds received from issuances of common stock through exercises of stock options and proceeds from the sale of stock under our employee stock purchase plan.
Our operating activities generated cash of $1.5 million during 2009. While we recorded a net loss of $33.0 million, this loss included non-cash items such as amortization of intangible assets of $0.4 million, depreciation of $7.0 million, stock-based compensation expense of $11.6 million and a reduction in deferred income taxes of $2.2 million resulting in our net loss adjusted for non-cash items totaling $16.2 million. Cash flow from changes in assets and liabilities was insignificant and was due to decreases in accounts receivable by $0.8 million due to the timing of collections, inventory by $10.2 million due to lower levels based on reduced demand and prepaid expenses, other current assets and other assets by $7.6 million due to the timing of payments made. These changes were partially offset by a decrease in accounts payable, accrued expenses and other liabilities totaling $0.8 million due to timing of payments.
Cash used in investing activities was $19.9 million during 2009. Proceeds from sales and maturities of investments of $182.5 million were offset by purchases of $198.7 million and $3.8 million used for purchases of property and equipment.
Cash used in financing activities during 2009 was $2.9 million. Repurchases of common stock of $9.7 million under our Stock Repurchase Program was offset by $6.8 million of proceeds received from issuances of common stock through exercises of stock options and proceeds from the sale of stock under our employee stock purchase plan.
At December 31, 2010 and 2009, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Accordingly, we are not exposed to the type of financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.
We believe that our current balances of cash, cash equivalents and short-term investments, and anticipated cash flows from operations, will satisfy our anticipated working capital and capital expenditure requirements at least through the next 12 months. Nonetheless, our future capital requirements may vary materially from those now planned and will depend on many factors including, but not limited to:
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 additional 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 any 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.
Our investment policy focuses on three objectives: to preserve capital, to meet liquidity requirements and to maximize total return. Our investment policy establishes minimum ratings for each classification of investment and investment concentration is limited in order to minimize risk, and the policy also limits the final maturity on any investment and the overall duration of the portfolio. We regularly review our investment portfolio to ensure adherence to our investment policy and to monitor individual investments for risk analysis and proper valuation.
We hold our marketable securities as trading and available-for-sale and mark them to market. We expect to realize the full value of our marketable securities upon maturity or sale, as we have the intent and believe we have the ability to hold the securities until the full value is realized. However, we cannot provide any assurance that our invested cash, cash equivalents and marketable securities will not be impacted by adverse conditions in the financial markets, which may require us to record an impairment charge that could adversely impact our financial results.
The following is a summary of fixed payments related to certain contractual obligations as of December 31, 2010 (in thousands):
The following is a summary of other long term liabilities, primarily related to certain contractual obligations as of December 31, 2010 (in thousands):
The above table does not reflect unrecognized tax benefits of $37.2 million as a disallowance of these items would be primarily reflected as an adjustment to our deferred tax assets and would not result in a significant impact on our cash balance. Refer to Note 11 to the Consolidated Financial Statements for additional discussion on unrecognized tax benefits.
Item 7AQuantitative and Qualitative Disclosures About Market Risk
We are exposed to financial market risks, including changes in interest rates and foreign currency exchange rates. We maintain an investment portfolio of various holdings, types, and maturities. See Note 4 to the Condensed consolidated Financial Statements. We hold our marketable securities as available-for-sale and mark them to market. We expect to realize the full value of all our marketable securities upon maturity or sale, as we have the intent and believe that we have the ability to hold the securities until the full value is realized. However, we cannot provide any assurance that our invested cash, cash equivalents and marketable securities will not be impacted by adverse conditions in the financial markets, which may require us to record an impairment charge that could adversely impact our financial results.
We consider various factors in determining whether we should recognize an impairment charge for our fixed income securities and publicly traded equity securities, including the length of time and extent to which the fair value has been less than our cost basis, the financial condition and near-term prospects of the investee, and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value.
Interest Rate Risk
We invest in a variety of financial instruments, consisting principally of investments in commercial paper, money market funds and highly liquid debt securities of corporations, municipalities and the United States government and its agencies and certificate of deposits insured by FDIC. These investments are denominated in United States dollars. We do not maintain derivative financial instruments. We place our investments in instruments that meet high credit quality standards, as specified in our investment policy guidelines.
