**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 June 30, 2003** |
|                                      |   |   |
| **or**                                    |
|                                      |   |   |
| **o**                                     |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|                                      |   |   |
|                                      |   | **For the transition period  from                              to                            ** |
|                                      |   |   |
| **Commission File 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 markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes ý No o

 

Indicateby check mark whether registrant is an accelerated filer (as defined by Rule12b-2 of the Exchange Act). Yes ý No o

 

The number of outstandingshares of the registrant’s Common Stock, $.001 par value, as of August 1,2003 was 28,113,951.

 

 

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**ZORAN CORPORATION**

 

**INDEX**

 
| **PART I.   FINANCIAL INFORMATION**                                                                      |   |
|--------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                               |   |
| Item 1.  Financial Statements                                                                                 |   |
|                                                                                                               |   |
| Unaudited Condensed Consolidated Balance  Sheets  June 30, 2003 and December 31, 2002                    | 3      |
|                                                                                                               |   |
| Unaudited Condensed Consolidated  Statements of Operations  Three and Six Months Ended June 30, 2003 and 2002 | 4      |
|                                                                                                               |   |
| Unaudited Condensed Consolidated  Statements of Cash Flows  Six Months Ended June 30, 2003 and 2002           | 5      |
|                                                                                                               |   |
| Unaudited  Notes to Condensed Consolidated Financial Statements                                                    | 6      |
|                                                                                                               |   |
| Item 2.  Management’s Discussion and  Analysis of Financial Condition and Results of Operations     | 11     |
|                                                                                                               |   |
| Item 3.   Quantitative and Qualitative Disclosures About Market Risk                                          | 29     |
|                                                                                                               |   |
| Item 4.   Controls and Procedures                                                                        | 29     |
|                                                                                                               |   |
| **PART II.   OTHER INFORMATION**                                                                         |   |
|                                                                                                               |   |
| Item 6.   Exhibits and Reports  on Form 8-K                                                                   | 30     |
|                                                                                                               |   |
| SIGNATURES                                                                                                         | 31     |

 

2

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**ZORAN CORPORATION**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

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

**(unaudited)**

 
|                                                                                                                    |   | **June 30,  2003** |    | **December 31,  2002** |   |
|-------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------|-----------------------------|--------|
|                                                                                                                    |   |                    |    |                        |   |
| ASSETS                                                                                                                  |   |                    |    |                        |   |
| Current  assets:                                                                                                        |   |                    |    |                        |   |
| Cash  and cash equivalents                                                                                              |   | $                       | 17,105  |                        | $      | 31,607 |   |
| Short-term  investments                                                                                                 |   | 125,579                 |    | 105,468                     |   |
| Accounts  receivable, net                                                                                               |   | 54,101                  |    | 34,652                      |   |
| Inventory                                                                                                               |   | 13,545                  |    | 12,686                      |   |
| Prepaid  expenses and other current assets                                                                              |   | 9,781                   |    | 6,479                       |   |
| Total  current assets                                                                                                   |   | 220,111                 |    | 190,892                     |   |
|                                                                                                                    |   |                    |    |                        |   |
| Property  and equipment, net                                                                                            |   | 7,264                   |    | 5,848                       |   |
| Other  investments                                                                                                      |   | 72,449                  |    | 78,334                      |   |
| Goodwill                                                                                                                |   | 59,131                  |    | 59,131                      |   |
| Intangible  assets                                                                                                      |   | 5,938                   |    | 8,411                       |   |
|                                                                                                                    |   |                    |    |                        |   |
|                                                                                                                    |   | $                       | 364,893 |                        | $      | 342,616 |   |
|                                                                                                                    |   |                    |    |                        |   |
|                                                                                                                    |   |                    |    |                        |   |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                                              |   |                    |    |                        |   |
| Current  liabilities:                                                                                                   |   |                    |    |                        |   |
| Accounts  payable                                                                                                       |   | $                       | 25,863  |                        | $      | 9,639 |   |
| Accrued  expenses and other liabilities                                                                                 |   | 22,175                  |    | 21,965                      |   |
| Total  current liabilities                                                                                              |   | 48,038                  |    | 31,604                      |   |
|                                                                                                                    |   |                    |    |                        |   |
| Stockholders’  equity:                                                                                             |   |                    |    |                        |   |
| Common  Stock, $0.001 par value; 55,000,000 shares authorized; 27,537,010 and 27,395,117  shares issued and outstanding |   | 28                      |    | 27                          |   |
| Additional  paid-in capital                                                                                             |   | 400,664                 |    | 399,052                     |   |
| Deferred  stock-based compensation                                                                                      |   | (63                     | )       | (83                         | )      |
| Accumulated  other comprehensive income                                                                                 |   | 292                     |    | 508                         |   |
| Accumulated  deficit                                                                                                    |   | (84,066                 | )       | (88,492                     | )      |
| Total  stockholders’ equity                                                                                        |   | 316,855                 |    | 311,012                     |   |
|                                                                                                                    |   |                    |    |                        |   |
|                                                                                                                    |   | $                       | 364,893 |                        | $      | 342,616 |   |

 

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

 

3

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**ZORANCORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(inthousands, except per share data)**

