**SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549**

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### **First Amendment to**

### **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 March 31, 2006**                                                                                                      |
|       |                                                                                                                                                    |
|       | **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**

**ZORAN CORPORATION**

(Exact name of registrantas specified in its charter)

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

 

**1390Kifer RoadSunnyvale, California 94086**(Address of principal executive offices, including zip code)

**(408)523-6500**(Registrant’s telephone number, including area code)

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Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes x   No o

Indicate by check mark whetherregistrant is a large accelerated filer, an accelerated filer or anon-accelerated filer.  See definition of“accelerated and large accelerated filer” in Rule 12b-2 of the ExchangeAct.  (Check one):

Large accelerated filer  x   Accelerated filer   o   Non accelerated-filer  o

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

As of May 8, 2006, therewere outstanding 49,009,551 shares of the registrant’s Common Stock, par value$0.001 per share.

 

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**ZORAN CORPORATION ANDSUBSIDIARIES**

**FORM10-Q/A**

**INDEX**
|                                    | ** ** | ** **                                                                                                             | ** ** | **Page** |
|------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------|------------|----------|
| ** **                         |
| ** **                         |
| ** **                         |       | Explanatory Note Regarding Restatements                                                                                |       | ii       |
| ** **                         |       |                                                                                                                   |       |     |
| ** **                         |       |                                                                                                                   |       |     |
| **PART I. FINANCIAL  INFORMATION** |
| ** **                         |       |                                                                                                                   |       |     |
| **Item 1.**                        |       | Financial  Statements (Unaudited):                                                                                     |       |     |
| ** **                         |       |                                                                                                                   |       |     |
| ** **                         |       | Condensed  Consolidated Balance Sheets as of March 31, 2006 and December 31, 2005, as  restated                        |       | 1        |
| ** **                         |       |                                                                                                                   |       |     |
| ** **                         |       | Condensed  Consolidated Statements of Operations for the Three Months Ended March 31,  2006 and 2005, as restated      |       | 2        |
|                               |       |                                                                                                                   |       |     |
|                               |       | Condensed Consolidated  Statements of Cash Flows for the Three Months Ended March 31, 2006 and  2005, as restated |       | 3        |
|                               |       |                                                                                                                   |       |     |
|                               |       | Notes to  Condensed Consolidated Financial Statements                                                                  |       | 4        |
|                               |       |                                                                                                                   |       |     |
| **Item 2.**                        |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                            |       | 25       |
|                               |       |                                                                                                                   |       |     |
| **Item 3.**                        |       | Quantitative  and Qualitative Disclosures About Market Risk                                                            |       | 34       |
| ** **                         |       |                                                                                                                   |       |     |
| **Item 4.**                        |       | Controls and  Procedures                                                                                               |       | 34       |
| ** **                         |       |                                                                                                                   |       |     |
|                               |       |                                                                                                                   |       |     |
| **PART II. OTHER  INFORMATION**    |
|                               |       |                                                                                                                   |       |     |
| **Item 1.**                        |       | Legal Proceedings                                                                                                      |       | 36       |
|                               |       |                                                                                                                   |       |     |
| **Item 1A.**                       |       | Risk  Factors                                                                                                          |       | 37       |
| ** **                         |       |                                                                                                                   |       |     |
| **Item  6.**                       |       | Exhibits                                                                                                               |       | 50       |
| ** **                         |       |                                                                                                                   |       |     |
| Signatures                         |       |                                                                                                                   |       | 51       |
|                                    |            |                                                                                                                        |            |          |  |  |

 

i

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**EXPLANATORY NOTE REGARDINGRESTATEMENTS**

In this Amendment No. 1 to our Quarterly Report on Form 10-Q for thequarter ended March 31, 2006 we have restated our condensed consolidated financialstatements for the three months ended March 31, 2006 and 2005, and the relateddisclosures. The restatements reflected in this report include adjustmentsarising from an independent investigation of Zoran’s historical stock optionpractices and related accounting for option grants.  For more information on these matters,including a detailed discussion of the effect of the restatement, please referto Note 2, “Restatement of Condensed Consolidated Financial Statements” of theNotes to Condensed Consolidated Financial Statements.

ii

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**PART I.FINANCIAL INFORMATION**

**Item 1.Financial Statements (Unaudited):**

**ZORAN CORPORATION**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

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

**(unaudited)**
| ** **                                                                                                                                                                                                                                                    | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                    | ** ** | **(Restated) (1)**  | ** ** | **(Restated) (1)**     | ** ** |
| ASSETS                                                                                                                                                                                                                                                        |       |                     |       |                        |       |
| Current assets:                                                                                                                                                                                                                                               |       |                     |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                                                                                                    |       | $                        | 113,752    |                        | $          | 78,856 |   |
| Short-term  investments                                                                                                                                                                                                                                       |       | 104,124                  |       | 70,490                      |       |
| Accounts  receivable, net                                                                                                                                                                                                                                     |       | 62,431                   |       | 70,174                      |       |
| Inventories                                                                                                                                                                                                                                                   |       | 38,663                   |       | 32,616                      |       |
| Prepaid expenses  and other current assets                                                                                                                                                                                                                    |       | 9,800                    |       | 11,746                      |       |
| Total current  assets                                                                                                                                                                                                                                         |       | 328,770                  |       | 263,882                     |       |
| Property and  equipment, net                                                                                                                                                                                                                                  |       | 14,905                   |       | 16,057                      |       |
| Other assets and  investments                                                                                                                                                                                                                                 |       | 21,627                   |       | 20,799                      |       |
| Goodwill                                                                                                                                                                                                                                                      |       | 178,662                  |       | 182,662                     |       |
| Intangible  assets, net                                                                                                                                                                                                                                       |       | 106,496                  |       | 119,231                     |       |
|                                                                                                                                                                                                                                                          |       | $                        | 650,460    |                        | $          | 602,631 |   |
|                                                                                                                                                                                                                                                          |       |                     |       |                        |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                    |       |                     |       |                        |       |
| Current  liabilities:                                                                                                                                                                                                                                         |       |                     |       |                        |       |
| Accounts payable                                                                                                                                                                                                                                              |       | $                        | 44,737     |                        | $          | 38,999 |   |
| Accrued expenses  and other liabilities                                                                                                                                                                                                                       |       | 54,183                   |       | 54,769                      |       |
| Total current  liabilities                                                                                                                                                                                                                                    |       | 98,920                   |       | 93,768                      |       |
| Other long-term  liabilities                                                                                                                                                                                                                                  |       | 12,770                   |       | 11,939                      |       |
| Commitments and  Contingencies (Note 11)                                                                                                                                                                                                                      |       |                     |       |                        |       |
| Stockholders’ equity:                                                                                                                                                                                                                                    |       |                     |       |                        |       |
| Common stock,  $0.001 par value; 105,000,000 shares authorized at March 31, 2006 and  December 31, 2005; 46,716,431 shares issued and outstanding as of March  31, 2006; and 45,426,912 shares issued and outstanding as of  December 31, 2005 |       | 47                       |       | 45                          |       |
| Additional paid-in  capital                                                                                                                                                                                                                                   |       | 759,699                  |       | 738,253                     |       |
| Deferred stock-based  compensation                                                                                                                                                                                                                            |       | —                   |       | (593                        | )          |
| Accumulated  other comprehensive income                                                                                                                                                                                                                       |       | 2,179                    |       | 3,057                       |       |
| Accumulated  deficit                                                                                                                                                                                                                                          |       | (223,155                 | )          | (243,838                    | )          |
| Total  stockholders’ equity                                                                                                                                                                                                                              |       | 538,770                  |       | 496,924                     |       |
|                                                                                                                                                                                                                                                          |       | $                        | 650,460    |                        | $          | 602,631 |   |

 

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(1) See Note 2, “Restatementof Condensed Consolidated Financial Statements” of the Notes to CondensedConsolidated Financial Statements.

The accompanyingnotes are an integral part of these unaudited condensed consolidated financialstatements.

1

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**ZORAN CORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(in thousands, except per sharedata)**

**(unaudited)**
| ** **                                                                     | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                     | ** ** | **March 31,**               | ** ** |
| ** **                                                                     | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| ** **                                                                     | ** ** | **(Restated) (1)**          | ** ** | **(Restated) (1)** | ** ** |
| Revenues:                                                                      |       |                             |       |   |   |
| Hardware product revenues                                                      |       | $                                | 99,169     |   | $ | 59,002 |   |
| Software and other revenues                                                    |       | 12,909                           |       | 14,882 |   |
| License revenues related to litigation settlement                              |       | 30,168                           |       | — |   |
| Total revenues                                                                 |       | 142,246                          |       | 73,884 |   |
|                                                                           |       |                             |       |   |   |
| Costs and  expenses:                                                           |       |                             |       |   |   |
| Cost of hardware product revenues                                              |       | 53,650                           |       | 36,935 |   |
| Research and development                                                       |       | 24,248                           |       | 20,087 |   |
| Selling, general and administrative                                            |       | 24,901                           |       | 22,841 |   |
| Amortization of intangible assets                                              |       | 12,735                           |       | 12,330 |   |
| Amortization of stock-based compensation resulting  from business combinations |       | —                           |       | 517 |   |
| Total costs and expenses                                                       |       | 115,534                          |       | 92,710 |   |
|                                                                           |       |                             |       |   |   |
| Operating income  (loss)                                                       |       | 26,712                           |       | (18,826 | ) |
|                                                                           |       |                             |       |   |   |
| Interest income                                                                |       | 1,593                            |       | 527 |   |
|                                                                           |       |                             |       |   |   |
| Other income  (loss), net                                                      |       | 1,193                            |       | (424 | ) |
|                                                                           |       |                             |       |   |   |
| Income (loss)  before income taxes                                             |       | 29,498                           |       | (18,723 | ) |
|                                                                           |       |                             |       |   |   |
| Provision for  income taxes                                                    |       | 8,815                            |       | — |   |
|                                                                           |       |                             |       |   |   |
| Net income  (loss)                                                             |       | $                                | 20,683     |   | $ | (18,723 | ) |
|                                                                           |       |                             |       |   |   |
| Basic net income  (loss) per share                                             |       | $                                | 0.45       |   | $ | (0.43 | ) |
|                                                                           |       |                             |       |   |   |
| Diluted net  income (loss) per share                                           |       | $                                | 0.43       |   | $ | (0.43 | ) |
|                                                                           |       |                             |       |   |   |
| Shares used to  compute basic net income (loss) per share                      |       | 46,207                           |       | 43,213 |   |
|                                                                           |       |                             |       |   |   |
| Shares used to compute  diluted net income (loss) per share                    |       | 48,487                           |       | 43,213 |   |

 

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(1) See Note 2, “Restatementof Condensed Consolidated Financial Statements” of the Notes to CondensedConsolidated Financial Statements.

The accompanying notes are an integral part of these unauditedcondensed consolidated financial statements.

2

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**ZORAN CORPORATIONCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(inthousands)**

**(unaudited)**
| ** **                                                                                | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                | ** ** | **March 31,**               | ** ** |
| ** **                                                                                | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| ** **                                                                                | ** ** | **(Restated) (1)**          | ** ** | **(Restated) (1)** | ** ** |
| Cash flows from  operating activities:                                                    |       |                             |       |   |   |
| Net income (loss)                                                                         |       | $                                | 20,683     |   | $ | (18,723 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by (used in) operations: |       |                             |       |   |   |
| Depreciation                                                                              |       | 2,361                            |       | 2,438 |   |
| Amortization                                                                              |       | 12,772                           |       | 12,338 |   |
| Stock-based compensation expense                                                          |       | 4,813                            |       | 583 |   |
| Changes in current assets and liabilities:                                                |       |                             |       |   |   |
| Accounts receivable                                                                       |       | 7,743                            |       | (8,160 | ) |
| Inventories                                                                               |       | (6,047                           | )          | 15,826 |   |
| Prepaid expenses and other current assets and other  assets                               |       | 176                              |       | (4,963 | ) |
| Accounts payable                                                                          |       | 5,738                            |       | (6,062 | ) |
| Accrued expenses and other liabilities, goodwill and  other long term liabilities         |       | 4,245                            |       | 2,207 |   |
| Net cash provided by (used in) operating activities                                       |       | 52,484                           |       | (4,516 | ) |
|                                                                                      |       |                             |       |   |   |
| Cash flows from  investing activities:                                                    |       |                             |       |   |   |
| Purchases of property and equipment                                                       |       | (1,209                           | )          | (1,489 | ) |
| Purchases of investments                                                                  |       | (90,952                          | )          | (4,883 | ) |
| Proceeds from sales and maturities of investments                                         |       | 57,345                           |       | 4,103 |   |
| Net cash used in investing activities                                                     |       | (34,816                          | )          | (2,269 | ) |
|                                                                                      |       |                             |       |   |   |
| Cash flows from  financing activities:                                                    |       |                             |       |   |   |
| Proceeds from issuance of common stock                                                    |       | 17,228                           |       | 375 |   |
| Net cash provided by financing activities                                                 |       | 17,228                           |       | 375 |   |
|                                                                                      |       |                             |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                                     |       | 34,896                           |       | (6,410 | ) |
|                                                                                      |       |                             |       |   |   |
| Cash and cash  equivalents at beginning of period                                         |       | 78,856                           |       | 37,435 |   |
|                                                                                      |       |                             |       |   |   |
| Cash and cash  equivalents at end of period                                               |       | $                                | 113,752    |   | $ | 31,025 |   |

 

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(1) See Note 2, “Restatementof Condensed Consolidated Financial Statements” of the Notes to CondensedConsolidated Financial Statements.

The accompanying notes are an integral part of these unauditedcondensed consolidated financial statements.

3

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**ZORANCORPORATIONNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(unaudited)**

**1.****              Basis ofPresentation**

The accompanyingunaudited condensed consolidated financial statements of Zoran Corporation andits subsidiaries (“Zoran” or the “Company”) have been prepared in conformitywith accounting principles generally accepted in the United States ofAmerica.  However, certain information orfootnote disclosures normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been condensed or omitted pursuant to the rules and regulationsof the Securities and Exchange Commission (“SEC”).  In the opinion of management, the condensedconsolidated financial statements reflect all adjustments considered necessary,consisting only of normal recurring adjustments, for a fair statement of theconsolidated financial position, operating results and cash flows for theperiods presented.  The results ofoperations for the interim periods presented are not necessarily indicative ofthe results that may be expected for the full fiscal year or in any futureperiod.  This Quarterly Report on Form10-Q should be read in conjunction with the audited consolidated financialstatements and notes thereto for the year ended December 31, 2006,included in the Company’s 2006 Annual Report on Form 10-K.

**Revenue**

Revenue for the three months ended March 31, 2006includes $30.2 million in license payment, net of withholding tax and amountspaid to holders of rights under certain patents involved in the litigation andamounts payable as legal fees. The license agreements provided for futureadditional net cash payments of $11.0 million during the three months endingJune 30, 2006 and $30.0 million payable in eleven quarterly installments whichwill be recorded as revenue when actual cash payments are received.

***RecentAccounting Pronouncements***

In February 2006, the FinancialAccounting Standards Board (“FASB”) issued Statement of Financial AccountingStandards (“SFAS”) No. 155, “Accounting for Certain Hybrid FinancialInstruments, an amendment of FASB Statements No. 133 and 140” (“Statement ofFinancial Accounting Standards (“SFAS”) No. 155”).  SFAS No. 155 permits fair value remeasurementfor hybrid financial instruments containing an embedded derivative whichotherwise requires bifurcation.  Thisstatement is effective for all financial instruments acquired or issued by theCompany after January 1, 2007.  TheCompany anticipates that the adoption of SFAS No. 155 will not have a materialimpact on its condensed consolidated financial statements.

In November 2005,the FASB issued FASB Staff Position (“FSP”) Nos. FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-TemporaryImpairment and Its Application to Certain Investments.”  This FSP addresses the determination as towhen an investment is considered impaired, whether that impairment is other thantemporary, and the measurement of an impairment loss. This FSP also includesaccounting considerations subsequent to the recognition of other-than-temporaryimpairments. The guidance in this FSP is effective for all periods beginningafter December 15, 2005. The adoption of this FSP did not have a materialeffect on the Company’s consolidated financial position, results of operationsor cash flows.

In May 2005, theFASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFASNo. 154”).  SFAS No. 154replaces Accounting Principals Board Opinion No. 20, “Accounting Changes”,and SFAS No. 3, “Reporting Accounting Changes in Interim FinancialStatements.”  SFAS No. 154 requiresretrospective application to prior periods’ financial statements of changes inaccounting principles, unless it is impracticable to determine either theperiod-specific effects or the cumulative effect of the change. SFAS 154 iseffective for all periods beginning after December 15, 2005. The adoptionof SFAS No. 154 did not have a material effect on the Company’sconsolidated financial position, results of operations or cash flows.

In December 2004, the FASB, issued SFASNo. 123(R),  “Share-Based Payment,”an Amendment of SFAS No. 123 (“SFAS No. 123(R)”).   SFAS No. 123(R) requires the Company tomeasure all employee stock-based compensation awards using a fair value methodand record such expense in its consolidated financial statements.  InMarch 2005, the SEC issued Staff Accounting Bulletin (“SAB”) No. 107,which provides the Staff’s views regarding interactions between SFAS No. 123(R)and certain SEC rules and regulations and provides interpretations of thevaluation of share-based payments for public companies. Effective January 1, 2006, theCompany adopted SFAS No. 123(R) on a modified prospective

4

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basis.As a result, the Company began to include stock-based compensation costs in itsresults of operations beginning with the quarter ended March 31, 2006.  See Note 3 “Stock-Based Compensation”.

**2.      Restatement of Condensed ConsolidatedFinancial Statements**

**Independent Investigation**

On July 3, 2006, theCompany announced that, at the recommendation of the Audit Committee, the Boardof Directors had created a special committee of independent directors (“SpecialCommittee”) to conduct a review of our historical stock option practices. As aresult of its investigation, the Special Committee found, among other things,that some of the original measurement dates used by the Company for optiongrants were not adequately supported by contemporaneous records, and thereforethe measurement dates used by us for accounting purposes required adjustment.The Special Committee concluded that the evidence did not establish that theerrors which it identified resulted from fraud or intentional misconduct by ourcurrent senior management.

Based on the SpecialCommittee’s findings and its own review of the facts, the Board of Directorsconcluded that there was no fraud or intentional misconduct by any currentmember of senior management.  The Boardalso concluded that it has confidence in the integrity of the Company’s ChiefExecutive Officer, Dr. Levy Gerzberg, and the Company’s Chief FinancialOfficer, Mr. Karl Schneider.

Based on informationobtained from the Special Committee’s review and additional work undertaken bythe Company, management has concluded, and the Audit Committee has agreed, thatthe Company should restate certain previously filed financial statements, toreflect additional stock-based compensation expense with regard to certain paststock option grants. The corrections made in the restatements relate to optionscovering approximately 3.6 million shares. These adjustments amounted to anadditional stock-based compensation expense of $180,000 and $66,000 in thethree months ended March 31, 2006 and 2005 respectively. There was no taximpact of these additional expenses due to full valuation allowance on our taxassets.

In connection with therestatement, the Company is recording additional non-cash adjustments that werepreviously considered to be immaterial relating to the timing of revenuerecognition, accrued expenses, amortization of premiums and discounts oninvestments and the amortization of stock-based compensation relating to abusiness combination in 2003.  TheCompany is also recording losses under Accounting Principles Board (“APB”) OpinionNo. 18 (“APB No. 18”), “The Equity Method of Accounting forInvestments in Common Stock,” to record the losses on investment of the prior17% ownership of Oren Semiconductor, Inc. under the equity method of accountingwhich was subsquently acquired by Zoran in 2005.   These additional adjustments resulted in acumulative expense of $1.3 million, including $0.2 million of tax expense,for the periods 2000 through 2005.

Through 2005, we applied APBOpinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”) andits related interpretations, and provided the required pro forma disclosuresunder Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accountingfor Stock-Based Compensation,” and SFAS No. 148, “Accounting forStock-Based Compensation-Transition and Disclosure.” Under APB No. 25,non-cash, stock-based compensation expense was recognized for any option forwhich the exercise price was below the market price on the actual grant date.Because each of the options identified below (other than those which we havedetermined should be accounted for variably) was deemed to have an exerciseprice below the market price on the appropriate measurement date, we shouldhave recognized a charge for each of those options under APB No. 25, in anamount equal to the number of shares covered by such options, multiplied by thedifference between the exercise price and the market price on the appropriatemeasurement date. That expense should have been amortized over the vestingperiods of the options. Starting in 2006, we adopted SFAS No. 123(R).  As a result, for 2006, the additionalstock-based compensation expense required to be recorded for each of theoptions identified below was equal to the incremental fair value of thoseoptions on the appropriate measurement date over the remaining vesting periodsof those options.  We did not record suchstock-based compensation expenses under APB No. 25 or SFAS No. 123(R)in our previously issued financial statements, and that is the reason for therestatement in this report.  To correctour past accounting for stock options, we recorded additional pre-tax,non-cash, stock-based compensation expense of (a) $11.7 million for the periods1997 to 2005 under APB No. 25 and (b) $180,000 for the three months endedMarch 31, 2006 under SFAS No. 123(R). The fair value of the optionsis being recorded using the accelerated amortization method under FIN 28 over therespective vesting periods of the awards.

