----

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**SECURITIESAND EXCHANGE COMMISSION****Washington,D.C.  20549**

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**FORM10-Q**

**(MarkOne)**

**ý****      QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES                    EXCHANGE ACT OF 1934**

             **For the quarterly period ended June 30, 2001**

** **

**or**

**o****      TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES                   EXCHANGE ACT OF 1934**

**             For the transition period from­­­­__________to__________**

** **

**Commission File Number: 0-27246**

 

**ZORANCORPORATION**(Exact name of registrant as specified inits charter)

 

| **Delaware**                                                           | ** 94-2794449**                  |
|------------------------------------------------------------------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or  organization) | (I.R.S. Employer  Identification No.) |

 

| **3112 Scott Boulevard, Santa Clara, California** | **95054**  |
|---------------------------------------------------|------------|
| (Address of principal  executive offices)         | (Zip Code) |

**(408) 919-4111**

Registrant's telephone number, includingarea code

 

Indicate by check mark whether theregistrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days.

                                                     Yesý                           No o

 

The number of outstanding shares of theregistrant's Common Stock, $.001 par value, as of July 31, 2001 was 17,672,354

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**ZORAN CORPORATION**

**INDEX**

|                                                                                                                         |                                                                                                |   |
|------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------|--------|
| **PART I.   FINANCIAL  INFORMATION**                                                                               |                                                                                                |
| Item1.     Financial Statements                                                                          |                                                                                                |
|                                                                                                                         | Condensed  Consolidated Balance Sheets June 30, 2001 and December 31, 2000                          |   |
|                                                                                                                         | Condensed  Consolidated Statements of Operations Three and Six Months Ended June 30,  2001 and 2000 |   |
|                                                                                                                         | Condensed  Consolidated Statements of Cash Flows Six Months Ended June 30, 2001 and 2000            |   |
|                                                                                                                         | Notes  to Condensed Consolidated Financial Statements                                               |   |
| Item  2.     Management’s Discussion and  Analysis of Financial Condition and Results of Operations |                                                                                                |
| Item  3.     Quantitative and Qualitative  Disclosures About Market Risk                                 |                                                                                                |
| **PART II.   OTHER INFORMATION**                                                                                   |                                                                                                |
| Item  4      Submission of Matters to a Vote  of Security Holders                                   |                                                                                                |
| Item  6      Exhibits and Reports on Form  8-K                                                      |                                                                                                |
| SIGNATURES                                                                                                                   |                                                                                                |
|                                                                                                                              |                                                                                                     |        |  |  |

**ZORAN CORPORATIONCONDENSED CONSOLIDATED BALANCE SHEETS(in thousands, except share data)(unaudited)**

|                                      | June 30, 2001                                                                                                         |    | December 31, 2000 |    |
|-------------------------------------------|-----------------------------------------------------------------------------------------------------------------------|---------|-------------------|---------|
|                                      |                                                                                                                       |    |                   |    |
| ASSETS                                    |                                                                                                                  |    |              |    |
|                                      | Current assets:                                                                                                       |    |              |    |   |
|                                      | Cash and cash equivalents                                                                                             | $       | 20,685            |    | $ | 16,099 |   |
|                                      | Short-term investments                                                                                                | 75,141  |              | 159,539 |   |
|                                      | Accounts receivable, net                                                                                              | 27,398  |              | 27,065  |   |
|                                      | Inventory                                                                                                             | 16,239  |              | 17,453  |   |
|                                      | Prepaid expenses and other current assets                                                                             | 3,995   |              | 5,575   |   |
|                                      |                                                                                                                       |    |                   |    |
|                                      | Total current assets                                                                                                  | 143,458 |              | 225,731 |   |
|                                      |                                                                                                                  |    |              |    |
|                                      | Property and equipment, net                                                                                           | 6,761   |              | 6,972   |   |
|                                      | Other investments                                                                                                     | 89,265  |              | 13,899  |   |
|                                      | Goodwill and other intangibles                                                                                        | 91,519  |              | 112,864 |   |
|                                      |                                                                                                                       |    |                   |    |
|                                      | $                                                                                                                     | 331,003 |              | $       | 359,466 |   |
|                                      |                                                                                                                       |    |                   |    |
|                                      |                                                                                                                  |    |              |    |
| LIABILITIES AND STOCKHOLDERS’ EQUITY |                                                                                                                  |    |              |    |
|                                      | Current liabilities:                                                                                                  |    |              |    |   |
|                                      | Accounts payable                                                                                                      | $       | 10,333            |    | $ | 11,156 |   |
|                                      | Accrued expenses and other liabilities                                                                                | 15,285  |              | 16,856  |   |
|                                      |                                                                                                                       |    |                   |    |
|                                      | Total current liabilities                                                                                             | 25,618  |              | 28,012  |   |
|                                      |                                                                                                                       |    |                   |    |
|                                      | Stockholders’ equity:                                                                                            |    |              |    |   |
|                                      | Common Stock, $0.001 par value; 55,000,000 shares authorized;  17,290,651and 17,423,216 shares issued and outstanding | 17      |         | 17      |    |
|                                      | Additional paid-in capital                                                                                            | 385,324 |              | 388,655 |   |
|                                      | Warrants                                                                                                              | 717     |              | 717     |   |
|                                      | Deferred stock-based compensation                                                                                     | (647    | )                 | (919    | ) |
|                                      | Accumulated other comprehensive income (loss)                                                                         | (684    | )                 | 1,109   |   |
|                                      | Accumulated deficit                                                                                                   | (79,342 | )                 | (58,125 | ) |
|                                      |                                                                                                                       |    |                   |    |
|                                      | Total stockholders' equity                                                                                            | 305,385 |              | 331,454 |   |
|                                      |                                                                                                                       |    |                   |    |
|                                      | $                                                                                                                     | 331,003 |              | $       | 359,466 |   |
|                                      |                                                                                                                       |    |                   |    |
|                                           |                                                                                                                       |         |                   |         |  |  |  |  |  |

Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.

**ZORAN CORPORATIONCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(in thousands, except per share data)(unaudited)**

|                                                        | Three Months Ended June 30,                                                                                   |    | Six Months Ended June 30, |   |
|-------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------|---------|---------------------------|--------|
|                                                        |                                                                                                               |    |                           |   |
|                                                        | 2001                                                                                                          |    | 2000                      |   | 2001 |   | 2000 |   |
|                                                        |                                                                                                               |    |                           |   |  |   |  |   |
| Revenues:                                                   |                                                                                                          |    |                      |   |   |   |   |   |
|                                                        | Product sales                                                                                                 | $       | 20,622                    |   | $ | 16,389 |   | $ | 37,937 |   | $ | 30,611 |   |
|                                                        | Software, licensing and development                                                                           | 1,302   |                      | 2,472  |   | 3,580 |   | 5,892 |   |
|                                                        |                                                                                                               |    |                           |   |  |   |  |   |
|                                                        | Total revenues                                                                                                | 21,924  |                      | 18,861 |   | 41,517 |   | 36,503 |   |
|                                                        |                                                                                                               |    |                           |   |  |   |  |   |
| Costs and expenses:                                         |                                                                                                          |    |                      |   |   |   |   |   |
|                                                        | Cost of product sales                                                                                         | 13,228  |                      | 9,069  |   | 24,104 |   | 17,205 |   |
|                                                        | Research and development                                                                                      | 5,922   |                      | 3,976  |   | 11,890 |   | 7,245 |   |
|                                                        | Selling, general and administrative                                                                           | 5,160   |                      | 4,443  |   | 10,403 |   | 8,580 |   |
|                                                        | Amortization of goodwill and other intangibles and write-off of  acquired in-process research and development | 10,809  |                      | 6,769  |   | 21,617 |   | 6,769 |   |
|                                                        |                                                                                                               |    |                           |   |  |   |  |   |
|                                                        | Total costs and expenses                                                                                      | 35,119  |                      | 24,257 |   | 68,014 |   | 39,799 |   |
|                                                        |                                                                                                               |    |                           |   |  |   |  |   |
| Operating loss                                              | (13,195                                                                                                       | )       | (5,396                    | )      | (26,497 | ) | (3,296 | ) |
| Interest and other income, net                              | 2,606                                                                                                         |    | 2,208                     |   | 5,351 |   | 4,214 |   |
|                                                        |                                                                                                               |    |                           |   |  |   |  |   |
| Income (loss) before income taxes                           | (10,589                                                                                                       | )       | (3,188                    | )      | (21,146 | ) | 918 |   |
| Provision for income taxes                                  | 28                                                                                                            |    | 537                       |   | 71 |   | 1,153 |   |
|                                                        |                                                                                                               |    |                           |   |  |   |  |   |
| Net loss                                                    | $                                                                                                             | (10,617 | )                         | $      | (3,725 | ) | $ | (21,217 | ) | $ | (235 | ) |
|                                                        |                                                                                                               |    |                           |   |  |   |  |   |
| Basic and diluted net loss per share                        | $                                                                                                             | (0.62   | )                         | $      | (0.26 | ) | $ | (1.23 | ) | $ | (0.02 | ) |
|                                                        |                                                                                                               |    |                           |   |  |   |  |   |
| Shares used to compute basic and diluted net loss per share | 17,263                                                                                                        |    | 14,113                    |   | 17,281 |   | 14,072 |   |
|                                                        |                                                                                                               |    |                           |   |  |   |  |   |
|                                                             |                                                                                                               |         |                           |        |  |  |  |  |  |  |  |  |  |  |

Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.

**ZORAN CORPORATIONCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands)(unaudited)**

|                                             | **Six Months Ended June 30,**                                                                        |     |
|--------------------------------------------------|------------------------------------------------------------------------------------------------------|----------|
|                                             | ****                                                                                                 |     |
|                                             | **2001**                                                                                             |     | **2000** |   |
|                                             | ****                                                                                                 |     | **** |   |
| Cash flows from operating activities:            |                                                                                                 |     |   |   |
|                                             | Net loss                                                                                             | $        | (21,217 | ) | $ | (235 | ) |
|                                             | Adjustments to reconcile net loss to net cash provided by operations:                                |     |   |   |   |
|                                             | Depreciation, amortization and other                                                                 | 1,963    |   | 1,395 |   |
|                                             | Amortization of goodwill and other intangibles and write-off of  in process research and development | 21,345   |   | 6,769 |   |
|                                             | Changes in current assets and liabilities:                                                           |     |   |   |   |
|                                             | Accounts receivable                                                                                  | (421     | ) | 222 |   |
|                                             | Inventory                                                                                            | 1,214    |   | (4,100 | ) |
|                                             | Prepaid expenses and other current assets                                                            | 1,490    |   | (1,260 | ) |
|                                             | Accounts payable                                                                                     | (823     | ) | 1,650 |   |
|                                             | Accrued expenses and other liabilities                                                               | (1,167   | ) | 1,147 |   |
|                                             |                                                                                                      |     |  |   |
|                                             | Net cash provided by operating activities                                                            | 2,384    |   | 5,588 |   |
|                                             |                                                                                                      |     |  |   |
| Cash flows from investing activities:            |                                                                                                 |     |   |   |
|                                             | Capital expenditures for property and equipment                                                      | (1,390   | ) | (1,308 | ) |
|                                             | Purchases of investments                                                                             | (123,220 | ) | (145,708 | ) |
|                                             | Sales and maturities of investments                                                                  | 131,314  |   | 144,953 |   |
|                                             | Purchases of long-term equity investments                                                            | (1,171   | ) | (2,250 | ) |
|                                             | Acquisition costs net of cash acquired                                                               | --       |   | (12 | ) |
|                                             |                                                                                                      |     |  |   |
|                                             | Net cash provided by (used in) investing activities                                                  | 5,533    |   | (4,325 | ) |
| Cash flows from financing activities:            |                                                                                                 |     |   |   |
|                                             | Proceeds from issuance of Common Stock, net                                                          | 536      |   | 1,490 |   |
|                                             | Repurchases of Common Stock                                                                          | (3,867   | ) | -- |   |
|                                             |                                                                                                      |     |  |   |
|                                             | Net cash provided by (used in)  financing activities                                                 | (3,331   | ) | 1,490 |   |
|                                             |                                                                                                      |     |  |   |
| Net increase in cash and cash equivalents        | 4,586                                                                                                |     | 2,753 |   |
|                                             |                                                                                                 |     |   |   |
| Cash and cash equivalents at beginning of period | 16,099                                                                                               |     | 12,665 |   |
|                                             |                                                                                                      |     |  |   |
| Cash and cash equivalents at end of period       | $                                                                                                    | 20,685   |   | $ | 15,418 |   |
|                                             |                                                                                                      |     |  |   |
|                                                  |                                                                                                      |          |  |  |  |  |  |  |  |  |

Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.

**ZORANCORPORATIONNOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS(unaudited)**

**1.**          **Basis of Presentation**

The accompanying unaudited condensedconsolidated financial statements contain all adjustments (consisting only ofnormal recurring adjustments) which, in the opinion of management, arenecessary to present fairly the financial information included therein.  While the Company believes that thedisclosures are adequate to make the information not misleading, it issuggested that these financial statements be read in conjunction with theaudited consolidated financial statements and accompanying notes included inthe Company's Annual Report on Form 10-K for the year ended December 31,2000.  Results for the interim periodspresented are not necessarily indicative of the results to be expected for thefull year.

**2.**          **Comprehensive Income**

The Company applies Statement ofFinancial Accounting Standards No. 130 (“SFAS 130”), Reporting ComprehensiveIncome.

The following are the components ofcomprehensive income (loss) (in thousands):

 

|                                      | **Three  Months Ended June 30,** |    | **Six  Months Ended June 30,** |   |
|-------------------------------------------|---------------------------------------|---------|-------------------------------------|--------|
|                                      | ****                                  |    | ****                                |   |
| ‏‏                            | **2001**                              |    | **2000**                            |   | **2001** |   | **2000** |   |
|                                      |                                       |    | ****                                |   | **** |   | **** |   |
| Net loss                                  | $                                     | (10,617 | )                                   | $      | (3,725 | ) | $ | (21,217 | ) | $ | (235 | ) |
| Unrealized loss on  short-term investment | (272                                  | )       | (1,592                              | )      | (1,793 | ) | (1,484 | ) |
|                                      |                                       |    |                                     |   |  |   |  |   |
| Comprehensive loss                        | $                                     | (10,889 | )                                   | (5,317 | ) | $ | (23,010 | ) | $ | (1,719 | ) |
|                                      |                                       |    |                                     |   |  |   |  |   |
|                                           |                                       |         |                                     |        |  |  |  |  |  |  |  |  |

The components of accumulated other comprehensive income (loss) are unrealizedgain (loss) on short-term investments.

 

**3.**          **Balance Sheet Components**(in thousands):

 

|           | **June  30,**   |   | **December  31,** |   |
|----------------|-----------------|--------|-------------------|--------|
|           | **2001**        |   | **2000**          |   |
|           |                 |   |                   |   |
| **Inventory:** |            |   |              |   |
|           | Work-in-process | $      | 6,707             |   | $ | 6,913 |   |
|           | Finished goods  | 9,532  |              | 10,540 |   |
|           |                 |   |                   |   |
|           | $               | 16,239 |              | $      | 17,453 |   |
|           |                 |   |                   |   |

**4.**          **Income Taxes**

The provision for income taxes reflectsthe estimated annualized effective tax rate applied to earnings for the interimperiods.  The effective tax rate differsfrom the U.S. statutory rate due to utilization of net operating losses,adjustments for the nondeductible amortization of goodwill and otherintangibles, and income tax rate differences on foreign earnings.  The company has provided tax on income inexcess of net operating loss carryforwards for U.S. Federal and Stateearnings.  The Company has also providedtax on its foreign earnings.

