Zoran 10-Q 2008
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2008
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 0-27246
(Exact name of registrant as specified in its charter)
1390 Kifer Road
Sunnyvale, California 94086
(Address of principal executive offices, including zip code)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See 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 o No x
As of November 5, 2008, there were outstanding 51,167,158 shares of the registrants Common Stock, par value $0.001 per share.
For the Quarter Ended September 30, 2008
(in thousands, except share data)
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
(in thousands, except per share data)
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of Zoran Corporation and its subsidiaries (Zoran or Company) have been prepared in conformity with accounting principles generally accepted in the United States of America. However, certain information or footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). In the opinion of management, the condensed consolidated financial statements reflect all necessary adjustments, consisting only of normal recurring adjustments, for a fair statement of the consolidated financial position, operating results and cash flows for the periods presented. The results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for the full fiscal year or in any future period. This Quarterly Report on Form 10-Q should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2007, included in the Companys 2007 Annual Report on Form 10-K filed with the SEC.
On January 25, 2006, the Company entered into an agreement with MediaTek to settle patent litigation between the companies. In consideration for licenses granted by Zoran, MediaTek agreed to pay Zoran $55.0 million, of which $44.0 million was paid in February 2006 and $11.0 million was paid in April 2006. These two payments, net of amounts attributable to a holder of rights under patents involved in the litigation, and amounts payable as legal fees, were recognized as license revenues related to litigation settlement. MediaTek was required to pay quarterly royalties totaling $30.0 million over a 30-month period that commenced on the date of the agreement based on future sales of covered MediaTek products. These royalty payments, net of amounts payable by Zoran to a holder of rights under patents involved in the litigation, and amounts payable as legal fees, are recognized as software and other revenues as they are received.
2. Stock-based Compensation
Stock Option Plans
As of September 30, 2008, the Company had outstanding options for the purchase of 8,816,109 shares of common stock held by employees and directors under the Companys 2005 Equity Incentive Plan (the 2005 Plan), 2005 Outside Directors Equity Plan, 2000 Nonstatutory Stock Option Plan, 1995 Outside Directors Stock Option Plan, 1993 Stock Option Plan and other various plans the Company assumed as a result of acquisitions. As of September 30, 2008, an aggregate of 3,697,701 shares remained available for future grants and awards. Options and stock appreciation rights granted under the 2005 Plan must have exercise prices per share not less than the fair market value of Zoran common stock on the date of grant and may not be repriced without stockholder approval. Such awards will vest and become exercisable upon conditions established by the Compensation Committee and may not have a term exceeding 10 years.
The following table summarizes stock-based compensation expense related to employee stock options, employee stock purchases and restricted stock unit grants for the three and nine month periods ended September 30, 2008 and 2007 as recorded in accordance with SFAS 123(R) (revised 2004), Share-Based Payment (SFAS 123(R)) (in thousands):
The income tax benefit for share-based compensation expense was $335,000 and $1,164,000 for the three and nine month periods ended September 30, 2008. The Company recognized no tax benefit during the three and nine month periods ended September 30, 2007 due to the Companys full valuation on its deferred tax assets, which was released in December 2007.
The Company estimates the fair value of stock options using the Black-Scholes valuation model with the following assumptions:
Expected Term: The expected term represents the period that the Companys stock-based awards are expected to be outstanding and was determined based on the Companys historical experience with similar awards, giving consideration to the contractual terms of the stock-based awards and vesting schedules.
Expected Volatility: The Company uses historical volatility in deriving its volatility assumption. Management believes that historical volatility appropriately reflects the markets expectations of future volatility.
Risk-Free Interest Rate: Management bases its assumptions regarding the risk-free interest rate on U.S. Treasury zero-coupon issues with an equivalent remaining term.
Expected Dividend: The Company has not paid and does not anticipate paying any dividends in the near future.
Stock Option Activity
The following is a summary of stock option activities:
Significant option groups outstanding as of September 30, 2008 and the related weighted average exercise price and contractual life information, are as follows:
Of the 8,816,109 stock options outstanding as of September 30, 2008, the Company estimates that 8,517,000 will fully vest over the remaining contractual term. As of September 30, 2008, these options had a weighted average remaining contractual life of 6.07 years, a weighted average exercise price of $17.45 and aggregate intrinsic value of $420,000.
The weighted average grant date fair value of options, as determined under SFAS No. 123(R), granted during the three and nine month periods ended September 30, 2008 was $4.22 and $7.23 per share, respectively. The weighted average grant date fair value of options, as determined under SFAS No. 123(R), granted during the three and nine month periods ended September 30, 2007 was $12.20 and $11.54 per share, respectively.