Consistent with theaccounting literature and recent guidance from the Securities and ExchangeCommission (“SEC”), the Company has organized the grants with respect to whichan accounting adjustment is required into categories based on grant type andprocess by which the grant was finalized. Based on the relevant facts and circumstances, the Company applied the relevantaccounting standards to determine the measurement date for every grant withineach category. The Company recorded accounting adjustments as required,resulting in stock-based compensation expense and related tax effects.  The Company organized the grants whereadjustments were required as follows:

·                                          *Company-wide option grants where optionees were addedor grant amounts were changed after the option list was complete, or whereinsufficient contemporaneous documentation of the grant date exists.* For seven Company-wide refresh and retentiongrants made between 1998 and 2003, the Company determined that some employeeswho were omitted from the option grant list were added to the list after thestated grant date, and that the number of shares covered by option grants tosome employees was not finally determined until after the stated grant date.  Further, in 2001 and 2002, insufficientcontemporaneous documentation of the stated grant date existed.  As a result of these issues, the Companyrestated its historical financial statements to increase stock-based compensationexpense by approximately $6.3 million, recognized over the vesting periods ofthe relevant options.

5

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·                                          *Re-priced options. *In August 2002, after consideration of relevant information,the Compensation Committee rescinded its April 2002 grant, and its June 2002grant, to executives and other key employees. The Company thereafter reissued the grants in August 2002.  At the time, in consultation with ourexternal advisors, we determined that these transactions did not requirevariable accounting.  As a result of theSpecial Committee review of our historical stock option practices, we havereassessed the circumstances surrounding these transactions with our externaladvisors and have determined that the grants should have been accounted forvariably.  As a result, the Companyrestated its historical financial statements to increase stock-basedcompensation expense by a cumulative net amount of approximately $3.8 million,recognized over the vesting periods of these options.

·                                          *Acquisition-related options*.  The Company determined a grant given toretain employees hired in connection with an acquisition in October 2000 shouldhave been accounted for variably.  As aresult, the Company restated its historical financial statements to increasestock-based compensation expense by approximately $0.3 million, recognizedover the vesting periods of these options.

·                                          *Improper measurement dates for non-refresh stockoption grants. *The Companyrevised the measurement dates for**certaingrants made to new hires and for promotional and other miscellaneous non-refreshgrants made between 1997 and 2003 as a result of approvals that were obtainedsubsequent to the stated grant dates or as a result of administrative delays orerrors and a small number of stock option grants to non-executives that weredetermined to have been established retrospectively. As a result, the Companyrestated its historical financial statements to increase stock-basedcompensation expense by approximately $1.3 million, recognized over the vestingperiods of these options.

In the aggregate, we haverecorded additional stock-based compensation expense for the periods 1997through 2005 of approximately $11.7 million on stock option grants made from1997 through 2003.

The incrementalimpact from recognizing stock-based compensation expense resulting from theinvestigation of past stock option grants is as follows (dollars in thousands):
| Fiscal Year                       | ** ** | **Expense  (Benefit)** | ** ** |
|----------------------------------------|------------|------------------------|------------|
| ** **                             | ** ** | ** **             | ** ** |
| 1997                                   |       | $                      | 190        |   |
| 1998                                   |       | 223                    |       |
| 1999                                   |       | 123                    |       |
| 2000                                   |       | 120                    |       |
| 2001                                   |       | 1,385                  |       |
| 2002                                   |       | 3,182                  |       |
| 2003                                   |       | 5,299                  |       |
| Cumulative effect at December 31, 2003 |       | 10,522                 |       |
| 2004                                   |       | (1,476                 | )          |
| 2005                                   |       | 2,623                  |       |
|                                   |       | $                      | 11,669     |   |

 

The cumulative effect ofall of the restatements through December 31, 2003 increased additional paid-incapital by $10.7 million from $703.8 million to $714.5 million, increasedaccumulated deficit by $9.0 million from $156.4 million to $165.4 million, anddecreased total stockholders’ equity by $0.7 million from $534.3 million to$533.6 million. All the restatements of financial statements, financial dataand related disclosures described in this report are collectively referred toin this report as the “restatements.”

In December 2006, theCompany amended options to purchase approximately 218,000 shares of commonstock held by Dr. Gerzberg and Mr. Schneider, to increase the exercise price ofthose options to the fair market value of the Company’s common stock on therevised measurement date so that these options are no longer subject to IRCSection 409A.

6

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We have not amended, andwe do not intend to amend, any of our previously filed Annual Reports on Form10-K.  Other than this report, we do notintend to amend any of our previously filed Quarterly Reports on Form 10-Q forthe periods affected by the restatements.

The impact of therestatements on the interim periods of each of the first three quarters of 2006and each of the quarters of 2005 are disclosed in “Selected Quarterly FinancialInformation (Unaudited)” included in the Company’s 2006 Annual Report onForm 10-K.

*Restatement and Impact on FinancialStatements*

Theincome statement impact of the restatements are as follows (in thousands):
| ** **                                                                                                                | ** ** | **Cumulative  effect at  December  31, 2005**  | ** ** | **Year Ended  December 31,   2005**       | ** ** | **Year Ended  December 31,  2004** | ** ** | **Cumulative  effect at  December  31, 2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------------------|------------|
| Net loss as  previously reported                                                                                          |       | $                                                        | (26,971    | )                                                        | $          | (47,354                                      | )          |                                                    |       |   |   |
| Additional  compensation (expense) benefit resulting from improper measurement dates for  stock option grants, net of tax |       |          (11,669 | )          | (2,623                                                   | )          | $                                            | 1,476      |                                                    | $          | (10,522 | ) |
| Other  adjustments, net of tax                                                                                            |       | (1,374                                                   | )          | (678                                                     | )          | (2,230                                       | )          | 1,534                                                   |       |
| Total increase  to net loss                                                                                               |       |          (13,043 | )          | (3,301                                                   | )          | (754                                         | )          | (8,988                                                  | )          |
| Net loss, as restated                                                                                                     |       |                                                     |       |          (30,272 | )          | (48,108                                      | )          |                                                    |       |
|                                                                                                                           |            |                                                          |            |                                                          |            |                                              |            |                                                         |            |  |  |  |  |

 

 
| ** **                                                                                          | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2003**                                   | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** | **1999** | ** ** | **1998** | ** ** | **1997** | ** ** |
| Stock based  compensation expense, as previously reported                                           |       | $                                          | (6,281     | ) | $ | (292 | ) | $ | (544 | ) | $ | (99 | ) | $ | — |   | $ | — |   | $ | — |   |
| Additional  compensation expense resulting from improper measurement dates for stock  option grants |       | (5,299                                     | )          | (3,182 | ) | (1,385 | ) | (120 | ) | (123 | ) | (223 | ) | (190 | ) |
| Stock based  compensation expense, as restated                                                      |       | $                                          | (11,580    | ) | $ | (3,474 | ) | $ | (1,929 | ) | $ | (219 | ) | $ | (123 | ) | $ | (223 | ) | $ | (190 | ) |

 

7

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In addition, the Company evaluated the impact of the restatements onits global tax provision. The Company and its subsidiaries file tax returns inmultiple tax jurisdictions around the world. In certain jurisdictions,including, but not limited to, the United States and Israel, the Company isable to claim a tax deduction relative to stock options. In thosejurisdictions, where a tax deduction is claimed, the Company has recordeddeferred tax assets relative to the book compensation now recorded on therestated options.  As with our otherdeferred tax assets, the company recorded a full valuation allowance on alldeferred tax assets relating to restated options.  The Company also believes that it should nothave taken a United States tax deduction of $0.6 million in prior yearsfor stock option related amounts pertaining to certain executives underInternal Revenue Code (IRC) Section 162(m) which limits the deductibility ofcompensation above certain thresholds. The deferred tax asset and relatedvaluation allowance have been adjusted accordingly.  The cumulative tax effect of all componentsof the restatements for 1997 to 2005 is an increase in tax expense of $200,000.

 

On February 27, 2007, theCompany elected to: (i) participate in the Internal Revenue Service remediationprogram 2007-18 and pay to the IRS, on behalf of affected and eligibleemployees (not including executive officers), their IRC 409A tax liabilitiesand penalties; (ii) participate in any similar remediation program that may beoffered by any state for applicable state tax liabilities and penalties; (iii)act directly with any state not offering a similar remediation program toaddress any applicable tax liabilities and penalties on behalf of employees;and (iv) pay to such employees a “gross-up” payment to offset the associatedfederal and state income tax consequences.  The Company took this action because the vast majority of the holders ofstock options issued by the Company that are now subject to re-measurement as aresult of the Company’s option investigation were not involved in or aware ofthe stock option pricing determination. Employees who exercised such options in 2006, other than executiveofficers at the time of option grant or entering into this program, willparticipate in this program.  The Companyestimates that the total cash payments needed to deal with the adverse taxconsequences of previously exercised discount priced options granted to non-officerswill be approximately $0.8 million, which is expected to be recorded in 2007.

In addition, the Companymay consider taking action to minimize the adverse tax consequences that may beincurred by the holders of unexercised discount options. Discount-priced stockoptions vesting after December 31, 2004 (“409A Affected Options”) subject U.S.option holders to a penalty tax under IRC Section 409A (and to similar penaltytaxes under California and other state tax laws, as applicable). The Companymay consider offering to amend the 409A Affected Options held by persons otherthan directors and executive officers to increase the exercise prices of thoseoptions to the market price of our common stock on the revised measurementdate. The amended options would not be subject to taxation under IRC Section409A. Under IRS regulations, the amendments for non-executives cannot beoffered until after this Report is filed and do not need to be completed untilDecember 31, 2007. The Company may also consider approving the payment ofbonuses to holders of those amended options to compensate them for theresulting increase in their option exercise price. The amount of these bonuseswould be effectively repaid to the Company if and when the options areexercised and the increased exercise price is paid (but there is no assurancethat the options will be exercised).  TheCompany has not estimated the expense of any such bonus payments.

The restatementadjustments did not affect the Company’s previously reported cash and cashequivalents and investments balances. The following presents the effect of therestatement adjustments by financial statement line item for the CondensedConsolidated Balance Sheets as of March 31, 2006 and December 31, 2005, andStatements of Operations and Statements of Cash Flows for the three monthsended March 31, 2006 and 2005.

8

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**CONDENSED CONSOLIDATED BALANCE SHEETS(in thousands, except share data)**
| ** **                                                                                                                                           | ** ** | **March 31,  2006** | ** ** | **Adjustments(1)** | ** ** | **March 31,  2006** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|--------------------|------------|--------------------------|------------|
| ** **                                                                                                                                           | ** ** | **(As reported)**   | ** ** | ** **         | ** ** | **(As restated)**   | ** ** |
| ASSETS                                                                                                                                               |       |                     |       |               |       |                     |       |
| Current assets:                                                                                                                                      |       |                     |       |               |       |                     |       |
| Cash and cash equivalents                                                                                                                            |       | $                        | 113,752    |               | $          | —                   |       | $ | 113,752 |   |
| Short-term investments                                                                                                                               |       | 104,124                  |       | —             |       | 104,124                  |       |
| Accounts receivable, net                                                                                                                             |       | 62,431                   |       | —             |       | 62,431                   |       |
| Inventories                                                                                                                                          |       | 38,663                   |       | —             |       | 38,663                   |       |
| Prepaid expenses and other current assets                                                                                                            |       | 9,800                    |       | —             |       | 9,800                    |       |
| Total current assets                                                                                                                                 |       | 328,770                  |       | —             |       | 328,770                  |       |
| Property and equipment, net                                                                                                                          |       | 14,905                   |       | —             |       | 14,905                   |       |
| Other assets and investments                                                                                                                         |       | 21,627                   |       | —             |       | 21,627                   |       |
| Goodwill                                                                                                                                             |       | 180,254                  |       | (1,592             | )          | 178,662                  |       |
| Intangible assets, net                                                                                                                               |       | 106,496                  |       | —             |       | 106,496                  |       |
|                                                                                                                                                 |       | $                        | 652,052    |               | $          | (1,592                   | )          | $ | 650,460 |   |
|                                                                                                                                                 |       |                     |       |               |       |                     |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                           |       |                     |       |               |       |                     |       |
| Current liabilities:                                                                                                                                 |       |                     |       |               |       |                     |       |
| Accounts payable                                                                                                                                     |       | $                        | 44,737     |               | $          | —                   |       | $ | 44,737 |   |
| Accrued expenses and other liabilities                                                                                                               |       | 53,562                   |       | 621                |       | 54,183                   |       |
| Total current liabilities                                                                                                                            |       | 98,299                   |       | 621                |       | 98,920                   |       |
| Other long-term liabilities                                                                                                                          |       | 12,770                   |       | —             |       | 12,770                   |       |
| Commitments and contingencies (Note 11)                                                                                                              |       |                     |       |               |       |                     |       |
| Stockholders’ equity:                                                                                                                           |       |                     |       |               |       |                     |       |
| Common stock, $0.001 par value; 105,000,000 shares  authorized at March 31, 2006;46,716,431 shares issued and outstanding as  of March 31, 2006 |       | 47                       |       | —             |       | 47                       |       |
| Additional paid-in capital                                                                                                                           |       | 748,792                  |       | 10,907             |       | 759,699                  |       |
| Accumulated other comprehensive income                                                                                                               |       | 2,179                    |       | —             |       | 2,179                    |       |
| Accumulated deficit                                                                                                                                  |       | (210,035                 | )          | (13,120            | )          | (223,155                 | )          |
| Total stockholders’ equity                                                                                                                      |       | 540,983                  |       | (2,213             | )          | 538,770                  |       |
|                                                                                                                                                 |       | $                        | 652,052    |               | $          | (1,592                   | )          | $ | 650,460 |   |

 

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(1)      The restated consolidated balance sheet as of March 31, 2006reflects a $13.1 million increase to accumulated deficit and a $10.9 millionincrease to additional paid-in capital primarily due to additional stock-based compensationrecorded in connection with this restatement to correct prior year stockoption-related accounting errors as described above and to reflect thecumulative impact of other adjustments that were previously considered to beimmaterial. The $1.6 million decrease to goodwill is the impact of recordinglosses associated with our investment in Oren Semiconductor under the equitymethod of accounting and $0.6 million increase to accrued expenses and otherliabilities relates to the accrual of royalty obligations that were previously notrecorded at March 31, 2006.

9

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| ** **                                                                                                                                                       | ** ** | **December 31,  2005** | ** ** | **Adjustments  (Note 1)** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|--------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                       | ** ** | **(As reported)**      | ** ** | ** **                     | ** ** | **(As restated)**      | ** ** |
| ASSETS                                                                                                                                                           |       |                        |       |                           |       |                        |       |
| Current assets:                                                                                                                                                  |       |                        |       |                           |       |                        |       |
| Cash and cash  equivalents                                                                                                                                       |       | $                           | 78,856     |                           | $          | —                      |       | $ | 78,856 |   |
| Short-term  investments                                                                                                                                          |       | 70,490                      |       | —                         |       | 70,490                      |       |
| Accounts  receivable, net                                                                                                                                        |       | 70,174                      |       | —                         |       | 70,174                      |       |
| Inventories                                                                                                                                                      |       | 32,616                      |       | —                         |       | 32,616                      |       |
| Prepaid expenses  and other current assets                                                                                                                       |       | 11,746                      |       | —                         |       | 11,746                      |       |
| Total current  assets                                                                                                                                            |       | 263,882                     |       | —                         |       | 263,882                     |       |
| Property and  equipment, net                                                                                                                                     |       | 16,057                      |       | —                         |       | 16,057                      |       |
| Other assets and  investments                                                                                                                                    |       | 20,799                      |       | —                         |       | 20,799                      |       |
| Goodwill                                                                                                                                                         |       | 184,254                     |       | (1,592                         | )          | 182,662                     |       |
| Intangible  assets, net                                                                                                                                          |       | 119,231                     |       | —                         |       | 119,231                     |       |
|                                                                                                                                                             |       | $                           | 604,223    |                           | $          | (1,592                      | )          | $ | 602,631 |   |
|                                                                                                                                                             |       |                        |       |                           |       |                        |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                       |       |                        |       |                           |       |                        |       |
| Current  liabilities:                                                                                                                                            |       |                        |       |                           |       |                        |       |
| Accounts payable                                                                                                                                                 |       | $                           | 38,999     |                           | $          | —                      |       | $ | 38,999 |   |
| Accrued expenses  and other liabilities                                                                                                                          |       | 53,937                      |       | 832                            |       | 54,769                      |       |
| Total current  liabilities                                                                                                                                       |       | 92,936                      |       | 832                            |       | 93,768                      |       |
| Other long-term  liabilities                                                                                                                                     |       | 11,939                      |       | —                         |       | 11,939                      |       |
| Stockholders’  equity:                                                                                                                                      |       |                        |       |                           |       |                        |       |
| Common stock,  $0.001 par value; 105,000,000 shares authorized at December 31, 2005;  45,426,912 shares issued and outstanding as of December 31, 2005 |       | 45                          |       | —                         |       | 45                          |       |
| Additional paid-in  capital                                                                                                                                      |       | 727,597                     |       | 10,656                         |       | 738,253                     |       |
| Deferred stock-based  compensation                                                                                                                               |       | (593                        | )          | —                         |       | (593                        | )          |
| Accumulated  other comprehensive income                                                                                                                          |       | 3,094                       |       | (37                            | )          | 3,057                       |       |
| Accumulated  deficit                                                                                                                                             |       | (230,795                    | )          | (13,043                        | )          | (243,838                    | )          |
| Total  stockholders’ equity                                                                                                                                 |       | 499,348                     |       | (2,424                         | )          | 496,924                     |       |
|                                                                                                                                                             |       | $                           | 604,223    |                           | $          | (1,592                      | )          | $ | 602,631 |   |

 

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(1)             The restated consolidated balancesheet for the fiscal year ended 2005 reflects a $13.0 million increase toaccumulated deficit and a $10.7 million increase to additional paid-in capitalprimarily due to additional stock-based compensation recorded in connectionwith this restatement to correct prior year stock option-related accountingerrors as described above and to reflect the cumulative impact of otheradjustments that were previously considered to be immaterial. The $1.6 milliondecrease to goodwill is the impact of recording losses associated with ourinvestment in Oren Semiconductor under the equity method of accounting and $0.8million increase to accrued expenses and other liabilities relates to theaccrual of royalty obligations that were previously not recorded at December31, 2005. 

