<PAGE>
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                            ------------------------

                                   FORM 10-K

                 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997

                         COMMISSION FILE NUMBER 0-23107

                            ------------------------

                                 FAROUDJA, INC.

             (Exact name of registrant as specified in its charter)

<TABLE>
<S>                           <C>
          DELAWARE                       77-0444978
(State or other jurisdiction  (I.R.S. Employer Identification
             of                             No.)
     incorporation and
       organization)
</TABLE>

                    750 PALOMAR AVENUE, SUNNYVALE, CA 94086

          (Address of principal executive offices, including zip code)

                                 (408) 735-1492

                        (Registrant's telephone number)

          Securities registered pursuant to Section 12(b) of the Act:

                                      NONE

          Securities registered pursuant to Section 12(g) of the Act:

                    COMMON STOCK, PAR VALUE $.001 PER SHARE

                                (Title of class)

                            ------------------------

    Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/  No / /

    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 voting stock held by non-affiliates of the
Registrant, based on the closing price of the Common Stock on March 1, 1998, as
reported on the NASDAQ National Market, was approximately $35 million. Shares of
Common Stock held by each officer and director and by each person who owns 5% or
more of the outstanding Common Stock have been excluded from this computation in
that such persons may be deemed to be affiliates. This determination of
affiliate status is not necessarily a conclusive determination for other
purposes.

    As of March 1, 1998 the Registrant had outstanding 12,058,913 shares of
Common Stock.

                      DOCUMENTS INCORPORATED BY REFERENCE

1.  Portions of the Registrant's Annual Report to Stockholders for the fiscal
    year ended December 31, 1997 are incorporated by reference into Part II of
    this Form 10-K Report. With the exception of those portions which are
    incorporated by reference, the Registrant's 1997 Annual Report is not deemed
    filed as part of this Report.

2.  Portions of the Registrant's Proxy Statement for the Annual Meeting of
    Stockholders to be held on June 10, 1998 are incorporated by reference into
    Part III of this Form 10-K Report.

--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>
                                 FAROUDJA, INC.

                                   FORM 10-K

                               DECEMBER 31, 1997

                                     INDEX

<TABLE>
<CAPTION>
                                                                             PAGE
                                                                             NO.
                                                                             ----
<S>       <C>                                                                <C>
PART I

Item 1.   BUSINESS.........................................................    3

          EXECUTIVE OFFICERS OF THE COMPANY................................   23

Item 2.   PROPERTIES.......................................................   23

Item 3.   LEGAL PROCEEDINGS................................................   24

Item 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..............   24

PART II

Item 5.   MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
            MATTERS........................................................   25

Item 6.   SELECTED FINANCIAL DATA..........................................   25

Item 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
            RESULTS OF OPERATIONS..........................................   25

Item 7A.  QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.........   25

Item 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA......................   25

Item 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
            FINANCIAL DISCLOSURE...........................................   25

PART III

Item 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT...............   25

Item 11.  EXECUTIVE COMPENSATION...........................................   25

Item 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT...   25

Item 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...................   26

PART IV

Item 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM
            8-K............................................................   26

SIGNATURES .................................................................  27
</TABLE>

                                       2
<PAGE>
    THIS FORM 10-K CONTAINS FORWARD LOOKING STATEMENTS CONCERNING THE COMPANY'S
FUTURE PRODUCTS, EXPENSES, REVENUE, LIQUIDITY AND CASH NEEDS AS WELL AS THE
COMPANY'S PLANS AND STRATEGIES. THESE FORWARD-LOOKING STATEMENTS ARE BASED ON
CURRENT EXPECTATIONS AND THE COMPANY ASSUMES NO OBLIGATIONS TO UPDATE THIS
INFORMATION. NUMEROUS FACTORS COULD CAUSE ACTUAL RESULTS TO DIFFER SIGNIFICANTLY
FROM THE RESULTS DESCRIBED IN THESE FORWARD-LOOKING STATEMENTS. FOR A DISCUSSION
OF VARIOUS RISKS AND UNCERTAINTIES AFFECTING THE COMPANY'S FUTURE OPERATIONS SEE
"FACTORS AFFECTING FUTURE OPERATING RESULTS."

                                     PART I

ITEM 1. BUSINESS

GENERAL

    Faroudja Inc. (the "Company"), designs, develops and markets a range of
video image enhancement products for the high-end home theater, industrial and
broadcast markets through its wholly-owned subsidiary, Faroudja Laboratories,
Inc. The Company is currently seeking to apply its technologies and experience
to address opportunities in the emerging digital television ("DTV") and high
definition television ("HDTV") broadcast and display environments and to
facilitate the convergence of the personal computer ("PC") and the TV.

    The Company began operations in 1971 through two related companies, Faroudja
Laboratories, Inc. ("FLI") and later Faroudja Research Enterprises, Inc.
("FRE"). The Company was incorporated in December 1996 under the laws of the
state of Delaware to succeed to the business of FLI and FRE. Thereafter, FRE was
merged into FLI with FLI surviving the merger and FLI was subsequently merged
into a newly-formed wholly-owned subsidiary of the Company.

BACKGROUND

    Video images are pervasive in today's society as sources of entertainment
and information. Images are displayed on a variety of electronic media including
color TVs, projection systems and PCs. Historically, there has been a
substantial difference in the quality of these various media, ranging from low
quality TV pictures to very high quality cinema pictures. This difference
resulted from a host of technical issues related to the capture, transmission
and display of video images. Current technologies make it possible to replicate
cinema quality on TVs, projection systems and PCs.

    With U.S. households owning approximately 250 million television sets, TV is
the dominant medium for viewing video images. While TV is an integral part of
modern life, it is optimized around image production, transmission and display
technology created more than 40 years ago. TV signals are produced in accordance
with the NTSC standard developed in the 1940s for black and white programs. This
standard was last modified in the 1950s to make possible the compatible
transmission of black and white and color programs. Technical compromises
required to achieve compatibility introduce image degrading imperfections, known
as artifacts. Additionally, analog transmission introduces noise in the TV
image. While always present, these imperfections are less evident on TV screens
smaller than 25 inches in size than on larger screens. Over the last decade,
consumer interest in larger screen TVs has increased dramatically, fueled by
decreasing equipment prices and an expanding universe of movies, sporting events
and other programming available via cable TV, video cassette, direct broadcast
satellite, laser disc and, most recently, digital video disc ("DVD"). As TV
screen sizes have increased, impairments in the image, such as low resolution,
artifacts and noise, have become more readily apparent. The better quality
images produced by DVDs, digital satellite transmission and high resolution
computer monitors have made viewers more discriminating and have elevated their
image quality expectations.

    The Company believes that this trend will accelerate with the announced
introduction of HDTV by some broadcasters in late 1998. HDTV images are expected
to incorporate cinema-like image quality in a wider screen format. The Federal
Communications Commission ("FCC") recently established standards

                                       3
<PAGE>
for DTV broadcasting in the United States and adopted rules mandating the
gradual introduction of DTV broadcasting. The FCC has targeted the eventual
phase-out of analog (NTSC) broadcasting by the year 2006. Current analog
broadcasting equipment is not compatible with the new DTV standards. In order to
transmit digital signals in accordance with the new DTV standards, broadcasters
will need to acquire new equipment, including digital transmission equipment, at
costs estimated to be as high as $10 million per station. Broadcasters are
seeking to reduce the costs of transitioning from analog to digital broadcasting
through strategies which will allow them to continue to use much of their
existing equipment.

    Advances in microprocessors, the availability of low cost memory and
storage, high quality displays, sophisticated software and the emergence of the
World Wide Web have fueled the growth in multimedia applications on the PC. The
PC is increasingly being used to view video stored on hard disk, CD-ROM, DVD and
laser disc, and video over the Internet. The Company believes that the use of
the PC as an entertainment device in the future will depend in large part on the
PC's ability to display TV images. Since TV signals use an interlaced format
while PCs use a progressive scanning display format, a TV signal must be
converted before being displayed on a PC. Until now, the interlace/progressive
conversion, along with other steps in the conversion of the TV signal, has
caused color distortion, motion artifacts, noise and other imperfections, which
have resulted in poor video quality on the PC. Image problems become even more
apparent when TV signals are viewed on a PC, as PC users sit relatively close to
their screens and PC monitors have higher resolution than most TVs.

FAROUDJA SOLUTIONS

    Faroudja designs, develops and markets video image enhancement products that
significantly improve images to achieve a cinema-like quality.

    The Company's products for the TV market substantially reduce the
imperfections inherent in analog NTSC signals, which become increasingly
apparent on large screen TV displays. The Company's technology improves picture
quality by removing artifacts and noise, detecting and compensating for motion,
enhancing resolution, and multiplying the number of lines displayed. Faroudja's
product sales for the TV market include sales of stand alone products to home
and industrial customers and board level products to original equipment
manufacturer ("OEM") customers.

    Faroudja is developing products which support the transition from analog to
DTV/HDTV broadcasting. As broadcasters make significant investments to satisfy
regulatory requirements, the Company believes that product solutions which
interface with additional necessary digital transmission equipment and current
studio equipment will help broadcasters minimize transition costs and maintain
flexibility in responding to evolving regulatory and market requirements. The
Company is developing standards conversion and upscaling products which it
believes will enable broadcasters to use much of the equipment present in their
existing studios to produce programming in various DTV/HDTV video formats. The
Company is currently testing prototypes of its first product in this field, the
Digital Format Translator-TM-.

    The Company is also developing products and technology that are intended to
solve the interlacing problem by significantly reducing the noise and artifacts
inherent in the display of high quality TV pictures on PC screens.

STRATEGY

    The Company's objective is to maintain and expand its position as the
industry standard of excellence for video image quality. Key elements of the
Company's strategy to achieve this objective include:

    MAINTAIN AND EXTEND TECHNOLOGY LEADERSHIP.  The Company intends to build
upon its technology leadership in video image processing by increasing its
investment in research and development. These efforts will focus on developing
patentable technology and innovative products for the TV and broadcast

                                       4
<PAGE>
markets. The Company also intends to leverage its image enhancement expertise in
TV into broadcast, DTV display and PC products and applications.

    PENETRATE BROADER MARKET SEGMENTS.  The Company has historically sold
products that addressed the needs of the industrial and high-end home theater
markets. The Company recently introduced a decoder and signal enhancer with
prices and capabilities targeting the consumer markets. The Company intends to
continue to seek opportunities in new and broader market segments, such as the
converging PC and TV markets and the emerging DTV/HDTV broadcast and display
markets.

    INCREASE BRAND NAME AWARENESS.  The Company has established a reputation for
excellence in video processing and video image enhancement in the commercial
broadcast, industrial and high-end home theater markets. The Company intends to
increase brand name awareness through increased advertising, the marketing of
stand alone image enhancement products and video source players carrying the
Company's trademarks, and co-branding agreements with OEM customers. The
distribution of Company-branded and co-branded products (particularly PC/TV
products) in new and broader market segments is also intended to increase
Faroudja brand awareness.

