**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

**______________________**

 

**FORM 10-Q**

 

**(Mark One)**

** **

**ý**     QUARTERLY REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

** **

**For thequarterly period ended September 30, 2001**

** **

**or**

** **

**o**     TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

** **

**For thetransition period from**_________**to**_________

** **

 

**CommissionFile Number:  0-27246**

 

 

**ZORAN CORPORATION**

(Exact name of registrantas specified in its charter)

 

 

| **Delaware**                                       |   | **94-2794449**      |
|----------------------------------------------------|--------|---------------------|
| (State or other  jurisdiction of                   |   | (I.R.S. Employer    |
| incorporation or  organization)                    |   | Identification No.) |
|                                               |   |                |
| **3112 Scott Boulevard, Santa Clara,  California** |   | **95054**           |
| (Address of principal  executive offices)          |   | (Zip Code)          |

 

 

Registrant's telephonenumber, including area code:    **(408)919-4111**

 

----

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes ý                Noo

 

 

The number of outstanding shares of the registrant's Common Stock,$.001 par value, as of October 30, 2001 was 17,822,361

 

 

 

**ZORAN CORPORATION**

 

**INDEX**

 
| **PART I. FINANCIAL INFORMATION** |
|-----------------------------------|
|                              |   |   |
| Item 1.                           | Financial Statements |   |
|                              |   |   |
|                              | Condensed  Consolidated Balance Sheets  September 30, 2001 and December 31, 2000 |   |
|                              |   |   |
|                              | Condensed  Consolidated Statements of Operations  Three and Nine Months Ended September 30, 2001 and 2000 |   |
|                              |   |   |
|                              | Condensed  Consolidated Statements of Cash Flows  Nine Months Ended September 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 6.                           | Exhibits and  Reports on Form 8-K |   |
|                              |   |   |
| SIGNATURES                        |   |

**ZORAN CORPORATION**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

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

**(unaudited)**

 
|                                                                                                                   |   | **September 30,  2001** |    | **December 31,  2000** |   |
|------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------|------------------------|--------|
|                                                                                                                   |   |                    |    |                   |   |
| ASSETS                                                                                                                 |   |                    |    |                   |   |
| Current assets:                                                                                                        |   |                    |    |                   |   |
| Cash and cash equivalents                                                                                              |   | $                       | 13,112  |                   | $      | 16,099 |   |
| Short-term investments                                                                                                 |   | 88,813                  |    | 159,539                |   |
| Accounts receivable, net                                                                                               |   | 31,075                  |    | 27,065                 |   |
| Inventory                                                                                                              |   | 19,049                  |    | 17,453                 |   |
| Prepaid expenses and other current assets                                                                              |   | 4,149                   |    | 5,575                  |   |
| Total current assets                                                                                                   |   | 156,198                 |    | 225,731                |   |
|                                                                                                                   |   |                    |    |                   |   |
| Property and equipment, net                                                                                            |   | 7,595                   |    | 6,972                  |   |
| Other investments                                                                                                      |   | 88,125                  |    | 13,899                 |   |
| Goodwill and other intangibles                                                                                         |   | 80,847                  |    | 112,864                |   |
|                                                                                                                   |   |                    |    |                   |   |
|                                                                                                                   |   | $                       | 332,765 |                   | $      | 359,466 |   |
|                                                                                                                   |   |                    |    |                   |   |
|                                                                                                                   |   |                    |    |                   |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                              |   |                    |    |                   |   |
| Current liabilities:                                                                                                   |   |                    |    |                   |   |
| Accounts payable                                                                                                       |   | $                       | 13,787  |                   | $      | 11,156 |   |
| Accrued expenses and other liabilities                                                                                 |   | 16,124                  |    | 16,856                 |   |
| Total current liabilities                                                                                              |   | 29,911                  |    | 28,012                 |   |
|                                                                                                                   |   |                    |    |                   |   |
| Stockholders’ equity:                                                                                             |   |                    |    |                   |   |
| Common Stock, $0.001 par value; 55,000,000 shares authorized;  17,571,355 and 17,423,216 shares issued and outstanding |   | 18                      |    | 17                     |   |
| Additional paid-in capital                                                                                             |   | 389,541                 |    | 388,655                |   |
| Warrants                                                                                                               |   | 717                     |    | 717                    |   |
| Deferred stock-based compensation                                                                                      |   | (511                    | )       | (919                   | )      |
| Accumulated other comprehensive income                                                                                 |   | 486                     |    | 1,109                  |   |
| Accumulated deficit                                                                                                    |   | (87,397                 | )       | (58,125                | )      |
| Total stockholders' equity                                                                                             |   | 302,854                 |    | 331,454                |   |
|                                                                                                                   |   |                    |    |                   |   |
|                                                                                                                   |   | $                       | 332,765 |                   | $      | 359,466 |   |

 

The accompanying notesare an integral part of these condensed consolidated financial statements.

 

**ZORAN CORPORATION**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

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

**(unaudited)**

 
|                                                                                                          |   | **Three Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |   |
|---------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                                                                                                          |   | **2001**                              |   | **2000**                             |   | **2001** |   | **2000** |   |
| Revenues:                                                                                                     |   |                                  |   |                                 |   |   |   |   |   |
| Product sales                                                                                                 |   | $                                     | 28,976 |                                 | $      | 20,378 |   | $ | 66,913 |   | $ | 50,989 |   |
| Software, licensing and development                                                                           |   | 1,448                                 |   | 3,636                                |   | 5,028 |   | 9,528 |   |
| Total revenues                                                                                                |   | 30,424                                |   | 24,014                               |   | 71,941 |   | 60,517 |   |
|                                                                                                          |   |                                  |   |                                 |   |   |   |   |   |
| Costs and expenses:                                                                                           |   |                                  |   |                                 |   |   |   |   |   |
| Cost of product sales                                                                                         |   | 18,971                                |   | 11,138                               |   | 43,075 |   | 28,343 |   |
| Research and development                                                                                      |   | 5,210                                 |   | 5,271                                |   | 17,100 |   | 12,516 |   |
| Selling, general and administrative                                                                           |   | 5,416                                 |   | 5,074                                |   | 15,819 |   | 13,654 |   |
| Amortization of goodwill and other intangibles and write-off of  acquired in-process research and development |   | 10,808                                |   | 1,503                                |   | 32,425 |   | 8,272 |   |
| Total costs and expenses                                                                                      |   | 40,405                                |   | 22,986                               |   | 108,419 |   | 62,785 |   |
|                                                                                                          |   |                                  |   |                                 |   |   |   |   |   |
| Operating income (loss)                                                                                       |   | (9,981                                | )      | 1,028                                |   | (36,478 | ) | (2,268 | ) |
|                                                                                                          |   |                                  |   |                                 |   |   |   |   |   |
| Interest and other income, net                                                                                |   | 2,412                                 |   | 2,226                                |   | 7,763 |   | 6,440 |   |
|                                                                                                          |   |                                  |   |                                 |   |   |   |   |   |
| Income (loss) before income taxes                                                                             |   | (7,569                                | )      | 3,254                                |   | (28,715 | ) | 4,172 |   |
|                                                                                                          |   |                                  |   |                                 |   |   |   |   |   |
| Provision for income taxes                                                                                    |   | 486                                   |   | 714                                  |   | 557 |   | 1,867 |   |
|                                                                                                          |   |                                  |   |                                 |   |   |   |   |   |
| Net income (loss)                                                                                             |   | $                                     | (8,055 | )                                    | $      | 2,540 |   | $ | (29,272 | ) | $ | 2,305 |   |
|                                                                                                          |   |                                  |   |                                 |   |   |   |   |   |
| Basic net income (loss) per share                                                                             |   | $                                     | (0.46  | )                                    | $      | 0.17 |   | $ | (1.68 | ) | $ | 0.16 |   |
|                                                                                                          |   |                                  |   |                                 |   |   |   |   |   |
| Diluted net income (loss) per share                                                                           |   | $                                     | (0.46  | )                                    | $      | 0.16 |   | $ | (1.68 | ) | $ | 0.15 |   |
|                                                                                                          |   |                                  |   |                                 |   |   |   |   |   |
| Shares used to compute basic net income (loss) per share                                                      |   | 17,502                                |   | 14,564                               |   | 17,373 |   | 14,145 |   |
|                                                                                                          |   |                                  |   |                                 |   |   |   |   |   |
| Shares used to compute diluted net income (loss) per share                                                    |   | 17,502                                |   | 16,009                               |   | 17,373 |   | 15,557 |   |

 

The accompanying notesare an integral part of these condensed consolidated financial statements.