 

**5.**          **Earnings Per Share**

Computation of basic and diluted earningsper share is as follows:

|                   | **Three Months Ended June 30,**           |   |
|------------------------|-------------------------------------------|--------|
|                   | **2001**                                  |   | **2000** |   |
|                   | ****                                      |   | **** |   |
|                   | **Income  (Numerator)**                   |   | **Shares  (Denominator)** |   | **Per Share  Amount** |   | **(Loss)  (Numerator)** |   | **Shares  (Denominator)** |   | **Per Share Amount** |   |
|                   | ****                                      |   | **** |   | **** |   | **** |   | **** |   | **** |   |
| Basic and Diluted EPS: |                                      |   |   |   |   |   |   |   |   |   |   |   |
|                   | Net loss available to common stockholders | $      |  (10,617 | ) | 17,263 |   | $ |  (0.62 | ) | $ |  (3,725 | ) | 14,113 |   | $ |  (0.26 | ) |
|                        |                                           |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

|                   | **Six Months Ended June 30,**             |   |
|------------------------|-------------------------------------------|--------|
|                   | **2001**                                  |   | **2000** |   |
|                   | ****                                      |   | **** |   |
|                   | **Income  (Numerator)**                   |   | **Shares  (Denominator)** |   | **Per Share  Amount** |   | **(Loss)  (Numerator)** |   | **Shares  (Denominator)** |   | **Per Share Amount** |   |
|                   | ****                                      |   | **** |   | **** |   | **** |   | **** |   | **** |   |
| Basic and Diluted EPS: |                                      |   |   |   |   |   |   |   |   |   |   |   |
|                   | Net loss available to common stockholders | $      |  (21,217 | ) | 17,281 |   | $ |  (1.23 | ) | $ |  (235 | ) | 14,072 |   | $ |  (0.02 | ) |
|                        |                                           |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

**6.**          **Repurchase of Common Stock**

During the six months ended June 30, 2001the Company repurchased 255,000 shares of its common stock for $3.9 million.

**7.**          **Recently Issued Accounting Standard**

In June 1998, the Financial AccountingStandards Board issued Statement of Financial Accounting Standards No. 133,Accounting for Derivative Instruments and Hedging Activities" ("SFAS133"). SFAS 133 establishes a new model for accounting for derivatives andhedging activities and supercedes and amends a number of existing accountingstandards. SFAS 133 requires that all derivatives be recognized in the balancesheet at their fair market value, and the corresponding derivative gains orlosses be either reported in the statement of operations or as a deferred itemdepending on the type of hedge relationship that exists with respect to suchderivative. Adopting the provisions of SFAS 133, as amended by SFAS 137, iseffective for the Company’s fiscal year 2001, and will not have a materialeffect on the Company’s consolidated financial statements.

In July 2001, the Financial AccountingStandards Board (FASB) issued FASB Statements Nos. 141 and 142 (FAS 141 and FAS142), “Business Combinations” and “Goodwill and Other Intangible Assets.” FAS141 replaces APB 16 and eliminates pooling-of-interests accounting prospectively.It also provides guidance on purchase accounting related to the recognition ofintangible assets and accounting for negative goodwill. FAS 142 changes theaccounting for goodwill from an amortization method to an impairment-onlyapproach. Under FAS 142, goodwill will be tested annually and whenever eventsor circumstances occur indicating that goodwill might be impaired. FAS 141 andFAS 142 are effective for all business combinations completed after June 30,2001. Upon adoption of FAS 142, amortization of goodwill recorded for businesscombinations consummated prior to July 1, 2001 will cease, and intangibleassets acquired prior to July 1, 2001 that do not meet the criteria forrecognition under FAS 141 will be reclassified to goodwill. Companies are requiredto adopt FAS 142 for fiscal years beginning after December 15, 2001, but earlyadoption is permitted. The Company will adopt FAS 142 on January 1, 2002. Inconnection with the adoption of FAS 142, the Company will be required toperform a transitional goodwill impairment assessment. The Company has not yetdetermined the impact these standards will have on its results of operationsand financial position.

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

***The followingdiscussion includes forward-looking statements with respect to the Company’sfuture financial performance.  Actualresults may differ materially from those currently anticipated depending upon avariety of factors, including those described below under the sub-heading,“Future Performance and Risk Factors” and discussed more fully in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2000.***

**Overview**

From our inception in 1981 through 1991,we derived the substantial majority of our revenue from digital filterprocessors and vector signal processors used principally in military,industrial and medical applications. In 1989, we repositioned our business todevelop and market data compression products for the evolving multimediamarkets and discontinued development of digital filter processor and vectorsignal processor products. In 1994, we discontinued production of theseproducts. Our current lines of digital audio and video products includeintegrated circuits and related products used in digital versatile disc players(“DVD”), movie and home theater systems, filmless digital cameras and videoediting systems.

We derive most of our revenues from thesale of our integrated circuit products. Historically, average selling pricesin the semiconductor industry in general, and for our products in particular,have decreased over the life of a particular product. Average selling pricesfor our hardware products have fluctuated substantially from period to period,primarily as a result of changes in our customer mix of original equipmentmanufacturer, or OEM, sales versus sales to distributors and the transitionfrom low-volume to high-volume production. In the past, we reduced the pricesof some of our products in order to better penetrate 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 of product sales consistsprimarily of fabrication costs, assembly and test costs, and the cost ofmaterials and overhead from operations. If we are unable to reduce our cost ofproduct sales to offset anticipated decreases in average selling prices, ourproduct gross margins will decrease. Our product gross margin is also dependenton product mix and on the percentage of products sold directly to our OEMcustomers versus indirectly through our marketing partners who purchase ourproducts at lower prices but absorb most of the associated marketing and salessupport expenses, maintain inventories and provide customer support andtraining. Lower gross margins on sales to distributors are partially offset byreduced selling and marketing expenses related to such sales. Product sales inJapan are primarily made through Fujifilm, our strategic partner anddistributor in Japan. Fujifilm provides more sales and marketing support thanour other distributors. We expect both product and customer mix to continue tofluctuate in future periods, causing further fluctuations in margins.

We also derive revenue from licensing oursoftware and other intellectual property. Licensing revenue includes one-timelicense fees and royalties based on the number of units distributed by thelicensee. In addition, we have historically generated a significant percentageof our total revenues from development contracts, primarily with key customers,although development revenue has declined as a percentage of total revenuesover the past several years. These development contracts have provided us withpartial funding for the development of some of our products. These developmentcontracts provide for license and milestone payments which are recorded asdevelopment revenue. We classify all development costs, including costs relatedto these development contracts, as research and development expenses. We retainownership of the intellectual property developed by us under these development contracts.While we intend to continue to enter into development contracts with certainstrategic partners, we expect development revenue to continue to decline as apercentage of total revenues.

Our research and development expensesconsist of salaries and related costs of employees engaged in ongoing research,design and development activities and costs of engineering materials andsupplies. We are also a party to research and development agreements with theChief Scientist in Israel's Ministry of Industry and Trade and theIsrael-United States Binational Industrial Research and Development Foundation,which fund up to 50% of incurred project costs for approved products up tospecified contract maximums. These agreements require us to use our best effortsto achieve specified results and require us to pay royalties at rates of 3% to5% of resulting product sales, and up to 30% of resulting license revenues, upto a maximum of 100% to 150% of total funding received. Reported research anddevelopment expenses are net of these grants, which fluctuate from period toperiod. We believe that significant investments in research and development arerequired for us to remain competitive and we expect to continue to devotesignificant resources to product development, although such expenses as apercentage of total revenues may fluctuate.

Our selling, general and administrativeexpenses consist primarily of employee-related expenses, royalties, salescommissions, product promotion and other professional services. We expect thatselling, general and administrative expenses will continue to increase tosupport our anticipated growth.

We conduct a substantial portion of ourresearch and development and certain sales and marketing and administrativeoperations in Israel through our wholly-owned Israeli subsidiary. As a result,some of our expenses are incurred in New Israeli Shekels. To date,substantially all of our product sales and our development and licensingrevenue have been denominated in U.S. dollars and most costs of product saleshave been incurred in U.S. dollars. We expect that most of our sales and costsof sales will continue to be denominated and incurred in U.S. dollars for theforeseeable future. We have not experienced material losses or gains as aresult of currency exchange rate fluctuations and have not engaged in hedgingtransactions to reduce our exposure to such fluctuations. We may in the futureelect to take appropriate action to reduce our foreign exchange risk.

Our effective income tax rate has benefitedfrom the availability of net operating losses which we have utilized to reducetaxable income for U.S. federal income tax purposes and by our Israelisubsidiary's status as an "Approved Enterprise" under Israeli law,which provides a ten-year tax holiday for income attributable to a portion ofour operations in Israel. Our U.S. federal net operating losses expire atvarious times between 2001 and 2020, and the benefits from our subsidiary'sApproved Enterprise status expire at various times beginning in 2003.

