Table of Contents

 

 

 

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

----

 

### **FORM 10-Q**

### ** **

| **x**                                                  | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934**  |
|--------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|
|                                                   |       |                                                                                                        |
| **For the  Quarterly Period Ended June 30, 2008** |
|                                                   |       |                                                                                                        |
| **OR**                                                 |
|                                                   |       |                                                                                                        |
| **o**                                                  | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934** |

 
| ** ** | ** ** | **For the transition period  from                                          to** |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

**CommissionFile No. 0-27246**

 

**ZORANCORPORATION**

(Exact name ofregistrant as specified in its charter)

** **

| **Delaware**                       | ** ** | **94-2794449**          |
|------------------------------------|------------|-------------------------|
| (State or other  jurisdiction      |       | (I.R.S. Employer        |
| of incorporation  or organization) |       | Identification  Number) |

 

**1390Kifer Road**

**Sunnyvale,California 94086**

(Address ofprincipal executive offices, including zip code)

 

**(408)523-6500**

(Registrant’stelephone number, including area code)

 

----

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days.  Yes x   No o

 

Indicateby check mark whether registrant is a large accelerated filer, an acceleratedfiler, a non-accelerated filer or a smaller reporting company.  See definitions of “large accelerated filer,”“accelerated filer” and “smaller reporting company” in Rule 12b-2 of theExchange Act.  (Check one):

 

| Large accelerated filer  x |   | Accelerated  filer o |   | Non-accelerated  filer o(Do not check if a smaller  reporting company) |   | Smaller  reporting company o |
|----------------------------|--------|----------------------|--------|------------------------------------------------------------------------|--------|------------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act) Yes o No x

 

As of August 6,2008, there were outstanding 51,874,521 shares of the registrant’s CommonStock, par value $0.001 per share.

 

 

 

----

Table of Contents

 

**ZORANCORPORATION AND SUBSIDIARIES**

**FORM 10-Q**

**INDEX**

 

**For theQuarter Ended June 30, 2008**

** **
| ** **                              | ** ** | ** **                                                                                                              | ** ** | **Page**   |
|-----------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** **                              | ** ** | ** **                                                                                                              | ** ** | ** ** |
| **PART I.  FINANCIAL INFORMATION** | ** ** | ** **                                                                                                              |
| ** **                              | ** ** | ** **                                                                                                              | ** ** | ** ** |
| Item 1.                                 |       | Financial Statements (Unaudited):                                                                                       |       |       |
|                                    |       |                                                                                                                    |       |       |
|                                    |       | Condensed  Consolidated Balance Sheets as of June 30, 2008 and December 31,  2007                             |       | 3          |
|                                    |       |                                                                                                                    |       |       |
|                                    |       | Condensed  Consolidated Statements of Operations for the Three Months and Six Months  Ended June 30, 2008 and 2007 |       | 4          |
|                                    |       |                                                                                                                    |       |       |
|                                    |       | Condensed  Consolidated Statements of Cash Flows for the Six Months Ended June 30,  2008 and 2007                  |       | 5          |
|                                    |       |                                                                                                                    |       |       |
|                                    |       | Notes to Condensed Consolidated Financial Statements                                                                    |       | 6          |
|                                    |       |                                                                                                                    |       |       |
| **Item 2.**                             |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                             |       | 18         |
|                                    |       |                                                                                                                    |       |       |
| **Item 3.**                             |       | Quantitative  and Qualitative Disclosures About Market Risk                                                             |       | 25         |
| ** **                              | ** ** | ** **                                                                                                              | ** ** | ** ** |
| **Item 4.**                             |       | Controls and  Procedures                                                                                                |       | 26         |
|                                    |       |                                                                                                                    |       |       |
| **PART II.  OTHER INFORMATION**    | ** ** | ** **                                                                                                              |
|                                    |       |                                                                                                                    |       |       |
| **Item 1.**                             |       | Legal Proceedings                                                                                                       |       | 27         |
|                                    |       |                                                                                                                    |       |       |
| **Item 1A.**                            |       | Risk Factors                                                                                                            |       | 27         |
| ** **                              | ** ** | ** **                                                                                                              | ** ** | ** ** |
| **Item 4.**                             |       | Submission  of Matters to a Vote of Security Holders                                                                    |       | 40         |
| ** **                              | ** ** | ** **                                                                                                              | ** ** | ** ** |
| **Item 6.**                             |       | Exhibits                                                                                                                |       | 41         |
| ** **                              | ** ** | ** **                                                                                                              | ** ** | ** ** |
| Signatures                              |       | 42                                                                                                                      |

 

2

----

Tableof Contents

 

**PART I. FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements:**

 

**ZORAN CORPORATION**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(in thousands, except share data)**

**(unaudited)**

 
| ** **                                                                                                                                                                                                                                                       | ** ** | **June 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ASSETS                                                                                                                                                                                                                                                           |       |                    |       |                        |       |
| Current assets:                                                                                                                                                                                                                                                  |       |                    |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                                                                                                       |       | $                       | 85,742     |                        | $          | 97,377 |   |
| Short-term  investments                                                                                                                                                                                                                                          |       | 216,654                 |       | 222,432                     |       |
| Accounts  receivable, net                                                                                                                                                                                                                                        |       | 57,877                  |       | 58,220                      |       |
| Inventories                                                                                                                                                                                                                                                      |       | 60,603                  |       | 48,992                      |       |
| Prepaid expenses  and other current assets                                                                                                                                                                                                                       |       | 25,412                  |       | 25,189                      |       |
| Total current  assets                                                                                                                                                                                                                                            |       | 446,288                 |       | 452,210                     |       |
| Property and  equipment, net                                                                                                                                                                                                                                     |       | 17,805                  |       | 17,636                      |       |
| Deferred income  taxes                                                                                                                                                                                                                                           |       | 45,289                  |       | 43,218                      |       |
| Other assets and  long-term investments                                                                                                                                                                                                                          |       | 84,453                  |       | 112,632                     |       |
| Goodwill                                                                                                                                                                                                                                                         |       | 168,691                 |       | 168,691                     |       |
| Intangible  assets, net                                                                                                                                                                                                                                          |       | 8,757                   |       | 25,945                      |       |
| Total assets                                                                                                                                                                                                                                                     |       | $                       | 771,283    |                        | $          | 820,332 |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                       |       |                    |       |                        |       |
| Current  liabilities:                                                                                                                                                                                                                                            |       |                    |       |                        |       |
| Accounts payable                                                                                                                                                                                                                                                 |       | $                       | 44,157     |                        | $          | 67,836 |   |
| Accrued expenses  and other current liabilities                                                                                                                                                                                                                  |       | 46,793                  |       | 43,968                      |       |
| Total current  liabilities                                                                                                                                                                                                                                       |       | 90,950                  |       | 111,804                     |       |
| Other long-term  liabilities                                                                                                                                                                                                                                     |       | 25,092                  |       | 20,756                      |       |
| Contingencies  (Note 12)                                                                                                                                                                                                                                         |       |                    |       |                        |       |
| Stockholders’  equity:                                                                                                                                                                                                                                      |       |                    |       |                        |       |
| Common stock,  $0.001 par value; 105,000,000 shares authorized at June 30, 2008 and  December 31, 2007; 51,840,769 shares issued and outstanding as of  June 30, 2008; and 51,407,860 shares issued and outstanding as of  December 31, 2007 |       | 52                      |       | 51                          |       |
| Additional  paid-in capital                                                                                                                                                                                                                                      |       | 858,263                 |       | 847,597                     |       |
| Accumulated  other comprehensive income (loss)                                                                                                                                                                                                                   |       | (905                    | )          | 995                         |       |
| Accumulated  deficit                                                                                                                                                                                                                                             |       | (202,169                | )          | (160,871                    | )          |
| Total  stockholders’ equity                                                                                                                                                                                                                                 |       | 655,241                 |       | 687,772                     |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                                                 |       | $                       | 771,283    |                        | $          | 820,332 |   |

 

The accompanying notesare an integral part of these unaudited condensed consolidated financialstatements.

 

3

----

Table of Contents

 

**ZORAN CORPORATION**

**CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS**

**(in thousands, except per share data)**

**(unaudited)**

 
| ** **                                                  | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                  | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                  | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                  | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues:                                                   |       |                             |       |                           |       |   |   |   |   |
| Hardware product  revenues                                  |       | $                                | 113,606    |                           | $          | 114,508 |   | $ | 207,903 |   | $ | 201,690 |   |
| Software and  other revenues                                |       | 15,079                           |       | 15,395                         |       | 29,813 |   | 29,872 |   |
| Total revenues                                              |       | 128,685                          |       | 129,903                        |       | 237,716 |   | 231,562 |   |
|                                                        |       |                             |       |                           |       |   |   |   |   |
| Costs and  expenses:                                        |       |                             |       |                           |       |   |   |   |   |
| Cost of hardware  product revenues                          |       | 68,360                           |       | 60,178                         |       | 126,149 |   | 104,376 |   |
| Research and  development                                   |       | 30,797                           |       | 29,976                         |       | 58,684 |   | 54,964 |   |
| Selling, general  and administrative                        |       | 24,260                           |       | 28,414                         |       | 49,899 |   | 57,007 |   |
| Amortization of  intangible assets                          |       | 9,256                            |       | 12,169                         |       | 18,493 |   | 24,338 |   |
| In-process  research and development                        |       | 22,383                           |       | —                         |       | 22,383 |   | — |   |
| Total costs and  expenses                                   |       | 155,056                          |       | 130,737                        |       | 275,608 |   | 240,685 |   |
|                                                        |       |                             |       |                           |       |   |   |   |   |
| Operating loss                                              |       | (26,371                          | )          | (834                           | )          | (37,892 | ) | (9,123 | ) |
|                                                        |       |                             |       |                           |       |   |   |   |   |
| Interest income                                             |       | 3,265                            |       | 3,845                          |       | 7,776 |   | 7,448 |   |
|                                                        |       |                             |       |                           |       |   |   |   |   |
| Other income  (expense), net                                |       | (434                             | )          | 37                             |       | (1,132 | ) | 639 |   |
|                                                        |       |                             |       |                           |       |   |   |   |   |
| Income (loss)  before income taxes                          |       | (23,540                          | )          | 3,048                          |       | (31,248 | ) | (1,036 | ) |
|                                                        |       |                             |       |                           |       |   |   |   |   |
| Provision for  income taxes                                 |       | 13,080                           |       | 2,850                          |       | 10,050 |   | 4,650 |   |
|                                                        |       |                             |       |                           |       |   |   |   |   |
| Net income  (loss)                                          |       | $                                | (36,620    | )                              | $          | 198 |   | $ | (41,298 | ) | $ | (5,686 | ) |
|                                                        |       |                             |       |                           |       |   |   |   |   |
| Basic net income  (loss) per share                          |       | $                                | (0.71      | )                              | $          | 0.00 |   | $ | (0.80 | ) | $ | (0.11 | ) |
|                                                        |       |                             |       |                           |       |   |   |   |   |
| Diluted net  income (loss) per share                        |       | $                                | (0.71      | )                              | $          | 0.00 |   | $ | (0.80 | ) | $ | (0.11 | ) |
|                                                        |       |                             |       |                           |       |   |   |   |   |
| Shares used to  compute basic net income (loss) per share   |       | 51,707                           |       | 49,600                         |       | 51,576 |   | 49,527 |   |
|                                                        |       |                             |       |                           |       |   |   |   |   |
| Shares used to  compute diluted net income (loss) per share |       | 51,707                           |       | 51,187                         |       | 51,576 |   | 49,527 |   |

 

The accompanying notesare an integral part of these unaudited condensed consolidated financialstatements.

 

4

----

Table of Contents

 

**ZORANCORPORATION**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(inthousands)**

**(unaudited)**

 
| ** **                                                                       | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                       | ** ** | **June 30,**              | ** ** |
| ** **                                                                       | ** ** | **2008**                       | ** ** | **2007** | ** ** |
| ** **                                                                       | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Cash flows from  operating activities:                                           | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Net loss                                                                         |       | $                              | (41,298    | ) | $ | (5,686 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operations: |       |                           |       |   |   |
| Depreciation                                                                     |       | 4,032                          |       | 4,021 |   |
| Amortization of  intangible assets                                               |       | 18,493                         |       | 24,338 |   |
| Stock-based  compensation expense                                                |       | 6,584                          |       | 7,032 |   |
| In-process  research and development                                             |       | 22,383                         |       | — |   |
| Deferred income  taxes                                                           |       | 6,440                          |       | — |   |
| Gain on sale of  short-term investments                                          |       | (115                           | )          | (809 | ) |
| Changes in  assets and liabilities, net of acquisition:                          |       |                           |       |   |   |
| Accounts  receivable                                                             |       | 343                            |       | (6,408 | ) |
| Inventories                                                                      |       | (11,611                        | )          | (2,021 | ) |
| Prepaid expenses  and other current assets and other assets                      |       | 979                            |       | (1,791 | ) |
| Accounts payable                                                                 |       | (23,922                        | )          | 14,871 |   |
| Accrued expenses  and other current liabilities and long-term liabilities        |       | (3,621                         | )          | 8,731 |   |
| Net cash  provided by (used in) operating activities                             |       | (21,313                        | )          | 42,278 |   |
|                                                                             |       |                           |       |   |   |
| Cash flows from  investing activities:                                           |       |                           |       |   |   |
| Purchases of  property and equipment                                             |       | (3,700                         | )          | (3,960 | ) |
| Purchases of  investments                                                        |       | (98,997                        | )          | (204,086 | ) |
| Sales and  maturities of investments                                             |       | 131,059                        |       | 160,546 |   |
| Acquisition of  Let It Wave, net of cash acquired of $1,261                      |       | (22,767                        | )          | — |   |
| Net cash  provided by (used in) investing activities                             |       | 5,595                          |       | (47,500 | ) |
|                                                                             |       |                           |       |   |   |
| Cash flows from  financing activities:                                           |       |                           |       |   |   |
| Proceeds from  issuance of common stock                                          |       | 4,083                          |       | 3,682 |   |
| Net cash  provided by financing activities                                       |       | 4,083                          |       | 3,682 |   |
|                                                                             |       |                           |       |   |   |
| Net decrease in  cash and cash equivalents                                       |       | (11,635                        | )          | (1,540 | ) |
|                                                                             |       |                           |       |   |   |
| Cash and cash  equivalents at beginning of period                                |       | 97,377                         |       | 100,034 |   |
|                                                                             |       |                           |       |   |   |
| Cash and cash  equivalents at end of period                                      |       | $                              | 85,742     |   | $ | 98,494 |   |

 

The accompanying notesare an integral part of these unaudited condensed consolidated financialstatements.

 

5

----

Tableof Contents

 

**ZORANCORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(unaudited)**

 

**1.****              Basisof Presentation**

 

The accompanyingunaudited condensed consolidated financial statements of Zoran Corporation andits subsidiaries (“Zoran” or “Company”) have been prepared in conformity withaccounting principles generally accepted in the United States of America.  However, certain information or footnotedisclosures normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States of Americahave been condensed or omitted pursuant to the rules and regulations ofthe Securities and Exchange Commission (“SEC”). In the opinion of management, the condensed consolidated financialstatements reflect all necessary adjustments, consisting only of normalrecurring adjustments, for a fair statement of the consolidated financial position,operating results and cash flows for the periods presented.  The results of operations for the interimperiods presented are not necessarily indicative of the results that may beexpected for the full fiscal year or in any future period.  This Quarterly Report on Form 10-Qshould be read in conjunction with the audited consolidated financialstatements and notes thereto for the year ended December 31, 2007,included in the Company’s 2007 Annual Report on Form 10-K filed with theSEC.

 

***Revenues***

 

On January 25, 2006,the Company entered into an agreement with MediaTek to settle patent litigationbetween the companies. In consideration for licenses granted by Zoran, MediaTekagreed to pay Zoran $55 million, of which $44 million was paid in February 2006and $11 million was paid in April 2006.  These two payments, net of amountsattributable to a holder of rights under patents involved in the litigation,and amounts payable as legal fees, were recognized as license revenues relatedto litigation settlement. MediaTek was required to pay quarterly royaltiestotaling $30 million over a 30-month period that commenced on the date ofthe agreement based on future sales of covered MediaTek products.  These royalty payments, net of amountspayable by Zoran to a holder of rights under patents involved in thelitigation, and amounts payable as legal fees, are recognized as software andother revenues as they are received.

 

**2.****              Stock-basedcompensation**

 

Thefollowing table summarizes stock-based compensation expense related to employeestock options, employee stock purchases and restricted stock unit grants forthe three and six month periods ended June 30, 2008 and 2007 as recordedin accordance with SFAS 123(R) (revised 2004), *Share-Based Payment* (“SFAS 123(R)”) (in thousands):

 
| ** **                           | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                           | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                 |       |                                            |       |                                          |       |   |   |   |   |
| Cost of hardware  product revenues   |       | $                                               | 105        |                                          | $          | 116 |   | $ | 200 |   | $ | 176 |   |
| Research and  development            |       | 1,305                                           |       | 1,468                                         |       | 2,464 |   | 2,163 |   |
| Selling, general  and administrative |       | 2,231                                           |       | 2,936                                         |       | 3,920 |   | 4,693 |   |
| Total costs and  expenses            |       | $                                               | 3,641      |                                          | $          | 4,520 |   | $ | 6,584 |   | $ | 7,032 |   |

 

Theincome tax benefit for share-based compensation expense was $378,000 and$829,000 for the three and six month periods ended June 30, 2008. TheCompany recognized no tax benefit during the three and six month periods ended June 30,2007 due to the Company’s full valuation on its deferred tax assets, which wasreleased in December 2007.