 

**ZORAN CORPORATIONCONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS(in thousands)(unaudited)**

 
|                                                                                                 |   | **Nine Months Ended  September 30,** |          |
|------------------------------------------------------------------------------------------------------|--------|--------------------------------------|---------------|
|                                                                                                 |   | **2001**                             |          | **2000** |   |
| Cash flows from operating activities:                                                                |   |                                 |          |   |   |
| Net income (loss)                                                                                    |   | $                                    | (29,272       | ) | $ | 2,305 |   |
| Adjustments to reconcile net income (loss) to net cash provided  by operations:                      |   |                                 |          |   |   |
| Depreciation, amortization and other                                                                 |   | 3,022                                |          | 2,223 |   |
| Amortization of goodwill and other intangibles and write-off of  in process research and development |   | 32,017                               |     | 8,272 |     |
| Changes in current assets and liabilities:                                                           |   |                                 |          |   |   |
| Accounts receivable                                                                                  |   | (3,618                               | )             | (6,655 | ) |
| Inventory                                                                                            |   | (1,596                               | )             | (6,173 | ) |
| Prepaid expenses and other current assets                                                            |   | 1,309                                |          | (2,286 | ) |
| Accounts payable                                                                                     |   | 2,631                                |          | 4,902 |   |
| Accrued expenses and other liabilities                                                               |   | (1,014                               | )             | 5,256 |   |
| Net cash provided by operating activities                                                            |   | 3,479                                |          | 7,844 |   |
|                                                                                                 |   |                                 |          |   |   |
| Cash flows from investing activities:                                                                |   |                                 |          |   |   |
| Capital expenditures for property and equipment                                                      |   | (3,120                               | )             | (2,606 | ) |
| Purchases of investments                                                                             |   | (160,558                             | )             | (166,562 | ) |
| Sales and maturities of investments                                                                  |   | 157,497                              |          | 163,897 |   |
| Purchases of long-term equity investments                                                            |   | (1,171                               | )             | (2,250 | ) |
| Acquisition costs net of cash acquired                                                               |   | --                                   |          | (12 | ) |
| Net cash used in investing activities                                                                |   | (7,352                               | )             | (7,533 | ) |
|                                                                                                 |   |                                 |          |   |   |
| Cash flows from financing activities:                                                                |   |                                 |          |   |   |
| Proceeds from issuance of Common Stock, net                                                          |   | 4,753                                |          | 2,931 |   |
| Repurchases of Common Stock                                                                          |   | (3,867                               | )             | -- |   |
| Net cash provided by financing activities                                                            |   | 886                                  |          | 2,931 |   |
|                                                                                                 |   |                                 |          |   |   |
| Net increase (decrease) in cash and cash equivalents                                                 |   | (2,987                               | )             | 3,242 |   |
|                                                                                                 |   |                                 |          |   |   |
| Cash and cash equivalents at beginning of period                                                     |   | 16,099                               |          | 12,665 |   |
|                                                                                                 |   |                                 |          |   |   |
| Cash and cash equivalents at end of period                                                           |   | $                                    | 13,112        |   | $ | 15,907 |   |
|                                                                                                 |   |                                 |          |   |   |
|                                                                                                 |   |                                 |          |   |   |
|                                                                                                 |   |                                 |          |   |   |
| Non-cash disclosures of investing activities:                                                        |   |                                 |          |   |   |
| Issuance of Common Stock in exchange for the net assets of  PixelCam, Inc.                           |   | $                                    | --            |   | $ | 24,649 |   |

 

The accompanying notesare an integral part of these condensed consolidated financial statements.

 

**ZORAN CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(unaudited)**

 

**1.             Basis of Presentation**

 

The accompanying unaudited condensed consolidated financial statementscontain all adjustments (consisting only of normal recurring adjustments)which, in the opinion of management, are necessary to present fairly thefinancial information included therein. While the Company believes that the disclosures are adequate to make theinformation not misleading, it is suggested that these financial statements beread in conjunction with the audited consolidated financial statements andaccompanying notes included in the Company's Annual Report on Form 10-K for theyear ended December 31, 2000.  Resultsfor the interim periods presented are not necessarily indicative of the resultsto be expected for the full year.

 

**2.             Comprehensive Income**

 

The Company applies Statement of Financial Accounting Standards No.130, Reporting Comprehensive Income.

 

The following are the components of comprehensive income (loss) (inthousands):

 
|                                              |   | **Three Months Ended  September 30,** |   | **Nine Months Ended****September  30,** |   |
|---------------------------------------------------|--------|---------------------------------------|--------|-----------------------------------------|--------|
|                                              |   | **2001**                              |   | **2000**                                |   | **2001** |   | **2000** |   |
|                                              |   |                                  |   |                                    |   |   |   |   |   |
| Net income (loss)                                 |   | $                                     | (8,055 | )                                       | $      | 2,540 |   | $ | (29,272 | ) | $ | 2,305 |   |
| Unrealized income (loss) on short-term investment |   | 1,170                                 |   | (680                                    | )      | (623 | ) | (2,164 | ) |
| Comprehensive income (loss)                       |   | $                                     | (6,885 | )                                       | $      | (1,860 | ) | $ | (29,895 | ) | $ | 141 |   |

 

 

 

Thecomponents of accumulated other comprehensive income (loss) are net unrealizedgains on short-term investments and long-term marketable securities.

 

 

**3.             Balance Sheet Components**(inthousands):

** **
|            |   | **September  30,  2001** |   | **December 31,  2000** | ** ** |
|-----------------|--------|--------------------------|--------|------------------------|------------|
| **Inventory:**  |   |                     |   |                   |       |
| Work-in-process |   | $                        | 8,117  |                   | $          | 6,913 |   |
| Finished goods  |   | 10,932                   |   | 10,540                 |       |
|            |   |                     |   |                   |       |
|            |   | $                        | 19,049 |                   | $          | 17,453 |   |

 

** **

**4.             Income Taxes**

 

The provision for income taxes reflects the estimated annualized effectivetax rate applied to earnings excluding charges for amortization of goodwill andother intangibles and the write-off of in-process research and development forthe interim periods.  The effective taxrate differs from the U.S. statutory rate due to utilization of net operatinglosses, adjustments for the nondeductible amortization of goodwill and otherintangibles and write-off of in-process research and development, and incometax rate differences on foreign earnings. The Company has provided for tax on income in excess of net operatingloss carryforwards for U.S. Federal and State earnings.  The Company has also provided for tax on itsforeign earnings.