All of our cash equivalents and marketable securities are treated as available-for-sale. Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if we are forced to sell securities that decline in market value due to changes in interest rates. However, because we generally classify our debt securities as available-for-sale no gains or losses are recognized due to changes in interest rates unless such securities are sold prior to maturity or declines in fair value are determined to be other than temporary. These securities are reported at fair value with the related unrealized gains and losses included in accumulated other comprehensive income, a component of stockholders equity, net of tax.
Due mainly to the short-term nature of the major portion of our investment portfolio, 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. Actual future gains and losses associated with our investments may differ from the sensitivity analyses performed as of December 31, 2010 due to the inherent limitations associated with predicting the changes in the timing and level of interest rates and our actual exposures and positions.
Exchange Rate Risk
We have direct exposure to foreign exchange rate fluctuations. We recorded exchange losses of $811,000 and exchange gain of $28,000 for the year ended December 31, 2010 and 2009, respectively. These fluctuations were primarily due to foreign currency remeasurement as a result of changes in the value of the US dollar in comparison to currencies in countries in which we operate.
Currently, sales and supply arrangements with third-party manufacturers provide for pricing and payment primarily in United States dollars and, therefore, are not subject to exchange rate fluctuations. Increases in the value of the United States dollar relative to other currencies would make our products more expensive, which could negatively impact our ability to compete. Conversely, decreases in the value of the United States dollar relative to other currencies could result in our suppliers raising their prices as a condition to their continuing to do business with us.
A portion of the cost of our operations, relating mainly to our personnel and facilities in Israel, Asia and Europe, are transacted in foreign currencies. To date, we have not engaged in any currency hedging activities, although we may do so in the future. Significant fluctuations in currency exchange rates could impact our business in the future. However, we do not believe that a hypothetical 10% favorable or unfavorable change in foreign currency exchange rates would not have a material impact on our financial position or results of operations.
Item 8Financial Statements and Supplemental Data
Index to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of
We have audited the accompanying consolidated balance sheets of Zoran Corporation and subsidiaries (the Company) as of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders equity and comprehensive income (loss), and cash flows for the years then ended. We also have audited the Companys internal control over financial reporting as of December 31, 2010, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. As described in Managements Report on Internal Control Over Financial Reporting, management excluded from its assessment the internal control over financial reporting at Microtune, Inc., which was acquired on November 30, 2010 and whose financial statements constitute approximately 35 percent of net assets, 30 percent of total assets, 2 percent of revenues and 3 percent of loss before income taxes of the consolidated financial statement amounts as of and for the year ended December 31, 2010. Accordingly, our audit did not include the internal control over financial reporting at Microtune, Inc. The Companys management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Companys internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the financial statements included 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. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A companys internal control over financial reporting is a process designed by, or under the supervision of, the companys principal executive and principal financial officers, or persons performing similar functions, and effected by the companys board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Zoran Corporation and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
As discussed in Note 1 to the consolidated financial statements, in 2009 the Company adopted new accounting guidance issued by the Financial Accounting Standards Board related to business combinations.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of
In our opinion, the accompanying consolidated statements of operations, of stockholders equity and comprehensive income (loss) and of cash flows for the year ended December 31, 2008 present fairly, in all material respects, the results of operations and cash flows of Zoran Corporation and its subsidiaries for the year ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
AND COMPREHENSIVE INCOME (LOSS)
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES
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, integrated circuit cores and embedded software used by original equipment manufacturers (OEMs), in digital audio and video products for commercial and consumer markets, digital television applications and digital imaging products. Current applications incorporating Zorans products and IP include digital versatile disc, or multimedia players and recorders, digital cameras, broadband receivers, professional and consumer video editing systems, digital speakers and audio systems, applications that enable the delivery and display of digital video content through a set-top box or television as well as digital imaging products consisting of semiconductor hardware and software that enable users to print, scan, process and transmit documents to computer peripherals that perform printing functions. The Company has two reportable segments, Consumer group and Imaging group.