    BUILD AND LEVERAGE STRATEGIC RELATIONSHIPS.  The Company intends to
establish and maintain strategic relationships with companies whose technology,
products and product strategies complement those of the Company. Through
selective licensing of its patented technologies, the Company intends to
increase penetration and recognition of its capabilities in markets currently
served and to facilitate migration into new markets.

    EXPAND INTERNATIONAL PRESENCE.  The Company intends to expand its
international presence in order to increase its export sales. These efforts will
include establishing a sales force and marketing activities for the European and
Asian markets, expanding the Company's international network of distributors and
dealers, continuing the development of OEM relationships with customers serving
international markets, such as Hughes/JVC Technology Corporation ("Hughes/JVC"),
Vidikron of America, Inc. ("Vidikron"), Cinema Pro Corporation dba Runco
International ("Runco") and NEC Technologies, Inc. USA ("NEC"), and product
development that incorporates various international specifications.

                                       5
<PAGE>
PRODUCTS

    Faroudja designs, develops and markets a range of video image enhancement
products for the TV and broadcast markets. The following table sets forth
certain information regarding the Company's current stand alone industrial and
home products:

<TABLE>
<CAPTION>
      MARKET           PRODUCT                                      DESCRIPTION
-------------------  -----------  --------------------------------------------------------------------------------
<S>                  <C>          <C>
TV-Image             VP401        Line quadrupler and video processor for large screen high resolution video
Enhancement/ Line    VP401U         projection system
Multiplying

                     VP201        Line doubler and video processor for large screen high resolution video
                     VP201U         projection system
                     VP251
                     VP281FD

                     VP301        Line tripler and video processor for large screen high resolution video
                                    projection system

                     VP100        Video decoder with detail and color enhancement
                     VP100P

Rear Screen System   RP4800       Rear screen projection system with line doubler

TV-Source            DV1000       DVD/CD player with detail and color enhancement
Players              LD1000       Laser disc player with audio enhancement

Broadcast            DFD-U        Low noise video decoder/frame synchronizer with video adjustments. Analog and
                                    digital red, green and blue (RGB) outputs.

                     CFD-SN       Very low noise video decoder with video adjustments and analog red, green and
                                    blue (RGB) outputs.
</TABLE>

    TV PRODUCTS

    LINE QUADRUPLERS (VP401 AND VP401U).  Faroudja line quadrupler video
processors produce cinema-like images. The processors accept input from sources
formatted for conventional 525-line or 625-line TV standards, and convert them
into line-quadrupled, noticeably artifact-free, high resolution signals for
direct-view or projection TV systems. The processors are precision instruments
employing three complex digital signal processes utilizing patented technology
in the fields of decoding, scan conversion and detail enhancement. These
products substantially reduce color blurring, rainbow patterns, dot crawl and
visible scan lines, and deliver sharp image details.

    LINE TRIPLING VIDEO PROCESSORS (VP301).  The Company's line tripling video
processors utilize certain of the same technologies as the Company's line
quadruplers, and deliver similar results for smaller direct-view or projection
TV systems.

    LINE DOUBLING VIDEO PROCESSORS (VP201, VP201U, VP251, VP281FD).  The
Company's line doubling video processors utilize certain of the same
technologies as the Company's line quadruplers, and deliver similar results for
smaller direct-view or projection TV systems.

    VP100 TV ENHANCER AND VP100P.  The VP100 and VP100P set top components apply
patented adaptive decoding, detail processing and color alignment correction for
use in standard and large screen S-video compatible TVs. These products
substantially reduce color decoding artifacts and greatly increase

                                       6
<PAGE>
image detail and depth. These products offer consumers a moderately priced video
enhancement technology that plugs directly into the TV unit.

    REAR PROJECTION SYSTEM (RP4800).  The Company's 48 inch wide rear screen
projection system incorporates a VP250 line doubling video processor. This
display system is designed for customers with space, remodeling or lighting
constraints and provides HDTV quality images.

    DV1000 HIGH DEFINITION DIGITAL VIDEO DISC AND CD PLAYER.  The DV1000 applies
custom circuitry to both video and audio processing to provide significantly
enhanced image detail and depth exceeding what is expected to be available from
standard DVD players.

    LD1000 HIGH DEFINITION LASER DISC AND CD PLAYER.  The LD1000 applies custom
circuitry for audio enhancement to provide an experience exceeding what is
available from standard laser disc players.

    TV product sales as a percentage of total revenues for fiscal 1995, 1996 and
1997 were 80%, 80% and 88%, respectively.

    BROADCAST PRODUCTS

    DFD-U DIGITAL DECODER.  The DFD-U uses 10-bit processing with patented
decoding and bandwidth expansion circuitry to convert PAL or NTSC analog signals
into the digital component data required for video compression. Additional
circuits include time base correction and full frame synchronization. The
combination results in a significantly artifact-free digital signal that enables
additional channel capacity with reduced noise levels and higher quality video
signals from MPEG video compression engines.

    CFD-SN.  The CFD decodes NTSC signals into high quality, artifact-free
components prior to the time the signal is transmitted. The output signal is
used in applications such as studio manipulation, display and digital video
compression.

    Broadcast product sales as a percentage of total revenues for fiscal 1995 ,
1996 and 1997 were 20%, 16% and 2%, respectively.

    OEM PRODUCTS

    The Company has designed and developed board level products incorporating
the Company's technologies for the OEM market. To date, sales from board level
products have not been material.

RESEARCH AND DEVELOPMENT; NEW PRODUCTS

    The Company has devoted, and expects to continue to devote, significant
resources to its research and development efforts. In 1996, the Company
established a VLSI design group to develop high performance video ASICs. In June
1997, the Company expanded its VLSI department by establishing a facility in
Phoenix, Arizona with five engineers. As of December 31, 1997, the Company had a
staff of 29 full-time research and development personnel. During 1995, 1996 and
1997, the Company's research and development expenses were approximately $1.5
million, $2.5 million and $4.2 million, respectively. The Company anticipates
that its research and development expenses will increase in absolute dollars for
the foreseeable future.

    The Company has a number of products in development with introduction
planned during the next several years. For the TV market, the Company is
developing an advanced line multiplier and scaling video processor for very
large screen high resolution systems, a video processor for liquid crystal
display ("LCD") and Digital Light Processing based projector systems ("DLP")
products and a video processor for less sophisticated industrial applications.
The Company is also developing a 58 inch wide rear screen projection TV system
incorporating the Company's line multiplication and enhancement technology. For

                                       7
<PAGE>
the OEM TV projection market, the Company is developing a board level decoder
with video enhancement features.

    For the broadcast market, the Company is developing an upconverter that
utilizes Faroudja technology to deliver HDTV quality video images in a variety
of DTV and HDTV video formats from NTSC sources. The Company is currently
testing prototypes of this product which it calls the Digital Format
Translator-TM-. If such testing is successful, the Company expects to begin
shipment of this product in the second quarter of 1998. The Digital Format
Translator-TM- is intended to provide broadcasters with the ability to leverage
their existing analog equipment and systems to produce programming in various
DTV/ HDTV video formats. The Company is also developing studio quality NTSC/PAL
decoders for broadcast and postproduction applications.

    For the PC/TV market, the Company is in the final stages of developing a
video decoder integrated circuit, which includes synchronization, time base
correction and detail enhancement. The Company is also developing "Presentation
Plus-TM-," a line multiplier and scaling product for high resolution video
computer monitors that incorporates time base correction, image enhancement and
video synchronization.

    The Company's other planned research products include expanded development
of line multipliers and compression pre-processors which include noise reduction
to increase compressor efficiency, and the extension of the Company's technology
to low bandwidth use for such applications as teleconferencing and video
telephones.

    The markets for the Company's products are characterized by evolving
industry standards, rapid technological change, frequent new product
introductions and short product life cycles. The Company's future success will
depend, in large part, on its ability to continue to enhance its existing
products, to develop new products and features to meet changing customer
requirements and evolving industry standards and to identify prospective
licensees and enter into royalty-generating license agreements. The Company
anticipates that sales from its line multiplier product lines will experience
limited growth, or may decline, in future periods. In the fourth quarter of
1997, the home theater market exhibited weakness which the Company attributes to
consumer confusion over HDTV. The Company believes that such confusion and
related market weakness could continue until HDTV broadcast begins as currently
anticipated at the end of the third quarter of 1998. The Company expects that
more than one-half of its total revenues in 1998 will be derived from licensing
revenue and sales of recently introduced products, as well as products which the
Company is developing. The success of new products depends on a number of
factors, including proper selection and timely introduction of planned new
products, successful and timely completion of product development, accurate
estimation of demand for new products, market acceptance of new products of the
Company and its OEM customers, the Company's ability to offer new products at
competitive prices, the availability of adequate staffing to produce and sell
such new products, and competition from products introduced by competitors.
Certain of these factors are outside the control of the Company. Sales of the
Company's board level products, and future license and royalty revenues, depend
in part upon the ability of the Company's OEM customers and licensees to
successfully develop and market products incorporating the Company's products or
technology. The Company's products intended for the digital broadcast market are
not expected to be available for sale until the second quarter of 1998. There
can be no assurance that the Company's broadcast products, assuming timely
development and satisfactory completion of field tests, will be accepted by the
broadcast market. There can be no assurance as to the amount of royalties, if
any, that the Company will receive in the future as S3 has advised the Company
that it will not make any payments necessary to maintain its exclusive license
rights with respect to any periods after March 31, 1998 and the Company does not
currently have any other license agreements in effect pursuant to which it
expects to receive substantial royalties.

    The incorporation of the Company's products into its OEM customers' product
designs often requires significant expenditures by the Company, which
expenditures may precede volume sales of the Company's products, if any, by one
year or more. The introduction of new or enhanced products also requires the

                                       8
<PAGE>
Company to manage the transition from older products in order to minimize
disruption in customer ordering patterns, to avoid excessive levels of older
product inventories and to ensure that adequate supplies of new products can be
delivered to meet customer demand.

    There can be no assurance that the Company will identify new product
opportunities, will successfully develop and bring to market new products, will
achieve design wins or will respond effectively to technological changes or
product announcements by others, or that the Company's new products will achieve
market acceptance. A failure in any of these areas would have a material adverse
effect on the Company's business, financial condition and operating results.

TECHNOLOGY

    The Company has significant expertise in a number of technologies relating
to video image enhancement.