 

**5.             Earnings Per Share**

 

Computation of basic and diluted earnings per share is as follows:

 
|                                                |   | **Three Months Ended September 30,** |   |
|-----------------------------------------------------|--------|--------------------------------------|--------|
|                                                |   | **2001**                             |   | **2000** |   |
|                                                |   | **(Loss)  (Numerator)**              |   | **Shares  (Denominator)** |   | **Per Share  Amount** |   | **Income  (Numerator)** |   | **Shares  (Denominator)** |   | **Per Share  Amount** |   |
|                                                |   |                                 |   |   |   |   |   |   |   |   |   |   |   |
| Basic and Diluted EPS:                              |   |                                 |   |   |   |   |   |   |   |   |   |   |   |
| Net income  (loss) available to common stockholders |   | $                                    | (8,055 | ) | 17,502 |     | $ | (0.46 | ) | $ | 2,540 |     | 14,564 |     | $ | 0.17 |     |
|                                                |   |                                 |   |   |   |   |   |   |   |   |   |   |   |
| Effects of Dilutive Securities:                     |   |                                 |   |   |   |   |   |   |   |   |   |   |   |
| Stock Options                                       |   |                                 |   | - |   |   |   |   |   | 1,404 |   |   |   |
| Warrants                                            |   |                                 |   | - |   |   |   |   |   | 41 |   |   |   |
|                                                |   |                                 |   |   |   |   |   |   |   |   |   |   |   |
| Diluted EPS:                                        |   |                                 |   |   |   |   |   |   |   |   |   |   |   |
| Income  (loss) available to common stockholders     |   | $                                    | (8,055 | ) | 17,502 |   | $ | (0.46 | ) | $ | 2,540 |   | 16,009 |   | $ | 0.16 |   |

 

 
|                                                |   | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------|--------|--------------------------------------|------------|
|                                                |   | **2001**                             |       | **2000** | ** ** |
|                                                |   | **(Loss)  (Numerator)**              |       | **Shares  (Denominator)** |   | **Per Share  Amount** |   | **Income  (Numerator)** |   | **Shares  (Denominator)** |   | **Per Share  Amount** |   |
|                                                |   |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Basic and Diluted EPS:                              |   |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Net income  (loss) available to common stockholders |   | $                                    | (29,272    | ) | 17,373 |     | $ | (1.68 | ) | $ | 2,305 |   | 14,145 |   | $ | 0.16 |     |
|                                                |   |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Effects of Dilutive Securities:                     |   |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Stock Options                                       |   |                                 |       | - |   |   |   |   |   | 1,372 |   |   |   |
| Warrants                                            |   |                                 |       | - |   |   |   |   |   | 40 |   |   |   |
|                                                |   |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Diluted EPS:                                        |   |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Income  (loss) available to common stockholders     |   | $                                    | (29,272    | ) | 17,373 |     | $ | (1.68 | ) | $ | 2,305 |     | 15,557 |     | $ | 0.15 |     |

 

 

**6.             Repurchase of Common Stock**

 

**Duringthe nine months ended September 30, 2001 the Company repurchased 255,000 sharesof its common stock for $3.9 million.**

 

 

**7.             Recently Issued Accounting Standard**

 

In June 1998, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standards No. 133, “Accounting for DerivativeInstruments and Hedging Activities" ("SFAS 133"). SFAS 133establishes a new model for accounting for derivatives and hedging activitiesand supercedes and amends a number of existing accounting standards. SFAS 133requires that all derivatives be recognized in the balance sheet at their fairmarket value, and the corresponding derivative gains or losses be eitherreported in the statement of operations or as a deferred item depending on thetype of hedge relationship that exists with respect to such derivative.Adopting the provisions of SFAS 133, as amended by SFAS 137, is effective forthe Company’s fiscal year 2001, and will not have a material effect on theCompany’s consolidated financial statements.

 

In July 2001, the FASB issued FASB Statements Nos. 141 and 142 (FAS 141and FAS 142), “Business Combinations” and “Goodwill and Other IntangibleAssets.” FAS 141 replaces APB 16 and eliminates pooling-of-interests accountingprospectively. It also provides guidance on purchase accounting related to therecognition of intangible assets and accounting for negative goodwill. FAS 142changes the accounting for goodwill from an amortization method to animpairment-only approach. Under FAS 142, goodwill will be tested annually andwhenever events or circumstances occur indicating that goodwill might beimpaired. FAS 141 and FAS 142 are effective for all business combinationscompleted after June 30, 2001. Upon adoption of FAS 142, amortization ofgoodwill recorded for business combinations consummated prior to July 1, 2001will cease, and intangible assets acquired prior to July 1, 2001 that do notmeet the criteria for recognition under FAS 141 will be reclassified togoodwill. Companies are required to adopt FAS 142 for fiscal years beginningafter December 15, 2001, but early adoption is permitted. The Company willadopt FAS 142 on January 1, 2002. In connection with the adoption of FAS 142,the Company will be required to perform a transitional goodwill impairmentassessment. The Company has not yet determined the impact these standards willhave on its results of operations and financial position.

 

In August 2001, the FASB issued SFAS No. 143 ("SFAS 143"),"Accounting for Asset Retirement Obligations". This Statementaddresses financial accounting and reporting for obligations associated withthe retirement of tangible long-lived assets and the associated asset retirementcosts. This Statement applies to all entities. It applies to legal obligationsassociated with the retirement of long-lived assets that result from theacquisition, construction, development and (or) the normal operation of along-lived asset, except for certain obligations of lessees. SFAS 143 iseffective for financial statements issued for fiscal years beginning after June25, 2002. The Company expects that the initial application of SFAS 143 will nothave a material impact on its financial statements.

 

In October 2001, the FASB issued SFAS No. 144 ("SFAS 144"),"Accounting for the Impairment or Disposal of Long-lived Assets". Theobjectives of SFAS 144 are to address significant issues relating to theimplementation of SFAS No. 121 ("SFAS 121"), "Accounting for theImpairment of Long-lived Assets and for Long-lived assets to be DisposedOf," and to develop a single accounting model, based on the frameworkestablished by SFAS 121, for long-lived assets to be disposed of by sale,whether previously held and used or newly acquired. Although SFAS 144supersedes SFAS 121, it retains some fundamental provisions of SFAS 121. SFASNo. 144 is effective for financial statements issued for fiscal years beginningafter December 15, 2001, and interim periods within those fiscal years. TheCompany expects that the initial application of SFAS 144 will not have amaterial impact on its financial statements.

 

 

**Item 2.   Management'sDiscussion and Analysis of Financial Condition and Results****ofOperations**

 

 

***The following discussion includesforward-looking statements with respect to the Company’s future financialperformance.  Actual results may differmaterially from those currently anticipated depending upon a variety offactors, including those described below under the sub-heading, “FuturePerformance and Risk Factors” and discussed more fully in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2000.***

 

 

**Overview**

 

From our inception in 1981 through 1991, we derived the substantialmajority of our revenue from digital filter processors and vector signalprocessors used principally in military, industrial and medical applications.In 1989, we repositioned our business to develop and market data compressionproducts for the evolving multimedia markets and discontinued development ofdigital filter processor and vector signal processor products. In 1994, wediscontinued production of these products. Our current lines of digital audioand video products include integrated circuits and related products used indigital versatile disc players (“DVD”), filmless digital cameras, movie andhome theater systems, and video editing systems.

 

We derive most of our revenues from the sale of our integrated circuitproducts. Historically, average selling prices in the semiconductor industry ingeneral, and for our products in particular, have decreased over the life of aparticular product. Average selling prices for our hardware products havefluctuated substantially from period to period, primarily as a result ofchanges in our customer mix of original equipment manufacturer, or OEM, salesversus sales to distributors and the transition from low-volume to high-volumeproduction. We have periodically reduced the prices of some of our products inorder to better penetrate consumer markets. We believe that, as our productlines continue to mature and competitive markets evolve, we are likely toexperience further declines in the average selling prices of our products,although we cannot predict the timing and amount of such future changes withany certainty.

