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                          UNITED STATES SECURITIES AND
 
                              EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                            ------------------------
 
                                   FORM 10-K
 
           [X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                        SECURITIES EXCHANGE ACT OF 1934
 
                      FOR THE YEAR ENDED DECEMBER 31, 1998
                          COMMISSION FILE NO. 0-23596
                                       OR
 
         [ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                        SECURITIES EXCHANGE ACT OF 1934
 
  FOR THE TRANSITION PERIOD FROM                     TO                     .
 
                            C-CUBE MICROSYSTEMS INC.
             (Exact name of registrant as specified in its charter)
 
<TABLE>
<S>                                            <C>
                  DELAWARE                                      77-0192108
       (State or other jurisdiction of                       (I.R.S. Employer
       incorporation or organization)                       Identification No.)
</TABLE>
 
                            1778 MCCARTHY BOULEVARD
                           MILPITAS, CALIFORNIA 95035
             (Address and zip code of principal executive offices)
 
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<S>                                                   <C>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:   (408) 490-8000
 
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF
  THE ACT:                                            NONE
 
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF
  THE ACT:                                            COMMON STOCK, $0.001 PAR VALUE.
</TABLE>
 
     Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. [X] Yes     [ ] No
 
     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
form 10-K. [X]
 
     The aggregate market value of the Registrant's common stock held by
non-affiliates on March 1, 1999 (based upon the average of the high and low
sales prices of such stock as of such date) was $731,104,762.
 
     As of March 1, 1999, 38,927,375 shares of the Registrant's common stock
were outstanding.
 
     THE REGISTRANT'S DEFINITIVE PROXY STATEMENT FOR THE 1999 ANNUAL MEETING OF
STOCKHOLDERS (THE "PROXY STATEMENT") IS INCORPORATED BY REFERENCE IN PART III OF
THIS FORM 10-K TO THE EXTENT STATED HEREIN. EXCEPT WITH RESPECT TO INFORMATION
SPECIFICALLY INCORPORATED BY REFERENCE IN THIS FORM 10-K, THE PROXY STATEMENT IS
NOT DEEMED TO BE FILED AS A PART HEREOF.
 
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                            C-CUBE MICROSYSTEMS INC.
 
                                   FORM 10-K
                      FOR THE YEAR ENDED DECEMBER 31, 1998
 
                               TABLE OF CONTENTS
 
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                                   PART I
Item 1.    Business....................................................    1
Item 2.    Properties..................................................   17
Item 3.    Legal Proceedings...........................................   17
Item 4.    Submission of Matters to a Vote of Security Holders.........   18
  Executive Officers of the Registrant.................................   18
                                   PART II
Item 5.    Market for Registrant's Common Stock and Related Stockholder
           Matters.....................................................   20
Item 6.    Selected Financial Data.....................................   21
Item 7.    Management's Discussion and Analysis of Financial Condition
           and Results of
           Operations..................................................   23
Item 7A.   Quantitative and Qualitative Disclosure About Market Risk...   30
Item 8.    Financial Statements and Supplementary Data.................   31
Item 9.    Changes in and Disagreements with Accountants on Accounting
           and Financial
           Disclosure..................................................   51
                                  PART III
Item 10.   Directors and Executive Officers of C-Cube Microsystems
           Inc.........................................................   52
Item 11.   Executive Compensation......................................   52
Item 12.   Security Ownership of Certain Beneficial Owners and
           Management..................................................   52
Item 13.   Certain Relationships and Related Transactions..............   52
                                   PART IV
Item 14.   Exhibits, Financial Statement Schedules and Reports on Form
           8-K.........................................................   52
Exhibit Index..........................................................   53
Signatures.............................................................   56
</TABLE>
 
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     This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. The forward-looking statements involve risks and
uncertainties. Actual results could differ materially from those projected in
the forward-looking statements as a result of certain factors, including those
set forth in Item 1, those described elsewhere in this report and those
described in other reports under the Securities Exchange Act of 1934. Such
forward-looking statements include, but are not limited to, those statements
marked with an asterisk (*) in this report. The Company assumes no obligation to
update any forward-looking statements.
 
                                     PART I
 
ITEM 1. BUSINESS
 
     C-Cube Microsystems Inc. (referred to in this document as "C-Cube" or the
"Company"), was established as a California corporation in 1988 and
reincorporated in Delaware in 1994. C-Cube designs, manufactures and sells
semiconductors and systems for digital video applications. As a leading supplier
of semiconductors used for digital video applications, C-Cube's Semiconductor
division has played a major role in enabling the growth of digital video. This
division is focused on working with its OEM customers and service providers to
enable key applications in its consumer and communications target markets. In
the consumer market, it is focused on Video Compact Disc (VideoCD), playback and
recordable Digital Video Disc (DVD) and Digital VCR players. The communications
market targets interactive set-top boxes, broadcast encoders and emerging
appliances like non-linear editing, time shifting and internet TV boxes.
 
     In addition to its role as a leading supplier of semiconductors, C-Cube is
also a leading provider of digital video communication systems through its
DiviCom subsidiary. Acquired by C-Cube in 1996, DiviCom designs, manufactures
and sells a full spectrum of products and systems that enable the transmission
of digital video, audio and data over a variety of networks including satellite,
wireless, terrestrial, fiber and cable. With both systems and semiconductor
divisions focused on digital video applications, C-Cube is uniquely positioned
to support the continued growth of digital video in a number of important
consumer and communication markets.
 
     The Company's two reportable segments described above are C-Cube
Semiconductor and DiviCom. Management evaluates and allocates resources based on
profit or loss from operations before interest, income taxes and extraordinary
items. See "Item 8. Financial Statements and Supplementary Data" for segment
financial information.
 
  COMPRESSION ENABLES MASS-MARKET APPLICATIONS OF DIGITAL VIDEO
 
     Since the 1930s, video images have been transmitted and stored almost
exclusively using analog formats. Digital video provides several fundamental
benefits over analog video. Unlike analog video, digital video can be
compressed, providing significant storage and transmission efficiencies, and can
be transmitted and reproduced without perceptible image degradation. In the
1980s, the benefits of digital formats led the U.S. consumer audio industry to
convert from analog long-playing records to digital CDs, resulting in growth in
the market for CD players. In the 1990s, the ongoing evolution from analog to
digital is transforming the way in which video is produced, stored, transmitted
and viewed.
 
     Representing video in digital form requires a large amount of data, which
in the past has made storage or transmission economically impractical. To
transmit a single uncompressed digital video program requires a whole satellite
transponder costing as much as $2 million per year. The sheer size of
uncompressed digital video has relegated it to niche applications of small
volumes.
 
     However, the very nature of video information lends itself to compression.
Any video sequence has inherent redundancies, for example, one frame of a movie
often differs very little from the next successive frame. Through digital
compression techniques, the redundancies in video data can be detected and
eliminated, significantly reducing the overall amount of data needed to recreate
the original image without affecting the image quality. Using video compression
techniques, a single satellite transponder can broadcast
 
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8 to 12 programs instead of the single program possible with uncompressed video.
C-Cube believes that the design and deployment of cost-effective and practical
video compression technology is critical to the development of mass-market
applications.
 
  STANDARDS ENHANCE THE GROWTH OF DIGITAL VIDEO MARKETS
 
     As digital video markets develop, so does the need for standards to ensure
that products from different manufacturers use the same formats for video
information. Throughout its history, C-Cube has been an active participant and
respected technology pioneer on International Organization for Standardization
(ISO) committees charged with creating standards for still image and digital
video compression. In this effort, C-Cube believes that it has taken its place
beside industry leading companies such as AT&T, IBM, JVC, Matsushita Electronics
Corporation (MEC), NTT, Philips, Scientific Atlanta and Sony.
 
     Key standards that have driven the growth of digital video include the
Joint Photographic Experts Group (JPEG) standard for still-image compression and
two Moving Pictures Experts Group (MPEG) standards for digital video and audio
compression. The MPEG-1 standard enabled the first digital video consumer
products such as VideoCD, while the more recent MPEG-2 standard has become the
accepted compression format in diverse applications such as broadcast
transmission, professional editing and DVD. The adoption and acceptance of these
standards has contributed greatly to the growth of digital video markets during
the 1990s.
 
  ENCODING ALGORITHMS DETERMINE VIDEO QUALITY
 
     As vital as the ISO standards have been to the development of digital
video, they have a built-in limitation. The standards determine
interoperability, not video quality. More specifically, the standards define the
format for compressed video data. An MPEG-compliant encoder (the compression
device) will create data that an MPEG-compliant decoder (the decompression
device) can reconstruct into a video image. But the process of encoding
necessarily involves discarding some of the image information to achieve
compression. If the encoder is "smart," that is, if it can correctly determine
which information is redundant or insignificant to the video quality, then the
encoded video will be a faithful representation of the source video and the
decoder can create a high-quality video image. But if the encoder makes poor
choices and discards important video information, then the decoder cannot
compensate. The reconstructed image will be poor in comparison to the original
source image. Encoder design, therefore, is the most important determining
factor for video quality.
 
     At the heart of encoder design is the development of encoding algorithms,
the mathematical rules that govern how the large volume of uncompressed video is
reduced to a manageable size without adversely affecting image quality. C-Cube's
core strength has been its expertise in the development, testing and refinement
of compression algorithms. These mathematical formulas are proprietary and
represent vital intellectual property of C-Cube. By incorporating these highly
efficient and powerful algorithms into our products, C-Cube has consistently
been recognized as the industry leader in digital video encoding. As evidence of
this leadership, C-Cube products perform the encoding for the majority of
digital video television currently being broadcast. Also, C-Cube is one of a
select group of technology companies that have been recognized by The National
Academy of Television Arts and Sciences for technical achievement, as shown by
their award of a special technology Emmy to C-Cube in 1995.
 
     C-Cube differentiates its products from competitors by offering both
encoding and decoding solutions that provide superior image quality (enhancing
the viewing experience), are fully compliant with the MPEG-1 or MPEG-2
international standards (and therefore interoperable with equipment from other
suppliers), are feature rich and are highly integrated. All C-Cube products are
programmable, permitting the incorporation of sophisticated system-level
features, while lessening design time and system cost. C-Cube also develops
proprietary product extensions and features such as RealSonic(TM) home theater
sound enhancement and ClearView(TM) error correction technology.
 
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  THE SYSTEMS SIDE OF COMMUNICATIONS
 
     Cable operators, internet service providers and broadcasters face a growing
technical challenge as they plan and deploy real-time digital video transmission
systems. These next-generation systems incorporate new system and network
technologies that are often outside of the service provider's core competency.
To meet the often-conflicting goals of interoperability, reliability and
efficiency, nearly all new systems for broadcasting digital video implement new
standards such as MPEG-2 and Digital Video Broadcasting (DVB). In some cases,
companies that have previously provided proprietary analog-based solutions have
developed their own proprietary digital-based solutions (or created proprietary
solutions where there are no standards, such as conditional access).
Increasingly, companies that broadcast digital video realize that they need to
foster interoperability and competition among their equipment suppliers.
Accordingly, adherence to industry standards is a key requirement for suppliers
in this market.
 
     C-Cube's DiviCom division has benefited from this trend through its
experience in a range of digital video technologies, as well as expertise in
integrating those technologies into complete network systems. By combining video
compression technologies with network and communications technologies, DiviCom
creates innovative products for producers and distributors of video and
video-enhanced information. Products include MPEG audio/video encoders,
multiplexing and network management systems, as well as integration services.
Based on the MPEG-2 international standard, DiviCom's products enable digital
video broadcasting over a variety of broadband networks including satellite,
cable, wireless cable (also known as Multichannel Multipoint Distribution System
or MMDS) and telephone networks. In 1998, DiviCom announced its move into
high-definition television (HDTV) in a collaborative effort with Victor Company
of Japan (JVC) to develop HDTV encoders.
 
MARKET TRENDS
 
     C-Cube addresses two broad industries where digital video is used,
communications and consumer electronics. This section describes some of the
trends affecting these markets.
 
  COMMUNICATIONS
 
     Digital video compression is currently enabling a number of new
applications and capabilities in the communications market in diverse segments
such as satellite, cable, telephone and wireless networks.
 
     SATELLITE
 
     The first full-scale digital video transmission systems to achieve full
deployment were a series of Direct Broadcast Satellite (DBS) networks (also
called Direct To Home or DTH). By combining digital video compression technology
with high-power Ku-band satellites, DBS systems typically provide 100 or more
channels to a large geographical area (e.g. the continental U.S.). This expanded
service usually imposes a relatively low cost per subscriber since the only
incremental investment needed by subscribers is the purchase of a small dish and
a decoder box.
 
     To compete with other high-speed media, satellite service providers are
beginning DBS deployments using high-speed satellite transmission to the home. A
disadvantage of this approach is that the return channel uses a standard modem
over telephone lines, thus limiting the interactive nature of the service.
 
     A major trend in this market during 1998 was consolidation through a number
of mergers and acquisitions, for example, the merger of DIRECTV and USSB
operations.* At the same time, the satellite market saw the first trials of HDTV
broadcasting during 1998.
 
     CABLE
 
     Cable providers are upgrading the level of their services using a variety
of approaches including switched digital video, fiber-to-the-curb (FTTC) and
hybrid-fiber cable (HFC). Open standards are expected to drive increased cable
revenue opportunities by creating a competitive marketplace for system network
equipment and end-terminal devices.* With real-time, two-way networks and
advanced set-top systems, the revenue base
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for cable operators is expected to expand from the current base of subscribers,
programmers and advertisers to encompass a new client class of retail, utility
and digital appliance service providers.*
 
     TELEPHONE NETWORKS
 
     Providers of telephone service such as the Regional Bell Operating
Companies (RBOCs) are deploying high-speed service over existing twisted-pair
lines using Digital Subscriber Line (DSL) technologies such as Asymmetric DSL
(ADSL). These network infrastructures are being put in place and enhanced
services over these networks are expected to increase in 1999.* Services using
the existing telephone infrastructure have a strong potential for two-way
applications such as e-commerce and interactive games.
 
     WIRELESS CABLE
 
     MMDS is a local "line-of-sight" broadcast system, which broadcasts video
over relatively short distances from a stationary ground-based antenna. Small
receiving antennas are placed in each subscriber's home to receive the
transmissions. Such systems are initially being deployed in areas where there
may not be an existing cable system, or as an alternative to existing cable
services in high-density urban centers. Wireless cable systems have
comparatively low fixed costs and a moderate cost per home. The advantages of
MMDS over DBS include the support of local content and quick infrastructure
set-up.
 
     CONSUMER ELECTRONICS
 
     Through the use of MPEG compression, video can be stored, reproduced and
distributed on the same media currently in use for other types of digital data,
such as 5-inch (12 cm) CDs that are commonly used for digital audio. Emerging
applications for digital video capture, playback and distribution at the
consumer level are being advanced by the rapid adoption of new consumer-oriented
media formats such as VideoCD players, DVD players, recordable DVD and consumer
digital video cameras and camcorders.
 
     RECORDABLE DIGITAL VIDEO DISC
 
     In 1998, several OEMs demonstrated consumer-oriented products positioned as
VCR replacements. C-Cube believes that rapid growth in this market will occur
only when single-chip codecs (encoder/decoder combination) reach a low enough
price point to enable a recordable unit at prices that will support a mass
market. Once this milestone is achieved, however, the potential for wide
consumer acceptance of a digital, disc-based VCR replacement is expected to be
high.* Key advantages of disc-based recording include higher video quality of
digital versus analog recording, the convenience of discs over tape, and the
ability to integrate the VCR recording function with other desirable consumer
features such as IntelligentTV program recording, timeshifting of programs and
DVD playback.
 
     DVD PLAYER
 
     Unlike the VideoCD standard, which is an adaptation of the audio CD, the
DVD standard was defined specifically for the very high-quality playback of
feature-length movies. The DVD format, now commercially available, provides up
to 135 minutes of playing time (270 for double-sided) on a disc the same
physical size as an audio CD with four times the image resolution of a standard
VideoCD. DVD uses MPEG-2 compression technology for video and audio.
 
     VIDEOCD PLAYER
 
     A VideoCD player is essentially an audio CD player with an MPEG-1 decoder
and a video output. While adding this functionality marginally increases the
cost to manufacture a typical CD player, these machines now have the ability to
play movies, music videos and other titles from MPEG-1 encoded CDs. The physical
VideoCD disc format is identical to a standard audio CD and is limited to 72
minutes playing time with video quality that is generally perceived as
comparable to an analog VHS tape. Several thousand VideoCD titles are now
available, including movies, music videos and karaoke titles. The VideoCD format
has thus far received mass-market adoption exclusively in China. In 1998,
leading Chinese manufacturers and the Chinese
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government introduced an enhanced version of VideoCD known as Chaoji VCD. Chaoji
VCD features improved video quality that is comparable to DVD video and backward
compatibility with VideoCD titles.
 
     DVD PLAYBACK FOR PERSONAL COMPUTERS
 
     Computer makers and users are increasingly embracing digital video as the
most flexible and feature-rich data type for educational, entertainment,
communication and training applications. DVD-ROMs offer significant speed and
capacity advantages over CD-ROMs and are experiencing rapid adoption rates. In
addition, computers are the primary platform for video editing and video
encoding through the addition of dedicated video-specific hardware.
 
     PC OEMs are now offering add-in DVD decoder cards bundled with DVD-ROM
drives as options for their desktop models. These allow the playback of full
motion video with Dolby surround sound. Some OEMs, such as C-Cube's customer
Dell, have begun bundling the DVD-ROM and decoder cards as part of its build-
to-order system offerings. DVD decoder cards offer advantages versus
software-decoders such as TV-out, full Dolby Digital surround sound and the
ability to use the computer for other tasks while a DVD video is being played.
 
     New portable PC models are also being designed as DVD-ready, and some,
including the Toshiba Portege, are featuring the DVD decoder built right onto
the motherboard. This allows the playback of full motion video from DVD discs
while maximizing battery life.
 
     DESKTOP EDITING SYSTEMS
 
     The capabilities of desktop editing systems continue to grow. Sophisticated
features such as non-linear editing, once the province of professional studios,
are now coming to the consumer and prosumer markets. An important enabling
factor is the availability of low-cost recordable CD-ROM drives, which provide a
convenient and cost-effective means to store edited digital video. This trend is
expected to accelerate in 1999, as the higher capacity recordable DVD drives
become more common in personal computers.*
 
PRODUCTS
 
     C-Cube supplies products for three main markets:
 
     - Communication systems
 
     - Communication semiconductors
 
     - Consumer electronics semiconductors
 
  COMMUNICATION SYSTEMS
 
     C-Cube provides communication systems through its DiviCom division. DiviCom
applies its unique compression algorithms and techniques to obtain optimal
performance from its family of MPEG-2/DVB system-level products. Furthermore,
DiviCom makes extensive use of C-Cube Semiconductor's products and support to
design leading-edge products for the markets it services. DiviCom supplements
its product offerings with complementary services including systems integration,
consulting, training and technical support.
 
     The DiviCom product line consists of:
 
     - Program encoders
 
     - Multiplexers
 
     - Control and automation products
 
     - Data networking products
 
     - Professional services and customer support
 
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     PROGRAM ENCODERS
 
     The workhorses of a digital video broadcast facility continue to be the
program encoders. DiviCom had its initial successes in supplying high-quality,
reliable program encoders, and this market continues to be both strategic and
profitable for the Company. The MediaView(TM) line of program encoders provides
MPEG-2 compression of video, audio and data channels. Using sophisticated signal
pre-processing, noise reduction and encoding algorithms, these encoders produce
high-quality video and audio at low data rates. Their compliance with MPEG-2 and
DVB standards enables interoperability with other products and systems.
 
     Introduced in February 1998, the MediaView MV40 encoder extends the
capabilities of the MediaView family by offering more channels and better video
quality. Based on C-Cube Semiconductor's DVxpert(TM) products, the MV40 encoder
was designed to optimize transmission bandwidth for broadcasters, satellite
operators, cable providers, wireless cable operators and telecommunication
services providers. The key to the MV40's performance is DiviTrack(TM), an
innovative look-ahead feature that has two DVxpert processors working together.
While one DVxpert processor is encoding data, the second is looking several
frames ahead in the video stream, analyzing the data and determining the optimum
parameters for the first DVxpert processor to use. This one-two combination
yields highly effective use of transmission bandwidth while maintaining superior
video quality. In recognition of the MV40's advance in technology, the National
Association of Broadcasters (NAB) named it "Editor's Pick" at the 1998 NAB show.
 
     MULTIPLEXERS
 
     In a broadcast facility, the video, audio and data streams must be combined
or multiplexed into a single stream prior to transmission. DiviCom's
MediaNode(TM) MN20 Remultiplexer performs this task, combining MPEG-2 compressed
streams from various sources into a single MPEG-2 transport stream. Sources are
DiviCom program encoders or third-party devices such as Near Video-On-Demand
(NVOD) servers. The MN20 Remultiplexer is especially designed for flexible
distribution to all types of networks including satellite, cable, wireless cable
and telephone networks. The MN20 Remultiplexer also provides scrambling and
monitoring/decoding capabilities.
 
     CONTROL AND AUTOMATION PRODUCTS
 
     Modern digital networks are a diverse array of hardware and software
components from a variety of vendors, using a number of network protocols and
standards. Network management is the glue that holds it all together, the tool
that lets service providers monitor and control their networks.
 