    ENCODING TECHNOLOGY.  A NTSC or PAL signal consists of a luminance signal
and two color-difference signals. In a conventional NTSC or PAL encoder, the
color-difference signals are modulated on a subcarrier and added to the
luminance signal. In this case, the spectrum of both the luminance signal and
the modulated chrominance signal are mixed together, which generates "rainbow
patterns," "dot crawl" and other artifacts in TV receivers. Faroudja's patented
pre-filtering technology is applied to luminance and chrominance signals
separately so that they will not interfere with each other. The two signals are
added together without an overlaid spectrum, which significantly reduces rainbow
patterns and other artifacts.

    DECODING TECHNOLOGY.  The color section of the NTSC standard was originally
designed with severe bandwidth restrictions. This causes colors in various video
images to "blur" and "smear." These effects are aggravated by storage media,
such as VHS tapes, that further degrade the chroma or color signal. The Faroudja
decoder technology utilizes proprietary circuitry to recreate and correct color
details. This is accomplished by making use of the sharper black and white
transitions to develop a correction signal that is then used to sharpen the
color transitions. As a result, colors are restored with sharp details and video
images retain their original crisp image. Digital adaptive comb filter circuitry
eliminates decoding errors from imperfect separation of the luminance and
chrominance signals and enables the reproduction of sharper, cleaner color
images. The Company's decoder technology has two separate correction circuits
that create color transitions that are clear, sharp and natural by eliminating
dot crawl, a rapid upward movement of colored dots on sharp vertical
transitions, and hanging dots which lie underneath all the colored horizontal
transitions. Dot crawl and hanging dots are easily apparent with large, highly
saturated, stationary graphics such as titles and credits.

    LINE MULTIPLIER TECHNOLOGY.  The line multiplier technology reduces scan
line visibility resulting from utilizing a 525 line broadcast standard on
today's large screen TVs by changing the interlaced video signal to a
progressively scanned signal. The Company's line multiplier technology detects
motion and interpolates correctly to "fill in the blanks." This technology can
detect the difference between a film image that has been transferred to video or
a video image that emanates from a video camera. After detecting the image type,
the line multiplier technology selects its algorithm to compensate accordingly.
This is critical because today's home theaters are primarily used to show films
that were transferred to video, whether on tape, laser disc or off the air.

    DETAIL ENHANCEMENT TECHNOLOGY.  The best video sources such as DVD (if
properly recorded) provide good resolution while others such as digital
satellite reception and laser discs often provide acceptable resolution.
However, common sources such as broadcast or VHS tapes are noticeably deficient.
The problem is compounded when scan lines are doubled or quadrupled and when
other signal processing is applied. The resulting picture is free of artifacts
(including visible scan lines) but dull, with loss of definition and a general
blurriness. The Company's proprietary technology increases the visibility of
small

                                       9
<PAGE>
image details, whether horizontal or vertical, without introducing ringing or
noise artifacts and without modifying large edge response. The Company's
technology also uses a form of non-linear processing similar to controlled
distortion. This technique expands the bandwidth of large edge signals without
introducing artifacts, such as ringing, in both the horizontal and vertical
domains. The combination of these two techniques results in a line doubled or
quadrupled image that gives a greater feeling of depth.

    MOTION COMPENSATION TECHNOLOGY.  The inherent scan and frame rate changes
that are required to display the enhanced video image make motion compensation
necessary in the reconstruction of the enhanced picture. TV images are
transmitted in an interlaced fashion in which the picture is transmitted in two
parts, the first being the odd lines of the picture, the second the even lines.
This creates a time delay of 16 milliseconds between the odd and even lines of
the image. If motion is present, artifacts can be generated in the conversion to
a line doubled or quadrupled image. Also, while TV images are displayed at
approximately 60 frames per second, cinema film sources are displayed at 24
frames per second. To ensure an image noticeably free from artifacts, the motion
of the video has to be taken into account and identification of the source
material as video or film is necessary. The Company's motion and film detection
technology is used in most of its video enhancement products.

    NOISE REDUCTION.  All analog video sources contain some degree of picture
noise. This is manifested as low level moving or shimmering artifacts, or an
excessive graininess in the picture. High quality digital sources such as DVDs
have much reduced noise content. Noise reduction processing is required to bring
analog sources, either existing archive material or new material from
traditional cameras, up to digital standards. Small static details in the
picture have to be distinguished from the moving noise artifacts so that correct
discrimination can be accomplished. The Company makes use of its motion
detection and adaptive video filtering technologies to optimize noise reduction
in the video images.

    TIME BASE CORRECTION.  Video sources which are being transmitted from a
broadcast studio or by a satellite or cable TV head end derive line and frame
scan rates from stable crystal controlled sources which are timing accurate.
Video produced by consumer video cassette recorders, camcorders and, to a lesser
extent, video discs are subject to timing errors, because the playback relies on
the mechanical rotation of the storage medium for timing accuracy. In the case
of VCRs, line lengths may vary causing color decoding and video picture
alignment problems. If a VCR source is to be transmitted in the industry
standard digital D1 format, this line timing variability is not permissible. The
Company's time base correction technology permits its decoders not only to
separate the luminance and chrominance components of the video source but to
re-lock the video to a crystal reference. This stabilizes the picture,
particularly when video is overlaid on other video sources, and makes it
compliant with digital studio transmission standards.

    SCALING.  As new video standards become available, the need to reformat the
video picture by scaling in both the horizontal and vertical domains becomes
more important. The Company currently produces line doublers and quadruplers
which scale the picture by a factor of two. The Company has under development
products which scale the picture by non-integer ratios. This will be required
for the Company's PC interface products, which will permit the adjustment of the
size of a video image in a window on the PC monitor. This is a completely
variable scaling application. LCD panels or TI's DLP mirror products have finite
numbers of pixels in the display format. At present, 800 horizontal pixels by
600 vertical pixels is a common size and was developed to match computer SVGA
display sizes. In the case of video being interfaced to pixel based displays to
ensure that video artifacts are not developed at the display device, the video
source is scaled to convert the original number of lines to the number of lines
in the display device. Non-integer scaling is employed in this transfer. Scaling
will also be used in the conversion of video between traditional sources and the
new DTV and HDTV formats.

                                       10
<PAGE>
SALES AND MARKETING

    Faroudja markets its products for the TV market through a network of home
theater, industrial and commercial dealers as well as OEM customers. As of
December 31, 1997, the Company maintained a sales force of eight persons at its
headquarters in Sunnyvale, California, and five employees in regional offices.
The Company's marketing programs include trade shows, training seminars, public
relations and advertising. Revenues from Hughes/JVC accounted for 12.1% of total
revenues in 1995. Revenues from Vidikron accounted for 10.5% of total revenues
in 1996. Revenues from S3 and Vidikron accounted for 10.6% and 11.1%
respectively, of total revenues in 1997.

    The Company currently distributes its home theater products through
approximately 330 home theater dealers throughout the United States. This
distribution channel is managed by a Company national sales manager, three
regional managers, one field training manager, independent sales representatives
and a customer service department.

    The Company services industrial applications, such as corporate boardrooms,
executive conference centers and auditoriums, through a network of more than 70
industrial dealers. These dealers typically provide installation, product
integration, on site training and customer support. This network is managed
directly by a national sales manager and three regional managers.

    For the broadcast market, the Company has relied, and expects to continue to
rely in the future, on direct sales and marketing. The Company has two employees
who sell directly to the broadcast markets.

    The Company has OEM relationships with Runco, Vidikron and Ampro Corporation
("Ampro"). Vidikron is also integrating the VP100 decoder into certain of its
projection systems, including the new Helios I projector based on Texas
Instrument Incorporated's ("TI") DLP. There can be no assurance that the Company
will continue to receive any revenues from any of these relationships.

    The Company has entered into co-branding arrangements with NEC and Runco
pursuant to which NEC and Runco have non-exclusive distribution rights to the
Company's line multiplier products. NEC and Runco are required to purchase a
certain minimum number of units per year to maintain their rights to co-brand
Company products. Under the NEC agreement, the Company has afforded NEC certain
price protections with respect to products listed therein. Specifically, in the
event of a price decrease for any such product, the Company will provide a
credit equal to the decrease for all such products remaining in inventory at
NEC. The Company has also entered into a co-branding arrangement with Ampro for
the development and sale of decoder boards for incorporation into the Ampro
three chip DLP product. There can be no assurance that the Company will continue
to receive any revenues from any of these arrangements.

    In 1995, 1996 and 1997, the Company generated approximately 13.1%, 15.3%,
and 13.2%, respectively, of its total revenues from export sales. The decrease
in the percentage of total revenues generated from export sales in 1997 from the
prior year was primarily due to (i) increased sales to certain U.S. customers
which, the Company believes, in turn exported the Company's products and (ii) a
reduction in international sales personnel. The Company intends to expand its
international presence in order to increase its export sales and intends to hire
a sales manager in 1998 to handle export sales. Consequently, the Company
believes that export sales will increase as a percentage of total revenues in
future periods. The Company has a non-exclusive worldwide distribution
arrangement with Vidikron pursuant to which Vidikron distributes the Company's
line doublers and line quadruplers. Further, Faroudja has a non-exclusive
worldwide distribution arrangement with Hughes/JVC for the industrial and
consumer market. Hughes/JVC distributes Faroudja's line doublers, quadruplers
and broadcast products. In addition, Faroudja has distributors or dealers in
over 35 countries worldwide. Export sales to international customers entail a
number of risks, including unexpected changes in, or impositions of, legislative
or regulatory requirements, delays resulting from difficulty in obtaining export
licenses for certain technology, tariffs, quotas and other trade barriers and
restrictions, longer payment cycles, greater difficulty in

                                       11
<PAGE>
accounts receivable collection, potential adverse taxes, currency exchange
fluctuations, the burdens of complying with a variety of foreign laws and other
factors beyond the Company's control.

    The Company's future success will depend, in large part, on the continued
efforts of its network of direct and indirect distributors and dealers. The loss
of, or reduction in sales to any of the Company's key customers could have a
material adverse effect on the Company's operating results.

    The Company's business is characterized by short lead times and quick
delivery schedules. As a result, the Company does not believe that backlog at
any given time is a meaningful indication of future sales.

MANUFACTURING

    TV AND BROADCAST PRODUCTS.  The Company's manufacturing operations are
located in Sunnyvale, California and consist mainly of materials procurement,
final assembly, testing, quality assurance and shipping of products. The only
product assembly performed by the Company is final assembly, which consists of
building chassis and installing circuit boards and wires and cables. The Company
performs testing and quality assurance of all products, except for rear
projection systems, at its Sunnyvale facilities and plans to expand its in-house
automated testing efforts as its product volume increases.

    The Company subcontracts other manufacturing functions, including the
production of its printed circuit boards. Bestronics, Inc. ("Bestronics")
assembles more than 80% of the Company's circuit boards. The Company's reliance
on independent printed circuit board assemblers limits its control over delivery
schedules, quality assurance and product cost. The Company also relies on
suppliers for components, such as DC Electronics, Inc. ("DC Electronics") which
builds all of the Company's wire and cable harnesses.