 

Our cost of product sales consists primarily of fabrication costs,assembly and test costs, and the cost of materials and overhead fromoperations. If we are unable to reduce our cost of product sales to offsetanticipated decreases in average selling prices, our product gross margins willdecrease. Our product gross margin is also dependent on product mix and on thepercentage of products sold directly to our OEM customers versus indirectlythrough our marketing partners who purchase our products at lower prices butabsorb most of the associated marketing and sales support expenses, maintaininventories and provide customer support and training. Lower gross margins onsales to distributors are partially offset by reduced selling and marketingexpenses related to such sales. Product sales in Japan are primarily madethrough Fujifilm, our strategic partner and distributor in Japan. Fujifilmprovides more sales and marketing support than our other distributors. Weexpect both product and customer mix to continue to fluctuate in futureperiods, causing further fluctuations in margins.

 

We also derive revenue from licensing our software and otherintellectual property. Licensing revenue includes one-time license fees androyalties based on the number of units distributed by the licensee. Inaddition, we have historically generated a significant percentage of our totalrevenues from development contracts, primarily with key customers, althoughdevelopment revenue has declined as a percentage of total revenues over thepast several years. These development contracts have provided us with partialfunding for the development of some of our products. These developmentcontracts provide for license and milestone payments which are recorded as developmentrevenue. We classify all development costs, including costs related to thesedevelopment contracts, as research and development expenses. We retainownership of the intellectual property developed by us under these developmentcontracts. While we intend to continue to enter into development contracts withcertain strategic partners, we expect development revenue to continue todecline as a percentage of total revenues.

 

Our research and development expenses consist of salaries and relatedcosts of employees engaged in ongoing research, design and developmentactivities and costs of engineering materials and supplies. We are also a partyto research and development agreements with the Chief Scientist in Israel'sMinistry of Industry and Trade and the Israel-United States BinationalIndustrial Research and Development Foundation, which fund up to 50% ofincurred project costs for approved products up to specified contract maximums.These agreements require us to use our best efforts to achieve specified resultsand require us to pay royalties at rates of 3% to 5% of resulting productsales, and up to 30% of resulting license revenues, up to a maximum of 100% to150% of total funding received. Reported research and development expenses arenet of these grants, which fluctuate from period to period. We believe thatsignificant investments in research and development are required for us toremain competitive and we expect to continue to devote significant resources toproduct development, although such expenses as a percentage of total revenuesmay fluctuate.

 

Our selling, general and administrative expenses consist primarily ofemployee-related expenses, royalties, sales commissions, product promotion andother professional services. We expect that selling, general and administrativeexpenses will continue to increase to support our anticipated growth.

 

We conduct most of our research and development and certain sales andmarketing and administrative operations in Israel through our wholly-ownedIsraeli subsidiary. As a result, some of our expenses are incurred in NewIsraeli Shekels. To date, substantially all of our product sales and ourdevelopment and licensing revenue have been denominated in U.S. dollars andmost costs of product sales have been incurred in U.S. dollars. We expect thatmost of our sales and costs of sales will continue to be denominated andincurred in U.S. dollars for the foreseeable future. We have not experiencedmaterial losses or gains as a result of currency exchange rate fluctuations andhave not engaged in hedging transactions to reduce our exposure to suchfluctuations. We may in the future elect to take appropriate action to reduceour foreign exchange risk.

 

Our effective income tax rate has benefited from the availability ofnet operating losses which we have utilized to reduce taxable income for U.S.federal income tax purposes and by our Israeli subsidiary's status as an"Approved Enterprise" under Israeli law, which provides a ten-yeartax holiday for income attributable to a portion of our operations in Israel.Our U.S. federal net operating losses expire at various times between 2001 and2020, and the benefits from our subsidiary's Approved Enterprise status expireat various times beginning in 2003.

 

In June 1999, we sold to MGI Software of Canada the intellectualproperty related to our SoftDVD product line and transferred to MGI certainrelated software development and support resources in exchange for cash, MGIcommon stock and future royalties. We do not currently expect, however, thatthese royalties will have a material impact on quarterly revenues for theforeseeable future. In addition, the shares of MGI stock received by us as partof this transaction are subject to future appreciation or depreciation. Oursoftware revenues have declined significantly as a result of the sale of theSoftDVD product line.

 

On June 29, 2000, we acquired PixelCam, Inc. (“PixelCam”), amanufacturer of megapixel CMOS image sensors, in exchange for 370,832 shares ofZoran common stock and options to purchase 4,168 shares of Zoran common stockwith an aggregate value of $24.6 million. The acquisition was accounted forunder the purchase method of accounting. Additional information regarding thisacquisition is contained in our Annual Report on Form 10-K for the year endedDecember 31, 2000.

 

On October 26, 2000, we acquired Nogatech Inc. (“Nogatech”) a providerof chips that compress digital video images and establish connections, or videoconnectivity, between video devices and computers, as well as between videodevices across a variety of networks, in exchange for 2,534,599 shares of ourcommon stock and options to purchase 168,472 shares of our common stock with anaggregate value of $163.6 million. The acquisition was accounted for under thepurchase method of accounting. Additional information regarding thisacquisition is contained in our Annual Report on Form 10-K for the year endedDecember 31, 2000.

 

**Results of Operations**

 

*Revenues*

 

Total revenueswere $30.4 million and $71.9 million for the three and nine month periods endedSeptember 30, 2001, compared to $24.0 million and $60.5 million for the sameperiods of 2000, representing increases of 26.7% and 18.9% for the respectiveperiods.  For the three and nine monthperiods ended September 30, 2001, product sales were $29.0 million and $66.9million, compared to $20.4 million and $51.0 million for the same periods in2000, increases of 42.2% and 31.2%, respectively.  Fueling the growth in product sales were increased unit sales inthe DVD and digital camera product lines as well as our acquisition of Nogatechin the fourth quarter of 2000. Software, licensing and development revenueswere $1.4 million and $5.0 million for the three and nine month periods endedSeptember 30, 2001, compared to $3.6 million and $9.5 million for the sameperiods of 2000, representing decreases of 60.2% and 47.2% for the respectiveperiods. These changes were primarily due to a reduction in the number and sizeof significant new licensing contracts, as well as the timing of revenuerecognition on development contracts.

*ProductGross Margin*

 

Product grossmargins were 34.5% and 35.6% for the three and nine month periods endedSeptember 30, 2001, compared to 45.3% and 44.4% for the same periods of 2000.The decrease was due to a product sales mix that included an increasedpercentage of lower-margin products and a shift in customer mix which resultedin a lower percentage of direct sales to OEM customers compared to the sameperiods in 2000. In addition, we experienced a decline in the average sellingprice of our older Vaddis III DVD chip that is being phased out as wetransition our customer base to our new Vaddis IV Plus DVD chip.

*Researchand Development*

 

Research anddevelopment (“R&D”) expenses were $5.2 million and $17.1 million for thethree and nine month periods ended September 30, 2001, compared to $5.3 millionand $12.5 million for the same periods of 2000. R&D expenses for thequarter were down from the same period last year due to the timing of major projectexpenses such as tape-outs. R&D expenses for the first nine monthsincreased as a result of our acquisitions of PixelCam and Nogatech, in June2000 and October 2000, respectively, the timing of major project expenses suchas tape-outs and the timing and recognition of project funding from externalsources. As a percentage of revenues, R&D expenses decreased to 17.1% andincreased to 23.8% for the three and nine month periods ended September 30,2001, compared to 21.9% and 20.7% for the same periods of 2000.

