**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

----

 

**FORM 10-Q**

 

| **(Mark One)** |                                                                                         |   |   |
|----------------|----------------------------------------------------------------------------------------------|--------|--------|
|           |                                                                                         |   |
| **ý**     | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|           |                                                                                         |
|           | **For the quarterly period ended  March 31, 2002**                                           |
|                |                                                                                              |        |        |  |

 

**or**

 

| **o**  | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                       |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                |
|   | **For the transition 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 incorporation or organization)             |   | (I.R.S. Employer  Identification No.) |
|                                                                        |   |                                  |
| **3112 Scott Boulevard, Santa Clara,  California**                          |   | **95054**                             |
| (Address of principal  executive offices)                                   |   | (Zip Code)                            |
|                                                                        |   |                                  |
| Registrant’s telephone  number, 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** | No o |
|--------|----------------|------|

 

The number of outstanding shares of the registrant’s Common Stock,$.001 par value, as of April 29, 2002 was 17,990,730.

 

 

----

 

**ZORAN CORPORATION**

 

**INDEX**

 
| **PART I.   FINANCIAL INFORMATION** |
|-----------------------------------------------|
|                                          |   |   |
| Item 1.                                       | Financial Statements |
|                                          |   |   |
|                                          |   | Condensed Consolidated  Balance Sheets March 31, 2002 and December 31, 2001 |
|                                          |   |   |
|                                          |   | Condensed  Consolidated Statements of Operations Three Months Ended March 31, 2002 and  2001 |
|                                          |   |   |
|                                          |   | Condensed  Consolidated Statements of Cash Flows Three Months Ended March 31, 2002 and  2001 |
|                                          |   |   |
|                                          |   | 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                                    |
|                                               |  |  |  |  |

 

2

----

 

**ZORAN CORPORATION**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

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

**(unaudited)**

 
|                                                                                                                    |   | **March 31,  2002** | ** ** | **December  31,  2001** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|--------|---------------------|------------|-------------------------|------------|
|                                                                                                                    |   |                |       |                    |       |
| ASSETS                                                                                                                  |   |                |       |                    |       |
| Current assets:                                                                                                         |   |                |       |                    |       |
| Cash and cash  equivalents                                                                                              |   | $                   | 27,460     |                    | $          | 20,287 |   |
| Short-term  investments                                                                                                 |   | 123,452             |       | 89,818                  |       |
| Accounts  receivable, net                                                                                               |   | 30,183              |       | 33,367                  |       |
| Inventory                                                                                                               |   | 12,874              |       | 15,681                  |       |
| Prepaid expenses  and other current assets                                                                              |   | 5,161               |       | 5,130                   |       |
| Total current  assets                                                                                                   |   | 199,130             |       | 164,283                 |       |
|                                                                                                                    |   |                |       |                    |       |
| Property and  equipment, net                                                                                            |   | 6,921               |       | 7,159                   |       |
| Other investments                                                                                                       |   | 56,886              |       | 89,727                  |       |
| Goodwill                                                                                                                |   | 59,131              |       | 59,131                  |       |
| Intangibles  assets                                                                                                     |   | 8,735               |       | 11,044                  |       |
|                                                                                                                    |   |                |       |                    |       |
|                                                                                                                    |   | $                   | 330,803    |                    | $          | 331,344 |   |
|                                                                                                                    |   |                |       |                    |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                              |   |                |       |                    |       |
| Current  liabilities:                                                                                                   |   |                |       |                    |       |
| Accounts payable                                                                                                        |   | $                   | 14,596     |                    | $          | 16,705 |   |
| Accrued expenses  and other liabilities                                                                                 |   | 16,801              |       | 16,801                  |       |
| Total current  liabilities                                                                                              |   | 31,397              |       | 33,506                  |       |
|                                                                                                                    |   |                |       |                    |       |
| Stockholders’  equity:                                                                                             |   |                |       |                    |       |
| Common Stock,  $0.001 par value; 55,000,000 shares authorized; 17,975,807 and 17,801,854  shares issued and outstanding |   | 18                  |       | 18                      |       |
| Additional  paid-in capital                                                                                             |   | 393,828             |       | 391,674                 |       |
| Warrants                                                                                                                |   | 717                 |       | 717                     |       |
| Deferred  stock-based compensation                                                                                      |   | (239                | )          | (375                    | )          |
| Accumulated  other comprehensive loss                                                                                   |   | (493                | )          | (6                      | )          |
| Accumulated  deficit                                                                                                    |   | (94,425             | )          | (94,190                 | )          |
| Total  stockholders’ equity                                                                                        |   | 299,406             |       | 297,838                 |       |
|                                                                                                                    |   |                |       |                    |       |
|                                                                                                                    |   | $                   | 330,803    |                    | $          | 331,344 |   |

 

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

 

3

----

 

**ZORAN CORPORATION**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

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

**(unaudited)**

 
|                                               |   | **Three  Months Ended  March 31,** |       |
|----------------------------------------------------|--------|------------------------------------|------------|
|                                               |   | ** **                         |
|                                               |   | **2002**                           | ** ** | **2001** | ** ** |
|                                               |   |                               |       |   |   |
| Revenues:                                          |   |                               |       |   |   |
| Product sales                                      |   | $                                  | 29,105     |   | $ | 17,315 |   |
| Software, licensing and development                |   | 1,985                              |       | 2,278 |   |
| Total revenues                                     |   | 31,090                             |       | 19,593 |   |
|                                               |   |                               |       |   |   |
| Costs and expenses:                                |   |                               |       |   |   |
| Cost of product sales                              |   | 18,832                             |       | 10,876 |   |
| Research and development                           |   | 5,521                              |       | 5,968 |   |
| Selling, general and administrative                |   | 5,740                              |       | 5,243 |   |
| Amortization of goodwill and other intangibles     |   | 2,445                              |       | 10,808 |   |
| Total costs and expenses                           |   | 32,538                             |       | 32,895 |   |
|                                               |   |                               |       |   |   |
| Operating loss                                     |   | (1,448                             | )          | (13,302 | ) |
| Interest and other income, net                     |   | 1,459                              |       | 2,745 |   |
| Income (loss) before income taxes                  |   | 11                                 |       | (10,557 | ) |
|                                               |   |                               |       |   |   |
| Provision for income taxes                         |   | 246                                |       | 43 |   |
|                                               |   |                               |       |   |   |
| Net loss                                           |   | $                                  | (235       | ) | $ | (10,600 | ) |
|                                               |   |                               |       |   |   |
| Basic net loss  per share                          |   | $                                  | (0.01      | ) | $ | (0.61 | ) |
|                                               |   |                               |       |   |   |
| Diluted net loss  per share                        |   | $                                  | (0.01      | ) | $ | (0.61 | ) |
|                                               |   |                               |       |   |   |
| Shares used to  compute basic net loss per share   |   | 17,849                             |       | 17,314 |   |
|                                               |   |                               |       |   |   |
| Shares used to  compute diluted net loss per share |   | 17,849                             |       | 17,314 |   |