    The Company's RP4800 Rear Projection System utilizes a projector chassis
provided by Audio Video Source, Inc. ("AVS") and modified to the Company's
specifications. AVS also manufactures the RP4800 for the Company on a contract
basis including integrating, assembling and testing the various components of
the system.

    Disruption in service by any of the Company's subcontractors or the
Company's suppliers could lead to supply constraints or delays in the delivery
of the Company's products. Such supply constraints or delays could have a
material adverse effect on the Company's business, operating results and
financial condition.

    WAFER FABRICATION.  The Company contracts all of its wafer fabrication,
assembly and testing to independent foundries and contractors, which enables the
Company to focus on its design strengths, minimize fixed costs and capital
expenditures and gain access to advanced manufacturing facilities. As the
Company continues to develop ASIC products, it will continue to contract out its
wafer production. The Company's engineers work closely with the Company's
foundries and subcontractors to increase yields, lower manufacturing costs and
assure quality. The Company's primary foundry is SGS-Thomson Microelectronics,
Inc. ("SGS-Thomson"). In addition, Micro Devices Technology, Inc. ("MDT") and
TEMIC North America, Inc. ("TEMIC") have manufactured the Company's integrated
circuits since 1993 and 1996, respectively. Most of the Company's devices are
currently fabricated using complementary metal oxide semiconductor ("CMOS")
process technology with 0.8 micron feature sizes. New devices that are being
designed are in 0.5 micron and 0.35 micron sizes. The Company currently
purchases products from all of its foundries under individually negotiated
purchase orders. The Company does not currently have a long-term supply contract
with any of its wafer fabrication foundries and, therefore, none are obligated
to supply products to the Company for any specific period, in any specific
quantity or at any specified price, except as may be provided in a particular
purchase order. The Company's reliance on independent foundries and assembly and
testing houses involves a number of risks.

                                       12
<PAGE>
COMPETITION

    The markets in which the Company competes are intensely competitive and are
characterized by rapid technological change, rapid product obsolescence and
price competition. The Company expects competition to increase in the future
from existing competitors and from other companies that may enter the Company's
existing or future markets with products or technologies which may be less
costly or provide higher performance or more desirable features than the
Company's products. The Company's existing and potential competitors include
several large domestic and international companies that have substantially
greater financial, manufacturing, technical, marketing, distribution and other
resources than the Company. In the market for TV video processors, the Company's
principal competitors are DWIN Electronics, Inc. ("DWIN"), Extron Electronics
("Extron"), NEC, Snell & Wilcox, Inc. ("Snell & Wilcox"), Sony Corporation
("Sony") and Yamashita Engineering Manufacturing, Inc. ("YEM"). In the market
for broadcast products, the Company's principal competitors are Extron, Leitch
Incorporated ("Leitch"), Matsushita Consumer Electronics Co. ("Matsushita"),
Snell & Wilcox, Sony Broadcast Products, Incorporated ("Sony Broadcast") and
Vistek Electronics, Ltd. ("Vistek"). As the Company's products penetrate broader
markets and as these markets become commercial markets, the Company expects to
face competition from diversified electronic and semiconductor companies.

    Yves Faroudja, the Company and General Instrument Corporation ("GI") are
parties to a royalty free, world-wide license agreement dated May 1, 1996
pursuant to which GI licensed certain patents to the Company and the Company
licensed certain patents to GI relating to video compression and decompression.
As a result of that agreement, GI could produce products in the field of scan
conversion of source material presented to a compression system competitive with
the Company's upconverter.

    The Company's licensees and OEM customers may be larger and have greater
market recognition and financial, technological engineering, manufacturing and
distribution capabilities than the Company. In addition, such licensees and OEM
customers may use such technologies and subsystems either alone or in
combination with other technologies to develop products which could compete with
the Company's technologies and products. At the present, the Company believes
that S3 and GI are licensees which could compete with certain of the Company's
technologies and products.

    Certain of the Company's principal competitors maintain their own
manufacturing facilities, including semiconductor foundries, and may therefore
benefit from certain capacity, cost and technical advantages. Since the Company
does not operate its own semiconductor manufacturing, assembly or testing
facilities, it may not be able to reduce its costs as rapidly as companies that
operate their own facilities. The failure of the Company to introduce lower cost
versions of its products in a timely manner or to successfully manage its
manufacturing, assembly and testing relationships would have a material adverse
effect on its business, operating results and financial condition.

    The Company believes that its ability to compete successfully in the rapidly
evolving markets for high performance video image enhancement technology depends
on a number of factors, including protection of its proprietary technology and
information, the price, quality and performance of the Company's and its
competitors' products, the timing and success of new product introductions by
the Company, its customers and its competitors, the emergence of new industry
standards, the Company's ability to obtain adequate foundry capacity, the number
and nature of the Company's competitors in a given market and general market and
economic conditions. There can be no assurance that the Company will compete
successfully in the future with respect to these or any other competitive
factors.

    The Company has licensed and intends to continue to license its technologies
and intellectual property. The Company also offers for sale board level or chip
level products, developed by or for the Company, which implement certain of the
Company's technologies. The Company's licensees and OEM customers may be larger
and have greater market recognition and financial, technological, engineering,
manufacturing and distribution capabilities than the Company. In addition, such
licensees and OEM

                                       13
<PAGE>
customers may use such technologies and subsystems either alone or in
combination with other technologies to develop products which could compete with
the Company's technologies and products. While the Company may sell board level
or chip level products and receive royalties from such licensees, there can be
no assurance that the technologies and products offered by such licensees and
OEM customers will not compete directly with those of the Company, have
performance, cost or other advantages over those of the Company or have an
adverse impact on the sales or other licensing activities of the Company.

PROPRIETARY RIGHTS AND LICENSES

    The Company's future success depends in part upon its ability to protect its
proprietary technology and information. Although the Company relies on a
combination of licensed patents, copyrights, trademarks, trade secrets and
licensing arrangements with third parties to protect certain of its intellectual
property, the Company believes that factors such as the technological and
creative skills of its personnel and the success of its ongoing product
development efforts are more important in maintaining its competitive position.
The Company generally enters into confidentiality or license agreements with its
employees, distributors, customers and potential customers and limits access to
its proprietary information. Yves Faroudja, the Company's founder and Chief
Technical Officer, personally holds or was assigned 35 U.S. and 8 foreign
patents, and 7 U.S. and 22 foreign patent applications, which have been licensed
to the Company, and on which the Company depends for the enhancement of its
current products and the development of future products. Mr. Faroudja has
granted the Company a perpetual, royalty-free, license to use patented and
unpatented technologies developed by him prior to January 20, 1997. As the
Company is a licensee of such patents and applications, it is subject to risks
not generally faced by other companies which own the intellectual property upon
which their businesses rely. There can be no assurance that patents will issue
from any pending applications or that any claims allowed from pending
applications will be of sufficient scope or strength, or be issued in all
countries where the Company's products can be sold, to provide meaningful
protection or any commercial advantage to the Company. Also, competitors of the
Company may be able to design around the licensed patents. The laws of certain
foreign countries in which the Company's products are or may be developed,
manufactured or sold, including various countries in Asia, may not protect the
Company's products or intellectual property rights to the same extent as the
laws of the United States, and thus, may increase the likelihood of piracy of
the Company's technology and products. There can be no assurance that the steps
taken by the Company to protect its intellectual property rights will be
adequate to prevent misappropriation of its technology or that the Company's
competitors will not independently develop technologies that are substantially
equivalent or superior to the Company's technology.

    The video image enhancement and related industries are characterized by
vigorous protection and pursuit of intellectual property rights or positions,
which have resulted in significant and often protracted and expensive
litigation. The Company may from time to time be subject to proceedings alleging
infringement by the Company of intellectual property rights owned by third
parties. If necessary or desirable, the Company may seek licenses under such
intellectual property rights. However, there can be no assurance that such
licenses will be offered or that the terms of any offered license will be
acceptable to the Company. The failure to obtain such a license from a third
party for technology used by the Company could cause the Company to incur
substantial liabilities and to suspend or cease the manufacture of products
requiring such technology.

    The Company may initiate claims or litigation against third parties for
infringement of the Company's proprietary rights or to establish the validity of
the Company's proprietary rights. For example, in January 1997 and May 1997, the
Company filed actions against DWIN and Snell & Wilcox, respectively, seeking
relief and damages for the infringement of US Patent Number 4,876,596 owned by
Yves Faroudja and licensed to the Company. DWIN and Snell & Wilcox have raised
defenses and counterclaims that the patent is invalid and not infringed.

                                       14
<PAGE>
EMPLOYEES

    As of December 31, 1997, the Company had 71 full-time and nine part-time and
contract employees, including 29 full-time employees primarily involved in
research and development activities, 13 in marketing and sales, 11 in finance
and administration and 18 in manufacturing and quality assurance. Most employees
are based at the Company's headquarters in Sunnyvale, California. The Company's
employees are not represented by any collective bargaining unit with respect to
their employment with the Company, and the Company has never experienced a work
stoppage. The Company believes that its employee relations are good. The Company
intends to expand its employee base in 1998, primarily in research and
development and sales and marketing, and believes that its future success will
depend largely on its ability to attract and retain highly-skilled managerial,
sales and marketing personnel. Competition for such personnel is intense. The
Company's future success will depend to a significant extent upon the continued
services of members of senior management and other key employees of the Company.
The loss of the service of any of these individuals could have a material
adverse effect on the Company.

FACTORS AFFECTING FUTURE OPERATING RESULTS

    POTENTIAL FLUCTUATIONS IN FUTURE OPERATING RESULTS; SEASONALITY.  The
Company's operating results have varied in the past and are likely to vary
significantly in the future from period to period as a result of a number of
factors, including the volume and timing of orders received during the period,
fluctuations in the amount and timing of license and royalty revenues, the
timing of new product introductions by the Company and its competitors, demand
for and market acceptance of the Company's products, product line maturation,
the impact of price competition on the Company's average selling prices, delays
encountered by the Company's strategic partners, the availability and pricing of
components for the Company's products, changes in product or distribution
channel mix, product returns or price protection charges from customers and the
unexpected loss of key customers. Many of these factors are beyond the Company's
control. In addition, due to the short product life cycles that characterize the
markets for the Company's products, the Company's failure to introduce new,
competitive products consistently and in a timely manner could materially
adversely affect operating results for one or more product cycles. The Company
had a license agreement with S3 pursuant to which the Company received quarterly
prepaid license fees to maintain exclusivity. S3 has advised the Company that it
will not make any payments necessary to maintain its exclusive license rights
with respect to any periods after March 31, 1998.