*Selling,General and Administrative*

 

Selling, generaland administrative (“SG&A”) expenses were $5.4 million and $15.8 millionfor the three and nine month periods ended September 30, 2001, compared to $5.1million and $13.7 million for the same periods of 2000. The increase was due toour acquisitions of PixelCam, Inc. and Nogatech, Inc. in June 2000 and October2000, respectively, increased sales and marketing expenses related to productmarket development and to support planned revenue growth particularly in theTaiwan, China and Korean markets.  As apercentage of revenues, SG&A expenses were 17.8% and 22.0% for the threeand nine month periods ended September 30, 2001, compared to 21.1% and 22.6%for the same periods of 2000.

*Amortization of Goodwill and OtherIntangibles and the Write-Off of In-Process Research and Development*

Amortization ofgoodwill and other intangibles for the three and nine months ended September30, 2001 were $10.8 million and $32.4 million compared to $1.5 million for thesame periods of 2000. These charges were associated with our acquisitions ofPixelCam and Nogatech.  We did not incurany charges for the write-off of in-process research and development for thethree and nine months ended September 30, 2001. For the nine months endedSeptember 30, 2000 we incurred in-process research and development charges of$6.8 million in conjunction with our acquisition of PixelCam in June 2000.

*Interestand Other Income, Net*

 

Net interest andother income for the three and nine month periods ended September 30, 2001 was$2.4 million and $7.8 million, respectively, an increase of 8.4% and 20.5%compared to the same periods in 2000. The increase resulted primarily fromincreased interest income on higher cash balances following our acquisition ofNogatech.

*Provisionfor Income Taxes*

 

Excluding charges related to the amortization of goodwill and otherintangibles and the write-off of in-process research and development, ourestimated effective tax rate remained at 15% for the current quarter, the sameas last year’s effective tax rate.

**Liquidityand Capital Resources**

 

At September 30, 2001, we had $13.1 million of cash and cashequivalents, $88.8 million of short-term investments and $126.3 million ofworking capital. In addition, we had $83.8 million of investments in long-termmarketable securities.

 

Our operating activities provided cash of $3.5 million during the ninemonths ended September 30, 2001, primarily due to the net loss adjusted for thenon-cash impact of depreciation and amortization and an increase in accountspayable and a decrease in prepaid expenses, offset by increases in accountsreceivable, inventory and accrued expenses.

 

Cash used in investing activities was $7.4 million during the ninemonths ended September 30, 2001, principally reflecting the purchases ofinvestments and capital expenditures for property and equipment.

 

Cash provided by financing activities was $886,000 for the nine monthsended Sept 30, 2001, consisting of proceeds from the issuance of our common stockoffset by the repurchase of 255,000 shares of our common stock during the ninemonths ended September 30, 2001.

 

We believe that our current balances of cash, cash equivalents andshort-term investments, and anticipated cash flow from operations, will satisfyour anticipated working capital and capital expenditure requirements at leastthrough the next 12 months. Nonetheless, our future capital requirements mayvary materially from those now planned and will depend on many factorsincluding, but not limited to:

 

•      the levels atwhich we maintain inventory and accounts receivable;

 

•      the marketacceptance of our products;

 

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

 

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

 

•      volumepricing concessions;

 

•      capitalimprovements to new and existing facilities;

 

•      technologicaladvances;

 

•      the responseof competitors to our products; and

 

•      ourrelationships with our suppliers and customers.

 

In addition, we may require an increase in the levelof working capital to accommodate planned growth, hiring and infrastructureneeds. Additional capital may also be required for acquisitions of businesses,products or technologies.

 

To the extent that our existing resources and cashgenerated from operations are insufficient to fund our future activities, wemay need to raise additional funds through public or private financings orborrowings. If additional funds are raised through the issuance of debtsecurities, these securities could have rights, preferences and privilegessenior to holders of common stock, and the terms of this debt could imposerestrictions on our operations. The sale of additional equity or convertibledebt securities could result in additional dilution to our stockholders. Wecannot be certain that additional financing will be available in amounts or onterms acceptable to us, if at all. If we are unable to obtain this additionalfinancing, we may be required to reduce the scope of our planned productdevelopment and sales and marketing efforts, which could harm our business,financial condition and operating results.

**Future Performance and Risk Factors**

 

The Company's futurebusiness, operating results and financial condition are subject to variousrisks and uncertainties, including those described below.

 

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

 

Our quarterly operating results have variedsignificantly due to a number of factors, including:

 

•      fluctuationin demand for our products;

 

•      the timing ofnew product introductions by us and our competitors;

 

•      the level ofmarket acceptance of new and enhanced versions of our products and ourcustomers' products;

 

•      the timing oflarge customer orders;

 

•      the lengthand variability of the sales cycle for our products;

 

•      the cyclicalnature of the semiconductor industry;

 

•      theavailability of development funding and the timing of development revenue;

 

•      changes inthe mix of products sold;

 

•      seasonalityin demand for our products;

 

•      competitivepricing pressures; and

 

•      the evolvingand unpredictable nature of the markets for products incorporating ourintegrated circuits and embedded software.

We expect that our operating results will continue tofluctuate in the future as a result of these factors and a variety of otherfactors, including:

 

•      the cost andavailability of adequate foundry capacity;

 

•      fluctuationsin manufacturing yields;

 

•      the emergenceof new industry standards;

 

•      productobsolescence; and

 

•      the amount ofresearch and development expenses associated with new product introductions.

 

Our operating results could also be harmed by:

 

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

 

•      otherconditions affecting the timing of customer orders; or

 

•      a downturn inthe markets for our customers' products, particularly the consumer electronicsmarket.

 

These factors are difficult or impossible to forecast.We place orders to purchase our products from independent foundries severalmonths in advance of the scheduled delivery date, often in advance of receivingnon-cancelable orders from our customers. If anticipated shipments in anyquarter are canceled or do not occur as quickly as expected, expense andinventory levels could be disproportionately high. If anticipated license revenuesin any quarter are canceled or do not occur, gross margins may be reduced. Asignificant portion of our expenses are relatively fixed, and the timing ofincreases in expenses is based in large part on our forecast of futurerevenues. As a result, if revenues do not meet our expectations we may beunable to quickly adjust expenses to levels appropriate to actual revenues,which could harm our operating results.

 

As a result of these factors, our operating resultsmay vary significantly from quarter to quarter. Any shortfall in revenues ornet income from levels expected by securities analysts could cause a decline inthe trading price of our stock.

**Our success for the foreseeablefuture will be dependent on growth in demand for integrated circuits forDVD,  filmless digital cameraapplications and, to a lesser extent, on digital audio and video editingapplications and our ability to market and sell our products to manufacturerswho incorporate those types of integrated circuits into their products.**

 

In 2000 and the first nine months of 2001, we deriveda majority of our product revenues from the sale of integrated circuits for DVDand, to a lesser extent, Super Video CD applications. We expect that sales ofour products for DVD 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 and to a lesser extent digital audioand video editing applications will also have an impact on our financialperformance for the foreseeable future. If the markets for these products andapplications decline or fail to develop as expected, or we are not successfulin our efforts to market and sell our products to manufacturers who incorporateintegrated circuits into these products, our financial results will be harmed.

 

**Our customers experiencefluctuating product cycles and seasonality, which causes our sales tofluctuate.**

 

Because the markets our customers serve arecharacterized 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, ordersfor our products may decline in those circumstances, even if our products areincorporated into both mature products and replacement products. A delay in thecustomer's transition to commercial production of a replacement product woulddelay our ability to recover the lost sales from the discontinuation of therelated mature product. Our customers also experience significant seasonalityin the sales of their consumer products, which affects their orders of ourproducts. Typically, the fourth calendar quarter represents a disproportionatepercentage of sales for our customers due to the holiday period, and thereforea disproportionate percentage of our sales. We expect these sales fluctuationsto continue for the foreseeable future.