     Because of its special expertise in digital video, audio and data, DiviCom
is uniquely qualified to help service providers with the network management side
of their operations as well. The THESYS(TM) Network Management Family includes a
full range of products that service providers can adapt and configure to meet
the needs of their deployments. The THESYS Family includes these individual
products:
 
     - THESYS Controller(TM) Solution: Allows network operators to configure and
       manage a digital video network
 
     - Sentinel(TM) System Monitor: Remote configuration, monitoring, alarm
       control and bandwidth validation
 
     - THESYS Alarm Manager(TM) Solution: Advanced features for fault isolation
       and alarm logging
 
     - Bandwidth Manager(TM) Solution: Analyzes network traffic and provides
       visual monitoring tools
 
     DATA NETWORKING PRODUCTS
 
     Cable service providers look to add interactive services to their service
offerings as a way to increase revenues with the existing infrastructure. To
enable this market, DiviCom used the International Broadcasting Conference (IBC)
in Amsterdam in September 1998 to introduce the InterSect(TM) interactive
set-top box controller. The InterSect controller enables cable service providers
to deliver Transmission Control Protocol (TCP)/Internet Protocol (IP) traffic
(the same format used on the internet) to their subscribers over two-
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way HFC networks. Each InterSect controller can support thousands of individual
set-top boxes and can be managed from a central facility or distributed
locations using standard internet network management protocols.
 
     DiviCom also addresses similar needs in the satellite broadcasting market
with its DiviCast(TM) data broadcast system. The DiviCast system enables IP
transmission over MPEG-2 networks. With DiviCast, service providers can increase
revenue by offering their subscribers high-speed data services such as "push"
information broadcasts, multimedia streaming and internet access. DiviCom
introduced the DiviCast system in a joint demonstration with Adaptec, Inc. at
the NAB show in April 1998.
 
     PROFESSIONAL SERVICES AND CUSTOMER SUPPORT
 
     To set up and operate a digital network, service providers often need more
than products, they need systems expertise. To help service providers set up new
services and integrate new features with existing services, DiviCom's
DiviSys(TM) technology integration group provides consulting and implementation
services to DiviCom customers worldwide. DiviSys draws upon its expertise in
broadcasting television, communications networking and compression technology to
design, integrate and install complete business solutions. DiviSys offers a
broad range of services including program management, budget analysis, technical
design and planning, parts inventory management, building and site preparation,
equipment installation and integration, end-to-end system testing and
comprehensive customer training.
 
     The DiviSys group also has extensive experience in integrating DiviCom
products with numerous third-party products and services. This includes the
procurement and integration of encoders, multiplexers, system/ network
controllers, ATM and TCP/IP network equipment, NVOD servers, modulators,
transmitters, antennas, downlink systems, satellite dishes/IRDs, subscriber
management systems, conditional access systems for pay-per-view, electronic
program guides and diagnostics/quality assurance tools.
 
     For technical support, service providers turn to DiviTec(TM), DiviCom's
customer service and support organization. The DiviTec Service Agreement
provides a customized set of services for ongoing maintenance, support-on-demand
and customer training. This service is designed to meet each customer's specific
needs in order to maximize the benefits they receive from DiviCom's products and
systems.
 
  COMMUNICATION SEMICONDUCTORS
 
     In most digital video applications, the encoding and decoding functions are
separated. For example, in broadcasting, the video is encoded by one or a small
number of encoders at the transmission facility, while a decoder at the viewer's
home reconstructs the broadcast for viewing. C-Cube has been, and continues to
be, a leader in supplying both encoders and decoders for a full spectrum of
digital video applications. However, C-Cube has long recognized that combining
the encoding and decoding functions into one processor, called a codec (for
encoder/decoder), would create significant new market opportunities. The Company
invested heavily in the development of a single-chip MPEG-2 codec architecture
and introduced DVxpert, the first product based on the new architecture, in
August 1997. C-Cube introduced two more codecs in 1998: DVxpress(TM), for
professional and prosumer editing applications, and DVxplore(TM), for recordable
digital video applications in consumer electronics. These new codecs have the
potential to further stimulate the digital video industry to offer significant
new products incorporating real-time MPEG-2 encoding.
 
     BROADCAST AND DISTRIBUTION ENCODERS
 
     In August 1997, C-Cube unveiled the DVxpert encoder family, the first
products based on C-Cube's new codec architecture. Encoders in the DVxpert
family offer improved image quality, efficient bandwidth utilization and
reliability for broadcasting and professional applications. The DVxpert
broadcast encoders target applications such as distribution, contribution, DVD
authoring and video servers. All DVxpert encoders use C-Cube's patented
PerfectView(TM) feature, which provides clear image quality with advanced
capabilities such as pre-filtering, error masking and inverse telecine.
 
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     An emerging trend in broadcasting is electronic news gathering, in which a
news crew captures video using a digital camcorder and transmits the video
directly from the field location to the studio. Since the video is usually
captured in a professional Digital Video (DV) format, it must be transcoded into
MPEG for transmission and editing. C-Cube's DVxpress-MX(TM) products were the
only single-chip solutions available in 1998 for this application.
 
     ENCODERS FOR EDITING APPLICATIONS
 
     Professional non-linear editing had been primarily the province of
motion-JPEG products due to the need for accurate cuts and special effects.
Because MPEG encoders essentially "collapse" some frames to achieve high levels
of compression, industry pundits doubted whether MPEG could ever achieve the
accuracy needed to supplant motion-JPEG for professional needs. However, C-Cube
showed that MPEG is a viable format for editing with the introduction of the
DVxpress codecs in April 1998. Based on the same architecture as the DVxpert
product, the DVxpress codecs feature C-Cube's proprietary Frame-Accurate MPEG
Editing (FAME(TM)) algorithm and dual-stream decoding, two capabilities for
professional non-linear editing.
 
     September 1998 saw a significant enhancement to C-Cube's non-linear editing
products with the introduction of the DVxpress-MX single-chip mixed-format
codecs. DVxpress-MX codecs can support both MPEG and DV video formats to allow
mixed-format editing where, for example, an MPEG stream and a DV stream are
edited together. This innovation is particularly important because DV is the
most popular format for consumer and professional digital camcorders, while MPEG
is the prevailing standard for transmission. Panasonic, the developer of the DV
format, and Avid, a leading non-linear editing OEM, both endorsed the
DVxpress-MX codec as a significant step toward unifying the MPEG and DV worlds.
 
     INTERACTIVE SET-TOP BOX DECODERS
 
     The primary communication application for MPEG-2 decoders is in the set-top
box market. To reconstruct the compressed broadcast program, several steps are
required. First, the MPEG-2 stream must be separated or demultiplexed into its
video and audio portions. Then the video and audio must be decompressed.
Finally, the video signal is combined with other on-screen information, such as
program guides and displayed on a monitor.
 
     C-Cube has been a technology leader in this arena, starting with the
introduction of the CL9100 MPEG-2 video decoder in 1994. The Company followed in
1995 by bringing to market the CL9110 Transport Demultiplexer which was licensed
from DiviCom, then a private company. Together, this two-chip combination
performed all the functions needed for digital video decoding and was
instrumental in enabling first-generation designs for digital set-top boxes.
 
     1996 saw the introduction of the AViA(TM) family of set-top box integrated
circuits. Building on the technology and market success of the CL9110 and CL9110
products, the AViA platform offered high-performance graphics, better quality
audio (Dolby AC-3), interoperability across both wired and wireless networks and
a tighter integration between the individual chips. By offering both high-end
and basic versions, the AViA family allowed OEMs to target their designs for the
needs of each deployment in terms of capabilities and price point.
 
     Recognizing the trends toward the convergence of digital broadcast,
internet access, interactivity and advanced graphics, C-Cube introduced the
AViA@TV(TM) platform in November 1998. Using AViA@TV products, service providers
can develop additional revenue-generating features and services such as
continuous two-way data exchange, advanced graphical user interfaces,
interactive advertising and internet services such as e-mail on TV, home banking
and on-line shopping. The AViA@TV line includes C-Cube's integrated
FlickerFilter, which dramatically improves the visual quality of HyperText
Markup Language (HTML) text displayed over video, an important feature for
interactive applications. AViA@TV provides Media Access Control (MAC) for
two-way network support so cable providers can deliver the interactive
multimedia applications needed for next-generation services. AViA@TV
multi-planar graphics enable the development of rich graphical user interfaces.
 
                                        8
<PAGE>   11
 
     An important endorsement came when Pace Micro Technology, a leading
European OEM, selected the AViA@TV architecture for its new set-top box design.
The Pace set-tops are targeted for a new interactive service being developed by
NTL, the UK's leading integrated communications company, which plans to offer
interactive data services such as web browsing, e-mail, chat, pay-per-view,
games and home shopping.
 
  CONSUMER ELECTRONICS SEMICONDUCTORS
 
     RECORDABLE DIGITAL VIDEO
 
     While DVD playback has achieved some level of success in both consumer
players and personal computer applications, C-Cube believes that the high-volume
applications of digital video in the consumer world depend on the ability to
both record and play back DVD-quality video. Thus, C-Cube extended its DVxpert
technology to the consumer world with its November 1998 introduction of the
DVxplore line of consumer codecs. DVxplore codecs are the world's first
single-chip consumer products to support both MPEG and DV formats. The initial
focus is on the personal computer market, where OEMs will use DVxplore codecs to
offer personal content creation, PC/TV and DVD-RAM applications. Users of these
products will be able to record hours of DVD-quality video obtained from any
video source, whether TV, VCR, DV camcorder or analog camcorder. Once they have
recorded the video, they will be able to edit and play back the video on
standard PCs and store the resulting video to DVD disc, web pages, e-mail,
recordable CD or PC hard-disk drives.
 
     In addition to the personal computer applications of the DVxplore
architecture, C-Cube believes that substantial opportunity exists for
stand-alone home entertainment players which could potentially replace the video
cassette recorder (VCR) in many home applications.* As OEMs begin to develop
these applications, C-Cube plans to work with its partners and customers to
adapt the DVxplore technology to these markets.
 
     VIDEOCD DECODERS
 
     VideoCD is a consumer entertainment format based on MPEG-1 technology.
VideoCD players allow consumers to enjoy movies, documentaries and karaoke
played from a disc similar to an audio CD disc. C-Cube has been a leading
supplier of MPEG decoders used in VideoCD players throughout the mid- and
late-1990s. The Company pioneered the MPEG-1 market with the introduction in
1992 of the CL450 MPEG-1 Video Decoder, the first commercially available MPEG-1
video decoder. The CL450 found uses in commercial and professional digital
karaoke players. It followed with the CL480 family of VideoCD decoders, products
that boosted C-Cube to market leadership in the rapidly growing market for
VideoCD players in China in the mid-1990s. The CL484 VideoCD Decoder, debuted in
1994, offers full VideoCD 1.1 and 2.0 compliance, DiscView(TM) menuing,
ClearView(TM) error concealment technology, FlexView(TM) National Television
Standards Committee (NTSC) to Phase Alternate Line (PAL) conversion and
additional karaoke features.
 
     C-Cube's flagship VideoCD product in 1998 was the CL680 Advanced VideoCD
Decoder. Introduced in 1996, the CL680 decoder is fully compliant with the CL484
decoder, allowing OEMs a convenient migration path for existing CL484-based
designs. The CL680 decoder integrates an NTSC/PAL encoder, improved ClearView
error concealment technology and a new WideSound(TM) feature, which simulates a
surround-sound experience from two stereo channels.
 
     CHAOJI VCD DECODERS
 
     As the VideoCD market matured in China, Chinese customers, OEMs and
government agencies all saw a need for a higher quality video experience. Due to
its expertise in both VideoCD and DVD, C-Cube was well qualified to help define
the new standard. The result of this effort was the introduction in 1998 of the
Chaoji VCD standard, an extension to VideoCD that was endorsed by the Chinese
government and leading OEMs. Chaoji VCD combines MPEG-2 video with VideoCD 2.0
to address the needs of China's consumers for high-quality video playback,
improved audio quality and low-cost players and disc media.
 
                                        9
<PAGE>   12
 
     Soon after the adoption of the Chaoji VCD standard, C-Cube introduced the
CL8800 family of Chaoji VCD decoders to its partner OEMs. The CL8830 decoder is
a full-featured product that features C-Cube's patented RealSonic(TM) audio
technology, offering significant advances in audio quality for home theater and
Karaoke applications. The CL8820 decoder targets more price-sensitive products
that do not demand the same audio quality as the CL8830 decoder. Both decoders
offer full backward compatibility with existing VideoCD and audio CD formats.
Leading Chinese OEMs have adopted the CL8800 decoders for their Chaoji VCD
product offerings.
 
     DVD DECODERS
 
     In 1997, C-Cube introduced the ZiVA(TM) family of DVD products, including
decoders and system-level design solutions for consumer and multimedia OEMs. The
ZiVA DVD decoder family incorporates eight critical DVD functions into a single
chip: MPEG-2 video decoding, Dolby Digital decoding, MPEG audio decoding,
sub-picture decoding, on-screen display, linear Pulse Code Modulation (PCM)
audio decoding, demultiplexing and audio/video synchronization. Later the same
year, C-Cube addressed a critical concern of content owners with SecureView(TM)
copy protection and decryption technology. SecureView made ZiVA decoders the
first single-chip products to support the DVD Consortium's Content Scramble
System (CSS) copy protection scheme. The adoption of ZiVA decoders continued to
grow in 1998, with consumer electronics OEMs such as Sony, LG Electronics,
Tatung, Hitachi and Acer all publicly announcing products using the ZiVA
decoder.
 
     Another application for DVD playback is the personal computer market.
C-Cube collaborated closely with partner Toshiba to develop a new version of the
ZiVA decoder targeted specifically at the notebook market. The result was the
introduction in May 1998 of the ZiVA-PC(TM) decoder, the first DVD hardware chip
with full PC98 compliance. The ZiVA-PC decoder offers the industry's lowest
overall system cost for hardware DVD playback, as well as the lowest power
consumption, while delivering true interactivity and flawless image quality.
Personal computer OEMs including Toshiba and Gateway adopted ZiVA decoders for
new DVD-enabled notebook designs.
 
     As 1998 drew to a close, C-Cube was readying its third-generation DVD
decoder, the ZiVA-3 line, for an early 1999 introduction at the Consumer
Electronics Show. Leading OEMs such as JVC, Samsung and LG Electronics had
already adopted the ZiVA-3 part for upcoming player designs. ZiVA-3 extended the
capabilities of the ZiVA line in a number of key areas, most particularly the
audio features.
 
     CONSUMER BRANDING PROGRAM
 
     C-Cube's consumer branding program, begun in 1996, saw continued success
throughout 1998. Many of the major VideoCD manufacturers located in C-Cube's
largest markets chose C-Cube's VideoCD decoder technology to use in their new
lines of VideoCD players. This trend continued with the introduction of the
Chaoji VCD format in China during 1998, as OEMs who had used C-Cube's VideoCD
decoders also chose C-Cube's Chaoji VCD decoders. The success of C-Cube's
consumer branding program is predicated on offering first-to-market technology,
superior feature sets and video playback quality and a roadmap to higher
quality, feature-rich digital video products.
 
     CHANGING PRODUCT MIX: DEPENDENCE ON DECODER PRODUCTS
 
     C-Cube offers a number of products for a variety of applications. However,
beginning in the second quarter of 1995, sales of C-Cube's VideoCD decoder
family of products have represented a significant percentage of the Company's
total net revenues. The Company expects that revenues from its VideoCD decoder
products including the CL680 and Chaoji VCD families of products will decrease
as a percentage of total revenues, but continue to account for a significant
portion of its product revenues in 1999.* C-Cube expects that price competition
will continue to result in declining average selling prices for this family of
products.* The Company has implemented several programs that have reduced costs
associated with these families of products. In the event that increases in unit
sales and other manufacturing efficiencies of these families of products do not
offset decreasing sales prices in the future, the Company's business and results
of
 
                                       10
<PAGE>   13
 
operations would be materially and adversely affected. C-Cube anticipates that
overall gross margin may decrease as a result of a number of factors including
anticipated declines in average selling prices over time.* The timing of volume
shipments and the life cycles of the Company's products are difficult to predict
due in large measure to the emerging nature of the markets for C-Cube's
products, the future effect of product enhancements by the Company and its
current and future competitors. Declines in demand for the Company's products,
particularly the CL680 and Chaoji VCD families of products, whether as a result
of competition, technological change or otherwise, would have a material adverse
effect on C-Cube's business and results of operations.
 
CUSTOMERS
 
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------
           MARKET                       APPLICATIONS                     TYPICAL CUSTOMERS
--------------------------------------------------------------------------------------------------
<C>                           <S>                                <C>
       Communication          Satellite delivery, terrestrial    British Digital Broadcasting,
          systems             and cable broadcasting, video      Canal+, Comark, DIRECTV, GTE,
                              networking                         Look Communications, NTL, Paxson
                                                                 Communications, Pioneer, Ultracom
--------------------------------------------------------------------------------------------------
       Communication          Interactive set-top boxes,         Avid, DiviCom, FAST, JVC, General
       semiconductors         professional non-linear editing,   Instruments, Matrox, NDS, Nokia,
                              broadcast encoding, electronic     Pace, Pinnacle, Scientific
                              news gathering                     Atlanta, Sharp, Sony, Zenith
--------------------------------------------------------------------------------------------------
    Consumer electronics      Recordable DVD players, DVD        Acer, ChangHong, Dell, Gateway,
       semiconductors         players, DVD add-in PC cards,      Hitachi, Idall, JVC, LG
                              VideoCD players                    Electronics, Malata, Samsung,
                                                                 SAST, Sony, Tatung, Toshiba,
                                                                 Xiamin Solid
--------------------------------------------------------------------------------------------------
</TABLE>
 
     During 1998, no individual customer accounted for 10% or more of net
revenues. Sales to Sinorex, a distributor, accounted for 20% and 12% of the
Company's net revenues during 1997 and 1996, respectively.
 
RESEARCH AND DEVELOPMENT
 
     C-Cube believes that the continued introduction of new products in its
target markets is essential to its growth. As of December 31, 1998, the Company
had 419 full-time employees engaged in research and development. Expenditures
for research and development in 1998, 1997 and 1996 were approximately $74.0
million, $64.2 million and $44.2 million, respectively. See "Item
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations."
 
     The markets for the Company's products are characterized by rapidly
changing technology and evolving industry standards. In addition, markets for
C-Cube's products are characterized by intense price competition. As the markets
for the Company's products develop and competition increases, C-Cube anticipates
that product life cycles will shorten and average selling prices will decline.*
In particular, the average selling price and product gross margin for each of
the Company's products will decline as such products mature and as per order
unit volumes for such products increase.* The Company's operating results will
depend to a significant extent on its ability to continue to successfully
introduce new products on a timely basis and to reduce costs of existing
products.* In particular, C-Cube currently intends to announce several new
products over the next year, including next generation MPEG-2 decoders.* There
can be no assurance that these products will be successfully developed or will
achieve market acceptance, and these products are not expected to contribute
significantly to revenues in the first half of 1999.* The failure of any of
these products to be successfully introduced and achieve market acceptance could
have a material adverse effect on the Company's business and results of
operations. In addition, the Company continues to sell a number of earlier
generation products; any failure to manage the transition to new products
effectively could have a material adverse effect on the Company's business and
results of operations. The success of new product introductions is dependent on
several factors, including proper new product definition, product cost, timely
completion and introduction of new product designs, quality of new products,
differentiation of new products from those of the Company's
 
                                       11
<PAGE>   14
 
competitors and market acceptance of C-Cube's and its customers' products. As a
result, the Company believes that continued significant expenditures for
research and development will be required in the future.* Because of the
complexity of its products, C-Cube has experienced delays from time-to-time in
completing development and introduction of new products, and as a result, has
from time-to-time not achieved the market share anticipated for such products.
There can be no assurance that such delays will not be encountered in the
development and introduction of future products, including the products
currently expected to be announced over the next year. There can be no assurance
that the Company will successfully identify new product opportunities and
develop and bring new products to market in a timely manner, that products or
technologies developed by others will not render C-Cube's products or
technologies obsolete or noncompetitive, or that the Company's products will be
selected for design into the products of its targeted customers. The failure of
any of the Company's new product development efforts could have a material
adverse effect on C-Cube's business and results of operations.
 
SALES AND MARKETING
 
     C-Cube's sales and marketing strategy targets markets for which digital
video compression is an enabling technology in order to achieve key design wins
with industry leaders, as well as early adopters of digital video technology. To
implement its strategy, the Company has established a direct sales force and a
worldwide network of independent sales representatives and distributors. In
addition, C-Cube has a team of application engineers who assist customers with
designing in the Company's products.
 
     In the United States, the Company sells its products through direct sales
channels, independent representatives and distributors. The Company records
revenues from product sales to customers at the time of shipment. The Company
records revenues from systems sales under contract accounting. Certain of the
Company's agreements with its distributors permit limited stock rotation and
provide for price protection. Allowances for returns and adjustments, including
price protection, are provided at the time revenues from product sales are
recorded. Generally, the Company pays its independent sales representatives on a
commission basis. As of December 1998, C-Cube had North American regional sales
offices in California, Florida, Georgia, Quebec and Virginia, and international
sales offices in the United Kingdom, France, Korea, China, Singapore, Taiwan and
Japan. In Japan, C-Cube sells products through the direct sales force of C-Cube
Japan, Inc. (CCJ) and two distributors. CCJ was formed by the Company and Kubota
Corporation in 1988 and is currently owned 65% by C-Cube and 35% by Kubota. The
primary business of CCJ is the marketing, sales and support of the Company's
products in Japan. Internationally, the Company has commissioned sales
representatives or distributors in Australia, Canada, Denmark, Finland, France,
Germany, Great Britain, Hong Kong, Ireland, India, Israel, Italy, Korea, Sweden
and Taiwan.
 