    Gross margins may vary from period to period as a result of a number of
factors, including the mix of products sold, new product introductions,
fluctuations in the receipt of license and royalty revenues and the mix of
distribution channels. The Company's gross margins may also be adversely
affected by shortages in the availability of key components for the Company's
products. To maintain favorable margin levels on product sales, the Company must
introduce new products, must introduce enhanced versions of its products, and
must continue its cost reduction efforts. The Company anticipates that it will
incur lower overall gross margins in future periods as it introduces lower
margin products for consumer markets.

    Customers generally order on an as-needed basis and, accordingly, the
Company has historically operated with a relatively small backlog.
Notwithstanding the difficulty in forecasting future sales and the relatively
small level of backlog at any given time, the Company generally must plan
production, order components and undertake its development, sales and marketing
activities and other commitments months in advance of orders for its products.
Accordingly, any shortfall in revenues in a given quarter may adversely impact
the Company's operating results due to an inability to adjust expenses during
the quarter to offset any reduced level of revenues for the quarter.

    The Company currently derives a substantial portion of its total revenues
from the sale of a relatively small number of high priced products. The
Company's backlog at the beginning of a quarter typically does not include all
sales required to achieve the Company's sales objectives for that quarter.
Consequently, the Company's total revenues and operating results for a quarter
depend upon the Company obtaining orders

                                       15
<PAGE>
or products to be shipped in the same quarter. In addition, from time to time, a
significant portion of the Company's sales have been derived from sales of
multiple products to a limited number of customers. The volume and timing of
orders received during a quarter are difficult to forecast. As a result of the
Company's typical sales cycle, a disproportionate percentage of the Company's
total revenues in any quarter may be generated in the last month of a quarter.
As a result, a shortfall in sales in any quarter as compared to expectations may
not be identifiable until the end of the quarter. A delay in shipment near the
end of a particular quarter, due, for example, to an unanticipated shipment
rescheduling, to cancellations by customers or to unexpected manufacturing
difficulties experienced by the Company or its suppliers may cause total
revenues in a particular quarter to fall significantly below the Company's
expectations and may thus materially adversely affect the Company's operating
results for such quarter. The Company's industry is subject to a high degree of
seasonality, and demand for the Company's products has historically been highest
in the third and fourth quarters of each calendar year. As a result, sales are
typically highest in these quarters and may be lower in following quarters.

    RISKS ASSOCIATED WITH NEW MARKETS AND APPLICATIONS; MARKET ACCEPTANCE.  A
substantial portion of the Company's revenues in 1997 were derived from sales of
products that address the high-end home theater and industrial TV markets.
Certain of the Company's current products and certain of its planned future
products generally address markets that are not now and may never become
substantial commercial markets. The Company's future growth will depend, in
large part, on the Company's ability to identify new markets for its products
and to apply its video enhancement technology to evolving markets and
applications that require superior visual images. There can be no assurance that
these markets will become substantial commercial markets or that they will
evolve in such a manner that the Company's products achieve market acceptance.
The Company also intends to exploit what it believes will be the convergence of
the TV and PC markets. There can be no assurance that the TV and PC markets will
converge, that this new market will present substantial commercial
opportunities, or that the Company's products will adequately address this
market in a timely manner. The Company has experienced, and expects to continue
to experience, technological and pricing constraints that may preclude the
development of products that address emerging markets. There can be no assurance
that the Company or its OEM customers will continue their existing product
development efforts, or, if continued, that such efforts will be successful,
that markets will develop in a timely manner, or at all, for any of the
Company's or such customers' products, or that the Company's and its customers'
products will not be superseded by other technology or products.

    RISKS ASSOCIATED WITH CHANGING TV STANDARDS.  The Company is developing
products that are designed to conform with certain current industry broadcast
standards. However, there can be no assurance that manufacturers will continue
to follow these standards or that competing standards will not emerge which will
be preferred by manufacturers or consumers. The acceptance of the Company's
products also depends in part upon third-party content providers developing and
marketing content for end user systems, such as video and audio playback
systems, in a format compatible with the Company's products. There can be no
assurance that these or other factors beyond the Company's control will not
adversely affect the development of markets for the Company's products.

    The FCC has required broadcasters to begin broadcasting digital signals in
May 1999, targeting the phase out of the current analog signals by the year
2006. There is considerable uncertainty among broadcasters and providers of
broadcast, reception and display equipment as to how DTV will be implemented, as
to how broadly and rapidly DTV will be deployed, and as to when, if ever, analog
TV will be discontinued. There can be no assurance that the market for the
Company's products will continue following the introduction of DTV or if
competing standards or technologies emerge that are preferred by manufacturers
and consumers. In addition, there can be no assurance that DTV and related
products will gain market acceptance or that third-party content providers will
develop and market content for end user systems using a digital format or a
format compatible with the Company's products. There can be no

                                       16
<PAGE>
assurance that such factors beyond the Company's control will not adversely
affect the development of markets for the Company's products.

    DEPENDENCE ON NEW PRODUCT DEVELOPMENT AND RISK OF TECHNOLOGICAL CHANGE.  The
markets for the Company's products are characterized by evolving industry
standards, rapid technological change, frequent new product introductions and
short product life cycles. The Company's future success will depend, in large
part, on its ability to continue to enhance its existing products, to develop
new products and features to meet changing customer requirements and evolving
industry standards and to identify and enter into royalty-generating license
agreements with prospective licensees. The Company anticipates that sales from
its line multiplier product lines will experience limited growth, or may
decline, in future periods. In the fourth quarter of 1997, the home theater
market exhibited weakness which the Company believes is attributable to consumer
confusion over HDTV. The Company believes that such confusion and related market
weakness could continue until HDTV broadcast begins as currently anticipated at
the end of the third quarter of 1998. The Company expects that more than
one-half of its total revenues in 1998 will be derived from licensing revenue
and sales of recently introduced products, as well as products which the Company
is developing. The success of new products depends on a number of factors,
including proper selection and timely introduction of planned new products,
successful and timely completion of product development, accurate estimation of
demand for new products, market acceptance of new products of the Company and
its OEM customers, the Company's ability to offer new products at competitive
prices, the availability of adequate staffing to produce and sell such new
products, and competition from products introduced by competitors. Certain of
these factors are outside the control of the Company. Sales of the Company's
board level products, and future license and royalty revenues, depend in part
upon the ability of the Company's OEM customers and licensees to successfully
develop and market products incorporating the Company's products or technology.
The Company's products intended for the digital broadcast market are not
expected to be available for sale until the second quarter of 1998. There can be
no assurance that the Company's broadcast products, assuming timely development
and satisfactory completion of field tests, will be accepted by the broadcast
market. There can be no assurance as to the amount of royalties, if any, that
the Company will receive going forward as S3 has advised the Company that it
will not make any payments necessary to maintain its exclusive license rights
with respect to any periods after March 31, 1998 and the Company does not
currently have any other license agreements in effect pursuant to which it
expects to receive substantial future royalties.

    The incorporation of the Company's products into its OEM customers' product
designs often requires significant expenditures by the Company, which
expenditures may precede volume sales of the Company's products, if any, by one
year or more. The introduction of new or enhanced products also requires the
Company to manage the transition from older products in order to minimize
disruption in customer ordering patterns, to avoid excessive levels of older
product inventories and to ensure that adequate supplies of new products can be
delivered to meet customer demand.

    There can be no assurance that the Company will identify new product
opportunities, will successfully develop and bring to market new products, will
achieve design wins or will respond effectively to technological changes or
product announcements by others, or that the Company's new products will achieve
market acceptance. A failure in any of these areas would have a material adverse
effect on the Company's business, financial condition and operating results.

    COMPETITION.  The markets in which the Company competes are intensely
competitive and are characterized by rapid technological change, rapid product
obsolescence and price competition. The Company expects competition to increase
in the future from existing competitors and from other companies that may enter
the Company's existing or future markets with products or technologies which may
be less costly or provide higher performance or more desirable features than the
Company's products. The Company's existing and potential competitors include
several large domestic and international companies that have substantially
greater financial, manufacturing, technical, marketing, distribution and other
resources than the Company. In the market for TV video processors, the Company's
principal

                                       17
<PAGE>
competitors are DWIN, Extron, NEC, Snell & Wilcox, Sony and YEM. In the market
for broadcast products, the Company's principal competitors are Extron, Leitch,
Matsushita, Snell & Wilcox, Sony Broadcast and Vistek. As the Company's products
penetrate broader markets and as these markets become commercial markets, the
Company expects to face competition from diversified electronic and
semiconductor companies.

    The Company believes that its ability to compete successfully in the rapidly
evolving markets for high performance video image enhancement technology depends
on a number of factors, including protection of its proprietary technology and
information, the price, quality and performance of the Company's and its
competitors' products, the timing and success of new product introductions by
the Company, its customers and its competitors, the emergence of new industry
standards, the Company's ability to obtain adequate foundry capacity, the number
and nature of the Company's competitors in a given market and general market and
economic conditions. There can be no assurance that the Company will compete
successfully in the future with respect to these or any other competitive
factors.

    Yves Faroudja, the Company and GI are parties to a royalty free, world-wide
license agreement dated May 1, 1996 pursuant to which GI licensed certain
patents to the Company and the Company licensed certain patents to GI relating
to video compression and decompression. As a result of that agreement, GI could
produce products in the field of scan conversion of source material presented to
a compression system competitive with the Company's proposed upconverter.

    The Company's licensees and OEM customers may be larger and have greater
market recognition and financial, technological engineering, manufacturing and
distribution capabilities than the Company. In addition, such licensees and OEM
customers may use such technologies and subsystems either alone or in
combination with other technologies to develop products which could compete with
the Company's technologies and products. At the present, the Company believes
that S3 and GI are licensees which could compete with certain of the Company's
technologies and products.

    Certain of the Company's principal competitors maintain their own
manufacturing facilities, including semiconductor foundries, and may therefore
benefit from certain capacity, cost and technical advantages. Since the Company
does not operate its own semiconductor manufacturing, assembly or testing
facilities, it may not be able to reduce its costs as rapidly as companies that
operate their own facilities. The failure of the Company to introduce lower cost
versions of its products in a timely manner or to successfully manage its
manufacturing, assembly and testing relationships would have a material adverse
effect on its business, operating results and financial condition.

    The Company believes that its ability to compete successfully in the rapidly
evolving markets for high performance video technology depends on a number of
factors, including protection of its proprietary technology and information, the
price, quality and performance of the Company's and its competitors products,
the timing and success of new product introductions by the Company, its
customers and its competitors, the emergence of new industry standards, the
Company's ability to obtain and locate adequate foundry capacity, the number and
nature of the Company's competitors in a given market and general market and
economic conditions. There can be no assurance that the Company will compete
successfully in the future with respect to these or any other competitive
factors.