 

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

 

4

----

 

**ZORAN CORPORATION**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**

**(unaudited)**

 
|                                                                             |   | **Three  Months Ended  March 31,** |   |
|----------------------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                             |   | ** **                         |
|                                                                             |   | **2002**                           |   | **2001** | ** ** |
| Cash flows from  operating activities:                                           |   |                               |   |   |   |
| Net loss                                                                         |   | $                                  | (235   | ) | $ | (10,600 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operations: |   |                               |   |   |   |
| Depreciation,  amortization and other                                            |   | 630                                |   | 852 |   |
| Amortization of  goodwill and other intangibles                                  |   | 2,445                              |   | 10,808 |   |
| Realized loss on  marketable securities                                          |   | 696                                |   | — |   |
| Changes in  current assets and liabilities:                                      |   |                               |   |   |   |
| Accounts  receivable                                                             |   | 3,382                              |   | (977 | ) |
| Inventory                                                                        |   | 2,807                              |   | (871 | ) |
| Prepaid expenses  and other current assets                                       |   | (31                                | )      | (205 | ) |
| Accounts payable                                                                 |   | (2,109                             | )      | (982 | ) |
| Accrued expenses  and other liabilities                                          |   | (111                               | )      | (2,305 | ) |
| Net cash  provided by (used in) operating activities                             |   | 7,474                              |   | (4,280 | ) |
|                                                                             |   |                               |   |   |   |
| Cash flows from  investing activities:                                           |   |                               |   |   |   |
| Capital  expenditures for property and equipment                                 |   | (386                               | )      | (974 | ) |
| Purchases of  investments                                                        |   | (18,149                            | )      | (43,855 | ) |
| Sales and  maturities of investments                                             |   | 16,080                             |   | 66,894 |   |
| Purchases of  equity investments                                                 |   | —                             |   | (1,171 | ) |
| Net cash  provided by (used in) investing activities                             |   | (2,455                             | )      | 20,894 |   |
|                                                                             |   |                               |   |   |   |
| Cash flows from  financing activities:                                           |   |                               |   |   |   |
| Proceeds from  issuance of Common Stock, net                                     |   | 2,154                              |   | 133 |   |
| Repurchases of  Common Stock                                                     |   | —                             |   | (3,867 | ) |
| Net cash  provided by (used in) financing activities                             |   | 2,154                              |   | (3,734 | ) |
|                                                                             |   |                               |   |   |   |
| Net increase in  cash and cash equivalents                                       |   | 7,173                              |   | 12,880 |   |
|                                                                             |   |                               |   |   |   |
| Cash and cash  equivalents at beginning of period                                |   | 20,287                             |   | 16,099 |   |
|                                                                             |   |                               |   |   |   |
|                                                                             |   |                               |   |   |   |
| Cash and cash  equivalents at end of period                                      |   | $                                  | 27,460 |   | $ | 28,979 |   |

 

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

 

5

----

 

**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 the financialinformation included therein.  While theCompany believes that the disclosures are adequate to make the information notmisleading, it is suggested that these financial statements be read inconjunction with the audited consolidated financial statements and accompanyingnotes included in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2000.  Results for theinterim periods presented are not necessarily indicative of the results to be expectedfor the full year.

 

**2.             Comprehensive Income**

 

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

 

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

 
|                                     |   | **Three  Months Ended March 31,** |       |
|------------------------------------------|--------|-----------------------------------|------------|
|                                          |   | **2002**                          | ** ** | **2001** | ** ** |
|                                     |   |                              |       |   |   |
| Net loss                                 |   | $                                 | (235       | ) | $ | (10,600 | ) |
| Unrealized loss on short-term investment |   | (487                              | )          | (1,521 | ) |
| Comprehensive  loss                      |   | $                                 | (722       | ) | $ | (12,121 | ) |

 

The components of accumulated other comprehensive lossare net unrealized losses on short-term investments and long-term marketablesecurities.

 

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

** **
|            |   | **March 31,  2002** |       | **December  31,  2001** |   |
|-----------------|--------|---------------------|------------|-------------------------|--------|
|            |   | ** **          | ** ** |
| **Inventory:**  |   |                |       |                    |   |
| Work-in-process |   | $                   | 5,352      |                    | $      | 3,119 |   |
| Finished goods  |   | 7,522               |       | 12,562                  |   |
|            |   |                |       |                    |   |
|            |   | $                   | 12,874     |                    | $      | 15,681 |   |

 

**4.             Goodwill and Other IntangibleAssets**

 

The Company adopted Financial AccountingStandards Board ("FASB") Statement No. 142 “Goodwill and OtherIntangible Assets” (“SFAS 142”) as of January 1, 2002. SFAS 142 changes theaccounting for goodwill from an amortization method to an impairment onlyapproach. Under SFAS 142, goodwill will be tested annually and whenever eventsor circumstances occur indicating that goodwill might be impaired. In connection with the adoption of SFAS 142,the Company has performed a transitional goodwill impairment assessment basedon its structure as one reporting unit and determined that no impairmentexisted at January 1, 2002.

 

6

----

 

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

 
|                        |   |                             |       | **March 31,  2002**         |       | **December  31, 2001**        |       |
|-----------------------------|--------|----------------------------------|------------|-----------------------------|------------|-------------------------------|------------|
|                        |   | **Weighted  Avg.  Life (Years)** | ** ** | **Gross  carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross  carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
|                        |   | ** **                       | ** ** | ** **                  | ** ** | ** **                    |
| Amortized intangible assets |   |                             |       |                        |       |                          |       |   |   |   |   |
| Covenant not to compete     |   | 3                                |       | $                           | 800        |                          | $          | 467 |   | $ | 800 |   | $ | 400 |   |
| Patents                     |   | 3                                |       | 900                         |       | 525                           |       | 900 |   | 450 |   |
| Core technology             |   | 3                                |       | 8,060                       |       | 3,859                         |       | 8,060 |   | 3,187 |   |
| Completed technology        |   | 2                                |       | 10,760                      |       | 7,747                         |       | 10,760 |   | 6,382 |   |
| Customer base               |   | 3                                |       | 1,560                       |       | 747                           |       | 1,560 |   | 617 |   |
|                        |   |                             |       |                        |       |                          |       |   |   |   |   |
| Total                       |   |                             |       | $                           | 22,080     |                          | $          | 13,345 |   | $ | 22,080 |   | $ | 11,036 |   |

 

During the quarter ended March 31, 2002, theCompany incurred $2.3 million in charges related to the amortization ofacquired intangible assets associated with the acquisitions of PixelCam Inc.and Nogatech Inc. in June and October 2000, respectively. The Company willincur charges of $5.8 million for the balance of 2002 and $2.9 million for 2003related to the amortization of these acquired intangible assets.