In June 1999, we sold to MGI Software ofCanada the intellectual property related to our SoftDVD product line andtransferred to MGI certain related software development and support resourcesin exchange for cash, MGI common stock and future royalties. We do notcurrently expect, however, that these royalties will have a material impact onquarterly revenues for the foreseeable future. In addition, the shares of MGIstock received by us as part of this transaction are subject to future appreciationor depreciation. Our software revenues have declined significantly as a resultof the sale of the SoftDVD product line.

On June 29, 2000, we acquired PixelCam,Inc. (“PixelCam”), a manufacturer of megapixel CMOS image sensors, in exchangefor 370,832 shares of Zoran common stock and options to purchase 4,168 sharesof Zoran common stock with an aggregate value of $24.6 million. The acquisitionwas accounted for under the purchase method of accounting. Additionalinformation regarding this acquisition is contained in our Annual Report onForm 10-K for the year ended December 31, 2000.

On October 26, 2000, we acquired NogatechInc. (“Nogatech”) a public company that provides chips that compress digitalvideo images and establish connections, or video connectivity, between videodevices and computers, as well as between video devices across a variety ofnetworks, in exchange for 2,534,599 shares of our common stock and options topurchase 168,472 shares of our common stock with an aggregate value of $163.6 million.The acquisition was accounted for under the purchase method of accounting.Additional information regarding this acquisition is contained in our AnnualReport on Form 10-K for the year ended December 31, 2000.

*Results of Operations*

*Revenues*

Total revenues were $21.9 million and$41.5 million for the three and six month periods ended June 30, 2001, comparedto $18.9 million and $36.5 million for the same periods of 2000, representingincreases of 16.2% and 13.7% for the respective periods.  For the three and six month periods endedJune 30, 2001, product revenues were $20.6 million and $37.9 million, comparedto $16.4 million and $30.6 million for the same periods in 2000, increases of25.8% and 23.9%, respectively.  Fuelingthe growth in product revenue were increased unit sales in the DVD and digitalcamera product lines as well as our acquisition of Nogatech in the fourthquarter of 2000. Software, licensing and development revenues were $1.3 millionand $3.6 million for the three and six month periods ended June 30, 2001,compared to $2.5 million and $5.9 million for the same periods of 2000,representing decreases of 47.3% and 39.2% for the respective periods. Thesechanges were primarily due to the timing of significant new licensingcontracts, as well as the timing of revenue recognition on developmentcontracts.

*Product Gross Margin*

Product gross margins were 35.9% and36.5% of product revenues for the three and six month periods ended June 30,2001, compared to 44.7% and 43.8% for the same periods of 2000. The decreasewas due to a product sales mix that included an increased percentage oflower-margin products and a shift in customer mix which resulted in a lowerpercentage of direct sales to OEM customers compared to the same quarter in2000. In addition, we experienced a decline in the average selling price of ourolder DVD Vaddis III chip that is being phased out as we transition ourcustomer base to our new DVD Vaddis IV Plus chip.

*Research and Development*

Research and development (“R&D”) expenseswere $5.9 million and $11.9 million for the three and six month periods endedJune 30, 2001, compared to $4.0 million and $7.2 million for the same periodsof 2000. R&D expenses increased as a result of our acquisitions of PixelCamand Nogatech, in June 2000 and October 2000, respectively, the timing of majorproject expenses such as tape-outs and the timing and recognition of projectfunding from external sources. As a percentage of revenues, R&D expensesincreased to 27.0% and 28.6% for the three and six month periods ended June 30,2001, compared to 21.1% and 19.8% for the same periods of 2000.

*Selling, General and Administrative*

Selling, general and administrative(“SG&A”) expenses were $5.2 million and $10.4 million for the three and sixmonth periods ended June 30, 2001, compared to $4.4 million and $8.6 millionfor the same periods of 2000. The increase was due to our acquisitions ofPixelCam, Inc. and Nogatech, Inc. in June 2000 and October 2000, respectively,and increased sales and marketing expenses related to product marketdevelopment and to support planned revenue growth particularly in the Taiwanand China markets.  As a percentage ofrevenues, SG&A expenses were 23.5% and 25.1% for the three and six monthperiods ended June 30, 2001, compared to 23.6% and 23.5% for the same periodsof 2000.

*Amortization of Goodwill and Other Intangibles and theWrite-Off of In-Process Research and Development*

Amortization of goodwill and otherintangibles for the three and six months ended June 30, 2001 was $10.8 millionand $21.6 million respectively. These charges were associated with ouracquisitions of PixelCam and Nogatech. There were no such charges during the same periods in 2000. We did notincur any charges for the write-off of in-process research and development forthe three and six months ended June 30, 2001. For the same periods in 2000 weincurred charges of $6.8 million in conjunction with our acquisition ofPixelCam in June 2000.

*Interest and Other Income, Net*

Net interest and other income for thethree and six month periods ended June 30, 2001 was $2.6 million and $5.4million, respectively, an increase of 18.0% and 27.0% compared to the sameperiods in 2000. The increase resulted primarily from increased interest incomeon higher cash balances following our acquisition of Nogatech.

*Provision for Income Taxes*

Excluding charges related to theamortization of goodwill and other intangibles and the write-off of in-processresearch and development our estimated effective tax rate remained at 15% forthe current quarter, the same as last year’s effective tax rate.

**Liquidity and Capital Resources**

At June 30, 2001, we had $20.7 million ofcash and cash equivalents, $75.1 million of short-term investments and $117.8million of working capital. In addition, we had $85.6 million of investments inlong-term marketable securities at June 30, 2001.

Our operating activities provided cash of$2.4 million during the six months ended June 30, 2001, primarily due to thenet loss adjusted for the non-cash impact of depreciation and amortization anda decrease in both prepaid expenses and inventory, partially offset bydecreases in accrued expenses and accounts payable.

Cash provided by investing activities was$5.5 million during the six months ended June 30, 2001, principally reflectingthe sales and maturities of investments.

Cash used in financing activities was$3.3 million for the six months ended June 30, 2001, primarily due to therepurchase of 255,000 shares of our common stock during the six months ended June30, 2001.

We believe that our current balances ofcash, cash equivalents and short-term investments, and anticipated cash flowfrom operations, will satisfy our anticipated working capital and capitalexpenditure requirements at least through the next 12 months. Nonetheless, ourfuture capital requirements may vary materially from those now planned and willdepend on many factors including, but not limited to:

|   | • | the  levels at which we maintain inventory and accounts receivable;                                                                                     |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | the  market acceptance of our products;                                                                                                                 |
|   | • | the  levels of promotion and advertising required to launch our new products or to  enter markets and attain a competitive position in the marketplace; |
|   | • | our  business, product, capital expenditure and research and development plans and  technology roadmap;                                                 |
|   | • | volume  pricing concessions;                                                                                                                            |
|   | • | capital  improvements to new and existing facilities;                                                                                                   |
|   | • | technological  advances;                                                                                                                                |
|   | • | the  response of competitors to our products; and                                                                                                       |
|   | • | our  relationships with our suppliers and customers.                                                                                                    |

In addition, we may require an increasein the level of working capital to accommodate planned growth, hiring andinfrastructure needs. Additional capital may also be required for acquisitionsof businesses, products or technologies.

To the extent that our existing resourcesand cash generated from operations are insufficient to fund our futureactivities, we may need to raise additional funds through public or privatefinancings or borrowings. If additional funds are raised through the issuanceof debt securities, these securities could have rights, preferences andprivileges senior to holders of common stock, and the terms of this debt couldimpose restrictions on our operations. The sale of additional equity orconvertible debt securities could result in additional dilution to ourstockholders. We cannot be certain that additional financing will be availablein amounts or on terms acceptable to us, if at all. If we are unable to obtainthis additional 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.

**Future Performance and Risk Factors**

The Company's future business, operatingresults and financial condition are subject to various risks and uncertainties,including those described below.

**Our quarterly revenues and operating results fluctuate due toa variety of factors, which may result in volatility or a decline in the priceof our stock**.