10

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**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(in thousands, except per share data)**
| ** **                                                                     | ** ** | **Three months Ended**March 31, 2006 | ** ** | **Three months Ended**March 31, 2005 | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                     | ** ** | **As  previously  reported**                             | ** ** | **Adjust-  ments  (1)**                                  | ** ** | **As  restated** | ** ** | **As  previously  reported** | ** ** | **Adjust-  ments  (1)** | ** ** | **As  restated** | ** ** |
|                                                                           |       |                                                     |       |                                                     |       |   |   |   |   |   |   |   |   |
| Revenues:                                                                      |       |                                                     |       |                                                     |       |   |   |   |   |   |   |   |   |
| Hardware product revenues                                                      |       | $                                                        | 99,169     |                                                     | $          | — |   | $ | 99,169 |   | $ | 59,002 |   | $ | — |   | $ | 59,002 |   |
| Software and other revenues                                                    |       | 12,909                                                   |       | —                                                   |       | 12,909 |   | 14,882 |   | — |   | 14,882 |   |
| License revenues related to litigation settlement                              |       | 30,168                                                   |       | —                                                   |       | 30,168 |   | — |   | — |   | — |   |
| Total revenues                                                                 |       | 142,246                                                  |       | —                                                   |       | 142,246 |   | 73,884 |   | — |   | 73,884 |   |
| Costs and  expenses:                                                           |       |                                                     |       |                                                     |       |   |   |   |   |   |   |   |   |
| Cost of hardware product revenues*                                             |       | 54,466                                                   |       | (816                                                     | )          | 53,650 |   | 36,964 |   | (29 | ) | 36,935 |   |
| Research and development*                                                      |       | 24,151                                                   |       | 97                                                       |       | 24,248 |   | 20,100 |   | (13 | ) | 20,087 |   |
| Selling, general and administrative*                                           |       | 24,755                                                   |       | 146                                                      |       | 24,901 |   | 23,174 |   | (333 | ) | 22,841 |   |
| Amortization of intangible assets                                              |       | 12,735                                                   |       | —                                                   |       | 12,735 |   | 12,330 |   | — |   | 12,330 |   |
| Amortization of stock-based compensation resulting  from business combinations |       | —                                                   |       | —                                                   |       | — |   | 517 |   | — |   | 517 |   |
| Total costs and expenses                                                       |       | 116,107                                                  |       | (573                                                     | )          | 115,534 |   | 93,085 |   | (375 | ) | 92,710 |   |
| Operating income  (loss)                                                       |       | 26,139                                                   |       | 573                                                      |       | 26,712 |   | (19,201 | ) | 375 |   | (18,826 | ) |
| Interest income                                                                |       | 1,630                                                    |       | (37                                                      | )          | 1,593 |   | 535 |   | (8 | ) | 527 |   |
| Other income  (loss), net                                                      |       | 1,193                                                    |       | —                                                   |       | 1,193 |   | (130 | ) | (294 | ) | (424 | ) |
| Income (loss)  before income taxes                                             |       | 28,962                                                   |       | 536                                                      |       | 29,498 |   | (18,796 | ) | 73 |   | (18,723 | ) |
| Provision for  income taxes                                                    |       | 8,202                                                    |       | 613                                                      |       | 8,815 |   | — |   | — |   | — |   |
| Net income  (loss)                                                             |       | $                                                        | 20,760     |                                                     | $          | (77 | ) | $ | 20,683 |   | $ | (18,796 | ) | $ | 73 |   | $ | (18,723 | ) |
| Basic net income  (loss) per share                                             |       | $                                                        | 0.45       |                                                     | $          | — |   | $ | 0.45 |   | $ | (0.43 | ) | $ | — |   | $ | (0.43 | ) |
| Diluted net  income (loss) per share                                           |       | $                                                        | 0.43       |                                                     | $          | — |   | $ | 0.43 |   | $ | (0.43 | ) | $ | — |   | $ | (0.43 | ) |
| Shares used to  compute basic net loss per share                               |       | 46,207                                                   |       |                                                     |       | 46,207 |   | 43,213 |   |   |   | 43,213 |   |
| Shares used to  compute diluted loss per share                                 |       | 48,487                                                   |       |                                                     |       | 48,487 |   | 43,213 |   |   |   | 43,213 |   |

 

----

* includes thefollowing amounts related to employee equity awards
| Cost of hardware  product revenues   |   | $ | 145   |   | $ | 8   |   | $ | 153   |   | $ | — |   | $ | 1  |   | $ | 1  |   |
|--------------------------------------|--------|---|-------|--------|---|-----|--------|---|-------|--------|---|--------|--------|---|----|--------|---|----|--------|
| Research and  development            |   | $ | 1,513 |   | $ | 97  |   | $ | 1,610 |   | $ | — |   | $ | 21 |   | $ | 21 |   |
| Selling, general  and administrative |   | $ | 2,904 |   | $ | 146 |   | $ | 3,050 |   | $ | — |   | $ | 44 |   | $ | 44 |   |

 

----

(1) In addition torestating the consolidated financial statements in response to the SpecialCommittee’s findings, the Company has recorded additional non-cash adjustmentsthat were considered to be immaterial to our previously filed consolidatedfinancial statements relating to the timing of revenue recognition,accrued expenses, amortization of premiums and discounts oninvestments, additional expense related to options granted to a consultant, andthe amortization of stock-based compensation relating to a business combinationin 2003.  In addition, the Company is also recordingretroactive losses under APB Opinion No. 18 (“APB No. 18”), “TheEquity Method of Accounting for Investments in Common Stock,” to recordthe losses on investment of the prior 17% ownership of OrenSemiconductor, Inc. under the equity method of accounting which was subsequentlyacquired by Zoran in 2005.

11

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**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**
| ** **                                                                        | ** ** | **Three months Ended**March 31, 2006 | ** ** | **Three months Ended  March 31, 2005** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                                                        | ** ** | **As  previously  reported**                             | ** ** | **Adjust-  ments**                                         | ** ** | **As restated** | ** ** | **As  previously  reported** | ** ** | **Adjust-  ments** | ** ** | **As  restated** | ** ** |
| Cash flows from  operating activities:                                            |       |                                                     |       |                                                       |       |   |   |   |   |   |   |   |   |
| Net income  (loss)                                                                |       | $                                                        | 20,760     |                                                       | $          | (77 | ) | $ | 20,683 |   | $ | (18,796 | ) | $ | 73 |   | $ | (18,723 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operations:  |       |                                                     |       |                                                       |       |   |   |   |   |   |   |   |   |
| Depreciation   .                                                             |       | 2,361                                                    |       | —                                                     |       | 2,361 |   | 2,438 |   | — |   | 2,438 |   |
| Amortization                                                                      |       | 12,735                                                   |       | 37                                                         |       | 12,772 |   | 12,330 |   | 8 |   | 12,338 |   |
| Stock-based compensation expense                                                  |       | 4,562                                                    |       | 251                                                        |       | 4,813 |   | 517 |   | 66 |   | 583 |   |
| Changes in assets and liabilities:                                                |       |                                                     |       |                                                       |       |   |   |   |   |   |   |   |   |
| Accounts receivable.                                                              |       | 7,743                                                    |       | —                                                     |       | 7,743 |   | (8,160 | ) | — |   | (8,160 | ) |
| Inventories                                                                       |       | (6,047                                                   | )          | —                                                     |       | (6,047 | ) | 15,826 |   | — |   | 15,826 |   |
| Prepaid expenses and other current assets and other  assets                       |       | 176                                                      |       | —                                                     |       | 176 |   | (4,833 | ) | (130 | ) | (4,963 | ) |
| Accounts payable.                                                                 |       | 5,738                                                    |       | —                                                     |       | 5,738 |   | (6,062 | ) | — |   | (6,062 | ) |
| Accrued expenses and other liabilities, goodwill and  other long term liabilities |       | 4,456                                                    |       | (211                                                       | )          | 4,245 |   | 2,224 |   | (17 | ) | 2,207 |   |
| Net cash provided by (used in) operating activities                               |       | 52,484                                                   |       | —                                                     |       | 52,484 |   | (4,516 | ) | — |   | (4,516 | ) |
| Cash flows from  investing activities:                                            |       |                                                     |       |                                                       |       |   |   |   |   |   |   |   |   |
| Purchases of property and equipment                                               |       | (1,209                                                   | )          | —                                                     |       | (1,209 | ) | (1,489 | ) | — |   | (1,489 | ) |
| Purchases of investments.                                                         |       | (90,952                                                  | )          | —                                                     |       | (90,952 | ) | (4,883 | ) | — |   | 4,883 |   |
| Proceeds from sales and maturities of investments                                 |       | 57,345                                                   |       | —                                                     |       | 57,345 |   | 4,103 |   | — |   | 4,103 |   |
| Net cash used in investing activities                                             |       | (34,816                                                  | )          | —                                                     |       | (34,816 | ) | (2,269 | ) | — |   | (2,269 | ) |
| Cash flows from  financing activities:                                            |       |                                                     |       |                                                       |       |   |   |   |   |   |   |   |   |
| Proceeds from issuance of commonstock                                             |       | 17,228                                                   |       | —                                                     |       | 17,228 |   | 375 |   | — |   | 375 |   |
| Net cash  provided by financing activities                                        |       | 17,228                                                   |       | —                                                     |       | 17,228 |   | 375 |   | — |   | 375 |   |
| Net increase  (decrease) in cash and cash equivalents                             |       | 34,896                                                   |       | —                                                     |       | 34,896 |   | (6,410 | ) | — |   | (6,410 | ) |
| Cash and cash  equivalents at beginning of period                                 |       | 78,856                                                   |       | —                                                     |       | 78,856 |   | 37,435 |   | — |   | 37,435 |   |
| Cash and cash  equivalents at end of period                                       |       | $                                                        | 113,752    |                                                       | $          | — |   | $ | 113,752 |   | $ | 31,025 |   | $ | — |   | $ | 31,025 |   |

** **

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**3.      Stock-Based Compensation**

Effective January 1, 2006, Zoran adopted SFAS No. 123(R), usingthe modified prospective application transition method, which establishesaccounting for stock-based awards exchanged for employee services.  Accordingly, stock-based compensation cost ismeasured at grant date, based on the fair value of the award, over therequisite service period.  The Companypreviously applied APB No. 25 and related interpretations andprovided the pro forma disclosures required by SFAS No. 123, “ Accountingfor Stock-Based Compensation “ (“SFAS No. 123”).

Periods Prior to the Adoption of SFAS No. 123(R) 

Prior to the adoption ofSFAS No. 123(R), the Company provided the disclosures required under SFAS No. 123,as amended by SFAS No. 148, “Accounting for Stock-Based Compensation –Transition and Disclosures.”

The pro forma effect ofrecognizing compensation expense pursuant to SFAS No. 123 for the threemonths ended March 31, 2005 was as follows (in thousands except per-shareamounts):
|                                                                          | ** ** | **Three Months Ended  March 31, 2005** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                                               | ** ** | **(restated)**                                             | ** ** |
|                                                                     |       |                                                       |       |
| Net loss as  reported                                                    |       | $                                                          | (18,723    | ) |
| Adjustments:                                                             |       |                                                       |       |
| Stock-based compensation expense included in  net loss.                  |       | 583                                                        |       |
| Stock-based compensation expense determined  under the fair value method |       | (7,260                                                     | )          |
|                                                                     |       |                                                       |       |
| Pro forma net  loss                                                      |       | $                                                          | (25,400    | ) |
| Pro forma net  loss per share:                                           |       |                                                       |       |
| Basic                                                                    |       | $                                                          | (0.59      | ) |
|                                                                     |       |                                                       |       |
| Diluted                                                                  |       | $                                                          | (0.59      | ) |
|                                                                     |       |                                                       |       |
| Net loss per  share as restated:                                         |       |                                                       |       |
| Basic                                                                    |       | $                                                          | (0.43      | ) |
|                                                                     |       |                                                       |       |
| Diluted                                                                  |       | $                                                          | (0.43      | ) |

 

For purposes of this proforma disclosure, the value of the options was estimated using the acceleratedamortization method under FIN 28 over the respective vesting periods of theawards. Due to the valuation allowance provided on our deferred tax assets, theCompany has not recorded any tax benefits attributable to pro forma stock-basedcompensation.

Impact of Adoption ofSFAS No. 123(R) 

During the three months ended March 31, 2006 theCompany recorded stock-based compensation expense for awards granted prior tobut not yet vested as of January 1, 2006 as if the fair value method requiredfor pro forma disclosure under SFAS No. 123were in effect for expense recognition purposes adjusted for estimatedforfeitures. For these awards the Company has continued to recognizecompensation expense using the accelerated amortization method. For stock-basedawards granted after January 1, 2006, the Company recognized compensationexpense based on the grant date fair value required under SFAS No. 123(R).For these awards the Company recognized compensation expense using astraight-line amortization method. As SFAS No. 123(R)requires that stock-based compensation expense be based on awards that areultimately expected to vest, estimated stock-based compensation for thethree-month period ended March 31, 2006 has been reduced for estimatedforfeitures.  The adoption of SFAS No. 123(R)resulted in a one-time benefit of $314,000 related to unvested awards for whichcompensation expense had already been recorded.

13

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The following table summarizes stock-basedcompensation expense related to employee stock options, employee stockpurchases and restricted stock unit grants for the three months endedMarch 31, 2006 as recorded in accordance with SFAS No. 123(R)  (including the effect of therestatements)  (in thousands):

|                                      | ** ** | **Three months Ended  March 31, 2006** | ** ** |
|--------------------------------------|------------|------------------------------------------------------------|------------|
|                                 |       |                                                       |       |
| Cost of hardware  product revenues.  |       | $                                                          | 153        |   |
| Research and  development            |       | 1,610                                                      |       |
| Selling, general  and administrative |       | 3,050                                                      |       |
| Total costs and  expenses            |       | $                                                          | 4,813      |   |

 

**Theeffect of recording additional stock-based compensation expense on basic anddiluted net income per share was $0.10 per share for the three months endedMarch 31, 2006.**

ValuationAssumptions

For purposes of the disclosure requirements ofSFAS No. 123and the requirements of SFAS No. 123(R), the Companyestimates the fair value of stock options using the Black-Scholes optionpricing model using the following weighted-average assumptions: 

|                               | ** ** | **Stock Option Plans**                       | ** ** |
|-------------------------------|------------|--------------------------------------------------------|------------|
| ** **                    | ** ** | **Three Months  Ended  March 31, 2006** | ** ** | **Three Months  Ended  March 31, 2005** | ** ** |
| ** **                    | ** ** | **(restated)**                                         | ** ** | **(restated)** | ** ** |
|                          |       |                                                   |       |   |   |
| Average expected term (years) |       | 5.7                                                    |       | 4.0 |   |
| Expected volatility           |       | 73                                                     | %          | 72 | % |
| Risk-free interest rate       |       | 4.6                                                    | %          | 3.7 | % |
| Dividend  yield               |       | 0                                                      | %          | 0 | % |

 

|                               | ** ** | **Employee Stock Purchase Plan**        | ** ** |
|-------------------------------|------------|--------------------------------------------------------|------------|
| ** **                    | ** ** | **Three Months  Ended  March 31, 2006** | ** ** | **Three Months  Ended  March 31, 2005** | ** ** |
| ** **                    | ** ** | **(restated)**                                         | ** ** | **(restated)** | ** ** |
|                          |       |                                                   |       |   |   |
| Average expected term (years) |       | 1.25                                                   |       | 1.25 |   |
| Expected volatility           |       | 57                                                     | %          | 55 | % |
| Risk-free interest rate       |       | 2.3                                                    | %          | 2.9 | % |
| Dividend  yield               |       | 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.

*Expected Volatility*:The Company uses historical volatility in deriving its volatilityassumption.  Management believes thathistorical volatility provides the most reliable indication of futurevolatility and is more reflective of market conditions.

*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.

14

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*Estimated Pre-vestingForfeitures:*When estimatingforfeitures, the Company considers voluntary termination behavior based onactual historical information.

Stock Option Activity

The following is asummary of stock option activities:

|                              | ** ** | **Shares Underlying  Outstanding Options** | ** ** | **Weighted Average  Exercise Price** | ** ** |
|------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------|------------|
| Balances,  December 31, 2005 |       | 12,955,585                                           |       | $                                              | 16.32      |   |
| Granted                      |       | 74,360                                               |       | $                                              | 19.76      |   |
| Exercised                    |       | (1,292,519                                           | )          | $                                              | 13.37      |   |
| Canceled*                    |       | (1,231,177                                           | )          | $                                              | 24.90      |   |
| Balances, March  31, 2006    |       | 10,506,249                                           |       | $                                              | 15.70      |   |

 

----

* Includes 1,060,536underwater options exchanged for restricted shares and restricted stock units.See “RestrictedShares and Restricted Stock Units” below.

Significantoption groups outstanding as of March 31, 2006 and the related weighted averageexercise price and contractual life information, are as follows:

|                          | ** ** | **Options Outstanding**                                  | ** ** | ** **                                                   | ** ** | **Options Exercisable**           | ** ** |
|--------------------------|------------|---------------------------------------------------------------|------------|--------------------------------------------------------------|------------|----------------------------------------|------------|
| **Exercise Prices** | ** ** | **Shares  Underlying  Options at  March 31,  2006** | ** ** | **Weighted  Average  Remaining  Contractual  Life  (Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Aggregate  Intrinsic  value (‘000)** | ** ** | **Shares  Underlying  Options at  March 31,  2006** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Aggregate  Intrinsic  value (‘000)** | ** ** |
|                     |       |                                                          |       |                                                         |       |                                   |       |   |   |   |   |   |   |   |   |
| $0.00 to $9.99           |       | 975,070                                                       |       | 5.36                                                         |       | $                                      | 6.27       |   | $ | 15,220 |   | 744,599 |   | $ | 6.31 |   | $ | 11,596 |   |
| $10.00 to $11.99         |       | 1,832,764                                                     |       | 7.84                                                         |       | $                                      | 10.62      |   | 20,639 |   | 841,650 |   | $ | 10.90 |   | 9,242 |   |
| $12.00 to $14.99         |       | 2,252,985                                                     |       | 6.84                                                         |       | $                                      | 12.94      |   | 20,144 |   | 1,490,220 |   | $ | 12.76 |   | 13,584 |   |
| $15.00 to $19.99         |       | 3,244,020                                                     |       | 7.64                                                         |       | $                                      | 17.10      |   | 15,519 |   | 1,738,627 |   | $ | 17.20 |   | 8,133 |   |
| $20.00 to $25.99         |       | 1,803,029                                                     |       | 6.97                                                         |       | $                                      | 24.02      |   | 206 |   | 1,242,385 |   | $ | 23.87 |   | 166 |   |
| $26.00 to $46.53         |       | 398,381                                                       |       | 4.39                                                         |       | $                                      | 28.75      |   | — |   | 398,131 |   | $ | 28.75 |   | — |   |
| Total                    |       | 10,506,249                                                    |       | 7.05                                                         |       | $                                      | 15.70      |   | $ | 71,728 |   | 6,455,612 |   | $ | 16.09 |   | $ | 42,721 |   |

 

The weighted average grant date fair value ofoptions, as determined under SFAS No. 123(R),granted during the three months ended March 31, 2006 was $11.09 per share.

The aggregate intrinsicvalue in the table above represents the total pretax intrinsic value, based onthe Company’s closing stock price of $21.88 as of March 31, 2006, which wouldhave been received by the option holders had all option holders exercised theiroptions as of that date.  The totalnumber of shares of common stock underlying in-the-money options exercisable asof March 31, 2006 was 4.9 million.

The total intrinsic valueof options exercised during the three month period ended March 31, 2006 was$8.9 million.  The total cash receivedfrom employees as a result of employee stock option exercises during the threemonths ended March 31, 2006 was approximately $17.3 million.  In connection with these exercises, there wasno tax benefit realized by the Company due to the Company’s current lossposition.

As of March 31, 2006, thetotal unrecognized compensation cost related to stock options not yetrecognized was $16.7 million after estimated forfeitures which are expected tobe recognized over an estimated amortization period of four years.

The Company settles employee stock optionexercises with newly issued common shares.

15

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Stock Option Plans

As of March 31, 2006, theCompany had outstanding options for the purchase of 10.5 million shares ofcommon stock held by employees and directors under the Company’s 2005 EquityIncentive Plan (the “2005 Plan”), 2005 Outside Directors Equity Plan, 2002Stock Option Plan, 1995 Outside Directors Stock Option Plan, the 1993 StockOption Plan and other various plans the Company assumed as a result ofacquisitions.  As of March 31, 2006,1,673,272 shares remained available for the future grants and awards. Optionsand stock appreciation rights granted under the 2005 Plan must have exerciseprices per share not less than the fair market value of Zoran common stock onthe date of grant and may not be repriced without stockholder approval.  Such awards will vest and become exercisableupon conditions established by the Compensation Committee and may not have aterm exceeding 10 years.

Restricted Shares andRestricted Stock Units

Restricted shares and restricted stock units aregranted under the 2005 Equity Incentive Plan. On January 6, 2006, the Companyfiled a Tender Offer Statement with the Securities and Exchange Commission andcommenced an offer to current employees to exchange outstanding options withexercise prices per share that were more than the greater of $20.00 and theclosing sale price of Zoran common stock on the offer expiration date ofFebruary 6, 2006.  The exchange offer wasapproved by Zoran’s stockholders at their 2005 annual meeting. On February 6,2006, the Company accepted for exchange options to purchase an aggregate of1,060,536 shares of Zoran common stock having an exercise price greater than$22.48. Subject to the terms and conditions of the exchange, the Companygranted 197,433 restricted shares of common stock or restricted stock units inexchange for the tendered options.  Theshares of restricted stock and restricted stock units granted as part of thisexchange vest over a period of two years. None of the directors or executive officers was eligible forparticipation in the exchange offer. This exchange was accounted as a modification under SFAS No. 123(R).  As of March 31, 2006, there was$0.7 million of total unrecognized stock-based compensation expense related torestricted shares and restricted stock units. This cost is expected to berecognized over the vesting period of two to four years.

The following is asummary of restricted shares and restricted stock units activities:
|                              | ** ** | **Outstanding  restricted shares  and stock units** | ** ** | **Weighted  average grant-  date fair value** | ** ** | **Aggregate  intrinsic value** | ** ** |
|------------------------------|------------|--------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                   | ** ** | ** **                                                         | ** ** | ** **                                                   | ** ** | **(in thousands)**             | ** ** |
| ** **                   | ** ** | ** **                                                         | ** ** | ** **                                                   | ** ** | ** **                          | ** ** |
| Balances,  December 31, 2005 |       | 65,333                                                             |       | $                                                            | 13.59      |                                | $          | 888 |   |
| Granted                      |       | 197,433                                                            |       | $                                                            | 21.56      |                                | 4,257      |   |
| Vested                       |       | —                                                             |       | —                                                       |       | —                              |       |
| Forfeited                    |       | —                                                             |       | —                                                       |       | —                              |       |
| Balances, March 31,  2006    |       | 262,766                                                            |       | $                                                            | 19.58      |                                | $          | 5,145 |   |

 

Employee StockPurchase Plan

The Company’s 1995 Employee Stock Purchase Plan(“ESPP”) was adopted by the Company’s Board 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.  There were no purchases during thequarter ended March 31, 2006.  As ofMarch 31, 2006, 1,574,596 shares were reserved and available for issuance underthis plan.

**3.****             ****Comprehensive Income (Loss)**

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

16

----

 

|                                                      | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                           | ** ** | **March 31,**               | ** ** |
| ** **                                           | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| ** **                                           | ** ** | **(restated)**                   | ** ** | **(restated)** | ** ** |
|                                                 |       |                             |       |   |   |
| Net income  (loss)                                   |       | $                                | 20,683     |   | $ | (18,723 | ) |
| Change in unrealized gain (loss) on investments, net |       | (878                             | )          | 975 |   |
| Total comprehensive  income (loss)                   |       | $                                | 19,805     |   | $ | (17,748 | ) |

 

The components ofaccumulated other comprehensive income (loss) are unrealized gain (loss) onmarketable securities.