 

**Reconciliationof Net Loss Excluding Goodwill Amortization**(in thousands except per share data):

 

|                           |   | **Three  Months Ended  March 31,** |       |
|--------------------------------|--------|------------------------------------|------------|
|                           |   | ** **                         |
|                           |   | **2002**                           | ** ** | **2001** | ** ** |
| Net loss:                      |   |                               |       |   |   |
| Net loss, as reported          |   | $                                  | (235       | ) | $ | (10,600 | ) |
| Add back goodwill amortization |   | —                             |       | 8,383 |   |
| Adjusted net loss              |   | $                                  | (235       | ) | $ | (2,217 | ) |
|                           |   |                               |       |   |   |
| Basic earnings per share:      |   |                               |       |   |   |
| Net loss, as reported          |   | $                                  | (0.01      | ) | $ | (0.61 | ) |
| Add back goodwill amortization |   | —                             |       | 0.48 |   |
| Adjusted net loss              |   | $                                  | (0.01      | ) | $ | (0.13 | ) |
|                           |   |                               |       |   |   |
| Diluted earnings per share:    |   |                               |       |   |   |
| Net loss, as reported          |   | $                                  | (0.01      | ) | $ | (0.61 | ) |
| Add back goodwill amortization |   | —                             |       | 0.48 |   |
| Adjusted net loss              |   | $                                  | (0.01      | ) | $ | (0.13 | ) |

 

**5.             Income Taxes**

 

The provision for income taxes reflects the estimated annualizedeffective tax rate applied to earnings excluding charges for amortization ofgoodwill and other intangibles for the interim periods.  The effective tax rate differs from the U.S.statutory rate due to utilization of net operating losses, adjustments for thenondeductible amortization of goodwill and other intangibles and income taxrate differences on foreign

 

7

----

 

earnings.  The Company hasprovided for tax on income in excess of net operating loss carryforwards forU.S. Federal and State earnings.  TheCompany has also provided for tax on its foreign earnings.

 

**6.             Repurchase of Common Stock**

 

**During the quarter ended March 31, 2001, the Companyrepurchased 255,000 shares of its common stock for $3.9 million.**

 

**7.             Recently Issued Accounting Standard**

 

In August 2001, the FASB issued SFAS No. 143(“SFAS 143”), “Accounting for Asset Retirement Obligations”. SFAS 143 addressesfinancial accounting and reporting for obligations associated with theretirement of tangible long-lived assets and the associated asset retirementcosts. SFAS 143 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.

 

**8.             SubsequentEvents**

 

On April 21, 2002, the Company's Board of Directors approved athree-for-two split of our common stock to be effected in the form of a 50percent stock dividend, payable on or about May 22, 2002 to stockholders ofrecord on May 7, 2002. All share and per share information in this report ispresented on a pre-split basis and does not give effect to the pending stocksplit.  Pro forma basic and diluted netloss per share, restated to reflect the effects of the stock split, would havebeen $0.01 and $0.41 for the three months ended March 31, 2002 and 2001,respectively.

** **

 

8

----

 

 

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

 

***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, 2001.***

 

**Overview**

 

From our inception in 1981 through 1991, wederived the substantial majority of our revenue from digital filter processorsand vector signal processors used principally in military, industrial andmedical applications. In 1989, we repositioned our business to develop andmarket data compression products for the evolving multimedia markets and discontinueddevelopment of digital filter processor and vector signal processor products.In 1994, we discontinued production of these products. Our current lines ofdigital audio and video products include integrated circuits and relatedproducts used in digital versatile disc players, movie and home theatersystems, filmless digital cameras and video editing systems.

 

We derive most of our revenues from the saleof our integrated circuit products. Historically, average selling prices in thesemiconductor industry in general, and for our products in particular, havedecreased over the life of a particular product. Average selling prices for ourhardware products have fluctuated substantially from period to period,primarily as a result of changes in our customer mix of original equipmentmanufacturer, or OEM, sales versus sales to distributors and the transitionfrom low-volume to high-volume production. In the past, we have reduced theprices of some of our products in order to better penetrate the consumer market.We believe that, as our product lines continue to mature and competitivemarkets evolve, we are likely to experience further declines in the averageselling prices of our products, although we cannot predict the timing andamount of such future changes with any certainty.

 

Our cost of product sales consists primarilyof fabrication costs, assembly and test costs, and the cost of materials andoverhead from operations. If we are unable to reduce our cost of product salesto offset anticipated decreases in average selling prices, our product grossmargins will decrease. Our product gross margin is also dependent on productmix and on the percentage of products sold directly to our OEM customers versusindirectly through our marketing partners who purchase our products at lowerprices but absorb most of the associated marketing and sales support expenses,maintain inventories and provide customer support and training. Lower grossmargins on sales 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 oursoftware and other intellectual property. Licensing revenue includes one-timelicense fees and royalties based on the number of units distributed by thelicensee. In addition, we have historically generated a significant percentageof our total revenues from development contracts, primarily with key customers,although development revenue has declined as a percentage of total revenuesover the past several years. These development contracts have provided us withpartial funding for the development of some of our products. These developmentcontracts provide for license and milestone payments which are recorded asdevelopment revenue. We classify all development costs, including costs relatedto these development contracts, as research and development expenses. We retainownership of the intellectual property developed by us under these 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.

 

9

----

 

Our research and development expensesconsist of salaries and related costs of employees engaged in ongoing research,design and development activities and costs of engineering materials andsupplies. We are also a party to research and development agreements with theChief Scientist in Israel’s Ministry of Industry and Trade and theIsrael-United States Binational Industrial Research and Development Foundation,which fund up to 50% of incurred project costs for approved products up tospecified contract maximums. These agreements require us to use our bestefforts to achieve specified results and require us to pay royalties at ratesof 3% to 5% of resulting product sales, and up to 30% of resulting licenserevenues, up to a maximum of 100% to 150% of total funding received. Reportedresearch and development expenses are net of these grants, which fluctuate fromperiod to period. We believe that significant investments in research anddevelopment are required for us to remain competitive and we expect to continueto devote significant resources to product development, although such expensesas a percentage of total revenues may fluctuate.