    DEPENDENCE ON STRATEGIC RELATIONSHIPS.  The Company expects that a
significant portion of its annual revenues and profits in the future will depend
on strategic relationships. The Company depends on Runco and Vidikron to sell
products which incorporate the Company's technology and a failure by these
companies to make such sales will adversely affect the Company's total revenues
in the future. There can be no assurance that the Company will identify new
strategic partners or enter into additional strategic relationships or that any
of the Company's strategic relationships will result in the introduction of new
products incorporating the Company's technology or will result in substantial
revenues for the Company. In the event that the Company's strategic
relationships fail to result in substantial revenues to the

                                       18
<PAGE>
Company, the Company's business, financial condition and operating results will
be materially adversely affected.

    The Company has licensed and intends to continue to license its technologies
and intellectual property. The Company also offers for sale board level or chip
level products, developed by or for the Company, which implement certain of the
Company's technologies. The Company's licensees and OEM customers may be larger
and have greater market recognition and financial, technological, engineering,
manufacturing and distribution capabilities than the Company. In addition, such
licensees and OEM customers may use such technologies and subsystems either
alone or in combination with other technologies to develop products which could
compete with the Company's technologies and products. While the Company may sell
board level or chip level products and receive royalties from such licensees,
there can be no assurance that the technologies and products offered by such
licensees and OEM customers will not compete directly with those of the Company,
have performance, cost or other advantages over those of the Company or have an
adverse impact on the sales or other licensing activities of the Company.

    RISKS ASSOCIATED WITH EXPORT SALES AND OPERATIONS.  The Company intends to
expand its international presence in order to increase its export sales and
believes that export sales will increase as a percentage of total revenues in
future periods. Export sales to international customers entail a number of
risks, including unexpected changes in, or impositions of, legislative or
regulatory requirements, delays resulting from difficulty in obtaining export
licenses for certain technology, tariffs, quotas and other trade barriers and
restrictions, longer payment cycles, greater difficulty in accounts receivable
collection, potentially adverse taxes, currency exchange fluctuations, the
burdens of complying with a variety of foreign laws and other factors beyond the
Company's control. The Company would also be subject to general geopolitical
risks in connection with international operations, such as political, social and
economic instability, potential hostilities and changes in diplomatic and trade
relationships. Although the Company has not to date experienced any material
adverse effect on its operations as a result of such regulatory, geopolitical
and other factors, there can be no assurance that such factors will not
adversely affect the Company's operations in the future or require the Company
to modify its current business practices. There can be no assurance that one or
more of the foregoing factors will not have a material adverse effect on the
Company's business, financial condition and operating results or require the
Company to modify its current business practices.

    DISTRIBUTION RISKS; DIVERSIFICATION OF SALES CHANNELS.  The Company sells
its products domestically and internationally through distributors and dealers,
as well as to OEM customers, and the Company's success depends on the continued
efforts of its network of direct and indirect distributors and dealers. The loss
of, or reduction in sales to, any of the Company's key customers could have a
material adverse affect on the Company's operating results. The short life
cycles of the Company's products and the difficulty in predicting future sales
increase the risk that new product introductions, price reductions by the
Company or its competitors or other factors affecting the video imaging industry
could result in significant product returns. In addition, there can be no
assurance that new product introductions by competitors or other market factors
will not require the Company to reduce prices in a manner or at a time which has
a material adverse impact upon the Company's business, financial condition and
operating results.

    An integral element of the Company's strategy is to enhance and diversify
its international and domestic distribution channels. The Company's ability to
achieve revenue growth in the future will depend in large part on its success in
recruiting and training sufficient sales personnel, distributors and resellers.
Certain of the Company's existing distributors currently distribute, or may in
the future distribute, the product lines of the Company's competitors. There can
be no assurance that the Company will be able to attract, train and retain a
sufficient number of its existing or future third-party distributors or direct
sales personnel or that such third-party distributors will recommend, or
continue to recommend, the Company's products or devote sufficient resources to
market and provide the necessary customer support for such products. All of
these factors could have a material adverse effect on the Company's business,
financial condition and operating results.

                                       19
<PAGE>
    RELIANCE ON INDEPENDENT FOUNDRIES AND MANUFACTURING.  The Company currently
relies on independent foundries to manufacture, assemble and test all of its
semiconductor components and products. These independent foundries fabricate
products for other companies and may also manufacture products of their own
design. The Company currently purchases products from all of its foundries
pursuant to individually negotiated purchase orders. The Company does not have a
long-term supply contract with any of these foundries, and, therefore, none of
them is obligated to supply products to the Company for any specific period, in
any specific quantity or at any specified price, except as may be provided in a
particular purchase order.

    The Company's reliance on independent foundries involves a number of risks,
including the inability to obtain adequate capacity, unavailability of or
interruption of access to certain process technologies, reduced control over
delivery schedules, quality assurance, manufacturing yields and cost, and
potential misappropriation of the Company's intellectual property. From time to
time, the semiconductor industry has experienced severe capacity constraints,
and this pattern is expected to continue. The Company obtains foundry capacity
through forecasts that are generated in advance of expected delivery dates, and
the Company places purchase orders up to six months prior to scheduled delivery.
The Company's ability to obtain the foundry capacity necessary to meet the
demand for its products is based in part on its ability to accurately forecast
demand. If the Company fails to accurately forecast its future demand, the
Company may be unable to obtain adequate supplies of integrated circuits on a
timely basis. There can be no assurance that the Company will be able to
accurately forecast the demand for its products or obtain sufficient foundry
capacity in the future. In addition, the Company's obligation to place purchase
orders in advance of delivery subjects the Company to inventory risks, including
the risk of obsolescence.

    While the Company has not experienced any material disruptions in supply to
date, there can be no assurance that manufacturing problems will not occur in
the future. In the event that any of the Company's foundries are unable or
unwilling to produce sufficient supplies of the Company's products in required
volumes at acceptable costs, the Company will be required to reallocate
production among its other existing foundries or to identify and qualify
acceptable alternative foundries. This qualification process could take six
months or longer, and no assurance can be given that any additional source would
become available to the Company or would be in a position to satisfy the
Company's production requirements on a timely basis. The loss of any of the
Company's foundries as a supplier, the inability of the Company in a period of
increased demand for its products to expand supply or the Company's inability to
obtain timely and adequate deliveries from its current or future suppliers could
reduce or delay shipments of the Company's products. Any of these developments
could damage relationships with the Company's current and prospective customers
and could have a material adverse effect on the Company's business, financial
condition and operating results.

    The Company subcontracts the manufacturing of its broadcast and TV products
pursuant to individually negotiated purchase orders. The Company does not have
any long term agreements with its subcontractors and contract manufacturers. The
Company's reliance on third-party manufacturers limits its control over delivery
schedules, quality assurance and product cost. Disruptions in the provision of
services by the Company's assemblers or other circumstances that would require
the Company to seek alternative sources of assembly could lead to supply
constraints or delays in the delivery of the Company's products. In addition,
the need for high quality assurance by the Company may increase costs paid by
the Company to third parties for manufacturing and assembly of the Company's
products. These constraints or delays could damage relationships with current
and prospective customers and could have a material adverse effect on the
Company's business, financial condition and operating results.

    LIMITED PROTECTION OF PROPERTY RIGHTS: RISK OF THIRD PARTY
INFRINGEMENT.  The Company's future success depends in part upon its ability to
protect its technology and information. The Company seeks to protect its
intellectual property rights and to limit access to its proprietary information
through a combination of patents, trademarks, copyrights, trade secrets, and
nondisclosure and licensing arrangements, all of which afford only limited
protection. There can be no assurance that patents will issue from any pending

                                       20
<PAGE>
applications or that any claims allowed from pending applications will be of
sufficient scope or strength, or be issued in all countries where the Company's
products can be sold, to provide meaningful protection or any commercial
advantage to the Company. Also, competitors of the Company may be able to design
around the licensed patents. The laws of certain foreign countries in which the
Company's products are or may be developed, manufactured or sold, including
various countries in Asia, may not protect the Company's products or
intellectual property rights to the same extent as the laws of the United
States, and thus, may increase the likelihood of piracy of the Company's
technology and products. There can be no assurance that the steps taken by the
Company to protect its intellectual property rights will be adequate to prevent
misappropriation of its technology or that the Company's competitors will not
independently develop technologies that are substantially equivalent or superior
to the Company's technology.

    There can be no assurance that the Company's intellectual property rights,
if challenged, will be upheld as valid, will be adequate to prevent
misappropriation of its technology or will prevent the development of
competitive products. Additionally, there can be no assurance that the Company
will be able to license or obtain patents or other intellectual property
protection in the future.

    Substantially all of the intellectual property used by the Company is
licensed to the Company by Yves Faroudja. The Company faces certain risks
because the Company is a licensee and not the owner of such intellectual
property rights. Under his agreement with the Company, Mr. Faroudja retains the
non-exclusive right to license his patents and technologies to third parties for
use outside the Company's field of use. Notwithstanding the particular terms of
the license agreement with Mr. Faroudja, the Company faces the risk that he may
attempt to terminate the granted licenses and that such an attempt may be
successful or that the response to such attempt may consume substantial
financial and personnel resources. In the event the Company's resources are so
consumed, such consumption may have a material adverse affect on the Company's
business, financial condition and operating results.

    The video image enhancement and related industries are characterized by
vigorous protection and pursuit of intellectual property rights or positions,
which have resulted in significant and often protracted and expensive
litigations. The Company may from time to time be subject to proceedings
alleging infringement by the Company of intellectual property rights owned by
third parties. If necessary or desirable, the Company may seek licenses under
such intellectual property rights. However, there can be no assurance that such
licenses will be offered or that the terms of any offered license will be
acceptable to the Company. The failure to obtain such a license from a third
party for technology used by the Company could cause the Company to incur
substantial liabilities and to suspend or cease the manufacture of products
requiring such technology.

    The Company may initiate claims or litigations against third parties for
infringement of the Company's proprietary rights or to establish the validity of
the Company's proprietary rights. Litigation by or against the Company could
result in significant expense to the Company and could divert the efforts of the
Company's technical and management personnel, whether or not such litigation
results in a favorable determination for the Company and such diversion may have
a material adverse effect on the Company's business, financial condition and
operating results. In addition, such litigation could result in the assertion of
counter claims against the Company. In the event of an adverse result in any
such litigation, the Company could be required to pay substantial damages,
attorney fees, costs and expenses, to cease infringing a third-party's
intellectual property rights (including, marketing, using, selling and importing
infringing products, and employing infringing methods or processes), to expend
significant resources to develop non-infringing technology, or to obtain
licenses to the technology allegedly infringed. There can be no assurance that
the Company would be successful in such development or that any such license
would be available on reasonable terms, or at all, and any such development or
license could require expenditures by the Company of substantial time and other
resources. In the event that any third party makes a successful intellectual
property claim against the Company or its customers, the Company's business,
financial condition and operating results could be materially adversely
affected.