**4.****             ****Inventories**

Inventories are stated at the lower of cost (first in,first out) or market and consisted of the following (in thousands):

|                                      | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **2006**           | ** ** | **2005**              | ** ** |
|                                 |       |               |       |                  |       |
| Purchased parts  and work in process |       | $                  | 19,082     |                  | $          | 14,904 |   |
| Finished goods                       |       | 19,581             |       | 17,712                |       |
|                                 |       | $                  | 38,663     |                  | $          | 32,616 |   |

 

**5.****              Goodwill and OtherIntangible Assets**

In accordance with SFAS No. 142, goodwill is not amortized. The Company monitors the recoverability of goodwill recorded inconnection with acquisitions, by reporting unit, annually, or sooner if eventsor changes in circumstances indicate that the carrying amount may not berecoverable.  The Company performed theannual analysis as of September 30, 2005 and concluded that goodwill was notimpaired, as the fair value of each reporting unit exceeded its carrying value,including goodwill.

***Componentsof Acquired Intangible Assets ( restated)****(in thousands):*

|                               | ** ** | ** **        | ** ** | **March 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|-------------------------------|------------|-------------------|------------|------------------------------|------------|---------------------------------|------------|
| ** **                    | ** ** | **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    |                            | $          | (114,700 | ) | $ | 80,805 |   | $ | 195,505 |   | $ | (105,088 | ) | $ | 90,417 |   |
| Patents                       |       | 3-5               |       | 40,265                       |       | (22,359                         | )          | 17,906 |   | 40,265 |   | (19,978 | ) | 20,287 |   |
| Customer base                 |       | 3-5               |       | 13,860                       |       | (7,738                          | )          | 6,122 |   | 13,860 |   | (7,123 | ) | 6,737 |   |
| Tradename and others          |       | 3-5               |       | 3,350                        |       | (1,687                          | )          | 1,663 |   | 3,350 |   | (1,560 | ) | 1,790 |   |
| Total                         |       |              |       | $                            | 252,980    |                            | $          | (146,484 | ) | $ | 106,496 |   | $ | 252,980 |   | $ | (133,749 | ) | $ | 119,231 |   |

 

Estimated future intangibleamortization expense, based on current balances, as of March 31, 2006 is asfollows (in thousands):

| Remaining nine months of  2006 |   | $      | 37,327  |   |
|--------------------------------|--------|--------|---------|--------|
| Year ending  December 31, 2007 |   | 43,224 |    |
| Year ending  December 31, 2008 |   | 23,315 |    |
| Year ending  December 31, 2009 |   | 1,820  |    |
| Year ending  December 31, 2010 |   | 810    |    |
|                           |   | $      | 106,496 |   |

 

17

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Goodwill by reporting units was as follows (inthousands):

|            | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------|------------|--------------------|------------|-----------------------|------------|
| ** ** | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| ** ** | ** ** | **(restated)**     | ** ** | **(restated)**        | ** ** |
| Consumer   |       | $                  | 173,023    |                  | $          | 176,623 |   |
| Imaging    |       | 5,639              |       | 6,039                 |       |
|       |       | $                  | 178,662    |                  | $          | 182,662 |   |

 

**6.****              IncomeTaxes**

Theprovision for income taxes reflects the effective tax rate applied to earnings,excluding charges for amortization of intangible assets for the interim periodsand a one-time charge of $6.7 million relating to the MediaTek settlement.  The effective tax rate differs from the U.S.statutory rate due to utilization of previously unbenefitted operating lossesand State of Israel tax benefits on foreign earnings.  The provision is due primarily to domesticincome offset by previously unbenefitted purchased NOLs which when utilizedreduce goodwill and not tax expense.

**7.****              SegmentReporting**

SFAS No. 131 establishesstandards for the reporting by public business enterprises of information aboutoperating segments, products and services, geographic areas, and majorcustomers.  The method for determiningwhat information to report is based on the manner in which management organizesthe operating segments within the Company for making operational decisions andassessments of financial performance. The Company’s chief operating decision-maker is considered to be theChief Executive Officer.

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.  During the first quarter of2006, the Company reorganized its operating structure to bring together itsconsumer electronic product lines under a single operating group, inrecognition of the accelerating convergence of consumer products and theCompany’s strategy of sharing technology among its various product lines.  The new Consumer group combines the formerDigital Versatile Disc (DVD), Digital Television (DTV) and Mobile productgroups whose operations were previously reported separately.  The Company will continue to report theoperations of its Imaging group as a separate operating segment.

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.

The chief operating decisionmaker allocates resources to and evaluates operating segment performance basedon net revenues and operating expenses of these segments.  The accounting policies of the operatingsegments are the same as those described in the summary of accountingpolicies.  No reportable segments havebeen aggregated.

18

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Informationabout reported segment income or loss is as follows for the three months endedMarch 31, 2006 and 2005 (in thousands):

|                       | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------|------------|--------------------------------------------------|------------|
| ** **            | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| ** **            | ** ** | **(restated)**                                   | ** ** | **(restated)** | ** ** |
| Net revenues:         |       |                                             |       |   |   |
| Consumer              |       | $                                                | 123,556    |   | $ | 52,976 |   |
| Imaging               |       | 18,690                                           |       | 20,908 |   |
|                  |       | $                                                | 142,246    |   | $ | 73,884 |   |
|                  |       |                                                  |       |  |   |
| Operating  expenses:  |       |                                             |       |   |   |
| Consumer              |       | $                                                | 87,615     |   | $ | 64,929 |   |
| Imaging               |       | 15,184                                           |       | 14,934 |   |
|                  |       | $                                                | 102,799    |   | $ | 79,863 |   |
| Contribution  margin: |       |                                             |       |   |   |
| Consumer              |       | $                                                | 35,941     |   | $ | (11,953 | ) |
| Imaging               |       | 3,506                                            |       | 5,974 |   |
|                  |       | $                                                | 39,447     |   | $ | (5,979 | ) |

 

A reconciliation of the totals reported for theoperating segments to the applicable line items in the consolidated financialstatements for the three months ended March 31, 2006 and 2005 is asfollows (in thousands):

|                                                                          | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                               | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| ** **                                                               | ** ** | **(restated)**                                   | ** ** | **(restated)** | ** ** |
| Contribution  margin from operating segments                             |       | $                                                | 39,447     |   | $ | (5,979 | ) |
| Amortization of  intangibles                                             |       | 12,735                                           |       | 12,330 |   |
| Amortization of  stock compensation resulting from business combinations |       | —                                           |       | 517 |   |
| Total operating  income (loss)                                           |       | $                                                | 26,712     |   | $ | (18,826 | ) |

 

Zoran maintainsoperations in Canada, China, Germany, Israel, Japan, Korea, Taiwan, the UnitedKingdom and the 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.

 The geographic distribution of total revenuesfor the three months ended March 31, 2006 and 2005 was as follows (inthousands):

|                                                            | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                 | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| **Revenue  from unaffiliated customers originating from:** |       |                                             |       |   |   |
| China                                                      |       | $                                                | 39,605     |   | $ | 27,965 |   |
| Japan                                                      |       | 27,364                                           |       | 24,046 |   |
| Korea                                                      |       | 8,562                                            |       | 3,910 |   |
| Taiwan                                                     |       | 53,708                                           |       | 5,403 |   |
| United States                                              |       | 7,118                                            |       | 5,610 |   |
| North America  (excluding United States)                   |       | 12                                               |       | 693 |   |
| Other                                                      |       | 5,877                                            |       | 6,257 |   |
| **Total  revenues**                                        |       | $                                                | 142,246    |   | $ | 73,884 |   |

 

19

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For the three months ended March 31, 2006, onecustomer accounted for 21% of total revenues attributable to the licenserevenue related to litigation settlement. For the same period of 2005, one customer accounted for 13% of totalrevenues.

As of March 31, 2006, twocustomers accounted for approximately 10% and 12% of total net accountsreceivable, respectively, and as of December 31, 2005 one customer accounted for approximately 14% of the net accountsreceivable balance.

**8.****     Employee Benefit Plans**

Under Israeli law, theCompany is required to make severance payments to its retired or dismissedIsraeli employees and Israeli employees leaving its employment in certain othercircumstances. The Company’s severance pay liability to its Israeli employees,which is calculated based on the salary of each employee multiplied by theyears of such employee’s employment, is reflected in the Company’s balancesheet in other long-term liabilities on an accrual basis, and is partiallyfunded by the purchase of insurance policies in the name of the employees. Thesurrender value of the insurance policies is recorded in other non-currentassets. The severance pay expenses for the three months ended March 31, 2006and 2005 were $46,000 and $62,000 respectively.

**9.****     Acquisitions**

**OrenSemiconductor, Inc.**

On June 10,2005, Zoran completed the acquisition of Oren Semiconductor, Inc. (“Oren”),a privately-held provider of demodulator ICs for the global high definitiontelevision market.  Prior to thisacquisition, Zoran had made investments in Oren that represented a 17%ownership interest with a net book value of $3.4 million at the time ofacquisition.  Under the terms of theacquisition agreement, Zoran acquired the remaining 83% of Oren’s outstandingstock by means of a merger of Oren with a wholly-owned subsidiary of Zoran, inconsideration for which Zoran paid an aggregate of $28.4 million in cashand issued 1,188,061 shares of Zoran common stock valued at $12.9 million,for total consideration of $41.3 million, to the other stockholders of Oren andto employees holding Oren options.  Aspart of the restatement, the Company considered the requirements underAccounting Principles Board Opinion No. 18 (“APB No. 18”), “TheEquity Method of Accounting for Investments in Common Stock,” to record thegains or losses on investment of the prior 17% ownership under the equity methodof accounting.  Based on the Company’sanalysis, the prior financial results of the Company were restated to recordthe loss on investment.

The primary purpose ofthe acquisition was to obtain Oren’s demodulator ICtechnology for the global high definition television market.  This technology was combined with Zoran’sdigital television technology to deliver a complete and cost-effective systemsolution for digital television makers. As of March 31, 2006, there have been no materialvariations from the underlying assumptions that were used in the originalcomputation of the value of the acquired entity.

Thetransaction was accounted for under SFAS No. 141, “Business Combinations,”using the purchase method of accounting. The Company incurred approximately $375,000 for acquisition-relatedexpenses consisting of financial advisory, legal and other consulting services.  The Company completed a valuation analysisand purchase price allocation. The results of operations of Oren have beenincluded in the consolidated financial statements from the date of acquisition.The acquisition resulted in goodwill of approximately $33.9 million. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”,goodwill will not be amortized and will be tested for impairment at leastannually.  The Company does not expectgoodwill to be deductible for tax purposes.

Allocation of the purchase price is as follows(restated) (in thousands):

| Net liabilities acquired             |   | $      | (941   | )      |
|--------------------------------------|--------|--------|--------|--------|
| In process  research and development |   | 2,650  |   |
| Intangible  assets                   |   | 9,100  |   |
| Goodwill                             |   | 33,897 |   |
|                                 |   | $      | 44,706 |   |

 

Tangible assets were valued at estimates of their current fairvalues.  The purchase priceexceeded the net assets acquired resulting in the recognition of goodwill andother intangible assets.  The amountsallocated to intangible assets include purchased technology totaling $7.0million, trade name and other intangible assets totaling $1.25 million andcustomer base totaling $850,000 which are being amortized over their estimateduseful lives of five years.

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Approximately $2.7 million of the purchase price wasallocated to in-process research and development which had not yet reachedtechnological feasibility and had no alternative future use.  Accordingly, this amount was immediatelyexpensed upon the acquisition date.  Thisamount was determined using management’s estimates including consultation withan independent appraiser.  The value ofthe in-process research and development was determined using a discounted cashflow method and factors including projected financial results, relative risk ofsuccessful development, time-value of money and level of completion.

**Pro Forma Financial Information**

Thefollowing unaudited pro forma financial information presents the combinedresults of operations of Zoran and Oren as if the acquisition had occurred asof the beginning of the period presented, after giving effect to certainadjustments, including amortization of intangibles. The unaudited pro formafinancial information does not necessarily reflect the results of operationsthat would have occurred had the combined companies constituted a single entityduring such periods, and is not necessarily indicative of results which may beobtained in the future.

|                                              | ** ** | **Year Ended  December 31, 2005** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                   | ** ** | **(restated)**                                   | ** ** |
|                                         |       |                                             |       |
| **In  thousands except for per share data:** |       |                                             |       |
| Pro forma  revenues                          |       | $                                                | 396,737    |   |
|                                         |       |                                                  |       |
| Pro forma net  income (loss)                 |       | $                                                | (33,024    | ) |
|                                         |       |                                                  |       |
| Pro forma net  income (loss) per share:      |       |                                             |       |
|                                         |       |                                             |       |
| Basic                                        |       | $                                                | (0.75      | ) |
|                                         |       |                                                  |       |
| Diluted                                      |       | $                                                | (0.75      | ) |

 

**10.****  NetIncome (Loss) Per Share**

Basic net income (loss)per share is calculated by dividing net income available to common stockholdersby the weighted average number of common shares outstanding during theperiod.  Diluted net income per share is calculated by using the weightedaverage number of common shares outstanding during the period increased toinclude the number of additional shares of common stock that would have beenoutstanding if the dilutive potential shares of common stock had beenissued.  The dilutive effect of outstanding options and restricted stockfor the three months ended Match 31, 2006 is reflected in diluted net income pershare by application of the treasury stock method, which includes considerationof stock-based compensation required by SFAS No. 123(R).

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The followingtable provides a reconciliation of the components of the basic and diluted netincome (loss) per share computations (in thousands, except per share data):

|                                                        | ** ** | **Three Months EndedMarch 31,** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                             | ** ** | **2006**                                       | ** ** | **2005** | ** ** |
| ** **                                             | ** ** | **(restated)**                                 | ** ** | **(restated)** | ** ** |
|                                                   |       |                                           |       |   |   |
| Net income (loss)                                      |       | $                                              | 20,683     |   | $ | (18,723 | ) |
|                                                   |       |                                           |       |   |   |
| Weighted average shares  outstanding                   |       | 46,207                                         |       | 43,213 |   |
| Effect of dilutive  options and restricted stock units |       | 2,280                                          |       | — |   |
| Dilutive weighted  average shares                      |       | 48,487                                         |       | 43,213 |   |
|                                                   |       |                                           |       |   |   |
| Net income (loss) per  share:                          |       |                                           |       |   |   |
| Basic                                                  |       | $                                              | 0.45       |   | $ | (0.43 | ) |
| Diluted                                                |       | $                                              | 0.43       |   | $ | (0.43 | ) |

 

**Options to purchase 3,413,722 shares were excluded from thecomputation of diluted net income per share for the three months ended March31, 2006 as these shares would have had an anti-dilutive effect.**

**Options to purchase 13,932,000 shares were excluded fromthe computation of diluted net loss per share for the three months ended March31, 2005 as these shares would have had an anti-dilutive effect.**

**11.****  LegalProceedings**

*U.S.Attorney and SEC Investigations:* On July 3, 2006, Zoran disclosed in a pressrelease that it received a grand jury subpoena from the office of the U.S.attorney for the Northern District of California requesting documents from 1995through the present referring to, relating to or involving stock options, andalso received an informal inquiry from the SEC requesting documents related toZoran’s stock option grants.  Zoranintends to cooperate fully in all government investigations.  These inquiries likely will require theCompany to expend significant management time and incur significant legal andother expenses, and could result in civil and criminal actions seeking, amongother things, injunctions against the Company and its officers and directorsand the payment of significant fines and penalties by the Company and itsofficers and directors, which may adversely affect its results of operationsand cash flow.  The Company cannotpredict how long it will take to or how much more time and resources it willhave to expend to resolve these government inquiries, nor can it predict theoutcome of these inquiries. Also, there can be no assurance that otherinquiries, investigations or actions will not be started by other United Statesfederal or state regulatory agencies or by foreign governmental agencies.

*Late SEC Filings and NasdaqDelisting Proceedings* Due to the Special Committeeinvestigation and the resulting restatements, the Company did not file on timeits Quarterly Reports on Form 10-Q for the quarters ended June 30, 2006 andSeptember 30, 2006, or its Annual Report on Form 10-K for the yearended December 31, 2006. As a result, the Company received Nasdaq StaffDetermination letters dated August 14, 2006, November 15, 2006 and March 20,2007 stating that the Company was not in compliance with the filingrequirements of Marketplace Rule 4310(c)(14) and, therefore, that the Company’sstock was subject to delisting from the Nasdaq Global Select Market. A hearingbefore a Nasdaq Listing Qualifications Panel was held on September 27, 2006 anda decision to grant the Company’s request for continued listing on Nasdaqsubject to certain conditions occurred on December 28, 2006.  The Company has appealed this decision, andthe Nasdaq Listing Council has determined to stay the December 28, 2006 Paneldecision, and any future Panel determinations to suspend Zoran’s securities fromtrading, pending further action from the Listing Council.  On March 2, 2007, the Company provided theListing Council with an additional submission for its consideration regardingcontinued listing.  The Listing Councilwill review the matter on the basis of the written record.

*Shareholder Class Actions and Derivative Litigation Relating toHistorical Stock Option Practices:*****As discussed further below, certain persons and entities identifying themselves asshareholders of Zoran have filed litigation purporting to assert claims arisingout of the historical accounting for stock options.

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*Zucker v. Zoran Corporation, et al..*  On August 10, 2006, a securities class actioncomplaint was filed against Zoran and certain of its officers and directors inthe United States District Court, Northern District of California, allegingviolations of federal securities laws. The Court selected Middlesex Pension Fund as lead plaintiff and approvedlead plaintiff’s selection of counsel for the class.  Plaintiff filed an amended complaint onFebruary 1, 2007 and a second amended complaint on February 20, 2007.  On March 8, 2007, Defendants filed a motionto dismiss.  On March 20, 2007, leadplaintiff filed a notice voluntarily dismissing the action with prejudice as tothe lead plaintiff.

*NCEA-IBEW Pension Fund (The Decatur Plan) v. Galil,et al.*  On June 12,2006, a purported shareholder derivative action was filed by the Decatur Planagainst Zoran as a nominal defendant and certain of its officers and directorsin the United States District Court, Northern District of California, alleging,inter alia, violations of federal and state securities laws and breaches offiduciary duty.  On December 4, 2006,Decatur Plan filed a notice of voluntary dismissal.

*Pfeiffer v. Zoran Corporation et al.*  On September 7, 2006, a purported shareholderderivative action was filed by Milton Pfeiffer against Zoran as a nominaldefendant and certain of its officers and directors in the United StatesDistrict Court, Northern District of California, alleging, inter alia,violations of federal securities laws and breaches of fiduciary duties.

*Gerald del Rosario v. Aharon et al.** *OnSeptember 26, 2006, a purported shareholder derivative action was filed byGerald del Rosario against Zoran as a nominal defendant and certain of itscurrent and former officers and directors in the United States District Court,Northern District of California, alleging, inter alia, violations of federalsecurities laws and breaches of fiduciary duty. On December 8, 2006, the Court issued an order consolidating the *Del Rosario* action with the *Pfeiffer*action.  The Court selected del Rosarioas lead plaintiff and approved lead plaintiff’s selection of counsel for theconsolidated derivative action. Plaintiffs filed a consolidated amended complaint on March 14, 2007.

*Barone v. Gerzberg et al.; Durco v. Gerzberg et al.* On October 23, 2006,two purported shareholder derivative actions were filed by Moshe Barone andJohn Durco against Zoran as a nominal defendant and certain of its current andformer officers and directors in the California Superior Court of Santa ClaraCounty, alleging, inter alia, violations of state securities laws and breachesof fiduciary duty.  On January 24, 2007the Court consolidated the *Barone*and *Durco*actions, appointed Messrs. Barone and Durco as co-leadplaintiffs and approved their selection of counsel for the consolidatedderivative action.  Co-Lead Plaintiffsfiled a consolidated amended complaint on March 26, 2007.

On February 20, 2007, the Company filed acomplaint against ArcSoft Inc. in the California Superior Court for the Countyof Alameda, seeking payment of $4 million in principal, together withaccrued interest then in the amount of approximately $525,000, under fourseparate convertible promissory notes. On February 28, 2007, the Company filed an application with theCourt seeking to attach assets of ArcSoft as security for the payment of itsobligations under the notes.  The notesrepresent amounts loaned by the Company to ArcSoft in 2004 in connection with atransaction involving the transfer to ArcSoft of rights related to a softwareproduct then under development and related agreements regarding the continueddevelopment and commercialization of the product.  On March 28, 2007, ArcSoft filed ananswer denying liability under the notes and asserting various affirmativedefenses.  ArcSoft also filed a crosscomplaint alleging fraud in the inducement of the business arrangement,fraudulent and negligent misrepresentation, breach of contract and of theimplied covenant of good faith and fair dealing, and unjust enrichment andseeking monetary damages of more than $6.9 million.  The hearing on our application for anattachment is currently scheduled for May 3, 2007.  