 

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

 

We conduct most of our research anddevelopment and certain sales and marketing and administrative operations inIsrael through our wholly-owned Israeli subsidiary. As a result, some of ourexpenses are incurred in New Israeli Shekels. To date, substantially all of ourproduct sales and our development and licensing revenue have been denominatedin U.S. dollars and most costs of product sales have been incurred in U.S.dollars. We expect that most of our sales and costs of sales will continue tobe denominated and incurred in U.S. dollars for the foreseeable future. We havenot experienced material losses or gains as a result of currency exchange ratefluctuations and have not engaged in hedging transactions to reduce ourexposure to such fluctuations. We may in the future elect to take action toreduce our foreign exchange risk.

 

Our effective income tax rate has benefitedfrom the availability of net operating losses which we have utilized to reducetaxable income for U.S. federal income tax purposes and by our Israelisubsidiary’s status as an “Approved Enterprise” under Israeli law, whichprovides a ten-year tax holiday for income attributable to a portion of ouroperations in Israel. Our U.S. federal net operating losses expire at varioustimes between 2002 and 2020, and the benefits from our subsidiary’s ApprovedEnterprise status expire at various times beginning in 2003.

 

In June 2000, we acquired PixelCam, Inc., amanufacturer of megapixel CMOS image sensors, in exchange for 370,832 shares ofour common stock and options to purchase 4,168 shares of our common stock withan aggregate value of $24.6 million. The acquisition was accounted for underthe purchase method of accounting. Additional information regarding thisacquisition is contained in our Annual Report on Form 10-K for the year endedDecember 31, 2001.

 

On October 26, 2000, we acquired NogatechInc., a provider of chips that compress digital video images and establishconnections, or video connectivity, between video devices and computers, aswell as between video devices across a variety of networks, in exchange for2,534,599 shares of our common stock and options to purchase 168,472 shares ofour common stock with an aggregate value of $163.6 million. The acquisition wasaccounted for under the purchase method of accounting. Additionalinformation regarding this acquisition is contained in our Annual Report onForm 10-K for the year ended December 31, 2001.

 

**Resultsof Operations**

 

*Revenues*

 

Total revenues for the quarter ended March31, 2002 increased by 58.7% to $31.1 million from $19.6 million for the sameperiod in 2001.  Product sales for thequarter increased by 68.1% to $29.1 million from $17.3 million for firstquarter of 2001.  The increase inproduct sales was driven by increased unit sales in our DVD product line, whichaccounted for 91% of our product sales. DVD sales should continue to comprisethe majority of our product sales for the balance of the year.  Software, licensing and development revenuesdecreased by 12.9% to $2.0 million for the first quarter of 2002, compared to$2.3 million for the first quarter 

 

10

----

 

of 2001. This decrease was primarily due tothe timing of revenue recognition on long-term development contracts.Development revenue is recognized on a percentage of completion basis.

* *

*ProductGross Margin*

 

Product gross margin for the quarter endedMarch 31, 2002 decreased to 35.3% from 37.2% for the same period in 2001.  The decrease was due to a substantial shiftin product mix to a higher percentage of lower-margin DVD products, which includeCPU companion chips that are sold at low margin, and a shift in customer mix toa lower percentage of direct sales to OEM customers.

* *

*Researchand Development*

 

Research and development (“R&D”)expenses for the quarter ended March 31, 2002 decreased by 7.5% to $5.5 millionfrom $6.0 million for the same period in 2001. R&D expenses were down from the same period last year due to thetiming of major project expenses such as tape-outs.  R&D expenses decreased as a percentage of total revenues from30.5% for the first quarter of 2001 to 17.8% for the first quarter of 2002primarily as a result of increased revenues.

* *

*Selling,General and Administrative*

 

Selling, general and administrative(“SG&A”) expenses for the quarter ended March 31, 2002 increased by 9.5% to$5.7 million from $5.2 million for the same period in 2001.  The increase was due to increased sales andmarketing expenses related to product market development and to support plannedrevenue growth particularly in the Asia Pacific markets.  SG&A expenses were 18.5% of totalrevenues for the three months ended March 31, 2002, compared to 26.8% for thesame period in 2001. SG&A expenses as a percent of total revenues decreasedas a result of increased revenues.

* *

*Amortizationof Goodwill and Other Intangibles*

 

Based on the adoption of FinancialAccounting Standards Board (FASB) Statements Nos. 141 and 142, “BusinessCombinations” and “Goodwill and Other Intangible Assets” (“SFAS 141” and “SFAS142”), we did not record charges for the amortization of goodwill during thequarter ended March 31, 2002. For the same period last year we recorded chargesof $8.4 million in connection with our acquisitions of PixelCam Inc. andNogatech Inc. SFAS 142 changes the accounting for goodwill from an amortizationmethod to an impairment-only approach. Under SFAS 142, goodwill will be testedannually and whenever events or circumstances occur indicating that goodwillmight be impaired. In connection with the adoption of SFAS 142, the Company hasperformed a transitional goodwill impairment assessment based on its structureas one reporting unit and determined that no impairment existed at January 1,2002.

 

During the quarter ended March 31, 2002, weincurred charges of $2.3 million related to the amortization of otherintangible assets, the same as incurred for the equivalent period last year.

 

*Interestand Other Income, Net*

 

Net interest and otherincome for the quarter ended March 31, 2002 decreased to $1.5 million from $2.7million for the same period in 2001. The decrease was primarily the result of anon-cash loss of $696,000 realized upon the conversion of equity securities inconjunction with the acquisition of the investee.

* *

*Provisionfor Income Taxes*

 

Excluding charges related to the amortization of goodwill and otherintangibles our estimated effective tax rate was reduced from 15% for the firstquarter of 2001 to 10% for the quarter ended March 31, 2002. The Company hasbooked a tax rate commensurate with the jurisdictional distribution of profitsbetween the U.S. and Israel and the underlying tax positions as a result of theapproved enterprise status in Israel. We anticipate utilizing the 10% tax ratefor the foreseeable future.

 

11

----

 

**Liquidityand Capital Resources**

 

At March 31, 2002, we had $27.5 million ofcash and cash equivalents, $123.5 million of short-term investments and $167.7million of working capital. In addition, we had $53.4 million of long-terminvestments in marketable securities.

 

Our operating activities provided cash of$7.5 million during the three months ended March 31, 2002, primarily due todecreases in accounts receivable and inventory, and the net loss adjusted forthe non-cash impact of depreciation and amortization of intangible assetspartially offset by a decrease in accounts payable.

 

Cash used in investing activities was $2.5million during the three months ended March 31, 2002, principally reflectingthe purchases of investments and capital expenditures for property andequipment.

 

Cash provided by financing activities was $2.2million for the three months ended March 31, 2002, consisting of proceeds fromthe issuance of our common stock.

 

As ofMarch 31, 2002 we are responsible for lease commitments of  $2.6 million associated with our worldwidefacilities of which $997,000 remains due in 2002, $649,000 is due in 2003 and$464,000 is due in 2004 and 2005, respectively. In addition, we had inventorypurchase commitments of $14.5 million at March 31, 2002.