Principles of consolidation and basis of presentation
The Company reports its financial results on a calendar fiscal year. The consolidated financial statements include the accounts of Zoran and all of its subsidiaries including Microtune, Inc. (Microtune) which was acquired on November 30, 2010. Intercompany transactions and balances have been eliminated in consolidation.
Use of estimates
The preparation of these financial statements in conformity with generally accepted accounting principles in the Unites States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ materially from those estimates.
Risks and uncertainties
The Company participates in a dynamic high-technology industry. Changes in any of the following areas could have a material adverse effect on the Companys future financial position, results of operations, or cash flows: reliance on limited number of suppliers; general economic conditions; advances and trends in new technologies; competitive pressures; changes in the overall demand for its future products; acceptance of the Companys products; litigation or claims against the Company based on intellectual property, patent, regulatory, or other factors; and the Companys ability to attract and retain employees necessary to support its growth.
Translation of foreign currencies
The majority of the Companys purchasing and sales transactions are denominated in U.S. dollars, which is the functional currency of the Company and its subsidiaries. The Company has not experienced material gain or losses as a result of currency exchange rate fluctuations and has not engaged in hedging transactions to reduce its exposure to such fluctuations. The Company may take action in the future to reduce its foreign exchange risk. Monetary assets and liabilities of the Companys foreign subsidiaries are translated into U.S. dollars from the local currency at rates in effect at period-end and non-monetary assets and liabilities are translated at historical rates. Revenues and expenses are remeasured at average rates during the period. Gains and losses arising from the translation of local currency financial statements are included in other expense, net. The Company recorded foreign currency translation gain (loss) of ($811,000), $28,000 and ($830,000) for each of the years ended December 31, 2010, 2009 and 2008, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The Companys policy is to recognize revenue from product sales upon shipment, provided that persuasive evidence of an arrangement exists, the price is fixed and determinable, collectibility is reasonably assured and legal title and risk of ownership has transferred. A provision for estimated future returns and potential warranty liability is recorded at the time revenue is recognized. Product returns and warranty expenses in 2010, 2009 and 2008, were immaterial. Development revenue under development contracts is recognized as the services are performed based on the specific deliverables outlined in each contract. Amounts received in advance of performance under contracts are recorded as deferred revenue and are recognized when the Companys obligations have been met. Costs associated with development revenues are included primarily in research and development expenses. Revenue resulting from the licensing of the Companys technology is recognized when significant contractual obligations have been fulfilled and the customer has indicated acceptance. The Companys software license agreements typically include obligations to provide maintenance and other support over a fixed term and allow for renewal of maintenance services on an annual basis. Periodic service and maintenance fees which 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 which typically ranges between one month to one quarter in arrears. Revenue from software licenses is recognized when all revenue recognition criteria are met and, if applicable, when vendor specific objective evidence (VSOE) exists to allocate the total license fee to each element of multiple-element software arrangements, including post-contract customer support. Post-contract support is recognized ratably over the term of the related contract. When a contract contains multiple elements wherein the only undelivered element is post-contract customer support and VSOE of the fair value of post-contract customer support does not exist, revenue from the entire arrangement is recognized ratably over the support period. Software royalty revenue is recognized based upon reports received from licensees during the period, unless collectibility is not reasonably assured, in which case revenue is recognized when payment is received from the licensee. Revenue from cancellation fees is recognized when cash is received from the customer.
In December 2007, the FASB revised their guidance on business combinations. The new guidance requires an acquiring entity to measure and recognize identifiable assets acquired and liabilities assumed at the acquisition date fair value with limited exceptions. The changes include the expensing of acquisition related transaction costs, the recognition of capitalized in-process research and development, the accounting for acquisition-related restructuring cost accruals subsequent to the acquisition date and the recognition of changes in the acquirers income tax valuation allowance. Under the previous guidance, in-process research and development was expensed and acquisition costs were capitalized as part of the purchase price consideration. The new guidance was effective for us beginning January 1, 2009.
Research and development costs
Research and development expenses are charged to operations as incurred and include salaries and related costs of employees engaged in ongoing research, design and development activities and costs of engineering materials and supplies.