*Indemnification Obligations***.** Subject to certain limitations, theCompany is obligated to indemnify its current and former directors, officersand employees in connection with the investigation of the Company’s historicalstock option practices and related government inquiries and litigation. Theseobligations arise under the terms of the Company’s certificate ofincorporation, its bylaws, applicable contracts, and Delaware and Californialaw. The obligation to indemnify generally means that the Company is requiredto pay or reimburse the individuals’ reasonable legal expenses and possiblydamages and other liabilities incurred in connection with these matters. TheCompany is currently paying or reimbursing legal expenses being incurred inconnection with these matters by a number of its current and former directors,officers and employees.

*Other Legal Matters.*The Company is named from time to time as a party to lawsuits in the normalcourse of 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.

**12.****  SubsequentEvents**

On February 27, 2007, theCompany elected to: (i) participate in the Internal Revenue Service remediationprogram 2007-18 and pay to the IRS, on behalf of affected and eligibleemployees (not including executive officers), their IRC 409A tax liabilitiesand penalties; (ii) participate in any similar remediation program that may beoffered by any state for applicable state tax liabilities and penalties; (iii),act directly with any state not offering a similar remediation program toaddress any applicable tax liabilities and penalties on behalf of employees;and (iv) pay to such employees a “gross-up” payment to offset the associatedfederal and state income tax consequences.  The Company took this action because the vast majority of the holders ofstock options issued by the Company that are now subject to re-measurement as aresult of the Company’s option investigation were not involved in or aware ofthe stock option pricing determination. Employees who exercised such options in 2006, other than executiveofficers at the time of option grant or entering into this program, willparticipate in this program.  The Companyestimates that the total cash payments needed to deal with the adverse taxconsequences of previously exercised discount priced options granted tonon-officers will be approximately $0.8 million, which is expected to berecorded in 2007.

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In addition, the Companymay consider taking action to minimize the adverse tax consequences that may beincurred by the holders of unexercised discount options. Discount-priced stockoptions vesting after December 31, 2004 (“409A Affected Options”) subject U.S.option holders to a penalty tax under IRC Section 409A (and to similar penaltytaxes under California and other state tax laws, as applicable). The Companymay consider offering to amend the 409A Affected Options held by persons other thandirectors and executive officers to increase the exercise prices of thoseoptions to the market price of our common stock on the revised measurementdate. The amended options would not be subject to taxation under IRC Section409A. Under IRS regulations, the amendments for non-executives cannot beoffered until after this Report is filed and do not need to be completed untilDecember 31, 2007. The Company may also consider approving the payment ofbonuses to holders of those amended options to compensate them for theresulting increase in their option exercise price. The amount of these bonuseswould be effectively repaid to the Company if and when the options areexercised and the increased exercise price is paid (but there is no assurancethat the options will be exercised).  TheCompany has not estimated the expense of any such bonus payments.

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**Item 2.   Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

*This report includes a number of forward-lookingstatements which reflect the Company’s current views with respect to futureevents and financial performance. These forward-looking statements aresubject to certain risks and uncertainties, including those discussed in “PartII, Item 1A. Risk factors” 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 these forward-lookingstatements, which speak only as of the date hereof.*

The following information has been adjusted to reflectthe restatement of the Company’s financial results, which is more fullydescribed in the “Explanatory Note” immediately preceding Part I, Item 1and in Note 2, “Restatement of Condensed Consolidated Financial Statements”of the Notes to Condensed Consolidated Financial Statements.

**Restatements**

On July 3, 2006, theCompany announced that, at the recommendation of the Audit Committee, the Boardof Directors had created a special committee of independent directors (“SpecialCommittee”) to conduct a review of our historical stock option practices. As aresult of its investigation, the Special Committee found, among other things,that some of the original measurement dates used by the Company for optiongrants were not adequately supported by contemporaneous records, and thereforethe measurement dates used by us for accounting purposes required adjustment.The Special Committee concluded that the evidence did not establish that theerrors which it identified resulted from fraud or intentional misconduct by ourcurrent senior management.

Based on the SpecialCommittee’s findings and its own review of the facts, the Board of Directorsconcluded that there was no fraud or intentional misconduct by any currentmember of senior management.  The Boardalso concluded that it has confidence in the integrity of the Company’s ChiefExecutive Officer, Dr. Levy Gerzberg, and the Company’s Chief FinancialOfficer, Mr. Karl Schneider.  

Based on informationobtained from the Special Committee’s review and additional work undertaken bythe Company, management has concluded, and the Audit Committee has agreed, thatthe Company should restate certain previously filed financial statements, toreflect additional stock-based compensation expense with regard to certain paststock option grants. The corrections made in the restatements relate to optionscovering approximately 3.6 million shares. These adjustments, after tax,amounted to an additional stock-based compensation expense of $180,000 and$66,000 in the three months ended March 31, 2006 and 2005 respectively. Therewas no tax impact of these additional stock-based compensation expenses due to thefull valuation allowance on our tax assets.

In connection with therestatement, the Company is recording additional non-cash adjustments that werepreviously considered to be immaterial relating to the timing of revenuerecognition, accrued expenses, amortization of premiums and discounts oninvestments, additional expense related to options granted to a consultant andthe amortization of stock-based compensation relating to a business combinationin 2003.  The Company is also recordinglosses under Accounting Principles Board (“APB”) Opinion No. 18 (“APB No. 18”),“The Equity Method of Accounting for Investments in Common Stock,” to recordthe losses on investment of the prior 17% ownership of Oren Semiconductor, Inc.under the equity method of accounting which was subsequently acquired by Zoranin 2005.  These additional adjustmentsresulted in a cumulative expense of $1.3 million, including $0.2 millionof tax expense, for the periods 2000 through 2005.

Through 2005, we applied APBNo. 25, “Accounting for Stock Issued to Employees,” and its relatedinterpretations, and provided the required pro forma disclosures underStatement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting forStock-Based Compensation,” and SFAS No. 148 “Accounting for Stock-BasedCompensation-Transition and Disclosure.” Under APB Opinion No. 25 (“APB No. 25”), non-cash, stock-basedcompensation expense was recognized for any option for which the exercise pricewas below the market price of our common stock on the actual grant date.Because each of the options identified below (other than those which we havedetermined should be accounted for variably) was deemed to have an exerciseprice below the market price on the appropriate measurement date, we shouldhave recognized a charge for each of those options under APB No. 25, in anamount equal to the number of shares covered by such options, multiplied by thedifference between the exercise price and the market price on the appropriatemeasurement date. That expense should have been amortized over the vestingperiods of the options. Starting in 2006, we adopted SFAS No. 123(R),“Share-Based Payment.” As a result, for 2006, the additional stock-basedcompensation expense required to be recorded for each of the options identifiedbelow was equal to the incremental fair value of those options on theappropriate measurement date over the remaining vesting periods of thoseoptions.  We did not record suchstock-based compensation expenses under APB No. 25 or SFAS No. 123(R) inour previously issued financial statements, and that is the reason for therestatement in this report.  To correctour past accounting for stock options, we recorded additional pre-tax,non-cash, stock-based compensation expense of (a) $11.7 million for the periods1997 to 2005 under APB No. 25 and (b) $180,000 for the three months ended March31, 2006 under SFAS No. 123(R). The fair value of the options is beingrecorded using the accelerated amortization method under FIN 28 over therespective vesting periods of the awards.

Consistent with theaccounting literature and recent guidance from the Securities and ExchangeCommission (“SEC”), the Company has organized the grants with respect to whichan accounting adjustment is required into categories based on grant type andprocess by which the grant was finalized. Based on the relevant facts and circumstances, the Company applied the relevantaccounting standards to determine the measurement date for every grant withineach category. The Company recorded accounting adjustments as required,resulting in stock-based compensation expense and related tax effects.  The Company organized the grants whereadjustments were required as follows:

·      *Company-wide option grants where optionees were addedor grant amounts were changed after the option list was complete, or whereinsufficient contemporaneous documentation of the grant date exists.* For seven Company-wide refresh and retentiongrants made between 1998 and 2003, the Company determined that some employeeswho were omitted from the option grant list were added to the list after thestated

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grant date, and that the number of shares covered byoption grants to some employees was not finally determined until after thestated grant date.  Further, in 2001 and2002, insufficient contemporaneous documentation of the stated grant dateexisted.  As a result of these issues,the Company restated its historical financial statements to increasestock-based compensation expense by approximately $6.3 million, recognized overthe vesting periods of the relevant options.

·      *Re-priced options. *In August 2002, after consideration of relevant information,the Compensation Committee rescinded its April 2002 grant, and its June 2002grant, to executives and other key employees. The Company thereafter reissued the grants in August 2002.  At the time, in consultation with ourexternal advisors, we determined that these transactions did not requirevariable accounting.  As a result of the SpecialCommittee review of our historical stock option practices, we have reassessed thecircumstances surrounding these transactions with our external advisors andhave determined that the grants should have been accounted for variably.  As a result, the Company restated itshistorical financial statements to increase stock-based compensation expense bya cumulative net amount of approximately $3.8 million, recognized over thevesting periods of these options.

·      *Acquisition-related options*.  The Company determined a grant given toretain employees hired in connection with an acquisition in October 2000 shouldhave been accounted for variably.  As aresult, the Company restated its historical financial statements to increasestock-based compensation expense by approximately $0.3 million, recognizedover the vesting periods of these options.

·      *Improper measurement dates for non-refresh stockoption grants. *The Companyrevised the measurement dates for**certaingrants made to new hires and for promotional and other miscellaneousnon-refresh grants made between 1997 and 2003 as a result of approvals thatwere obtained subsequent to the stated grant dates or as a result ofadministrative delays or errors and a small number of stock option grants tonon-executives that were determined to have been established retrospectively.As a result, the Company restated its historical financial statements toincrease stock-based compensation expense by approximately $1.3 million,recognized over the vesting periods of these options.

In the aggregate, we haverecorded additional stock-based compensation expense for the periods 1997through 2005 of approximately $11.7 million on stock option grants made from1997 through 2003.

The incrementalimpact from recognizing stock-based compensation expense resulting from theinvestigation of past stock option grants is as follows (dollars in thousands):
| Fiscal Year                            | ** ** | **Expense  (Benefit)** | ** ** |
|----------------------------------------|------------|------------------------|------------|
| ** **                             |       |                   |       |
| 1997                                   |       | $                      | 190        |   |
| 1998                                   |       | 223                    |       |
| 1999                                   |       | 123                    |       |
| 2000                                   |       | 120                    |       |
| 2001                                   |       | 1,385                  |       |
| 2002                                   |       | 3,182                  |       |
| 2003                                   |       | 5,299                  |       |
| Cumulative effect at December 31, 2003 |       | 10,522                 |       |
| 2004                                   |       | (1,476                 | )          |
| 2005                                   |       | 2,623                  |       |
|                                   |       | $                      | 11,669     |   |

 

The cumulative effect ofall of the restatements up through December 31, 2003 increased additionalpaid-in capital by $10.7 million from $703.8 million to $714.5 million,increased accumulated deficit by $9.0 million from $156.4 million to $165.4 million,and decreased total stockholders’ equity by $0.7 million from $534.3 million to$533.6 million. All the restatements of financial statements, financial dataand related disclosures described in this report are collectively referred toin this report as the “restatements.”

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In December 2006, theCompany amended options to purchase approximately 218,000 shares of commonstock held by Dr. Gerzberg and Mr. Schneider, to increase the exercise price ofthose options to the fair market value of the Company’s common stock on therevised measurement date so that these options are no longer subject to IRCSection 409A.

We have not amended, andwe do not intend to amend, any of our other previously filed Annual Reports onForm 10-K.  Other than this report, we donot intend to amend any of our previously filed Quarterly Reports on Form 10-Qfor the periods affected by the restatements. We present restated quarterly financial information for each of thequarters in 2006 and 2005 in “Selected Quarterly Financial Information(Unaudited)” included in the Company’s Annual Report on Form 10-K for2006.

The restatements did nothave a material impact on our analysis of results of operations, financialposition and changes in financial position included in Management’s Discussionand Analysis of Financial Condition and Results of Operations of our previouslyfiled Quarterly Reports on Form 10-Q. Accordingly, we have not updated thosediscussions and analyses.

**Internal Controls**

Based on the definitionof “material weakness” in the Public Company Accounting Oversight Board’sAuditing Standard No. 2, *An Audit of InternalControl Over Financial Reporting Performed in Conjunction With an Audit ofFinancial Statements*, the restatement of financial statements inprior filings with the SEC is a strong indicator of the existence of a “materialweakness” in the design or operation of internal control over financialreporting. However, the Company has concluded that the control deficienciesthat resulted in the restatement of the previously issued consolidatedfinancial statements did not constitute a material weakness as ofMarch 31, 2006 because management determined that as of March 31,2006 the Company’s internal controls were effective.

For a more completediscussion of remedial measures and our controls and procedures, please referto Item 4– Controls and Procedures.

The SEC may disagree withthe manner in which we have accounted for and reported, or not reported, thefinancial impact of past option grant measurement date errors, and there is arisk that its inquiry could lead to circumstances in which we may have tofurther restate our prior financial statements, amend prior filings with theSEC, or otherwise take other actions not currently contemplated. In addition,the SEC may issue guidance on disclosure requirements related to the financialimpact of past option grant measurement date errors that may require us toamend this filing or prior filings with the SEC to provide additionaldisclosures pursuant to this guidance. Any such circumstance could also lead tofuture delays in filing our subsequent SEC reports and delisting of our commonstock from the NASDAQ Global Select Market.

As a result of the investigation of its historical stockoption practices, we analyzed Zoran’s internal control over financial reportingfor periods before January 1, 2003, and determined that the Company did nothave sufficient safeguards in place to monitor its control practices regardingstock option pricing and related financial reporting and to foster an effectiveflow of information between those responsible for stock option pricing andthose responsible for financial reporting. Inadequate training, communicationand coordination in and among the Company’s human resources, stockadministration, legal and finance functions prevented the Company from assuringthat stock options were priced and accounted for correctly, primarily for theyears 1997 through 2002.

From 2003 through 2005, in compliance with theSarbanes-Oxley Act of 2002 and evolving accounting guidance, the Companyimplemented improved procedures, processes and systems to provide additionalsafeguards and greater internal control over its stock option granting andadministration. These improvements included:

·                  Documenting andassessing the design and operation of internal controls;

·                  Segregatingresponsibilities, adding reviews and reconciliations, and redefining roles andresponsibilities;

·                  Implementing anew equity accounting system and a new stock administration function; and

·                  Implementing,prior to the adoption of SFAS No. 123(R), the practice of using the receipt ofthe final Board or Compensation Committee approval as the grant and measurementdate for stock option grants.

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As a result of the recommendations of theSpecial Committee of our Board of Directors and deliberations of theCompensation Committee of our Board of Directors, we have adopted the followingpolicies governing all stock option grants:

 

·                  All option grants must be approved by theCompensation Committee or the Board of Directors; the authority to approveoption grants may not be delegated. 

·                  Option grants (including officer, vicepresident, rank and file, promotional and new hire grants) are generallyconsidered at regularly scheduled quarterly meetings of the CompensationCommittee or the Board of Directors, and action may not be taken by unanimouswritten consent.  

·                  Grants are generally effective as of thelater of (i) the second trading day following the Company’s public announcementof its financial results for the preceding quarter or (ii) the date of theBoard or committee meeting.   

·                  Grants should be recorded promptly in the Company’s optionaccounting database, and grantees should receive prompt written notification oftheir grants.

·                  The annual focal review process willidentify a specific date to complete the process of generating recommendedgrant amounts, after which the recommendations will be submitted to theCompensation Committee or the Board of Directors for approval. 

·                  Board or committee minutes are to bedrafted and circulated to directors for comment as soon as reasonably possible.

 

The Special Committeeinvestigation and the Company’s related activities discovered no stock optiongrant after December 31, 2003 that required accounting adjustments.

**Related Proceedings**

*U.S.Attorney and SEC Requests.* On July 3, 2006, Zoran disclosed in a pressrelease that it received a grand jury subpoena from the office of the U.S.attorney for the Northern District of California requesting documents from 1995through the present referring to, relating to or involving stock options, andalso received an informal inquiry from the SEC requesting documents related toZoran’s stock option grants.  Zoranintends to cooperate fully in all government inquiries or investigations.  There is no assurance that we will not besubject to inquiries related to our stock option grant practices by otherfederal, state or foreign regulatory agencies. All such inquiries are likely torequire us to continue to expend significant management time and incursignificant legal and other expenses, and could result in civil and criminalactions seeking injunctions, fines or other sanctions that could adverselyaffect our business and financial results.

*ShareholderClass Actions and Derivative Litigation Relating to Historical Stock OptionPractices:*****Asdiscussed under Part II—Item 1—Legal Proceedings above, certain persons and entitiesidentifying themselves as shareholders of Zoran have filed class actioncomplaints against the Company and derivative actions purporting to assert claimson behalf of and in the name of the Company against various of the Company’scurrent and former directors and officers relating to Zoran’s historicalaccounting for and disclosures related to stock options. There may beadditional lawsuits of this nature filed in the future.  We cannot predict the outcome of any suchlitigation, or the amount of time and expenses that will be required to resolvethem.  If these lawsuits become timeconsuming and expensive, or if there are unfavorable outcomes in any of thesecases, there could be a material adverse effect on our business, financialcondition and results of operations.

*Cost ofRelated Proceedings and Restated Financial Statements*. Wehave incurred substantial expenses for legal, accounting, tax and otherprofessional services in connection with the Special Committee investigation,our own related review work, the preparation of the restated financialstatements, the SEC and Department of Justice matters and inquiries from othergovernment agencies, and the related litigation. We have recorded expenses of$5.8 million in aggregate through 2006 and we expect to incur additionalcosts in the future.

*Restatement and Impact on FinancialStatements*

The following informationhas been adjusted to reflect the restatement of the Company’s financialresults, which is more fully described in the “Explanatory Note” immediatelypreceding Part I, Item 1 and in Note 2, “Restatement of ConsolidatedFinancial Statements” in Notes to Consolidated Financial Statements of thisAnnual Report on Form 10-K.

In connection with therestatement, the Company is recording additional non-cash adjustments that werepreviously considered to be immaterial relating to the timing of revenuerecognition, accrued expenses, amortization of premiums and discounts oninvestments, additional expense related to options granted to a consultant, andthe calculation of amortization of stock-based compensation relating to abusiness combination in 2003.

For additionalinformation, refer to “Note 2 – Restatement of Consolidated FinancialStatements,” in Notes to Consolidated Financial Statements.

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The income statement impact of the restatements are as follows (inthousands):
| ** **                                                                                                                | ** ** | **Cumulative  effect at  December  31, 2005** | ** ** | **Year Ended  December 31,   2005** | ** ** | **Year Ended  December 31,  2004** | ** ** | **Cumulative  effect at  December  31, 2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------------------|------------|
| Net loss as  previously reported                                                                                          |       | $                                                       | (26,971    | )                                                  | $          | (47,354                                      | )          |                                                    |       |   |   |
| Additional  compensation (expense) benefit resulting from improper measurement dates for  stock option grants, net of tax |       | (11,669                                                 | )          | (2,623                                             | )          | $                                            | 1,476      |                                                    | $          | (10,522 | ) |
| Other  adjustments, net of tax                                                                                            |       | (1,374                                                  | )          | (678                                               | )          | (2,230                                       | )          | 1,534                                                   |       |
| Total increase  to net loss                                                                                               |       | (13,043                                                 | )          | (3,301                                             | )          | (754                                         | )          | (8,988                                                  | )          |
| Net loss, as restated                                                                                                     |       |                                                    |       | (30,272                                            | )          | (48,108                                      | )          |                                                    |       |
|                                                                                                                           |            |                                                         |            |                                                    |            |                                              |            |                                                         |            |  |  |  |  |

 
| ** **                                                                                          | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2003**                                   | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** | **1999** | ** ** | **1998** | ** ** | **1997** | ** ** |
| Stock based  compensation expense, as previously reported                                           |       | $                                          | (6,281     | ) | $ | (292 | ) | $ | (544 | ) | $ | (99 | ) | $ | — |   | $ | — |   | $ | — |   |
| Additional  compensation expense resulting from improper measurement dates for stock  option grants |       | (5,299                                     | )          | (3,182 | ) | (1,385 | ) | (120 | ) | (123 | ) | (223 | ) | (190 | ) |
| Stock based  compensation expense, as restated                                                      |       | $                                          | (11,580    | ) | $ | (3,474 | ) | $ | (1,929 | ) | $ | (219 | ) | $ | (123 | ) | $ | (223 | ) | $ | (190 | ) |

 

 

 

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**Overview**

Our productsconsist of integrated circuits and related products used in digital versatiledisc players, or DVDs, movie and home theater systems, digital cameras andvideo editing systems.  We also provideintegrated circuits, software and platforms for digital television applicationsthat enable the delivery and display of digital video content through a set-topbox or television as well as digital imaging products consisting ofsemiconductor hardware and software that enable users to print, scan, processand transmit documents to computer peripherals that perform printingfunctions.  Subsequent to our acquisitionof Emblaze Semiconductor Ltd. on July 8, 2004, we also provide highperformance, low-power application processors, technology and products for themultimedia mobile telephone market. Through the acquisition of Oren Semiconductor, Inc. onJune 10, 2005, Zoran obtained Oren’s demodulator ICtechnology for the global high definition television market.