 

6

----

Tableof Contents

 

***ValuationAssumptions***

 

The Company estimates thefair value of stock options using the Black-Scholes valuation model with thefollowing assumptions:

 
| ** **                    | ** ** | **Stock Option Plans**                | ** ** |
|-------------------------------|------------|-------------------------------------------------|------------|
| ** **                    | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
| ** **                    | ** ** | **2008**                                        | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| Average expected term (years) |       | 5.5                                             |       | 5.5 |   | 5.4 |   | 5.5 |   |
| Expected volatility           |       | 54                                              | %          | 60 | % | 54 | % | 60 | % |
| Risk-free interest rate       |       | 3.2                                             | %          | 4.8 | % | 3.0 | % | 4.8 | % |
| Dividend yield                |       | 0                                               | %          | 0 | % | 0 | % | 0 | % |

 
| ** **                    | ** ** | **Employee Stock Purchase Plans**  | ** ** |
|-------------------------------|------------|---------------------------------------------------|------------|
| ** **                    | ** ** | **Three Months Ended****June 30,** | ** ** | **Six Months Ended****June 30,** | ** ** |
| ** **                    | ** ** | **2008**                                          | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
|                          |       |                                              |       |   |   |   |   |   |   |
| Average expected term (years) |       | 1.25                                              |       | 1.27 |   | 1.36 |   | 1.28 |   |
| Expected volatility           |       | 53                                                | %          | 46 | % | 53 | % | 47 | % |
| Risk-free interest rate       |       | 1.8                                               | %          | 4.9 | % | 3.3 | % | 4.8 | % |
| Dividend yield                |       | 0                                                 | %          | 0 | % | 0 | % | 0 | % |

 

*Expected Term:*  The expected term represents the period thatthe Company’s stock-based awards are expected to be outstanding and wasdetermined based on the Company’s historical experience with similar awards,giving consideration to the contractual terms of the stock-based awards andvesting schedules.

 

*ExpectedVolatility*: The Company uses historical volatility in deriving its volatilityassumption.  Management believes thathistorical volatility appropriately reflects the market’s expectations offuture volatility.

 

*Risk-Free Interest Rate*:  Management bases its assumptions regardingthe risk-free interest rate on U.S. Treasury zero-coupon issues with anequivalent remaining term.

 

*Expected Dividend:*TheCompany has not paid and does not anticipate paying any dividends in the nearfuture.

 

StockOption Activity

 

The following is asummary of stock option activities:

 
| ** **                           | ** ** | **Shares Underlying  Outstanding Options** | ** ** | **Weighted Average  Exercise Price** | ** ** |
|--------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                           | ** ** | ** **                                           | ** ** | ** **                                     | ** ** |
| Outstanding at  January 1, 2008 |       | 7,703,071                                            |       | $                                              | 17.92      |   |
| Granted                              |       | 1,478,930                                            |       | $                                              | 14.12      |   |
| Exercised                            |       | (80,515                                              | )          | $                                              | 8.88       |   |
| Canceled                             |       | (157,836                                             | )          | $                                              | 17.54      |   |
| Outstanding at  June 30, 2008   |       | 8,943,650                                            |       | $                                              | 17.38      |   |

 

7

----

Tableof Contents

 

Significant option groupsoutstanding as of June 30, 2008 and the related weighted average exerciseprice and contractual life information, are as follows:

 
| ** **               | ** ** | **Options Outstanding**                                 | ** ** | **Options Exercisable**                                 | ** ** |
|--------------------------|------------|--------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| **Exercise Prices** | ** ** | **Shares  Underlying  Options at  June 30,  2008** | ** ** | **Weighted  Average  Remaining  Contractual  Life  (Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Aggregate  intrinsic value  (‘000)** | ** ** | **Shares  Underlying  Options at  June 30,  2008** | ** ** | **Weighted  Average  Remaining  Contractual  Life  (Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Aggregate  intrinsic  value (‘000)** | ** ** |
| $0.00 to $9.99           |       | 328,809                                                      |       | 3.95                                                         |       | $ | 6.69 |   | $ | 1,648 |   | 321,309 |   | 3.88 |   | $ | 6.63 |   | $ | 1,628 |   |
| $10.00 to $11.99         |       | 895,988                                                      |       | 5.83                                                         |       | $ | 10.55 |   | 1,027 |   | 895,988 |   | 5.83 |   | $ | 10.55 |   | 1,027 |   |
| $12.00 to $14.99         |       | 2,715,950                                                    |       | 7.63                                                         |       | $ | 13.78 |   | — |   | 1,144,733 |   | 4.88 |   | $ | 13.36 |   | — |   |
| $15.00 to $19.99         |       | 2,662,613                                                    |       | 6.89                                                         |       | $ | 18.23 |   | — |   | 1,819,405 |   | 6.03 |   | $ | 17.60 |   | — |   |
| $20.00 to $25.99         |       | 1,958,133                                                    |       | 5.69                                                         |       | $ | 23.96 |   | — |   | 1,755,951 |   | 5.31 |   | $ | 23.99 |   | — |   |
| $26.00 to $46.53         |       | 382,157                                                      |       | 2.21                                                         |       | $ | 28.59 |   | — |   | 380,173 |   | 2.18 |   | $ | 28.60 |   | — |   |
| Total                    |       | 8,943,650                                                    |       | 6.44                                                         |       | $ | 17.38 |   | $ | 2,675 |   | 6,317,559 |   | 5.25 |   | $ | 17.71 |   | $ | 2,655 |   |

 

Of the 8,943,650 stockoptions outstanding as of June 30, 2008, the Company estimates that8,585,000 will fully vest over the remaining contractual term.  As of June 30, 2008, these options had aweighted average remaining contractual life of 6.31 years, a weightedaverage exercise price of $17.43 and aggregate intrinsic value of $2,664,000.

 

The weighted average grant date fair value ofoptions, as determined under SFAS No. 123(R), granted during the three andsix month periods ended June 30, 2008 was $7.31 and $7.28 per share,respectively.  The weighted average grant date fair valueof options, as determined under SFAS No. 123(R), granted during the threeand six month periods ended June 30, 2007 was $11.47 per share.

 

The aggregate intrinsicvalue in the table above represents the total pretax intrinsic value, based onthe Company’s closing stock price of $11.70 as of June 30, 2008, whichwould have been received by the option holders had all option holders exercisedtheir options as of that date.  The totalnumber of shares of common stock underlying in-the-money options exercisable asof June 30, 2008 was 1,215,000.  Thetotal intrinsic value of options exercised during the three and six monthperiods ended June 30, 2008 was $307,000 and $432,000 respectively.  There was no excess tax benefit realized bythe Company in 2008 and 2007 for option exercises due to the availability ofnon stock related net operating loss carry forwards which fully offset ourtaxable income.

 

As of June 30, 2008, the Company had $19,400,000of unrecognized stock-based compensation cost related to stock options afterestimated forfeitures, which are expected to be recognized over the weightedaverage remaining term of 2.86 years.

 

TheCompany settles employee stock option exercises with newly issued commonshares.

 

***Stock Option Plans***

 

As of June 30, 2008,the Company had outstanding options for the purchase of 8,943,650 shares ofcommon stock held by employees and directors under the Company’s 2005 EquityIncentive Plan (the “2005 Plan”), 2005 Outside Directors Equity Plan, 2000Nonstatutory Stock Option Plan, 1995 Outside Directors Stock Option Plan, the1993 Stock Option Plan and other various plans the Company assumed as a resultof acquisitions.  As of June 30,2008, an aggregate of 3,670,941 shares remained available for future grants andawards.  Options and stock appreciationrights granted under the 2005 Plan must have exercise prices per share not lessthan the fair market value of Zoran common stock on the date of grant and maynot be repriced without stockholder approval. Such awards will vest and become exercisable upon conditions establishedby the Compensation Committee and may not have a term exceeding 10 years.

 

8

----

Tableof Contents

 

***RestrictedShares and Restricted Stock Units***

 

Restrictedshares and restricted stock units are granted under the 2005 Plan.  As of June 30, 2008, we had$99,000 of unrecognized stock-based compensation cost related to restrictedshares and restricted stock units, which areexpected to be recognized over the weighted average remaining term of 1.51years.

 

The following is asummary of restricted shares and restricted stock units activities:

 
| ** **                        | ** ** | **Outstanding  Restricted Shares  And Stock Units** | ** ** | **Weighted-  Average Grant-  Date Fair Value** | ** ** |
|-----------------------------------|------------|--------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                        | ** ** | ** **                                                         | ** ** | ** **                                                    | ** ** |
| Balances,  December 31, 2007 |       | 77,345                                                             |       | $                                                             | 18.53      |   |
| Granted                           |       | —                                                             |       | $                                                             | —     |   |
| Released/vested                   |       | (51,316                                                            | )          | $                                                             | 20.29      |   |
| Forfeited                         |       | (612                                                               | )          | $                                                             | 21.56      |   |
| Balances,  June 30, 2008     |       | 25,417                                                             |       | $                                                             | 14.91      |   |

 

***EmployeeStock Purchase Plan***

 

TheCompany’s 1995 Employee Stock Purchase Plan (“ESPP”) was adopted by the Company’sBoard of Directors in October 1995 and approved by its stockholders in December 1995.  The ESPP enables employees to purchase sharesthrough payroll deductions at approximately 85% of the lesser of the fair valueof common stock at the beginning of a 24-month offering period or the end ofeach six-month segment within such offering period.  The ESPP is intended to qualify as an “employeestock purchase plan” under Section 423 of the U.S. Internal RevenueCode.  During the three month periodended June 30, 2008, 301,119 shares were purchased by employees under theterms of the plan agreements at a weighted average price of $11.19 per share.  As of June 30, 2008, 1,825,833 shareswere reserved and available for issuance under the ESPP.

 

**3.****  ComprehensiveLoss**

 

The following table presents the calculation ofcomprehensive loss as required by SFAS 130 “Reporting Comprehensive Income.”  The components of comprehensive loss, net oftax, are as follows (in thousands):

 
| ** **                                                   | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                   | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Net income  (loss)                                           |       | $                                               | (36,620    | )                                             | $          | 198 |   | $ | (41,298 | ) | $ | (5,686 | ) |
| Change in  unrealized gain (loss) on investments, net of tax |       | (1,599                                          | )          | (907                                          | )          | (1,900 | ) | (2,349 | ) |
| Total  comprehensive loss                                    |       | $                                               | (38,219    | )                                             | $          | (709 | ) | $ | (43,198 | ) | $ | (8,035 | ) |

 

The accumulated other comprehensive income(loss) is unrealized gain (loss), net of tax, on marketable securities.

 

9

----

Tableof Contents

 

**4.****  Marketable Securities**

 

The Company’s portfolioof marketable securities as of June 30, 2008 was as follows (inthousands):

 
| ** **                                                                         | ** ** | **Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|-----------------------|------------|------------------------|------------|----------------------------|------------|
| Corporate notes  and bonds                                                         |       | $        | 167,069    |                  | $          | 432                    |       | $                          | (1,334     | ) | $ | 166,167 |   |
| Auction rate  securities                                                           |       | 57,775   |       | —                |       | —                 |       | 57,775                     |       |
| U.S. government  and agency securities                                             |       | 31,789   |       | 11                    |       | (159                   | )          | 31,641                     |       |
| Foreign and  municipal bonds                                                       |       | 15,804   |       | 59                    |       | (11                    | )          | 15,852                     |       |
| Certificates of  deposit                                                           |       | 1,997    |       | 11                    |       | —                 |       | 2,008                      |       |
| Total fixed  income securities                                                     |       | 274,434  |       | 513                   |       | (1,504                 | )          | 273,443                    |       |
| Publicly traded  equity securities                                                 |       | 1,393    |       | —                |       | (407                   | )          | 986                        |       |
|                                                                               |       | 275,827  |       | 513                   |       | (1,911                 | )          | 274,429                    |       |
| Less: Auction  rate securities included in other assets and long- term investments |       | (57,775  | )          | —                |       | —                 |       | (57,775                    | )          |
|                                                                               |       |     |       |                  |       |                   |       |                       |       |
| Total short-term  investments                                                      |       | $        | 218,052    |                  | $          | 513                    |       | $                          | (1,911     | ) | $ | 216,654 |   |

 

TheCompany’s portfolio of marketable securities as of December 31, 2007 wasas follows (in thousands):

 
| ** **                                                                         | ** ** | **Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|-----------------------|------------|------------------------|------------|----------------------------|------------|
| Corporate notes  and bonds                                                         |       | $        | 162,339    |                  | $          | 580                    |       | $                          | (305       | ) | $ | 162,614 |   |
| Auction rate  securities                                                           |       | 85,350   |       | —                |       | —                 |       | 85,350                     |       |
| U.S. government  and agency securities                                             |       | 36,290   |       | 206                   |       | —                 |       | 36,496                     |       |
| Foreign and  municipal bonds                                                       |       | 17,421   |       | 55                    |       | (1                     | )          | 17,475                     |       |
| Certificates of  deposit                                                           |       | 3,994    |       | 4                     |       | (1                     | )          | 3,997                      |       |
| Total fixed  income securities                                                     |       | 305,394  |       | 845                   |       | (307                   | )          | 305,932                    |       |
| Publicly traded  equity securities                                                 |       | 1,393    |       | 457                   |       | —                 |       | 1,850                      |       |
|                                                                               |       | 306,787  |       | 1,302                 |       | (307                   | )          | 307,782                    |       |
| Less: Auction  rate securities included in other assets and long- term investments |       | (85,350  | )          | —                |       | —                 |       | (85,350                    | )          |
|                                                                               |       |     |       |                  |       |                   |       |                       |       |
| Total short-term  investments                                                      |       | $        | 221,437    |                  | $          | 1,302                  |       | $                          | (307       | ) | $ | 222,432 |   |

 

Thefollowing table summarizes the maturities of the Company’s fixed incomesecurities as of June 30, 2008 (in thousands):

 
| ** **                     | ** ** | **Cost** | ** ** | **Estimated  Fair  Value** | ** ** |
|--------------------------------|------------|----------|------------|----------------------------|------------|
| Less than 1 year               |       | $        | 85,372     |                       | $          | 85,234 |   |
| Due in 1 to 2  years           |       | 86,978   |       | 86,570                     |       |
| Due in 2 to 5  years           |       | 44,309   |       | 43,864                     |       |
| Greater than  5 years*    |       | 57,775   |       | 57,775                     |       |
|                           |       |     |       |                       |       |
| Total fixed  income securities |       | $        | 274,434    |                       | $          | 273,443 |   |

 

----

*Comprised of auctionrate securities which have reset dates of 90 days or less but final expirationdates over 5 years.  These securities areincluded in other assets and long-term investments as of June 30, 2008.

 

10

----

Table of Contents

 

**5.****  Fair Value**

 

Effective January 1,2008, the Company adopted SFAS No. 157, “Fair Value Measurements” (“SFAS157”).  In February 2008, the FASBissued FASB Staff Position No. FAS 157-2, “Effective Date of FASB StatementNo. 157,” which provides a one year deferral of the effective date of SFAS157 for non-financial assets and non-financial liabilities, except those thatare recognized or disclosed in the financial statements at fair value at leastannually.  Therefore, the Company hasadopted the provisions of SFAS 157 with respect to its financial assets andliabilities only.  SFAS 157 defines fairvalue, establishes a framework for measuring fair value under generally acceptedaccounting principles and enhances disclosures about fair valuemeasurements.  Fair value is definedunder SFAS 157 as the exchange price that would be received for an asset orpaid to transfer a liability (an exit price) in the principal or most advantageousmarket for the asset or liability in an orderly transaction between marketparticipants on the measurement date. Valuation techniques used to measure fair value under SFAS 157 mustmaximize the use of observable inputs and minimize the use of unobservableinputs.  The standard describes a fairvalue hierarchy based on three levels of inputs that may be used to measurefair value, of which the first two are considered observable and the lastunobservable:

 

·                  Level 1 - Quoted prices in active marketsfor identical assets or liabilities.

 

·                  Level 2 - Inputsother than Level 1 that are observable, either directly or indirectly, such asquoted prices for similar assets or liabilities; quoted prices in markets thatare not active; or other inputs that are observable or can be corroborated by observablemarket data for substantially the full term of the assets or liabilities.

 

·                  Level 3 -Unobservable inputs that are supported by little or no market activity and thatare significant to the fair value of the assets or liabilities.

 

The adoption of thisstatement did not have a material impact on the Company’s consolidated resultsof operations and financial condition.

 

Effective January 1,2008, the Company adopted SFAS No. 159 “The Fair Value Option forFinancial Assets and Financial Liabilities” (“SFAS 159”).  SFAS 159 allows an entity the irrevocableoption to elect fair value for the initial and subsequent measurement forspecified financial assets and liabilities on a contract-by-contractbasis.  The Company did not elect toadopt the fair value option under this Statement.