The aggregate intrinsic value in the table above represents the total pretax intrinsic value, based on the Companys closing stock price of $8.16 as of September 30, 2008, which would have been received by the option holders had all option holders exercised their options as of that date. The total number of shares of common stock underlying in-the-money options exercisable as of September 30, 2008 was 207,000. The total intrinsic value of options exercised during the three and nine month periods ended September 30, 2008 was $137,000 and $569,000 respectively. There was no excess tax benefit realized by the Company in 2008 and 2007 for option exercises due to the availability of non stock related net operating loss carry forwards which fully offset our taxable income.
As of September 30, 2008, the Company had $20,587,000 of unrecognized stock-based compensation cost related to stock options after estimated forfeitures, which are expected to be recognized over the weighted average remaining term of 2.75 years. The Company settles employee stock option exercises with newly issued common shares.
Restricted Shares and Restricted Stock Units
Restricted shares and restricted stock units are granted under the 2005 Plan. As of September 30, 2008, we had $199,000 of unrecognized stock-based compensation cost related to restricted shares and restricted stock units, which are expected to be recognized over the weighted average remaining term of 2.51 years.
The following is a summary of restricted shares and restricted stock units activities:
Employee Stock Purchase Plan
The Companys 1995 Employee Stock Purchase Plan (ESPP) was adopted by the Companys Board of Directors in October 1995 and approved by its stockholders in December 1995. The ESPP enables employees to purchase shares through payroll deductions at approximately 85% of the lesser of the fair value of common stock at the beginning of a 24-month offering period or the end of each six-month segment within such offering period. The ESPP is intended to qualify as an employee stock purchase plan under Section 423 of the U.S. Internal Revenue Code. There were no purchases during the quarter ended September 30, 2008. As of September 30, 2008, 1,825,874 shares were reserved and available for issuance under the ESPP.
Stock Repurchase Program
In March 2008, the Companys Board of Directors authorized a stock repurchase program under which the Company may repurchase up to $100.0 million of outstanding Zoran common stock. The Company repurchased 1,163,569 shares for $10.0 million under this program during the three and nine months ended September 30, 2008. As of September 30, 2008, the authorized amount that remains available under the Companys stock repurchase program was $90.0 million.
The Company retires all shares repurchased under the stock repurchase program. The purchase price for the repurchased shares of the Companys stock repurchased is reflected as a reduction of common stock and additional paid-in capital.
3. Comprehensive Income (Loss)
The following table presents the calculation of comprehensive income (loss) as required by SFAS 130 Reporting Comprehensive Income. The components of comprehensive income (loss), net of tax, are as follows (in thousands):
The accumulated other comprehensive income (loss) consists of unrealized gain (loss), net of tax, on marketable securities.
4. Marketable Securities
The Companys portfolio of marketable securities as of September 30, 2008 was as follows (in thousands):
The Companys portfolio of marketable securities as of December 31, 2007 was as follows (in thousands):
The following table summarizes the maturities of the Companys fixed income securities as of September 30, 2008 (in thousands):
*Comprised of auction rate securities which have reset dates of 90 days or less but final expiration dates over 5 years. These securities are included in other assets and long-term investments as of September 30, 2008. In October 2008, the Company accepted an offer (the UBS Offer) from UBS AG (UBS), one of its investment providers. As a UBS client who holds Auction Rate Securities (ARS), the Company will receive ARS Rights, which entitle the Company to sell 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. The Company also received communications from Wachovia Securities indicating that Wachovia will soon offer to purchase, no later than June 30, 2009, ARS held by the Company at par value. The Company currently holds $37.4 million of ARS with UBS and $20.4 million of ARS with Wachovia.
5. Fair Value
Effective January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements (SFAS 157). In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No. 157, which provides a one year deferral of the effective date of SFAS 157 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually. Therefore, the Company has adopted the provisions of SFAS 157 with respect to its financial assets and liabilities only. SFAS 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and enhances disclosures about fair value measurements. Fair value is defined under SFAS 157 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value under SFAS 157 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs that may be used to measure fair value, of which the first two are considered observable and the last unobservable:
· Level 1 - Quoted prices in active markets for identical assets or liabilities.
· Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
· Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The adoption of this statement did not have a material impact on the Companys consolidated results of operations and financial condition. In October 2008 the FASB Issued FASB Staff Position No. FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for that Asset is Not Active (FSP 157-3), to clarify the application of the provisions of SFAS 157 in an inactive market and how an entity would determine fair value in an inactive market. FSP 157-3 is effective immediately and applies to the Companys current quarter financial statements. The application of the provision of FSP 157-3 did not impact the Companys results of operations or financial condition as of and for the periods ended September 30, 2008.
Effective January 1, 2008, the Company adopted SFAS No. 159 The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS 159 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for specified financial assets and liabilities on a contract-by-contract basis. The Company did not elect to adopt the fair value option under this Statement.