Cash equivalents and investments
All highly liquid investments purchased with an original maturity of 90 days or less are considered to be cash equivalents.
The Company holds marketable securities which are classified as available-for-sale and held-to-maturity. The available-for-sale securities are reported at fair value with unrealized gains and losses, net of related tax, if any,
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
included as accumulated other comprehensive income (loss), a component of stockholders equity. Gains and losses realized upon sales of all such securities are reported in other expense, net. At December 31, 2010 and 2009, the Companys available-for-sale marketable securities included corporate debt, U.S. government securities, auction rate securities, foreign bonds, municipal bonds, marketable equity securities and certificate of deposits. See Note 4.
The Companys held-to-maturity securities are comprised of certificate of deposits insured by FDIC. The carrying values of the held-to-maturity securities approximate fair value. At December 31, 2010 and 2009, the Company recorded $247,000 and $0 certificate of deposits as long term investment, respectively. The certificate of deposits recorded under long term investments will mature in 2012.
Other-than- temporary impairment
All of the Companys available-for-sale investments are subject to a periodic impairment review. The Company recognizes an impairment charge when a decline in the fair value of its investments below the cost basis is judged to be other-than-temporary. The Company considers various factors in determining whether to recognize an impairment charge, including the length of time and extent to which the fair value has been less than the Companys cost basis, the financial condition and near-term prospects of the investee, and the Companys intent and ability to hold, or whether it is more likely than not it will be required to sell, the investment before recovery of the investments amortized cost basis. The Company recorded $302,000 other-than-temporary impairment (OTTI) charges on its available-for-sale securities in 2009. No OTTI was recorded in 2010 or 2008.
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, investments in marketable debt securities and trade accounts receivable. The Company places its cash in banks and cash equivalents consist primarily of commercial paper. The Company, by policy, limits the amount of its credit exposure through diversification and restricting its investment purchases to highly rated securities only. Individual securities are limited to comprising no more than 10% of the portfolio value at the time of purchase. Highly rated securities are defined as having a minimum Moody or Standard & Poors rating of A2 or A respectively. The average maturity of the portfolio shall not exceed 24 months. 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 following table summarizes the accounts receivable from significant customers representing 10% or more of the net accounts receivable balance:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Inventory is 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. The Company writes down inventory to net realizable value based on forecasted demand and market conditions. Inventory write-downs are not reversed and permanently reduce the cost basis of the affected inventory until such inventory is sold or scrapped. The Company assesses the valuation of its inventory in each reporting period. Although the Company attempts to forecast future inventory demand, given the competitive pressures and cyclical nature of the semiconductor industry, there may be significant unanticipated changes in demand or technological developments that could have a significant impact on the value of the Companys inventories and reported operating results.
Inventory write downs inherently involve judgments as to assumptions about expected future demand and the impact of market conditions on those assumptions. Although the Company believes that the assumptions it used in estimating inventory write downs are reasonable, significant changes in any one of the assumptions in the future could produce a significantly different result. There can be no assurances that future events and changing market conditions will not result in significant inventory write downs.
Property and equipment
Property and equipment are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which are generally three to five years for computer equipment, five years for furniture, machinery and equipment and three years for software. 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.
Goodwill is not amortized. The Company monitors the recoverability of goodwill recorded in connection with acquisitions, by reporting unit, annually, or sooner if events or changes in circumstances indicate that the carrying amount may not be recoverable. See Note 6.
Intangible assets consist primarily of customer relationships, developed technologies, in-process research and development and trade names were recorded in connection with the acquisitions of Oak Technology, Inc., Emblaze Semiconductor, Ltd., Oren Semiconductor, Inc., Let It Wave and Microtune. The net intangible assets as of December 31, 2010 and 2009 relate to Microtune and Let It Wave and are being amortized over the estimated useful lives of one to nine years.
The fair value of in-process research and development is recorded as an indefinite-lived intangible asset until the underlying project is completed, at which time the intangible asset is amortized over its estimated useful life, or abandoned, at which time the intangible asset is expensed (prior to fiscal 2010, in-process research and development was expensed at the acquisition date).