We derive most ofour revenues 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.

Our cost ofhardware product revenues consists primarily of fabrication costs, assembly andtest costs, 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.

We also deriverevenue from licensing our software and other intellectual property.  Licensing revenue includes 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 apercentage of total revenues over the past several years.  These development contracts have provided uswith partial funding for the development of some of our products.  These development contracts provide forlicense and milestone payments which are recorded as development revenue.  We classify all development costs, includingcosts related to these development contracts, as research and developmentexpenses.  We retain ownership of theintellectual property 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 recognizesoftware license revenues in accordance with the provisions of Statement ofPosition (SOP) No. 97-2, *SoftwareRevenue Recognition,*as amended by SOP No. 98-9, *Modification of*SOP No. 97-2, *Software Revenue Recognition, With Respect to CertainTransactions.* Our software license agreements typically includeobligations to provide maintenance and other support over a fixed term andallow for renewal of maintenance services on an annual basis. We determine thefair value of our maintenance obligations with reference to substantive renewalrates within the agreement or objective evidence of fair value as requiredunder SOP No. 97-2. Maintenance and support revenue is recognized ratablyover the term of the arrangement.  Wealso receive royalty revenues based on per unit shipments of products embeddingour software which we recognize upon receipt of a royalty report from the customer,typically one quarter in arrears.

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 are a partyto research and development agreements with the Chief Scientist in Israel’sMinistry of Industry and Trade and the Israel-United States BinationalIndustrial Research and Development Foundation, which fund up to 50% ofincurred project costs for approved products up to specified contract maximums.  These agreements require us to use our bestefforts to achieve specified results and require us to pay royalties at ratesof 3% to 5% of resulting product sales, and up to 30% of resulting licenserevenues, up to a maximum of 100% to 150% of total funding received.

Reported researchand development expenses are net of these grants, which fluctuate from periodto period.  We believe that significantinvestments in research and development are required for us to remaincompetitive, and we expect to continue to devote significant resources toproduct development, although such expenses as a percentage of total revenuesmay fluctuate.

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Our selling,general and administrative expenses consist primarily of employee-relatedexpenses, sales commissions, product promotion and other professionalservices.  We expect that selling,general and administrative expenses will continue to increase to support ouranticipated growth.

We conduct amaterial amount of our research and development and certain sales and marketingand administrative operations in our foreign subsidiary offices.  As a result, some of our expenses areincurred in foreign currency.  To date,substantially all of our hardware product revenues and our software and otherrevenues have been denominated in U.S. dollars and most costs of hardwareproduct revenues have been incurred in U.S. dollars.  We expect that most of our revenues and costsof revenue will continue to be denominated and incurred in U.S. dollars for theforeseeable future.  We have notexperienced material losses or gains as a result of currency exchange ratefluctuations and have not engaged in hedging transactions to reduce ourexposure to such fluctuations.  We may inthe future elect to take action to reduce our foreign exchange risk.

Our effectiveincome tax rate has benefited from the availability of previously unbenefittednet operating losses which we have utilized to reduce taxable income forU.S.  federal income tax purposes and byour Israel based subsidiary’s status as an “Approved Enterprise” under Israelilaw, which provides a ten-year tax holiday for income attributable to a portionof our operations in Israel.  Our U.S.federal net operating losses expire at various times between 2017 and 2024, andthe benefits from our subsidiary’s Approved Enterprise status expire at varioustimes beginning in 2008.

**RecentAcquisition**

*OrenSemiconductor, Inc.*

On June 10,2005, we completed our acquisition of Oren Semiconductor, Inc. (“Oren”), aprivately-held provider of demodulator ICs for the global high definitiontelevision market.  Prior to thisacquisition, we had made investments in Oren that represented a 17% ownershipinterest with a net book value of $3.4 million at the time of acquisition.Under the terms of the acquisition agreement, we acquired the remaining 83% ofOren’s outstanding stock by means of a merger of Oren with a wholly-ownedsubsidiary of Zoran, in consideration for which we paid an aggregate of$28.4 million in cash and issued 1,188,061 shares of Zoran common stockvalued at $12.9 million, for total consideration of $41.3 million, to theother stockholders of Oren and to employees holding Oren options.  The acquisition was accounted for under thepurchase method of accounting.

Following thecompletion of the acquisition, the results of operations of Oren have beenincluded in our consolidated financial statements.  In addition, we recorded lossesunder Accounting Principles Board Opinion No. 18 (“APB No. 18”), “TheEquity Method of Accounting for Investments in Common Stock,” to recordthe losses on investment of the prior 17% ownership of OrenSemiconductor, Inc. under the equity method of accounting.  Accordingly, our results of operations forthe three months ended March 31, 2006 include Oren’s operations for thefull year; our results of operations for the year ended December 31, 2005include Oren’s operations between June 10, 2005 and December 31, 2005 and$218,000 representing our portion of the losses incurred by Oren betweenJanuary 1, 2005 and June 10, 2005; and our results of operations for the yearended December 31, 2004 do not include Oren’s operations.

**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.  During the first quarter of 2006, wereorganized our operating structure to bring together our consumer electronicproduct lines under a single operating group, in recognition of theaccelerating convergence of consumer products and our strategy of sharingtechnology among its various product lines. The new Consumer group combines the former Digital Versatile Disc (DVD),Digital Television (DTV) and Mobile product groups whose operations werepreviously reported separately.  We willcontinue to report the operations of its Imaging group as a separate operatingsegment.

**Results of Operations**

*Revenues*

Totalrevenues increased 92.4% to $142.2 million for the three months ended March 31,2006 compared to $73.9 million for the three months ended March 31, 2005.  Consumer segment revenues increased $70.6million while Imaging segmentrevenues decreased $2.2 million.  Withinthe Consumer segment, license revenues related to the settlement of litigationin the first quarter of 2006 accounted for $30.2 million of the increase.  The remaining increase of $40.4 million inConsumer segment revenues was a result of increasedrevenues in the Mobile, DTV and DVD product lines of $23.1 million, $13.0million and $4.3 million, respectively.

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Hardwareproduct revenues for the three months ended March 31, 2006 were $99.2 millioncompared to $59.0 million for the comparable period of the prior year.  Hardware product revenues increased $41.4million in the Consumer segment and decreased $1.2 million in the Imagingsegment.  Within the Consumer segment, hardware product revenues increased $23.6 millionin the Mobile product line, $13.7 million in the DTV product line and $4.1million in the DVD product line, in each case driven by increased unit shipments.

Softwareand other revenues were $12.9 million and $14.9 million for the three monthsended March 31, 2006 and 2005, respectively. The decrease in software and otherrevenues was largely attributable to a $1.0 million decrease in the Imagingsegment.

*Cost of Hardware Product Revenues*

Cost of hardware productrevenues was $53.7 million for the quarter ended March 31, 2006 compared to$37.0 million for the same period of 2005. The increase in costs was primarily a result of the corresponding increasein hardware product revenues.  As apercentage of hardware product revenues, hardware product costs decreased from62.6% for the three months ended March 31, 2005 to 54.1% for the three monthsended March 31, 2006.  The decrease inhardware product costs as a percentage of hardware product revenues wasprimarily due to a change in product mix within the DVD product line to anincreased percentage of lower cost products.

*Research and Development*

Researchand development expenses were $24.2 million for the three months ended March31, 2006, compared to $20.1 million for the same period of 2005. This increasewas primarily attributed to stock-based compensation expenses of $1.6 millionrecorded in the current period as a result of the adoption of SFAS No. 123(R)and the inclusion of the operations of Oren which was acquired in June 2005.

*Selling, General and Administrative*

Selling, general andadministrative expenses were $24.9 million for the three months ended March 31,2006 compared to $22.8 million for the same period of 2005.  This increase was primarily attributed tostock-based compensation expenses of $3.0 million recorded under SFAS No. 123(R)in the current period, continued increases in marketing and field applicationsupport expenses to support revenue growth in our Asia Pacific markets and theinclusion of the Oren operations.  Theseincreases were partially offset by a decrease in legal fees as a result of thesettlement of our patent litigation with Mediatek, Inc.

*Amortization of Intangible Assets*

During the three monthsended March 31, 2006, we incurred charges of $12.7 million related to theamortization of intangible assets compared to $12.3 million for the threemonths ended March 31, 2005.  Thisincrease was a result of the addition of $9.1 million of amortizable intangibleassets acquired in the Oren acquisition in June 2005.  At March 31, 2006,we had approximately $106.5 million in net intangible assets acquired throughthe Oak, Emblaze and Oren acquisitions which we will continue to amortize on astraight line basis through 2010.

*Amortization of stock compensationresulting from business combinations*

As a result of theadoption of SFAS No. 123(R) during the first quarter of 2006, we now record acharge for all stock-based compensation expenses as described in Note 2 toCondensed Consolidated Financial Statements. As a result, we no longer record a separate charge for amortization ofstock compensation resulting from business combinations.  For the three months ended March 31, 2005, werecorded a charge of $517,000 related to the amortization of stock compensationresulting from business combinations primarily as a result of stock optionsgranted in connection with the Oak acquisition.

*Interest and Other Income*

Interestand other income was $2.8 million for the three month period ended March 31,2006, compared to $103,000 for the same period of 2005.  This increase was a result of net gains ininvestments of $1.0 million recorded during the first quarter of 2006 as wellas an increase in interest income as a result of our higher average cash andshort term investment balances.

*Provision for Income Taxes*

Werecorded a tax provision of $8.8 million for the three month period endedMarch 31, 2006.  We did not record atax provision or benefit for the quarter ended March 31, 2005. Our effectiveincome tax rate has benefited from the availability of previously

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unbenefittednet operating losses which we have utilized to reduce taxable income forU.S.  federal income tax purposes and byour Israel based subsidiary’s status as an “Approved Enterprise” under Israelilaw, which provides a ten-year tax holiday for income attributable to a portionof our operations in Israel.  Our U.S.federal net operating losses expire at various times between 2017 and 2024, andthe benefits from our subsidiary’s Approved Enterprise status expire at varioustimes beginning in 2008. At March 31, 2006, we continue to carry a fullvaluation allowance against our net deferred tax assets as management hasdetermined that it is more likely than not that our deferred tax assets may notbe realized.

**Liquidity and Capital Resources**

AtMarch 31, 2006, we had $113.8 million of cash and cash equivalents and $104.1million of short-term investments.  AtMarch 31, 2006, we had $229.9 million of working capital.

Ouroperating activities generated cash of $52.5 million during the first quarterof 2006, primarily due to net income of $20.7 million and non-cash items suchas amortization of $12.8 million, depreciation of $2.4 million and stock-basedcompensation expense of $4.8 million. Cash provided by operations also increased due to a decrease of $7.7million in accounts receivable due to the timing of collections and a netincrease in accounts payable, accrued expenses and other liabilities, goodwilland other long term liabilities totaling $10.1 million.  These increases were partially offset by a$6.0 million increase in inventories to meet the increasing demand for ourproducts.

Cashused in investing activities was $35.0 million during the three months endedMarch 31, 2006, principally reflecting the net purchase of investmentsof $33.6 million. In addition we spent $1.2 million for property and equipment.

Cash provided by financing activities was$17.2 million during the three months ended March 31, 2006 due to proceedsreceived from issuances of common stock through exercises of employee stockoptions.

Net cash used inoperating activities during the first three months of 2005 was $4.5million.  While we recorded a net loss of$18.7 million, this loss included non-cash charges of $2.4 million fordepreciation of property and equipment, $12.3 million for amortization and$583,000 for stock-based compensation. Additional cash used in operating activities was a result of the changesin current assets and liabilities totaling $1.1 million.

Cash used in investingactivities was $2.3 million during the three months ended March 31, 2005,reflecting the net purchase of investments of $780,000 and the purchases of$1.5 million of property and equipment.

Cash provided byfinancing activities was $375,000 during the three months ended March 31, 2005attributable to the issuance of common stock during the period.

At March 31, 2006, we did not have any relationships withunconsolidated entities or financial partnerships, such as entities oftenreferred to as structured finance or special purpose entities, established forthe purpose of facilitating off-balance sheet arrangements or othercontractually narrow or limited purposes. Accordingly, we are not exposed to the type of financing, liquidity,market or credit risk that could arise if we had engaged in such relationships.

We believe that 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.  Nonetheless, our future capitalrequirements may vary materially from those now planned and will depend on manyfactors 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;

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·                  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.

Tothe extent that our existing resources and cash generated from operations areinsufficient to fund our future activities, we may need to raise additionalfunds through public or private financings or borrowings.  If additional funds are raised through theissuance of debt securities, these securities could have rights, preferencesand privileges senior to holders of common stock, and the terms of this debtcould impose restrictions on our operations. The sale of additional equity or convertible debt securities couldresult in additional dilution to our stockholders.  We cannot be certain that additionalfinancing will be available in amounts or on terms acceptable to us, if atall.  If we are unable to obtain thisadditional financing, we may be required to reduce the scope of our plannedproduct development and sales and marketing efforts, which could harm ourbusiness, financial condition and operating results.

**Item3.  Quantitative and QualitativeDisclosures About Market Risk**

We are exposed to financialmarket risks including changes in interest rates and foreign currency exchangerates.

The fair value of our investment portfolio or relatedincome would not be significantly impacted by either a 10% increase or decreasein interest rates due mainly to the short-term nature of the major portion ofour investment portfolio.

A majority of our revenue and capital spending istransacted in U.S. dollars, although a portion of the cost of our operations,relating mainly to our personnel and facilities in Israel, is incurred in NewIsraeli Shekels.  As a result, webear the risk that the rate of inflation in Israel or the decline in the valueof U.S. dollars compared to the NewIsraeli Shekel will increase our costs as expressed in U.S. dollars.We have notengaged in hedging transactions to reduce our exposure to fluctuations that mayarise from changes in foreign exchange rates. Based on our overall currency rate exposure at March 31, 2006, anear-term 10% appreciation or depreciation of the New Israeli Shekel would havean immaterial affect on our financial condition.

**Item 4.  Controls and Procedures**

*Disclosure Controls andProcedures*

Under the supervision andwith the participation of the Company’s management, including the Company’sChief Executive Officer and Chief Financial Officer, the Company conducted anevaluation of its disclosure controls and procedures as defined in Rules13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended(“Exchange Act”).  Based on thisevaluation, our Chief Executive Officer and Chief Financial Officer concludedthat the Company’s disclosure controls and procedures were effective as of March 31,2006. The Company's disclosure controls and procedures are designed to ensurethat information required to be disclosed by us in the reports we file underthe Exchange Act is recorded, processed, summarized and reported within thetime periods specified in the SEC's rules and forms and that such informationis accumulated and communicated to management, including the Chief ExecutiveOfficer and Chief Financial Officer, to allow timely discussions regardingrequired disclosures.

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*Management's Consideration of theRestatement*

As disclosed in Note2,"Restatement of Consolidated Financial Statements," to ourconsolidated financial statements included in Item 8 of our Annual Report onForm 10-K, we restated previously issued financial statements to recordincremental non-cash stock based compensation charges under APB No. 25 in theamount of $11.7 million between 1997 and 2005 and an additional $0.4 million in2006 under SFAS No. 123(R).  Theseaccounting errors arose from the use of incorrect stock option grantmeasurement dates for grants made during the period 1997 to 2003.

In coming to theconclusion that our disclosure controls and procedures were effective as of March 31,2006, management considered control deficiencies related to the stock optiongranting process that resulted in the need to restate our previously issuedfinancial statements.

During fiscal year 2004in compliance with the Sarbanes-Oxley Act of 2002, the Company implementedimproved procedures, processes and systems to provide additional safeguards andgreater internal control over its stock option granting and administration.These improvements included:

·                  Segregatingresponsibilities, adding reviews and reconciliations, and redefining roles andresponsibilities in the human resources function;

·                  Upgradingsystems and system controls that support the grant process and improving theaccuracy and timeliness of accounting for grants, including robustdocumentation of grant approvals and usage of a hosted stock administrationsystem; and

·                  Obtaining andtraining more qualified competent individuals in the human resources and stockadministration function.

The Company believes thatthese changes remediated the historical control deficiency. Consequently, thestock option grant process did not constitute a control deficiency as of December 31,2006.

*Changes to Internal Control OverFinancial Reporting*

There were no changes inthe Company’s internal control over financial reporting during the quarterended March 31, 2006 that have materially affected, or are reasonablylikely to materially affect, the Company’s internal control over financialreporting.

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**PART II. OTHER INFORMATION**

**Item 1.Legal Proceedings**

*U.S.Attorney and SEC Investigations:* On July 3, 2006, Zoran disclosed in a pressrelease that it received a grand jury subpoena from the office of the U.S.attorney for the Northern District of California requesting documents from 1995through the present referring to, relating to or involving stock options, andalso received an informal inquiry from the SEC requesting documents related toZoran’s stock option grants.  Zoranintends to cooperate fully in all government investigations.  These inquiries likely will require theCompany to expend significant management time and incur significant legal andother expenses, and could result in civil and criminal actions seeking, amongother things, injunctions against the Company and its officers and directorsand the payment of significant fines and penalties by the Company and itsofficers and directors, which may adversely affect its results of operationsand cash flow.  The Company cannotpredict how long it will take to or how much more time and resources it willhave to expend to resolve these government inquiries, nor can it predict theoutcome of these inquiries. Also, there can be no assurance that otherinquiries, investigations or actions will not be started by other United Statesfederal or state regulatory agencies or by foreign governmental agencies.

*Late SEC Filings and NasdaqDelisting Proceedings* Due to the Special Committeeinvestigation and the resulting restatements, the Company did not file on timeits Quarterly Reports on Form 10-Q for the quarters ended June 30, 2006 andSeptember 30, 2006. As a result, the Company received Nasdaq StaffDetermination letters,  dated August 14,2006, November 15, 2006 and March 20, 2007 stating that it was not incompliance with the filing requirements of Marketplace Rule 4310(c)(14) and,therefore, that the Company’s stock was subject to delisting from the NasdaqGlobal Select Market. A hearing before a Nasdaq Listing Qualifications Panelwas held on September 27, 2006 and a decision to grant the Company’s requestfor continued listing on Nasdaq subject to certain conditions occurred onDecember 28, 2006.  The Company hasappealed this decision, and the Nasdaq Listing Council has determined to staythe December 28, 2006 Panel decision, and any future Panel determinations to suspendZoran’s securities from trading, pending further action from the ListingCouncil.  On March 2, 2007, the Companyprovided the Listing Council with an additional submission for itsconsideration regarding continued listing. The Listing Council will review the matter on the basis of the writtenrecord.

*Shareholder Class Actions and Derivative Litigation Relating toHistorical Stock Option Practices:*****As discussed further below, certain persons and entities identifying themselves asshareholders of Zoran have filed litigation purporting to assert claims arisingout of the historical accounting for stock options.

*Zucker v. Zoran Corporation, et al..*  On August 10, 2006, a securities class actioncomplaint was filed against Zoran and certain of its officers and directors inthe United States District Court, Northern District of California, allegingviolations of federal securities laws. The Court selected Middlesex Pension Fund as lead plaintiff and approvedlead plaintiff’s selection of counsel for the class.  Plaintiff filed an amended complaint onFebruary 1, 2007 and a second amended complaint on February 20, 2007.  On March 8, 2007, Defendants filed a motionto dismiss.  On March 20, 2007, leadplaintiff filed a notice voluntarily dismissing the action with prejudice as tothe lead plaintiff.

*NCEA-IBEW Pension Fund (The Decatur Plan) v. Galil,et al.*  On June 12,2006, a purported shareholder derivative action was filed by the Decatur Planagainst Zoran as a nominal defendant and certain of its  officers and directors in the United States DistrictCourt, Northern District of California, alleging, inter alia, violations offederal and state securities laws and breaches of fiduciary duty.  On December 4, 2006, Decatur Plan filed anotice of voluntary dismissal.

*Pfeiffer v. Zoran Corporation et al.*  On September 7, 2006, a purported shareholderderivative action was filed by Milton Pfeiffer against Zoran as a nominaldefendant and certain of its officers and directors in the United StatesDistrict Court, Northern District of California, alleging, inter alia,violations of federal securities laws and breaches of fiduciary duties.

*Gerald del Rosario v. Aharon et al.** *OnSeptember 26, 2006, a purported shareholder derivative action was filed byGerald del Rosario against Zoran as a nominal defendant and certain of itscurrent and former officers and directors in the United States District Court,Northern District of California, alleging, inter alia, violations of federalsecurities laws and breaches of fiduciary duty. On December 8, 2006, the Court issued an order consolidating the *Del Rosario* action with the *Pfeiffer*action.  The Court selected del Rosarioas lead plaintiff and approved lead plaintiff’s selection of counsel for theconsolidated derivative action. Plaintiffs filed a consolidated amended complaint on March 14, 2007.