In accordance with SFAS 157, the following table represents the Companys fair value hierarchy for its financial assets (cash equivalents and investments) measured at fair value on a recurring basis as of September 30, 2008 (in thousands):
The Companys Level 3 investments as of September 30, 2008 include high-grade auction rate securities primarily consisting of government guaranteed student loans. Auction rate securities are securities that are structured with short-term interest rates which periodically reset through auctions, typically within every 90 days. At the end of each reset period, investors can sell or continue to
hold the securities at par. During the current year, some of the auction rate securities were sold and others failed to auction successfully due to market supply exceeding market demand. In the event of a failed auction, the notes continue to bear interest at a predetermined maximum rate based on the credit rating of notes as determined by one or more nationally recognized statistical rating organizations. The funds associated with failed auctions will not be accessible until a successful auction occurs, a buyer is found outside of the auction process, the issuers redeem the securities or the underlying securities have matured. As a result, the Company has classified all auction rate securities as long-term assets at cost in the condensed consolidated balance sheets. In October 2008, the Company accepted an offer (the UBS Offer) from UBS AG (UBS), one of its investment providers. As a UBS client who holds Auction Rate Securities (ARS), the Company will receive ARS Rights, which entitle the Company to sell 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. The Company also received communications from Wachovia Securities indicating that Wachovia will soon offer to purchase, no later than June 30, 2009, ARS held by the Company at par value. The Company currently holds $37.4 million of ARS with UBS and $20.4 million of ARS with Wachovia.
Due to the current economic environment in which there is a lack of market activity for auction rate securities, the Company has been unable to obtain quoted prices or market prices for identical assets as of the measurement date resulting in significant unobservable inputs used in determining the fair value. The Company estimated the fair value of these auction rate securities using the income approach based on the following: (i) the underlying structure and contractual provisions of each security; (ii) the present value of future principal and interest payments discounted at rates considered to reflect current market conditions; and (iii) consideration of the probabilities of default, auction failure, or repurchase at par for each period. These estimated fair values could change significantly based on future market conditions, which could result in recognizing an other-than-temporary impairment loss.
The fair value indicated by this approach yielded a value that approximated the par value of the respective securities.
The reconciliation of beginning and ending balances for auction rate securities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the period was as follows (in thousands):
Inventories are stated at the lower of cost (first in, first out) or market and consisted of the following (in thousands):
7. Goodwill and Other Intangible Assets
The Company conducted its annual impairment test of goodwill as of September 30, 2008 in accordance with Statement of Financial Accounting Standard 142 (SFAS 142), Goodwill and Other Intangible Assets and SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Impairment is tested at the reporting unit level which is one level below the reportable segments. Potential goodwill impairment is measured based upon a two-step process. In the first step, the Company compares the fair value of a reporting unit with its carrying amount including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired, thus the second step of the impairment test is unnecessary. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of an impairment loss.
As a result of this test, the Company determined that the carrying amounts of its Consumer segment reporting units exceeded their fair values and recorded a goodwill impairment charge of approximately $164.5 million and an impairment charge for other intangibles of $3.1 million in the current quarter. The impairment charge was primarily due to a decrease in valuation based on a decline in the Companys business forecasts as a result of the current economic downturn as well as a decline in the Companys stock value over the last several months due to the current global financial crisis. The fair values of reporting units were estimated using the expected present value of future cash flows. The total of all reporting fair values was also compared to the Companys market capitalization plus a control premium for reasonableness.
Components of Acquired Intangible Assets (in thousands):
Estimated future intangible amortization expense, based on current balances, as of September 30, 2008 is as follows (in thousands):
Changes in the carrying amount of goodwill for the three and nine month periods ended September 30, 2008 are as follows (in thousands):
Goodwill by reportable segment was as follows (in thousands):
8. Income Taxes
The Company follows the liability method of accounting for income taxes, which requires recognition of deferred tax liabilities and assets for the expected future tax consequence of temporary differences between the financial statement carrying amounts and the tax 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, 2007, historical operating income and projected future profits represented sufficient positive evidence that the Companys deferred tax assets will more likely than not be realized and, accordingly, the valuation allowance was released.
The Companys effective tax rate is highly dependent upon the geographic distribution of our worldwide earnings or losses, the tax regulations and tax holiday benefits in certain jurisdictions, and the effectiveness of our tax planning strategies. The provision for income taxes for the three and nine month periods ended September 30, 2008 reflects the estimated annual tax rate applied to the year to date net earnings after the exclusion of a material foreign jurisdiction where the Company is unable to accurately project earnings for future periods. A separate tax calculation was done for that jurisdiction, which was included in the total provision for income taxes. In addition, due to a statute of limitations lapse the Company released approximately $1.0 million of its FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48) reserve and a provision to return adjustment of $1.0 million that were fully recognized in the period they occurred. 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 benefits from this tax holiday expire at various times beginning in 2008.