Our quarterly operating results havevaried significantly due to a number of factors, including:

|   | • | fluctuation  in demand for our products;                                                                                         |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------|
|   | • | the  timing of new product introductions by us and our competitors;                                                              |
|   | • | the  level of market acceptance of new and enhanced versions of our products and  our customers' products;                       |
|   | • | the  timing of large customer orders;                                                                                            |
|   | • | the  length and variability of the sales cycle for our products;                                                                 |
|   | • | the  cyclical nature of the semiconductor industry;                                                                              |
|   | • | the  availability of development funding and the timing of development revenue;                                                  |
|   | • | changes  in the mix of products sold;                                                                                            |
|   | • | seasonality  in demand for our products;                                                                                         |
|   | • | competitive  pricing pressures; and                                                                                              |
|   | • | the  evolving and unpredictable nature of the markets for products incorporating  our integrated circuits and embedded software. |

 

We expect that our operating results willcontinue to fluctuate in the future as a result of these factors and a varietyof other factors, including:

|   | • | the  cost and availability of adequate foundry capacity;                                     |
|--------|--------|----------------------------------------------------------------------------------------------|
|   | • | fluctuations  in manufacturing yields;                                                       |
|   | • | the  emergence of new industry standards;                                                    |
|   | • | product  obsolescence; and                                                                   |
|   | • | the  amount of research and development expenses associated with new product  introductions. |

Our operating results could also beharmed by:

|   | • | economic  conditions generally or in various geographic areas where we or our customers  do business;  |
|--------|--------|--------------------------------------------------------------------------------------------------------|
|   | • | other  conditions affecting the timing of customer orders; or                                          |
|   | • | a  downturn in the markets for our customers' products, particularly the  consumer electronics market. |

These factors are difficult or impossibleto forecast. We place orders to purchase our products from independentfoundries several months in advance of the scheduled delivery date, often inadvance of receiving non-cancelable orders from our customers. If anticipatedshipments in any quarter are canceled or do not occur as quickly as expected,expense and inventory levels could be disproportionately high. If anticipatedlicense revenues in any quarter are canceled or do not occur, gross margins maybe reduced. A significant portion of our expenses are relatively fixed, and thetiming of increases in expenses is based in large part on our forecast offuture revenues. As a result, if revenues do not meet our expectations we maybe unable to quickly adjust expenses to levels appropriate to actual revenues,which could harm our operating results.

As a result of these factors, ouroperating results may vary significantly from quarter to quarter. Any shortfallin revenues or net income from levels expected by securities analysts couldcause a decline in the trading price of our stock.

**Our success for the foreseeable future will be dependent ongrowth in demand for integrated circuits for DVD, Super Video CD, digitalaudio, video editing and filmless digital camera applications and our abilityto market and sell our products to manufacturers who incorporate those types ofintegrated circuits into their products.**

In 2000 and the first six months of 2001,we derived a majority of our product revenues from the sale of integratedcircuits for DVD and Super Video CD applications. We expect that sales of ourproducts for DVD and Super Video CD applications, digital audio applicationsand video editing applications will continue to account for a significantportion of our revenues for the near future. Our ability to sell our productsfor filmless digital camera applications will also have a significant impact onour financial performance for the foreseeable future. If the markets for theseproducts and applications decline or fail to develop as expected, or we are notsuccessful in our efforts to market and sell our products to manufacturers whoincorporate integrated circuits into these products, our financial results willbe harmed.

**Our customers experience fluctuating product cycles andseasonality, which causes our sales to fluctuate.**

Because the markets our customers serveare characterized by numerous new product introductions and rapid productenhancements, our operating results may vary significantly from quarter toquarter. During the final production of a mature product, our customerstypically exhaust their existing inventory of our products. Consequently,orders for our products may decline in those circumstances, even if ourproducts are incorporated into both mature products and replacement products. Adelay in the customer's transition to commercial production of a replacementproduct would delay our ability to recover the lost sales from thediscontinuation of the related mature product. Our customers also experience significantseasonality in the sales of their consumer products, which affects their ordersof our products. Typically, the fourth calendar quarter represents adisproportionate percentage of sales for our customers due to the holidayperiod, and therefore a disproportionate percentage of our sales. We expectthese sales fluctuations to continue for the foreseeable future.

**Product supply and demand in the semiconductor industry issubject to cyclical variations.**

The semiconductor industry is subject tocyclical variations in product supply and demand. Downturns in the industryoften occur in connection with, or anticipation of, maturing product cycles forboth semiconductor companies and their customers and declines in generaleconomic conditions. These downturns have been characterized by abruptfluctuations in product demand, production over-capacity and accelerateddecline of average selling prices. In some cases, these downturns have lastedmore than one year. A downturn in the semiconductor industry could harm oursales and revenues if demand drops or our gross margins if average sellingprices decline.

**The development and evolution of markets for our integratedcircuits is dependent on factors such as industry standards, over which we haveno control; for example, if manufacturers adopt new or competing industrystandards with which our products are not compatible, our existing productswould become less desirable to the manufacturers and our sales would suffer.**

The emergence of markets for our productsis affected by a variety of factors beyond our control. In particular, ourproducts are designed to conform to current specific industry standards.Manufacturers may not continue to follow these standards, which would make ourproducts less desirable to manufacturers and reduce our sales. Also, competingstandards may emerge that are preferred by manufacturers, which could alsoreduce our sales and require us to make significant expenditures to develop newproducts. The emergence of new markets for our products is also dependent inpart upon third parties developing and marketing content in a format compatiblewith commercial and consumer products that incorporate our products. If contentcompatible with commercial and consumer products that incorporate our productsis not available, manufacturers may not be able to sell products incorporatingour integrated circuits, and our sales to manufacturers would suffer.

**We rely on independent foundries and contractors for themanufacture, assembly and testing of our integrated circuits, 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 manufacturingfacilities, and we rely on independent foundries to manufacture substantiallyall of our products. These independent foundries fabricate products for othercompanies and may also produce products of their own design. From time to timethere are manufacturing capacity shortages in the semiconductor industry. We donot have long-term supply contracts with any of our suppliers, including ourprincipal supplier, Taiwan Semiconductor Manufacturing Company, or TSMC.Therefore, TSMC is not obligated to manufacture products for us for anyspecific period, in any specific quantity or at any specified price, except asmay be provided in a particular purchase order.

Our reliance on independent foundriesinvolves a number of risks, including:

|   | • | the  inability to obtain adequate manufacturing capacity;                                                                    |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------|
|   | • | the  unavailability of or interruption in access to certain process technologies  necessary for manufacture of our products; |
|   | • | reduced  control over delivery schedules;                                                                                    |
|   | • | reduced  control over quality assurance;                                                                                     |
|   | • | reduced  control over manufacturing yields and cost; and                                                                     |
|   | • | potential  misappropriation of our intellectual property.                                                                    |

In addition, TSMC and some of our otherfoundries are located in areas of the world which are subject to naturaldisasters such as earthquakes. While the 1999 earthquake in Taiwan did not havea material impact on our independent foundries, a similar event centered nearTSMC's facility could severely reduce TSMC's ability to manufacture ourintegrated circuits. The loss of any of our manufacturers as a supplier, ourinability to expand the supply of our products in response to increased demand,or our inability to obtain timely and adequate deliveries from our current orfuture suppliers due to a natural disaster or any other reason could delay orreduce shipments of our products. Any of these circumstances could damage ourrelationships with current and prospective customers and harm our sales andfinancial results.

We also rely on independent contractorsfor the assembly and testing of our products. At present, all of oursemiconductor products are assembled by one of five independent contractors:ASE, Amkor, ASAT, National Semiconductor, or Vate. Our semiconductor productsare tested by these contractors or other independent contractors. Our relianceon independent assembly and testing houses limits our control over deliveryschedules, quality assurance and product cost. Disruptions in the servicesprovided by our assembly or testing houses or other circumstances that wouldrequire us to seek alternative sources of assembly or testing could lead tosupply constraints or delays in the delivery of our products. These constraintsor delays could damage our relationships with current and prospective customersand harm our sales and financial results.