INTERNATIONAL BUSINESS ACTIVITIES
 
     During 1998, 1997 and 1996, international revenues accounted for
approximately 62%, 65% and 67% of the Company's net revenues, respectively, and
C-Cube believes that international revenues will continue to account for a
significant portion of net revenues.* The Company's success will depend in part
upon its ability to manage international marketing and sales operations. In
addition, C-Cube purchases a substantial portion of its manufacturing services
from foreign suppliers. C-Cube's international manufacturing and sales are
subject to changes in foreign political and economic conditions, and to other
risks, including currency or export/import controls, changes in tax laws,
tariffs and freight rates and changes in the ownership and/or leadership of
international customers that may result in delayed or canceled orders. For
example, China is the primary market for VideoCD and Chaoji VCD players
utilizing the Company's decoder products. As a consequence, any political or
economic instability in China could significantly reduce demand for the
Company's products. The Company has made a significant investment in additional
foundry capacity in Taiwan and is subject to the risk of political instability
in Taiwan, including but not limited to the potential for conflict between
Taiwan and the People's Republic of China. The Company sells products to
customers in Korea and is subject to the risk of economic and political
instability in Korea, including the potential for conflict between North and
South Korea. In addition, the Company sells certain products in international
markets and buys certain products from its foundries in currencies other than
the U.S. dollar. As a result, currency fluctuations could, in the long term,
have
 
                                       12
<PAGE>   15
 
a material adverse effect on the Company's business and results of operations.
With respect to international sales that are denominated in U.S. dollars,
increases in the value of the U.S. dollar relative to foreign currencies can
increase the effective price of, and reduce demand for, the Company's products
relative to competitive products priced in the local currency. The United States
has considered trade sanctions against Japan and has had disputes with China
relating to trade and human rights issues. If trade sanctions were imposed,
Japan or China could enact trade sanctions in response. Because a number of the
Company's current and prospective customers and suppliers are located in Japan
and China, trade sanctions, if imposed, could have a material adverse effect on
C-Cube's business and results of operations. Similarly, protectionist trade
legislation in either the United States or foreign countries could have a
material adverse effect on the Company's ability to manufacture or sell its
products in foreign markets.
 
     The Asian consumer electronics markets accounted for approximately 49%, 55%
and 62% of total Company sales in 1998, 1997 and 1996, respectively, and are
expected to continue to account for a substantial, though declining, percentage
of sales in the future.* The economic crisis in Asia has been characterized by
increases in idle production capacity, real estate vacancies, unemployment and
bank failures, and has resulted in currency devaluation, falling consumer
spending and domestic price deflation. Any of these factors could significantly
reduce the demand for the end-user goods in which the Company's products are
incorporated. Most of the Company's sales in Asia were of decoder chips, which
are used in VideoCD and Chaoji VCD players. The Company believes purchases of
VideoCD and Chaoji VCD players are not as likely to be deferred as are purchases
of higher priced consumer durables and production equipment, which have
dramatically impacted U.S. export sales.* However, there can be no assurance
that the Company will not experience reduced sales of its products into Asia
because of declining consumer spending or because of its customers' increasing
difficulty in obtaining letters of credit, which the Company requires prior to
shipment.
 
MANUFACTURING
 
     C-Cube has chosen to use independent silicon foundries to fabricate its
integrated circuits. Assembly, test and packaging are also subcontracted to
third parties. This approach enables the Company to concentrate its resources on
product design and development, where C-Cube believes it has greater competitive
advantages. The Company continually evaluates alternative sources for wafer
assembly and test capacity.
 
     During 1998, the Company's devices were fabricated using complementary
metal oxide semiconductor (CMOS) process technology with 0.65 micron, 0.5
micron, 0.35 micron, 0.30 micron and 0.25 micron process feature sizes, using
either three or four layers of metal interconnect. In 1999, the Company began
using 0.22 micron technology with five layers of metal interconnect. Fabricated
wafers are either tested by the fabrication facility to C-Cube specifications or
the Company takes receipt of untested wafers and works with subcontractor
testing facilities. Once the fully tested and accepted wafers are received by
C-Cube, the die are assembled into packages by subcontractors, primarily located
in Japan, Taiwan, Korea and the United States. The Company utilizes multiple
assembly subcontractors for its products.
 
     In the second quarter of 1996, the Company expanded and formalized its
relationship with Taiwan Semiconductor Manufacturing Co., Ltd. (TSMC) to provide
additional wafer production capacity in the years 1996 to 2001. The agreement
with TSMC provided that TSMC would produce and ship wafers to C-Cube at
specified prices and required C-Cube to make two advance payments totaling $49
million. An advance payment of $24.5 million was made in June 1996. In May 1997,
the Company amended its agreement with TSMC which resulted in a reduction of the
Company's future wafer purchase commitments and the forgiveness of the second
advance payment of $24.5 million. TSMC will apply the June 1996 prepayment
against a portion of the wafer cost as product is delivered to C-Cube.
Accordingly, the prepaid amount, which has been allocated between current and
long-term assets, will be amortized to inventory as wafers are received. At
December 31, 1998, $5.6 million of the remaining $18.2 million production
capacity rights is included in other current assets. In January 1999, the
Company signed a second amendment to its agreement with TSMC which will result
in a refund to the Company of $11.7 million from the remaining $18.2 million
balance of production capacity rights.
 
                                       13
<PAGE>   16
 
     The Company believes that an increase in the demand for semiconductor
wafers over currently expected levels, or a failure of foundry capacity in the
industry to grow at anticipated rates could result in greater difficulty in
obtaining adequate foundry capacity, increased prices and increased lead times.*
The Company's future operating results depend in substantial part on its ability
to increase the capacity available to it from its existing or new foundries. In
order to secure such capacity, the Company has considered and will continue to
consider various possible transactions, which could include, without limitation,
equity investments in, prepayments to, non-refundable deposits with or loans to
foundries in exchange for guaranteed capacity, "take or pay" contracts that
commit the Company to purchase specified quantities of wafers over extended
periods, joint ventures or other partnership relationships with foundries.*
There can be no assurance that the Company will be able to make any such
arrangement in a timely fashion, or at all, that the Company will not require
additional issuances of equity or debt in order to raise capital for any such
arrangements or that any such financing would be available to the Company on
acceptable terms, or at all. If the Company were not able on a timely basis to
obtain additional foundry capacity, its business and results of operations would
be materially and adversely affected.
 
     The Company has entered into an agreement with MEC, JVC and Sharp whereby
they provided assistance in the development of the CL480 family of products, the
CL9100 and the CL680, and currently provide C-Cube with preferential access to
MEC's 0.5 and 0.35 micron manufacturing processes. As part of the agreement
C-Cube provides MEC the right to sell the CL480 family of products and the CL680
to its internal divisions and to a limited group of VideoCD manufacturers. MEC's
right to sell the CL480 has certain volume limitations and is subject to royalty
payments to C-Cube.
 
     C-Cube sources its integrated circuit products from MEC, TSMC and Yamaha
and is in the process of qualifying additional foundries. This dependence on a
small number of foundries subjects the Company to risks associated with an
interruption in supply from these foundries. In connection with the manufacture
of its newer products, C-Cube needs to continue to evaluate and qualify new
foundries that employ advanced manufacturing and process technologies, which are
currently available from a limited number of foundries. For example, certain of
the new products that the Company intends to introduce require advanced CMOS
processes. The Company has in the past experienced increased costs and delays in
connection with the qualification of new foundries. There can be no assurance
that any delays, cost increases or quality problems resulting from the
qualification of new foundries will not have a material adverse effect on
C-Cube's business and results of operations.
 
     The Company's reliance on subcontractors to manufacture and assemble its
products involves significant risks, including reduced control over delivery
schedules, quality assurance, manufacturing yields and cost; the potential lack
of adequate capacity and potential misappropriation of C-Cube intellectual
property. The Company obtains foundry capacity through forecasts that are
generated in advance of expected delivery dates. The Company's ability to obtain
the foundry capacity necessary to meet the future demand for its products is
based on its ability to accurately forecast such future demand. If the Company
fails to accurately forecast such future demand, the Company may be unable to
timely obtain an adequate supply of wafers necessary to manufacture the number
of products required to satisfy the actual demand. There can be no assurance
that the Company will continue to accurately forecast the future demand for its
products and obtain sufficient foundry capacity in the future.
 
     C-Cube has from time-to-time experienced disruptions in supply, although
none of those disruptions have to date materially adversely affected results.
There can be no assurance that manufacturing or assembly problems will not occur
in the future or that any such disruptions will not have a material adverse
effect upon the Company's results of operations. Further, there can be no
assurance that suppliers who have committed to provide product will do so, or
that the Company will meet all conditions imposed by such suppliers. Failure to
obtain an adequate supply of products on a timely basis would delay product
delivery to C-Cube's customers, which would have a material adverse effect on
the Company's business and results of operations. In addition, C-Cube's business
could also be materially and adversely affected if the operations of any
supplier are interrupted for a substantial period of time, or if the Company is
required, as a result of capacity constraints in the semiconductor industry or
otherwise, to increase the proportion of wafers or finished goods purchased from
higher cost suppliers in order to obtain adequate product volumes.
                                       14
<PAGE>   17
 
     The markets into which C-Cube sells its products are subject to extreme
price competition. Thus, the Company expects to continue to experience declines
in the selling prices of its products over the life cycle of each product.* In
order to offset or partially offset declines in the selling prices of its
products, C-Cube must continue to reduce the costs of products through product
design changes, manufacturing process changes, volume discounts, yield
improvements and other savings negotiated with its manufacturing
subcontractors.* Since the Company does not operate its own manufacturing
facilities and must make volume commitments to subcontractors at prices that
remain fixed over certain periods of time, it may not be able to reduce its
costs as rapidly as its competitors who perform their own manufacturing. The
failure of the Company to design and introduce, in a timely manner, lower cost
versions of existing products or new products with higher gross margins, or to
successfully manage its manufacturing subcontractor relationships would have a
material adverse effect on C-Cube's gross margins.
 
     DiviCom's manufacturing strategy is focused on the rapid transition of
products from engineering development to production. DiviCom makes extensive use
of the services of electronic component suppliers, referred to as manufacturing
distributors and subcontract assembly houses in order to minimize inventory
risks, obtain competitive pricing and increase supply flexibility.
 
     DiviCom's manufacturing group establishes relationships with key supply and
subcontract partners. Electronic component distributors are responsible for the
procurement and "kitting" of components in preparation for contract assemble.
 
     Once a product or subsystem has demonstrated design stability, it is
transitioned from the DiviCom engineering group to the contract partner for
management and full turnkey assembly. The contract partner purchases components
to DiviCom specifications, contracts with the assembly facility to perform
product builds and ships the completed systems to DiviCom. DiviCom manages the
final integration, system testing, reliability and quality assurance testing and
configuration per customer requirements
 
COMPETITION
 
     The markets in which C-Cube competes are intensely competitive and are
characterized by declining average selling prices and rapid technology change.
C-Cube believes that it competes favorably in the areas of product definition,
system cost, functionality, time-to-market, reliability and reputation. C-Cube
competes with major domestic and international companies, most of which have
substantially greater financial and other resources than C-Cube with which to
pursue engineering, manufacturing, marketing and distribution of their products.
Some of these companies own proprietary video compression technology competitive
with C-Cube's standards-based systems.
 
     In the market for consumer electronics semiconductors, principal
competitors include ESS Technology, Inc., SGS-Thomson, Zoran, LSI Logic, Oak
Technology, Winbond and UMC as well as several large, integrated Japanese and
Korean consumer electronics companies, such as Sony, MEC, Toshiba, NEC and
Samsung, which have their own semiconductor design and manufacturing capacity.
In the computer segment of the consumer electronics market, principal C-Cube
competitors include the increasingly powerful CPUs that are now available from,
among others, Intel and Motorola, as well as hardware solutions from Zoran,
LuxSonar and IBM. Graphics chip manufacturers such as ATI, S3 Incorporated and
Trident Microsystems, Inc. are also potential competitors. In the market for
communications decoders, C-Cube's principal competitors include SGS-Thomson,
Philips, LSI Logic, Broadcom and VLSI Technologies.
 
     IBM is the principal competitor in the broadcast encoder market, while Sony
is the principal competitor in the consumer encoder market. C-Cube expects that
other companies will introduce competing encoder products in the future.*
Although the timing of the production availability of such encoders is
uncertain, their availability could have an adverse impact on C-Cube's encoder
product revenues and margins. C-Cube may also face increased competition in the
future from new entrants into its markets.* As the markets for C-Cube's products
develop, competition from large semiconductor companies, such as
ST-Microelectronics and Philips, and from vertically integrated companies such
as Sony, MEC, Toshiba and NEC, may increase significantly.* If C-Cube can offer
low-cost hardware solutions, then it may continue to compete with providers of
software solutions such as National and AMD, and manufacturers of CPUs such as
Intel and Motorola.* The ability of
                                       15
<PAGE>   18
 
C-Cube to compete successfully in the rapidly evolving markets for
high-performance video compression technology depends on factors both within and
outside of its control, including success in designing and subcontracting the
manufacture of new products that implement new technologies, adequate sources of
raw materials, protection of Company products by effective utilization of
intellectual property laws, product quality, reliability, price and the
efficiency of production, the pace at which customers incorporate C-Cube's
integrated circuits into their products or technologies, success of competitors'
products and general economic conditions. There can be no assurance that C-Cube
will be able to compete successfully in the future.
 
     A variety of other approaches to digital video compression have been
introduced, including wavelets, fractal image compression, proprietary
compression algorithms and software only solutions. Competitor companies are
designing products around these and other alternative approaches. In addition,
manufacturers of general-purpose microprocessors, such as Intel, and graphics
chip manufacturers are positioning their products as offering digital video
compression capability. There can be no assurance that system manufacturers will
not use such processors for video compression applications. While MPEG has
become the accepted standard, any of the alternative approaches, individually or
collectively, could be adopted on a widespread basis in the emerging video
compression market. If this were to happen, C-Cube's business and results of
operations would be materially and adversely affected.
 
     In the video networking system business, DiviCom competes with vertically
integrated system suppliers including General Instruments, Scientific Atlanta,
NDS, SGS-Thomson and Philips, as well as more specialized suppliers including
SkyStream and Imedia. C-Cube believes that its DiviCom subsidiary competes
favorably based on its expertise and focus in the area of digital video network
systems and its constituent components such as digital video compression,
digital network and transmission technology. In addition, DiviCom possesses the
practical knowledge and experience required to design, manufacture, integrate
and support such systems in real-world deployments. Several of these
competitors, including General Instruments, Scientific Atlanta and Philips have
been established in the analog technology market for many years. Others such as
Tadiran/Scopus and Tiernan have come into the market in recent years as the
early stages of digital technology emerged.
 
INTELLECTUAL PROPERTY AND LICENSES
 
     The Company attempts to protect its technology through a combination of
patents, copyrights, trade secret laws, confidentiality procedures and licensing
arrangements. As of December 31, 1998, the Company has 42 issued United States
patents and 63 U.S. patent applications pending and has filed certain
corresponding applications in certain foreign jurisdictions. These patents
expire at various times from 2010 to 2016. The Company intends to continue to
seek patents on its technology where appropriate. Notwithstanding its patent
position, the Company believes that, in view of the rapid pace of technological
change in the semiconductor industry, the technical experience and creative
skills of its engineers and other personnel are the most important factors in
determining the Company's future technological success.
 
     There can be no assurance that patents will issue from any pending
applications or that any claims allowed from existing or pending patents will be
sufficiently broad to protect the Company's technology. While the Company
intends to protect its intellectual property rights vigorously, there can be no
assurance that any patents held by the Company will not be challenged,
invalidated or circumvented, or that the rights granted thereunder will provide
competitive advantages to the Company. Moreover, while the Company holds or has
applied for patents relating to the design of its products, the Company's
products are based in part on standards, including MPEG-1, MPEG-2 and JPEG, and
the Company does not hold patents or other intellectual property rights for such
standards. The semiconductor industry is characterized by frequent litigation
regarding patent and other intellectual property rights.
 
     The Company receives from time-to-time notices of potential infringement of
third-party rights and there can be no assurance that third parties will not
assert claims against the Company with respect to existing or future products or
that licenses will be available on reasonable terms, or at all, with respect to
any third-party technology including third-party technology which is or may be
embodied in standards. In the event of litigation to determine the validity of
any third-party claims, such litigation could result in significant expense to
the Company and divert the efforts of the Company's technical and management
personnel, whether or not
 
                                       16
<PAGE>   19
 
such litigation is determined in favor of the Company. In the event of an
adverse result in any such litigation, the Company could be required to pay
substantial amounts in damages and to cease selling the infringing product
unless and until the Company is able to develop non-infringing technology or to
obtain licenses to the technology which was the subject of the litigation. There
can be no assurance that the Company would be successful in such development or
that such licenses would be available, and any such development or license could
require expenditure of substantial time and other resources.
 
     In order to defray the cost of developing its products and to develop
products with specifications meeting customer requirements, C-Cube has
established development relationships with certain companies. Under these
arrangements, these companies provided the Company with development funding
and/or technical assistance, and participated with C-Cube in determining the
specifications for the performance requirements of various products. As a result
of these relationships, the Company believes it has been able to more rapidly
introduce products meeting the demands of these as well as other customers for
similar applications. In certain cases, as consideration for such development
assistance, C-Cube has agreed to pay royalties to such customers and generally
C-Cube retains ownership of such products.
 
EMPLOYEES
 
     As of December 31, 1998, the Company had approximately 929 employees, 419
of whom are engaged in, or directly support, the Company's research and
development, 240 of whom are in sales and marketing, 158 of whom are in
operations and 112 of whom are in administration. C-Cube's employees are not
represented by any collective bargaining agreement, and the Company has never
experienced a work stoppage. C-Cube believes its employee relations are good.
 
     C-Cube's future success is heavily dependent upon its ability to hire and
retain qualified technical, marketing and management personnel. The loss of the
services of key personnel could have a material adverse effect on the Company's
business. C-Cube is currently seeking certain additional engineering, marketing
and management personnel. The Company's success in the future will depend in
part on the successful assimilation of such new personnel. C-Cube also obtains
assistance from customers whose engineers participate in development programs at
the Company. The continuing availability of such support is dependent upon a
number of factors, including relationships with customers and the ability of
such engineers, many of whom are foreign residents, to obtain immigration visas.
The competition for such personnel, particularly for engineering personnel, is
intense and the loss of such personnel could have a material adverse effect on
C-Cube.
 
ACQUISITIONS
 
     On August 28, 1996, the Company acquired DiviCom, a digital video
networking company. C-Cube paid $65.7 million in cash, issued 2.3 million shares
of its common stock, assumed options exercisable for 264,000 shares of its
common stock and incurred $1.35 million in other costs in exchange for the
outstanding shares of DiviCom stock that C-Cube did not already own.
 
ITEM 2. PROPERTIES
 
     C-Cube's principal facilities consist of approximately 303,000 square feet
of space in six buildings located in Milpitas, California. This space is leased
pursuant to five agreements that expire on various dates through April 14, 2005.
The Company believes its existing facilities and other available facilities will
be adequate to meet its requirements for at least the next 12 months.
 
ITEM 3. LEGAL PROCEEDINGS
 
     From time-to-time the Company is party to certain litigation or legal
claims. Management has reviewed all pending legal matters and believes that the
resolution of such matters will not have a significant adverse effect on the
Company's financial position or results of operations.
 
                                       17
<PAGE>   20
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
     None.
 
EXECUTIVE OFFICERS OF THE REGISTRANT
 
     The following table lists the names, ages and positions held with the
Registrant of all executive officers of the Registrant as of March 1, 1999.
There are no family relationships between any director or executive officer and
any other director or executive officer of the Registrant. Executive officers
serve at the discretion of the Board of Directors.
 
<TABLE>
<CAPTION>
                    NAME                   AGE                         POSITION
                    ----                   ---                         --------
    <S>                                    <C>   <C>
    Alexandre A. Balkanski, Ph.D. .......  38    President, Chief Executive Officer and Director
    Umesh Padval.........................  41    President, C-Cube Semiconductor
    Tom Lookabaugh, Ph.D. ...............  37    President, DiviCom
    Walt Walczykowski....................  48    Vice President of Finance and Chief Financial
                                                 Officer
    Fred Brown...........................  55    Senior Vice President of Worldwide Sales
    Richard Foreman......................  44    Vice President, Chief Information Officer and
                                                 Corporate Secretary
</TABLE>
 
     Dr. Alexandre Balkanski co-founded the Company in July 1988 and has served
as President and Chief Executive Officer since July 1995. He had previously
served as the Company's Executive Vice President and Chief Operating Officer.
Prior to joining C-Cube, Dr. Balkanski co-founded and served as President of
Diamond Devices, a semiconductor company specializing in Digital Signal
Processing (DSP). Dr. Balkanski was elected to the Board of Directors of the
Company in April 1993. He serves as an outside director on the board of
PMC-Sierra, Inc., a semiconductor company. Dr. Balkanski has a B.A. in physics
from Harvard College, and an M.S. in physics and a Ph.D. in business economics
from Harvard University.
 
     Mr. Padval joined C-Cube as President of C-Cube's Semiconductor division in
October 1998. He has over 14 years of broad management experience in the
semiconductor industry. His management experience includes business unit,
marketing, sales and engineering positions at VLSI Technology and Advanced Micro
Devices. Prior to joining C-Cube, Mr. Padval served as Senior Vice President and
General Manager of the Consumer Digital Entertainment division at VLSI
Technology, Inc. from May 1997 to October 1998. In this position he managed
marketing, engineering, applications and operational aspects of the division
which focused on providing solutions into global digital set-top box
deployments. From August 1994 to May 1997, Mr. Padval served as Vice President
and General Manager for VLSI's Computing Solutions division, which focused on
the PC, workstation, mass storage and peripherals market. Before joining VLSI
Technology, Mr. Padval worked for Advanced Micro Devices where he held variety
of marketing and engineering positions. Mr. Padval holds a bachelor of
technology from Indian Institute of Technology in Bombay, an M.S. degree from
Pennsylvania State University and an M.S. degree from Stanford University.
 