The Company evaluates the recoverability of its long-lived assets, other than goodwill, whenever events or changes in circumstance indicate the carrying amounts of the assets may not be recoverable. The Company evaluates these assets by comparing expected undiscounted cash flows to the carrying value of the related assets. If the expected undiscounted cash flows are less than the carrying value of the assets, the Company recognizes an impairment charge based on the fair value of the assets. See Note 6.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Fair value of financial instruments
The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The carrying amounts for cash and cash equivalents, short-term investments, accounts receivable, accounts payable and accrued liabilities approximate their respective fair values because of the short-term maturity of these items. See Note 5.
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 basis of assets and liabilities. Realization of deferred tax assets is based on the Companys ability to generate sufficient future taxable income. As of December 31, 2010, historical operating income and projected future profits represented sufficient positive evidence that the realization of $54.9 million of the Companys deferred tax assets are more likely than not. In certain material jurisdictions, where future income is less certain, the company has recorded a valuation allowance against its deferred tax assets until such time as it is more likely than not that those assets will be realized.
The calculation of the Companys tax liabilities involves dealing with uncertainties in the application of complex tax regulations. The Company records liabilities for anticipated tax audit issues based on its estimate of whether, and the extent to which, additional taxes may be due. Actual tax liabilities may be different than the recorded estimates and could result in an additional charge or benefit to the tax provision in the period when the ultimate tax assessment is determined.
The Companys effective tax rate is highly dependent upon the geographic distribution of its worldwide earnings or losses, the tax regulations and tax holiday benefits in certain jurisdictions, and the effectiveness of its tax planning strategies. The Companys Israel based subsidiary is an Approved Enterprise under Israeli law, which provides a ten-year tax holiday for income attributable to a portion of the Companys operations in Israel. The Companys U.S. federal net operating losses expire at various times between 2017 and 2029, and the benefits from the Companys subsidiarys Approved Enterprise status expire at various times beginning in 2012.
Earnings per share
The Company reports Earnings Per Share (EPS), both basic and diluted, on the consolidated 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 common stock issuable upon the exercise of stock options, employee stock purchase plan and restricted stock units.
Stock- based compensation
Effective January 1, 2006, the Company adopted Financial Accounting Standards Board (FASB) issued Accounting Standards Codification (ASC) 718 Compensation-Stock Compensation, using the modified prospective application transition method, which establishes accounting for stock-based awards exchanged for employee services. Accordingly, stock-based compensation cost is measured at grant date, based on the fair value of the award, over the requisite service period.
During the years ended December 31, 2010, 2009 and 2008, the Company recorded stock-based compensation expense for awards granted prior to but not yet vested as of January 1, 2006 as if the fair value method required for pro forma disclosure under share-based payments guidance were in effect for expense recognition purposes adjusted for estimated forfeitures. For these awards, the Company has continued to recognize compensation expense using the accelerated amortization method. For stock-based awards granted
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
after January 1, 2006, the Company recognized compensation expense based on the grant date fair value required share-based payments guidance. For these awards, the Company recognized compensation expense using a straight-line amortization method. As the share-based payments guidance requires that stock-based compensation expense be based on awards that are ultimately expected to vest, estimated stock-based compensation for the years ended December 31, 2010, 2009 and 2008 has been reduced for estimated forfeitures.
The following table summarizes stock-based compensation expense related to employee stock options, employee stock purchases and restricted stock unit grants for the years ended December 31, 2010, 2009 and 2008 as recorded in accordance with share-based payments guidance (in thousands):
The income tax benefit for share-based compensation expense was $1.4 million, $1.3 million and $1.6 million for the year ended December 31, 2010, 2009 and 2008. The amount of stock-based compensation capitalized as inventory at December 31, 2010 and 2009 was immaterial.
ASC 280 Disclosure about Segments of an Enterprise and Related Information established standards for the reporting by public business enterprises of information about reportable segments, products and services, geographic areas, and major customers. The method for determining what information to report is based on the manner in which management organizes the reportable segments within the Company for making operational decisions and assessments of financial performance. The Companys chief operating decision-maker is considered to be its Chief Executive Officer.