 

In accordance with SFAS157, the following table represents the Company’s fair value hierarchy for itsfinancial assets (cash equivalents and investments) measured at fair value on arecurring basis as of June 30, 2008 (in thousands):

 
| ** **                             | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|-----------|------------|
| Corporate notes  and bonds             |       | $                | —     |             | $          | 166,167          |       | $         | —     |   | $ | 166,167 |   |
| Auction rate  securities               |       | —           |       | —           |       | 57,775           |       | 57,775    |       |
| U.S. government  and agency securities |       | —           |       | 31,641           |       | —           |       | 31,641    |       |
| Foreign and  municipal bonds           |       | —           |       | 15,852           |       | —           |       | 15,852    |       |
| Certificates of  deposit               |       | —           |       | 2,008            |       | —           |       | 2,008     |       |
| Total fixed  income securities         |       | —           |       | 215,668          |       | 57,775           |       | 273,443   |       |
| Publicly traded  equity securities     |       | 986              |       | —           |       | —           |       | 986       |       |
|                                   |       |             |       |             |       |             |       |      |       |
| Total                                  |       | $                | 986        |             | $          | 215,668          |       | $         | 57,775     |   | $ | 274,429 |   |

 

The Company’s Level 3investments as of June 30, 2008 include high-grade auction rate securitiesprimarily consisting of government guaranteed student loans.  Auction rate securities are securities thatare structured with short-term interest rates which periodically reset throughauctions, typically within every 90 days. At the end of each reset period, investors can sell or continue to holdthe securities at par. During the current quarter, some of the auction ratesecurities were sold and others failed to auction successfully due to marketsupply exceeding market demand.  In theevent of a failed auction, the notes continue to bear interest at apredetermined maximum rate based on the credit rating of notes as determined byone or more nationally recognized statistical rating organizations.  The funds associated with failed auctionswill not be accessible until a successful auction occurs, a buyer is foundoutside of the auction process, the issuers redeem the securities or theunderlying securities have matured.  As aresult, the Company has classified all auction rate securities as long-termassets in the condensed consolidated balance sheets.

 

11

----

Tableof Contents

 

Due to the currenteconomic environment in which there is a lack of market activity for auctionrate securities, the Company has been unable to obtain quoted prices or marketprices for identical assets as of the measurement date resulting in significantunobservable inputs used in determining the fair value.  The Company estimated the fair value of theseauction rate securities using the income approach based on the following: (i) theunderlying structure and contractual provisions of each security; (ii) thepresent value of future principal and interest payments discounted at ratesconsidered to reflect current market conditions; and (iii) considerationof the probabilities of default, auction failure, or repurchase at par for eachperiod.  These estimated fair valuescould change significantly based on future market conditions, which couldresult in recognizing an other-than-temporary impairment loss.

 

The fair value indicatedby this approach yielded a value that approximated the par value of therespective securities.

 

The reconciliation ofbeginning and ending balances for auction rate securities measured at fairvalue on a recurring basis using significant unobservable inputs (Level 3)during the period was as follows *(inthousands):*

 
| ** **                                    | ** ** | **Fair Value Measurements  using Significant Unobservable  Inputs (Level 3)** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|
| ** **                                    | ** ** | **Auction rate securities**                                                                       | ** ** |
| ** **                                    | ** ** | ** **                                                                                                  | ** ** |
| Balance at  January 1, 2008              |       | $                                                                                                           | —     |   |
| Total gains or  losses (realized/unrealized)  |       |                                                                                                        |       |
| Included in  earnings                         |       | —                                                                                                      |       |
| Included in  other comprehensive income       |       | —                                                                                                      |       |
| Purchases,  sales, issuances, and settlements |       | —                                                                                                      |       |
| Transfers in  and/or out of Level 3           |       | 62,775                                                                                                      |       |
| Balance at  March 31, 2008               |       | 62,775                                                                                                      |       |
| Total gains or  losses (realized/unrealized)  |       |                                                                                                        |       |
| Included in  earnings                         |       | —                                                                                                      |       |
| Included in  other comprehensive income       |       | —                                                                                                      |       |
| Purchases,  sales, issuances, and settlements |       | (5,000                                                                                                      | )          |
| Transfers in  and/or out of Level 3           |       | —                                                                                                      |       |
| Balance at  June 30, 2008                |       | $                                                                                                           | 57,775     |   |

 

**6.****              Inventories**

 

Inventories are stated atthe lower of cost (first in, first out) or market and consisted of thefollowing (in thousands):

 
| ** **                           | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **2008**          | ** ** | **2007**              | ** ** |
|                                 |       |              |       |                  |       |
| Purchased parts  and work in process |       | $                 | 29,580     |                  | $          | 28,498 |   |
| Finished goods                       |       | 31,023            |       | 20,494                |       |
|                                 |       | $                 | 60,603     |                  | $          | 48,992 |   |

 

**7.****              Goodwilland Other Intangible Assets**

 

The Company monitors therecoverability of goodwill recorded in connection with acquisitions, byreporting unit, annually, or sooner if events or changes in circumstancesindicate that the carrying amount may not be recoverable.  The Company performed the annual analysis asof September 30, 2007 and concluded that goodwill was not impaired, as thefair value of each reporting unit exceeded its carrying value, includinggoodwill.

 

12

----

Tableof Contents

 

***Components of Acquired Intangible Assets****(in thousands):*

 
| ** **                    | ** ** | ** **        | ** ** | **June 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|-------------------------------|------------|-------------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **                    | ** ** | **Life  (Years)** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization**   | ** ** | **Net   Balance** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net   Balance** | ** ** |
| Amortized  intangible assets: |       |              |       |                        |       |                            |       |   |   |   |   |   |   |   |   |
| Purchased  technology         |       | 2-3               |       | $                           | 195,505    |                            | $          | (189,741 | ) | $ | 5,764 |   | $ | 195,505 |   | $ | (175,451 | ) | $ | 20,054 |   |
| Patents                       |       | 3-5               |       | 40,265                      |       | (39,661                         | )          | 604 |   | 40,265 |   | (36,961 | ) | 3,304 |   |
| Customer base                 |       | 3-5               |       | 13,860                      |       | (13,273                         | )          | 587 |   | 13,860 |   | (12,043 | ) | 1,817 |   |
| Tradename and  others         |       | 3-5               |       | 4,655                       |       | (2,853                          | )          | 1,802 |   | 3,350 |   | (2,580 | ) | 770 |   |
|                          |       |              |       |                        |       |                            |       |   |   |   |   |   |   |   |   |
| Total                         |       |              |       | $                           | 254,285    |                            | $          | (245,528 | ) | $ | 8,757 |   | $ | 252,980 |   | $ | (227,035 | ) | $ | 25,945 |   |

 

Estimated futureintangible amortization expense, based on current balances, as of June 30,2008 is as follows (in thousands):

 
| Remaining six  months of 2008       |   | $     | 5,058  |   |
|-------------------------------------|--------|-------|--------|--------|
| Year ending  December 31, 2009 |   | 2,255 |   |
| Year ending  December 31, 2010 |   | 1,245 |   |
| Year ending  December 31, 2011 |   | 199   |   |
|                                |   | $     | 8,757  |   |

 

Goodwill by reportingunit was as follows (in thousands):

 
| ** ** | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------|------------|-------------------|------------|-----------------------|------------|
| ** ** | ** ** | **2008**          | ** ** | **2007**              | ** ** |
|       |       |              |       |                  |       |
| Consumer   |       | $                 | 164,494    |                  | $          | 164,494 |   |
| Imaging    |       | 4,197             |       | 4,197                 |       |
|       |       | $                 | 168,691    |                  | $          | 168,691 |   |

 

# **8.**              Income Taxes

# ** **

The Company follows theliability method of accounting for income taxes, which requires recognition ofdeferred tax liabilities and assets for the expected future tax consequence oftemporary differences between the financial statement carrying amounts and thetax basis of assets and liabilities. Realization of deferred tax assets is based on the Company’s ability togenerate sufficient future taxable income. As of December 31, 2007,historical operating income and projected future profits represented sufficientpositive evidence that the Company’s deferred tax assets will more likely thannot be realized and, accordingly, the valuation allowance was released.

 

Oureffective tax rate is highly dependent upon the geographic distribution of ourworldwide earnings or losses, the tax regulations and tax holiday benefits incertain jurisdictions, and the effectiveness of our tax planning strategies.  The provision for income taxes for the threeand six month periods ended June 30, 2008 reflects the estimated annualtax rate applied to the year to date net loss, adjusted for certain discreetitems that are fully recognized in the period they occur.  The Company benefits from our Israel basedsubsidiary’s status as an “Approved Enterprise” under Israeli law, whichprovides a ten-year tax holiday for income attributable to a portion of theCompany’s operations in Israel.

 

OnJanuary 1, 2007, the Company adopted FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes (“FIN 48”).  Under FIN 48, the impact of an uncertainincome tax position on income tax expense must be recognized at the amount thatis more-likely-than-not of being sustained. As of December 31, 2007, the Company had $26.5 million ofunrecognized tax benefits which have not materially changed during the currentperiod.  The application of income tax law is inherently complex.  Laws and regulations in this area arevoluminous and are often ambiguous and the Company is required to make manysubjective assumptions and judgments regarding its income tax exposures.  In addition, interpretations of and guidancesurrounding income tax laws and regulations are subject to change overtime.  Any changes in our subjectiveassumptions and judgments could materially affect amounts recognized in 

 

13

----

Table ofContents

 

the consolidated balancesheets and statements of income.  TheCompany’s ongoing tax audit in Israel may result in apositive or negative adjustment to the Company’s unrecognized tax benefitswithin the next 12 months.

 

**9.****              SegmentReporting**

 

The Company’s productsare based on highly integrated application-specific integrated circuits, orASICs, and system-on-a-chip, or SOC, solutions. The Company also licenses certain software and other intellectualproperty.  The Company has two reportablesegments — Consumer group and Imaging group.

 

The Consumer groupprovides products for use in DVD players, recordable DVD players, standard andhigh definition digital television products, digital camera products andmultimedia mobile phone products.  TheImaging group provides products used in digital copiers, laser and inkjetprinters as well as multifunction peripherals.

 

Information aboutreported segment income or loss is as follows for the three and six monthperiods ended June 30, 2008 and 2007 (in thousands):

 
| ** **            | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **            | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
|                  |       |                                            |       |                                          |       |   |   |   |   |
| Net revenues:         |       |                                            |       |                                          |       |   |   |   |   |
| Consumer              |       | $                                               | 108,822    |                                          | $          | 107,281 |   | $ | 197,194 |   | $ | 188,733 |   |
| Imaging               |       | 19,863                                          |       | 22,622                                        |       | 40,522 |   | 42,829 |   |
|                  |       | $                                               | 128,685    |                                          | $          | 129,903 |   | $ | 237,716 |   | $ | 231,562 |   |
|                  |       |                                            |       |                                          |       |   |   |   |   |
| Operating  expenses:  |       |                                            |       |                                          |       |   |   |   |   |
| Consumer              |       | $                                               | 108,926    |                                          | $          | 102,230 |   | $ | 205,473 |   | $ | 184,516 |   |
| Imaging               |       | 14,491                                          |       | 16,338                                        |       | 29,259 |   | 31,831 |   |
|                  |       | $                                               | 123,417    |                                          | $          | 118,568 |   | $ | 234,732 |   | $ | 216,347 |   |
|                  |       |                                            |       |                                          |       |   |   |   |   |
| Contribution  margin: |       |                                            |       |                                          |       |   |   |   |   |
| Consumer              |       | $                                               | (104       | )                                             | $          | 5,051 |   | $ | (8,279 | ) | $ | 4,217 |   |
| Imaging               |       | 5,372                                           |       | 6,284                                         |       | 11,263 |   | 10,998 |   |
|                  |       | $                                               | 5,268      |                                          | $          | 11,335 |   | $ | 2,984 |   | $ | 15,215 |   |

 

A reconciliation of thetotals reported for the operating segments to the applicable line items in thecondensed consolidated financial statements for the three and six month periodsended June 30, 2008 and 2007 is as follows (in thousands):

 
| ** **                                   | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                   | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                         |       |                                            |       |                                          |       |   |   |   |   |
| Contribution  margin from operating segments |       | $                                               | 5,268      |                                          | $          | 11,335 |   | $ | 2,984 |   | $ | 15,215 |   |
| Amortization of  intangible assets           |       | 9,256                                           |       | 12,169                                        |       | 18,493 |   | 24,338 |   |
| In-process  research and development         |       | 22,383                                          |       | —                                        |       | 22,383 |   | — |   |
| Total operating  loss                        |       | $                                               | (26,371    | )                                             | $          | (834 | ) | $ | (37,892 | ) | $ | (9,123 | ) |

 

Zoran maintainsoperations in Canada, China, France, Germany, India, Israel, Japan, Korea,Taiwan, the United Kingdom and United States. Activities in Israel and the United States consist of corporateadministration, product development, logistics and worldwide salesmanagement.  Other foreign operationsconsist of sales, product development and technical support.

 

14

----

Table of Contents

 

The geographicdistribution of total revenues for the three and six month periods ended June 30,2008 and 2007 was as follows (in thousands):

 
| ** **                                                 | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                 | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Revenue  from unaffiliated customers originating from:** |       |                                            |       |                                          |       |   |   |   |   |
| China                                                      |       | $                                               | 54,945     |                                          | $          | 51,866 |   | $ | 94,505 |   | $ | 82,379 |   |
| Japan                                                      |       | 18,353                                          |       | 21,807                                        |       | 40,241 |   | 46,905 |   |
| Korea                                                      |       | 15,816                                          |       | 3,932                                         |       | 30,829 |   | 9,999 |   |
| Taiwan                                                     |       | 27,171                                          |       | 35,983                                        |       | 47,149 |   | 61,652 |   |
| United States                                              |       | 8,550                                           |       | 7,401                                         |       | 16,650 |   | 14,570 |   |
| Other                                                      |       | 3,850                                           |       | 8,914                                         |       | 8,342 |   | 16,057 |   |
| **Total  revenues**                                        |       | $                                               | 128,685    |                                          | $          | 129,903 |   | $ | 237,716 |   | $ | 231,562 |   |

 

For the three and six month periods ended June 30, 2008, threecustomers accounted for 11%, 11% and 10% of total revenues, respectively. Forthe same periods of 2007, one customer accounted for 14% of total revenues.

 

As of June 30, 2008,three customers accounted for approximately 13%, 13% and 12% of total netaccounts receivable, respectively, and as of December 31, 2007 threecustomers accounted for approximately 11%, 11% and 10% of the net accountsreceivable balance, respectively.

 

**10.****       Acquisition**

 

**LetIt Wave**

 

On June 12, 2008,the Company completed the acquisition of Let It Wave, a fablessdevelopment-stage semiconductor company based in Paris, France. Under the termsof the acquisition agreement, the Company acquired Let It Wave in an all-cashtransaction valued at $24.0 million, including approximately $650,000 oftransaction costs.  The Company alsoagreed to make contingent payments up to $4.5 million in additionalconsideration, contingent upon completion of certain milestones, a portion ofwhich is subject to continuous employment and will be expensed as incurred.

 

This acquisition’sprimary purpose was to obtain Let It Wave’s in-process development of a video frame rate conversion and imageenhancement product for flat panel televisions and other consumerelectronics.  By acquiring Let It Wave,the Company intends to deliver high performance image processing that enablesartifact-free true-Motion Compensated Frame Rate Conversion (MCFRC) for flatpanel televisions and other video consumer electronics products.  Let It Wave is at least six to ninemonths from completing the development of its MCFRC product and currently hasno other products, revenues or a customer base. Upon completion of a finishedproduct, the Company expects to market this technology for 120Hz LCDtelevisions within the Consumer segment group.

 

The Company accounted forthis transaction as an asset acquisition in accordance with Statement ofFinancial Accounting Standard 142 (“SFAS 142”), “Goodwill and Other IntangibleAssets”**and Emerging Issues Task Force No. 98-3(“EITF 98-3”), “Determining Whether a Nonmonetary Transaction Involves Receipt ofProductive Assets or of a Business.” The results of operations of Let It Wave have been included in thecondensed consolidated financial statements from the date of acquisition.

 

Allocation of thepurchase price is as follows (in thousands):

 
| In-process  research and development |   | $     | 22,383 |   |
|--------------------------------------|--------|-------|--------|--------|
| Assembled  workforce                 |   | 1,305 |   |
| Net assets  acquired                 |   | 340   |   |
|                                 |   | $     | 24,028 |   |

 

Net assets acquired wererecorded at net book value, which approximates their fair values.  The purchase price in excess of the fairvalues of net assets acquired was allocated to in-process research anddevelopment and assembled workforce based on the relative fair values.

 

15

----

Table of Contents

 

The in-process researchand development has not yet reached technological feasibility and has noalternative future use.  Accordingly theamount allocated to in-process research and development was immediately expensedupon the acquisition date.  The value ofin-process research and development was determined using the multi-periodexcess earnings method by estimating the expected net cash flows from theprojects once commercially viable, discounting the net cash flows back to theirpresent value using a discount rate of 15%. This rate was based on the industry segment for the technology, natureof the products to be developed, relative risk of successful development,time-value of money, length of time to complete the project and overallmaturity and history of the development team. Revenues for the incremental core technology are expected to commence in2009.  Revenue projections were based onestimates of market size and growth, expected trends in technology and theexpected timing of new product introductions.