*Barone v. Gerzberg et al.; Durco v. Gerzberg et al.* On October 23, 2006,two purported shareholder derivative actions were filed by Moshe Barone andJohn Durco against Zoran as a nominal defendant and certain of its current andformer officers and directors in the California Superior Court of Santa ClaraCounty, alleging, inter alia, violations of state securities laws and breachesof fiduciary duty.  On January 24, 2007the Court consolidated the *Barone*and *Durco*actions, appointed Messrs.

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Barone and Durco as co-lead plaintiffs and approved their selection ofcounsel for the consolidated derivative action. Co-Lead Plaintiffs filed a consolidated amended complaint on March 26,2007.

On February 20, 2007, the Company filed a complaintagainst ArcSoft Inc. in the California Superior Court for the County of Alameda,seeking payment of $4 million in principal, together with accrued interest thenin the amount of approximately $525,000, under four separate convertiblepromissory notes.  On February 28,2007, the Company filed an application with the Court seeking to attach assetsof ArcSoft as security for the payment of its obligations under the notes.  The notes represent amounts loaned by theCompany to ArcSoft in 2004 in connection with a transaction involving thetransfer to ArcSoft of rights related to a software product then underdevelopment and related agreements regarding the continued development andcommercialization of the product.  OnMarch 28, 2007, ArcSoft filed an answer denying liability under the notesand asserting various affirmative defenses. ArcSoft also filed a cross complaint alleging fraud in the inducement ofthe business arrangement, fraudulent and negligent misrepresentation, breach ofcontract and of the implied covenant of good faith and fair dealing, and unjustenrichment and seeking monetary damages of more than $6.9 million.  The hearing on our application for anattachment is currently scheduled for May 3, 2007.

*Indemnification Obligations***.** Subject to certain limitations, theCompany is obligated to indemnify its current and former directors, officersand employees in connection with the investigation of the Company’s historicalstock option practices and related government inquiries and litigation. Theseobligations arise under the terms of the Company’s certificate ofincorporation, its bylaws, applicable contracts, and Delaware and Californialaw. The obligation to indemnify generally means that the Company is requiredto pay or reimburse the individuals’ reasonable legal expenses and possiblydamages and other liabilities incurred in connection with these matters. TheCompany is currently paying or reimbursing legal expenses being incurred inconnection with these matters by a number of its current and former directors,officers and employees.

*Other Legal Matters.*The Company is named from time to time as a party to lawsuits in the normalcourse of 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.

**Item 1A.   RiskFactors**

Our future business, operating results and financialcondition are subject to various risks and uncertainties, including thosedescribed below.

**Thediscovery that the appropriate measurement dates for financial accountingpurposes of certain stock option grants differed from the recorded grant datesof those awards has had, and may continue to have, a material adverse effect onour financial results.**

We cannot predict the outcome of the pendinggovernment inquiries or stockholder lawsuits, and we may face additionalgovernment actions, stockholder lawsuits and other legal proceedings related toour historical stock option practices and the remedial actions we have taken.All of these events have required us, and will continue to require us, toexpend significant management time and incur significant accounting, legal, andother expenses. This could divert attention and resources from the operation ofour business and adversely affects our financial condition and results ofoperations.

**The independentinvestigation of our historical stock option practices and resultingrestatements has been time consuming and expensive, and has had a material adverseeffect on our financial performance.**

The independent investigation of our historical stock option practicesand resulting restatement activities have required us to expend significantmanagement time and incur significant accounting, legal and other expensestotaling $5.8 million in 2006 and we expect to incur additional costs in the futureperiods.  The resulting restatements havehad a material adverse effect on our results of operations. We have recordedadditional stock-based compensation expense of $11.7 million for stockoption grants, recognized over the periods from 1997 to 2005. There was no taximpact of these additional stock-based compensation expenses due to the fullvaluation allowance on our tax assets.  Inaddition, we have recorded other adjustments previously considered to beimmaterial totaling $1.3 million (net of tax of $0.2 million).  As a result, our restated consolidatedfinancial statements reflect a decrease in net income of $13.0 million forthe period of 1997 to 2005.  The effectof the restatement adjustments on our consolidated balance sheet at December31, 2005 resulted in a $2.4 million decrease in stockholders’ equity.

**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 inquiries by the United States Attorney’sOffice for the Northern District of California (“USAO”) and the United StatesSecurities and Exchange Commission (“SEC”) into our historical stock optionpractices are ongoing. We have cooperated with the USAO and the SEC and intendto continue to do so. The period of time necessary to resolve these inquiriesis uncertain, and we cannot predict the outcome of these inquiries or whetherwe will face additional government inquiries, investigations or other actionsrelated to our historical stock option practices. These inquiries will likelyrequire us to continue to expend significant management time and incursignificant legal and other expenses, and could result in civil and criminalactions seeking, among other things, injunctions against the Company and thepayment of significant fines and penalties by the Company, which may have amaterial adverse effect on our financial condition, results of operations andcash flow.

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**Wehave not been in compliance with SEC reporting requirements and Nasdaq listingrequirements and may continue to face compliance issues with both. If we areunable to remain in compliance with SEC reporting requirements and Nasdaqlisting requirements, there may be a material adverse effect on us and ourstockholders.**

Due to the independent investigation andresulting restatements, in recent periods we were unable to file our periodicreports with the SEC on time and faced the possibility of delisting of ourstock from the Nasdaq Global Select Market.  As a result of our delay in filing periodicreports on a timely basis, we will not be eligible to use a registrationstatement on Form S-3 to register offers and sales of our securities untilall periodic reports have been timely filed for at least 12 months.  If the Nasdaq Listing and Hearing ReviewCouncil concludes that we are not in compliance with applicable listingrequirements, then we may be unable to maintain an effective listing of ourstock on a national securities exchange. If this happens, the price of ourstock and the ability of our stockholders to trade in our stock could beadversely affected. In addition, we would be subject to a number ofrestrictions regarding the registration of our stock under federal securitieslaws, and we would not be able to issue stock options or other equity awards toour employees or non-employees or allow them to exercise their outstandingoptions, which could adversely affect our business and results of operations.

**Wehave been named as a party to stockholder derivative and class action lawsuitsrelating to our historical stock option practices, and we may be named inadditional lawsuits in the future. This litigation could become time consumingand expensive and could result in the payment of significant judgments andsettlements, which could have a material adverse effect on our financialcondition and results of operations.**

In connection with ourhistorical stock option practices and resulting restatements, a number ofderivative actions were filed against certain of our current and formerdirectors, officers and certain other individuals purporting to assert claimson Zoran’s behalf. In addition, a securities class action complaint was filedagainst us and certain of our current and former officers and our currentdirectors, seeking damages related to our historical stock option practices.There may be additional lawsuits of this nature filed in the future. We cannotpredict the outcome of these lawsuits, nor can we predict the amount of timeand expense that will be required to resolve these lawsuits. If these lawsuitsbecome time consuming and expensive, or if there are unfavorable outcomes inany of these cases, there could be a material adverse effect on our business,financial condition and results of operations.

Our insurance coverage will not cover our totalliabilities and expenses in these lawsuits, in part because we have asignificant deductible on certain aspects of the coverage. In addition, we areobligated to indemnify our current and former directors, officers and employeesin connection with the investigation of our historical stock option practicesand the related government inquiries and litigation. We currently holdinsurance policies for the benefit of our directors and officers, although ourinsurance coverage may not be sufficient in some or all of these matters.Furthermore, the insurers may seek to deny or limit coverage in some or all ofthese matters, in which case we may have to self-fund all or a substantialportion of our indemnification obligations.

**Weare subject to the risks of additional lawsuits from former officers andemployees in connection with our historical stock option practices, theresulting restatements, and the remedial measures we have taken.**

In addition to the possibilities that there maybe additional governmental actions and shareholder lawsuits against us, we maybe sued or taken to arbitration by former officers and employees in connectionwith their stock options and other matters. These lawsuits may be timeconsuming and expensive, and cause further distraction from the operation ofour business. The adverse resolution of any specific lawsuit could have amaterial adverse effect on our business, financial condition and results ofoperations.

**Failureto maintain effective internal controls may cause us to delay filing ourperiodic reports with the SEC, affect our Nasdaq listing, and adversely affectour stock price.**

We are required to include a report ofmanagement on internal control over financial reporting in our Annual Report onForm 10-K that contains an assessment by management of the effectiveness of ourinternal control over financial reporting. In addition, our independentregistered public accounting firm must attest to and report on management’sassessment of the effectiveness of the internal control over financialreporting.  The restatement of financialstatements in prior filings with the SEC is a strong indicator of the existenceof a “material weakness” in the design or operation of internal control overfinancial reporting. However, we have concluded that the control deficienciesthat resulted in the restatement of the previously issued consolidatedfinancial statements did not constitute a material weakness as of March 31,2006 because management determined that as of March 31, 2006 there wereeffective controls designed and in place to prevent or detect a materialmisstatement and therefore the likelihood of stock-based compensation, deferredcompensation and deferred tax assets being materially misstated is not morethan remote.

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The SEC may disagree with the manner in which wehave accounted for and reported, or not reported, the financial impact of pastoption grant measurement date errors, and there is a risk that its inquirycould lead to circumstances in which we may have to further restate our priorfinancial statements, amend prior filings with the SEC, or otherwise take otheractions not currently contemplated. In addition, the SEC may issue guidance ordisclosure requirements related to the financial impact of past option grantmeasurement date errors that may require us to amend this filing or priorfilings with the SEC to provide additional disclosures pursuant to thisguidance. Any such circumstance could also lead to future delays in filing oursubsequent SEC reports and delisting of our common stock from the NASDAQ GlobalSelect Market.

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

We expect that the issues arising from ourhistorical stock option grant practices and the related accounting will make itmore difficult to obtain director and officer insurance coverage in thefuture.  If we are able to obtain this coverage, it could be significantlymore costly than in the past, which would have an adverse effect on ourfinancial results and cash flow. As a result of this and related factors, ourdirectors and officers could face increased risks of personal liability inconnection with the performance of their duties. As a result, we may havedifficultly attracting and retaining qualified directors and officers, whichcould adversely affect our business.

**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 operating results have variedsignificantly from period to period due to a number of factors, including:

·                  fluctuation indemand for our products;

·                  the timing ofnew product introductions or enhancements by us and our competitors;

·                  the level ofmarket acceptance of new and enhanced versions of our products and our customers’products;

·                  the timing orcancellation of large customer orders;

·                  the length andvariability of the sales cycle for our products;

·                  pricing policychanges by us and by our competitors and suppliers;

·                  the cyclicalnature of the semiconductor industry;

·                  the availabilityof development funding and the timing of development revenue;

·                  changes in themix of products sold;

·                  seasonality indemand for our products;

·                  increasedcompetition in product lines, and competitive pricing pressures; and

·                  the evolving andunpredictable nature of the markets for products incorporating our integratedcircuits and embedded 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:

·                  thecost and availability of adequate foundry capacity;

·                  fluctuationsin manufacturing yields;

·                  changesin or the emergence of new industry standards;

·                  failureto anticipate changing customer product requirements;

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·                  theloss or gain of important customers;

·                  productobsolescence; and

·                  theamount of research and development expenses associated with new productintroductions.

Our operating results could also be harmed by:

·                  economicconditions generally or in various geographic areas where we or our customersdo business;

·                  terrorism andinternational conflicts or other crises;

·                  other conditionsaffecting the timing of customer orders;

·                  changes ingovernmental regulations that could affect our products;

·                  a downturn inthe markets for our customers’ products, particularly the consumer electronicsmarket;

·                  disruptionin commercial activities associated with heightened security concerns affectinginternational travel and commerce;

·                  reduceddemand for consumer electronic products due to a potential economic slowdown;

·                  tightenedimmigration controls that may adversely affect the residence status of keynon-U.S. managers and technical employees in our U.S. facilities or our abilityto hire new non-U.S. employees in such facilities; or

·                  potentialexpansion of armed conflict in the Middle East which could adversely affect ouroperations in Israel.

These factors aredifficult or impossible to forecast.  Weplace orders with independent foundries several months in advance of thescheduled delivery date, often in advance of receiving non-cancelable ordersfrom our customers.  This limits ourability to react to fluctuations in demand for their products.  If anticipated shipments in any quarter arecanceled or do not occur as quickly as expected, or if we fail to foresee atechnology change that could render a product obsolete, expense and inventorylevels could be disproportionately high. If anticipated license revenues in any quarter are canceled or do notoccur, gross margins may be reduced.  Asignificant portion of our expenses are relatively fixed, and the timing ofincreases in expenses is based in large part on our forecast of futurerevenues.  As a result, if revenues donot meet our expectations, we may be unable to quickly adjust expenses tolevels appropriate to actual revenues, which could harm our operating results.

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

Because themarkets that our customers serve are characterized by numerous new productintroductions and rapid product enhancements, our operating results may varysignificantly from quarter to quarter. During the final production of a mature product, our customers typicallyexhaust their existing inventories of our products.  Consequently, orders for our products maydecline in those circumstances, even if the products are incorporated into bothmature products and replacement products. 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 experience significant seasonality in the sales oftheir consumer products, which affects their orders of our products.  Typically, the second half of the calendaryear represents a disproportionate percentage of sales for our customers due tothe holiday shopping period for consumer electronics products, and therefore, adisproportionate percentage of our sales. We expect these seasonal sales fluctuations to continue for theforeseeable future.

Our ability to match production mix with the product mix needed to fillcurrent orders and orders to be delivered in the given quarter may affect ourability to meet that quarter’s revenue forecast.  In addition, when responding to customers’requests for shorter shipment lead times, we manufacture products based onforecasts of customers’ demands.  Theseforecasts are based on multiple assumptions. If we inaccurately forecast customer demand, we may hold inadequate,excess or obsolete inventory that would reduce our profit margins and adverselyaffect our results of operations and financial condition.

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

Average sellingprices for our products decline over relatively short time periods, while manyof our manufacturing costs are fixed. When our average selling prices decline,our revenues decline unless we are able to sell more units, and our grossmargins decline unless we are able to reduce our manufacturing costs by acommensurate amount.  Our operating resultssuffer when gross margins decline.  Wehave experienced these problems, and we expect to continue to experience themin the future, although we cannot predict when they may occur or how severethey 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 inconnection with, or anticipation of, maturing product cycles for both semiconductorcompanies and their customers and declines in general economic conditions.  These downturns have been characterized byabrupt fluctuations in product demand, production over-capacity and accelerateddecline of average selling prices.  Insome cases, these downturns have lasted more than one year. We cannot predictwhether we will achieve timely, cost-effective access to that capacity whenneeded, or when there will be a capacity shortage again in the future.  A downturn in the semiconductor industrycould harm our sales and revenues if demand drops, or our gross margins ifaverage selling prices decline.

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

In recent years, we have derived a substantialmajority of our product revenues from the sale of integrated circuits for DVDand digital camera applications.  Weexpect that sales of our products for these applications will continue to accountfor a significant portion of our revenues for the foreseeable future. Ourfuture financial performance will also depend on our ability to successfullydevelop and market new products in the digital television, HDTV and digitalimaging markets.  If the markets forthese products and applications decline or fail to develop as expected, or weare not successful in our efforts to market and sell our products tomanufacturers who incorporate integrated circuits into these products, ourfinancial results will be harmed.

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

Our financial performance depends in large part on ourability to successfully develop and market next-generation and new products ina rapidly changing technological environment. If we fail to successfully identify new product opportunities and timelydevelop and introduce new products that achieve market acceptance, we may loseour 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, DVDrecorders, digital cameras, broadband digital television and HDTV.  These markets are characterized by the incorporationof a steadily increasing level of integration and numbers of features on a chipat the 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 tocontinually develop and introduce integrated circuits with increasing levels ofintegration and new features at competitive prices, our operating results willsuffer.

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 arecharacterized by the incorporation of a steadily increasing level ofintegration and higher speeds on a chip at the same or lower system cost,enabling original equipment manufacturers, or OEMs, to continually improve theperformance and features or reduce the prices of the systems they sell.  If we are unable to develop and introduceintegrated circuits with increasing levels of integration, performance and newfeatures at competitive prices, our operating results will suffer. Theperformance of our software licensing business is dependent on our ability todevelop and introduce new releases of our software, which incorporate new orenhanced printing standards, as well as performance enhancements required byour OEM customers. If we are unable to develop and release versions of oursoftware supporting required standards and offering enhanced performance, ouroperating results will suffer.

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**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.**

Themarkets in which we compete are intensely competitive and are characterized byrapid technological change, declining average unit selling prices and rapidproduct obsolescence.  We expectcompetition to increase in the future from existing competitors and from othercompanies that may enter our existing or future markets with solutions whichmay be less costly or provide higher performance or more desirable featuresthan our products.  Competition typicallyoccurs at the design stage, when customers evaluate alternative designapproaches requiring integrated circuits. Because of short product life cycles,there are frequent design win competitions for next-generation systems.

Our existing and potential competitors include many largedomestic and international companies that have substantially greater financial,manufacturing, technological, market, distribution and other resources.  These competitors may also have broaderproduct lines and longer standing relationships with customers and suppliersthan 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 includeCheertek, ESS, LSI Logic, Magnum Semiconductor, Matsushita, MediaTek, RenesasTechnology, Samsung and Sunplus. In the markets for JPEG-based products for usein digital cameras, our principal competitors are in-house solutions developedand used by major Japanese OEMs, as well as products sold by Sunplus and TexasInstruments.  In the market forJPEG-based products for desktop video editing applications, our principalcompetitor is Sunplus.  Cirrus Logic(Crystal Semiconductor), Fujitsu, Freescale Semiconductor, STMicroelectronicsand Yamaha are currently shipping Dolby Digital-based audio compressionproducts.  Our principal competitors fordigital semiconductor devices in the digital television market include AdvancedMicro Devices, Broadcom, Renesas Technology, M-Star, Mediatek and STMicroelectronics.  Others who alsoparticipate in this market are ALi Corporation, Cheertek, Fujitsu, GenesisMicrochip, NEC, Pixelworks and Trident Microsystems. Competitors in the Printerand Multifunction peripheral space include Sigmatel Inc., MarvellSemiconductor, TAK Imaging, Peerless Systems, Global Graphics and in-housecaptive suppliers.

Webelieve that growth of the DVD player market will be modest in the foreseeablefuture, and that continued strong competition will lead to further pricereductions, and reduced profit margins. We also face significantcompetition in the digital Imaging and digital camera markets.  The futuregrowth of both markets is highly dependent on OEMs continuing to outsourcean increasing portion of their product development work. Many of our existing competitors,as well as OEM customers that are expected to compete with us in the future,have substantially greater financial, manufacturing, technical, marketing,distribution and other resources, broader product lines and longer standingrelationships with customers than we have.  In addition, much of ourfuture success is dependent on the success of our OEM customers.  If we orour OEM customers are unable to compete successfully against current and futurecompetitors, we could experience price reductions, order cancellations andreduced gross margins, any one of which could harm our business.

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

Our future successwill depend on our ability to anticipate and adapt to changes in technology andindustry standards and our customers’ changing demands.  The consumer electronics market, inparticular, is characterized by rapidly changing technology, evolving industrystandards, frequent new product introductions, short product life cycles andincreasing demand for higher levels of integration.  Our ability to adapt to these changes and toanticipate future standards, and the rate of adoption and acceptance of thosestandards, will be a significant factor in maintaining or improving ourcompetitive position and prospects for growth. If new industry standards emerge, our products or the products of ourcustomers could become unmarketable or obsolete, and we could lose market shareor be required to incur substantial unanticipated costs to comply with thesenew standards**.**

Our success willalso depend on the successful development of new markets and the applicationand acceptance of new technologies and products in those new markets.  For example, our success will depend on theability of our customers to develop new products and enhance existing productsin the recordable DVD player market and products for the broadband digitaltelevision and HDTV markets and to introduce and promote those productssuccessfully.  These markets may notcontinue to develop to the extent or in the time periods that we currentlyanticipate due to factors outside our control, such as delays in implementationof FCC 02-320 requiring all new televisions to include a digital receiver byFebruary 2009. If new markets do not develop as we anticipate, or if ourproducts do not gain widespread acceptance in these markets, our business,financial condition and results of operations could be harmed.  The emergence of new markets for our productsis also dependent in part upon third parties developing and marketing contentin a format compatible with commercial and consumer products that incorporateour products.  If this content is notavailable, manufacturers may not be able to sell products incorporating ourproducts, and our sales would suffer.

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**We relyon 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 any manufacturing facilities, and werely on independent foundries to manufacture substantially all of ourproducts.  These independent foundriesfabricate products for other companies and may also produce products of theirown design.  From time to time, there aremanufacturing capacity shortages in the semiconductor industry.  We do not have long-term supply contractswith any of our suppliers, including our principal supplier, TaiwanSemiconductor Manufacturing Company, or TSMC. Therefore, TSMC and our other suppliers are not obligated to manufactureproducts for us for any specific period, in any specific quantity or at anyspecified price, except as may be provided in a particular purchase order.

Our reliance on independent foundries involves anumber of risks, including:

·                  theinability to obtain adequate manufacturing capacity;

·                  theunavailability of or interruption in access to certain process technologiesnecessary for manufacture of our products;

·                  lack of controlover delivery schedules;

·                  lack of controlover quality assurance;

·                  lack of controlover manufacturing yields and cost; and

·                  potentialmisappropriation of our intellectual property.