     Dr. Lookabaugh joined DiviCom as its Vice President of Research and
Business Development in June 1993 and was named Vice President of Marketing in
February 1996. From March 1997 to December 1997, Dr. Lookabaugh served as Senior
Vice President and General Manager. He was appointed President of DiviCom in
December 1997. Prior to joining DiviCom, Dr. Lookabaugh served as Executive
Director of Research and New Business Technology for Compression Labs, Inc., a
digital video systems company, where he managed the development of an MPEG-1
decoder for video on demand. Dr. Lookabaugh has a Ph.D. in Electrical
Engineering, an M.S. in Statistics, an M.S. in Engineering Management, and an
M.S. in Electrical Engineering from Stanford University and a B.S. in
Engineering Physics from the Colorado School of Mines.
 
     Mr. Walczykowski joined the Company as Corporate Controller in September
1995, bringing nineteen years of financial management experience. He was
promoted to Vice President of Finance and Chief Financial Officer in July 1998.
Prior to joining C-Cube, Mr. Walczykowski served from January 1989 to August
1995 as Corporate Controller for Zycad Corporation, a provider of technology and
services to designers of integrated
 
                                       18
<PAGE>   21
 
circuits and systems. Since starting his career at Arthur Young and Company in
San Francisco, Mr. Walczykowski has held key positions at several Northern
California high tech companies including Measurex, Dataproducts Corporation,
Triad Systems and Friden Alcatel. Mr. Walczykowski holds a B.S. in Accounting
from San Jose State University.
 
     Mr. Brown joined the Company in December of 1993 as Director of Asia
Pacific Sales, and was named Vice President in November 1995. Mr. Brown was
promoted to Vice President, Worldwide Sales in May 1998 and Senior Vice
President in November 1998. Prior to joining C-Cube, he spent eleven years at
LSI Logic, most recently as Vice President, Asia Pacific Sales located in Hong
Kong. Mr. Brown holds a BSEE degree from Carnegie Institute of Technology (now
Carnegie Mellon University).
 
     Mr. Foreman joined the Company in November 1994 as Director of Information
Technology. In January 1996 he was appointed Vice President, Chief Information
Officer and Corporate Secretary. During 1994, Mr. Foreman was Vice President of
the Intouch Group and an information systems consultant to Sybase Corporation.
From April 1983 to January 1994, Mr. Foreman held management positions at
Cypress Semiconductor, including Corporate Controller and Director of
Information Systems. Mr. Foreman holds a B.S., with honors, in Mechanical
Engineering from Villanova University, an M.S. in Systems Engineering from the
University of Pennsylvania and an M.B.A. from the Wharton Graduate School.
 
                                       19
<PAGE>   22
 
                                    PART II
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
 
     The Company's common stock has been included for quotation on the Nasdaq
National Market under the Nasdaq symbol "CUBE" since the Company's initial
public offering in April 1994. The following table sets forth, for the periods
indicated, the high and low closing sale prices for the common stock on such
market.
 
<TABLE>
<CAPTION>
                                                                HIGH          LOW
                                                                ----          ---
<S>                                                           <C>           <C>
1997:
  First Quarter.............................................    $39 1/4       $25 1/4
  Second Quarter............................................     28 13/16      17 3/8
  Third Quarter.............................................     34 1/2        17 21/32
  Fourth Quarter............................................     33 13/16      16 3/16
1998:
  First Quarter.............................................    $22 1/4       $17 5/8
  Second Quarter............................................     24 11/16      15 11/16
  Third Quarter.............................................     20 3/16       14 9/16
  Fourth Quarter............................................     29 13/16      15 1/4
</TABLE>
 
     At March 1, 1999, the Company had 896 holders of record of its common stock
and 38,927,375 shares outstanding.
 
     The market price of C-Cube's common stock has fluctuated significantly
since its initial public offering in April 1994. The market price of the common
stock could be subject to significant fluctuations in the future based on
factors such as announcements of new products by C-Cube or its competitors,
quarterly fluctuations in C-Cube's financial results or other semiconductor or
digital video networking companies' financial results, changes in analysts'
estimates of C-Cube's financial performance, general conditions in the
semiconductor and digital video networking industries, conditions in the
financial markets and general conditions in the global economy which might
adversely affect consumer purchasing. In addition, the stock market in general
has experienced extreme price and volume fluctuations, which have particularly
affected the market prices for many high technology companies and which have
often been unrelated to the operating performance of the specific companies. The
market price of C-Cube's common stock has declined substantially from its
historic highs, and may continue to experience significant fluctuations in the
future.
 
DIVIDEND POLICY
 
     The Company has never paid cash dividends on its common stock. The Company
presently intends to retain all cash for use in the operation and expansion of
the Company's business and does not anticipate paying any cash dividends in the
near future. In addition, the Company's existing bank credit agreement prohibits
the declaration or payment of cash dividends on its common stock.
 
                                       20
<PAGE>   23
 
ITEM 6. SELECTED FINANCIAL DATA
 
     The following selected consolidated financial data for each of the five
years in the period ended December 31, 1998 have been derived from the audited
consolidated financial statements of the Company included herein. The selected
consolidated financial data set forth below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the consolidated financial statements and notes thereto included
elsewhere in this report.
 
<TABLE>
<CAPTION>
                                                                     YEARS ENDED DECEMBER 31,
                                                     --------------------------------------------------------
                                                       1998        1997        1996        1995        1994
                                                     ---------   ---------   ---------   ---------   --------
                                                     (IN THOUSANDS, EXCEPT PERCENTAGE AND PER SHARE AMOUNTS)
<S>                                                  <C>         <C>         <C>         <C>         <C>
STATEMENT OF OPERATIONS DATA:
Net revenues:
  Product..........................................  $351,797    $337,012    $319,758    $123,190    $42,026
  Development contracts............................        --          --          --       1,412      2,993
                                                     --------    --------    --------    --------    -------
         Total.....................................   351,797     337,012     319,758     124,602     45,019
                                                     --------    --------    --------    --------    -------
Costs and expenses:
  Cost of product revenues.........................   160,839     151,333     144,985      59,253     19,574
  Research and development.........................    74,031      64,204      44,177      14,342      9,774
  Selling, general and administrative..............    60,512      52,732      39,002      19,227     11,283
  Purchased in-process technology..................        --          --     131,349       3,800         --
                                                     --------    --------    --------    --------    -------
         Total.....................................   295,382     268,269     359,513      96,622     40,631
                                                     --------    --------    --------    --------    -------
Income (loss) from operations......................    56,415      68,743     (39,755)     27,980      4,388
Interest income (expense), net.....................     4,239      (1,757)        (28)      2,059        689
                                                     --------    --------    --------    --------    -------
Income (loss) before income taxes, minority
  interest and extraordinary item..................    60,654      66,986     (39,783)     30,039      5,077
Income tax expense.................................    18,196      22,895      32,944       4,933         69
                                                     --------    --------    --------    --------    -------
Income (loss) before minority interest and
  extraordinary item...............................    42,458      44,091     (72,727)     25,106      5,008
Minority interest in net income (loss) of
  subsidiary.......................................      (337)       (248)        318         211         --
                                                     --------    --------    --------    --------    -------
Income (loss) before extraordinary item............    42,795      44,339     (73,045)     24,895      5,008
Extraordinary gain on repurchase of convertible
  notes (net of tax)...............................     3,494          --          --          --         --
                                                     --------    --------    --------    --------    -------
Net income (loss)..................................  $ 46,289    $ 44,339    $(73,045)   $ 24,895    $ 5,008
                                                     ========    ========    ========    ========    =======
Basic earnings (loss) per share:(1)
  Income (loss) before extraordinary item..........  $   1.14    $   1.21    $  (2.15)   $   0.78    $  0.18
  Extraordinary item (net of tax)..................      0.09          --          --          --         --
                                                     --------    --------    --------    --------    -------
  Net income (loss)................................  $   1.24    $   1.21    $  (2.15)   $   0.78    $  0.18
                                                     ========    ========    ========    ========    =======
Diluted earnings (loss) per share:(1)
  Income (loss) before extraordinary item..........  $   1.11    $   1.15    $  (2.15)   $   0.74    $  0.16
  Extraordinary item (net of tax)..................      0.09          --          --          --         --
                                                     --------    --------    --------    --------    -------
  Net income (loss)................................  $   1.19    $   1.15    $  (2.15)   $   0.74    $  0.16
                                                     ========    ========    ========    ========    =======
Shares:(1)
  Basic............................................    37,382      36,497      33,928      31,819     28,248
                                                     ========    ========    ========    ========    =======
  Diluted..........................................    40,754      41,683      33,928      35,000     31,433
                                                     ========    ========    ========    ========    =======
PRODUCT GROSS MARGIN DATA:
Net product revenues...............................  $351,797    $337,012    $319,558    $123,190    $42,026
Cost of product revenues...........................   160,839     151,333     144,985      59,253     19,574
                                                     --------    --------    --------    --------    -------
Product gross margin...............................  $190,958    $185,679    $174,573    $ 63,937    $22,452
                                                     ========    ========    ========    ========    =======
Product gross margin percentage....................      54.3%       55.1%       54.6%       51.9%      53.4%
                                                     ========    ========    ========    ========    =======
BALANCE SHEET DATA:
Cash and short-term investments....................  $207,827    $166,350    $ 82,246    $144,089    $43,833
Working capital....................................   220,466     208,391     124,487     158,577     48,751
Total assets.......................................   343,171     304,108     279,515     203,526     67,862
Short-term debt and current portion of long-term
  obligations......................................       355         608      25,337       3,093      6,908
Long-term obligations, net of current portion......    23,557      87,462      87,700      88,010      2,081
Stockholders' equity...............................   243,375     175,415     118,572      87,535     53,488
</TABLE>
 
---------------
(1) See Note 1 of Notes to Consolidated Financial Statements for an explanation
    of the computation of net income (loss) per share.
 
                                       21
<PAGE>   24
 
QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
 
<TABLE>
<CAPTION>
                                                         1998                                    1997
                                         -------------------------------------   -------------------------------------
                                         FOURTH     THIRD    SECOND     FIRST    FOURTH     THIRD    SECOND     FIRST
                                         QUARTER   QUARTER   QUARTER   QUARTER   QUARTER   QUARTER   QUARTER   QUARTER
                                         -------   -------   -------   -------   -------   -------   -------   -------
                                                    (IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE AMOUNTS)
<S>                                      <C>       <C>       <C>       <C>       <C>       <C>       <C>       <C>
Net revenues...........................  $95,800   $86,162   $82,518   $87,317   $90,065   $81,717   $71,098   $94,132
                                         -------   -------   -------   -------   -------   -------   -------   -------
Costs and expenses:
  Cost of product revenues.............  44,071    38,757    36,997    41,014    42,330    36,750    31,278     40,975
  Research and development.............  18,897    18,867    18,596    17,671    16,344    16,798    15,450     15,612
  Selling, general and
    administrative.....................  16,756    15,207    13,963    14,586    13,767    13,555    12,340     13,070
                                         -------   -------   -------   -------   -------   -------   -------   -------
        Total..........................  79,724    72,831    69,556    73,271    72,441    67,103    59,068     69,657
                                         -------   -------   -------   -------   -------   -------   -------   -------
Income from operations.................  16,076    13,331    12,962    14,046    17,624    14,614    12,030     24,475
Interest income (expense), net.........   1,692     1,636       638       273      (122)      (33)     (535)    (1,067)
                                         -------   -------   -------   -------   -------   -------   -------   -------
Income before income taxes, minority
  interest and extraordinary item......  17,768    14,967    13,600    14,319    17,502    14,581    11,495     23,408
Income tax expense.....................   5,327     4,490     4,083     4,296     6,030     4,958     3,949      7,958
                                         -------   -------   -------   -------   -------   -------   -------   -------
Income before minority interest and
  extraordinary item...................  12,441    10,477     9,517    10,023    11,472     9,623     7,546     15,450
Minority interest in net income (loss)
  of subsidiary........................      17      (185)      (28)     (141)     (125)      (40)     (138)        55
                                         -------   -------   -------   -------   -------   -------   -------   -------
Income before extraordinary item.......  12,424    10,662     9,545    10,164    11,597     9,663     7,684     15,395
Extraordinary gain on repurchase of
  convertible notes (net of tax).......      --     2,356     1,138        --        --        --        --         --
                                         -------   -------   -------   -------   -------   -------   -------   -------
Net income.............................  $12,424   $13,018   $10,683   $10,164   $11,597   $9,663    $7,684    $15,395
                                         =======   =======   =======   =======   =======   =======   =======   =======
Diluted earnings per share:(1)
  Income before extraordinary item.....  $ 0.31    $ 0.28    $ 0.25    $ 0.27    $ 0.30    $ 0.25    $ 0.21    $  0.40
  Extraordinary item (net of tax)......      --      0.06      0.03        --        --        --        --         --
                                         -------   -------   -------   -------   -------   -------   -------   -------
  Net income per share.................  $ 0.31    $ 0.34    $ 0.28    $ 0.27    $ 0.30    $ 0.25    $ 0.21    $  0.40
                                         =======   =======   =======   =======   =======   =======   =======   =======
Shares used in computation(1)..........  40,708    39,686    41,485    41,137    42,023    42,055    40,938     41,209
                                         =======   =======   =======   =======   =======   =======   =======   =======
Gross margin percentage................    54.0%     55.0%     55.2%     53.0%     53.0%     55.0%     56.0%      56.5%
                                         =======   =======   =======   =======   =======   =======   =======   =======
</TABLE>
 
---------------
(1) See Note 1 of Notes to Consolidated Financial Statements for an explanation
    of the computation of net income per share.
 
                                       22
<PAGE>   25
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS
 
RESULTS OF OPERATIONS
 
     The following table sets forth certain operating data as a percentage of
net revenues for the years ended December 31, 1998, 1997 and 1996:
 
<TABLE>
<CAPTION>
                                                                   YEARS ENDED
                                                                  DECEMBER 31,
                                                              ---------------------
                                                              1998    1997    1996
                                                              -----   -----   -----
<S>                                                           <C>     <C>     <C>
Net revenues................................................  100.0%  100.0%  100.0%
                                                              -----   -----   -----
Costs and expenses:
  Cost of product revenues..................................   45.7    44.9    45.3
  Research and development..................................   21.0    19.1    13.8
  Selling, general and administrative.......................   17.2    15.6    12.2
  Purchased in-process technology...........................     --      --    41.1
                                                              -----   -----   -----
          Total.............................................   84.0    79.6   112.4
                                                              -----   -----   -----
Income (loss) from operations...............................   16.0    20.4   (12.4)
Interest income (expense), net..............................    1.2    (0.5)     --
                                                              -----   -----   -----
Income (loss) before income taxes, minority interest and
  extraordinary item........................................   17.2    19.9   (12.4)
Income tax expense..........................................    5.2     6.8    10.3
                                                              -----   -----   -----
Income (loss) before minority interest and extraordinary
  item......................................................   12.1    13.1   (22.7)
Minority interest in net income (loss) of subsidiary........   (0.1)   (0.1)    0.1
                                                              -----   -----   -----
Income (loss) before extraordinary item.....................   12.2    13.2   (22.8)
Extraordinary gain on repurchase of convertible notes (net
  of tax)...................................................    1.0      --      --
                                                              -----   -----   -----
Net income (loss)...........................................   13.2%   13.2%  (22.8)%
                                                              =====   =====   =====
</TABLE>
 
     ACQUISITIONS
 
     On August 28, 1996, the Company acquired DiviCom Inc., a digital video
networking company. C-Cube paid $65.7 million in cash, issued 2.3 million shares
of its common stock, assumed options exercisable for 264,000 shares of its
common stock and incurred $1.35 million in other costs in exchange for the
outstanding shares of DiviCom stock that C-Cube did not already own. C-Cube
assumed net liabilities of $1.9 million, purchased technology of $14.2 million,
which will be amortized over five years, and wrote off $131.3 million of
in-process technology.
 
     The Company incurred acquisition-related charges of $133 million in the
third quarter of 1996, which included the in-process technology write-off and
bonuses paid to DiviCom employees.
 
     The acquisition of DiviCom was accounted for as a purchase and therefore
DiviCom financial results from the date of acquisition, August 28, 1996, are
included in C-Cube's consolidated financial results.
 
     NET REVENUES
 
     Net revenues increased 4% to $351.8 million in 1998 compared to $337.0
million in 1997. Revenue from the Company's family of encoder products increased
due to growth in sales of communications products, which was led by DiviCom and
increased sales of the Company's DVxpress and DVxpert families of codecs.
Revenue from MPEG-2 decoder chips used primarily in digital set-top boxes and in
DVD-ROMs on PCs increased from 1997 due to customers' adoption of the Company's
AViA and ZiVA families of decoder chips and the wider acceptance of the DVD
format. The Company also had sales from the introduction of its Chaoji VCD
decoder. These increases were partially offset by a decrease in revenues from
MPEG-1 decoder chips used in VideoCD players sold primarily in China, due to
price reductions made in response to competitive pricing pressures, partially
offset by an increase in unit volumes.
 
                                       23
<PAGE>   26
 
     In 1997, net revenues increased 5% to $337.0 million compared to $319.8
million in 1996. Revenue from the Company's family of encoder products increased
primarily due to sales of encoder systems developed by DiviCom, which was
acquired in the third quarter of 1996. See "Acquisitions." The Company also
began volume shipments of its MPEG-2 DVD decoder chips used primarily in
DVD-ROMs on PCs. Revenue from MPEG-1 decoder chips used in VideoCD players which
are sold primarily in China, decreased from the prior year due to price
reductions made in response to competition. The decreased prices for these
products were partially offset by an increase in unit volumes.
 
     The sales returns allowance at December 31, 1998 was $13.1 million, up from
$6.7 million at December 31, 1997. During 1998, additions to the sales returns
allowance were $12.6 million and deductions were $6.2 million. The deductions to
the allowance were primarily due to price protection credits given to
distributors and other pricing adjustments. The allowance at December 31, 1998
is to cover price protection, pricing adjustments and stock rotation credits to
distributors.
 
     The sales returns allowance at December 31, 1997 was $6.7 million, down
from $11.5 million at December 31, 1996. During 1997, additions to the sales
returns allowance were $3.3 million and deductions were $8.1 million. The
deductions to the allowance were primarily due to price protection credits given
to distributors in the first quarter of 1997 as the Company significantly
reduced the selling prices of its MPEG-1 decoder chips in response to
competitive pressures.
 
     During 1998, no individual customer accounted for 10% or more of net
revenues. Sales to Sinorex, a distributor, accounted for 20% and 12% of the
Company's net revenues during 1997 and 1996, respectively.
 
     International revenues accounted for 62%, 65% and 67% of net revenues in
1998, 1997 and 1996, respectively. International revenues were a significant
portion of total revenues primarily due to volume shipments of the CL480, CL680
and CL8800 families of products in Asia for VideoCD and Chaoji VCD players in
the consumer market. The Company sells products and supports customers
internationally through subsidiaries in Hong Kong and Japan. The Company expects
that international revenues will continue to represent a significant portion of
net revenues.* C-Cube's international sales and manufacturing are subject to
changes in foreign political and economic conditions and to other risks,
including fluctuations in foreign exchange rates, export/import controls and
changes in tax laws, tariffs and freight rates. See "Item 1.
Business -- International Business Activities."
 
     GROSS MARGIN
 
     C-Cube's gross margin percentage decreased to 54.3% in 1998 from 55.1% in
1997. This decrease is due primarily to higher product transition costs and
lower average selling prices partially offset by reduced product material costs
and a shift in product mix to higher margin encoder products. The Company has
been able to reduce product material costs through the negotiation of lower
foundry wafer prices, the adoption of finer geometry fabrication processes and
the redesign of products to reduce die size. C-Cube's gross margin percentage
increased to 55.1% in 1997 from 54.6% in 1996. This improvement is due primarily
to lower product transition costs, reduced product costs and a shift in product
mix to higher margin encoder products.
 
     The markets into which C-Cube sells its products are subject to extreme
price competition. Thus, the Company expects to continue to experience declines
in the selling prices of its products over the life cycle of each product.* In
particular, C-Cube expects to continue to experience significant price
competition in the markets for decoder chips.* In order to offset or partially
offset declines in the selling prices of its products, C-Cube must continue to
reduce the costs of products through product design changes, manufacturing
process changes, volume discounts, yield improvements and other savings
negotiated with its manufacturing subcontractors. Since the Company does not
believe that it can continually achieve cost reductions which fully offset the
price declines of its products, it expects gross margin percentages to decline
for existing products over their life cycles.*
 
     C-Cube does not operate its own manufacturing facilities and must make
volume commitments to subcontractors at prices that remain fixed over certain
periods of time. Therefore, the Company may not be able to reduce its costs as
rapidly as its competitors who perform their own manufacturing. Failure of the
 
                                       24
<PAGE>   27
 
Company to design and introduce, in a timely manner, lower cost versions of
existing products or new products with higher gross margins, or to successfully
manage its manufacturing subcontractor relationships, would have a material
adverse effect on C-Cube's gross margins.
 