 

# **11.**       Net Income (Loss) Per Share

# ** **

Basic net income (loss)per share is calculated by dividing net income (loss) available to commonstockholders by the weighted average number of common shares outstanding duringthe period.  Diluted net income (loss)per share is calculated by using the weighted average number of common sharesoutstanding during the period increased to include the number of additionalshares of common stock that would have been outstanding if the dilutivepotential shares of common stock had been issued.

 

**The following table provides a reconciliation of thecomponents of the basic and diluted net income (loss) per share computations(in thousands, except per share data):**

** **
| ** **                                                                 | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                 | ** ** | **2008 **                                  | ** ** | **2007**                                      | ** ** | **2008 ** | ** ** | **2007** | ** ** |
| ** **                                                                 | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income  (loss)                                                         |       | $                                               | (36,620    | )                                             | $          | 198 |   | $ | (41,298 | ) | $ | (5,686 | ) |
|                                                                       |       |                                            |       |                                          |       |   |   |   |   |
| Weighted average  shares outstanding                                       |       | 51,707                                          |       | 49,600                                        |       | 51,576 |   | 49,527 |   |
| Effect of  dilutive options, restricted shares, and restricted stock units |       | —                                          |       | 1,587                                         |       | — |   | — |   |
| Dilutive  weighted average shares                                          |       | 51,707                                          |       | 51,187                                        |       | 51,576 |   | 49,527 |   |
|                                                                       |       |                                            |       |                                          |       |   |   |   |   |
| Net income  (loss) per share:                                              |       |                                            |       |                                          |       |   |   |   |   |
| Basic                                                                      |       | $                                               | (0.71      | )                                             | $          | 0.00 |   | $ | (0.80 | ) | $ | (0.11 | ) |
| Diluted                                                                    |       | $                                               | (0.71      | )                                             | $          | 0.00 |   | $ | (0.80 | ) | $ | (0.11 | ) |

** **

**For the three month periods ended June 30,2008 and 2007, outstanding options, restricted shares, and restricted stockunits totaling 6.9 million and 3.3 million shares, respectively, were excludedfrom the computation of diluted net income (loss) per share as the inclusion ofsuch shares would have had an anti-dilutive effect.**

** **

**For the six month periods ended June 30,2008 and 2007, outstanding options and restricted stock units totaling 6.3million and 9.0 million shares, respectively, were excluded from thecomputation of diluted net income (loss) per share as the inclusion of suchshares would have had an anti-dilutive effect.**

** **

# **12.**       Contingencies

# ** **

*MattersRelated to Historical Stock Option Practices:*  As discussed further below, certain persons andentities identifying themselves as shareholders of Zoran have filed derivativeactions purporting to assert claims on behalf of and in the name of the Companyagainst various of the Company’s current and former directors and officersrelating to the Company’s historical accounting for stock options. The Companycannot quantify the extent of its potential liability, if any.

 

16

----

Table of Contents

 

*Pfeiffer v. Zoran Corporation et al.*  OnSeptember 7, 2006, a purported shareholder derivative action was filed byMilton Pfeiffer against Zoran as a nominal defendant and certain of itsofficers and directors in the United States District Court, Northern Districtof California, alleging, among other things, violations of federal securitieslaws and breaches of fiduciary duties.

 

*Geralddel Rosario v. Aharon et al.* On September 26, 2006, a purported shareholder derivative actionwas filed by Gerald del Rosario against Zoran as a nominal defendant andcertain of its current and former officers and directors in the United StatesDistrict Court, Northern District of California, alleging, among other things,violations of federal securities laws and breaches of fiduciary duty. On December 8,2006, the Court issued an order consolidating the Del Rosario action with thePfeiffer action. The Court selected del Rosario as lead plaintiff and approvedlead plaintiff’s selection of counsel for the consolidated derivative action.Plaintiffs filed a consolidated amended complaint on March 14, 2007. On June 5,2007 the Court issued an order granting in part and denying in part defendants’motion to dismiss.  On September 11,2007, the parties participated in a court-ordered mediation session.  On April 7, 2008, the Court deniedpreliminary approval of the parties’ proposed settlement agreement.  On May 29, 2008, the parties reached arevised agreement in principle to settle the action.  On June 11, 2008, the Court grantedpreliminary approval of the settlement. The settlement remains subject to final approval by the Court.

 

*Baronev. Gerzberg et al.; Durco v. Gerzberg et al.*  On October 23, 2006, two purportedshareholder derivative actions were filed by Moshe Barone and John Durcoagainst Zoran as a nominal defendant and certain of its current and formerofficers and directors in the California Superior Court of Santa Clara County,alleging, among other things, violations of state securities laws and breaches offiduciary duty. On January 24, 2007 the Court consolidated the Barone andDurco actions, appointed Messrs. Barone and Durco as co-lead plaintiffsand approved their selection of counsel for the consolidated derivative action.The co-lead plaintiffs filed a consolidated amended complaint on March 26,2007. On June 15, 2007 the Court issued an order staying all proceedingsuntil further order of the Court.

 

*U.S.Attorney Investigation:* On July 3, 2006, Zoran disclosed in a press release that itreceived and was responding to a grand jury subpoena from the office of theU.S. Attorney for the Northern District of California requesting documentsrelating to stock options.  Should anyfurther such requests be made by the U.S. Attorney, Zoran intends to continuecooperating fully.

 

*Zoran Corporation v. ArcSoft, Inc. *On February 20, 2007, the Company fileda complaint against ArcSoft Inc. in the California Superior Court for theCounty of Alameda, seeking payment of $4,000,000 in aggregate principalunder four separate convertible promissory notes, together with accruedinterest thereon in the amount of approximately $528,000.  The notesrepresented amounts loaned by the Company to ArcSoft in 2004.  At thattime, the Company also entered into a business arrangement with ArcSoftinvolving the licensing and grant of certain rights to ArcSoft related to aproduct then under development and related agreements regarding the continueddevelopment and commercialization of the product.  On March 28, 2007,ArcSoft filed an answer denying liability under the notes and asserting variousaffirmative defenses.  ArcSoft also filed a cross-complaint alleging fraudin the inducement of the business arrangement, fraudulent and negligentmisrepresentation, breach of contract and of the implied covenant of good faithand fair dealing, and unjust enrichment, and seeking monetary damages of morethan $6,900,000.  The Company filed an answer to ArcSoft’s cross-complaintdenying liability and asserting various affirmative defenses.  The Companyalso filed a cross-complaint alleging various breach of contract claims againstArcSoft.  On July 9, 2008, ArcSoft and the Company entered into asettlement agreement that resolved all claims between the parties.  TheCompany made no payment to ArcSoft related to the resolution of ArcSoft’scross-complaint.

 

*IndemnificationObligations.*  Subjectto certain limitations, the Company is obligated to indemnify its current andformer directors, officers and employees in connection with the investigation ofthe Company’s historical stock option practices and related governmentinquiries and litigation. These obligations arise under the terms of theCompany’s certificate of incorporation, its bylaws, applicable contracts, andDelaware and California law. The obligation to indemnify generally means thatthe Company is required to pay or reimburse the individuals’ reasonable legalexpenses and possibly damages and other liabilities incurred in connection withthese matters. The Company is currently paying or reimbursing legal expensesbeing incurred in connection with these matters by a number of its current andformer directors, officers and employees.

 

*OtherLegal Matters.*  TheCompany is named from time to time as a party to lawsuits in the normal courseof its business. Litigation, in general, and intellectual property andsecurities litigation in particular, can be expensive and disruptive to normalbusiness operations. Moreover, the results of legal proceedings are difficultto predict.

 

17

----

Table of Contents

 

**Item2.   Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

*This report includes a number of forward-looking statementswhich reflect the Company’s current views with respect to future events andfinancial performance. These forward-looking statements are subject to certainrisks and uncertainties, including those discussed in “Part II, Item 1A. RiskFactors” below. In this report, the words “anticipates,” “believes,” “expects,”“intends,” “future” and similar expressions identify forward-lookingstatements. Readers are cautioned not to place undue reliance on theseforward-looking statements, which speak only as of the date hereof.*

 

**Overview**

 

Our products consist ofintegrated circuits and related products used in digital versatile discplayers, or DVDs, movie and home theater systems, digital cameras and videoediting systems.  We also provide integratedcircuits, software and platforms for standard and high definition digitaltelevision applications that enable the delivery and display of digital videocontent through a set-top box or television, demodulator IC technology for theglobal high definition television market. We also provide digital imaging products consisting of semiconductorhardware and software that enable users to print, scan, process and transmitdocuments to computer peripherals that perform printing functions.  We also provide highperformance, low-power application processors, technology and products for themultimedia mobile telephone market.

 

*Revenues*

 

We derive most of ourrevenues from the sale of our integrated circuit products.  Historically, average selling prices in thesemiconductor industry in general, and for our products in particular, havedecreased over the life of a particular product.  Average selling prices for our hardwareproducts have fluctuated substantially from period to period, primarily as aresult of changes in our customer mix of original equipment manufacturer, orOEM, sales versus sales to resellers and the transition from low-volume tohigh-volume production.  In the past, wehave periodically reduced the prices of some of our products in order to betterpenetrate the consumer market.  Webelieve that, as our product lines continue to mature and competitive marketsevolve, we are likely to experience further declines in the average sellingprices of our products, although we cannot predict the timing and amount ofsuch future changes with any certainty.

 

We also derive revenuesfrom licensing our software and other intellectual property.  Licensing revenues include one-time licensefees and royalties based on the number of units distributed by the licensee.  Quarterly licensing revenue can besignificantly affected by the timing of a small number of licensingtransactions, each accounting for substantial revenues.  Accordingly, licensing revenues havefluctuated, and will continue to fluctuate, on a quarterly basis.  In addition, we have historically generated aportion of our total revenues from development contracts, primarily with keycustomers, although development revenue has declined substantially as a percentageof total revenues over the past several years. These development contracts have provided us with partial funding forthe development of some of our products. These development contracts provide for license and milestone paymentswhich are recorded as development revenue. We classify all development costs, including costs related to thesedevelopment contracts, as research and development expenses.  We retain ownership of the intellectualproperty developed by us under these development contracts.  While we intend to continue to enter intodevelopment contracts with certain strategic partners, we expect developmentrevenue to continue to decline as a percentage of total revenues.

 

We recognize softwarelicense revenues in accordance with the provisions of Statement of Position(SOP) 97-2, Software RevenueRecognition, as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions.Our software license agreements typically include obligations to providemaintenance and other support over a fixed term and allow for renewal ofmaintenance services on an annual basis. We determine the fair value of ourmaintenance obligations with reference to substantive renewal rates within theagreement or objective evidence of fair value as required under SOP 97-2.Maintenance and support revenue is recognized ratably over the term of thearrangement.  We also receive royaltyrevenues based on per unit shipments of products embedding our software, whichwe recognize upon receipt of a royalty report from the customer, typically onequarter in arrears.

 

*Cost of Hardware ProductRevenues*

* *

Our cost of hardwareproduct revenues consists primarily of fabrication costs, assembly and testcosts, and the cost of materials and overhead from operations.  If we are unable to reduce our cost ofhardware product revenues to offset anticipated decreases in average sellingprices, our product gross margins will decrease.  We expect both product and customer mix tocontinue to fluctuate in future periods, causing fluctuations in margins.

 

18

----

Tableof Contents

 

*Research and Development*

* *

Our research anddevelopment expenses consist of salaries and related costs of employees engagedin ongoing research, design and development activities and costs of engineeringmaterials and supplies.  We believe thatsignificant investments in research and development are required for us toremain competitive, and we expect to continue to devote significant resourcesto product development, although such expenses as a percentage of totalrevenues may fluctuate.

 

*Selling, General andAdministrative*

* *

Our selling, general andadministrative expenses consist primarily of employee-related expenses, salescommissions, product promotion and other professional services.  We expect that selling, general andadministrative expenses will continue to increase to support our anticipatedgrowth.

 

*Income Taxes*

* *

Our effective tax rate ishighly dependent upon the geographic distribution of our worldwide earnings orlosses. The increase to our 2008 tax rate is primarily due to income in hightax jurisdictions which are only partially offset by losses in low taxjurisdiction. Our Israel based subsidiary is an “Approved Enterprise” underIsraeli law, which provides a ten-year tax holiday for income attributable to aportion of our operations in Israel.  OurU.S. federal net operating losses expire at various times between 2017 and2024, and the benefits from our subsidiary’s Approved Enterprise status expireat various times beginning in 2008.

 

We arecurrently under a tax audit in Israel for tax years 2003 through 2005.  We believe that we have adequately provided for any potential assessmentsassociated with this audit.  It is possible that the amount of our liabilityfor unrecognized income tax benefits may change within the next 12 months.  In addition, our income tax expense could beaffected as other events occur, income tax audits conclude or statutes oflimitations expire.  We cannot estimateat this time the range of possible changes in our tax expense.

 

**Acquisitions**

 

*Let It Wave*

 

On June 12, 2008, wecompleted the acquisition of Let It Wave, a fabless development-stagesemiconductor company based in Paris, France. Under the terms of theacquisition agreement, we acquired Let It Wave in an all cash transactionvalued at $24.0 million including approximately $650,000 of transactioncosts.  We also agreed to make contingentpayments of up to $4.5 million in additional consideration, contingent uponcompletion of certain milestones, a portion of which is subject to continuousemployment and will be expensed as incurred. We recorded an in-process research and development expense of $22.4million in connection with the acquisition.

 

We accounted for thistransaction as an asset acquisition in accordance with Statement of FinancialAccounting Standard 142 (“SFAS 142”), “Goodwill and Other Intangible Assets”**and Emerging Issues Task Force No. 98-3 (“EITF 98-3”),“DeterminingWhether a Nonmonetary Transaction Involves Receipt of Productive Assets or of aBusiness.”

 

Following the completionof the acquisition, the results of operations of Let It Wave have been includedin our condensed consolidated financial statements.  Accordingly, our results of operations for thethree and six month periods ended June 30, 2008 include Let It Wave’soperations from the acquisition date.

 

**Segments**

 

Our products are based onhighly integrated application-specific integrated circuits, or ASICs, andsystem-on-a-chip, or SOC, solutions.  Wealso license certain software and other intellectual property.  We operate in two operating segments –Consumer group and Imaging group.  TheConsumer group provides products for use in DVD players, recordable DVDplayers, standard and high definition digital television products, digitalcamera products and multimedia mobile phone products.  The Imaging group provides products used indigital copiers, laser and inkjet printers as well as multifunction peripherals.

 

**Critical Accounting Policies and Estimates**

 

The discussion and analysisof our financial condition and results of operations are based upon ourunaudited condensed consolidated financial statements, which have been preparedin accordance with accounting principles generally accepted in the UnitedStates. The preparation of these financial statements requires us to makeestimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses, and related disclosure of contingent assetsand liabilities. On an on-going basis, we evaluate our 

 

19

----

Table of Contents

 

critical accountingpolicies and estimates. We base our estimates on historical experience and onvarious other assumptions that we believe to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets and liabilities that are not readily apparentfrom other sources. Actual results may differ from these estimates underdifferent assumptions or conditions. Our critical accounting policies andestimates are discussed in our Annual Report on Form 10-K for the fiscalyear ended December 31, 2007 with the exception of the additional policydiscussed below.

 

*Fair value measurements*

 

Effective January 1,2008, we adopted SFAS No. 157, “Fair Value Measurements” (“SFAS 157”).  In February 2008, the FASB issued FASBStaff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157,”which provides a one year deferral of the effective date of SFAS 157 fornon-financial assets and non-financial liabilities, except those that arerecognized or disclosed in the financial statements at fair value at leastannually. Therefore, we have adopted the provisions of SFAS 157 with respect toits financial assets and liabilities only. SFAS 157 defines fair value, establishes a framework for measuring fairvalue under generally accepted accounting principles and enhances disclosuresabout fair value measurements. Fair value is defined under SFAS 157 as theexchange price that would be received for an asset or paid to transfer aliability (an exit price) in the principal or most advantageous market for theasset or liability in an orderly transaction between market participants on themeasurement date. Valuation techniques used to measure fair value under SFAS157 must maximize the use of observable inputs and minimize the use ofunobservable inputs. The standard describes a fair value hierarchy based onthree levels of inputs, that may be used to measure fair value, of which thefirst two are considered observable and the last unobservable:

 

·                  Level 1 - Quoted prices in active marketsfor identical assets or liabilities.

 

·                  Level 2 - Inputsother than Level 1 that are observable, either directly or indirectly, such asquoted prices for similar assets or liabilities; quoted prices in markets thatare not active; or other inputs that are observable or can be corroborated byobservable market data for substantially the full term of the assets orliabilities.

 

·                  Level 3 -Unobservable inputs that are supported by little or no market activity and thatare significant to the fair value of the assets or liabilities.

 

The adoption of thisstatement did not have a material impact on our consolidated results of operationsand financial condition.

 

Our Level 3 investmentsas of June 30, 2008 include high-grade auction rate securities primarilyconsisting of government guaranteed student loans.  Auction rate securities are securities thatare structured with short-term interest rates which periodically reset throughauctions, typically within every 90 days. At the end of each reset period, investors can sell or continue to holdthe securities at par. During the current quarter, some of the auction ratesecurities were sold and others failed to auction successfully due to marketsupply exceeding market demand.  In theevent of a failed auction, the notes continue to bear interest at apredetermined maximum rate based on the credit rating of notes as determined byone or more nationally recognized statistical rating organizations. The fundsassociated with failed auctions will not be accessible until a successfulauction occurs, a buyer is found outside of the auction process, the issuersredeem the securities or the underlying securities have matured.  As a result, we have classified all auctionrate securities as long-term assets in the condensed consolidated balancesheets.