** **

**Product supply and demandin the semiconductor industry is subject to cyclical variations.**

 

The semiconductor industry is subject to cyclicalvariations in product supply and demand. Downturns in the industry often occurin connection with, or anticipation of, maturing product cycles for bothsemiconductor companies and their customers and declines in general economicconditions. These downturns have been characterized by abrupt fluctuations inproduct demand, production over-capacity and accelerated decline of averageselling prices. In some cases, these downturns have lasted more than one year.A downturn in the semiconductor industry could harm our sales and revenues ifdemand drops or our gross margins if average selling prices decline.

 

**The development andevolution of markets for our integrated circuits is dependent on factors suchas industry standards, over which we have no control; for example, ifmanufacturers adopt new or competing industry standards with which our productsare not compatible, our existing products would become less desirable to themanufacturers and our sales would suffer.**

 

The emergence of markets for our products is affectedby a variety of factors beyond our control. In particular, our products aredesigned to conform to current specific industry standards. Manufacturers maynot continue to follow these standards, which would make our products lessdesirable to manufacturers and reduce our sales. Also, competing standards mayemerge that are preferred by manufacturers, which could also reduce our salesand require us to make significant expenditures to develop new products. Theemergence of new markets for our products is also dependent in part upon thirdparties developing and marketing content in a format compatible with commercialand consumer products that incorporate our products. If content compatible withcommercial and consumer products that incorporate our products is notavailable, manufacturers may not be able to sell products incorporating ourintegrated circuits, and our sales to manufacturers would suffer.

**We relyon independent foundries and contractors for the manufacture, assembly andtesting of our integrated circuits, and the failure of any of these thirdparties to deliver products or otherwise perform as requested could damage ourrelationships with our customers and harm our sales and financial results.**

 

We do not operate any manufacturing facilities, and werely on independent foundries to manufacture substantially all of our products.These independent foundries fabricate products for other companies and may alsoproduce products of their own design. From time to time there are manufacturingcapacity shortages in the semiconductor industry. We do not have long-termsupply contracts with any of our suppliers, including our principal supplier,Taiwan Semiconductor Manufacturing Company, or TSMC. Therefore, TSMC  and these other suppliers are not obligatedto manufacture products for us for any specific period, in any specificquantity or at any specified price, except as may be provided in a particularpurchase order.

 

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

 

•      the inabilityto obtain adequate manufacturing capacity;

 

•      theunavailability of or interruption in access to certain process technologies necessaryfor manufacture of our products;

 

•      reducedcontrol over delivery schedules;

 

•      reducedcontrol over quality assurance;

 

•      reducedcontrol over manufacturing yields and cost; and

 

•      potentialmisappropriation of our intellectual property.

 

In addition, TSMC and some of our other foundries arelocated in areas of the world which are subject to natural disasters such asearthquakes. While the 1999 earthquake in Taiwan did not have a material impacton our independent foundries, a similar event centered near TSMC's facilitycould severely reduce TSMC's ability to manufacture our integrated circuits.The loss of any of our manufacturers as a supplier, our inability to expand thesupply of our products in response to increased demand, or our inability toobtain timely and adequate deliveries from our current or future suppliers dueto a natural disaster or any other reason could delay or reduce shipments ofour products. Any of these circumstances could damage our relationships withcurrent and prospective customers and harm our sales and financial results.

 

We also rely on independent contractors for theassembly and testing of our products. At present, all of our semiconductorproducts are assembled by one of five independent contractors: ASE, Amkor, ASAT,National Semiconductor, or Vate. Our semiconductor products are tested by thesecontractors or other independent contractors. Our reliance on independentassembly and testing houses limits our control over delivery schedules, qualityassurance and product cost. Disruptions in the services provided by ourassembly or testing houses or other circumstances that would require us to seekalternative sources of assembly or testing could lead to supply constraints ordelays in the delivery of our products. These constraints or delays coulddamage our relationships with current and prospective customers and harm oursales and financial results.

 

** **

**Because foundry capacityis limited from time to time we may be required to enter into costly long-termsupply arrangements to secure foundry capacity.**

 

If we are not able to obtain additional foundrycapacity as required, our relationships with our customers would be harmed andour sales would likely be reduced. In order to secure additional foundrycapacity, we have considered and will continue to consider various arrangementswith suppliers, which could include, among others:

 

•      optionpayments or other prepayments to a foundry;

 

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

 

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

 

•      issuance ofour equity securities to a foundry;

 

•      investment ina foundry;

 

•      jointventures; or

 

•      otherpartnership relationships with foundries.

 

We may not be able to make any such arrangement in atimely fashion or at all, and such arrangements, if any, may not be on termsfavorable to us. Moreover, if we are able to secure foundry capacity, we may beobligated to utilize all of that capacity or incur penalties. Such penaltiesmay be expensive and could harm our financial results.

** **

**If our independent foundries do notachieve satisfactory yields, our relationships with our customers may beharmed.**

 

The fabrication of silicon wafers is a complex process.Minute levels of contaminants in the manufacturing environment, defects inphotomasks used to print circuits on a wafer, difficulties in the fabricationprocess or other factors can cause a substantial portion of the integratedcircuits on a wafer to be non-functional. Many of these problems are difficultto detect at an early stage of the manufacturing process and may be timeconsuming and expensive to correct. As a result, foundries often experienceproblems achieving acceptable yields, which are represented by the number ofgood integrated circuits as a proportion of the number of total integratedcircuits on any particular wafer.  Pooryields from our independent foundries would reduce our ability to deliver ourproducts to customers, harm our relationships with our customers, and harm ourbusiness.

 

**To be successful, we mustefficiently develop new and enhanced products to meet rapidly changing customerrequirements and industry standards.**

 

The markets for our products are characterized by:

 

•      rapidlychanging technologies;

 

•      evolvingindustry standards;

 

•      frequent newproduct introductions; and

 

•      short productlife cycles.

 

Over the long run, 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 orpotential competition from companies with greater resources than ours, and ifwe are unable to compete effectively with these companies, our market share maydecline and our business could be harmed.**

 

Competition in the compression technology market hashistorically been dominated by large companies, such as STMicroelectronics, andcompanies that develop and use their own integrated circuits, such as Sony. Asthis market continues to develop, we face competition from other largesemiconductor vendors, including:

 

•      Cirrus Logic(Crystal Semiconductor);

 

•      Conexant;

 

•      ESSTechnology, Inc.

 

•      Fujitsu;

 

•      LSI Logic(including recently acquired C-Cube Microsystems Inc.);

 

•      Motorola;

 

•      SunplusTechnology; and

 

•      TexasInstruments.

 

For example, in the markets for JPEG-based productsfor use in filmless digital cameras, Conexant is providing CMOS sensor andcamera DSP solutions to third parties. We also face competition frominternally-developed solutions developed and used by major Japanese originalequipment manufacturers, who may also be our customers.

 

Many of our existing and potential competitors havesubstantially greater resources than ours in many areas, including:

 

•      finances;

 

•      manufacturing;

 

•      technology;

 

•      marketing;and

 

•      distribution.

 

Many of our competitors have broader product lines andlonger standing relationships with customers than we do. Moreover, ourcompetitors may foresee the course of market developments more accurately thanwe do and could in the future develop new technologies that compete with ourproducts or even render our products obsolete. In addition, a number of privatecompanies have announced plans for new products to address the same digitalmultimedia compression problems that our products address. If we are unable tocompete successfully against our current and future competitors, we couldexperience price reductions, order cancellations and reduced gross margins, anyone of which could harm our business.