 

At March31, 2002 and 2001, we did not have any relationships with unconsolidatedentities or financial partnerships, such as entities often referred to asstructured finance or special purpose entities, established for the purpose offacilitating off-balance sheet arrangements or other contractually narrow orlimited purposes. Accordingly, we are not exposed to the type of financing,liquidity, market or credit risk that could arise if we had engaged in suchrelationships.

 

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

 

•                  the levels at which we maintain inventoryand accounts receivable;

 

•                  the market acceptance of our products;

 

•                  the levels of promotion and advertisingrequired to launch our new products or to enter markets and attain acompetitive position in the marketplace;

 

•                  our business, product, capital expenditureand research and development plans and technology roadmap;

 

•                  volume pricing concessions;

 

•                  capital improvements to new and existingfacilities;

 

•                  technological advances;

 

•                  the response of competitors to our products;and

 

•                  our relationships with our suppliers andcustomers.

 

In addition, we may require an increase inthe level of working capital to accommodate planned growth, hiring andinfrastructure needs. Additional capital may also be required for consummationof any acquisitions of businesses, products or technologies.

 

12

----

 

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

 

**Our quarterly revenues and operating results fluctuatedue to a variety of factors, which may result in volatility or a decline in theprice of our stock**.

 

Our quarterly operatingresults have varied significantly due to a number of factors, including:

 

•                  fluctuation in demand for our products;

 

•                  the timing of new product introductions byus and our competitors;

 

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

 

•                  the timing of large customer orders;

 

•                  the length and variability of the salescycle for our products;

 

•                  the cyclical nature of the semiconductorindustry;

 

•                  the availability of development funding andthe timing of development revenue;

 

•                  changes in the mix of products sold;

 

•                  seasonality in demand for our products;

 

•                  competitive pricing pressures; and

 

•                  the evolving and unpredictable nature of themarkets for products incorporating our integrated circuits and embeddedsoftware.

 

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

 

•                  the cost and availability of adequatefoundry capacity;

 

•                  fluctuations in manufacturing yields;

 

•                  the emergence of new industry standards;

 

•                  product obsolescence; and

 

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

 

13

----

 

Our operating results couldalso be harmed by:

 

•                  economic conditions generally or in variousgeographic areas where we or our customers do business;

 

•                  other conditions affecting the timing ofcustomer orders; or

 

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

 

These factors are difficultor impossible to forecast. We place orders to purchase our products fromindependent foundries several months in advance of the scheduled delivery date,often in advance of receiving non-cancelable orders from our customers. Ifanticipated shipments in any quarter are canceled or do not occur as quickly asexpected, expense and inventory levels could be disproportionately high. Ifanticipated license revenues in any quarter are canceled or do not occur, grossmargins may be reduced. A significant portion of our expenses are relativelyfixed, and the timing of increases in expenses is based in large part on ourforecast of future revenues. As a result, if revenues do not meet ourexpectations we may be unable to quickly adjust expenses to levels appropriateto actual revenues, which could harm our operating results.

 

As a result of thesefactors, our operating results may vary significantly from quarter to quarter.Any shortfall in revenues or net income from levels expected by securitiesanalysts could cause a decline in the trading price of our stock.

 

**Oursuccess for the foreseeable future will be dependent on growth in demand forintegrated circuits for DVD, filmless digital camera applications and, to alesser extent, on digital audio and video editing applications and our abilityto market and sell our products to manufacturers who incorporate those types ofintegrated circuits into their products.**

 

In 2001 and the firstquarter of 2002, we derived a substantial majority of our product revenues fromthe sale of integrated circuits for DVD 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.

 

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

 

Because the markets ourcustomers serve are characterized by numerous new product introductions andrapid product enhancements, our operating results may vary significantly fromquarter to quarter. During the final production of a mature product, ourcustomers typically exhaust their existing inventory of our products.Consequently, orders for our products may decline in those circumstances, evenif our products are incorporated into both mature products and replacementproducts. A delay in the customer’s transition to commercial production of areplacement product would delay our ability to recover the lost sales from thediscontinuation of the related mature product. Our customers also experiencesignificant seasonality in the sales of their consumer products, which affectstheir orders of our products. Typically, the fourth calendar quarter representsa disproportionate percentage of sales for our customers due to the holidayperiod, and therefore a disproportionate percentage of our sales. We expectthese sales fluctuations to continue for the foreseeable future.

** **

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

 

The semiconductor industryis subject to cyclical variations in product supply and demand. Downturns inthe industry often occur in connection with, or anticipation of, maturingproduct cycles for both semiconductor 

 

14

----

 

companies and theircustomers and declines in general economic conditions. These downturns havebeen characterized by abrupt fluctuations in product demand, productionover-capacity and accelerated decline of average selling prices. In some cases,these downturns have lasted more than one year. A downturn in the semiconductorindustry could harm our sales and revenues if demand drops or our gross marginsif average selling prices decline.

 

**Thedevelopment and evolution of markets for our integrated circuits is dependenton factors such as industry standards, over which we have no control; forexample, if manufacturers adopt new or competing industry standards with whichour products are not compatible, our existing products would become lessdesirable to the manufacturers and our sales would suffer.**

 

The emergence of marketsfor our products is affected by a variety of factors beyond our control. Inparticular, our products are designed to conform to current specific industrystandards. Manufacturers may not continue to follow these standards, which wouldmake our products less desirable to manufacturers and reduce our sales. Also,competing standards may emerge that are preferred by manufacturers, which couldalso reduce our sales and require us to make significant expenditures todevelop new products. The emergence of new markets for our products is alsodependent in part upon third parties developing and marketing content in aformat compatible with commercial and consumer products that incorporate ourproducts. If content compatible with commercial and consumer products thatincorporate our products is not available, manufacturers may not be able tosell products incorporating our integrated circuits, and our sales tomanufacturers would suffer.

 

**Werely on 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 anymanufacturing facilities, and we rely on independent foundries to manufacturesubstantially all of our products. These independent foundries fabricateproducts for other companies and may also produce products of their own design.From time to time there are manufacturing capacity shortages in thesemiconductor industry. We do not have long-term supply contracts with any ofour suppliers, including our principal supplier, Taiwan SemiconductorManufacturing Company, or TSMC. Therefore, TSMC  and these other suppliers are not obligated to manufactureproducts for us for any specific period, in any specific quantity or at anyspecified price, except as may be provided in a particular purchase order.

 

Our reliance on independentfoundries involves a number of risks, including:

 

•                  the inability to obtain adequatemanufacturing capacity;

 

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

 

•                  reduced control over delivery schedules;

 

•                  reduced control over quality assurance;

 

•                  reduced control over manufacturing yieldsand cost; and

 

•                  potential misappropriation of ourintellectual property.