 

Due to the currenteconomic environment in which there is a lack of market activity for auctionrate securities, we have been unable to obtain quoted prices or market pricesfor identical assets as of the measurement date resulting in significantunobservable inputs used in determining the fair value.  We estimated the fair value of these auctionrate securities using the income approach based on the following: (i) theunderlying structure and contractual provisions of each security; (ii) thepresent value of future principal and interest payments discounted at ratesconsidered to reflect current market conditions; and (iii) considerationof the probabilities of default, auction failure, or repurchase at par for eachperiod. These estimated fair values could change significantly based on futuremarket conditions, which could result in recognizing an other-than-temporaryimpairment loss.

 

The fair value indicatedby this approach yielded a value that approximated the par value of therespective securities.

 

20

----

Tableof Contents

 

**Resultsof Operations**

** **

The following tablesummarizes selected consolidated statement of operations data and changes fromthe period to period (dollars in thousands, except for percentages):

 
| ** **                                                  | ** ** | **Three Months Ended****June 30,** | ** ** | **Change** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------------------------|------------|------------|------------|
| ** **                                                  | ** ** | **2008**                                          | ** ** | **2007**   | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                                  | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues:                                                   |       |                                              |       |       |       |   |   |   |   |
| Hardware product  revenues                                  |       | $                                                 | 113,606    |       | $          | 114,508 |   | $ | (902 | ) | (0.8 | )% |
| Software and  other revenues                                |       | 15,079                                            |       | 15,395     |       | (316 | ) | (2.1 | )% |
| Total revenues                                              |       | 128,685                                           |       | 129,903    |       | (1,218 | ) | (0.9 | )% |
|                                                        |       |                                              |       |       |       |   |   |   |   |
| Cost and  expenses:                                         |       |                                              |       |       |       |   |   |   |   |
| Cost of hardware  product revenues                          |       | 68,360                                            |       | 60,178     |       | 8,182 |   | 13.6 | % |
| Research and  development                                   |       | 30,797                                            |       | 29,976     |       | 821 |   | 2.7 | % |
| Selling, general  and administrative                        |       | 24,260                                            |       | 28,414     |       | (4,154 | ) | (14.6 | )% |
| Amortization of  intangible assets                          |       | 9,256                                             |       | 12,169     |       | (2,913 | ) | (23.9 | )% |
| In-process  research and development.                       |       | 22,383                                            |       | —     |       | 22,383 |   | 100.0 | % |
| Total costs and  expenses                                   |       | 155,056                                           |       | 130,737    |       | 24,319 |   | 18.6 | % |
| Operating loss                                              |       | (26,371                                           | )          | (834       | )          | (25,537 | ) |   | * |
|                                                        |       |                                              |       |       |       |   |   |   |   |
| Interest and  other income (expense), net                   |       | 2,831                                             |       | 3,882      |       | (1,051 | ) | (27.1 | )% |
| Provision for  income taxes                                 |       | 13,080                                            |       | 2,850      |       | 10,230 |   | * |   |
| Net income  (loss)                                          |       | $                                                 | (36,620    | )          | $          | 198 |   | $ | (36,818 | ) | * |   |
|                                                        |       |                                              |       |       |       |   |   |   |   |
| Supplemental  Operating Data:                               |       |                                              |       |       |       |   |   |   |   |
| Cost of hardware  product as % of hardware product revenues |       | 60.2                                              | %          | 52.6       | %          |   |   |   |   |

 

----

* not meaningful

 

21

----

Tableof Contents

 
| ** **                                                  | ** ** | **Six Months Ended****June 30,** | ** ** | **Change** | ** ** |
|-------------------------------------------------------------|------------|-------------------------------------------------|------------|------------|------------|
| ** **                                                  | ** ** | **2008**                                        | ** ** | **2007**   | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                                  | ** ** | ** **                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues:                                                   |       |                                            |       |       |       |   |   |   |   |
| Hardware product  revenues                                  |       | $                                               | 207,903    |       | $          | 201,690 |   | $ | 6,213 |   | 3.1 | % |
| Software and  other revenues                                |       | 29,813                                          |       | 29,872     |       | (59 | ) | (0.2 | )% |
| Total revenues                                              |       | 237,716                                         |       | 231,562    |       | 6,154 |   | 2.7 | % |
|                                                        |       |                                            |       |       |       |   |   |   |   |
| Cost and  expenses:                                         |       |                                            |       |       |       |   |   |   |   |
| Cost of hardware  product revenues                          |       | 126,149                                         |       | 104,376    |       | 21,773 |   | 20.9 | % |
| Research and  development                                   |       | 58,684                                          |       | 54,964     |       | 3,720 |   | 6.8 | % |
| Selling, general  and administrative                        |       | 49,899                                          |       | 57,007     |       | (7,108 | ) | (12.5 | )% |
| Amortization of  intangible assets                          |       | 18,493                                          |       | 24,338     |       | (5,845 | ) | (24.0 | )% |
| In-process  research and development                        |       | 22,383                                          |       | —     |       | 22,383 |   | 100.0 | % |
| Total costs and  expenses                                   |       | 275,608                                         |       | 240,685    |       | 34,923 |   | 14.5 | % |
| Operating loss                                              |       | (37,892                                         | )          | (9,123     | )          | (28,769 | ) | * |   |
| Interest and  other income (expense), net                   |       | 6,644                                           |       | 8,087      |       | (1,443 | ) | (17.8 | )% |
| Provision for  income taxes                                 |       | 10,050                                          |       | 4,650      |       | 5,400 |   | 116.1 | % |
| Net loss                                                    |       | $                                               | (41,298    | )          | $          | (5,686 | ) | $ | (35,612 | ) | * |   |
|                                                        |       |                                            |       |       |       |   |   |   |   |
| Supplemental  Operating Data:                               |       |                                            |       |       |       |   |   |   |   |
| Cost of hardware  product as % of hardware product revenues |       | 60.7                                            | %          | 51.8       | %          |   |   |   |   |

 

----

* not meaningful

 

*Revenues*

 

Total revenues were$128.7 million for the three months ended June 30, 2008 compared to $129.9million for the three months ended June 30, 2007.  Consumer segment revenues increased by $1.5million while Imaging segment revenues decreased $2.7 million.  The increase in Consumer segment revenues wasa result of increases in revenues for DTV and Mobile products of $19.6 millionand $2.0 million, respectively, which was partially offset by decrease inrevenues for DVD products by $20.1 million. The decrease in Imaging segmentrevenues was primarily due to a reduction in Imaging hardware product revenues.

 

Total revenues were$237.7 million for the six months ended June 30, 2008 compared to $231.6million for the six months ended June 30, 2007.  Consumer segment revenues increased by $8.4million while Imaging segment revenues decreased $2.3 million.  The increase in Consumer segment revenues wasprimarily a result of increases in revenues for DTV products of $30.2 millionwhich was partially offset by decrease in revenues for DVD products by $21.9million.  The decrease in Imaging segmentrevenues was primarily due to a reduction in Imaging hardware product revenues.

 

Hardware product revenuesfor the three months ended June 30, 2008 were $113.6 million compared to$114.5 million for the comparable period of the prior year.  Hardware product revenues increased $1.6million in the Consumer segment, offset by a $2.5 million decrease in theImaging segment.  Within the Consumersegment, hardware product revenues increased by $19.5 million for DTV products,primarily due to increased unit shipments, and by $2.0 million in the Mobileproducts, also driven by increased unit shipments. Partially offsetting theincreases for DTV and Mobile products was a decrease of $19.9 million for DVDproducts mainly attributable to a reduction in unit shipments.  The Imaging hardware product revenuesdecreased due to lower average selling prices and reduced unit shipments.

 

Hardware product revenuesfor the six months ended June 30, 2008 were $207.9 million compared to$201.7 million for the comparable period of the prior year.  Hardware product revenues increased $9.1million in the Consumer segment, partially offset by a $2.9 million decrease inthe Imaging segment.  Within the Consumersegment, hardware product revenues increased by $30.4 million for 

 

22

----

Tableof Contents

 

DTV products, which wereprimarily driven by increased unit shipments. This increase was partially offset by a decrease of $21.4 million forDVD products, mainly attributable to an erosion of average selling price.  The decrease in Imaging hardware productrevenues was due to lower average selling prices.

 

Software and otherrevenues were $15.1 million and $29.8 million for the three and six monthperiods ended June 30, 2008, respectively, compared to $15.4 million and$29.9 million for the three and six month periods ended June 30, 2007,respectively.  The changes in softwareand other revenues were primarily due to the timing of new agreements.

 

*Cost of Hardware Product Revenues*

 

Theincrease in hardware product costs as a percentage of hardware product revenuesfor the three and six month periods ended June 30, 2008, compared to thesame period in 2007, was primarily a result of product mix – productswith a higher percent of cost per revenue represented a greater proportion ofproducts sold.  In the first half of2008, we experienced initial cost challenges related to ramp in volume of newproducts.  As we move forward with theseproducts’ volume ramp, we expect to see improvements in their coststructure.  Cost of hardware productrevenues as a percentage to product revenue was also impacted by declines inaverage selling prices, particularly for our DVD products.

 

*Research and Development*

 

Research and developmentexpenses increased by $0.8million and $3.7 million for the three and six month periods ended June 30,2008, respectively, compared to the same periods in 2007.  Research and development expenses tendto fluctuate based on the timing of major engineering-related expenses, such astape-outs as well as continued investments in research and development acrossboth of our segments.

 

*Selling, General and Administrative*

 

Selling,general and administrative expenses decreased by $4.2 million and $7.1 millionfor the three and six month periods ended June 30, 2008, respectively,compared to the same periods in 2007.  These decreases were primarily attributed todecreases in legal and accounting expenses which were higher in 2007 inconnection with our review of historical stock option granting practices.  In addition, stock-based compensationexpenses were lower for the three and six month periods ended June 30,2008 compared to the same periods in 2007.

 

*Amortization of Intangible Assets*

 

During the three and sixmonth periods ended June 30, 2008, we incurred charges of $9.3 and $18.5million, respectively, related to the amortization of intangible assetscompared to $12.2 million and $24.3 million of such charges for the three andsix month periods ended June 30, 2007, respectively.  At June 30, 2008, we had approximately$8.8 million in net intangible assets acquired through the Oak, Emblaze, Orenand Let It Wave acquisitions, which we will continue to amortize on a straightline basis through 2011.

 

*In-ProcessResearch and Development*

 

During the quarter ended June 30,2008, the Company recorded an in-process research and development expense of$22.4 million as part of the June 2008 acquisition of Let ItWave.  There were no charges recorded forin-process research and development during 2007.

 

*Interest and Other Income(Expense)*

 

Interest and other income(expense) was $2.8 and $6.6 million for the three and six month periods ended June 30,2008, respectively, compared to $3.9 million and $8.1 million for the sameperiods of 2007, respectively.   Interestincome was $3.3 million and $7.8 million for the three and six month periodsended June 30, 2008, respectively, compared to $3.8 million and $7.4million for the same period of 2007. The decrease in interest income for thethree months ended June 30, 2008 was primarily due to lower averageinterest earned on our cash and short term investment balances due to declinesin the interest rate.  The decreases inother income (expense) for the three and six month periods ended June 30,2008 were primarily due to foreign currency remeasurement losses as a result ofthe decline in the value of the U.S. dollar in comparison to currencies incountries in which we operate and fluctuations in realized gains due to timingof sale of investments.

 

23

----

Tableof Contents

 

*Provision for Income Taxes*

 

We recorded a taxprovision of $13.1 and $10.0 million for the three and six month periods ended June 30,2008, respectively, compared to a tax provision of $2.8 million and $4.6million for the three and six month periods ended June 30, 2007,respectively.  The expense for the threeand six month periods ended June 30, 2008 reflects the estimated annualtax rate applied to the year to date pre tax loss, adjusted for certaindiscrete items that are fully recognized in the period they occur.  The income tax expense for these periods wasaffected by the geographic distribution of our worldwide earnings or losses,the impact of recording a valuation allowance and the release of the valuationallowance at December 31, 2007, non-tax-deductible expenses such as SFAS123R stock-based compensation expense, as well as the accrual of liabilitiesassociated with unrecognized tax benefits.  In addition, our Israel based subsidiary is an“Approved Enterprise” under Israeli law, which provides a ten-year tax holidayfor income attributable to a portion of our operations in Israel.

 

**Liquidity and Capital Resources**

 

At June 30, 2008, wehad $85.7 million of cash and cash equivalents, $216.7 million of short terminvestments and $57.8 million of long term investments.  At June 30, 2008, we had $355.3 millionof working capital.

 

Cash used in operatingactivities was $21.3 million during the first six months of 2008.  While we recorded a net loss of $41.3million, this loss included non-cash items such as amortization of $18.5million, depreciation of $4.0 million, in-process research and developmentexpense of $22.4 million and stock-based compensation expense of $6.6million.  Cash used in operations wasprimarily due to an increase in inventory by $11.6 million to meet the expectedincrease in demand for our newer products and decrease in accounts payable,accrued expenses and other liabilities totaling $27.6 million due to timing ofpayments.  These changes were partiallyoffset by a decrease in accounts receivable, prepaid expenses and other currentassets and other assets by $1.3 million due to the timing of collections andpayments.

 

Cash provided byinvesting activities was $5.6 million during the six months ended June 30,2008 principally reflecting the proceeds from sales and maturities ofinvestments, net of purchases, of $32.1 million.  This was partially offset by $22.8 millionused for the acquisition of Let It Wave and $3.7 million used for purchases ofproperty and equipment.

 

Cash provided byfinancing activities during the six months ended June 30, 2008 was $4.1million consisting of proceeds received from issuances of common stock throughexercises of stock options and proceeds from the sale of stock under ouremployee stock purchase plan.

 

Our operating activitiesgenerated cash of $42.3 million during the first six months of 2007. While werecorded a net loss of $5.7 million, this loss included non-cash items such asamortization of $24.3 million, depreciation of $4.0 million and stock- basedcompensation expense of $7.0 million. Cash provided by operations also increased due to an increase in accountspayable by $14.9 million; accrued expenses and other liabilities and other longterm liabilities by $8.7 million due to timing of payments. These increaseswere partially offset by an increase in accounts receivable by $6.4 million dueto increase in revenue, increase in inventory by $2.0 million and an increasein prepaid expenses and other current assets by $1.8 million.

 

Cash used in investingactivities was $47.5 million during the six months ended June 30, 2007,principally reflecting the net purchase of investments of $43.5 million. Inaddition we spent $4.0 million for the purchases of property and equipment.

 

Cash provided byfinancing activities during the six months ended June 30, 2007 was$3.7 million consisting of proceeds received from issuances of commonstock through exercises of stock options.

 

At June 30, 2008, wedid not have any relationships with unconsolidated entities or financialpartnerships, such as entities often referred to as structured finance orspecial purpose entities, established for the purpose of facilitatingoff-balance sheet arrangements or other contractually narrow or limitedpurposes.  Accordingly, we are notexposed to the type of financing, liquidity, market or credit risk that couldarise if we had engaged in such relationships.

 

We believe that ourcurrent balances of cash, cash equivalents and short-term investments, andanticipated cash flow from operations, will satisfy our anticipated workingcapital and capital expenditure requirements at least through the next 12months.  We intend to hold our auctionrate securities for the foreseeable future and have classified them as along-term asset and do not expect this to have 

 

24

----

Tableof Contents

 

an impact on ourliquidity.  Nonetheless, our futurecapital requirements may vary materially from those now planned and will dependon many factors including, but not limited to:

 

·                  thelevels at which we maintain inventories and accounts receivable;

 

·                  themarket acceptance of our products;

 

·                  thelevels of promotion and advertising required to launch our new products or toenter markets and attain a competitive position in the marketplace;

 

·                  ourbusiness, product, capital expenditure and research and development plans andtechnology roadmap;

 

·                  volumepricing concessions;

 

·                  capitalimprovements to new and existing facilities;

 

·                  technologicaladvances;

 

·                  theresponse of competitors to our products; and

 

·                  ourrelationships with our suppliers and customers.

 

In addition, we mayrequire an increase in the level of working capital to accommodate plannedgrowth, hiring and infrastructure needs. Additional capital may also be required for additional acquisitions ofbusinesses, products or technologies.

 

To the extent that ourexisting resources and cash generated from operations are insufficient to fundour future activities, we may need to raise additional funds through public orprivate financings or borrowings.  Ifadditional funds are raised through the issuance of debt securities, thesesecurities could have rights, preferences and privileges senior to holders ofcommon stock, and the terms of this debt could impose restrictions on ouroperations.  The sale of additionalequity or convertible debt securities could result in additional dilution toour stockholders.  We cannot be certainthat additional financing will be available in amounts or on terms acceptableto us, if at all.  If we are unable toobtain this additional financing, we may be required to reduce the scope of ourplanned product development and sales and marketing efforts, which could harmour business, financial condition and operating results.

 

**Item3.  Quantitative and Qualitative DisclosuresAbout Market Risk**

 

We are exposed tofinancial market risks, including changes in interest rates and foreigncurrency exchange rates.