 

The DVD market is growing, and additional competitorsare expected to enter the market for DVD players and software. Some of thesepotential competitors may develop captive implementations for use only withtheir 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 arecharacterized by average selling prices that decline over relatively short timeperiods; if we are unable to reduce our costs or introduce new products withhigher average selling prices, our financial results would suffer.**

 

Average selling prices for our products decline overrelatively short time periods. Many of our manufacturing costs are fixed. Whenour average selling prices decline, our revenues decline unless we sell moreunits, 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 ourrevenue from sales to a small number of large customers, and if we are not ableto retain these customers, or they reschedule, reduce or cancel orders, ourrevenues would be reduced and our financial results would suffer.**

 

Our largest customers account for a substantialpercentage of our revenues. In 2000, sales to Fujifilm accounted for 25.2% ofour total revenues and 27.5% of our product sales. Our four largest customersin 2000 accounted for approximately 45.4% of our total revenues.  During 1999, our four largest customersaccounted for approximately 56.9% of our revenues with Fujifilm accounting for37.3%. Sales to these large customers have varied significantly from year toyear and will continue to fluctuate in the future.  These sales also may fluctuate significantly from quarter toquarter. We may not be able to retain our key customers or these customers maycancel purchase orders or reschedule or decrease their level of purchases fromus. Any substantial decrease or delay in sales to one or more of our keycustomers could harm our sales and financial results. In addition, anydifficulty in collecting amounts due from one or more key customers could harmour financial results.

 

**We are dependent on ourrelationship with Fujifilm for a significant percentage of our product sales,and if this relationship were terminated, our business would be harmed.**

 

Fujifilm has been our largest customer in four of thelast five years. Fujifilm purchases our products primarily as a distributor.Under our arrangement with Fujifilm, Fujifilm acts as the primary distributorin Japan of products developed by us under development contracts with Fujifilm.Fujifilm also sells some of these products in Japan under its own name. We maysell these products directly in Japan only to specified customers and mustfirst 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 generallyhave long sales cycles and implementation periods, which increases our costs inobtaining orders and reduces the predictability of our earnings.**

 

Our products are technologically complex. Prospectivecustomers generally must make a significant commitment of resources to test andevaluate our products and to integrate them into larger systems. As a result,our sales process is often subject to delays associated with lengthy approvalprocesses that typically accompany the design and testing of new products. Thesales cycles of our products often last for many months or even years. Longersales cycles require us to invest significant resources in attempting to makesales and delay the generation of revenue.

 

Long sales cycles also subject us to other risks,including customers' budgetary constraints, internal acceptance reviews andcancellations. In addition, orders expected in one quarter could shift toanother because of the timing of customers' purchase decisions. The timerequired for our customers to incorporate our products into their own can varysignificantly with the needs of our customers and generally exceeds severalmonths, which further complicates our planning processes and reduces thepredictability of our operating results.

** **

**We are not protected bylong-term contracts with our customers.**

 

We generally do not enter into long-term purchasecontracts with our customers, and we cannot be certain as to future orderlevels from our customers. When we do enter into a long-term contract, thecontract 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 ourinternational sales and operations; economic, political or military events in acountry where we make significant sales or have significant operations couldinterfere with our success or operations there and harm our business.**

 

During the first nine months of 2001, 91% of our totalrevenues were derived from international sales. We anticipate thatinternational sales will continue to represent a substantial majority 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 in doing businessinternationally, including:

 

•      unexpectedchanges in regulatory requirements;

 

•      fluctuationsin exchange rates;

 

•      political andeconomic instability;

 

•      imposition oftariffs and other barriers and restrictions; and

 

•      the burdensof complying with a variety of foreign laws.

 

The majority of our research and development personneland facilities and a significant portion of our sales personnel are located inIsrael. Political, economic and military conditions in Israel directly affectour operations. Some of our officers and employees in Israel are obligated toperform up to 39 days of military reserve duty annually. The absence of theseemployees for significant periods during the work week may cause us to operateinefficiently during these periods.

 

Our operations in China are subject to the economicand political 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.

 

**Our business and futureoperating results could be harmed by terrorist activity or armed conflict.**

** **

**Our business and operating results are subject touncertainties arising out of possible terrorist attacks on the United Statesand other regions of the world including locations where we maintain operationsand by the potential expansion of armed conflict and potential instabilityassociated with terrorism. Our operations could be harmed due to:**

** **

•      disruption incommercial activities associated with heightened security concerns affectinginternational travel and commerce;

 

•      reduceddemand for consumer electronic products due to a potential extension of theglobal economic slowdown.

 

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

 

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

** **

**The prices of our productsmay become less competitive due to foreign exchange fluctuations.**

 

Foreign currency fluctuations may affect the prices ofour products. Prices for our products are currently denominated in U.S. dollarsfor sales to our customers throughout the world. If there is a significantdevaluation of the currency in a specific country, the prices of our productswill increase relative to that country's currency and our products may be lesscompetitive in that country. Also, we cannot be sure that our internationalcustomers will continue to be willing to place orders denominated in U.S.dollars. If they do not, our revenue and operating results will be subject toforeign exchange fluctuations.

 

**Our ability to competecould be jeopardized if we are unable to protect our intellectual propertyrights from challenges by third parties.**

 

Our success and ability to compete depend in largepart upon protecting our proprietary technology. We rely on a combination ofpatent, trade secret, copyright and trademark laws, non-disclosure and othercontractual agreements and technical measures to protect our proprietaryrights. These agreements and measures may not be sufficient to protect ourtechnology from third-party infringement, or to protect us from the claims ofothers. Monitoring unauthorized use of our products is difficult and we cannotbe certain that the steps we have taken will prevent unauthorized use of ourtechnology, particularly in foreign countries where the laws may not protectour proprietary rights as fully as in the United States. The laws of certainforeign countries in which our products are or may be developed, manufacturedor sold, including various countries in Asia, may not protect our products orintellectual property rights to the same extent as do the laws of the UnitedStates and thus make the possibility of piracy of our technology and productsmore likely in these countries. If competitors are able to use our technology,our ability to compete effectively could be harmed.

 

**We could become subjectto claims and litigation regarding intellectual property rights, which couldseriously harm our business and require us to incur significant costs.**

 

In recent years, there has been significant litigationin the United States involving patents and other intellectual property rights.In the past, we have been subject to claims and litigation regarding allegedinfringement of other parties' intellectual property rights. We could becomesubject to litigation in the future either to protect our intellectual propertyor as a result of allegations that we infringe others' intellectual propertyrights. Claims that our products infringe proprietary rights would force us todefend ourselves and possibly our customers or manufacturers against thealleged infringement. These claims and any resulting lawsuit, if successful,could subject us to significant liability for damages and invalidation of ourproprietary rights. These lawsuits, regardless of their success, would likelybe time-consuming and expensive to resolve and would divert management time andattention. Any potential intellectual property litigation could force us to doone or more of the following:

 

•      stop sellingour products that incorporate the challenged intellectual property;

 

•      obtain fromthe owner of the infringed intellectual property right a license to sell or usethe relevant technology, which license may not be available on reasonable termsor at all;

 

•      pay damages;or

 

•      redesignthose products that use such technology.

 

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

 

**If necessary licenses ofthird-party technology are not available to us or are very expensive, ourproducts could become obsolete.**

 

From time to time we may be required to license technologyfrom third parties to develop new products or product enhancements. Third partylicenses may not be available to us on commercially reasonable terms, if atall. If we are unable to obtain any third-party license required to develop newproducts and product enhancements, we may have to obtain substitute technologyof lower quality or performance standards or at greater cost, either of whichcould seriously harm the competitiveness of our products.

 

**If we are not able toapply our net operating losses against taxable income in future periods, ourfinancial results will be harmed.**

 

Our future net income and cash flow will be affectedby our ability to apply our net operating losses, which totaled approximately$55.0 million for federal tax reporting purposes as of December 31, 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 makecould disrupt our business and severely harm our financial condition.**

 

We have made investments in, and acquisitions of,complementary companies, products and technologies. During 2000, we acquiredPixelCam and Nogatech, and we may acquire additional businesses, products, ortechnologies in the future. In the event of any future acquisitions, we could:

 

•      issue stockthat would dilute our current stockholders' percentage ownership;

 

•      incur debt;

 

•      assumeliabilities;

 

•      incur amortizationexpenses related to goodwill and other intangible assets; or

 

•      incur largewrite-offs immediately or in the future.