On January 1, 2007, the Company adopted FIN 48. Under FIN 48, the impact of an uncertain income tax position on income tax expense must be recognized at the amount that is more-likely-than-not of being sustained. As of December 31, 2007, the Company had $26.5 million of unrecognized tax benefits which have not materially changed during the current period. The application of income tax law is inherently complex. Laws and regulations in this area are voluminous and are often ambiguous and the Company is required to make many subjective assumptions and judgments regarding its income tax exposures. In addition, interpretations of and guidance surrounding income tax laws and regulations are subject to change over time. Any changes in our subjective assumptions and judgments could materially affect amounts recognized in the consolidated balance sheets and statements of income. The Companys ongoing tax audit in Israel may result in a positive or negative adjustment to the Companys unrecognized tax benefits within the next 12 months.
The Emergency Economic Stabilization Act of 2008, which contains the Tax Extenders and Alternative Minimum Tax Relief Act of 2008, was signed into law on October 3, 2008. Under the Act, the research credit was retroactively extended for amounts paid or incurred after December 31, 2007 and before January 1, 2010. The effects of the change in the tax law will be recognized in our fourth quarter, which is the quarter in which the law was enacted. The Company is currently in the process of analyzing the impact of the new law.
9. Segment Reporting
The Companys products are based on highly integrated application-specific integrated circuits, or ASICs, and system-on-a-chip, or SOC, solutions. The Company also licenses certain software and other intellectual property. The Company has two reportable segments Consumer group and Imaging group.
The Consumer group provides products for use in DVD players, recordable DVD players, standard and high definition digital television 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.
Information about reported segment income or loss is as follows for the three and nine month periods ended September 30, 2008 and 2007 (in thousands):
A reconciliation of the totals reported for the operating segments to the applicable line items in the condensed consolidated financial statements for the three and nine month periods ended September 30, 2008 and 2007 is as follows (in thousands):
Zoran maintains operations in Canada, China, France, Germany, India, Israel, Japan, Korea, Taiwan, the United Kingdom and United States. Activities in Israel and the United States consist of corporate administration, product development, logistics and worldwide sales management. Other foreign operations consist of sales, product development and technical support.
The geographic distribution of total revenues based upon customer location for the three and nine month periods ended September 30, 2008 and 2007 was as follows (in thousands):
For the three months ended September 30, 2008, two customers accounted for 16% and 11% of total revenues, respectively. For the same period in 2007, one customer accounted for 11% of total revenues. For the nine months ended September 30, 2008, three customers accounted for 13%, 10% and 10% of total revenues, respectively. For the same period in 2007, one customer accounted for 13% of total revenues.
As of September 30, 2008, one customer accounted for approximately 22% of total net accounts receivable and as of December 31, 2007 three customers accounted for approximately 11%, 11% and 10% of the net accounts receivable balance, respectively.
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 consideration, contingent upon completion of certain milestones, a portion of which is subject to continuous employment and will be expensed as incurred.
This acquisitions primary purpose was to obtain Let It Waves in-process development of a video frame rate conversion and image enhancement product 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 is at least six months from completing the development of its MCFRC product and currently has no other products, revenues or a customer base. Upon completion of a finished product, the Company expects to market this technology for 120Hz LCD televisions within the Consumer group.
The Company accounted for this transaction as an asset acquisition in accordance with Statement of Financial Accounting Standard 142 (SFAS 142), Goodwill and Other Intangible Assets and Emerging Issues Task Force No. 98-3 (EITF 98-3), Determining Whether a Nonmonetary Transaction Involves Receipt of Productive Assets or of a Business. The results of operations of Let It Wave have been included in the condensed consolidated financial statements from the date of acquisition.
Allocation of the purchase price is 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 has not yet reached technological feasibility and has 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. Revenues for the incremental core technology are expected to commence in 2009. Revenue projections were based on estimates of market size and growth, expected trends in technology and the expected timing of new product introductions. As of September 30, 2008, there have been no material variations from the underlying assumptions that were used in the original computation of the value of the acquired entity.
11. Net Income (Loss) Per Share
Basic net income (loss) per share is calculated by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is calculated by using the weighted average number of common shares outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the dilutive potential shares of common stock had been issued.
The following table provides a reconciliation of the components of the basic and diluted net income (loss) per share computations (in thousands, except per share data):
For the three month periods ended September 30, 2008 and 2007, outstanding options, restricted shares and restricted stock units totaling 8.6 million and 3.7 million shares, respectively, were excluded from the computation of diluted net income (loss) per share as the inclusion of such shares would have had an anti-dilutive effect.
For the nine month periods ended September 30, 2008 and 2007, outstanding options and restricted stock units totaling 6.8 million and 3.8 million shares, respectively, were excluded from the computation of diluted net income (loss) per share as the inclusion of such shares would have had an anti-dilutive effect.