 

**InterestRate Risk**

 

We invest in a variety offinancial instruments, consisting principally of investments in commercialpaper, money market funds, auction rate securities and highly liquid debtsecurities of corporations, municipalities and the United States government andits agencies. These investments are denominated in United States dollars. We donot maintain derivative financial instruments. We place our investments ininstruments that meet high credit quality standards, as specified in ourinvestment policy guidelines.

 

We account for ourinvestment instruments in accordance with SFAS 115, *Accounting for Certain Investments in Debt and EquitySecurities*. All of the cash equivalents and marketable securitiesare treated as “available-for-sale” under SFAS 115. Investments in bothfixed rate and floating rate interest earning instruments carry a degree ofinterest rate risk. Fixed rate securities may have their market value adverselyimpacted due to a rise in interest rates, while floating rate securities mayproduce less income than expected if interest rates fall. Due in part to thesefactors, our future investment income may fall short of expectations due tochanges in interest rates or we may suffer losses in principal if we are forcedto sell securities that decline in market value due to changes in interestrates. However, because we classify our debt securities as “available-for-sale”no gains or losses are recognized due to changes in interest rates unless suchsecurities are sold prior to maturity or declines in fair value are determinedto be other than temporary. These securities are reported at fair value withthe related unrealized gains and losses included in accumulated othercomprehensive income, a component of stockholders’ equity, net of tax.

 

25

----

Tableof Contents

 

Due mainly to theshort-term nature of the major portion of our investment portfolio, the fairvalue of our investment portfolio or related income would not be significantlyimpacted by either a 10% increase or decrease in interest rates.

 

**ExchangeRate Risk**

 

We consider our directexposure to foreign exchange rate fluctuations to be minimal. Currently, salesand arrangements with third-party manufacturers provide for pricing and paymentin United States dollars, and, therefore, are not subject to exchange ratefluctuations. Increases in the value of the United States’ dollar relative toother currencies would make our products more expensive, which could negativelyimpact our ability to compete. Conversely, decreases in the value of the UnitedStates’ dollar relative to other currencies could result in our suppliersraising their prices in order to continue doing business with us.

 

A portion of the cost ofour operations, relating mainly to our personnel and facilities in Israel, Asiaand Europe, are transacted in foreign currencies. To date, we have not engagedin any currency hedging activities, although we may do so in the future.Significant fluctuations in currency exchange rates could impact our businessin the future.

 

**Item 4.Controls and Procedures**

 

***DisclosureControls and Procedures****.*Underthe supervision and with the participation of our management, including ourChief Executive Officer and our Chief Financial Officer, we evaluated theeffectiveness of our disclosure controls and procedures, as such term isdefined under Rule 13a-15(e) promulgated under the SecuritiesExchange Act of 1934, as amended. Based upon that evaluation, our ChiefExecutive Officer and Chief Financial Officer****concluded that our disclosure controls and procedures were effectiveas of the end of the period covered by this quarterly report.

 

***Changes to Internal Control OverFinancial Reporting.*** There were no changes in our internal controlover financial reporting during the quarter ended June 30, 2008 that havematerially affected****or arereasonably likely to materially affect our internal control over financialreporting.

 

26

----

Tableof Contents

 

**PART II. OTHER INFORMATION**

 

**Item 1. Legal Proceedings**

 

The discussion in Part I, Item 1, Note 12, “Contingencies” isincorporated herein by reference.   

 

**Item 1A.   Risk Factors**

 

Our future business,operating results and financial condition are subject to various risks anduncertainties, including those described below.

 

**Ourannual revenues and operating results fluctuate due to a variety of factors,which may result in volatility or a decline in the prices of our common stock.**

 

Our historical operatingresults have varied significantly from period to period due to a number offactors, including:

 

fluctuation in demand for our productsincluding reduced demand resulting from an economic slowdown;

 

the timing of new product introductions orenhancements by us and our competitors;

 

the level of market acceptance of new andenhanced versions of our products and our customers’ products;

 

the timing or cancellation of large customerorders;

 

the length and variability of the sales cyclefor our products;

 

pricing policy changes by us and by ourcompetitors and suppliers;

 

the cyclical nature of the semiconductorindustry;

 

the availability of development funding andthe timing of development revenue;

 

changes in the mix of products sold;

 

seasonality in demand for our products;

 

increased competition in product lines, andcompetitive pricing pressures; and

 

                        the evolving and unpredictablenature of the markets for products incorporating our integrated circuits andembedded software.

 

We expect that ouroperating results will continue to fluctuate in the future as a result of thesefactors and a variety of other factors, including:

 

the cost and availability of adequate foundrycapacity;

 

fluctuations in manufacturing yields;

 

changes in or the emergence of new industrystandards;

 

failure to anticipate changing customerproduct requirements;

 

the loss or gain of important customers;

 

product obsolescence; and

 

the amount of research and developmentexpenses associated with new product introductions.

 

Our operating resultscould also be harmed by:

 

                        economic conditions generallyor in various geographic areas where we or our customers do business (includingrecent events in the subprime mortgage market);

 

terrorism and international conflicts orother crises;

 

other conditions affecting the timing ofcustomer orders;

 

changes in governmental regulations thatcould affect our products;

 

a downturn in the markets for our customers’products, particularly the consumer electronics market;

 

disruption in commercial activitiesassociated with heightened security concerns affecting international travel andcommerce;

 

reduced demand for consumer electronicproducts due to an economic slowdown;

 

27

----

Tableof Contents

 

an inability to hold our auction ratesecurities for a sufficient time to allow the market activity to recover;

 

                        tightened immigration controlsthat may adversely affect the residence status of key non-U.S. managers andtechnical employees in our U.S. facilities or our ability to hire new non-U.S.employees in such facilities; or

 

potential expansion of armed conflict in theMiddle East which could adversely affect our operations in Israel.

 

These factors aredifficult or impossible to forecast. We place orders with independent foundriesseveral months in advance of the scheduled delivery date, often in advance ofreceiving non-cancelable orders from our customers. This limits our ability toreact to fluctuations in demand for their products. If anticipated shipments inany quarter are canceled or do not occur as quickly as expected, or if we failto foresee a technology change that could render a product obsolete, expenseand inventory levels could be disproportionately high. If anticipated licenserevenues in any quarter are canceled or do not occur, gross margins may bereduced.

 

A significant portion ofour expenses are relatively fixed, and the timing of increases in expenses isbased in large part on our forecast of future revenues. As a result, ifrevenues do not meet our expectations, we may be unable to quickly adjustexpenses to levels appropriate to actual revenues, which could harm ouroperating results.

 

**Ourcustomers experience fluctuating product cycles and seasonality, which causestheir sales to fluctuate.**

 

Because the markets thatour customers serve are characterized by numerous new product introductions andrapid product enhancements, our operating results may vary significantly fromquarter to quarter. During the final production of a mature product, ourcustomers typically exhaust their existing inventories of our products.Consequently, orders for our products may decline in those circumstances, evenif the products are incorporated into both mature products and replacementproducts. A delay in a customer’s transition to commercial production of areplacement product would delay our ability to recover the lost sales from thediscontinuation of the related mature product. Our customers also experiencesignificant seasonality in the sales of their consumer products, which affectstheir orders of our products. Typically, the second half of the calendar yearrepresents a disproportionate percentage of sales for our customers due to theholiday shopping period for consumer electronics products, and therefore, adisproportionate percentage of our sales. We expect these seasonal sales fluctuationsto continue for the foreseeable future and an economic slowdown could increasethe seasonal decline in sales that we typically see in the first half of thecalendar year.

 

Our ability to matchproduction mix with the product mix needed to fill current orders and orders tobe delivered in the given quarter may affect our ability to meet that quarter’srevenue forecast. In addition, when responding to customers’ requests forshorter shipment lead times, we manufacture products based on forecasts ofcustomers’ demands. These forecasts are based on multiple assumptions. If weinaccurately forecast customer demand, we may hold inadequate, excess orobsolete inventory that would reduce our profit margins and adversely affectour results of operations and financial condition.

 

**Weak economic conditions couldadversely impact consumer spending, which could affect our business.**

 

A further slowdown in theeconomy, or other economic conditions affecting disposable consumer income suchas employment levels, inflation, business conditions, fuel and energy costs,consumer debt levels, interest rates and tax rates, may reduce overall consumerspending or shift consumer spending to products other than digitalentertainment and digital imaging products. The resulting reduced sales by our customers could adversely affect ourbusiness by slowing new product introductions by our customers and by us,lowering net sales of our products, decreasing our inventory turnover, and/orreducing profitability.

 

**Ourproducts are characterized by average selling prices that typically declineover relatively short time periods; if we are unable to reduce our costs orintroduce new products with higher average selling prices, our financialresults will suffer.**

 

Average selling pricesfor our products typically decline over relatively short time periods, whilemany of our manufacturing costs are fixed. When our average selling pricesdecline, our revenues decline unless we are able to sell more units and ourgross margins decline unless we are able to reduce our manufacturing costs by acommensurate amount. Our operating results suffer when gross margins decline.We have experienced these problems, and we expect to continue to experiencethem in the future, although we cannot predict when they may occur or howsevere they will be.

 

**Productsupply and demand in the semiconductor industry is subject to cyclicalvariations.**

 

The semiconductorindustry is subject to cyclical variations in product supply and demand.Downturns in the industry often occur in connection with, or anticipation of,maturing product cycles for both semiconductor companies and their customersand declines in 

 

28

----

Tableof Contents

 

general economicconditions. These downturns have been characterized by abrupt fluctuations inproduct demand, production over-capacity and accelerated decline of averageselling prices. In some cases, these downturns have lasted more than one year.The recent emergence of a number of negative economic factors, includingheightened fears of a recession, could lead to such a downturn. We cannotpredict whether we will achieve timely, cost-effective access to that capacitywhen needed, or when there will be a capacity shortage again in the future. Adownturn in the semiconductor industry could harm our sales and revenues ifdemand drops, or our gross margins if average selling prices decline.

 

**Oursuccess for the foreseeable future will depend on demand for integratedcircuits for a limited number of applications.**

 

In recent years, we havederived a substantial majority of our product revenues from the sale ofintegrated circuits for DVD and digital camera applications. We expect thatsales of our products for these applications will continue to account for asignificant portion of our revenues for the foreseeable future. Our futurefinancial performance will also depend on our ability to successfully developand market new products in the digital television, HDTV and digital imagingmarkets. If the markets for these products and applications decline or fail todevelop as expected, or we are not successful in our efforts to market and sellour products to manufacturers who incorporate integrated circuits into theseproducts, our financial results will be harmed.

 

**Ourfinancial performance is highly dependent on the timely and successfulintroduction of new and enhanced products.**

 

Our financial performancedepends in large part on our ability to successfully develop and marketnext-generation and new products in a rapidly changing technologicalenvironment. If we fail to successfully identify new product opportunities andtimely develop and introduce new products that achieve market acceptance, wemay lose our market share and our future revenues and earnings may suffer.

 

In the consumerelectronic market, our performance has been dependent on our successfuldevelopment and timely introduction of integrated circuits for DVD players,digital cameras, multimedia accelerators for mobile phones, broadband digitaltelevision and HDTV. These markets are characterized by the incorporation of asteadily increasing level of integration and numbers of features on a chip atthe same or lower system cost, enabling original equipment manufacturers, orOEMs, to continually improve the features or reduce the prices of the systemsthey sell. If we are unable to continually develop and introduce integratedcircuits with increasing levels of integration and new features at competitiveprices, our operating results will suffer.

 

In the Imaging market,our performance has been dependent on our successful development and timelyintroduction of integrated circuits for printers and multi-functionperipherals. These markets are characterized by the incorporation of a steadilyincreasing level of integration and higher speeds on a chip at the same orlower system cost, enabling OEMs to improve the performance and featuresor reduce the prices of the systems they sell. If we are unable to develop andintroduce integrated circuits with increasing levels of integration,performance and new features at competitive prices, our operating results willsuffer. The performance of our software licensing business is dependent on ourability to develop and introduce new releases of our software, whichincorporate new or enhanced printing standards, as well as performanceenhancements required by our OEM customers. If we are unable to develop andrelease versions of our software supporting required standards and offeringenhanced performance, our operating results will suffer.

 

**Weface competition or potential competition from companies with greater resourcesthan ours, and if we are unable to compete effectively with these companies,our market share may decline and our business could be harmed.**

 

The markets in which wecompete are intensely competitive and are characterized by rapid technologicalchange, declining average unit selling prices and rapid product obsolescence.We expect competition to increase in the future from existing competitors andfrom other companies that may enter our existing or future markets withsolutions which may be less costly or provide higher performance or moredesirable features than our products. Competition typically occurs at thedesign stage, when customers evaluate alternative design approaches requiringintegrated circuits. Because of short product life cycles, there are frequentdesign win competitions for next-generation systems.

 

Our existing andpotential competitors include many large domestic and international companiesthat have substantially greater financial, manufacturing, technological,market, distribution and other resources. These competitors may also havebroader product lines and longer standing relationships with customers andsuppliers than we have.

 

Some of our principalcompetitors maintain their own semiconductor foundries and may thereforebenefit from capacity, cost and technical advantages. Our principal competitorsin the integrated audio and video devices for DVD applications includeMediaTek, and Sunplus. In the markets for digital cameras, our principalcompetitors are in-house solutions developed and used by major 

 

29

----

Tableof Contents

 

Japanese OEMs, as well asproducts sold by Ambarella, Fujitsu, MediaTek, Novatech, Sunplus and TexasInstruments. In the market for multimedia acceleration for Mobile phones, ourprincipal competitors include AMD, Broadcom, CoreLogic, MtekVision, Nvidia andTelechips.  In the market for JPEG-basedproducts for desktop video editing applications, our principal competitor isSunplus. Cirrus Logic (Crystal Semiconductor), Freescale Semiconductor,Fujitsu, STMicroelectronics and Yamaha are currently shipping DolbyDigital-based audio compression products. Our principal competitors for digitalsemiconductor devices in the digital television market include Broadcom,M-Star, Mediatek and ST Microelectronics. Others who also participate in thismarket are Micronass, NXP and Trident Microsystems.  Competitors in the printer and multifunctionperipheral space include Freescale, Global Graphics, Marvell Semiconductor,Peerless Systems and in-house captive suppliers.

 

We believe that growth ofthe DVD player market will be modest in the foreseeable future, and thatcontinued strong competition will lead to further price reductions, and reducedprofit margins. We also face significant competition in the digital imaging anddigital camera markets. The future growth of both markets is highly dependenton OEMs continuing to outsource an increasing portion of their productdevelopment work. Many of our existing competitors, as well as OEM customersthat are expected to compete with us in the future, have substantially greaterfinancial, manufacturing, technical, marketing, distribution and otherresources, broader product lines and longer standing relationships withcustomers than we have. In addition, much of our future success is dependent onthe success of our OEM customers. If we or our OEM customers are unable tocompete successfully against current and future competitors, we couldexperience price reductions, order cancellations and reduced gross margins, anyone of which could harm our business.

 

**Wemust keep pace with rapid technological changes and evolving industry standardsto remain competitive.**

 

Our future success willdepend on our ability to anticipate and adapt to changes in technology andindustry standards and our customers’ changing demands. The consumerelectronics market, in particular, is characterized by rapidly changingtechnology, evolving industry standards, frequent new product introductions,short product life cycles and increasing demand for higher levels ofintegration. Our ability to adapt to these changes and to anticipate futurestandards, and the rate of adoption and acceptance of those standards, will bea significant factor in maintaining or improving our competitive position andprospects for growth. If new industry standards emerge, our products or theproducts of our customers could become unmarketable or obsolete, and we couldlose market share or be required to incur substantial unanticipated costs to complywith these new standards.

 

Our success will alsodepend on the successful development of new markets and the application andacceptance of new technologies and products in those new markets. For example,our success will depend on the ability of our customers to develop new productsand enhance existing products in the DVD player market and products for thebroadband digital television and HDTV markets and to introduce and promotethose products successfully. These markets may not continue to develop to theextent or in the time periods that we currently anticipate due to factorsoutside our control, such as delays in implementation of FCC 02-320 requiringall new televisions to include a digital receiver by February 2009. If newmarkets do not develop as we anticipate, or if our products do not gainwidespread acceptance in these markets, our business, financial condition andresults of operations could be harmed. The emergence of new markets for ourproducts is also dependent in part upon third parties developing and marketingcontent in a format compatible with commercial and consumer products thatincorporate our products. If this content is not available, manufacturers maynot be able to sell products incorporating our products, and our sales would suffer.

 

**Our newframe rate conversion technology remains unproven, and if it is not accepted byour customers, our financial results and ability to compete could be harmed.**

 

Through our acquisitionof Let It Wave in June 2008, we acquired a frame rate conversiontechnology that is currently under development. We plan to continue to invest in developing this technology and to makeit available for customer integration in the future.  There is no assurance, however, that this newtechnology will be accepted by our customers. In addition, our competitors may develop a superior performance imageprocessing technology and introduce it on the market before us.  If we can not successfully market and sellour new frame rate conversion technology, we will not be able to recoup ourcosts of acquiring Let It Wave and further development costs for thistechnology, and our financing results and ability to compete could be adverselyaffected.