In addition, TSMCand some of our other foundries are located in areas of the world that aresubject to natural disasters such as earthquakes.  While the 1999 earthquake in Taiwan did nothave a material impact on our independent foundries, a similar event centerednear TSMC’s facility could severely reduce TSMC’s ability to manufacture ourintegrated circuits.  The loss of any ofour manufacturers as a supplier, our inability to expand the supply of theirproducts in response to increased demand, or our inability to obtain timely andadequate deliveries from our current or future suppliers due to a naturaldisaster or any other reason could delay or reduce shipments of ourproducts.  Any of these circumstancescould damage our relationships with current and prospective customers and harmour sales and financial results.

We also rely on alimited number of independent contractors for the assembly and testing of ourproducts.  Our reliance on independentassembly and testing houses limits our control over delivery schedules, qualityassurance and product cost.  Disruptionsin the services provided by our assembly or testing houses or othercircumstances that would require them to seek alternative sources of assemblyor testing could lead to supply constraints or delays in the delivery of ourproducts.  These constraints or delayscould damage our relationships with current and prospective customers and harmour 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 ableto obtain additional foundry capacity as required, our relationships with ourcustomers would be harmed and our sales would likely be reduced.  In order to secure additional foundrycapacity, we have considered, and may in the future need to consider, variousarrangements with suppliers, which could include, among others:

·                  optionpayments or other prepayments to a foundry;

·                  nonrefundabledeposits with or loans to foundries in exchange for capacity commitments;

·                  contractsthat commit us to purchase specified quantities of silicon wafers over extendedperiods;

·                  issuanceof our equity securities to a foundry;

·                  investmentin a foundry;

·                  jointventures; or

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·                  otherpartnership relationships with foundries.

We may not be ableto make any such arrangement in a timely fashion or at all, and sucharrangements, if any, may not be on terms favorable to us.  Moreover, if we are able to secure foundrycapacity, we may be obligated to utilize all of that capacity or incurpenalties.  Such penalties may be expensiveand could harm our financial results.

**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 the manufacturing environment, defectsin photo masks used to print circuits on a wafer, difficulties in thefabrication process or other factors can cause a substantial portion of theintegrated circuits on a wafer to be non-functional.  Many of these problems are difficult todetect at an early stage of the manufacturing process and may be time consumingand expensive to correct.  As a result,foundries often experience problems achieving acceptable yields, which arerepresented by the number of good integrated circuits as a proportion of thenumber of total integrated circuits on any particular wafer.  Poor yields from our independent foundrieswould reduce our ability to deliver our products to customers, harm ourrelationships with 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.**

During2006, only 7% of our total revenues were derived from North America sales.  We anticipate that international sales willcontinue to account for a substantial majority of our total revenues for theforeseeable future.  In addition,substantially all of our semiconductor products are manufactured, assembled andtested outside of the United States by independent foundries andsubcontractors.

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

·                  unexpectedchanges in regulatory requirements;

·                  fluctuationsin exchange rates;

·                  politicaland economic instability;

·                  impositionof tariffs and other barriers and restrictions;

·                  theburdens of complying with a variety of foreign laws; and

·                  healthrisks 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 military conditions in Israel directly affectour operations.  Some of our employees inIsrael are obligated to perform up to 39 days of military reserve dutyannually.  The absence of these employeesfor significant periods during the work week may cause us to operateinefficiently during these periods.

Our operations in Chinaare subject to the economic and political uncertainties affecting thatcountry.  For example, the Chineseeconomy has experienced significant growth in the past decade, but such growthhas been uneven across geographic and economic sectors.  This growth may decrease and any slowdown mayhave a negative effect on our business. We also maintain offices in Taipei, Taiwan, Hong Kong and Seoul, Korea,and our operations are subject to the economic and political uncertaintiesaffecting 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 significant OEM customers inJapan, Korea and other parts of Asia. Adverse economic circumstances in Japan and elsewhere in Asia couldaffect these customers’ willingness or ability to do business with us in thefuture or their success in developing and launching devices containing ourproducts.

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**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 are currentlydenominated in U.S. dollars for sales to our customers throughout theworld.  If there is a significantdevaluation of the currency in a specific country, the prices of our productswill increase relative to that country’s currency, our products may be lesscompetitive in that country and our revenues may be adversely affected.  Also, we cannot be sure that ourinternational customers will continue to be willing to place orders denominatedin U.S. dollars.  If they do not, ourrevenue and operating results will be subject to foreign exchange 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 significant portion of our research anddevelopment and engineering activities at our design center in Haifa, Israel, a109,700 square foot facility where we employ approximately 390 people.  We also conduct a portion of our sales andmarketing operations at our Haifa facility. We have an additional 16,100 squarefoot facility in Kfar Netter, Israel, where we conduct research and developmentactivities.

Haifa was a principal target in the recent armedconflict in Northern Israel, and, accordingly, our facility and personnel inHaifa were at significant risk during that conflict.  Although we suffered no damage to ourfacilities or injury to our personnel during the recent conflicts, significantdamage to our facilities in Israel, injury of our employees working there, ordamage to the Israeli business or transportation infrastructure as a result offuture military conflict or terrorist activity could materially affect ouroperations in Israel and harm our business. In addition, some of our employees in Israel serve in the militaryreserve. Any prolonged absence of a substantial number of these employees couldmaterially harm our business.

In addition to their impact on our operations inIsrael, military conflict in the Middle East or future terrorist activitiesthere or elsewhere in the world could harm our business as a result of adisruption in commercial activity affecting international commerce or a generaleconomic slowdown and reduced demand for consumer electronic products.

**The Israeli rate of inflation maynegatively impact our costs if it exceeds the rate of devaluation of the NewIsraeli shekel against the United States dollar.**

A portion of the cost of our operations, relatingmainly to our personnel and facilities in Israel, is incurred in New Israeli Shekels.  As a result, we bear the risk that the rateof inflation in Israel or the decline in the value of United States dollarcompared to the New Israeli Shekel will increase our costs as expressed inUnited States dollars.  To date, we havenot engaged in hedging transactions.  Inthe future, we may enter into currency hedging transactions to decrease therisk of financial exposure from fluctuations in the exchange rate of the UnitedStates dollar against the New Israeli Shekel. These measures may not adequately protect us from the impact ofinflation in Israel.

**We derive most of our revenue fromsales to a small number of large customers, and if we are not able to retainthese customers, or they reschedule, reduce or cancel orders, our revenueswould be reduced and our financial results would suffer.**

Our largest customers have accounted for a substantialpercentage of our revenues.  In 2005, nosingle customer accounted for more than 10% of our total revenues, althoughsales to our four largest customers accounted for 29% of our total revenues.  In 2004, one customer accounted for 11% ofour total revenues while sales to our four largest customers accounted for 35%of our total revenues.  Sales to theselarge customers have varied significantly from year to year and will continueto fluctuate in the future.  These salesalso may fluctuate significantly from quarter to quarter.  We may not be able to retain our keycustomers, or these customers may cancel purchase orders or reschedule ordecrease their level of purchases from us. Any substantial decrease or delay in sales to one or more of our keycustomers could harm our sales and financial results.  In addition, any difficulty in collectingamounts due from one or more key customers could harm our financial results.

**Our products generally have longsales cycles and implementation periods, which increases our costs in obtainingorders and reduces the predictability of our operating results.**

Our products are technologically complex.  Prospective customers generally must make asignificant commitment of resources to test and evaluate our products and tointegrate them into larger systems.  As aresult, our sales processes are often subject to delays associated with lengthyapproval processes that typically accompany the design and testing of new products.  The sales cycles of our products often lastfor many months**. **Longersales cycles require us to invest significant resources in attempting to makesales and delay the generation of revenue**.**

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Long sales cycles alsosubject us to other risks, including customers’ budgetary constraints, internalacceptance reviews and cancellations.  Inaddition, orders expected in one quarter could shift to another because of thetiming of customers’ purchase decisions. The time required for our customers to incorporate our products intotheir own can vary significantly with the needs of our customers and generallyexceeds several months, which further complicates our planning processes andreduces the predictability of our 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 our products subject to cancelable short-termpurchase 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-term contract, the contract is generallyterminable at the convenience of the customer. 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 usand our customers, errors may be found in existing or new products.  This could result in, among other things, adelay in recognition or loss of revenues, loss of market share or failure toachieve market acceptance.  These defectsmay cause us to incur significant warranty, support and repair costs, divertthe attention of our engineering personnel from our product development effortsand harm our relationships with customers. The occurrence of these problems could result in the delay or loss ofmarket acceptance of our products and would likely harm our business.  Defects, integration issues or otherperformance problems in our products could result in financial or other damagesto customers or could damage market acceptance of such products.  Our customers could also seek damages from usfor their losses.  A product liabilityclaim brought against us, even if unsuccessful, would likely be time consumingand costly to defend.

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

The FederalCommunications Commission, or FCC, has broad jurisdiction over our targetmarkets in the digital television business. Various international entities or organizations may also regulateaspects of our business or the business of our customers.  Although our products are not directlysubject to regulation by any agency, the transmission pipes, as well as much ofthe equipment into which our products are incorporated, are subject to directgovernment 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 our customers or the industries in which ourcustomers operate may in turn harm our business.  FCC regulatory policies affecting the abilityof cable operators or telephone companies to offer certain services and otherterms on which these companies conduct their business may impede sales of ourproducts.  In addition, our digitaltelevision business may also be adversely affected by the imposition of tariffs,duties and other import restrictions on our suppliers or by the imposition ofexport restrictions on products that we sell internationally.  Changes in current laws or regulations or theimposition of new laws or regulations in the United States or elsewhere couldharm our business.  For example, anydelays by the FCC in imposing its pending requirement that all new televisionshave a digital receiver could have an adverse 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 proprietarytechnology.  We rely on a combination ofpatent, trade secret, copyright and trademark laws, non-disclosure and othercontractual agreements and technical measures to protect our proprietaryrights.  These agreements and measuresmay not be sufficient to protect our technology from third-party infringement,or to protect us from the claims of others. Monitoring unauthorized use of our products is difficult, and we cannotbe certain that the steps we have taken will prevent unauthorized use of ourtechnology, particularly in foreign countries where the laws may not protectour proprietary rights as fully as in the United States.  The laws of certain foreign countries inwhich our products are or may be developed, manufactured or sold, includingvarious countries in Asia, may not protect our products or intellectualproperty rights to the same extent as do the laws of the United States and thusmake the possibility of piracy of our technology and products more likely inthese countries.  If competitors are ableto use our technology, our ability to compete effectively could be harmed.

The protection offered bypatents is subject to numerous uncertainties. For example, our competitors may be able to effectively design aroundour patents, or the patents may be challenged, invalidated orcircumvented.  Those competitors may alsoindependently develop technologies that are substantially equivalent orsuperior to our technology.  Moreover,while we hold, or have applied for, patents

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relating to the design ofour products, some of our products are based in part on standards, for which wedo not hold patents or other intellectual property rights.

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, SOC platform firmware and drivers for the digital officemarket and in limited circumstances with respect to firmware on SCS products,firmware and platforms for our DTV, DVDR products, we grant licenses that giveour customers access to and restricted use of the source code of our****software.  This access increases thelikelihood of misappropriation or misuse of our technology.

**Claimsand litigation regarding intellectual property rights could seriously harm ourbusiness and require us to incur significant costs.**

In recent years, therehas been significant litigation in the United States involving patents andother intellectual property rights.  Inthe past, Zoran has been subject to claims and litigation regarding allegedinfringement of other parties’ intellectual property rights, and both Oak andZoran have been parties to a number of patent-related lawsuits, both asplaintiff and defendant.  We could becomesubject to additional litigation in the future, either to protect ourintellectual property or as a result of allegations that we infringe others’intellectual property rights.  Claims thatour products infringe proprietary rights would force us to defend ourselves andpossibly our customers or manufacturers against the alleged infringement.  Future litigation against us, if successful,could subject us to significant liability for damages or invalidation of ourproprietary rights.  These lawsuits,regardless of their success, are time-consuming and expensive to resolve andrequire significant management time and attention.  Future intellectual property litigation couldforce us to do one or more of the following:

·                  stopselling products that incorporate the challenged intellectual property;

·                  obtainfrom the owner of the infringed intellectual property right a license to sellor use the relevant technology, which license may not be available onreasonable terms or at all;

·                  paydamages; or

·                  redesignthose products that use such technology.

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 more limited patent portfolio thanmany of our competitors.  If a successfulclaim is made against us or any of our customers and a license is not madeavailable to us on commercially reasonable terms or we are required to paysubstantial damages or awards, our business, financial condition and results ofoperations would 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 partylicenses may not be available on commercially reasonable terms, if at all.  If we are unable to obtain any third-partylicense required to develop new products and product enhancements, we may haveto obtain substitute technology of lower quality or performance standards or atgreater cost, either of which could seriously harm the competitiveness of ourproducts.

We rely on licenses to use various technologies thatare material to our products.  We do not own the patents that underliethis license.  Our rights to use these technologies and employ theinventions claimed in the licensed patents are subject to our abiding by theterms of the licenses.  Under the license agreements we must fulfillconfidentiality obligations and pay royalties.  If we fail to abide by theterms of the license, we would be unable to sell and market the products underlicense.  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.

**If weare not able to apply our net operating losses against taxable income in futureperiods, our financial results will be harmed.**

Our future net income andcash flow will be affected by our ability to apply our net operating losses, orNOLs, against taxable income in future periods. Our NOLs totaled approximately$185 million for federal and $36 million for state tax reporting purposes as ofDecember 31, 2006. The Internal Revenue Code contains a number of provisionsthat limit the use of NOLs under certain

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circumstances.  During 2006 we reduced the NOL deferred taxasset for amounts which we believe will expire before they become available forutilization. Changes in tax laws in the United States may further limit ourability to utilize these NOLs.  Any further limitation on our ability toutilize these respective NOLs could harm our financial condition.

**Changes in, orinterpretations of, tax rules and regulations may adversely affect oureffective tax rates.**

Unanticipated changes in our tax rates couldaffect our future results of operations. Our future effective tax rates couldbe unfavorably affected by changes in tax laws or the interpretation of tax laws,by unanticipated decreases in the amount of revenue or earnings in countrieswith low statutory tax rates, or by changes in the valuation of our deferredtax assets and liabilities. While we believe our tax reserves adequatelyprovide for any tax contingencies, the ultimate outcomes of any future taxaudits are uncertain, and we can give no assurance as to whether an adverseresult from one or more of them will have a material effect on our operatingresults and financial position.

**Anyadditional acquisitions we make could disrupt our business and severely harmour financial condition.**

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 anyfuture acquisitions, we could:

·                  issuestock that would dilute its current stockholders’ percentage ownership;

·                  incurdebt;

·                  usea significant amount of our cash;

·                  assumeliabilities;

·                  incurexpenses related to the future impairment of goodwill and the amortization ofother intangible assets; or

·                  incurother large write-offs immediately or in the future.

Our operation of anyother acquired business will also involve numerous risks, including:

·                  problemscombining the purchased operations, technologies or products;

·                  unanticipatedcosts;

·                  diversion ofmanagement’s attention from our core business;

·                  adverse effectson existing business relationships with customers;

·                  risks associatedwith entering markets in which we have no or limited prior experience; and

·                  potential lossof key employees, particularly those of the purchased organizations.

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

**If ourgoodwill or amortizable intangible assets become impaired we may be required torecord a significant charge to earnings.**

Under generally accepted accounting principles,we review our amortizable intangible assets for impairment when events orchanges in circumstances indicate the carrying value may not be recoverable.Goodwill is required to be tested for impairment at least annually. Factorsthat may be considered a change in circumstances indicating that the carryingvalue of our goodwill or amortizable intangible assets may not be recoverableinclude a decline in stock price and market capitalization, future cash flows,and slower growth rates in our industry. We may be required to record asignificant charge to earnings in our financial statements during the period inwhich any impairment of our goodwill or amortizable intangible assets isdetermined resulting in an impact on our results of operations.

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**We mayneed additional funds to execute our business plan, and if we are unable toobtain such funds, we will not be able to expand our business as planned.**

We may requiresubstantial additional capital to finance our future growth, secure additionalfoundry capacity and fund our ongoing research and development activitiesduring 2007 and beyond.  Our capitalrequirements will depend on many factors, including:

·                  the levels atwhich we maintain inventory and accounts receivable;

·                  the marketacceptance of our products;

·                  the levels ofpromotion and advertising required to launch our new products or to entermarkets and attain a competitive position in the marketplace;

·                  our business,product, capital expenditure and research and development plans and technologyroadmap;

·                  volume pricingconcessions;

·                  capitalimprovements to new and existing facilities;

·                  technologicaladvances;

·                  the response ofcompetitors 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.

**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 to manage growth successfullywill also require us to expand and improve administrative, operational,management and financial systems and controls. Many of our key operations, including a material portion of our researchand development operations and a significant portion of our sales andadministrative operations are located in Israel.  A majority of our sales and marketing andcertain of our research and development and administrative personnel, includingour President and Chief Executive Officer and other officers, are based in theUnited States.  The geographic separationof these operations places additional strain on our resources and our abilityto manage growth effectively.  If we areunable to manage growth effectively, our business will be harmed.

**We rely on the services of ourexecutive officers and other key personnel, whose knowledge of our business andindustry would be extremely difficult to replace.**

Our success depends to a significant degree upon thecontinuing contributions of our senior management.  Management and other employees mayvoluntarily terminate their employment with us at any time upon shortnotice.  The loss of key personnel coulddelay product development cycles or otherwise harm our business.  We believe that our future success will alsodepend in large part on our ability to attract, integrate and retainhighly-skilled engineering, managerial, sales and marketing personnel, locatedin the United States, Israel and China. Competition for such personnel is intense, and we may not be successfulin attracting, integrating and retaining such personnel.  Failure to attract, integrate and retain keypersonnel could harm our ability to carry out our business strategy and competewith other companies.

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

Our certificate of incorporation and bylaws and Delaware law containprovisions that could make it more difficult for a third party to acquire us,even if doing so would be beneficial to our stockholders.  These include provisions:

·                  prohibitinga merger with a party that has acquired control of 15% or more of ouroutstanding common stock, such as a party that has completed a successfultender offer, until three years after that party acquired control of 15% of ouroutstanding common stock;

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·                  authorizingthe issuance of up to 3,000,000 shares of “blank check” preferred stock;

·                  eliminatingstockholders’ rights to call a special meeting of stockholders; and

·                  requiringadvance notice of any stockholder nominations of candidates for election to ourboard of directors.

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

The market price of our common stock has fluctuatedsignificantly since our initial public offering in 1995.  Between January 1, 2005 and March 31,2006, the closing sale price of our common stock, as reported on the NasdaqGlobal Select Market, ranged from a low of $8.97 to a high of $22.48.  The market price of our common stock issubject to significant fluctuations in the future in response to a variety offactors, including:

·      results of regulatory investigations;

·                  announcementsconcerning our business or that of our competitors or customers;

·                  annualand quarterly variations in our operating results;

·                  changesin analysts’ earnings estimates;

·                  announcementsof technological innovations;

·                  theintroduction of new products or changes in product pricing policies by Zoran orits competitors;

·                  lossof key personnel;

·                  proprietaryrights or other litigation;

·                  generalconditions in the semiconductor industry; and

·                  developmentsin the financial markets.

In addition, the stockmarket has, from time to time, experienced extreme price and volumefluctuations that have particularly affected the market prices for semiconductorcompanies or technology companies generally and which have been unrelated tothe operating performance of the affected companies.  Broad market fluctuations of this type mayreduce the future market price of our common stock.

**Item 6.  Exhibits**
| 10.48(1)  |   | Amended Summary of Compensation Arrangements with  Named Executive Officers and Non Employee Directors                                                                   |
|-----------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.15(2)* |   | PC Optical Storage Technology Patent License  Agreement dated as of January 25, 2006 among Zoran, Zoran’s subsidiary  Oak Technology, Inc., and MediaTek, Inc. |
| 10.16(3)* |   | PC Optical Storage Patent Cross License Agreement  dated as of January 25, 2006 among Zoran, Zoran’s subsidiary Oak Technology,  Inc., and MediaTek, Inc.           |
| 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.                                                                                           |

 

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(1)    Incorporated by referenceto Exhibit 99.1 to Registrant’s Form 8-K Current Report filed on March 31,2006.

 

(2)    Incorporated by reference to Exhibit 10.54to Registrant’s Quarterly Report on Form 10-Q for the period ended March 31,2006.

 

(3)    Incorporated by reference to Exhibit 10.55to Registrant’s Quarterly Report on Form 10-Q for the period ended March 31,2006.

 

*       Confidential treatment has been requestedwith respect to portions of this Exhibit.

 

 

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**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: April  19, 2007 | /s/ Karl Schneider                                              |   |   |
|                        | Karl Schneider                                                  |   |
|                        | Senior Vice President, Finance                                  |   |
|                        | and Chief Financial Officer                                     |   |
|                        | (principal financial officer and principal accounting  officer) |   |
|                             |                                                                 |        |        |  |

 

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