                                       21
<PAGE>
    DEPENDENCE ON SENIOR MANAGEMENT AND OTHER KEY EMPLOYEES.  The Company's
future success will depend to a significant extent upon the continued service of
members of senior management and other key employees of the Company,
particularly Yves Faroudja, the Company's founder and Chief Technical Officer
("CTO"), and Michael Moone, the Company's President and Chief Executive Officer.
The loss of the service of any of these individuals could have a material
adverse effect on the Company. Mr. Faroudja has entered into an agreement with
the Company pursuant to which he will serve as the Company's CTO until a new CTO
is identified and hired. Thereafter, Mr. Faroudja will serve as a Senior Fellow
to the Company, advising the Company in a variety of areas, with time to be
devoted at Mr. Faroudja's discretion. The Company does not maintain key man life
insurance on any of its employees. The Company believes that its future success
will depend to a significant extent upon its ability to attract, train and
retain highly skilled technical, management, sales, marketing and consulting
personnel. Competition for such personnel is intense, and the Company expects
that such competition will continue for the foreseeable future. The Company has
from time to time experienced difficulty in locating candidates with appropriate
qualifications. There can be no assurance that the Company will be successful in
attracting or retaining such personnel, and the failure to attract or retain
such personnel could have a material adverse effect on the Company's business,
financial condition and operating results.

    SHARES ELIGIBLE FOR FUTURE SALES.  Sales of substantial amounts of Common
Stock (including shares issued upon the exercise of outstanding options) in the
public market could materially adversely affect the market price of the
Company's Common Stock. Such sales might also make it more difficult for the
Company to sell equity securities or equity related securities in the future at
a time and price that the Company deems appropriate. As of December 31, 1997
there were 12,058,913 shares of Common Stock outstanding, 8,608,913 of which are
"restricted" shares under the Securities Act of 1993, as amended (the
"Securities Act"). In addition to the 3,450,000 shares currently available for
sale in the public market, approximately 8,608,913 shares will be available for
sale in the public market on April 28, 1998 upon expiration of certain lockup
agreements and pursuant to Rules 144, 144(k) or 701 promulgated under the
Securities Act, subject in some cases to certain volume and other resale
restrictions pursuant to Rule 144. In addition, the Company is required to
register for re-sale by April 28, 1998 an aggregate of 8,200,000 shares of
Common Stock. The Company intends to register on a registration statement on
Form S-8 a total of 2,442,620 shares of Common Stock for issuance pursuant to
the Company's 1995 Stock Option Plan (the "1995 Option Plan"), 1997 Performance
Stock Option Plan (the "1997 Option Plan"), 1997 Directors Stock Option Plan
(the "Directors Plan") and the 1997 Employee Stock Purchase Plan ("Purchase
Plan"). BancAmerica Robertson Stephens in its sole discretion and at any time
without notice can release all or any portion of the securities subject to
lock-up agreements.

POSSIBLE VOLATILITY OF STOCK PRICE

    Factors such as announcements of developments related to the Company's
business, announcements of technological innovations or new products or
enhancements by the Company or its competitors, sales of the Company's Common
Stock into the public market, developments in the Company's relationships with
its customers, distributors and suppliers, shortfalls or changes in total
revenues, gross margin, earnings or other financial results from analysts'
expectations, regulatory developments, fluctuations in results of operations and
general conditions in the Company's market or the market served by the Company's
customers or the economy could cause the price of the Company's Common Stock to
fluctuate, perhaps substantially. In addition, in recent years the stock market
in general, and the market for shares of small capitalization and technology
stocks in particular, have experienced extreme price and volume fluctuations,
which have often been unrelated or disproportionate to the operating performance
of affected companies. There can be no assurance that the market price of the
Company's Common Stock will not decline substantially from the initial public
offering price, or otherwise experience significant fluctuations in the future,
including fluctuations that are unrelated to the Company's performance.

                                       22
<PAGE>
EXECUTIVE OFFICERS OF THE COMPANY

    Set forth below is the name, age and offices held with the Company of each
of the executive officers of the Company as of March 15, 1998 and such executive
officers' other business experience during the past five years. Except as
otherwise indicated, each such executive officer was elected at the meeting of
the Board of Directors held after the annual meeting of stockholders held on
August 12, 1997. The term of office for each executive officer extends until the
next meeting of the Board of Directors for the election of officers and until
their respective successors are duly elected.

    MICHAEL J. MOONE (age 51) has served as President, Chief Executive Officer
and a director of the Company since joining the Company in July 1996. From
February 1995 to June 1996, Mr. Moone was President, Chief Executive Officer and
a director of Healthrider, Inc., a home fitness equipment supplier. In June
1993, he co-founded Kid One, Inc., a developer of electronic toys and games, and
served as its Chief Executive Officer and a director through February 1995. In
1985, Mr. Moone founded Merchantec International, a credit card processing
company, and served as its President, Chief Executive Officer and a director
through May 1993.

    YVES C. FAROUDJA (age 64) is co-founder of the Company and has served as a
director of the Company since its inception in 1971. Mr. Faroudja served as the
Company's President from 1971 to July 1996, has been the Company's Chief
Technical Officer since July 1996 and is currently Chairman of its Executive
Committee of the Board of Directors.

    MICHAEL C. HOBERG (age 46) joined the Company in December 1996 as Vice
President--Finance and Chief Financial Officer. From March 1995 to December
1996. Mr. Hoberg was Principal Accounting Officer of DSP Group, Inc. ("DSP"), a
semiconductor company, and from January 1994 to March 1995 he was DSP's
Corporate Controller. From March 1992 to January 1994, Mr. Hoberg served as Vice
President of Finance and Chief Financial Officer at Arix Corporation ("Arix"), a
UNIX superminicomputer manufacturer, and from 1989 to March 1992 was Arix's
Corporate Controller.

    DONALD S. BUTLER (age 52) joined the Company in May 1996 as Vice President
and General Manager of the VLSI Division. In October 1996, as Vice
President--Engineering, he assumed responsibility for all engineering functions
other than research and development. Prior to joining the Company, Mr. Butler
was Vice President of Engineering at the Integrated Systems Center of GI, a
manufacturer of satellite and cable TV equipment, a position he held from 1989
to May 1996. From 1974 to 1989, he held several engineering and engineering
management positions within GI's Microelectronics Division.

    THOMAS A. HARVEY (age 49) joined the Company in June 1997 as Vice
President--Sales and Marketing. From September 1990 to May 1997, Mr. Harvey was
Senior Vice President of the Western Zone Sales Consumer Products Group of Sony
Electronics, Inc. ("Sony Electronics"), a leading electronics supplier. From
June 1989 to August 1990, Mr. Harvey was the President of the Consumer Sales
Company division of Sony Electronics. From August 1987 to May 1989, he was the
President of the Consumer Audio Products group of Sony Electronics.

    KENNETH S. BOSCHWITZ (age 44) joined the Company in June 1997 as Vice
President--Business Development and General Counsel. From May 1984 to September
1996, Mr. Boschwitz held various legal and management positions with GI,
including Vice President & General Counsel of GI's Communications Division.

ITEM 2.  PROPERTIES

    The Company's headquarters is located in approximately 20,000 square feet of
space in Sunnyvale, California pursuant to a lease which expires September 30,
2003. In 1997, the Company also entered into a lease for approximately 10,000
square feet to expand its headquarters in Sunnyvale, California which expires in
September 2003 and for approximately 2,000 square feet for a research and
development facility in Phoenix, Arizona which expires in June 1999. The
aggregate annual gross rent for the Company's

                                       23
<PAGE>
facilities was approximately $186,000 in 1996 and $289,000 in 1997, and the
Company estimates that this amount will increase to approximately $431,000 in
1998.

ITEM 3.  LEGAL PROCEEDINGS

    In January 1997 and May 1997, the Company filed actions against DWIN and
Snell & Wilcox, respectively, seeking relief and damages for the infringement of
US Patent Number 4,876,596, which was issued on October 24, 1989, is owned by
Yves Faroudja and is licensed to the Company. DWIN and Snell & Wilcox have
raised defenses and counterclaims that the patent is invalid and not infringed.
The actions against DWIN and Snell & Wilcox were filed in the United States
District Court, Northern District of California, San Jose Division as Civil
Action No. C-97 20010 SW (PVT) and Civil Action No. C-97 20422 SW (PVT),
respectively. The Company is seeking an injunction and unspecified monetary
damages against both DWIN and Snell & Wilcox. DWIN and Snell & Wilcox have filed
counterclaims seeking declaratory judgements that all of the claims of the
patents are invalid and/or that US Patent Number 4,876,596 has not been
infringed. They are also seeking recovery of their respective attorneys' fees
and costs. Discovery has commenced in both matters. The Company's management
believes that a finding that all of the claims of the patent are invalid or that
the patent has not been infringed in one or both actions would not have a
material adverse effect on the Company because the Company's products and
business are protected by a variety of patents and the Company will remain
competitive even in the absence of the protection afforded by the patent which
is the subject of these litigation matters.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

    None.

                                       24
<PAGE>
                                    PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

    The section labeled "Price Range of Common Stock" appearing on page 14 of
the Registrant's Annual Report to Stockholders for the year ended December 31,
1997 (the "1997 Annual Report") is incorporated herein by reference.

ITEM 6.  SELECTED FINANCIAL DATA.

    The section labeled "Selected Consolidated Financial Data" appearing on page
14 of the Registrant's 1997 Annual Report is incorporated herein by reference.

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATION.

    The section labeled "Management's Discussion and Analysis of Financial
Condition and Results of Operations" appearing on pages 15 through 19 of the
1997 Annual Report is incorporated herein by reference.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS.

    Not Applicable.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

    The consolidated financial statements and related notes and independent
auditors report appearing on pages 20 through 32 of the 1997 Annual Report are
incorporated herein by reference.

    The section labeled "Quarterly Data" appearing on page 14 of the 1997 Annual
Report is incorporated herein by reference.

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
       FINANCIAL DISCLOSURE.

    Not applicable.

                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

    Information concerning directors of the Company is incorporated herein by
reference from the Registrant's definitive proxy statement to be filed for the
annual meeting of stockholders to be held on June 10, 1998 ("1998 Proxy
Statement"). Information concerning the executive officers of the Registrant is
included in Part I, page 23, of this annual report on Form 10-K.

ITEM 11.  EXECUTIVE COMPENSATION.

    The section labeled "Executive Compensation" of the 1998 Proxy Statement is
incorporated herein by reference.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

    The section labeled "Security Ownership of Certain Beneficial Owners" of the
1998 Proxy Statement is incorporated herein by reference.

                                       25
<PAGE>
ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

    The section labeled "Certain Relationships and Related Transactions" of the
1998 Proxy Statement is incorporated herein by reference.

                                    PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

    (a) The following documents have been filed as a part of this Annual Report
on Form 10-K.