Our operation of any acquired business will alsoinvolve numerous risks, including:

 

•      problemscombining the purchased operations, technologies or products;

 

•      unanticipatedcosts;

 

•      diversion ofmanagement's attention from our core business;

 

•      adverseeffects on existing business relationships with customers;

 

•      risksassociated with entering markets in which we have no or limited priorexperience; and

 

•      potentialloss of key employees, particularly those of the purchased organizations.

 

We may not be able to successfully integrate anybusinesses, products or technologies or personnel that we might acquire in thefuture and any failure to do so could disrupt our business and seriously harmour financial condition.

 

**Our products couldcontain defects, which could reduce sales of those products or result in claimsagainst us.**

 

We develop complex and evolving products. Despite testingby us and our customers, errors may be found in existing or new products. Thiscould result in, among other things, a delay in recognition or loss ofrevenues, loss of market share or failure to achieve market acceptance. Thesedefects may cause us to incur significant warranty, support and repair costs,divert the attention of our engineering personnel from our product developmentefforts and harm our relationships with our customers. The occurrence of theseproblems could result in the delay or loss of market acceptance of our productsand would likely harm our business. Defects, integration issues or otherperformance problems in our products could result in financial or other damagesto our customers or could damage market acceptance of our products. Ourcustomers could also seek damages from us for their losses. A product liabilityclaim brought against us, even if unsuccessful, would likely be time consumingand costly to defend.

 

**If we do not maintain ourcurrent development contracts or are unable to enter into new developmentcontracts, our business could be harmed.**

 

We historically have generated a significantpercentage of our total revenues from development contracts, primarily with keycustomers. These development contracts have provided us with partial fundingfor the development of some of our products. Under these contracts, we receivepayments upon reaching certain development milestones. If we fail to achievethe milestones specified in our existing development contracts, if our existingcontracts are terminated or we are unable to secure future developmentcontracts, our ability to cost-effectively develop new products would bereduced and our business would be harmed.

 

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

 

We may require substantial additional capital tofinance our future growth, secure additional foundry capacity and fund ourongoing research and development activities beyond 2001. Our capitalrequirements will depend on many factors, including:

 

•      acceptance ofand demand for our products;

 

•      the types ofarrangements that we may enter into with our independent foundries; and

 

•      the extent towhich we invest in new technology and research and development projects.

 

To the extent that our existing sources of liquidityand cash flow from operations are insufficient to fund our activities, we mayneed to raise additional funds. If we raise additional funds through the issuanceof equity securities, the percentage ownership of our existing stockholderswould be reduced. Further, such equity securities may have rights, preferencesor privileges senior to those of our common stock. Additional financing may notbe available to us when needed or, if available, it may not be available onterms favorable to us.

 

**If we fail to manage ourfuture growth, if any, our business would be harmed.**

 

We anticipate that our future growth, if any, willrequire us to recruit and hire a substantial number of new engineering,managerial, sales and marketing personnel. Our ability to manage our growthsuccessfully 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 servicesof our executive officers and other key personnel, whose knowledge of ourbusiness and industry would be extremely difficult to replace.**

 

Our success depends to a significant degree upon thecontinuing contributions of our senior management. The loss of key managementpersonnel could delay product development cycles or otherwise harm ourbusiness. 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 in Israel.Competition for such personnel is intense, and we may not be successful inattracting, 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 ofinflation may negatively impact our costs if it exceeds the rate of devaluationof the New Israeli Shekel against the U.S. dollar.**

 

A portion of the cost of our operations, relatingmainly to our personnel and facilities in Israel, is incurred in New IsraeliShekels. As a result, we bear the risk that the rate of inflation in Israelwill exceed the rate of devaluation of the New Israeli Shekel in relation tothe dollar, which will increase our costs as expressed in dollars. To date, wehave not engaged in hedging transactions. In the future, we may enter intocurrency hedging transactions to decrease the risk of financial exposure fromfluctuations in the exchange rate of the U.S. dollar against the New Israeli Shekel.These measures may not adequately protect us from the impact of inflation inIsrael.

 

**The government programswe participate in and tax benefits we receive require us to meet severalconditions and may be terminated or reduced in the future, which would increaseour costs.**

 

In the year ended December 31, 2000, we received anaggregate of $333,000 in grants for research and development from the ChiefScientist in Israel's Ministry of Industry and Trade. To continue to beeligible 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.

**Wehave anti-takeover provisions in our charter documents and there are provisionsof Delaware law that could prevent or delay a change in control of our company.**

 

Our certificate of incorporation, our bylaws and Delawarelaw contain provisions that could make it more difficult for a third party toacquire us, even if doing so would be beneficial to our stockholders. Theseinclude provisions:

 

•      prohibiting amerger with a party that has acquired control of 15% or more of our outstandingcommon stock, such as a party that has completed a successful tender offer,until three years after that party acquired control of 15% of our outstandingcommon stock;

 

•      authorizingthe issuance of up to 3,000,000 shares of "blank check" preferredstock;

 

•      eliminatingstockholders' rights to call a special meeting of stockholders; and

 

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

 

** **

**Our stock price hasfluctuated and may continue to fluctuate widely.**

 

The market price of our common stock has fluctuatedsignificantly since our initial public offering in 1995. Between January 1,2000 and December 31, 2000, the closing sale price of our common stock, asreported on the Nasdaq National Market, ranged from a low of $13.19 to a highof $74.31.  During the first nine monthsof 2001 the closing sale price ranged from a low of $13.00 to a high of$40.55.  The market price of our commonstock is subject to significant fluctuations in the future in response to avariety of factors, including:

 

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

 

•      quarterlyvariations in operating results;

 

•      changes inanalysts’ earnings estimates;

 

•      announcementsof technological innovations;

 

•      theintroduction of new products or changes in product pricing policies by us orour competitors;

 

•      proprietaryrights or other litigation;

 

•      generalconditions in the semiconductor industry; and

 

•      developmentsin the financial markets.

 

In addition, the stock market has, from time to time, experiencedextreme price and volume fluctuations that have particularly affected themarket prices for semiconductor companies or technology companies generally andwhich have been unrelated to the operating performance of the affectedcompanies. Broad market fluctuations of this type may reduce the future marketprice of our common stock.

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

 

We are exposed to financial market risks including changes in interestrates and foreign currency exchange rates.

 

The fair value of our investment portfolio or related income would notbe significantly impacted by either a 10% increase or decrease in interestrates due mainly to the short-term nature of the major portion of ourinvestment portfolio.

 

A majority of our revenue and capital spending is transacted in U.S.dollars, although a portion of the cost of our operations, relating mainly toour personnel and facilities in Israel, is incurred in New Israeli Shekels. Wehave not engaged in hedging transactions to reduce our exposure to fluctuationsthat may arise from changes in foreign exchange rates. Based on our overallcurrency rate exposure at September 30, 2001, a near-term 10% appreciation ordepreciation of the New Israeli Shekel would have an immaterial affect on ourfinancial condition.

 

 

**PARTII. OTHER INFORMATION**

 

 

 

**Item6.  Exhibits and Reports on Form 8-K**

 

(a)   Exhibits

 

   No exhibits.

 

 

(b)   Reports on Form 8-K

 

   No reports on Form 8-K were filed duringthe quarter ended September 30, 2001.

 

 

 

 

 

 

 

**SIGNATURES**

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

 

                                                                                                **ZORANCORPORATION**

 

 

 

 

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