The Companys products consist of application-specific integrated circuits and system-on-a-chip solutions. The Company also licenses certain software and other intellectual property. The Company has two reportable segmentsConsumer group and Imaging group.
The Consumer group provides products for use in multimedia players, standard and high definition digital television products, broadband receiver products, digital camera products and multimedia mobile phone products. The Imaging group provides products used in digital copiers, laser and inkjet printers as well as multifunction peripherals.
Comprehensive income (loss)
Comprehensive income (loss) is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources.
The components of accumulated other comprehensive income (loss) as of December 31, 2010, 2009 and 2008 consisted of the unrealized gain (loss) on marketable securities, net of related taxes.
Shipping and Handling Costs
Costs incurred for shipping and handling are included in cost of revenue at the time the related revenue is recognized.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Recent Accounting Pronouncements
In October, 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2009-13Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangementsa consensus of the FASB Emerging Issues Task Force (ASU 2009-13). ASU 2009-13 addresses how to measure and allocate arrangement consideration to one or more units of accounting within a multiple-deliverable arrangement. ASU 2009-13 modifies the requirements for determining whether a deliverable can be treated as a separate unit of accounting by removing the criteria that objective evidence of fair value exist for the undelivered elements. ASU 2009-13 is effective for the Company prospectively for revenue arrangements entered into or materially modified beginning January 1, 2011. Early adoption is permitted. The Company adopted this standard in January, 2011 which did not have a material impact on our financial statements.
In October, 2009, the FASB issued ASU No. 2009-14Software (Topic 985): Certain Revenue Arrangements That Include Software Elementsa consensus of the FASB Emerging Issues Task Force (ASU 2009-14). ASU 2009-14 modifies the scope of the software revenue recognition guidance to exclude arrangements that contain tangible products for which the software element is essential to the functionality of the tangible products. ASU 2009-14 is effective for the Company prospectively for revenue arrangements entered into or materially modified beginning January 1, 2011. Early adoption is permitted. The Company adopted this standard in January, 2011 which did not have a material impact on our financial statements.
In April, 2010, the FASB issued Accounting ASU No. 2010-13, Compensation-Stock Compensation (Topic 718)Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Tradesa consensus of the FASB Emerging Issues Task Force (ASU 2010-13). ASU 2010-13 provides amendments to Topic 718 to further clarify that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entitys equity securities trades should classify such an award as equity. The amendments in this update do not expand the recurring disclosures required by Topic 718. The amendments in this update are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. The company adopted this standard in January, 2011 which did not have a material impact on our financial statements.
In December, 2010, the FASB issued ASU No. 2010-29Business Combination (Topic 805Disclosure of Supplementary Pro Forma Information for Business Combinationsa consensus of the FASB Emerging Issues Task Force (ASU 2010-29). ASU 2010-29 specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. ASU 2010-29 also expands the supplemental pro forma disclosures under Topic 805 to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. ASU 2010-29 is effective for the Company prospectively for business combinations for which the acquisition date is on or after January 1, 2011. Early adoption is permitted. The Company adopted this standard in January, 2011 which did not have a material impact on our financial statements.
In March, 2010, the FASB issued ASU No. 2010-11, Derivative and Hedging (Topic 815)Scope Exception Related to Embedded Credit Derivatives (ASU 2010-11). ASU 2010-11 provides amendments to Subtopic 815-15 to clarify the scope exception for embedded credit derivative features related to the transfer of credit risk in the form of subordination of one financial instrument to another. An entity must ensure that an impairment analysis of the investment has been performed before the initial adoption of the amendment in this update. This update is effective for fiscal quarter beginning after September 15, 2010. The adoption of this standard update did not have any impact on the Companys consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
On November 30, 2010 (the closing date), the Company completed the acquisition of Microtune, a receiver solutions company that designs and markets advanced radio frequency (RF) and demodulator electronics for worldwide customers based in Plano, Texas. The Company acquired Microtune, among other things, to enhance its position in the core markets it serves and expand its worldwide presence, improving its ability to serve its customers as a single point-of-service provider. Under the terms of the acquisition agreement dated September 7, 2010, the Company acquired all outstanding shares of Microtunes common stock at $2.92 per share for a total payment of $159.2 million in cash. In addition, the Company converted each Microtunes outstanding restricted stock units to 0.42 shares of Zorans restricted stock units. Upon completion of the acquisition, Microtune was integrated into the Companys consumer segment.