 

In addition, TSMC and someof our other foundries are located in areas of the world which are subject tonatural disasters such as earthquakes. While the 1999 earthquake in Taiwan didnot have a material impact on our independent foundries, a similar eventcentered near TSMC’s facility could severely reduce TSMC’s ability to manufactureour integrated circuits. The loss of any of our manufacturers as a supplier,our inability to expand the supply of our products in response to increaseddemand, or our inability to obtain timely and adequate deliveries from ourcurrent or future suppliers due to a natural disaster or any other reason could

 

15

----

 

delay or reduce shipmentsof our products. Any of these circumstances could damage our relationships withcurrent and prospective customers and harm our sales and financial results.

 

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

** **

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

 

If we are not able toobtain additional foundry capacity as required, our relationships with ourcustomers would be harmed and our sales would likely be reduced. In order tosecure additional foundry capacity, we have considered and will continue toconsider various arrangements with suppliers, which could include, amongothers:

 

•                  option payments or other prepayments to afoundry;

 

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

 

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

 

•                  issuance of our equity securities to afoundry;

 

•                  investment in a foundry;

 

•                  joint ventures; or

 

•                  other partnership relationships withfoundries.

 

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

 

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

 

The fabrication of siliconwafers is a complex process. Minute levels of contaminants in the manufacturingenvironment, defects in photomasks used to print circuits on a wafer,difficulties in the fabrication process or other factors can cause asubstantial portion of the integrated circuits on a wafer to be non-functional.Many of these problems are difficult to detect at an early stage of themanufacturing process and may be time consuming and expensive to correct. As aresult, foundries often experience problems achieving acceptable yields, whichare represented by the number of good integrated circuits as a proportion ofthe number of total integrated circuits on any particular wafer.  Poor yields from our independent foundrieswould reduce our ability to deliver our products to customers, harm ourrelationships with our customers, and harm our business.

 

16

----

 

**Tobe successful, we must efficiently develop new and enhanced products to meetrapidly changing customer requirements and industry standards.**

 

The markets for ourproducts are characterized by:

 

•                  rapidly changing technologies;

 

•                  evolving industry standards;

 

•                  frequent new product introductions; and

 

•                  short product life cycles.

 

Over the long run, weexpect to increase our product development expenses, and our future successwill depend to a substantial degree upon our ability to develop and introduce,on a timely and cost-effective basis, new and enhanced products that meetrapidly changing customer requirements and industry standards. We may notsuccessfully develop, introduce or manage the transition to new products.Delays in the introduction or shipment of new or enhanced products, lack ofmarket acceptance for such products or problems associated with new producttransitions could harm our sales and financial results.

** **

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

 

Competition in thecompression technology market has historically been dominated by largecompanies, such as STMicroelectronics, and companies that develop and use theirown integrated circuits, such as Sony. As this market continues to develop, weface competition from other large semiconductor vendors, including:

 

•                  Atmel Corporation;

 

•                  Cirrus Logic (Crystal Semiconductor);

 

•                  ESS Technology, Inc.;

 

•                  Fujitsu;

 

•                  LSI Logic (including C-Cube MicrosystemsInc. acquired during 2001);

 

•                  Motorola;

 

•                  Omnivision Technologies, Inc.;

 

•                  Sunplus Technology; and

 

•                  Texas Instruments.

 

We also face competitionfrom internally-developed solutions developed and used by major Japaneseoriginal equipment manufacturers, who may also be our customers.

 

Many of our existing andpotential competitors have substantially greater resources than ours in manyareas, including:

 

•                  finances;

 

•                  manufacturing;

 

•                  technology;

 

17

----

 

•                  marketing; and

 

•                  distribution.

 

Many of our competitorshave broader product lines and longer standing relationships with customersthan we do. Moreover, our competitors may foresee the course of marketdevelopments more accurately than we do and could in the future develop newtechnologies that compete with our products or even render our productsobsolete. In addition, a number of private companies have announced plans fornew products to address the same digital multimedia compression problems thatour products address. If we are unable to compete successfully against ourcurrent and future competitors, we could experience price reductions, ordercancellations and reduced gross margins, any one of which could harm ourbusiness.

 

The DVD market is growing,and additional competitors are expected to enter the market for DVD players andsoftware. Some of these potential competitors may develop captiveimplementations for use only with their own PC and consumer electronicsproducts. It is also possible that application software vendors, such asMicrosoft, may attempt to enter the DVD application market in the future. Thisincreased competition may result in price reductions, reduced profit marginsand loss of market share.

 

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

 

Average selling prices forour products decline over relatively short time periods. Many of ourmanufacturing costs are fixed. When our average selling prices decline, ourrevenues decline unless we sell more units, and our gross margins declineunless we are able to reduce our manufacturing costs by a commensurate amount.Our operating results suffer when gross margins decline. We have experiencedthese problems and may continue to experience them in the future and cannotpredict when they may occur or their severity.

 

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

 

Our largest customersaccount for a substantial percentage of our revenues. In 2001, sales toFujifilm accounted for 29.2% of our total revenue. Our four largest customersin 2001 accounted for approximately 56.3% of our total revenues.  During 2000, our four largest customersaccounted for approximately 45.4% of our revenues with Fujifilm accounting for25.2%. 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.

 

**Weare dependent on our relationship with Fujifilm for a significant percentage ofour product sales, and if this relationship were terminated, our business wouldbe harmed.**

 

Fujifilm has been ourlargest customer in four of the last five years. Fujifilm purchases ourproducts primarily as a distributor. Under our arrangement with Fujifilm,Fujifilm acts as the primary distributor in Japan of products developed by usunder development contracts with Fujifilm. Fujifilm also sells some of theseproducts in Japan under its own name. We may sell these products directly inJapan only to specified customers and must first buy the products fromFujifilm. Fujifilm provides more sales and marketing support than our other distributors.Fujifilm also has a nonexclusive license to distribute most of our productsoutside of Japan. Fujifilm has provided wafer manufacturing services on amost-favored terms basis to us since 1993 and has also provided funding tosupport our development efforts. If our relationship with Fujifilm wereterminated, our business would be harmed.

 

18

----

 

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

 

Our products aretechnologically complex. Prospective customers generally must make asignificant commitment of resources to test and evaluate our products and tointegrate them into larger systems. As a result, our sales process is oftensubject to delays associated with lengthy approval processes that typicallyaccompany the design and testing of new products. The sales cycles of ourproducts often last for many months or even years. Longer sales cycles requireus to invest significant resources in attempting to make sales and delay thegeneration of revenue.