**Because foundry capacity is limited from time to time we maybe required to enter into costly long-term supply arrangements to securefoundry capacity.**

If we are not able to obtain additionalfoundry capacity as required, our relationships with our customers would beharmed and our sales would likely be reduced. In order to secure additionalfoundry capacity, we have considered and will continue to consider variousarrangements with suppliers, which could include, among others:

|   | • | option  payments or other prepayments to a foundry;                                                  |
|--------|--------|------------------------------------------------------------------------------------------------------|
|   | • | nonrefundable  deposits with or loans to foundries in exchange for capacity commitments;             |
|   | • | contracts  that commit us to purchase specified quantities of silicon wafers over  extended periods; |
|   | • | issuance  of our equity securities to a foundry;                                                     |
|   | • | investment  in a foundry;                                                                            |
|   | • | joint  ventures; or                                                                                  |
|   | • | other  partnership relationships with foundries.                                                     |

We may not be able to make any sucharrangement in a timely fashion or at all, and such arrangements, if any, maynot 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 expensive and could harm our financialresults.

**If our independent foundries do not achieve satisfactoryyields, our relationships with our customers may be harmed.**

The fabrication of silicon wafers is acomplex process. Minute levels of contaminants in the manufacturingenvironment, defects in photomasks used to print circuits on a wafer,difficulties in the fabrication process or other factors can cause asubstantial portion of the integrated circuits on a wafer to be non-functional.Many of these problems are difficult to detect at an early stage of themanufacturing process and may be time consuming and expensive to correct. As aresult, foundries often experience problems achieving acceptable yields, whichare represented by the number of good integrated circuits as a proportion ofthe number 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.

**To be successful, we must efficiently develop new andenhanced products to meet rapidly changing customer requirements and industrystandards.**

The markets for our products arecharacterized by:

|   | • | rapidly  changing technologies;          |
|--------|--------|------------------------------------------|
|   | • | evolving  industry standards;            |
|   | • | frequent  new product introductions; and |
|   | • | short  product life cycles.              |

We expect to increase our productdevelopment expenses, and our future success will depend to a substantialdegree upon our ability to develop and introduce, on a timely andcost-effective basis, new and enhanced products that meet rapidly changingcustomer requirements and industry standards. We may not successfully develop,introduce or manage the transition to new products. Delays in the introductionor shipment of new or enhanced products, lack of market acceptance for suchproducts or problems associated with new product transitions could harm oursales and financial results.

**We face competition or potential competition from companieswith greater resources than ours, and if we are unable to compete effectivelywith these companies, our market share may decline and our business could beharmed.**

Competition in the compression technologymarket has historically been dominated by large companies such asSTMicroelectronics and companies that develop and use their own integratedcircuits, such as Sony. As this market continues to develop, we facecompetition from other large semiconductor vendors, including:

|   | • | Cirrus  Logic (Crystal Semiconductor);                             |
|--------|--------|--------------------------------------------------------------------|
|   | • | Conexant;                                                          |
|   | • | Fujitsu;                                                           |
|   | • | LSI  Logic (including recently acquired C-Cube Microsystems Inc.); |
|   | • | Motorola;  and                                                     |
|   | • | Texas  Instruments.                                                |

For example, in the markets forJPEG-based products for use in filmless digital cameras, Conexant is providingCMOS sensor and camera DSP solutions to third parties. We also face competitionfrom internally-developed solutions developed and used by major Japaneseoriginal equipment manufacturers, who may also be our customers.

Many of our existing and potentialcompetitors have substantially greater resources than ours in many areas,including:

|   | • | finances;       |
|--------|--------|-----------------|
|   | • | manufacturing;  |
|   | • | technology;     |
|   | • | marketing;  and |
|   | • | distribution.   |

Many of our competitors have broaderproduct lines and longer standing relationships with customers than we do.Moreover, our competitors may foresee the course of market developments moreaccurately than we do and could in the future develop new technologies thatcompete with our products or even render our products obsolete. In addition, anumber of private companies have announced plans for new products to addressthe same digital multimedia compression problems that our products address. Ifwe are unable to compete successfully against our current and futurecompetitors, we could experience price reductions, order cancellations andreduced gross margins, any one of which could harm our business.

The DVD market is growing, and additionalcompetitors are expected to enter the market for DVD players and software. Someof these potential competitors may develop captive implementations for use onlywith their own PC and consumer electronics products. It is also possible thatapplication software vendors, such as Microsoft, may attempt to enter the DVDapplication market in the future. This increased competition may result inprice reductions, reduced profit margins and loss of market share.

**Our products are characterized by average selling prices thatdecline over relatively short time periods; if we are unable to reduce ourcosts or introduce new products with higher average selling prices, ourfinancial results would suffer.**

Average selling prices for our productsdecline over relatively short time periods. Many of our manufacturing costs arefixed. When our average selling prices decline, our revenues decline unless wesell more units, and our gross margins decline unless we are able to reduce ourmanufacturing costs by a commensurate amount. Our operating results suffer whengross margins decline. We have experienced these problems and may continue toexperience them in the future and cannot predict when they may occur or theirseverity.

**We derive most of our revenue from sales to a small number oflarge customers, and if we are not able to retain these customers, or theyreschedule, reduce or cancel orders, our revenues would be reduced and ourfinancial results would suffer.**

Our largest customers account for asubstantial percentage of our revenues. In 2000, sales to Fujifilm accountedfor 25.2% of our total revenues and 27.5% of our product sales. Our fourlargest customers in 2000 accounted for approximately 45.4% of our totalrevenues.  During 1999, our four largestcustomers accounted for approximately 56.9% of our revenues with Fujifilmaccounting for 37.3%. Sales to these large customers have varied significantlyfrom year to year and will continue to fluctuate in the future.  These sales also may fluctuate significantlyfrom quarter to quarter. We may not be able to retain our key customers orthese customers may cancel purchase orders or reschedule or decrease theirlevel of purchases from us. Any substantial decrease or delay in sales to oneor more of our key customers could harm our sales and financial results. Inaddition, any difficulty in collecting amounts due from one or more keycustomers could harm our financial results.

**We are dependent on our relationship with Fujifilm for asignificant percentage of our product sales, and if this relationship wereterminated, our business would be harmed.**

Fujifilm has been our largest customer infour of the last five years. Fujifilm purchases our products primarily as adistributor. Under our arrangement with Fujifilm, Fujifilm acts as the primarydistributor in Japan of products developed by us under development contractswith Fujifilm. Fujifilm also sells some of these products in Japan under itsown name. We may sell these products directly in Japan only to specified customersand must first buy the products from Fujifilm. Fujifilm provides more sales andmarketing support than our other distributors. Fujifilm also has a nonexclusivelicense to distribute most of our products outside of Japan. Fujifilm hasprovided wafer manufacturing services on a most-favored terms basis to us since1993 and has also provided funding to support our development efforts. If ourrelationship with Fujifilm were terminated, our business would be harmed.

**Our products generally have long sales cycles andimplementation periods, which increases our costs in obtaining orders andreduces the predictability of our earnings.**

Our products are technologically complex.Prospective customers generally must make a significant commitment of resourcesto test and evaluate our products and to integrate them into larger systems. Asa result, our sales process is often subject to delays associated with lengthyapproval processes that typically accompany the design and testing of newproducts. The sales cycles of our products often last for many months or evenyears. Longer sales cycles require us to invest significant resources inattempting to make sales and delay the generation of revenue.

Long sales cycles also subject us toother risks, including customers' budgetary constraints, internal acceptancereviews and cancellations. In addition, orders expected in one quarter couldshift to another because of the timing of customers' purchase decisions. Thetime required for our customers to incorporate our products into their own canvary significantly with the needs of our customers and generally exceedsseveral months, which further complicates our planning processes and reducesthe predictability of our operating results.

**We are not protected by long-term contracts with ourcustomers.**

We generally do not enter into long-termpurchase contracts with our customers, and we cannot be certain as to futureorder levels from our customers. When we do enter into a long-term contract,the contract is generally terminable at the convenience of the customer. In theevent of an early termination by one of our major customers, it is unlikelythat we will be able to rapidly replace that revenue source, which would harmour financial results.

**We are dependent upon our international sales and operations;economic, political or military events in a country where we make significantsales or have significant operations could interfere with our success oroperations there and harm our business.**

During the first six months of 2001, 88%of our total revenues were derived from international sales. We anticipate thatinternational sales will continue to represent a significant portion of ourtotal revenues for the foreseeable future. In addition, substantially all ofour semiconductor products are manufactured, assembled and tested outside ofthe United States by independent foundries and subcontractors.