 

**Werely on independent foundries and contractors for the manufacture, assembly andtesting of our integrated circuits and other hardware products, and the failureof any of these third parties to deliver products or otherwise perform asrequested could damage our relationships with our customers and harm our salesand financial results.**

 

We do not operate anymanufacturing facilities, and we rely on independent foundries to manufacturesubstantially all of our products. These independent foundries fabricateproducts for other companies and may also produce products of their own design.From time 

 

30

----

Tableof Contents

 

to time, there aremanufacturing capacity shortages in the semiconductor industry. We do not have long-termsupply contracts with any of our suppliers, including our principal supplierTaiwan Semiconductor Manufacturing Company, or TSMC, and our principal assemblyhouses. Therefore, TSMC and our other suppliers are not obligated tomanufacture products for us for any specific period, in any specific quantityor at any specified price, except as may be provided in a particular purchaseorder.

 

Our reliance onindependent foundries involves a number of risks, including:

 

the inability to obtain adequate manufacturingcapacity;

 

the unavailability of or interruption inaccess to certain process technologies necessary for manufacture of ourproducts;

 

lack of control over delivery schedules;

 

lack of control over quality assurance;

 

lack of control over manufacturing yields andcost; and

 

potential misappropriation of ourintellectual property.

 

In addition, TSMC andsome of our other foundries are located in areas of the world that are subjectto natural disasters such as earthquakes. While the 1999 earthquake in Taiwandid not have a material impact on our independent foundries, a similar eventcentered near TSMC’s facility could severely reduce TSMC’s ability tomanufacture our integrated circuits. The loss of any of our manufacturers as asupplier, our inability to expand the supply of their products in response toincreased demand, or our inability to obtain timely and adequate deliveriesfrom our current or future suppliers due to a natural disaster or any otherreason could delay or reduce shipments of our products. Any of thesecircumstances could damage our relationships with current and prospectivecustomers and harm our sales and financial results.

 

We also rely on a limitednumber of independent contractors for the assembly and testing of our products.Our reliance on independent assembly and testing houses limits our control overdelivery schedules, quality assurance and product cost. Disruptions in theservices provided by our assembly or testing houses or other circumstances thatwould require them to seek alternative sources of assembly or testing couldlead to supply constraints or delays in the delivery of our products. Theseconstraints or delays could damage our relationships with current andprospective customers and harm our financial results.

 

**Becausefoundry capacity is limited from time to time, we may be required to enter intocostly long-term supply arrangements to secure foundry capacity.**

 

If we are not able toobtain additional foundry capacity as required, our relationships with our customerswould be harmed and our sales would likely be reduced. In order to secureadditional foundry capacity, we have considered, and may in the future need toconsider, various arrangements with suppliers, which could include, amongothers:

 

option payments or other prepayments to afoundry;

 

nonrefundable deposits with or loans tofoundries in exchange for capacity commitments;

 

contracts that commit us to purchasespecified quantities of silicon wafers over extended periods;

 

issuance of our equity securities to afoundry;

 

investment in a foundry;

 

joint ventures; or

 

other partnership relationships withfoundries.

 

We may not be able tomake any such arrangement in a timely fashion or at all, and such arrangements,if any, may not be on terms favorable to us. Moreover, if we are able to securefoundry capacity, we may be obligated to utilize all of that capacity or incurpenalties. Such penalties may be expensive and could harm our financialresults.

 

**Ifour independent foundries do not achieve satisfactory yields, our relationshipswith our customers may be harmed.**

 

The fabrication ofsilicon wafers is a complex process. Minute levels of contaminants in themanufacturing environment, defects in photo masks used to print circuits on awafer, difficulties in the fabrication process or other factors can cause asubstantial portion of 

 

31

----

Tableof Contents

 

the integrated circuitson a wafer to be non-functional. Many of these problems are difficult to detectat an early stage of the manufacturing process and may be time consuming andexpensive to correct. As a result, foundries often experience problemsachieving acceptable yields, which are represented by the number of goodintegrated circuits as a proportion of the number of total integrated circuitson any particular wafer. Poor yields from our independent foundries wouldreduce our ability to deliver our products to customers, harm our relationshipswith our customers and harm our business.

 

**Weare dependent upon our international sales and operations; economic, politicalor military events in a country where we make significant sales or havesignificant operations could interfere with our success or operations there andharm our business.**

 

During 2007, only 7% ofour total revenues were derived from North America sales. We anticipate thatinternational sales will continue to account for a substantial majority of ourtotal revenues for the foreseeable future. Substantially all of oursemiconductor products are manufactured, assembled and tested outside of theUnited States by independent foundries and subcontractors.  Let It Wave, which we acquired in June 2008,operates in France.

 

We are subject to avariety of risks inherent in doing business internationally, including:

 

operating innew countries where we have limited or no experience;

 

unexpected changes in regulatoryrequirements;

 

fluctuations in exchange rates;

 

political and economic instability;

 

imposition of tariffs and other barriers andrestrictions;

 

the burdens of complying with a variety offoreign laws; and

 

health risks in a particular region.

 

A material amount of ourresearch and development personnel and facilities and a portion of our salesand marketing personnel are located in Israel. Political, economic and militaryconditions in Israel directly affect our operations. Some of our employees inIsrael are obligated to perform up to 36 days of military reserve duty annually.The absence of these employees for significant periods during the work week maycause us to operate inefficiently during these periods.

 

Our operations in Chinaare subject to the economic and political uncertainties affecting that country.For example, the Chinese economy has experienced significant growth in the pastdecade, but such growth has been uneven across geographic and economic sectors.This growth may decrease and any slowdown may have a negative effect on ourbusiness.

 

We also maintain officesin Canada, England, France, Germany, Hong Kong, India, Israel, Japan, Korea andTaiwan, and our operations are subject to the economic and politicaluncertainties affecting these countries as well.

 

The significantconcentration of our manufacturing activities with third party foundries inTaiwan exposes us to the risk of political instability in Taiwan, including thepotential for conflict between Taiwan and China. We have several significantOEM customers in Japan, Korea and other parts of Asia. Adverse economiccircumstances in Asia could affect these customers’ willingness or ability todo business with us in the future or their success in developing and launchingdevices containing our products.

 

32

----

Tableof Contents

 

**Thecomplexity of our international operations may****increase our operating expenses and disrupt ourrevenues and business.**

 

We transact business andhave operations worldwide.  For example,international transactions form a substantial majority of our sales, oursemiconductor products are manufactured, assembled and tested outside of theUnited States, and in June 2008 we acquired a foreign corporation.  Our global operations involve significantcomplexity and difficulties, including:

 

monitoring andcomplying with applicable laws and regulatory requirements;

 

staffing andmanaging global operations;

 

complying withstatutory equity requirements; and

 

managing taxconsequences.

 

If we are unable tomanage the complexity of our global operations successfully, our financialperformance and operating results could suffer.

 

**Theprices of our products may become less competitive due to foreign exchangefluctuations.**

 

Foreign currencyfluctuations may affect the prices of our products. Prices for our products arecurrently denominated in U.S. dollars for sales to our customers throughout theworld. If there is a significant devaluation of the currency in a specific country,the prices of our products will increase relative to that country’s currency,our products may be less competitive in that country and our revenues may beadversely affected. Also, we cannot be sure that our international customerswill continue to be willing to place orders denominated in U.S. dollars. Ifthey do not, our revenue and operating results will be subject to foreignexchange fluctuations.

 

**Becausewe have significant operations in Israel, our business and future operatingresults could be harmed by future terrorist activity or military conflict.**

 

We conduct a significantportion of our research and development and engineering activities at ourdesign center in Haifa, Israel, a 109,700 square foot facility where we employapproximately 400 people. We also conduct a portion of our sales and marketingoperations at our Haifa facility. We have an additional 16,100 square footfacility in Kfar Netter, Israel, where we conduct research and developmentactivities.

 

In addition, militaryconflict in the Middle East or future terrorist activities there or elsewherein the world could harm our business as a result of a disruption in commercialactivity affecting international commerce or a general economic slowdown andreduced demand for consumer electronic products.

 

**Theinflation in foreign countries****or thedecline in the value of United States dollar compared to those foreigncurrencies may negatively impactour costs.**

 

A portion of the cost ofour operations, relating mainly to our personnel and facilities is incurred inforeign currencies. As a result, we bear the risk that the rate of inflation inthose foreign countries or the decline in the value of United States dollarcompared to those foreign currencies will increase our costs as expressed in UnitedStates dollars. To date, we have not engaged in hedging transactions. In thefuture, we may enter into currency hedging transactions to decrease the risk offinancial exposure from fluctuations in the exchange rate of the United Statesdollar against foreign currencies. These measures may not adequately protect usfrom the impact of inflation in foreign countries.

 

**Wederive most of our revenue from sales to a small number of large customers, andif we are not able to retain these customers, or they reschedule, reduce orcancel orders, our revenues would be reduced and our financial results wouldsuffer.**

 

Our largest customershave accounted for a substantial percentage of our revenues. In 2007, onecustomer accounted for 13% of our total revenues, while sales to our tenlargest customers accounted for 60% of our total revenues. In 2006, onecustomer accounted for 12% of our total revenues, and sales to our ten largestcustomers accounted for 58% of our total revenues. Sales to these largecustomers have varied significantly from year to year and will continue tofluctuate in the future. These sales also may fluctuate significantly fromquarter to quarter. We may not be able to retain our key customers, or thesecustomers may cancel purchase orders or reschedule or decrease their level ofpurchases from us. Any substantial decrease or delay in sales to one or more ofour key customers could harm our sales and financial results. In addition, anydifficulty in collecting amounts due from one or more key customers could harmour financial results. As of December 31, 2007 three customers accountedfor approximately 11%, 11% and 10% of the net accounts receivable balance,respectively.

 

33

----

Tableof Contents

 

**Ourproducts generally have long sales cycles and implementation periods, whichincreases our costs in obtaining orders and reduces the predictability of ouroperating results.**

 

Our products aretechnologically complex. Prospective customers generally must make asignificant commitment of resources to test and evaluate our products and tointegrate them into larger systems. As a result, our sales processes are oftensubject to delays associated with lengthy approval processes that typicallyaccompany the design and testing of new products. The sales cycles of ourproducts often last for many months. Longer sales cycles require us to investsignificant resources in attempting to make sales and delay the generation ofrevenue.

 

Long sales cycles alsosubject us to other risks, including customers’ budgetary constraints, internalacceptance reviews and cancellations. In addition, orders expected in onequarter could shift to another because of the timing of customers’ purchasedecisions.

 

The time required for ourcustomers to incorporate our products into their own can vary significantlywith the needs of our customers and generally exceeds several months, whichfurther complicates our planning processes and reduces the predictability ofour operating results.

 

**Weare not protected by long-term contracts with our customers.**

 

We generally do not enterinto long-term purchase contracts with our customers, and we cannot be certainas to future order levels from our customers. Customers generally purchase ourproducts subject to cancelable short-term purchase orders. We cannot predictwhether our current customers will continue to place orders, whether existingorders will be canceled, or whether customers who have ordered products willpay invoices for delivered products. When we do enter into a long-termcontract, the contract is generally terminable at the convenience of thecustomer. Early termination by one of our major customers would harm our financialresults.

 

**Ourproducts could contain defects, which could reduce sales of those products orresult in claims against us.**

 

We develop complex andevolving products. Despite testing by us and our customers, errors may be foundin existing or new products. This could result in, among other things, a delayin recognition or loss of revenues, loss of market share or failure to achievemarket acceptance. These defects may cause us to incur significant warranty,support and repair costs, divert the attention of our engineering personnelfrom our product development efforts and harm our relationships with customers.The occurrence of these problems could result in the delay or loss of marketacceptance of our products and would likely harm our business. Defects,integration issues or other performance problems in our products could resultin financial or other damages to customers or could damage market acceptance ofsuch products. Our customers could also seek damages from us for their losses.A product liability claim brought against us, even if unsuccessful, wouldlikely be time consuming and costly to defend.

 

**Regulationof our customers’ products may slow the process of introducing new products andcould impair our ability to compete.**

 

The Federal CommunicationsCommission, or FCC, has broad jurisdiction over our target markets in thedigital television business. Various international entities or organizationsmay also regulate aspects of our business or the business of our customers.Although our products are not directly subject to regulation by any agency, thetransmission pipes, as well as much of the equipment into which our productsare incorporated, are subject to direct government regulation. For example,before they can be sold in the United States, advanced televisions and emerginginteractive displays must be tested and certified by Underwriters Laboratoriesand meet FCC regulations. Accordingly, the effects of regulation on ourcustomers or the industries in which our customers operate may in turn harm ourbusiness. FCC regulatory policies affecting the ability of cable operators ortelephone companies to offer certain services and other terms on which thesecompanies conduct their business may impede sales of our products. In addition,our digital television business may also be adversely affected by theimposition of tariffs, duties and other import restrictions on our suppliers orby the imposition of export restrictions on products that we sellinternationally. Changes in current laws or regulations or the imposition ofnew laws or regulations in the United States or elsewhere could harm ourbusiness. For example, any delays by the FCC in imposing its pendingrequirement that all new televisions have a digital receiver could have anadverse effect on our HDTV business.

 

**Ourability to compete could be jeopardized if we are unable to protect ourintellectual property rights.**

 

Our success and abilityto compete depend in large part upon protection of our proprietary technology.We rely on a combination of patent, trade secret, copyright and trademark laws,non-disclosure and other contractual agreements and technical measures toprotect our proprietary rights. These agreements and measures may not besufficient to protect our technology from third-party infringement, 

 

34

----

Tableof Contents

 

or to protect us from theclaims of others. Monitoring unauthorized use of our products is difficult, andwe cannot be certain that the steps we have taken will prevent unauthorized useof our technology, particularly in foreign countries where the laws may notprotect our proprietary rights as fully as in the United States. The laws ofcertain foreign countries in which our products are or may be developed,manufactured or sold, including various countries in Asia, may not protect ourproducts or intellectual property rights to the same extent as do the laws ofthe United States and thus make the possibility of piracy of our technology andproducts more likely in these countries. If competitors are able to use ourtechnology, our ability to compete effectively could be harmed.

 

The protection offered bypatents is subject to numerous uncertainties. For example, our competitors maybe able to effectively design around our patents, or the patents may bechallenged, invalidated or circumvented. Those competitors may alsoindependently develop technologies that are substantially equivalent or superiorto our technology. Moreover, while we hold, or have applied for, patentsrelating to the design of our products, some of our products are based in parton standards, for which we do not hold patents or other intellectual propertyrights.

 

We have generally limitedaccess to and distribution of the source and object code of our software andother proprietary information. With respect to our page descriptionlanguage software, System On a Chip platform firmware and drivers for thedigital office market and in limited circumstances with respect to firmware andplatforms for our DTV, DVDR products, we grant licenses that give our customersaccess to and restricted use of the source code of our software. This accessincreases the likelihood of misappropriation or misuse of our technology.

 

**Claimsand litigation regarding intellectual property rights and breach of contractclaims could seriously harm our business and require us to incur significantcosts.**

 

In recent years, therehas been significant litigation in the United States involving patents andother intellectual property rights. In the past, we have been subject to claimsand litigation regarding alleged infringement of other parties’ intellectualproperty rights, and we have been parties to a number of patent-relatedlawsuits, both as plaintiff and defendant. We could become subject toadditional litigation in the future, either to protect our intellectualproperty or as a result of allegations that we infringe others’ intellectualproperty rights or have breached our contractual obligations to others. Claimsthat our products infringe proprietary rights or that we have breachedcontractual obligations would force us to defend ourselves and possibly ourcustomers or manufacturers against the alleged infringement or breach. Futurelitigation against us, if successful, could subject us to significant liabilityfor damages or invalidation of our proprietary rights. These lawsuits,regardless of their success, are time-consuming and expensive to resolve and requiresignificant management time and attention. Future intellectual property andbreach of contract litigation could force us to do one or more of thefollowing:

 

stop selling products that incorporate thechallenged intellectual property;

 

obtain from the owner of the infringed intellectual property right alicense to sell or use the relevant technology, which license may not beavailable on reasonable terms or at all;

 

pay damages; or

 

redesign those products that use suchtechnology.

 

Although patent disputesin the semiconductor industry have often been settled through cross-licensingarrangements, we may not be able in any or every instance to settle an allegedpatent infringement claim through a cross-licensing arrangement. We have a morelimited patent portfolio than many of our competitors. If a successful claim ismade against us or any of our customers and a license is not made available tous on commercially reasonable terms or we are required to pay substantialdamages or awards, our business, financial condition and results of operationswould be materially adversely affected.

 

**Ifnecessary licenses of third-party technology are not available to us or arevery expensive, our products could become obsolete.**

 

From time to time, we maybe required to license technology from third parties to develop new products orproduct enhancements. Third party licenses may not be available on commerciallyreasonable terms, if at all. If we are unable to obtain any third-party licenserequired to develop new products and product enhancements, we may have toobtain substitute technology of lower quality or performance standards or atgreater cost, either of which could seriously harm the competitiveness of ourproducts.

 

35

----

Tableof Contents

 

We rely on licenses touse various technologies that are material to our products. We do not own thepatents that underlie this license. Our rights to use these technologies andemploy the inventions claimed in the licensed patents are subject to ourabiding by the terms of the licenses. Under the license agreements we mustfulfill confidentiality obligations and pay royalties. If we fail to abide bythe terms of the license, we would be unable to sell and market the productsunder license. In addition, we do not control the prosecution of the patentssubject to this license or the strategy for determining when such patentsshould be enforced. As a result, we are dependent upon our licensor todetermine the appropriate strategy for prosecuting and enforcing those patents.