     RESEARCH AND DEVELOPMENT EXPENSES
 
     In 1998, research and development expenses were $74.0 million or 21.0% of
net revenues, compared to $64.2 million or 19.1% of net revenues in 1997. The
increase in research and development expenses from the prior year is primarily
related to an increase in employee-related costs associated with increases in
product engineering staff, partially offset by decreases in start-up and
non-recurring engineering costs. In 1997, research and development expenses were
$64.2 million or 19.1% of net revenues, compared to $44.2 million or 13.8% of
net revenues in 1996. The increase in absolute research and development expenses
from the prior year primarily represents the inclusion of DiviCom's operations
for a full year in 1997, compared to the 1996 period subsequent to the August
28, 1996 date of acquisition. The increase over 1996 was also due to additional
employee-related costs associated with increased staffing, reflecting the
Company's continuing efforts to provide industry leading digital video solutions
at the chip and systems levels. The Company anticipates that absolute levels of
research and development expenses will continue to increase in future periods.*
 
     SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
 
     Selling, general and administrative expenses increased to $60.5 million or
17.2% of net revenues in 1998 compared to $52.7 million or 15.6% of net revenues
for 1997. The increase in absolute dollars was primarily due to increased
travel, staffing and related expenses partially offset by decreased commissions
to distributors. Selling, general and administrative expenses increased to $52.7
million or 15.6% of net revenues in 1997 compared to $39.0 million or 12.2% of
net revenues for 1996. The increase in spending was primarily due to the
inclusion of DiviCom's operations for a full year in 1997, compared to the 1996
period subsequent to the August 28, 1996 date of acquisition. The increase over
1996 was also due to increased headcount and related expenses, increased travel
costs and higher advertising costs. The Company expects that absolute levels of
selling, general and administrative expenses will continue to increase in future
periods.*
 
     OTHER INCOME (EXPENSE)
 
     Interest income and other increased to $8.5 million in 1998 compared to
$4.3 million in 1997 primarily due to higher average balances of cash and
investments in 1998 compared to 1997. Interest income and other decreased to
$4.3 million in 1997 compared to $5.9 million in 1996 primarily due to lower
average balances in cash and investments in 1997 compared to 1996. Interest
expense and other decreased to $4.3 million in 1998 compared to $6.0 million in
1997 primarily due to lower average outstanding debt balances due to the
repurchase of a significant portion of the Company's convertible subordinated
notes. Interest expense and other remained consistent at $6.0 million in 1997
and 1996 and consisted primarily of interest paid on the $86.3 million principal
of convertible subordinated notes issued in the fourth quarter of 1995.
 
     INCOME TAX EXPENSE
 
     The Company provided $18.2 million for income taxes in 1998 on income
before taxes, minority interest and extraordinary items of $60.7 million, for an
effective tax rate of 30%. In 1997, the Company provided $22.9 million on income
before taxes and minority interest of $67.0 million, for an effective tax rate
of 34%. In 1996, the Company provided $32.9 million on a loss before income
taxes and minority interest of $39.8 million, as the write-off of purchased
in-process technology in 1996 was not tax deductible. The effective tax rate in
1996 was 36% excluding the 1996 purchased in-process technology charge. The
effective tax rates for 1998, 1997 and 1996 are less than the combined federal
and state statutory rate primarily due to tax credits and lower foreign taxes.
 
                                       25
<PAGE>   28
 
     EXTRAORDINARY ITEM
 
     During 1998, the Company repurchased $63.5 million of the face value of the
Company's 5.875% subordinated convertible notes due in 2005 at 88.4% of the
principal amount with accrued interest to the date of repurchase. Upon
repurchase of the notes, the Company recognized extraordinary gains of $3.5
million, or $0.09 per diluted share, net of related income taxes of $2.4
million.
 
FACTORS THAT MAY AFFECT FUTURE RESULTS
 
     The Company's quarterly and annual operating results have been, and will
continue to be, affected by a wide variety of factors that could have a material
adverse effect on revenues and profitability during any particular period,
including the level of orders which are received and can be shipped in a
quarter, the rescheduling or cancellation of orders by its customers,
competitive pressures on selling prices, changes in product or customer mix,
availability and cost of foundry capacity and raw materials, fluctuations in
yield, loss of any strategic relationships, C-Cube's ability to introduce new
products and technologies on a timely basis, unanticipated problems in the
performance of the Company's next generation or cost-reduced products, the
ability to successfully introduce products in accordance with OEM design
requirements and design cycles, new product introductions by the Company's
competitors, market acceptance of products of both C-Cube and its customers,
supply constraints for other components incorporated into its customers'
products, fluctuations in the Japanese yen and Great Britain pound to U.S.
dollar exchange rates, and the level of expenditures in manufacturing, research
and development and sales, general and administrative functions.*
 
     In addition, C-Cube's operating results are subject to fluctuations in the
markets for its customers' products, particularly the consumer electronics
market, which has been extremely volatile in the past, and the satellite
broadcast and wireless cable markets, which are in an early stage, creating
uncertainty with respect to product volume and timing. The Company has devoted a
substantial portion of its research and development efforts in recent quarters
to developing chips used in DVD systems. The Company's DVD products are subject
to the new product risks described in the preceding paragraph, including in
particular C-Cube's ability to timely introduce these products and the market's
acceptance of them, which could have a materially adverse affect on its
operating results. Furthermore, to the extent the Company is unable to fulfill
its customers' purchase orders on a timely basis, these orders may be canceled
due to changes in demand in the markets for its customers' products.
Historically, the Company has generally shipped a substantial portion of its
product in the last month of a given quarter. A significant portion of C-Cube's
expenses are fixed in the short term, and the timing of increases in expenses is
based in large part on the Company's forecast of future revenues. As a result,
if revenues do not meet the Company's expectations, it may be unable to quickly
adjust expenses to levels appropriate to actual revenues, which could have a
material adverse effect on the Company's business and results of operations.
 
     Due to the Company's dependence on the consumer electronics market, the
substantial seasonality of sales in that market could impact the Company's
revenues and net income. In particular, C-Cube believes that there may be
seasonality in the Asia-Pacific region related to the Chinese New Year, which
falls within the first calendar quarter, which could result in relatively lower
product demand from mid-first quarter until mid-third quarter.* If the future
geographic mix of the Company's sales shifts towards the U.S. and Europe, C-Cube
would anticipate higher revenues and net income in the third and fourth calendar
quarters as system manufacturers in these areas make purchases in preparation
for the holiday season, and comparatively less revenues and net income in the
first and second calendar quarters.*
 
     The economic crisis in Asia has been characterized by increases in idle
production capacity, real estate vacancies, unemployment and bank failures, and
has resulted in currency devaluation, falling consumer spending and domestic
price deflation. Any of these factors could significantly reduce the demand for
the end user goods in which the Company's products are used.
 
     As a result of the foregoing, the Company's operating results and stock
price may be subject to significant volatility, particularly on a quarterly
basis. Any shortfall in net revenues or net income from levels expected by
securities analysts could have an immediate and significant adverse effect on
the trading price of the
 
                                       26
<PAGE>   29
 
Company's common stock. See "Concentration of Credit Risk" and "Product and
Geographic Risks" in Note 1 of Notes to Consolidated Financial Statements.
 
     The market price of C-Cube's common stock has fluctuated significantly
since the initial public offering in April 1994. The market price of the common
stock could be subject to significant fluctuations in the future based on
factors such as announcements of new products by C-Cube or its competitors,
quarterly fluctuations in C-Cube's financial results or other semiconductor
companies' financial results, changes in analysts' estimates of C-Cube's
financial performance, general conditions in the semiconductor and digital video
networking industries, conditions in the financial markets and general
conditions in the global economy which might adversely affect consumer
purchasing. In addition, the stock market in general has experienced extreme
price and volume fluctuations, which have particularly affected the market
prices for many high technology companies and which have often been unrelated to
the operating performance of the specific companies. The market price of
C-Cube's common stock has declined substantially from historic highs, and may
continue to experience significant fluctuations in the future.
 
     YEAR 2000
 
     The Company is aware of the issues associated with the programming code in
existing computer systems as the millennium (Year 2000) approaches. The Year
2000 problem is pervasive and complex, as virtually every computer operation
will be affected by the rollover of the two digit year value to 00. The issue is
whether computer systems will properly recognize date sensitive information when
the year changes to 2000. Systems that do not properly recognize such
information could generate erroneous data or cause a system to fail. C-Cube has
initiated a Year 2000 project designed to identify and assess the risks
associated with its information systems, products, operations and
infrastructure, suppliers and customers that are not Year 2000 compliant, and to
develop, implement and test remediation and contingency plans to mitigate these
risks. C-Cube is replacing or upgrading systems, equipment and facilities that
are known to be Year 2000 non-compliant. For the Year 2000 non-compliance issues
identified to date, management believes the cost of upgrade or remediation will
not exceed $500,000, which is not expected to be material to the Company's
operating results.* If implementation of replacement systems is delayed, or if
significant new non-compliance issues are identified, the Company's results of
operations or financial condition could be materially adversely affected.
 
     Information Systems. A review of the Company's information systems has been
completed and the Company has initiated the work necessary for the existing
systems to become Year 2000 compliant. Testing of all information systems will
be conducted throughout 1999. The Company is also actively reviewing its
hardware and systems infrastructure, such as networks, in order to ensure that
they are Year 2000 compliant. Based on the current status of the assessments and
remediation plans made to date, and as the costs incurred to date have not been
material, the Company does not expect total Year 2000 related costs pertaining
to its information systems and hardware and systems infrastructure to be
material.*
 
     Products. The Company has assessed the capabilities of its products sold to
customers and has not identified any problems related to Year 2000 compliance.
The Company is in the process of identifying and assessing the risks related to
integrated systems that include third party products sold by its DiviCom
subsidiary. The Company believes its current products are Year 2000 compliant;
however, since all customer situations cannot be anticipated, particularly those
involving third party products, C-Cube may see an increase in warranty and other
claims as a result of the Year 2000 transition. In addition, litigation against
the Company regarding Year 2000 compliance issues may occur in the future. For
these reasons, the impact of customer claims could have a material adverse
impact on the Company's results of operations or financial condition.
 
     Operations and Infrastructure. Machinery and equipment and other items used
in the operations and facilities of the Company have been inventoried and are
currently being assessed for Year 2000 compliance. The assessment to date has
not uncovered any material issues.
 
     Suppliers. C-Cube is in the process of contacting its critical suppliers to
determine whether their operations, products and services are Year 2000
compliant. Where practicable, C-Cube will attempt to
                                       27
<PAGE>   30
 
mitigate its risks with respect to the failure of suppliers to be Year 2000
compliant. In the event that suppliers are not Year 2000 compliant, the Company
will seek alternative sources of supplies. However, such failures remain a
possibility and could have a material impact on the Company's results of
operations or financial condition.
 
     Customers. The Company is actively responding to all customer requests for
compliance, surveys and other general information related to its Year 2000
programs. The Company will also request assurance from its key customers that
they, and their products which incorporate C-Cube's products, are Year 2000
compliant.
 
     General. The Company does not currently expect its costs associated with
the Year 2000 problem to be material, and expects to be able to fund these costs
through operating cash flows.* However, the Company has not yet completed its
assessments, developed remediation plans for all problems, developed contingency
plans, or completely implemented or tested any of its remediation plans. The
risks associated with the Year 2000 problem can be difficult to identify and to
address, and could result in material adverse consequences to the Company. Even
if the Company, in a timely manner, completes all of its assessments, identifies
and tests remediation plans believed to be adequate, and develops contingency
plans believed to be adequate, some problems may not be identified or corrected
in time to prevent material adverse consequences to the Company.
 
     As the Year 2000 project continues, the Company may discover additional
Year 2000 problems, may not be able to develop, implement, or test remediation
or contingency plans in a timely manner, or may find that the costs of these
activities exceed current expectations and become material. In many cases, the
Company is relying on assurances from suppliers and customers that new and
upgraded information systems and other products will be Year 2000 compliant. The
Company plans to test certain third-party products, but cannot be sure that its
tests will be adequate or that, if problems are identified, they will be
addressed by the supplier in a timely and satisfactory way.
 
     Because the Company uses a variety of information systems and has
additional systems embedded in its operations and infrastructure, the Company
cannot be sure that all of its systems will work together in a Year
2000-compliant fashion. Furthermore, the Company cannot be sure that it will not
suffer business interruptions, either because of its own Year 2000 problems or
those of its customers or suppliers whose Year 2000 problems may make it
difficult or impossible for them to fulfill their commitments to the Company. If
the Company fails to satisfactorily resolve Year 2000 issues related to its
products in a timely manner, it could be exposed to liability to third parties.
 
     The Company has not developed a "worst case" scenario with respect to Year
2000 issues, but instead has focused its resources on identifying material,
remediable problems and reducing uncertainties generally, through the Year 2000
project described above.
 
     If the Company or the third parties with which it has relationships were to
cease or not successfully complete its or their Year 2000 remediation efforts,
the Company would encounter disruptions to its business that could have a
material adverse effect on its business, financial position and results of
operations. The Company could be materially and adversely impacted by widespread
economic or financial market disruption or by Year 2000 computer system failures
at third parties with which it has relationships.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     Cash, cash equivalents and short-term investments increased to $207.8
million at December 31, 1998 from the $166.4 million at the end of 1997. Working
capital increased to $220.5 million at December 31, 1998 from $208.4 million at
the end of 1997.
 
     The Company's operating activities generated cash of $98.3 million in 1998,
compared to $88.6 million in 1997 reflecting increased income taxes payable,
accounts payable and accrued liabilities balances and decreased accounts
receivable balances.
 
     C-Cube's investing activities, exclusive of the sales and maturities and
purchases of short-term investments of $69.7 million and $147.3 million,
respectively, used cash of $19.8 million, primarily for capital expenditures.
 
                                       28
<PAGE>   31
 
     Cash used in financing activities was $37.5 million, primarily from $56.1
million used to repurchase a portion of the Company's convertible subordinated
notes, partially offset by sales of stock pursuant to employee stock plans of
$20.1 million.
 
     At December 31, 1998, the Company had an available bank line of credit of
$30.0 million which expires May 1, 1999. Borrowings bear interest at LIBOR plus
1.25% or the bank's prime rate (7.75% at December 31, 1998). The line of credit
agreement requires the Company, among other things, to maintain a minimum
tangible net worth, annual net income (no quarterly loss exceeding $3.0 million)
and certain financial ratios. In addition, the bank agreement prohibits the
payment of cash dividends. At December 31, 1998, the Company was in compliance
with these covenants, and there were no borrowings under this line.
 
     In the second quarter of 1996, the Company expanded and formalized its
relationship with Taiwan Semiconductor Manufacturing Co., Ltd. (TSMC) to provide
additional wafer production capacity in the years 1996 to 2001. The agreement
with TSMC provided that TSMC would produce and ship wafers to C-Cube at
specified prices and required C-Cube to make two advance payments totaling $49.0
million. An advance payment of $24.5 million was made in June 1996. In May 1997,
the Company amended its agreement with TSMC which resulted in a reduction of the
Company's future wafer purchase commitments and the forgiveness of the second
advance payment of $24.5 million. TSMC will apply the June 1996 prepayment
against a portion of the wafer cost as product is delivered to C-Cube.
Accordingly, the prepaid amount, which has been allocated between current and
long-term assets, will be amortized to inventory as wafers are received. At
December 31, 1998, $5.6 million of the remaining $18.2 million production
capacity rights is included in other current assets. In January 1999, the
Company signed a second amendment to its agreement with TSMC which will result
in a refund to the Company of $11.7 million from the remaining $18.2 million
balance in production capacity.
 
     Based on current plans and business conditions, C-Cube expects that its
cash, cash equivalents and short-term investments together with any amounts
generated from operations and available borrowings, will be sufficient to meet
the Company's cash requirements for at least the next 12 months.* However, there
can be no assurance that the Company will not be required to seek other
financing sooner or that such financing, if required, will be available on terms
satisfactory to the Company. In addition, the Company has considered and will
continue to consider various possible transactions to secure additional foundry
capacity, which could include, without limitation, equity investments in,
prepayments to, non-refundable deposits with or loans to foundries in exchange
for guaranteed capacity, "take or pay" contracts that commit the Company to
purchase specified quantities of wafers over extended periods, joint ventures or
other partnership relationships with foundries.
 
                                       29
<PAGE>   32
 
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
     The following discussion about the Company's market risk disclosures
involves forward-looking statements. Actual results could differ materially from
those projected in the forward-looking statements. The Company is exposed to
market risk related to changes in interest rates and foreign currency exchange
rates. The Company does not use derivative financial instruments for speculative
or trading purposes.
 
     Interest Rate Sensitivity. The Company maintains a short-term investment
portfolio consisting mainly of income securities with an average maturity of
less than two years. The market value of this portfolio was $99.6 million at
December 31, 1998. These available-for-sale securities are subject to interest
rate risk and will fall in value if market interest rates increase. If market
interest rates were to increase immediately and uniformly by 10% from current
levels at December 31, 1998, the fair value of the portfolio would decline by
$0.4 million. The Company has the ability to hold its fixed income investments
until maturity, and therefore the Company would not expect its operating results
or cash flows to be affected to any significant degree by the effect of a sudden
change in market interest rates on its securities portfolio.* The Company does
not hedge any interest rate exposures.
 
     The Company has fixed rate long-term debt of approximately $22.8 million,
and a hypothetical 10% decrease in current interest rates from levels at
December 31, 1998 would not have a material impact on the fair market value of
this debt.
 
     Foreign Currency Exchange Risk. The Company enters into foreign exchange
forward contracts and foreign currency options to hedge certain economic
exposures, balance sheet exposures and intercompany balances against future
movements in the dollar/yen and dollar/pound exchange rates. Gains and losses on
the forward contracts are largely offset by gains and losses on the underlying
exposure. A hypothetical 10% appreciation of the U.S. dollar from December 31,
1998 market rates would increase the unrealized value of the Company's forward
contracts by $0.3 million. Conversely, a hypothetical 10% depreciation of the
U.S. dollar from December 31, 1998 market rates would decrease the unrealized
value of the Company's forward contracts by $0.3 million. In either scenario,
the gains or losses on the forward contracts are largely offset by the gains or
losses on the underlying transactions and consequently a sudden or significant
change in foreign exchange rates would not be expected to have a material impact
on future net income or cash flows.
 
     All of the potential changes noted above are based on sensitivity analyses
performed on the Company's financial positions at December 31, 1998. Actual
results may differ materially.
 
                                       30
<PAGE>   33
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
         INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
 
<TABLE>
<CAPTION>
                                                              PAGE
                                                              ----
<S>                                                           <C>
Financial Statements:
  Independent Auditors' Report..............................   32
  Consolidated Balance Sheets at December 31, 1998 and
     1997...................................................   33
  Consolidated Statements of Operations for the years ended
     December 31, 1998, 1997 and 1996.......................   34
  Consolidated Statements of Changes in Stockholders' Equity
     for the years ended December 31, 1998, 1997 and 1996...   35
  Consolidated Statements of Cash Flows for the years ended
     December 31, 1998, 1997 and 1996.......................   36
  Notes to Consolidated Financial Statements................   37
Financial Statement Schedule:
  Independent Auditors' Report..............................   57
  Schedule II -- Valuation and Qualifying Accounts and
     Reserves...............................................   58
</TABLE>
 
     All other schedules are omitted because they are not required, are not
applicable, or the information is included in the financial statements or notes
thereto.
 
                                       31
<PAGE>   34
 
                          INDEPENDENT AUDITORS' REPORT
 
To the Board of Directors and Stockholders of
C-Cube Microsystems Inc.:
 
     We have audited the accompanying consolidated balance sheets of C-Cube
Microsystems Inc. and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1998. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
 
     In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of C-Cube Microsystems Inc. and
subsidiaries at December 31, 1998 and 1997, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1998 in conformity with generally accepted accounting principles.
 