    1.  Index to Financial Statements.

    The following financial statements and related notes and auditor's reports
are included in the 1997 Annual Report and are incorporated herein by reference
pursuant to Item 8.

<TABLE>
<CAPTION>
                                                                                 PAGE IN 1997
DESCRIPTION                                                                      ANNUAL REPORT
-------------------------------------------------------------------------------  -------------
<S>                                                                              <C>
Consolidated Balance Sheets as of December 31, 1997 and 1996...................            20

Consolidated Statements of Income for the years ended December 31, 1997, 1996
  and 1995.....................................................................            21

Consolidated Statements of Stockholders' Equity for the years ended December
  31, 1997, 1996 and 1995......................................................            22

Consolidated Statements of Cash Flows for the years ended
  December 31, 1997, 1996 and 1995.............................................            23

Notes to Consolidated Financial Statements.....................................      24 to 31

Report of Ernst & Young LLP, Independent Auditors..............................            32
</TABLE>

    2.  Index to Financial Statement Schedules.

    The following financial statement schedules and related auditor's reports
are filed as part of this Annual Report on Form 10-K:

<TABLE>
<CAPTION>
                                                                                   PAGE IN THIS
                                                                                   ANNUAL REPORT
DESCRIPTION                                                                        ON FORM 10-K
-------------------------------------------------------------------------------  -----------------
<S>                                                                              <C>
Schedule II: Valuation and Qualifying Accounts.................................            S-1
</TABLE>

    All other schedules are omitted because they are not applicable or not
required or because the required information is included in the Consolidated
Financial Statements or the Notes thereto.

    3.  Exhibits

    The exhibits noted in the accompanying Index to Exhibits on pages 30 to 31
are filed as part of this Annual Report on Form 10-K.

    (b) Reports on Form 8-K.

    No reports on Form 8-K were filed during the last quarter of 1997.

                                       26
<PAGE>
                                   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.

<TABLE>
<S>                             <C>  <C>
                                FAROUDJA, INC.

                                By:             /s/ MICHAEL J. MOONE
                                      ---------------------------------------
                                                  Michael J. Moone
                                       PRESIDENT AND CHIEF EXECUTIVE OFFICER

                                Date: March 27, 1998
</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
------------------------------  ---------------------------  -------------------

<C>                             <S>                          <C>
                                Chief Executive Officer,
     /s/ MICHAEL J. MOONE         President and Director
------------------------------    (Principal Executive         March 27, 1998
       Michael J. Moone           Officer)

                                Vice President--Finance and
    /s/ MICHAEL C. HOBERG         Chief Financial Officer
------------------------------    (Principal Financial and     March 27, 1998
      Michael C. Hoberg           Accounting Officer)

                                Chief Technical Officer,
     /s/ YVES C. FAROUDJA         Director and Chairman of
------------------------------    the Executive Committee,     March 27, 1998
       Yves C. Faroudja           Secretary

    /s/ WILLIAM J. TURNER
------------------------------  Director                       March 27, 1998
      William J. Turner

    /s/ KEVIN B. KIMBERLIN
------------------------------  Director                       March 27, 1998
      Kevin B. Kimberlin

    /s/ MATTHEW D. MILLER
------------------------------  Director                       March 27, 1998
      Matthew D. Miller
</TABLE>

                                       27
<PAGE>
<TABLE>
<CAPTION>
          SIGNATURE                        TITLE                    DATE
------------------------------  ---------------------------  -------------------

<C>                             <S>                          <C>
     /s/ WILLIAM N. SICK
------------------------------  Director                       March 27, 1998
       William N. Sick

     /s/ MERV L. ADELSON
------------------------------  Director                       March 27, 1998
       Merv L. Adelson

   /s/ STUART D. BUCHALTER
------------------------------  Director                       March 27, 1998
     Stuart D. Buchalter
</TABLE>

                                       28
<PAGE>
                                 FAROUDJA, INC.

                 SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS

                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                         BALANCE AT     CHARGED TO     CHARGED TO                     BALANCE
                                                          BEGINNING      COSTS AND        OTHER       DEDUCTIONS      END OF
                                                          OF PERIOD      EXPENSES       ACCOUNTS          (1)         PERIOD
                                                        -------------  -------------  -------------  -------------  -----------
<S>                                                     <C>            <C>            <C>            <C>            <C>
Year ended December 31, 1997 deducted from asset
  accounts:
  Allowance for doubtful accounts.....................    $     110      $     101                     $      44     $     167
                                                              -----          -----          -----          -----         -----
Year ended December 31, 1996 deducted from asset
  accounts:
  Allowance for doubtful accounts.....................    $      10      $     143      $  --          $      43     $     110
                                                              -----          -----          -----          -----         -----
Year ended December 31, 1995 deducted from asset
  account:
  Allowance for doubtful account......................    $      10      $  --          $  --          $  --         $      10
                                                              -----          -----          -----          -----         -----
</TABLE>

------------------------

(1) Uncollectible accounts written off, net of recoveries.

                                       29
<PAGE>
                                 FAROUDJA, INC.

                               INDEX TO EXHIBITS

                                  (ITEM 14(C))

<TABLE>
<CAPTION>
  EXHIBIT
  NUMBER                                                   DESCRIPTION
-----------  --------------------------------------------------------------------------------------------------------
<C>          <S>
       3.1   The Company's Restated Certificate of Incorporation, as amended on August 12, 1997. (1)
       3.2   The Company's By-Laws. (1)
       4.1   Warrant, dated January 20, 1997, for the purchase of Common Stock issued to Yves Faroudja. (1)
       4.2   Warrant, dated December 17, 1997, for the purchase of Common Stock issued to Adelson Investors, LLC.
       4.3   Specimen of Common Stock Certificate. (1)
      10.1   Letter Agreement, dated December 31, 1996, between the Company and Merv L. Adelson for certain
               consulting services. (1)
      10.2   Amendment to Letter Agreement, dated December 17, 1997, between the Company and Merv L. Adelson.
      10.3   Letter Agreement, dated November 13, 1995, by and among certain stockholders of the Company listed
               therein and Spencer Trask Holdings, Inc. (1)
      10.4   Amendment to Letter Agreement, dated February 9, 1996, among certain stockholders of the Company listed
               therein and Spencer Trask Holdings, Inc. (1)
      10.5   Lease Agreement, dated August 27, 1997, by and among the Company and the Landlords listed therein. (1)
      10.6   The Company's 1995 Stock Option Plan, dated August 1, 1995 and amended on August 19, 1996, February 11,
               1997, April 30, 1997 and June 13, 1997. (1)
      10.7   The Company's 1997 Non-Employee Directors Stock Option Plan, dated January 2, 1997. (1)
      10.8   The Company's 1997 Performance Stock Option Plan, dated January 2, 1997 and amended on June 13, 1997.
               (1)
      10.9   The Company's Amended 1997 Employee Stock Purchase Plan, dated January 2, 1997 and amended on August 12,
               1997 and September 30, 1997. (1)
     10.10   Employment Agreement, dated as of July 8, 1996, between the Company and Michael J. Moone. (1)
     10.11   Employment Agreement, dated March 8, 1996, between the Company and Yves C. Faroudja. (1)
     10.12   Registration and Shareholders' Rights Agreement, dated March 7, 1997, among the Company and Yves &
               Isabell Faroudja and certain Stockholders of the Company. (1)
     10.13   Three (3) Registration Rights Agreements, dated December 31, 1996 among the Company and each of Adelson
               Investors, LLC, Images Partners, LP and Roger K. Baumberger as Liquidating Trustee for Faroudja
               Images, Inc. (1)
     10.14   Registration Rights Agreement, dated March 7, 1997 among the Company and Faroudja Images Investors, LLC.
               (1)
     10.15   Agreement, dated January 20, 1997 among Yves Faroudja and the Company for the transfer of intellectual
               property to the Company. (1)
     10.16   License Agreement, dated March 31, 1997, between the Company and S3 Incorporated. (1) (2)
     10.17   Stock Purchase Agreement, dated June 30, 1997, between the Company and S3 Incorporated. (1)
     10.18   Investor's Rights Agreement, dated June 30, 1997, between the Company and S3 Incorporated. (1)
</TABLE>

                                       30
<PAGE>
                                 FAROUDJA, INC.

                               INDEX TO EXHIBITS

                                  (ITEM 14(C))

<TABLE>
<CAPTION>
  EXHIBIT
  NUMBER                                                   DESCRIPTION
-----------  --------------------------------------------------------------------------------------------------------
<C>          <S>
     10.19   Business Loan Agreement, dated April 5, 1997, between the Company and Silicon Valley Bank. (1)
     10.20   Commercial Guaranty, dated April 5, 1997, by the Company for the benefit of Silicon Valley Bank. (1)
     10.21   Commercial Security Agreement, dated April 5, 1997, by the Company for the benefit of Silicon Valley
               Bank. (1)
     10.22   Promissory Note, dated April 5, 1997, by the Company for the benefit of Silicon Valley Bank. (1)
     10.23   Promissory Note, dated June 6, 1997, by the Company for the benefit of Silicon Valley Bank. (1)
     10.24   Loan Modification Agreement, dated June 6, 1997, by and between the Company and Silicon Valley Bank. (1)
     10.25   Three (3) Amended and Restated Options to Purchase Shares of Common Stock of the Company, dated March 7,
               1997 among the Company, Yves Faroudja and Isabell Faroudja, Faroudja Images, Inc. and each of Adelson
               Investors, LLC, Faroudja Images Investors, LLC and Images Partners, LP. (1)
     10.26   Amended and Restated Option to Purchase Shares of Common Stock of the Company, dated December 31, 1996
               among the Company, Yves Faroudja and Isabell Faroudja, Faroudja Images, Inc. and Roger K. Baumberger
               as Liquidating Trustee of Faroudja Images, Inc. (1)
     10.27   Consulting Services Agreement, dated July 22, 1997, between the Company and Matthew D. Miller. (1)
     10.28   License Agreement, dated May 1, 1996 between the Company, Yves Faroudja and General Instrument
               Corporation of Delaware. (1) (2)
     10.29   Purchase Agreement dated December 18, 1997, between the Company and Audio Video Source, Inc. (3)
     10.30   Agreement, dated March 8, 1998, between the Company and Yves Faroudja for advisory services.
      13.1   Annual Report to Stockholders for the year ended December 31, 1997.
      21.1   List of the Subsidiaries of the Company. (1)
      23.0   Consent of Ernst & Young LLP, Independent Auditors.
        27   Financial Data Schedules.
</TABLE>

------------------------

(1) Filed as an exhibit to the Registrant's Registration Statement on Form S-1,
    File No. 333-32375, and incorporated herein by reference.

(2) Confidential treatment has been granted. Non-public information has been
    omitted and filed separately with Commission.

(3) Confidential treatment has been requested. Non-public information has been
    omitted and filed separately with the Commission.

                                       31