We are subject to the risks inherent indoing business internationally, including:

|   | • | unexpected  changes in regulatory requirements;                 |
|--------|--------|-----------------------------------------------------------------|
|   | • | fluctuations  in exchange rates;                                |
|   | • | political  and economic instability;                            |
|   | • | imposition  of tariffs and other barriers and restrictions; and |
|   | • | the  burdens of complying with a variety of foreign laws.       |

The majority of our research anddevelopment personnel and facilities and a significant portion of our salespersonnel are located in Israel. Political, economic and military conditions inIsrael directly affect our operations. Some of our officers and employees inIsrael are obligated to perform up to 39 days of military reserve dutyannually. The absence of these employees for significant periods during thework week may cause us to operate inefficiently during these periods.

During 1998, we opened an office inShenzhen, China. Our operations in China are subject to the economic andpolitical uncertainties affecting that country. For example, the Chineseeconomy has experienced significant growth in the past decade, but such growthhas been uneven across geographic and economic sectors and has recently beenslowing. This growth may continue to decrease and any slowdown may have anegative effect on our business. During 2000 and the beginning of 2001 we alsoopened offices in Taipei, Taiwan, Hong Kong and Seoul, Korea. Our operationsare subject to the economic and political uncertainties affecting thesecountries as well.

**The prices of our products may become less competitive due toforeign exchange fluctuations.**

Foreign currency fluctuations may affectthe prices of our products. Prices for our products are currently denominatedin U.S. dollars for sales to our customers throughout the world. If there is asignificant devaluation of the currency in a specific country, the prices ofour products will increase relative to that country's currency and our productsmay be less competitive in that country. Also, we cannot be sure that ourinternational customers will continue to be willing to place orders denominatedin U.S. dollars. If they do not, our revenue and operating results will besubject to foreign exchange fluctuations.

**Our ability to compete could be jeopardized if we are unableto protect our intellectual property rights from challenges by third parties.**

Our success and ability to compete dependin large part upon protecting our proprietary technology. We rely on acombination of patent, trade secret, copyright and trademark laws,non-disclosure and other contractual agreements and technical measures toprotect our proprietary rights. These agreements and measures may not besufficient to protect our technology from third-party infringement, or toprotect us from the claims of others. Monitoring unauthorized use of ourproducts is difficult and we cannot be certain that the steps we have takenwill prevent unauthorized use of our technology, particularly in foreigncountries where the laws may not protect our proprietary rights as fully as inthe United States. The laws of certain foreign countries in which our productsare or may be developed, manufactured or sold, including various countries inAsia, may not protect our products or intellectual property rights to the sameextent as do the laws of the United States and thus make the possibility ofpiracy of our technology and products more likely in these countries. Ifcompetitors are able to use our technology, our ability to compete effectivelycould be harmed.

**We could become subject to claims and litigation regardingintellectual property rights, which could seriously harm our business andrequire us to incur significant costs.**

In recent years, there has beensignificant litigation in the United States involving patents and otherintellectual property rights. In the past, we have been subject to claims andlitigation regarding alleged infringement of other parties' intellectualproperty rights. We could become subject to litigation in the future either toprotect our intellectual property or as a result of allegations that weinfringe others' intellectual property rights. Claims that our productsinfringe proprietary rights would force us to defend ourselves and possibly ourcustomers or manufacturers against the alleged infringement. These claims andany resulting lawsuit, if successful, could subject us to significant liabilityfor damages and invalidation of our proprietary rights. These lawsuits, regardlessof their success, would likely be time-consuming and expensive to resolve andwould divert management time and attention. Any potential intellectual propertylitigation could force us to do one or more of the following:

|   | • | stop  selling our products that incorporate the challenged intellectual property;                                                                                                         |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | obtain  from the owner of the infringed intellectual property right a license to sell  or use the relevant technology, which license may not be available on  reasonable terms or at all; |
|   | • | pay  damages; or                                                                                                                                                                          |
|   | • | redesign  those products that use such technology.                                                                                                                                        |

If we are forced to take any of theforegoing actions, our business could be severely harmed.

**If necessary licenses of third-party technology are notavailable to us or are very expensive, our products could become obsolete.**

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

**If we are not able to apply our net operating losses againsttaxable income in future periods, our financial results will be harmed.**

Our future net income and cash flow willbe affected by our ability to apply our net operating losses, which totaledapproximately $55.0 million for federal tax reporting purposes as of December31, 2000, against taxable income infutureperiods. Our net operating losses incurred prior to the consummation of ourinitial public offering in 1995 that we can use to reduce future taxable incomefor federal tax purposes are limited to approximately $3.0 million per year.Changes in tax laws in the United States may further limit our ability toutilize our net operating losses. Any further limitation on our ability toutilize our net operating losses could harm our financial condition.

**Any acquisitions we make could disrupt our business andseverely harm our financial condition.**

We have made investments in, andacquisitions of, complementary companies, products and technologies. During2000, we acquired PixelCam and Nogatech, and we may acquire additionalbusinesses, products, or technologies in the future. In the event of any futureacquisitions, we could:

|   | • | issue  stock that would dilute our current stockholders' percentage ownership;   |
|--------|--------|----------------------------------------------------------------------------------|
|   | • | incur  debt;                                                                     |
|   | • | assume  liabilities;                                                             |
|   | • | incur  amortization expenses related to goodwill and other intangible assets; or |
|   | • | incur  large write-offs immediately or in the future..                           |

Our operation of any acquired businesswill also involve numerous risks, including:

|   | • | problems  combining the purchased operations, technologies or products;                       |
|--------|--------|-----------------------------------------------------------------------------------------------|
|   | • | unanticipated  costs;                                                                         |
|   | • | diversion  of management's attention from our core business;                                  |
|   | • | adverse  effects on existing business relationships with customers;                           |
|   | • | risks  associated with entering markets in which we have no or limited prior  experience; and |
|   | • | potential  loss of key employees, particularly those of the purchased organizations.          |

We may not be able to successfullyintegrate any businesses, products or technologies or personnel that we mightacquire in the future and any failure to do so could disrupt our business andseriously harm our financial condition.

**Our products could contain defects, which could reduce salesof those products or result in claims against us.**

We develop complex and evolving products.Despite testing by us and our customers, errors may be found in existing or newproducts. This could result in, among other things, a delay in recognition orloss of revenues, loss of market share or failure to achieve market acceptance.These defects may cause us to incur significant warranty, support and repaircosts, divert the attention of our engineering personnel from our productdevelopment efforts and harm our relationships with our customers. Theoccurrence of these problems could result in the delay or loss of marketacceptance of our products and would likely harm our business. Defects,integration issues or other performance problems in our products could resultin financial or other damages to our customers or could damage marketacceptance of our products. Our customers could also seek damages from us fortheir losses. A product liability claim brought against us, even ifunsuccessful, would likely be time consuming and costly to defend.

**If we do not maintain our current development contracts orare unable to enter into new development contracts, our business could beharmed.**

We historically have generated asignificant percentage of our total revenues from development contracts,primarily with key customers. These development contracts have provided us withpartial funding for the development of some of our products. Under thesecontracts, we receive payments upon reaching certain development milestones. Ifwe fail to achieve the milestones specified in our existing developmentcontracts, if our existing contracts are terminated or we are unable to securefuture development contracts, our ability to cost-effectively develop newproducts would be reduced and our business would be harmed.

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

We may require substantial additionalcapital to finance our future growth, secure additional foundry capacity andfund our ongoing research and development activities beyond 2001. Our capitalrequirements will depend on many factors, including:

 

|   | • | acceptance  of and demand for our products;                                              |
|--------|--------|------------------------------------------------------------------------------------------|
|   | • | the  types of arrangements that we may enter into with our independent foundries;  and   |
|   | • | the  extent to which we invest in new technology and research and development  projects. |

To the extent that our existing sourcesof liquidity and cash flow from operations are insufficient to fund ouractivities, we may need to raise additional funds. If we raise additional fundsthrough the issuance of equity securities, the percentage ownership of ourexisting stockholders would be reduced. Further, such equity securities mayhave rights, preferences or privileges senior to those of our common stock.Additional financing may not be available to us when needed or, if available,it may not be available on terms favorable to us.