 

**Ifwe are not able to apply our net operating losses against taxable income infuture periods, our financial results will be harmed.**

 

Our future net income andcash flow will be affected by our ability to apply our net operating losscarryforwards, or NOLs, against taxable income in future periods. Our NOLstotaled approximately $141 million for federal and $32 million forstate tax reporting purposes as of December 31, 2007. The Internal RevenueCode contains a number of provisions that limit the use of NOLs under certaincircumstances. In 2006, we reduced the NOL deferred tax asset for amounts whichwe believe will expire before they become available for utilization. Changes intax laws in the United States may further limit our ability to utilize theseNOLs. Any further limitation on our ability to utilize these respective NOLscould harm our financial condition.

 

**Changesin, or interpretations of, tax rules and regulations may adversely affectour effective tax rates.**

 

Unanticipated changes inour tax rates could affect our future results of operations. Our futureeffective tax rates could be unfavorably affected by changes in tax laws or theinterpretation of tax laws, by unanticipated decreases in the amount of revenueor earnings in countries with low statutory tax rates, or by changes in thevaluation of our deferred tax assets and liabilities. While we believe our taxreserves adequately provide for any tax contingencies, the ultimate outcomes ofany future tax audits are uncertain, and we can give no assurance as to whetheran adverse result from one or more of them will have a material effect on ouroperating results and financial position.

 

**Anyacquisitions we make could disrupt our business and severely harm our financialcondition.**

 

We have made investmentsin, and acquisitions of other complementary companies, products andtechnologies, and we may acquire additional businesses, products or technologiesin the future. In the event of any future acquisitions, we could:

 

issue stock that would dilute its currentstockholders’ percentage ownership;

 

incur debt;

 

use a significant amount of our cash;

 

assume liabilities;

 

incur expenses related to the futureimpairment of goodwill and the amortization of other intangible assets; or

 

incur other large write-offs immediately orin the future.

 

Our operation of acquiredbusiness will also involve numerous risks, including:

 

problems combining the purchased operations,technologies or products;

 

acquisition of unproven technologies underdevelopment;

 

unanticipated costs;

 

diversion of management’s attention from ourcore business;

 

adverse effects on existing businessrelationships with customers;

 

risks associated with entering markets inwhich we have no or limited prior experience; and

 

potential loss of key employees, particularlythose of the purchased organizations.

 

36

----

Tableof Contents

 

In June 2008 weacquired Let It Wave, a French company, and its frame rate conversiontechnology, which is still in development. There is no assurance that we will be able to integrate Let It Wave withour business, or complete the development of this technology and bring it tomarket.

 

We may not be able tosuccessfully complete the integration of the business, products or technologiesor personnel that we have acquired in the past or might acquire in the future,and any failure to do so could disrupt our business and seriously harm ourfinancial condition.

 

**Ifour goodwill or amortizable intangible assets become impaired we may berequired to record a significant charge to earnings.**

 

We review our goodwilland intangible assets for impairment, no less often than annually, when changesin circumstances indicate the carrying value may not be recoverable. A changein circumstances may be indicated, and the carrying value of our goodwill or intangibleassets may be impaired (not be recoverable), where there are declines in ourstock price and market capitalization, declines in expected future cash flows,or slower growth rates in our industry. We may be required to record a significant charge to earnings for theperiod in which any impairment of our goodwill or intangible assets isdetermined, which would adversely affect our results of operations.  In addition, our impairment analysis involvesdetermining the fair value of our business using a projected discounted cashflow analysis that is based on significant estimates, such as our projectionsof future sales volume and timing, margins and operating costs, and thediscount rate we use to calculate present value of future cash flow.  Changes to these estimates may cause us torecognize an impairment loss that could be material to our financial results.

 

**Ifwe fail to manage our future growth, if any, our business would be harmed.**

 

We anticipate that ourfuture growth, if any, will require us to recruit and hire a substantial numberof new engineering, managerial, sales and marketing personnel. Our ability tomanage growth successfully will also require us to expand and improveadministrative, operational, management and financial systems and controls.Many of our key operations, including a material portion of our research anddevelopment operations and a significant portion of our sales andadministrative operations are located in Israel. A majority of our sales andmarketing and certain of our research and development and administrativepersonnel, including our President and Chief Executive Officer and otherofficers, are based in the United States. The geographic separation of theseoperations places additional strain on our resources and our ability to managegrowth effectively. If we are unable to manage growth effectively, our businesswill be harmed.

 

**Weare exposed to fluctuations in the market values of our portfolio investmentsand in interest rates.**

 

At the end of June 2008,we had $360.2 million in cash, cash equivalents and investments. We investour cash in a variety of financial instruments, consisting principally ofinvestments in commercial paper, money market funds, auction rate securitiesand highly liquid debt securities of corporations, municipalities and theUnited States government and its agencies. These investments are denominated inU.S. dollars.

 

The Company’s investmentsat June 30, 2008 include $57.8 million of high-grade auction ratesecurities primarily consisting of government guaranteed student loans. Auctionrate securities are securities that are structured with short-term interestrates which periodically reset through auctions, typically within every90 days. At the end of each reset period, investors can sell or continueto hold the securities at par. During February 2008, some of the auctionrate securities failed to auction successfully due to market supply exceedingmarket demand. In the event of a failed auction, the notes continue to bearinterest at a predetermined maximum rate based on the credit rating of notes asdetermined by one or more nationally recognized statistical ratingorganizations. The funds associated with failed auctions will not be accessibleuntil a successful auction occurs, a buyer is found outside of the auctionprocess, the issuers redeem the securities or the underlying securities havematured. As a result, the Company has classified all auction rate securities aslong-term assets in the condensed consolidated balance sheets as of June 30,2008 and December 31, 2007.

 

Investments in both fixedrate and floating rate interest earning instruments carry a degree of interestrate risk. Fixed rate debt securities may have their market value adverselyimpacted due to a rise in interest rates, while floating rate securities mayproduce less income than expected if interest rates fall. Due in part to thesefactors, our future investment income may fall short of expectations due tochanges in interest rates or if the decline in fair value of our publiclytraded equity investments and auction rate securities is judged to beother-than-temporary. We may suffer losses in principal if we are forced tosell securities that decline in market value due to changes in interest rates.However, because any debt securities we hold are classified as “available-for-sale,”generally no gains or 

 

37

----

Tableof Contents

 

losses are recognized dueto changes in interest rates unless such securities are sold prior to maturity.Recent events in the subprime mortgage market and with auction rate securitiescould negatively impact our return on investment for these debt securities andthereby reduce the amount of cash and cash equivalents and long-terminvestments on our balance sheet.

 

**Werely on the services of our executive officers and other key personnel, whoseknowledge of our business and industry would be extremely difficult to replace.**

 

Our success depends to asignificant degree upon the continuing contributions of our senior management.Management and other employees may voluntarily terminate their employment withus at any time upon short notice. The loss of key personnel could delay productdevelopment cycles or otherwise harm our business. We believe that our futuresuccess will also depend in large part on our ability to attract, integrate andretain highly-skilled engineering, managerial, sales and marketing personnel,located in the United States and overseas. Competition for such personnel isintense, and we may not be successful in attracting, integrating and retainingsuch personnel. Failure to attract, integrate and retain key personnel couldharm our ability to carry out our business strategy and compete with othercompanies.

 

**Provisionsin our charter documents and Delaware law could prevent or delay a change incontrol of Zoran.**

 

Our certificate ofincorporation and bylaws and Delaware law contain provisions that could make itmore difficult for a third party to acquire us, even if doing so would bebeneficial to our stockholders. These include provisions:

 

                        prohibiting a merger with aparty that has acquired control of 15% or more of our outstanding common stock,such as a party that has completed a successful tender offer, until three yearsafter that party acquired control of 15% of our outstanding common stock;

 

authorizing the issuance of up to 3,000,000shares of “blank check” preferred stock;

 

eliminating stockholders’ rights to call aspecial meeting of stockholders; and

 

requiring advance notice of any stockholdernominations of candidates for election to our board of directors.

 

**Ourstock price has fluctuated and may continue to fluctuate widely.**

 

The market price of ourcommon stock has fluctuated significantly since our initial public offering in1995. Between January 1, 2008 and June 30, 2008, the closing saleprice of our common stock, as reported on the Nasdaq Global Select Market,ranged from a low of $11.49 to a high of $22.48. The market price of our commonstock is subject to significant fluctuations in the future in response to avariety of factors, including:

 

announcements concerning our business or thatof our competitors or customers;

 

annual and quarterly variations in ouroperating results;

 

changes in analysts’ earnings estimates;

 

announcements of technological innovations;

 

the introduction of new products or changesin product pricing policies by Zoran or its competitors;

 

loss of key personnel;

 

proprietary rights or other litigation;

 

general conditions in the semiconductorindustry; and

 

developments in the financial markets.

 

38

----

Tableof Contents

 

From time to time thestock market experiences extreme price and volume fluctuations that haveparticularly affected the market prices for semiconductor companies ortechnology companies generally and which have been unrelated to the operating performanceof the affected companies. Broad market fluctuations of this type may reducethe future market price of our common stock.

 

**Theindependent investigation of our historical stock option practices andresulting restatements and derivative lawsuits have been time consuming andexpensive, and may continue to have an adverse effect on our financialperformance.**

 

The independentinvestigation of our historical stock option practices and resultingrestatement activities and derivative lawsuits have required us to expendsignificant management time and incur significant accounting, legal and otherexpenses totaling $7.9 million in 2007 and $0.1 million and $1.6 millionfor the three and six month periods ended June 30, 2008. The resultingrestatements recorded in the 2006 Annual Report on Form 10-K had amaterial adverse effect on our results of operations. We recorded additionalstock-based compensation expense of $11.7 million for stock option grants,recognized over the periods from 1997 to 2005. There was no tax impact of theseadditional stock-based compensation expenses due to the full valuationallowance on our tax assets at the time of restatement. In addition, werecorded other adjustments previously considered to be immaterial totaling $1.3 million(net of tax of $0.2 million). As a result, our restated consolidatedfinancial statements included in the 2006 Annual Report on Form 10-Kreflected a decrease in net income of $13.0 million for the period of 1997to 2005.  As a result of the amount of managementattention and expenditure of funds on the investigation, restatement andlitigation, we may have missed important market opportunities or ourcompetitors may have gained advantages, and we may not find similaropportunities or adequately cope with those competitive challenges.

 

**Ongoinggovernment inquiries relating to our historical stock option practices are timeconsuming and expensive and could result in injunctions, fines and penaltiesthat may have a material adverse effect on our financial condition and resultsof operations.**

 

The inquiry by the UnitedStates Attorney’s Office for the Northern District of California (“USAO”) intoour historical stock option practices is ongoing. We have cooperated with theUSAO and intend to continue to do so. The period of time necessary to resolvethis inquiry is uncertain, and we cannot predict the outcome of the inquiry orwhether we will face additional government inquiries, investigations or otheractions related to our historical stock option practices. This inquiry mayrequire us to continue to expend significant management time and incursignificant legal and other expenses, and could result in criminal actionsagainst the Company which may have a material adverse effect on our business,financial condition, results of operations or cash flows.

 

**Duringparts of 2006 and 2007, we were not timely in the filing of our periodicreports with the SEC, which led Nasdaq to warn us of a possible de-listing ofour common stock. Should we have similar issues in the future, our listing onNasdaq, and the availability of a liquid market for resale of your shares,could be at risk.**

 

From August 2006 to April 2007,we were unable to file our periodic reports with the SEC on time and faced thepossibility of delisting of our stock from the Nasdaq Global Select Market. Asa result of our delay in filing periodic reports on a timely basis, we were noteligible to use a registration statement on Form S-3 to register offersand sales of our securities until all of our periodic reports were timely filedfor at least 12 months, which occurred with the filing of this QuarterlyReport on Form 10-Q. If in the future we have similar issues filingperiodic reports and fail to comply with applicable listing requirements, thenour common stock may be de-listed and the market for resales of our commonstock may become less liquid. If this happens, the price of our stock and theability of our stockholders to trade in our stock could be adversely affected.In addition, we would be subject to restrictions regarding the registration ofour stock under federal securities laws, and we would not be able to issuestock options or other equity awards to our employees or allow them to exercisetheir outstanding options, which could adversely affect our business andresults of operations.

 

**Wehave been named as a party to stockholder derivative lawsuits relating to ourhistorical stock option practices, and we may be named in additional lawsuitsin the future. This litigation has become time consuming and expensive and mayresult in the payment of significant judgments and settlements, which couldhave a material adverse effect on our financial condition and results ofoperations.**

 

In connection with ourhistorical stock option practices and resulting restatements, a number ofpurported shareholder derivative actions were filed against certain of ourcurrent and former directors, officers and certain other individuals, whichpurport to assert claims on our behalf. There may be additional lawsuits of thisnature filed in the future. We cannot predict the outcome of these lawsuits,nor can we predict the amount of time and expense that will be required toresolve these lawsuits.  These lawsuitsare time consuming and expensive, and their outcomes may be unfavorable, whichcould have a material adverse effect on our business, financial condition,results of operations or cash flows.

 

39

----

Tableof Contents

 

Our insurance coveragewill not cover our total liabilities and expenses in these lawsuits, in partbecause we have a significant deductible on certain aspects of the coverage. Inaddition, we are obligated to indemnify our current and former directors,officers and employees in connection with the investigation of our historicalstock option practices and the related government inquiries and litigation. Wecurrently hold insurance policies for the benefit of our directors and officers,although our insurance coverage may not be sufficient in some or all of thesematters. Furthermore, the insurers may seek to deny or limit coverage in someor all of these matters, in which case we may have to self-fund all or asubstantial portion of our indemnification obligations.

 

**Itmay be difficult or costly to obtain director and officer liability insurancecoverage as a result of our stock options issues.**

 

We expect that the issuesarising from our historical stock option grant practices and the relatedaccounting will make it more difficult to obtain director and officer insurancecoverage in the future. If we are able to obtain this coverage, it could besignificantly more costly than in the past, which would have an adverse effecton our financial results and cash flow. As a result of this and relatedfactors, our directors and officers could face increased risks of personalliability in connection with the performance of their duties. As a result, wemay have difficultly attracting and retaining qualified directors and officers,which could adversely affect our business.

 

**Item 4.  Submission ofMatters to a Vote of Security Holders**

 

Our 2008 Annual Meetingof Stockholders was held on June 12, 2008.  At the meeting, thefollowing eight persons nominated by management were elected to serve asmembers of our Board of Directors:

 
| ** **                | ** ** | **Shares**         | ** ** |
|---------------------------|------------|--------------------|------------|
| **Nominee**               | ** ** | **Voted For** | ** ** | **Withheld** | ** ** |
| ** **                | ** ** | ** **         | ** ** | ** ** | ** ** |
| Levy Gerzberg             |       | 47,238,690         |       | 634,793 |   |
|                      |       |               |       |   |   |
| Uzia Galil                |       | 42,669,151         |       | 5,204,332 |   |
|                      |       |               |       |   |   |
| Raymond A.  Burgess       |       | 47,145,522         |       | 727,961 |   |
|                      |       |               |       |   |   |
| James D. Meindl           |       | 44,000,252         |       | 3,873,231 |   |
|                      |       |               |       |   |   |
| James B.  Owens, Jr. |       | 47,535,977         |       | 337,506 |   |
|                      |       |               |       |   |   |
| David Rynne               |       | 47,364,809         |       | 508,674 |   |
|                      |       |               |       |   |   |
| Arthur B.  Stabenow       |       | 44,008,134         |       | 3,865,349 |   |
|                      |       |               |       |   |   |
| Philip M. Young           |       | 47,235,707         |       | 637,776 |   |

 

Thefollowing additional proposals were voted upon at the meeting:

 

Proposal to approve anincrease in the maximum aggregate number of shares that may be issued under theZoran Corporation 2005 Equity Incentive Plan by 2,500,000 shares was approvedby a vote of 28,839,765 shares for; 12,870,582 shares against and 30,604 sharesabstaining.  There were 6,132,532 brokernon-votes with respect to this proposal.

 

Proposalto ratify the appointment of PricewaterhouseCoopers LLP as our independentregistered public accounting firm for the fiscal year ending December 31,2008 was approved by a vote of 47,504,366 shares for; 345,314 shares againstand 23,803 shares abstaining. There were no broker non-votes with respect tothis proposal.

 

40

----

Tableof Contents

 

**Item 6. Exhibits**

 
| 31.1 | Certification of Chief Executive Officer pursuant to  Rule 13a-14(a) or 15d-14(a). |
|------|----------------------------------------------------------------------------------------------|
| 31.2 | Certification of Chief Financial Officer pursuant to  Rule 13a-14(a) or 15d-14(a). |
| 32.1 | Certification of Chief Executive Officer, pursuant  to 18 U.S.C. Section 1350.          |
| 32.2 | Certification of Chief Financial Officer, pursuant  to 18 U.S.C. Section 1350.          |

 

41

----

Tableof Contents

 

**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|                             | **ZORAN CORPORATION**                         |
|----------------------------------|-----------------------------------------------|
|                             |                                          |
|                             |                                          |
| Dated: August 11, 2008 | /s/ Karl Schneider                            |
|                             | Karl Schneider                                |
|                             | Senior Vice President,  Finance               |
|                             | and Chief Financial  Officer                  |
|                             | (Principal Financial  and Accounting Officer) |

 

42

----