/s/  Deloitte & Touche LLP
 
DELOITTE & TOUCHE LLP
 
San Jose, California
January 21, 1999
 
                                       32
<PAGE>   35
 
                          CONSOLIDATED BALANCE SHEETS
                    (IN THOUSANDS, EXCEPT PAR VALUE AMOUNTS)
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                              DECEMBER 31,   DECEMBER 31,
                                                                  1998           1997
                                                              ------------   ------------
<S>                                                           <C>            <C>
Current assets:
  Cash and equivalents......................................    $108,224       $145,034
  Short-term investments....................................      99,603         21,316
  Accounts receivable, net of allowances: 1998 -- $17,034,
     1997 -- $10,175........................................      36,980         40,606
  Inventories...............................................      16,073         15,270
  Deferred income taxes.....................................      11,170         11,496
  Other current assets......................................      19,977         14,666
                                                                --------       --------
          Total current assets..............................     292,027        248,388
Property and equipment -- net...............................      29,622         23,561
Production capacity rights..................................      12,600         18,200
Distribution rights -- net..................................       1,483          1,648
Purchased technology -- net.................................       5,921          9,408
Other assets................................................       1,518          2,903
                                                                --------       --------
          Total.............................................    $343,171       $304,108
                                                                ========       ========
 
                          LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable..........................................    $ 19,942       $  9,221
  Accrued compensation and benefits.........................      12,379          9,639
  Other accrued liabilities.................................      16,628         14,167
  Income taxes payable......................................      15,551          2,467
  Deferred contract revenue.................................       6,706          3,895
  Current portion of long-term obligations..................         355            608
                                                                --------       --------
          Total current liabilities.........................      71,561         39,997
Long-term obligations.......................................      23,557         87,462
Deferred income taxes.......................................       4,650            869
                                                                --------       --------
          Total liabilities.................................      99,768        128,328
                                                                --------       --------
Minority interest in subsidiary.............................          28            365
Stockholders' equity:
  Preferred stock, $0.001 par value, 5,000 shares
     authorized.............................................          --             --
  Common stock, $0.001 par value, 150,000 shares authorized;
     shares outstanding: 1998 -- 38,261, 1997 -- 36,787.....     225,265        203,728
  Accumulated other comprehensive loss......................      (1,852)        (1,986)
  Retained earnings (deficit)...............................      19,962        (26,327)
                                                                --------       --------
          Total stockholders' equity........................     243,375        175,415
                                                                --------       --------
          Total.............................................    $343,171       $304,108
                                                                ========       ========
</TABLE>
 
                See notes to consolidated financial statements.
                                       33
<PAGE>   36
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                                 YEARS ENDED DECEMBER 31,
                                                              ------------------------------
                                                                1998       1997       1996
                                                              --------   --------   --------
<S>                                                           <C>        <C>        <C>
Net revenues................................................  $351,797   $337,012   $319,758
                                                              --------   --------   --------
Costs and expenses:
  Cost of product revenues..................................   160,839    151,333    144,985
  Research and development..................................    74,031     64,204     44,177
  Selling, general and administrative.......................    60,512     52,732     39,002
  Purchased in-process technology...........................        --         --    131,349
                                                              --------   --------   --------
          Total.............................................   295,382    268,269    359,513
                                                              --------   --------   --------
Income (loss) from operations...............................    56,415     68,743    (39,755)
Other income (expense):
  Interest income and other.................................     8,511      4,291      5,934
  Interest expense and other................................    (4,272)    (6,048)    (5,962)
                                                              --------   --------   --------
          Total.............................................     4,239     (1,757)       (28)
                                                              --------   --------   --------
Income (loss) before income taxes, minority interest and
  extraordinary item........................................    60,654     66,986    (39,783)
Income tax expense..........................................    18,196     22,895     32,944
                                                              --------   --------   --------
Income (loss) before minority interest and extraordinary
  item......................................................    42,458     44,091    (72,727)
Minority interest in net income (loss) of subsidiary........      (337)      (248)       318
                                                              --------   --------   --------
Income (loss) before extraordinary item.....................    42,795     44,339    (73,045)
Extraordinary gain on repurchase of convertible notes (net
  of tax)...................................................     3,494         --         --
                                                              --------   --------   --------
Net income (loss)...........................................  $ 46,289   $ 44,339   $(73,045)
                                                              ========   ========   ========
Basic earnings (loss) per share:
  Income (loss) before extraordinary item...................  $   1.14   $   1.21   $  (2.15)
  Extraordinary item (net of tax)...........................  $   0.09   $     --   $     --
                                                              --------   --------   --------
  Net income (loss).........................................  $   1.24   $   1.21   $  (2.15)
                                                              ========   ========   ========
Diluted earnings (loss) per share:
  Income (loss) before extraordinary item...................  $   1.11   $   1.15   $  (2.15)
  Extraordinary item (net of tax)...........................  $   0.09   $     --   $     --
                                                              --------   --------   --------
  Net income (loss).........................................  $   1.19   $   1.15   $  (2.15)
                                                              ========   ========   ========
Shares:
  Basic.....................................................    37,382     36,497     33,928
                                                              ========   ========   ========
  Diluted...................................................    40,754     41,683     33,928
                                                              ========   ========   ========
</TABLE>
 
                See notes to consolidated financial statements.
                                       34
<PAGE>   37
 
           CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>
                                                                             NOTES        ACCUMULATED
                                         COMMON STOCK        DEFERRED      RECEIVABLE        OTHER       RETAINED        TOTAL
                                       -----------------      STOCK           FROM       COMPREHENSIVE   EARNINGS    STOCKHOLDERS'
                                       SHARES    AMOUNT    COMPENSATION   STOCKHOLDERS       LOSS        (DEFICIT)      EQUITY
                                       ------   --------   ------------   ------------   -------------   ---------   -------------
<S>                                    <C>      <C>        <C>            <C>            <C>             <C>         <C>
BALANCES, JANUARY 1, 1996............  32,363   $ 87,124      $(635)         $(459)         $  (874)     $  2,379      $ 87,535
Net loss.............................                                                                     (73,045)      (73,045)
Accumulated translation
  adjustments........................                                                          (378)                       (378)
Unrealized gain on investments.......                                                             1                           1
Comprehensive loss...................
Common stock issued under stock
  plans..............................   1,359      7,302                                                                  7,302
Common stock issued and stock options
  assumed in connection with business
  acquisition........................   2,291     76,580                                                                 76,580
Tax benefit from employee stock
  transactions.......................             20,038                                                                 20,038
Amortization of deferred stock
  compensation.......................                           385                                                         385
Collection of notes receivable from
  stockholders.......................                                          154                                          154
                                       ------   --------      -----          -----          -------      --------      --------
BALANCES, DECEMBER 31, 1996..........  36,013    191,044       (250)          (305)          (1,251)      (70,666)      118,572
Net income...........................                                                                      44,339        44,339
Accumulated translation
  adjustments........................                                                          (731)                       (731)
Unrealized loss on investments.......                                                            (4)                         (4)
Comprehensive income.................
Common stock issued under stock
  plans..............................     774      9,111                                                                  9,111
Tax benefit from employee stock
  transactions.......................              3,573                                                                  3,573
Amortization of deferred stock
  compensation.......................                           250                                                         250
Collection of notes receivable from
  stockholders.......................                                          305                                          305
                                       ------   --------      -----          -----          -------      --------      --------
BALANCES, DECEMBER 31, 1997..........  36,787    203,728         --             --           (1,986)      (26,327)      175,415
Net income...........................                                                                      46,289        46,289
Accumulated translation
  adjustments........................                                                            41                          41
Unrealized gain on investments.......                                                            93                          93
Comprehensive income.................
Common stock issued under stock
  plans..............................   1,474     20,111                                                                 20,111
Tax benefit from employee stock
  transactions.......................              1,426                                                                  1,426
                                       ------   --------      -----          -----          -------      --------      --------
BALANCES, DECEMBER 31, 1998..........  38,261   $225,265      $  --          $  --          $(1,852)     $ 19,962      $243,375
                                       ======   ========      =====          =====          =======      ========      ========
 
<CAPTION>
                                           TOTAL
                                       COMPREHENSIVE
                                          INCOME
                                          (LOSS)
                                       -------------
<S>                                    <C>
BALANCES, JANUARY 1, 1996............
Net loss.............................    $(73,045)
Accumulated translation
  adjustments........................        (378)
Unrealized gain on investments.......           1
                                         --------
Comprehensive loss...................    $(73,422)
                                         ========
Common stock issued under stock
  plans..............................
Common stock issued and stock options
  assumed in connection with business
  acquisition........................
Tax benefit from employee stock
  transactions.......................
Amortization of deferred stock
  compensation.......................
Collection of notes receivable from
  stockholders.......................
                                         --------
BALANCES, DECEMBER 31, 1996..........
Net income...........................    $ 44,339
Accumulated translation
  adjustments........................        (731)
Unrealized loss on investments.......          (4)
                                         --------
Comprehensive income.................    $ 43,604
                                         ========
Common stock issued under stock
  plans..............................
Tax benefit from employee stock
  transactions.......................
Amortization of deferred stock
  compensation.......................
Collection of notes receivable from
  stockholders.......................
                                         --------
BALANCES, DECEMBER 31, 1997..........
Net income...........................    $ 46,289
Accumulated translation
  adjustments........................          41
Unrealized gain on investments.......          93
                                         --------
Comprehensive income.................    $ 46,423
                                         ========
Common stock issued under stock
  plans..............................
Tax benefit from employee stock
  transactions.......................
BALANCES, DECEMBER 31, 1998..........
</TABLE>
 
                See notes to consolidated financial statements.
                                       35
<PAGE>   38
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                 YEARS ENDED DECEMBER 31,
                                                              -------------------------------
                                                                1998        1997       1996
                                                              ---------   --------   --------
<S>                                                           <C>         <C>        <C>
Cash flows from operating activities:
  Net income (loss).........................................  $  46,289   $ 44,339   $(73,045)
  Adjustments to reconcile net income (loss) to net cash
     provided by operating activities:
     Extraordinary gain on repurchase of convertible
       notes................................................     (3,494)        --         --
     Minority interest in subsidiary........................       (337)      (248)       318
     Depreciation and amortization..........................     22,577     17,396      7,728
     Deferred income taxes..................................      4,107      3,356     (9,007)
     Purchased in-process technology........................         --         --    131,349
     Changes in assets and liabilities:
       Receivables..........................................      4,138       (146)      (890)
       Inventories..........................................       (490)    12,712     (6,751)
       Production capacity rights...........................         --         --    (24,500)
       Prepaids and other assets............................     (4,457)    10,956       (455)
       Accounts payable.....................................     10,153     (8,993)    (6,685)
       Income taxes payable.................................     10,680      2,147     (9,789)
       Deferred contract revenue............................      2,811     (2,815)     6,710
       Accrued liabilities..................................      6,352      9,926        238
                                                              ---------   --------   --------
  Net cash provided by operating activities.................     98,329     88,630     15,221
                                                              ---------   --------   --------
Cash flows from investing activities:
  Sales and maturities of short-term investments............     69,736     14,850     54,701
  Purchases of short-term investments.......................   (147,322)   (29,956)   (49,297)
  Capital expenditures......................................    (20,037)   (13,572)   (17,141)
  Acquisition of business (net of $8.4 million cash acquired
     in 1996)...............................................         --         --    (58,568)
  Other assets..............................................        207        368       (126)
                                                              ---------   --------   --------
  Net cash used in investing activities.....................    (97,416)   (28,310)   (70,431)
                                                              ---------   --------   --------
Cash flows from financing activities:
  Bank borrowings...........................................     39,541         --         --
  Repayment of bank borrowings..............................    (39,541)        --         --
  Notes payable -- net......................................         --         --     (8,836)
  Payment of purchase consideration.........................     (1,125)        --         --
  Payments of capital lease obligations.....................       (369)      (467)      (626)
  Repurchase of convertible subordinated notes..............    (56,099)        --         --
  Sale of common stock, net of notes receivable.............     20,111      9,111      7,302
  Collection of stockholder notes receivable................         --        305        154
                                                              ---------   --------   --------
  Net cash provided by (used in) financing activities.......    (37,482)     8,949     (2,006)
                                                              ---------   --------   --------
Exchange rate impact on cash and equivalents................       (241)      (476)        43
                                                              ---------   --------   --------
Net increase (decrease) in cash and equivalents.............    (36,810)    68,793    (57,173)
Cash and equivalents, beginning of period...................    145,034     76,241    133,414
                                                              ---------   --------   --------
Cash and equivalents, end of period.........................  $ 108,224   $145,034   $ 76,241
                                                              =========   ========   ========
Supplemental schedule of noncash investing and financing
  activities:
  Unrealized gain (loss) on investments.....................  $      93   $     (4)  $      1
  Purchase of production capacity rights for note payable...         --         --    (24,500)
  Forgiveness of note payable for production capacity
     rights.................................................         --     24,500         --
  Equipment acquired under lease............................        861         --         --
Supplemental disclosure of cash flow information --
  Cash paid during the period for:
     Interest...............................................  $   4,410   $  5,609   $  5,852
     Income taxes...........................................      1,092     11,473     38,127
</TABLE>
 
                See notes to consolidated financial statements.
 
                                       36
<PAGE>   39
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
 
     ORGANIZATION
 
     C-Cube Microsystems Inc. (the "Company" or "C-Cube") was founded in July
1988. The Company operates in two segments as a leading provider of both digital
video semiconductor solutions which implement international standards for
digital video, including MPEG-1 and MPEG-2, and digital video networks for
broadcast communications applications.
 
     CONSOLIDATION
 
     The consolidated financial statements include the Company, its wholly owned
subsidiaries and C-Cube Japan, Inc. (a 65% owned Japanese subsidiary) after
elimination of intercompany accounts and transactions.
 
     CASH AND EQUIVALENTS AND SHORT-TERM INVESTMENTS
 
     All highly liquid debt instruments purchased with a remaining maturity of
three months or less are classified as cash equivalents.
 
     Management determines the classification of debt and equity securities at
the time of purchase and reevaluates the classification at each balance sheet
date. Short-term investments are classified as available-for-sale when the
Company generally has the ability and intent to hold such securities to
maturity, but, in certain circumstances, may potentially dispose of such
securities prior to their maturity to implement management strategies.
Securities available-for-sale are reported at fair value with unrealized gains
and losses reported as a separate component of stockholders' equity. All
available-for-sale securities are classified as current assets.
 
     INVENTORIES
 
     Inventories are stated at the lower of cost (first-in, first-out) or
market. Cost is computed on a currently adjusted standard basis (which
approximates actual cost on a current average or first-in, first-out basis).
 
     PROPERTY AND EQUIPMENT
 
     Property and equipment are stated at cost. Depreciation is provided using
the straight-line method over estimated useful lives of three years. Equipment
under capital lease and leasehold improvements are amortized over the shorter of
their estimated useful lives, generally three years, or the lease term.
 
     INVESTMENTS IN COMPANIES
 
     Investments in 20% to 50% owned companies are accounted for using the
equity method. Investments in less than 20% owned companies are accounted for
using the cost method unless the Company can exercise significant influence or
the investee is economically dependent upon the Company, in which case the
equity method is used. Such investments are included in other assets.
 
     PRODUCTION CAPACITY RIGHTS
 
     Production capacity rights are allocated between current and long-term
assets and are amortized to inventory as wafers are received.
 
     REVENUE RECOGNITION
 
     The Company records product sales to customers and distributors at the time
of shipment. Certain of the Company's agreements with its distributors permit
limited stock rotation and provide for price protection. Allowances for returns
and adjustments, including price protection, are provided at the time sales are
recorded.
 
                                       37
<PAGE>   40
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
     Revenue from systems contracts is recognized based on milestones which
approximate the percentage of completion method. Estimates are reviewed and
revised periodically throughout the lives of the contracts. Any revisions are
recorded in the accounting period in which the revisions are made.
 
     RESEARCH AND DEVELOPMENT
 
     Research and development expenses include costs and expenses associated
with the development of the Company's design methodology and the design and
development of new products, including initial nonrecurring engineering and
product verification charges from foundries. Research and development is
expensed as incurred.
 
     INCOME TAXES
 
     The accounting for income taxes requires an asset and liability approach
and requires recognition of deferred tax liabilities and assets for the expected
future tax consequences of temporary differences between the financial statement
carrying amounts and the tax bases of assets and liabilities and net operating
loss and tax credit carryforwards.
 
     ESTIMATES
 
     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect reported amounts of assets, liabilities, revenues and
expenses as of the dates and for the periods presented. Actual results could
differ from those estimates.
 
     FAIR VALUE OF FINANCIAL INSTRUMENTS
 
     Financial instruments include cash equivalents, short-term investments, a
promissory note and convertible subordinated notes. Cash equivalents and
short-term investments are stated at fair value based on quoted market prices.
Fair value of convertible subordinated notes is determined using market
information and valuation methodologies considered to be appropriate. The
estimated fair value of the Company's convertible subordinated notes was $38
million and $70 million at December 31, 1998 and 1997, respectively. The
estimated fair value of all other financial instruments at December 31, 1998 and
1997 was not materially different from the values presented in the consolidated
balance sheets.
 
     CONCENTRATION OF CREDIT RISK
 
     Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of cash equivalents, short-term
investments, accounts receivable and financial instruments used in hedging
transactions. By policy, the Company places its investments only with financial
institutions meeting its credit guidelines and, other than U.S. Government
Treasury instruments, limits the amounts invested in any one institution or in
any type of instrument. Almost all of the Company's accounts receivable are
derived from sales to manufacturers and distributors in the consumer
electronics, computer and communications markets. The Company performs ongoing
credit evaluations of its customers' financial condition and manages its
exposure to losses from bad debts by limiting the amount of credit extended
whenever deemed necessary and generally does not require collateral.
 
     The Company is subject to credit risks related to sales made into Asia,
where an economic crisis, which resulted in several countries sharply devaluing
their currencies in 1998, is reducing the cash flows and the access to credit of
some of the Company's major customers. Approximately 49% of the Company's sales
in 1998 were into Asia. The Company is requiring letters of credit for
substantially all of its sales into Asia, except for those made into Japan and
Taiwan. Nevertheless, banks have failed in some of these countries in recent
months, and it is possible that there will be more such failures before the
crisis is settled. Bank failures
 
                                       38
<PAGE>   41
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
could cause the letters of credit upon which the Company is relying on not to be
paid or to be paid much later than is called for in the contract. To reduce this
risk, the Company is requiring its customers in Asia to obtain letters of credit
from only the largest banks in the customer's country, or in the case of China,
the largest banks in Hong Kong and China. However, there can be no assurance
that the largest banks in these countries will not fail, causing defaults
against letters of credit.
 
     PRODUCT AND GEOGRAPHIC RISKS
 
     Sales of the Company's VideoCD and Chaoji VCD decoder products represent a
significant percentage of the Company's total net revenues. Declines in demand
for these products, whether as a result of competition, technological change or
otherwise, would have a material adverse effect on the Company's business and
results of operations.
 
     The Asian consumer electronics markets accounted for approximately 49%, 55%
and 62% of total Company sales in 1998, 1997 and 1996, respectively. The
economic crisis in Asia has been characterized by increases in idle production
capacity, real estate vacancies, unemployment and bank failures, and has
resulted in currency devaluation, falling consumer spending and domestic price
deflation. Any of these factors could significantly reduce the demand for the
end user goods in which the Company's products are incorporated. Most of the
Company's sales in Asia were of decoder chips, which are used in VideoCD
players. There can be no assurance that the Company will not experience reduced
sales of its products into Asia because of declining consumer spending or
because of its customers' increasing difficulty in obtaining letters of credit,
which the Company requires prior to shipment.
 
     FOREIGN CURRENCY TRANSLATION
 
     The functional currency of C-Cube Japan is the Japanese yen. Accordingly
all assets and liabilities of C-Cube Japan are translated at the current
exchange rate at the end of the period and revenues and costs at average
exchange rates in effect during the period. Gains and losses from foreign
currency translation are recorded as a separate component of stockholders'
equity.
 
     FORWARD EXCHANGE CONTRACTS
 
     In the normal course of business, the Company has exposure to foreign
currency fluctuations arising from foreign currency purchases and intercompany
sales, among other things. The Company enters into forward exchange contracts to
neutralize the impact of foreign currency fluctuations on assets and
liabilities. All foreign exchange contracts are designated as and effective as
hedges. Gains and losses on forward exchange contracts are deferred and
recognized in income when the related transactions being hedged are recognized.
The costs of entering into such contracts are not material to the Company's
financial results. The fair value of exchange contracts is determined by
obtaining quoted market prices of comparable contracts at the balance sheet
date, adjusted by interpolation where necessary for maturity differences.
 
     At December 31, 1998, the Company had $0.6 million of outstanding foreign
exchange contracts to buy Japanese yen and $1.6 million of outstanding foreign
exchange contracts to sell Japanese yen. The net carrying value of contracts at
December 31, 1998 was $1.0 million and estimated fair value of these contracts
was $1.0 million. These contracts mature through March 1999. Also, at December
31, 1998, the Company had $4.2 million of outstanding foreign exchange contracts
to sell British pounds. The estimated fair value of these contracts was $4.2
million. These contracts mature through February 1999. Unrealized losses on
forward exchange contracts at December 31, 1998 were not material. The Company's
risk in these contracts is the cost of replacing, at current market rates, these
contracts in the event of default by the other party. These contracts are
executed with credit worthy financial institutions and are denominated in the
currency of major industrial nations.
 
                                       39
<PAGE>   42
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
     At December 31, 1997, the Company had $13.4 million of outstanding foreign
exchange contracts to buy Japanese yen and $1.3 million of outstanding foreign
exchange contracts to sell Japanese yen, maturing through April 1998. The net
carrying value of contracts at December 31, 1997 was $12.1 million and estimated
fair value of these contracts was $11.7 million. Unrealized losses on forward
exchange contracts at December 31, 1997 were $0.4 million. Prior to 1997, the
Company held no foreign exchange contracts.
 
     AMORTIZATION OF INTANGIBLES
 
     The Company amortizes distribution rights over 15 years and other
intangible assets over 5 years. The Company evaluates the recoverability of
intangibles and other long-lived assets on a regular basis based on estimated
future undiscounted cash flows.
 
     During 1995, the Company and Kubota Corporation contributed additional
equity to C-Cube Japan and the Company recorded a $768,000 adjustment to paid-in
capital to reflect subsidiary losses previously recognized.
 
     EARNINGS (LOSS) PER SHARE
 
     Basic earnings per share (EPS) excludes dilution and is computed by
dividing net income by the weighted average number of common shares outstanding
for the period. Diluted EPS reflects the potential dilution that would occur if
securities or other contracts to issue common stock were exercised or converted
into common stock.
 
     STOCK-BASED COMPENSATION
 
     The Company accounts for stock-based awards to employees using the
intrinsic value method in accordance with Accounting Principles Board No. 25,
"Accounting for Stock Issued to Employees."
 
     RECENTLY ISSUED ACCOUNTING STANDARDS
 
     In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities," which
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. Adoption of this statement is not expected to
materially impact the Company's consolidated financial position, results of
operations or cash flows. The Company is required to adopt this statement in the
first quarter of fiscal year 2000, with early adoption permitted.
 
     RECLASSIFICATIONS
 
     Certain prior year amounts have been reclassified to conform to the current
year presentation. These reclassifications had no effect on net income, net loss
or stockholders' equity.
 
NOTE 2. ACQUISITIONS
 
     On August 28, 1996, the Company acquired DiviCom Inc., a digital video
networking company. C-Cube paid $65.7 million in cash, issued 2.3 million shares
of its common stock valued at $69.6 million, assumed options exercisable for
264,000 shares of its common stock valued at $7.0 million and incurred $1.35
million in other costs in exchange for the outstanding shares of DiviCom stock
that C-Cube did not already own. The
 
                                       40
<PAGE>   43
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
purchase price was allocated on the basis of the estimated fair value of the
assets acquired and liabilities assumed as follows (in thousands):
 
<TABLE>
<S>                                                           <C>
Fair value of tangible assets acquired (including cash of
  $8,448)...................................................  $ 53,741
Purchased technology........................................    14,159
In-process technology.......................................   131,349
Liabilities assumed (including deferred tax liabilities of
  $5,239)...................................................   (55,653)
                                                              --------
Purchase consideration......................................  $143,596
                                                              ========
</TABLE>
 
     The purchased technology is being amortized over 5 years. The Company
incurred acquisition-related charges of $133 million, which include the
in-process technology write-off and bonuses paid to DiviCom employees.
 
     The acquisition of DiviCom was accounted for as a purchase and therefore
DiviCom financial results from the date of acquisition, August 28, 1996, are
included in C-Cube's consolidated financial results.
 