**If we fail to manage our future growth, if any, our businesswould be harmed.**

We anticipate that our future growth, ifany, will require us to recruit and hire a substantial number of newengineering, managerial, sales and marketing personnel. Our ability to manageour growth successfully will also require us to expand and improve our administrative,operational, management and financial systems and controls. Many of our keyoperations, including the major portion of our research and developmentoperations and a significant portion of our sales and administrativeoperations, 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 separation of these operations places additionalstrain on our resources and our ability to effectively manage our growth. If weare unable to manage growth effectively, our business would be harmed.

**We rely on the services of our executive officers and otherkey personnel, whose knowledge of our business and industry would be extremelydifficult to replace.**

Our success depends to a significantdegree upon the continuing contributions of our senior management. The loss ofkey management personnel could delay product development cycles or otherwiseharm our business. We may not be able to retain the services of any of our keyemployees. We believe that our future success will also depend in large part onour ability to attract, integrate and retain highly-skilled engineering,managerial, sales and marketing personnel, both in the United States and inIsrael. Competition for such personnel is intense, and we may not be successfulin attracting, integrating and retaining such personnel. Failure to attract,integrate and retain key personnel could harm our ability to carry out ourbusiness strategy and compete with other companies.

**The Israeli rate of inflation may negatively impact our costsif it exceeds the rate of devaluation of the New Israeli Shekel against theU.S. dollar.**

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, we bear the risk that the rate of inflation inIsrael will exceed the rate of devaluation of the New Israeli Shekel inrelation to the dollar, which will increase our costs as expressed in dollars.To date, we have not engaged in hedging transactions. In the future, we mayenter into currency hedging transactions to decrease the risk of financialexposure from fluctuations in the exchange rate of the U.S. dollar against theNew Israeli Shekel. These measures may not adequately protect us from theimpact of inflation in Israel.

**The government programs we participate in and tax benefits wereceive require us to meet several conditions and may be terminated or reducedin the future, which would increase our costs.**

In the year ended December 31, 2000, wereceived an aggregate of $333,000 in grants for research and development fromthe Chief Scientist in Israel's Ministry of Industry and Trade. To continue tobe eligible for these grants, our development projects must be approved by theChief Scientist on a case-by-case basis. If our development projects are not approved by the Chief Scientist, wewill not receive grants to fund these projects, which would increase ourresearch and development costs. We also receive tax benefits, in particularexemptions and reductions as a result of the "Approved Enterprise"status of our existing operations in Israel. To be eligible for these taxbenefits, we must maintain our Approved Enterprise status by meetingconditions, including making specified investments in fixed assets located inIsrael and investing additional equity in our Israeli subsidiary. If we fail tomeet these conditions in the future, the tax benefits would be canceled and wecould be required to refund the tax benefits already received. These taxbenefits may not be continued in the future at their current levels or at anylevel. Israeli governmental authorities have indicated that the government mayreduce or eliminate these benefits in the future, which would harm ourbusiness.

**We have anti-takeover provisions in our charter documents andthere are provisions of Delaware law that could prevent or delay a change incontrol of our company.**

Our certificate of incorporation, ourbylaws and Delaware law contain provisions that could make it more difficultfor a third party to acquire us, even if doing so would be beneficial to ourstockholders. These include provisions:

|   | • | prohibiting  a merger with a party that has acquired control of 15% or more of our  outstanding common stock, such as a party that has completed a successful  tender offer, until three years after that party acquired control of 15% of  our outstanding common stock; |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | • | authorizing  the issuance of up to 3,000,000 shares of "blank check" preferred  stock;                                                                                                                                                                          |
|   | • | eliminating  stockholders' rights to call a special meeting of stockholders; and                                                                                                                                                                                          |
|   | • | requiring  advance notice of any stockholder nominations of candidates for election to  our board of directors.                                                                                                                                                           |

**Our stock price has fluctuated and may continue to fluctuatewidely.**

The market price of our common stock hasfluctuated significantly since our initial public offering in 1995. BetweenJanuary 1, 2000 and December 31, 2000, the closing sale price of our commonstock, as reported on the Nasdaq National Market, ranged from a low of $13.19to a high of $74.31.  During the firstsix months of 2001 the closing sale price ranged from a low of $13.00 to a highof $29.72.  The market price of ourcommon stock is subject to significant fluctuations in the future in responseto a variety of factors, including:

|   | • | announcements  concerning our business or that of our competitors or customers;                     |
|--------|--------|-----------------------------------------------------------------------------------------------------|
|   | • | quarterly  variations in operating results;                                                         |
|   | • | changes  in analysts’ earnings estimates;                                                      |
|   | • | announcements  of technological innovations;                                                        |
|   | • | the  introduction of new products or changes in product pricing policies by us or  our competitors; |
|   | • | proprietary  rights or other litigation;                                                            |
|   | • | general  conditions in the semiconductor industry; and                                              |
|   | • | developments  in the financial markets.                                                             |

In addition, the stock market has, fromtime to time, experienced extreme price and volume fluctuations that haveparticularly affected the market prices for semiconductor companies ortechnology companies generally and which have been unrelated to the operatingperformance of the affected companies. Broad market fluctuations of this typemay reduce the future market price of our common stock.

**Item 3.   Quantitative and Qualitative DisclosuresAbout Market Risk**

We are exposed to financial market risksincluding changes in interest rates and foreign currency exchange rates.

The fair value of our investmentportfolio or related income would not be significantly impacted by either a 10%increase or decrease in interest rates due mainly to the short-term nature ofthe major portion of our investment portfolio.

A majority of our revenue and capitalspending is transacted in U.S. dollars, although a portion of the cost of ouroperations, relating mainly to our personnel and facilities in Israel, isincurred in New Israeli Shekels. We have not engaged in hedging transactions toreduce our exposure to fluctuations that may arise from changes in foreignexchange rates. Based on our overall currency rate exposure at June 30, 2001, anear-term 10% appreciation or depreciation of the New Israeli Shekel would havean immaterial affect on our financial condition.

 

**PART II. OTHER INFORMATION**

**Item 4.   Submission of Matters to a vote of SecurityHolders**

The Company’s 2001 Annual Meeting ofStockholders was held on June 29, 2001. At the meeting the following five persons nominated by management wereelected to serve as directors of the Company:

|               | Shares     |
|--------------------|------------|
|               |            |
| Nominee            | Voted  For |   | Withheld |
|                    |            |   |  |
| Levy  Gerzberg     | 15,355,784 |   | 139,302 |
| Uzia  Galil        | 15,357,885 |   | 137,201 |
| James  D. Meindl   | 15,357,885 |   | 137,201 |
| Arthur  B Stabenow | 15,357,885 |   | 137,201 |
| Philip  M. Young   | 15,357,885 |   | 137,201 |

 

             Thefollowing additional items were voted upon at the meeting:

|   | 1.     | A  proposal to amend the Company’s 1995 Employee Stock Purchase Plan to increase  the number of shares of Common Stock reserved for issuance thereunder by  50,000 shares was approved by a vote of 14,497,892 shares for; 975,037 shares  against; 22,157 shares abstaining. |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                               |
|   | 2.     | A  proposal to ratify the appointment of PricewaterhouseCoopers LLP as the  independent accountants of the Company for the fiscal year ending December  31, 2001 was approved by a vote of 15,356,270 shares for; 124,578 shares  against; 14,238 shares abstaining.               |

 

**Item 6.  Exhibits andReports on Form 8-K**

(a)         Exhibits

10.2     1995 Outside Directors Stock OptionPlan as amended to date.

10.3     Amended and Restated 1995 EmployeeStock Purchase Plan as amended to date.

10.38   Form of Amendment of Nonstatutory StockOption Agreement for Outside Directors

             (b)        Reports on Form 8-K

             No reports on Form 8-K were filedduring the quarter ended June 30, 2001.

**SIGNATURES**

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 

|                        | **ZORAN CORPORATION**                         |
|-----------------------------|-----------------------------------------------|
| Date:  August 14, 2001 | /s/  Karl Schneider                      |
|                        |                                               |
|                        | Karl  Schneider                               |
|                        | Vice  President of Finance                    |
|                        | And  Chief Financial Officer                  |
|                        | (Principal  Financial and Accounting Officer) |