The transaction is accounted for consistent with the provisions of ASC 805 Business Combinations and the assets and liabilities acquired are recorded at their estimated fair values. The estimated fair values are preliminary and represent managements best estimate of fair value as of the closing date. The consideration paid by the Company of $161.2 million exceeds the estimated fair value of the acquired net assets of $145.3 million, and purchased intangible assets of $33.8 million resulting in goodwill of $15.9 million.
Following the completion of the acquisition, the results of operations of Microtune have been included in our consolidated financial statements. Accordingly, our results of operations for the year ended December 31, 2010 reflect Microtunes operations since December 1, 2010 while our results of operations for the year ended December 31, 2009 and 2008 reflected only Zorans historical operation.
The total purchase price for Microtune was approximately $161.2 million and was comprised of the following items (in thousands):
The following are the preliminary estimated fair value of assets acquired and liabilities assumed as of the closing date (in thousands):
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table sets forth the components of intangible assets acquired in connection with the Microtune acquisition:
Customer relationships represent the fair values of the underlying relationships with Microtunes customers. In-process research and development represents the fair values of incomplete Microtune research and development projects that had not reached technological feasibility as of the date of acquisition. Developed technology represents the fair values of Microtune products that have reached technological feasibility and are a part of Microtunes product lines. Tradename represents the fair values of brand and name recognition associated with the marketing of Microtunes products and services.
The following unaudited pro forma condensed financial information presents the combined results of operations of the Company and Microtune as if the acquisition had occurred as of January 1, 2009:
The pro forma financial information for all periods presented includes (1) amortization charges from acquired intangible assets of $4.2 million in 2010 and $4.9 million in 2009, (2) the estimated stock-based compensation expense related to the restricted stock-based awards assumed of $1.5 million for 2010 and 2009; (3) the elimination of historical stock-based compensation charges recorded by Microtune of $4.4 million in 2010 and $4.8 million in 2009, as a result of the cancellation of all outstanding options on the acquisition date; (4) the elimination of acquisition related costs of $9.0 million for 2010 and (5) the related tax benefit of $4.7 million in 2010 and $4.9 million in 2009 for such items. The unaudited pro forma condensed financial information is not intended to represent or be indicative of the condensed results of operations of the Company that would have been reported had the acquisition been completed as of the beginning of the periods presented, and should not be taken as representative of the future consolidated results of operations of the Company.
The Company incurred acquisition related costs, including advisory, legal, valuation and other professional fees, of $4.1 million which were expensed in 2010.
Fiscal 2008 Acquisitions
Let It Wave
On June 12, 2008, the Company completed the acquisition of Let It Wave, a fabless development-stage semiconductor company based in Paris, France. Under the terms of the acquisition agreement, the Company acquired Let It Wave in an all-cash transaction valued at $24.0 million, including approximately $650,000 of transaction costs. The Company also agreed to make contingent payments up to $4.5 million in additional
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
consideration, subject to the completion of certain milestones as well as continuous employment. The milestones were not achieved and thus there were no payments in relation to the milestones. All contingent payments have been completed as of December 31, 2010.
The primary purpose of the acquisition was to obtain Let It Waves in-process development of a video frame rate conversion and image enhancement technology for flat panel televisions and other consumer electronics. By acquiring Let It Wave, the Company intends to deliver high performance image processing that enables artifact-free true-Motion Compensated Frame Rate Conversion (MCFRC) for flat panel televisions and other video consumer electronics products. Let It Wave currently has no other products, revenues or a customer base. The development of the in process technology was completed in the second quarter of 2009 as anticipated and the technology is being marketed for 120Hz LCD televisions within the Consumer group. The Company accounted for this transaction as an asset acquisition. The results of operations of Let It Wave have been included in the consolidated financial statements from the date of acquisition.