     Excluding the one-time charge of $133 million, intercompany sales and cost
of sales, and including amortization of purchased technology, pro forma revenue,
net income and diluted earnings per share would be $354 million, $49 million and
$1.27, respectively for the year ended December 31, 1996, assuming DiviCom had
been acquired at the beginning of the period. The pro forma results are not
necessarily indicative of what actually would have occurred if the acquisition
had been in effect for the entire period presented or of future operations of
the combined companies.
 
NOTE 3. PRODUCTION CAPACITY RIGHTS
 
     In the second quarter of 1996, the Company expanded and formalized its
relationship with Taiwan Semiconductor Manufacturing Co., Ltd. (TSMC) to provide
additional wafer production capacity in the years 1996 to 2001. The agreement
with TSMC provided that TSMC would produce and ship wafers to C-Cube at
specified prices and required C-Cube to make two advance payments totaling $49
million. An advance payment of $24.5 million was made in June 1996. In May 1997,
the Company amended its agreement with TSMC which resulted in a reduction of the
Company's future wafer purchase commitments and the forgiveness of the second
advance payment of $24.5 million. TSMC will apply the June 1996 prepayment
against a portion of the wafer cost as product is delivered to C-Cube.
Accordingly, the prepaid amount, which has been allocated between current and
long-term assets, will be amortized to inventory as wafers are received. At
December 31, 1998, $5.6 million of the remaining $18.2 million production
capacity rights is included in other current assets. In January 1999, the
Company signed a second amendment to its agreement with TSMC which will result
in a refund to the Company of $11.7 million from the remaining $18.2 million
balance in prepaid capacity.
 
                                       41
<PAGE>   44
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
NOTE 4. SHORT-TERM INVESTMENTS
 
     Short-term investments include the following available-for-sale securities
as of December 31, 1998 and 1997:
 
<TABLE>
<CAPTION>
                                                                       UNREALIZED   UNREALIZED
                                                 AMORTIZED   MARKET     HOLDING      HOLDING
                                                   COST       VALUE      GAINS        LOSSES
                                                 ---------   -------   ----------   ----------
                                                                (IN THOUSANDS)
<S>                                              <C>         <C>       <C>          <C>
1998:
  Commercial paper.............................   $40,554    $40,550      $ 20         $(24)
  Municipal bonds..............................    32,856     32,929        88          (15)
  U.S. government agencies.....................    26,117     26,124         7           --
                                                  -------    -------      ----         ----
          Total short-term investments.........   $99,527    $99,603      $115         $(39)
                                                  =======    =======      ====         ====
1997:
  Commercial paper.............................   $21,333    $21,316      $ --         $(17)
                                                  =======    =======      ====         ====
</TABLE>
 
     The Company's holdings of commercial paper and U.S. government agencies
mature within one year. Holdings of municipal bonds maturing within one year
have a market value of $10.7 million, and maturing in one to five years have a
market value of $22.3 million.
 
     The Company realized net gains of $80,000 on the sale of investments in
1998, and no gains or losses on the sale of investments in 1997 or 1996.
 
NOTE 5. INVENTORIES
 
     Inventories consist of:
 
<TABLE>
<CAPTION>
                                                                 DECEMBER 31,
                                                              ------------------
                                                               1998       1997
                                                              -------    -------
                                                                (IN THOUSANDS)
<S>                                                           <C>        <C>
Finished goods..............................................  $ 3,566    $ 9,158
Work-in-process.............................................    6,281      3,852
Raw materials...............................................    6,226      2,260
                                                              -------    -------
          Total.............................................  $16,073    $15,270
                                                              =======    =======
</TABLE>
 
NOTE 6. PROPERTY AND EQUIPMENT
 
     Property and equipment consist of:
 
<TABLE>
<CAPTION>
                                                                 DECEMBER 31,
                                                              -------------------
                                                                1998       1997
                                                              --------   --------
                                                                (IN THOUSANDS)
<S>                                                           <C>        <C>
Equipment under capital lease...............................  $  2,108   $  2,834
Machinery and equipment -- principally computers............    52,355     44,307
Furniture and fixtures......................................     4,542      3,559
Leasehold improvements......................................     5,529      4,727
                                                              --------   --------
          Total.............................................    64,534     55,427
Accumulated depreciation and amortization...................   (34,912)   (31,866)
                                                              --------   --------
Property and equipment -- net...............................  $ 29,622   $ 23,561
                                                              ========   ========
</TABLE>
 
                                       42
<PAGE>   45
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
NOTE 7. LINE OF CREDIT AND NOTES PAYABLE TO BANKS
 
     At December 31, 1998, the Company had an available bank line of credit of
$30,000,000 which expires May 1, 1999. Borrowings bear interest at LIBOR plus
1.25% or the bank's prime rate (7.75% at December 31, 1998). The line of credit
agreement requires the Company, among other things, to maintain a minimum
tangible net worth, annual net income (no quarterly loss exceeding $3,000,000)
and certain financial ratios. In addition, the bank agreement prohibits the
payment of cash dividends. At December 31, 1998, the Company was in compliance
with these covenants, and there were no outstanding balances under this line.
 
NOTE 8. LONG-TERM OBLIGATIONS
 
     Long-term obligations consist of the following:
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                              -----------------
                                                               1998      1997
                                                              -------   -------
                                                               (IN THOUSANDS)
<S>                                                           <C>       <C>
Convertible notes (see below)...............................  $22,790   $86,250
Purchase consideration (see below)..........................       --     1,125
Capital lease obligations (see Note 9)......................      717       225
Other long-term obligations.................................      405       470
                                                              -------   -------
                                                               23,912    88,070
Current portion.............................................     (355)     (608)
                                                              -------   -------
Long-term portion...........................................  $23,557   $87,462
                                                              =======   =======
</TABLE>
 
     In November 1995, the Company completed a public debt offering of $86.3
million of convertible subordinated notes. The notes mature in 2005. Interest is
payable semi-annually at 5.875% per annum. The notes are convertible at the
option of the note holders into the Company's common stock at an initial
conversion price of $30.70 per share, subject to adjustment. Beginning in
November 1997, the notes are redeemable at the option of the Company at an
initial redemption price of 104.7% of the principal amount.
 
     During 1998, the Company repurchased $63.5 million of the face value of the
notes at 88.4% of the principal amount, with accrued interest to the date of
repurchase. Upon repurchase of the notes, the Company recognized extraordinary
gains of $3.5 million, or $0.09 per diluted share, net of related income taxes
of $2.4 million. The Company has reserved 742,345 shares of common stock for
conversion of the notes outstanding at December 31, 1998. Total offering costs
of $793,000 are included in other assets and are amortized on a straight-line
basis as an adjustment to interest expense over the remaining term of the notes.
 
     On November 1995, the Company acquired all of the outstanding capital stock
of Media Computer Technologies, Inc. (MCT), and withheld $1.1 million of the
purchase price for indemnification against unknown claims, which was included in
long-term obligations at December 31, 1997. In 1998, the Company released the
purchase consideration to MCT shareholders and option holders, as specified
under the merger agreement.
 
NOTE 9. LEASE COMMITMENTS
 
     Equipment with a cost and accumulated depreciation of $2,108,000 and
$1,391,000, respectively, at December 31, 1998 (cost of $2,834,000 fully
depreciated at December 31, 1997) has been leased under capital leases. In
addition, the Company rents office and research facilities under operating lease
agreements which expire through April 2005.
 
                                       43
<PAGE>   46
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
     Future minimum annual operating and capital lease commitments at December
31, 1998 are as follows:
 
<TABLE>
<CAPTION>
                                                              OPERATING   CAPITAL
                                                              ---------   -------
                                                                (IN THOUSANDS)
<S>                                                           <C>         <C>
1999........................................................   $ 4,425     $304
2000........................................................     3,297      304
2001........................................................     1,436      152
2002........................................................     1,329       --
2003........................................................     1,338       --
Thereafter..................................................     1,037       --
                                                               -------     ----
Total minimum lease payments................................   $12,862      760
                                                               =======
Amount representing interest................................                (43)
                                                                           ----
Present value of minimum lease payments.....................                717
Current portion.............................................               (278)
                                                                           ----
Long-term portion...........................................               $439
                                                                           ====
</TABLE>
 
     Rent expense for operating leases was approximately $3,586,000, $3,385,000
and $2,048,000 for the years ended December 31, 1998, 1997 and 1996,
respectively.
 
NOTE 10. STOCKHOLDERS' EQUITY
 
     PREFERRED STOCK
 
     The number of shares of preferred stock authorized to be issued is
5,000,000 with a par value of $0.001 per share. Preferred stock may be issued
from time-to-time in one or more series. The Board of Directors is authorized to
provide for the rights, preferences, privileges and restrictions of the shares
of such series. As of December 31, 1998, no shares of preferred stock had been
issued.
 
     COMMON STOCK
 
     The Company has authorized 38,626,670 shares of its common stock for
issuance to founders, employees and others as designated by the Board of
Directors through the Company's stock option plans or through stock purchase
agreements. Notes receivable from stockholders were collected in 1997.
 
     EMPLOYEE STOCK OPTION PLANS
 
     The Company's stock option plans (the "Plans") authorize the issuance of
35,777,670 shares of common stock (included in the 38,626,670 authorized shares
discussed above) for the grant of incentive or nonstatutory stock options and
the direct award or sale of shares to employees, directors, contractors and
consultants. Under the Plans, options are generally granted at fair value at the
date of grant. Such options become exercisable over periods of one to five years
and expire up to 10 years from the grant date.
 
     Upon the acquisition of DiviCom in August 1996, 268,285 outstanding options
under DiviCom's Stock Option Plan at an average exercise price of $7.75 were
assumed by C-Cube. These options retained their original terms.
 
     The Company repriced 6,429,078 options to $19.94, the market price on July
14, 1997, and 3,532,716 options to $38.13, the market price on September 11,
1996. The repriced shares are treated as canceled and regranted; however, the
vesting terms on the 1997 regrants were extended six months. The 1996 regrants
retained their original vesting terms.
 
                                       44
<PAGE>   47
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
     Option activity under the Plans was as follows:
 
<TABLE>
<CAPTION>
                                                                              WEIGHTED
                                                              NUMBER OF       AVERAGE
                                                                SHARES     EXERCISE PRICE
                                                              ----------   --------------
<S>                                                           <C>          <C>
Outstanding, January 1, 1996 (1,316,523 exercisable at a
  weighted average price of $4.16)..........................   6,013,818      $ 12.20
Granted (weighted average fair value of $17.87).............   8,076,424        40.57
Exercised...................................................  (1,189,523)       (4.56)
Canceled....................................................  (3,899,002)      (44.38)
                                                              ----------
Outstanding, December 31, 1996 (2,301,108 exercisable at a
  weighted average price of $9.36)..........................   9,001,717        24.63
Granted (weighted average fair value of $13.02).............  11,025,405        21.38
Exercised...................................................    (570,164)       (8.47)
Canceled....................................................  (7,542,412)      (31.90)
                                                              ----------
Outstanding, December 31, 1997 (3,699,655 exercisable at a
  weighted average price of $12.93).........................  11,914,546        17.80
Granted (weighted average fair value of $11.82).............   5,416,528        18.60
Exercised...................................................  (1,250,803)      (13.14)
Canceled....................................................  (1,861,978)      (19.95)
                                                              ----------
Outstanding, December 31, 1998..............................  14,218,293      $ 18.23
                                                              ==========
</TABLE>
 
     Additional information regarding options outstanding as of December 31,
1998 is as follows:
 
<TABLE>
<CAPTION>
                              OPTIONS OUTSTANDING                   OPTIONS EXERCISABLE
                  -------------------------------------------   ----------------------------
                                  WEIGHTED
                                  AVERAGE
                                 REMAINING        WEIGHTED                       WEIGHTED
   RANGE OF         NUMBER      CONTRACTUAL       AVERAGE         NUMBER         AVERAGE
EXERCISE PRICES   OUTSTANDING   LIFE (YEARS)   EXERCISE PRICE   EXERCISABLE   EXERCISE PRICE
---------------   -----------   ------------   --------------   -----------   --------------
<S>               <C>           <C>            <C>              <C>           <C>
$ 0.14 - $ 1.50      314,225        3.98           $ 0.54          314,225        $ 0.54
  2.87 -  14.75    2,221,839        6.90             9.69        1,612,265          8.17
 14.81 -  19.50    4,819,212        9.12            17.93          701,221         17.70
 19.56 -  19.94    5,012,486        7.73            19.93        1,935,004         19.94
 20.06 -  63.00    1,850,531        8.76            27.68          419,932         32.33
---------------   ----------        ----           ------        ---------        ------
$ 0.14 - $63.00   14,218,293        8.12           $18.23        4,982,647        $15.64
===============   ==========        ====           ======        =========        ======
</TABLE>
 
     At December 31, 1998, 871,511 shares were available for future grants.
 
     EMPLOYEE STOCK PURCHASE PLAN
 
     The Company has an employee stock purchase plan, under which eligible
employees may authorize payroll deductions of up to 10% of their compensation
(as defined in the plan) to purchase common stock at a price equal to 85% of the
lower of the fair market values as of the beginning or the end of the offering
period. There are 1,580,000 shares authorized under this plan. Stock issued
under the plan was 223,000, 211,000 and 171,000 shares in 1998, 1997 and 1996 at
weighted average prices of $15.52, $20.52 and $11.07, respectively. The weighted
average fair value of the 1998, 1997 and 1996 awards was $7.06, $9.46 and
$10.39, respectively. At December 31, 1998, 800,300 shares of common stock were
available for issuance under this plan.
 
     ADDITIONAL STOCK PLAN INFORMATION
 
     As discussed in Note 1, the Company continues to account for its
stock-based awards using the intrinsic value method in accordance with
Accounting Principles Board No. 25, "Accounting for Stock Issued to Employees"
and its related interpretations. Accordingly, no compensation expense has been
recognized in the financial statements for employee stock arrangements which are
granted with exercise prices equal to the fair market value at grant date.
 
                                       45
<PAGE>   48
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
     Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," (SFAS 123) requires the disclosure of pro forma net
income and earnings per share had the Company adopted the fair value method as
of the beginning of fiscal 1995. Under SFAS 123, the fair value of stock-based
awards to employees is calculated through the use of option pricing models, even
though such models were developed to estimate the fair value of freely tradable,
fully transferable options without vesting restrictions, which significantly
differ from the Company's stock option awards. These models also require
subjective assumptions, including future stock price volatility and expected
time to exercise, which greatly affect the calculated values. The Company's
calculations were made using the Black-Scholes option pricing model with the
following weighted average assumptions: expected life, 5.60 in 1998, 5.50 years
in 1997 and 6.25 years in 1996; stock volatility, 68% in 1998, 63% in 1997 and
66% in 1996; risk free interest rates, 5.2% in 1998, 6.1% in 1997 and 6.1% in
1996; and no dividends during the expected term. The Company's calculations are
based on a single option valuation approach and forfeitures are recognized as
they occur. If the computed fair values of the 1998, 1997 and 1996 awards had
been amortized to expense over the vesting period of the awards, pro forma net
income would have been $15.2 million ($0.52 per share) in 1998, $18.0 million
($0.54 per share) in 1997 and net loss would have been $85.6 million ($2.52 per
share) in 1996. However, the impact of outstanding non-vested stock options
granted prior to 1995 has been excluded from the pro forma calculation;
accordingly, the 1998, 1997 and 1996 pro forma adjustments are not indicative of
future period pro forma adjustments, when the calculation will apply to all
applicable stock options. Per share amounts above represent diluted earnings per
share under SFAS 128 (see Note 1).
 
     DEFERRED STOCK COMPENSATION
 
     In connection with the grants of certain stock options to employees in 1994
and 1993, the Company recorded deferred stock compensation for the difference
between the deemed fair value for accounting purposes and the option price as
determined by the Board at the grant dates. Deferred stock compensation was
amortized over the vesting period of the related stock options and was fully
amortized by December 31, 1997.
 
NOTE 11. EARNINGS (LOSS) PER SHARE
 
     The following table sets forth the computation of basic and diluted
earnings per share (in thousands, except per share amounts):
 
<TABLE>
<CAPTION>
                                                               QUARTER ENDED                YEAR ENDED
                                                            -------------------   ------------------------------
                                                            DEC. 31,   DEC. 31,   DEC. 31,   DEC. 31,   DEC. 31,
                                                              1998       1997       1998       1997       1996
                                                            --------   --------   --------   --------   --------
<S>                                                         <C>        <C>        <C>        <C>        <C>
Numerator:
  Net income (loss) before extraordinary item.............  $12,424    $11,597    $42,795    $44,339    $(73,045)
  Extraordinary item......................................       --         --      3,494         --          --
                                                            -------    -------    -------    -------    --------
  Numerator for basic earnings (loss) per share...........   12,424    $11,597     46,289     44,339     (73,045)
  Addback interest expense after tax related to
    convertible shares....................................      211        883      2,242      3,532          --
                                                            -------    -------    -------    -------    --------
  Numerator for diluted earnings (loss) per share.........  $12,635    $12,480    $48,531    $47,871    $(73,045)
Denominator:
  Weighted-average shares -- denominator for basic
    earnings (loss) per share.............................   37,884     36,738     37,382     36,497      33,928
  Convertible shares......................................      743      2,809      1,871      2,809          --
  Dilutive common stock equivalents, using treasury stock
    method................................................    2,081      2,476      1,501      2,377          --
                                                            -------    -------    -------    -------    --------
  Denominator for diluted earnings (loss) per share.......   40,708     42,023     40,754     41,683      33,928
                                                            =======    =======    =======    =======    ========
Basic earnings (loss) per share...........................  $  0.33    $  0.32    $  1.24    $  1.21    $  (2.15)
                                                            =======    =======    =======    =======    ========
Diluted earnings (loss) per share.........................  $  0.31    $  0.30    $  1.19    $  1.15    $  (2.15)
                                                            =======    =======    =======    =======    ========
</TABLE>
 
                                       46
<PAGE>   49
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
NOTE 12. COMPREHENSIVE INCOME
 
     In the first quarter of 1998, the Company adopted Statement of Financial
Accounting Standards No. 130 (SFAS 130), "Reporting Comprehensive Income," which
requires an enterprise to report, by major components and as a single total, the
change in net assets during the period from nonowner sources. SFAS 130 requires
unrealized gains or losses on investments and foreign currency translation
adjustments, which prior to adoption were reported separately in stockholders'
equity, to be included in other comprehensive income; however, the adoption of
this Statement had no impact on net income or stockholders' equity. The Company
has presented its comprehensive income or loss in the Statement of Changes in
Stockholders' Equity. Prior year amounts have been reclassified to conform to
the requirements of SFAS 130.
 
     The following are the components of accumulated other comprehensive loss:
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                              -----------------
                                                               1998      1997
                                                              -------   -------
                                                               (IN THOUSANDS)
<S>                                                           <C>       <C>
Unrealized gain (loss) on investments:
  Unrealized holding gains (losses) arising during period...  $    93   $    (4)
  Less: reclassification adjustment for losses included in
     net income.............................................      (17)      (13)
                                                              -------   -------
Net unrealized gain (loss) on investments...................       76       (17)
Accumulated translation adjustments.........................   (1,928)   (1,969)
                                                              -------   -------
          Total.............................................  $(1,852)  $(1,986)
                                                              =======   =======
</TABLE>
 
NOTE 13. INCOME TAXES
 
     The provision for income taxes is as follows:
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                        -----------------------------
                                                         1998       1997       1996
                                                        -------    -------    -------
                                                               (IN THOUSANDS)
<S>                                                     <C>        <C>        <C>
Current:
  Federal.............................................  $10,348    $14,336    $37,087
  State...............................................    1,598      2,938      4,686
  Foreign.............................................    2,143      2,265        170
                                                        -------    -------    -------
          Total.......................................   14,089     19,539     41,943
Deferred:
  Federal.............................................    4,430      3,105     (6,660)
  State...............................................     (323)      (899)    (1,189)
  Foreign.............................................       --      1,150     (1,150)
                                                        -------    -------    -------
          Total.......................................    4,107      3,356     (8,999)
                                                        -------    -------    -------
  Total...............................................  $18,196    $22,895    $32,944
                                                        =======    =======    =======
</TABLE>
 
     The tax benefit associated with dispositions from employee stock plans
reduced taxes currently payable by $1,426,000, $3,573,000 and $20,038,000 for
1998, 1997 and 1996, respectively.
 
                                       47
<PAGE>   50
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
     Income tax expense differs from the amount computed by applying the federal
statutory income tax rate to income before taxes as follows:
 
<TABLE>
<CAPTION>
                                                           YEARS ENDED DECEMBER 31,
                                                         ----------------------------
                                                          1998      1997       1996
                                                         -------   -------   --------
                                                                (IN THOUSANDS)
<S>                                                      <C>       <C>       <C>
Tax expense (benefit) computed at federal statutory
  rate.................................................  $21,228   $23,445   $(14,035)
State income taxes, net of federal effect..............    1,329     1,248     (1,865)
Tax credits............................................   (2,609)   (2,646)    (4,710)
Change in valuation allowance..........................       --        --     (1,324)
Purchased in-process technology........................       --        --     52,080
Foreign operations taxed at different rates............   (2,533)    1,068      1,239
Other..................................................      781      (220)     1,559
                                                         -------   -------   --------
          Income tax expense...........................  $18,196   $22,895   $ 32,944
                                                         =======   =======   ========
</TABLE>
 
     The components of the net deferred tax asset as of December 31 were as
follows:
 
<TABLE>
<CAPTION>
                                                               1998      1997
                                                              -------   -------
                                                               (IN THOUSANDS)
<S>                                                           <C>       <C>
Deferred tax assets:
  Accruals and reserves recognized in different periods.....  $11,719   $11,603
  Net operating loss carryforwards..........................      444       289
  Tax credit carryforwards..................................       --     1,607
  Deferred revenue..........................................    1,700        --
  Tax basis depreciation....................................       --       990
  Other.....................................................       --       972
                                                              -------   -------
          Total.............................................   13,863    15,461
Valuation allowance.........................................     (444)     (218)
                                                              -------   -------
          Net...............................................   13,419    15,243
Deferred tax liabilities:
  Purchased technology......................................   (2,925)   (4,616)
  Unrepatriated foreign earnings............................   (3,974)       --
                                                              -------   -------
Net deferred tax assets.....................................  $ 6,520   $10,627
                                                              =======   =======
</TABLE>
 
     At December 31, 1998, the Company has foreign net operating loss
carryforwards of approximately $966,000 expiring through 2003.
 