 

Long sales cycles alsosubject us to other risks, including customers’ budgetary constraints, internalacceptance reviews and cancellations. In addition, orders expected in onequarter could shift to another because of the timing of customers’ purchasedecisions. The time required for our customers to incorporate our products intotheir own can vary significantly with the needs of our customers and generallyexceeds several months, which further complicates our planning processes andreduces the predictability of our operating results.

** **

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

 

We generally do not enterinto long-term purchase contracts with our customers, and we cannot be certainas to future order levels from our customers. When we do enter into a long-termcontract, the contract is generally terminable at the convenience of thecustomer. In the event of an early termination by one of our major customers,it is unlikely that we will be able to rapidly replace that revenue source,which would harm our financial results.

 

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

 

During 2001, 93% of ourtotal revenues were derived from international sales. We anticipate that internationalsales will continue to represent a substantial majority of our total revenuesfor the foreseeable future. In addition, substantially all of our semiconductorproducts are manufactured, assembled and tested outside of the United States byindependent foundries and subcontractors.

 

We are subject to the risksinherent in doing business internationally, including:

 

•                  unexpected changes in regulatoryrequirements;

 

•                  fluctuations in exchange rates;

 

•                  political and economic instability;

 

•                  imposition of tariffs and other barriers andrestrictions; and

 

•                  the burdens of complying with a variety offoreign laws.

 

The majority of ourresearch and development personnel and facilities and a significant portion ofour sales personnel are located in Israel. Political, economic and militaryconditions in Israel directly affect our operations. Some of our officers andemployees in Israel are obligated to perform up to 39 days of military reserveduty annually. The absence of these employees for significant periods duringthe work week may cause us to operate inefficiently during these periods.

 

Our operations in China aresubject to the economic and political uncertainties affecting that country. Forexample, the Chinese economy has experienced significant growth in the pastdecade, but such growth has been uneven across geographic and economic sectorsand has recently been slowing. This growth may continue to decrease and anyslowdown may have a negative effect on our business. During 2000 and the 

19

----

 

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.

** **

**Ourbusiness and future operating results could be harmed by terrorist activity orarmed conflict.**

** **

**Our business and operatingresults are subject to uncertainties arising out of possible terrorist attackson the United States and other regions of the world including locations wherewe maintain operations and by the potential expansion of armed conflict andpotential instability associated with terrorism. Our operations could be harmeddue to:**

** **

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

 

•                  reduced demand for consumer electronicproducts due to a potential extension of the global economic slowdown;

 

•                  tightened immigration controls that mayadversely affect the residence status of key non-U.S. managers and technicalemployees in our U.S. facilities or our ability to hire new non-U.S. employeesin such facilities; or

 

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

 

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

 

Foreign currencyfluctuations may affect the prices of our products. Prices for our products arecurrently denominated in U.S. dollars for sales to our customers throughout theworld. If there is a significant devaluation of the currency in a specificcountry, the prices of our products will increase relative to that country’scurrency and our products may be less competitive in that country. Also, wecannot be sure that our international customers will continue to be willing toplace orders denominated in U.S. dollars. If they do not, our revenue andoperating results will be subject to foreign exchange fluctuations.

 

**Ourability to compete could be jeopardized if we are unable to protect ourintellectual property rights from challenges by third parties.**

 

Our success and ability tocompete depend in large part upon protecting our proprietary technology. Werely on a combination of patent, trade secret, copyright and trademark laws, non-disclosureand other contractual agreements and technical measures to protect ourproprietary rights. These agreements and measures may not be sufficient toprotect our technology from third-party infringement, or to protect us from theclaims of others. Monitoring unauthorized use of our products is difficult andwe cannot be certain that the steps we have taken will prevent unauthorized useof our technology, particularly in foreign countries where the laws may notprotect our proprietary rights as fully as in the United States. The laws ofcertain foreign countries in which our products are or may be developed,manufactured or sold, including various countries in Asia, may not protect ourproducts or intellectual property rights to the same extent as do the laws ofthe United States and thus make the possibility of piracy of our technology andproducts more likely in these countries. If competitors are able to use ourtechnology, our ability to compete effectively could be harmed.

 

**Wecould become subject to claims and litigation regarding intellectual propertyrights, which could seriously harm our business and require us to incursignificant costs.**

 

In recent years, there hasbeen significant litigation in the United States involving patents and other intellectualproperty rights. In the past, we have been subject to claims and litigationregarding alleged infringement of other parties’ intellectual property rights.We could become subject to litigation in the future either to protect ourintellectual property or as a result of allegations that we infringe others’intellectual property rights. Claims that our products infringe proprietaryrights would force us to defend ourselves and possibly our customers ormanufacturers against the alleged infringement. These claims and any resulting 

 

20

----

 

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 selling our products that incorporatethe challenged intellectual property;

 

•                  obtain from the owner of the infringedintellectual property right a license to sell or use the relevant technology,which license may not be available on reasonable terms or at all;

 

•                  pay damages; or

 

•                  redesign those products that use suchtechnology.

 

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

** **

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

 

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

 

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

 

Our future net income andcash flow will be affected by our ability to apply our net operating losses,which totaled approximately $48.0 million for federal tax reporting purposes asof December 31, 2001, against taxable income in future periods. Our netoperating losses incurred prior to the consummation of our initial publicoffering in 1995 that we can use to reduce future taxable income for federaltax purposes are limited to approximately $3.0 million per year. Changes in taxlaws in the United States may further limit our ability to utilize our netoperating losses. Any further limitation on our ability to utilize our netoperating losses could harm our financial condition.

 

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

 

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

 

•                  issue stock that would dilute our currentstockholders’ percentage ownership;

 

•                  incur debt;

 

•                  assume liabilities;

 

•                  incur amortization expenses related togoodwill and other intangible assets; or

 

•                  incur large write-offs immediately or in thefuture.

 

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

 

•                  problems combining the purchased operations,technologies or products;

 

•                  unanticipated costs;

 

21

----

 

•                  diversion of management’s attention from ourcore business;

 

•                  adverse effects on existing businessrelationships with customers;

 

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

 

•                  potential loss of key employees,particularly those of the purchased organizations.

 

We may not be able tosuccessfully integrate any businesses, products or technologies or personnelthat we might acquire in the future and any failure to do so could disrupt ourbusiness and seriously harm our financial condition.

 

In addition, we have mademinority equity investments in early-stage companies, and we expect to continueto review opportunities to make additional investments in such companies wherewe believe such investments will provide us with opportunities to gain accessto important technologies or otherwise enhance important commercialrelationships. We have little or no influence over the early-stage companies inwhich we have made or may make strategic, minority equity investments. Each ofthese investments involves a high degree of risk. We may not be successful in achievingthe technological or commercial advantage upon which any given investment ispremised, and failure by the early-stage company to achieve its own businessobjectives could result in a loss of all or part of our invested capital.