Allocation of the purchase price was as follows (in thousands):
Net assets acquired were recorded at net book value, which approximates their fair values. The purchase price in excess of the fair values of net assets acquired was allocated to in-process research and development and assembled workforce based on the relative fair values.
The in-process research and development had not yet reached technological feasibility and had no alternative future use. Accordingly the amount allocated to in-process research and development was immediately expensed upon the acquisition date. The value of in-process research and development was determined using the multi-period excess earnings method by estimating the expected net cash flows from the projects once commercially viable, discounting the net cash flows back to their present value using a discount rate of 15%. This rate was based on the industry segment for the technology, nature of the products to be developed, relative risk of successful development, time-value of money, length of time to complete the project and overall maturity and history of the development team. As of December 31, 2010, there have been no material variations from the underlying assumptions that were used in the original computation of the value of the acquired entity.
NOTE 3BALANCE SHEET COMPONENTS (in thousands)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
NOTE 4MARKETABLE SECURITIES
The Companys portfolio of available for sale securities as of December 31, 2010 was as follows (in thousands):
The Companys portfolio of available for sale securities as of December 31, 2009 was as follows (in thousands):
The following table summarizes the maturities of the Companys fixed income securities as of December 31, 2010 (in thousands):
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table summarizes the maturities of the Companys fixed income securities as of December 31, 2009 (in thousands):
In October 2008, the Company accepted an offer (the UBS Offer) from UBS AG (UBS), one of its investment managers. Under the UBS Offer, UBS issued to the Company Series C-2 Auction Rate Securities Rights (ARS Rights) that entitle the Company to sell its eligible ARS to UBS affiliates during the period from June 30, 2010 to July 2, 2012 for a price equal to par value. In exchange for the issuance of the ARS Rights, the UBS affiliates have the discretionary right to sell the Companys eligible ARS on the Companys behalf, without prior notification, at any time during a two-year period beginning June 30, 2010.
In connection with its acceptance of the UBS Offer during the fourth quarter of 2008, the Company transferred its ARS from investments available-for-sale to trading securities. The transfer to trading securities reflects managements intent to exercise its ARS Rights on June 30, 2010 and as a result has classified these ARS as short-term investments. Prior to its agreement with UBS, the Company classified the related ARS as investments available-for-sale.
On July 1, 2010, the Company exercised its right and redeemed its entire ARS at par value.
The following table shows the fair value of investments in available for sale securities that have been in an unrealized loss position for less than 12 months or for 12 months or longer as of December 31, 2010 (in thousands):
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The table below shows the fair value of investments in available for sale securities that have been in an unrealized loss position for less than 12 months or for 12 months or longer as of December 31, 2009 (in thousands):
Interest income on cash and marketable securities was $6.7 million, $9.4 million and $13.8 million for the years ended December 31, 2010, 2009, and 2008, respectively.
The Companys investment policy focuses on three objectives: to preserve capital, to meet liquidity requirements and to maximize total return. The Companys investment policy establishes minimum ratings for each classification of investment and investment concentration is limited in order to minimize risk, and the policy also limits the final maturity on any investment and the overall duration of the portfolio. Given the overall market conditions, the Company regularly reviews its investment portfolio to ensure adherence to its investment policy and to monitor individual investments for risk analysis and proper valuation.
The Company holds its marketable securities as trading and available-for-sale and marks them to market. The Company expects to realize the full value of all its marketable securities upon maturity or sale, as the Company has the intent and believes it has the ability to hold the securities until the full value is realized. However, the Company cannot provide any assurance that its invested cash, cash equivalents and marketable securities will not be impacted by adverse conditions in the financial markets, which may require the Company to record an impairment charge that could adversely impact its financial results.
NOTE 5FAIR VALUE
When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and it considers assumptions that market participants would use when pricing the asset or liability.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The Company had no assets or liabilities utilizing Level 3 inputs as of December 31, 2010 and had utilized Level 3 inputs for the Auction Rate Securities (ARS) held as of December 31, 2009.
The following table represents the Companys fair value hierarchy for its financial assets (investments) measured at fair value on a recurring basis as of December 31, 2010 (in thousands):