     U.S. income taxes were not provided on a cumulative total of approximately
$17 million and $13 million of undistributed earnings from foreign subsidiaries
for the years ending December 31, 1998 and 1997, respectively. The Company
intends to reinvest these earnings indefinitely in foreign operations. It is not
practicable to estimate the income tax liability that might be incurred upon the
remittance of such earnings. The valuation allowance relates to foreign net
operating losses which the Company believes may not be realized.
 
NOTE 14. EXTRAORDINARY ITEM
 
     During 1998, the Company repurchased $63.5 million of the face value of the
Company's 5.875% subordinated convertible notes due in 2005 at 88.4% of the
principal amount, with accrued interest to the date of repurchase. Upon
repurchase of the notes, the Company recognized extraordinary gains of $3.5
million, or $0.09 per diluted share, net of related income taxes of $2.4
million.
 
                                       48
<PAGE>   51
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
NOTE 15. EMPLOYEE BENEFIT PLAN
 
     The Company has a 401(k) tax-deferred savings plan under which participants
may contribute up to 20% of their compensation, subject to certain Internal
Revenue Service limitations. The Company is not required to contribute and has
not contributed to the plan to date.
 
NOTE 16. DEVELOPMENT AGREEMENTS
 
     The Company enters into development agreements with other companies for
which it receives development fees with certain payments contingent upon
attaining contract milestones. The Company generally retains ownership of the
products developed under the agreements; however, some agreements limit the
product markets in which the Company may sell the developed product. In
addition, under certain of the agreements, the Company is required to pay
royalties based on a percentage of the net sales of the products developed under
the agreements. Royalty expense was $587,000 in 1998, $1,960,000 in 1997 and
$1,860,000 in 1996.
 
NOTE 17. SEGMENT INFORMATION
 
     On December 31, 1998, the Company adopted Statement of Financial Accounting
Standards No. 131, "Disclosures About Segments of an Enterprise and Related
Information," which established standards for reporting information about
operating segments in annual financial statements, along with related
disclosures about products and services, geographic areas, and major customers.
The information for 1997 and 1996 has been restated from the prior year's
presentation to conform to the 1998 presentation.
 
     Operating segments are defined as components of an enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision maker. By this definition, C-Cube has two operating
segments: DiviCom, a wholly-owned subsidiary, and Semiconductor, a division of
C-Cube Microsystems Inc. Each of these operating segments requires its own
development and marketing strategies and therefore has separate management
teams. C-Cube acquired DiviCom in 1996 and retained the management team at that
time. DiviCom develops and integrates products and systems that enable the
transmission of digital video, audio and data over satellite, broadcast, cable
and wireless networks. These products and services allow its customers to create
"end-to-end" digital video systems. DiviCom's products include program encoders,
multiplexers, control and automation products and integration services. C-Cube's
Semiconductor division provides powerful, highly integrated, standards-based
digital video compression and decompression semiconductors. This technology has
enabled the development of a significant number of new or enhanced applications
in the consumer electronics and communications markets including VideoCD and DVD
players, desktop video production systems, decoders for digital set-top boxes
and broadcast and professional encoders.
 
     The Company evaluates performance and allocates resources based on profit
or loss from operations before interest, income taxes and extraordinary items.
The accounting policies of the segments are the same as those described in the
summary of significant accounting policies.
 
                                       49
<PAGE>   52
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
     SEGMENT PROFIT AND ASSETS
 
<TABLE>
<CAPTION>
                                                            YEARS ENDED DECEMBER 31,
                                                         ------------------------------
                                                           1998       1997     1996(2)
                                                         --------   --------   --------
                                                                 (IN THOUSANDS)
<S>                                                      <C>        <C>        <C>
Revenues:(1)
  Semiconductor........................................  $209,082   $218,252   $270,631
  DiviCom..............................................   142,715    118,760     49,127
                                                         --------   --------   --------
Consolidated net revenues..............................  $351,797   $337,012   $319,758
                                                         ========   ========   ========
Income (loss) from operations:
  Semiconductor........................................  $ 33,113   $ 38,648   $(54,794)
  DiviCom..............................................    23,302     30,095     15,039
                                                         --------   --------   --------
Consolidated income (loss) from operations.............  $ 56,415   $ 68,743   $(39,755)
                                                         ========   ========   ========
Segment assets:
  Semiconductor........................................  $259,297   $233,959   $232,497
  DiviCom..............................................    83,874     70,149     47,018
                                                         --------   --------   --------
Consolidated net assets................................  $343,171   $304,108   $279,515
                                                         ========   ========   ========
Capital expenditures:
  Semiconductor........................................  $ 12,867   $  7,918   $ 15,783
  DiviCom..............................................     7,170      5,654      1,358
                                                         --------   --------   --------
Consolidated capital expenditures......................  $ 20,037   $ 13,572   $ 17,141
                                                         ========   ========   ========
</TABLE>
 
---------------
(1) Revenues are shown net of eliminations of intersegment revenues. This
    presentation is consistent with the Company's internal presentation of
    financial information to management.
 
(2) DiviCom revenues, income from operations and capital expenditures for 1996
    are presented subsequent to the August 28, 1996 date of acquisition. In
    1996, acquisition-related charges of $131.3 million and $2.6 million are
    included in income (loss) from operations for Semiconductor and DiviCom,
    respectively.
 
                                       50
<PAGE>   53
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
     GEOGRAPHIC INFORMATION
 
<TABLE>
<CAPTION>
                                             1998                     1997                     1996
                                    ----------------------   ----------------------   ----------------------
                                                    NET                      NET                      NET
                                    REVENUES(1)   PROPERTY   REVENUES(1)   PROPERTY   REVENUES(1)   PROPERTY
                                    -----------   --------   -----------   --------   -----------   --------
                                                                 (IN THOUSANDS)
<S>                                 <C>           <C>        <C>           <C>        <C>           <C>
North America.....................   $132,513     $27,462     $119,575     $22,392     $105,301     $21,538
China.............................    120,348         155      123,100         122       91,731          19
Europe............................     42,441         629       31,464         174       16,738          93
Japan.............................     20,143         483       23,443         480       39,089         621
Other Asia........................     30,345         893       38,854         393       66,624         382
Rest of World.....................      6,007          --          576          --          275          --
                                     --------     -------     --------     -------     --------     -------
          Total...................   $351,797     $29,622     $337,012     $23,561     $319,758     $22,653
                                     ========     =======     ========     =======     ========     =======
</TABLE>
 
---------------
(1) Revenues are broken out geographically by the ship-to location of the
    customer.
 
     MAJOR CUSTOMERS
 
     During 1998, no individual customer accounted for 10% or more of the
Company's consolidated revenues. Revenues from one customer of the Company's
Semiconductor segment accounted for $67.7 million and $39.1 million of the
Company's consolidated revenues in 1997 and 1996, respectively.
 
ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
       DISCLOSURE
 
     Not applicable.
 
                                       51
<PAGE>   54
 
                                    PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF C-CUBE MICROSYSTEMS INC.
 
     The information required by Item 10 of Form 10-K with respect to
identification of directors is incorporated by reference to the information
contained in the section captioned "Proposal No. 1: Election of Directors" in
C-Cube's definitive Proxy Statement for the Annual Meeting of Stockholders to be
held April 27, 1999 (the "Proxy Statement"), a copy of which has been filed with
the Securities and Exchange Commission. For information with respect to the
executive officers of the Registrant, see "Executive Officers of the Registrant"
at the end of Part I of this report.
 
ITEM 11. EXECUTIVE COMPENSATION
 
     The information required by Item 11 of Form 10-K is incorporated by
reference to the information contained in the section captioned "Executive
Compensation and Other Matters" in the Proxy Statement.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
     The information required by Item 12 of Form 10-K is incorporated by
reference to the information contained in the section captioned "Stock Ownership
of Certain Beneficial Owners and Management" in the Proxy Statement.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
     The information required by Item 13 of Form 10-K is incorporated by
reference to the information contained in the section captioned "Executive
Compensation and Other Matters -- Certain Relationships and Related
Transactions" in the Proxy Statement.
 
                                    PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
 
(a)(1) FINANCIAL STATEMENTS -- See Index to Consolidated Financial Statements
       and Financial Statement Schedule at page 31 of this Form 10-K.
 
   (2) FINANCIAL STATEMENT SCHEDULE -- See Index to Consolidated Financial
       Statements and Financial Statement Schedule at page 31 of this Form 10-K.
 
   (3) EXHIBITS -- See Exhibit Index at page 53 of this Form 10-K.
 
(b)    The Registrant did not file any reports on Form 8-K during the fourth
       quarter of 1998.
 
                                       52
<PAGE>   55
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
          3.1            Restated Certificate of Incorporation filed June 30,
                         1994.(3)
          3.2            By-Laws.(1)
          4.1            Specimen of Common Stock Certificate.(1)
          4.2            Restated Registration Rights and Shareholder Rights
                         Agreement dated December 18, 1992.(1)
         10.1            Form of Indemnity Agreement for directors and officers.(1)
         10.2            1994 Employee Stock Plan and form of agreement
                         thereunder.(1)
         10.3            1994 Outside Directors Stock Option Plan and form of
                         agreement thereunder.(1)
         10.4            1994 Employee Stock Purchase Plan.(1)
         10.5            1990 Stock Plan and forms of agreements thereunder.(1)
         10.6            Employee Stock Option Plan and form of agreements
                         thereunder.(1)
         10.7            Series A Preferred Stock Purchase Agreement dated July 25,
                         1988 and January 20, 1989.(1)
         10.8            Series B Preferred Stock Purchase Agreement Dated October
                         1989, January 26, 1990 and May 30, 1990.(1)
         10.9            Series C Preferred Stock Purchase Plan Agreements dated
                         March 15, 1991, December 16, 1991 and December 18, 1992.(1)
         10.10           Common Stock Purchase Agreement dated December 18, 1992.(1)
         10.11           Loan and Security Agreement and Promissory Note with
                         Comerica Bank -- California dated December 27, 1993.(1)
         10.12           Joint Venture Agreement dated July 11, 1990 and First
                         Amendment to and Restatement of Joint Venture Agreement
                         dated December 18, 1992 with Kubota Corporation.(1)
         10.13           Strategic Relationship Agreement dated July 5, 1988, First
                         Amendment to and Restatement of Strategic Relationship
                         Agreement dated July 11, 1990 and Second Amendment to and
                         Restatement of Strategic Relationship Agreement dated
                         December 18, 1992 with Kubota Corporation and Kubota C-Cube,
                         Inc.(1)
         10.14           Stock Exchange Agreement and License and Purchase Agreement
                         each dated December 18, 1992, with Kubota Corporation and
                         Kubota C-Cube, Inc.(1)
         10.15           Warrant Agreement dated December 18, 1992 with Kubota
                         Corporation.(1)
         10.16           Financial Support Agreement dated December 18, 1992 and form
                         of Amendment to Financial Support Agreement with Kubota
                         Corporation and Kubota C-Cube, Inc.(1)
         10.17           Agreement Regarding Collateral dated December 20, 1993 with
                         Kubota Corporation.(1)
         10.18(2)        Letter of Intent dated December 15, 1992 with Advanced Micro
                         Devices, Inc.(1)
         10.19(2)        Technology License and Wafer Foundry Agreement dated
                         December 22, 1992 with Texas Instruments Incorporated.(1)
         10.20(2)        Development Agreement and Agreement on CL450A Procurement,
                         each dated June 30, 1993 and Amended Agreement on CL450A
                         Procurement dated September 1, 1993 with Victor Company of
                         Japan, Limited.(1)
         10.21           Secured Promissory Note dated February 17, 1993 by William
                         J. O'Meara.(1)
         10.22           Secured Promissory Note dated October 21, 1993 by James G.
                         Burke.(1)
</TABLE>
 
                                       53
<PAGE>   56
 
<TABLE>
<CAPTION>
        EXHIBIT
         NUMBER                                  DESCRIPTION
        -------                                  -----------
<C>                      <S>
         10.23           Standard Industrial Lease -- Multi-Tenant dated August 1991
                         with San Bernardino County Employees Retirement Association,
                         as amended October 19, 1992, January 8, 1993, June 15, 1993
                         and December 9, 1993.(1)
         10.24           Oxford Financial Services Corporation Master Lease Agreement
                         dated as of May 31, 1994.(3)
         10.25           Agreement dated June 29, 1994 with Donald T. Valentine.(3)
         10.26           Revolving Credit Loan Agreement with Comerica
                         Bank-California dated August 18, 1994.(4)
         10.27(2)        Manufacturing and Sales Agreement between C-Cube
                         Microsystems Inc. and Matsushita Electronics Corporation.(6)
         10.28           Sublease agreement with Atari Games Corporation dated
                         October 4, 1995.(7)
         10.29           Agreement and Plan of Merger By and Among C-Cube
                         Microsystems Inc., MCT Acquisition Corporation, Media
                         Computer Technologies, Inc., Dhimant Bhayani and Hemant
                         Bhayani dated November 17, 1995.(8)
         10.30           Supplemental Stock Option Plan.(9)
         10.31           Amendment to Revolving Credit Loan Agreement dated January
                         3, 1996.(9)
         10.32(2)        Option Agreement dated May 18, 1996 with Taiwan
                         Semiconductor Manufacturing Co., Ltd.(10)
         10.33           Form of Affiliate Agreement among C-Cube Microsystems, Inc.,
                         SAGEM S.A., SAGEM International S.A., Tregor Electronique
                         S.A., and Iena International S.A. dated as of May 28,
                         1996.(11)
         10.34           Form of Affiliate Agreement among C-Cube Microsystems Inc.,
                         DiviCom Inc. and certain stockholders of DiviCom Inc.(11)
         10.35           Form of Voting Agreement among C-Cube Microsystems Inc.,
                         SAGEM S.A, SAGEM International S.A. Tregor Electronique S.A.
                         and Iena International S.A. dated as of May 28, 1996.(11)
         10.36           Lease agreement with Callahan-Pentz Properties dated July 9,
                         1996.(12)
         10.37           Sublease agreement with LSI Logic Corporation dated January
                         8, 1997.(13)
         10.38           Amendment to Option Agreement dated May 30, 1997 with Taiwan
                         Semiconductor Manufacturing Co., Ltd.(14)
         10.39           Amendment to Lease Agreement with APT-IND/APTS Realty, Inc.
                         dated September 2, 1997.(15)
         10.40           Amendment to Loan Agreement with Comerica Bank-California
                         dated October 10, 1997.(15)
         21.1            List of Subsidiaries
         23.1            Independent Auditors' Consent.
         27.1            Financial Data Schedule
</TABLE>
 
---------------
 (1) Incorporated by reference to the corresponding Exhibit previously filed as
     an Exhibit to Registrant's Registration Statement on Form S-1 filed March
     4, 1994, as amended (File No. 33-76082).
 
 (2) Confidential treatment has been granted as to a portion of this Exhibit.
 
 (3) Incorporated by reference to the corresponding Exhibit previously filed as
     an Exhibit to Registrant's Form 10-Q filed August 5, 1994 (File No.
     0-23596).
 
 (4) Incorporated by reference to the corresponding Exhibit previously filed as
     an Exhibit to Registrant's Form 10-Q filed October 28, 1994 (File No.
     0-23596).
 
 (5) Confidential treatment has been requested as to a portion of this Exhibit.
 
                                       54
<PAGE>   57
 
 (6) Incorporated by reference to the corresponding Exhibit previously filed as
     an Exhibit to Registrant's Form 10-K filed March 21, 1995 (File No.
     0-23596).
 
 (7) Incorporated by reference to the corresponding Exhibit previously filed as
     an Exhibit to Registrant's Form 8-K filed November 14, 1995 (File No.
     0-23596).
 
 (8) Incorporated by reference to the corresponding Exhibit previously filed as
     an Exhibit to Registrant's Form 10-K filed March 15, 1996 (File No.
     0-23596).
 
 (9) Incorporated by reference to the corresponding Exhibit previously filed as
     an Exhibit to Registrant's Form 10-Q filed May 10, 1996 (File No. 0-23596).
 
(10) Incorporated by reference to the corresponding Exhibit previously filed as
     an Exhibit to Registrant's Form 10-Q filed August 9, 1996 (File No.
     0-23596).
 
(11) Incorporated by reference to the corresponding Exhibit previously filed as
     an Exhibit to Registrant's Registration Statement on Form S-4 filed August
     8, 1996, as amended (File No. 33-06653).
 
(12) Incorporated by reference to the corresponding Exhibit previously filed as
     an Exhibit to Registrant's Form 10-Q filed November 13, 1996 (File No.
     0-23596).
 
(13) Incorporated by reference to the corresponding Exhibit previously filed as
     an Exhibit to Registrant's Form 10-Q filed May 15, 1997 (File No. 0-23596).
 
(14) Incorporated by reference to the corresponding Exhibit previously filed as
     an Exhibit to Registrant's Form 10-Q filed December 22, 1998, as amended
     (File No. 0-23596).
 
(15) Incorporated by reference to the corresponding Exhibit previously filed as
     an Exhibit to Registrant's Form 10-Q filed November 14, 1997 (File No.
     0-23596).
 
                                       55
<PAGE>   58
 
                                   SIGNATURES
 
     PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
 
                                          C-CUBE MICROSYSTEMS INC.
                                                (Registrant)
 
<TABLE>
<S>                                                    <C>
 
Dated: March 22, 1999                                           By: /s/ ALEXANDRE A. BALKANSKI, PH.D.
                                                          -------------------------------------------------
-----------------------------------------------------               Alexandre A. Balkanski, Ph.D.
                                                                President and Chief Executive Officer
</TABLE>
 
     PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
 
<TABLE>
<CAPTION>
                      SIGNATURE                                     TITLE                    DATE
                      ---------                                     -----                    ----
<S>                                                    <C>                              <C>
 
               /s/ DONALD T. VALENTINE                          Director and            March 22, 1999
-----------------------------------------------------       Chairman of the Board
                (Donald T. Valentine)
 
          /s/ ALEXANDRE A. BALKANSKI, PH.D.                      President,             March 22, 1999
-----------------------------------------------------      Chief Executive Officer
           (Alexandre A. Balkanski, Ph.D.)                      and Director
                                                        (Principal Executive Officer)
 
                /s/ WALT WALCZYKOWSKI                      Vice President, Finance      March 22, 1999
-----------------------------------------------------    and Chief Financial Officer
                 (Walt Walczykowski)                      (Principal Financial and
                                                             Accounting Officer)
 
                 /s/ GREGORIO REYES                               Director              March 22, 1999
-----------------------------------------------------
                  (Gregorio Reyes)
 
                  /s/ T.J. RODGERS                                Director              March 22, 1999
-----------------------------------------------------
                   (T.J. Rodgers)
 
                  /s/ BARYN S. FUTA                               Director              March 22, 1999
-----------------------------------------------------
                   (Baryn S. Futa)
 
                 /s/ DONALD MCKINNEY                              Director              March 22, 1999
-----------------------------------------------------
                  (Donald McKinney)
</TABLE>
 
                                       56
<PAGE>   59
 
                                                                     
                          INDEPENDENT AUDITORS' REPORT
 
To the Board of Directors and Stockholders of
C-Cube Microsystems Inc.:
 
     We have audited the consolidated financial statements of C-Cube
Microsystems Inc. as of December 31, 1998 and 1997, and for each of the three
years in the period ended December 31, 1998, and have issued our report thereon
dated January 21, 1999. Our audits also included the consolidated financial
statement schedule of C-Cube Microsystems Inc., listed in the Index at Item
14(a)(2). This consolidated financial statement schedule is the responsibility
of the Company's management. Our responsibility is to express an opinion based
on our audits. In our opinion, such consolidated financial statement schedule,
when considered in relation to the basic consolidated financial statements taken
as a whole, presents fairly in all material respects the information set forth
therein.
 
/s/  Deloitte & Touche LLP
 
DELOITTE & TOUCHE LLP
 
San Jose, California
January 21, 1999
<PAGE>   60
 
                                                                     SCHEDULE II
 
                 VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
              FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                               ADDITIONS
                                                        -----------------------
                                           BALANCE AT   CHARGED TO   CHARGED TO    DEDUCTIONS    BALANCE
                                           BEGINNING    COSTS AND      OTHER          FROM       AT END
                                           OF PERIOD     EXPENSES     ACCOUNTS      RESERVES    OF PERIOD
                                           ----------   ----------   ----------    ----------   ---------
<S>                                        <C>          <C>          <C>           <C>          <C>
YEAR ENDED DECEMBER 31, 1998:
  Sales returns allowance................   $ 6,740      $12,553       $   --        $6,169      $13,124
  Allowance for doubtful accounts........     3,435          479           --             4        3,910
  Warranty...............................     1,573          316           --           331        1,558
 
YEAR ENDED DECEMBER 31, 1997:
  Sales returns allowance................   $11,529      $ 3,297       $   --        $8,086      $ 6,740
  Allowance for doubtful accounts........     2,563        1,010           --           138        3,435
  Warranty...............................     1,859          547           --           833        1,573
 
YEAR ENDED DECEMBER 31, 1996:
  Sales returns allowance................   $ 1,800      $12,188       $   --        $2,459      $11,529
  Allowance for doubtful accounts........       987          900          707(1)         31        2,563
  Warranty...............................       567          919        1,467(1)      1,094        1,859
</TABLE>
 
---------------
 
(1) Adjustments relating to purchased business.
 
                                       57