 

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

 

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

 

**Ifwe do not maintain our current development contracts or are unable to enterinto new development contracts, our business could be harmed.**

 

We historically havegenerated a significant percentage of our total revenues from developmentcontracts, primarily with key customers. These development contracts haveprovided us with partial funding for the development of some of our products.Under these contracts, we receive payments upon reaching certain developmentmilestones. If we fail to achieve the milestones specified in our existingdevelopment contracts, if our existing contracts are terminated or we areunable to secure future development contracts, our ability to cost-effectivelydevelop new products would be reduced and our business would be harmed.

 

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

 

We may require substantialadditional capital to finance our future growth, secure additional foundrycapacity and fund our ongoing research and development activities beyond 2002.Our capital requirements will depend on many factors, including:

 

•                  acceptance of and demand for our products;

 

•                  the types of arrangements that we may enterinto with our independent foundries; and

 

22

----

 

•                  the extent to which we invest in newtechnology and research and development projects.

 

To the extent that ourexisting sources of liquidity and cash flow from operations are insufficient tofund our activities, we may need to raise additional funds. If we raiseadditional funds through the issuance of equity securities, the percentageownership of our existing stockholders would be reduced. Further, such equitysecurities may have rights, preferences or privileges senior to those of ourcommon stock. Additional financing may not be available to us when needed or,if available, it may not be available on terms favorable to us.

 

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

 

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

 

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

 

Our success depends to asignificant degree upon the continuing contributions of our senior management.The loss of key management personnel could delay product development cycles orotherwise harm our business. We may not be able to retain the services of anyof our key employees. We believe that our future success will also depend inlarge part on our ability to attract, integrate and retain highly-skilledengineering, managerial, sales and marketing personnel, both in the UnitedStates and in Israel. Competition for such personnel is intense, and we may notbe successful in attracting, integrating and retaining such personnel. Failureto attract, integrate and retain key personnel could harm our ability to carryout our business strategy and compete with other companies.

 

**TheIsraeli rate of inflation may negatively impact our costs if it exceeds therate of devaluation of the New Israeli Shekel against the U.S. dollar.**

 

A portion of the cost ofour operations, relating mainly to our personnel and facilities in Israel, isincurred in New Israeli Shekels. As a result, we bear the risk that the rate ofinflation in Israel will exceed the rate of devaluation of the New IsraeliShekel in relation to the dollar, which will increase our costs as expressed indollars. To date, we have not engaged in hedging transactions. In the future,we may enter into currency hedging transactions to decrease the risk offinancial exposure from fluctuations in the exchange rate of the U.S. dollaragainst the New Israeli Shekel. These measures may not adequately protect usfrom the impact of inflation in Israel.

 

**Thegovernment programs we participate in and tax benefits we receive require us tomeet several conditions and may be terminated or reduced in the future, whichwould increase our costs.**

 

In the year ended December31, 2001, we did not receive proceeds from grants for research and developmentfrom the Chief Scientist in Israel’s Ministry of Industry and Trade. However,we did receive an aggregate of $333,000 in such grants  during 2000. We plan to seek additionalgrants from the Chief Scientist in the future. To be eligible for these grants,our development projects must be approved by the Chief Scientist on acase-by-case basis.  If our developmentprojects are not approved by the Chief Scientist, we will not receive grants tofund these projects, which would increase our research and development costs.We also receive tax benefits, in particular exemptions and reductions as aresult of the “Approved Enterprise” status of our existing operations inIsrael. To be eligible for these tax benefits, we must maintain our ApprovedEnterprise status by meeting conditions, including making specified investmentsin fixed assets 

 

23

----

 

located in Israel andinvesting additional equity in our Israeli subsidiary. If we fail to meet theseconditions in the future, the tax benefits would be canceled and we could berequired to refund the tax benefits already received. These tax benefits maynot be continued in the future at their current levels or at any level. Israeligovernmental authorities have indicated that the government may reduce oreliminate these benefits in the future, which would harm our business.

 

**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 ofincorporation, our bylaws and Delaware law contain provisions that could makeit more difficult for a third party to acquire us, even if doing so would be beneficialto our stockholders. These include provisions:

 

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

 

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

 

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

 

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

** **

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

 

The market price of ourcommon stock has fluctuated significantly since our initial public offering in1995. Between January 1, 2001 and December 31, 2001, the closing sale price ofour common stock, as reported on the Nasdaq National Market, ranged from a lowof $13.00 to a high of $40.55.  Themarket price of our common stock is subject to significant fluctuations in thefuture in response to a variety of factors, including:

 

•                  announcements concerning our business orthat of our competitors or customers;

 

•                  quarterly variations in operating results;

 

•                  changes in analysts’ earnings estimates;

 

•                  announcements of technological innovations;

 

•                  the introduction of new products or changesin product pricing policies by us or our competitors;

 

•                  proprietary rights or other litigation;

 

•                  general conditions in the semiconductorindustry; and

 

•                  developments in the financial markets.

 

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

 

24

----

 

 

**Item 3.  Quantitative and Qualitative Disclosures About Market Risk**

 

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

 

The fair value of our investment portfolioor related income would not be significantly impacted by either a 10% increaseor decrease in interest rates due mainly to the short-term nature of the majorportion of our investment portfolio.

 

A majority of our revenue and capitalspending is transacted in U.S. dollars, although a portion of the cost of ouroperations, relating mainly to our personnel and facilities in Israel, isincurred in New Israeli Shekels. We have not engaged in hedging transactions toreduce our exposure to fluctuations that may arise from changes in foreignexchange rates. Based on our overall currency rate exposure at March 31, 2002,a near-term 10% appreciation or depreciation of the New Israeli Shekel wouldhave an immaterial affect on our financial condition.

 

25

----

 

**PARTII.     OTHER INFORMATION**

 

Item 6.    Exhibitsand Reports on Form 8-K

 

(a)   Exhibits

 

No exhibits.

 

(b)   Reportson Form 8-K

 

No reports on Form 8-Kwere filed during the three months ended March 31, 2002.

 

26

----

 

**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.

 
|                      |   |                      |   | **ZORAN  CORPORATION**                       |
|---------------------------|--------|---------------------------|--------|----------------------------------------------|
|                      |   |                      |   |                                         |
|                      |   |                      |   |                                         |
| Date:  May  15, 2002 |   | /s/  Karl  Schneider |   |
|                      |   |                      |   | Karl Schneider                               |
|                      |   |                      |   | Vice President Finance                       |
|                      |   |                      |   | And Chief Financial Officer                  |
|                      |   |                      |   | (Principal Financial and Accounting Officer) |

 

27

----