**(unaudited)**

 
|                                                 |   | **Three  Months Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|------------------------------------------------------|--------|----------------------------------------|--------|--------------------------------------|--------|
|                                                 |   | **2003**                               |   | **2002**                             |   | **2003** |   | **2002** |   |
|                                                 |   |                                   |   |                                 |   |   |   |   |   |
| Revenues:                                            |   |                                   |   |                                 |   |   |   |   |   |
| Product  sales                                       |   | $                                      | 41,510 |                                 | $      | 32,199 |   | $ | 78,607 |   | $ | 61,304 |   |
| Software,  licensing and development                 |   | 3,221                                  |   | 1,795                                |   | 3,957 |   | 3,780 |   |
| Total  revenues                                      |   | 44,731                                 |   | 33,994                               |   | 82,564 |   | 65,084 |   |
|                                                 |   |                                   |   |                                 |   |   |   |   |   |
| Costs  and expenses:                                 |   |                                   |   |                                 |   |   |   |   |   |
| Cost  of product sales                               |   | 26,227                                 |   | 20,559                               |   | 52,937 |   | 39,391 |   |
| Research  and development                            |   | 6,231                                  |   | 5,521                                |   | 10,710 |   | 11,042 |   |
| Selling,  general and administrative                 |   | 7,796                                  |   | 5,905                                |   | 14,738 |   | 11,645 |   |
| Amortization  of goodwill and other intangibles      |   | 954                                    |   | 2,445                                |   | 1,907 |   | 4,890 |   |
| Total  costs and expenses                            |   | 41,208                                 |   | 34,430                               |   | 80,292 |   | 66,968 |   |
|                                                 |   |                                   |   |                                 |   |   |   |   |   |
| Operating  income (loss)                             |   | 3,523                                  |   | (436                                 | )      | 2,272 |   | (1,884 | ) |
| Interest  income                                     |   | 1,435                                  |   | 1,766                                |   | 3,028 |   | 3,823 |   |
| Other  income (loss), net                            |   | (149                                   | )      | 86                                   |   | (171 | ) | (512 | ) |
|                                                 |   |                                   |   |                                 |   |   |   |   |   |
| Income  before income taxes                          |   | 4,809                                  |   | 1,416                                |   | 5129 |   | 1,427 |   |
|                                                 |   |                                   |   |                                 |   |   |   |   |   |
| Provision  for income taxes                          |   | 576                                    |   | 386                                  |   | 703 |   | 632 |   |
|                                                 |   |                                   |   |                                 |   |   |   |   |   |
| Net  income                                          |   | $                                      | 4,233  |                                 | $      | 1,030 |   | $ | 4,426 |   | $ | 795 |   |
|                                                 |   |                                   |   |                                 |   |   |   |   |   |
| Basic  net income per share                          |   | $                                      | 0.15   |                                 | $      | 0.04 |   | $ | 0.16 |   | $ | 0.03 |   |
|                                                 |   |                                   |   |                                 |   |   |   |   |   |
| Diluted  net income per share                        |   | $                                      | 0.15   |                                 | $      | 0.04 |   | $ | 0.15 |   | $ | 0.03 |   |
|                                                 |   |                                   |   |                                 |   |   |   |   |   |
| Shares  used to compute basic net income per share   |   | 27,481                                 |   | 27,054                               |   | 27,452 |   | 26,949 |   |
|                                                 |   |                                   |   |                                 |   |   |   |   |   |
| Shares  used to compute diluted net income per share |   | 28,991                                 |   | 28,923                               |   | 28,588 |   | 28,862 |   |

** **

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

 

4

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**ZORAN CORPORATION**

**CONDENSED CONSOLIDATED STATEMENTS OFCASH FLOWS**

**(in thousands)**

**(unaudited)**

 
|                                                                     |   | **Six Months  Ended  June 30,** |   |
|--------------------------------------------------------------------------|--------|--------------------------------------|--------|
|                                                                     |   | **2003**                             |   | **2002** |   |
| Cash  flows from operating activities:                                   |   |                                 |   |   |   |
| Net  income                                                              |   | $                                    | 4,426  |   | $ | 795 |   |
| Adjustments  to reconcile net income to net cash provided by operations: |   |                                 |   |   |   |
| Depreciation,  amortization and other                                    |   | 2,394                                |   | 1,371 |   |
| Amortization  of goodwill and other intangibles                          |   | 1,907                                |   | 4,890 |   |
| Realized  loss on exchange of marketable securities                      |   | —                               |   | 696 |   |
| Changes  in current assets and liabilities:                              |   |                                 |   |   |   |
| Accounts  receivable                                                     |   | (19,326                              | )      | (2,740 | ) |
| Inventory                                                                |   | (859                                 | )      | (1,512 | ) |
| Prepaid  expenses and other current assets                               |   | (1,437                               | )      | 335 |   |
| Accounts  payable                                                        |   | 16,324                               |   | 818 |   |
| Accrued  expenses and other liabilities                                  |   | 296                                  |   | (220 | ) |
| Net  cash provided by operating activities                               |   | 3,725                                |   | 4,433 |   |
|                                                                     |   |                                 |   |   |   |
| Cash  flows from investing activities:                                   |   |                                 |   |   |   |
| Capital  expenditures for property and equipment                         |   | (3,224                               | )      | (663 | ) |
| Purchases  of investments                                                |   | (77,670                              | )      | (75,728 | ) |
| Sales  of investments                                                    |   | 6,968                                |   | 31,070 |   |
| Maturities  of investments                                               |   | 56,237                               |   | 43,679 |   |
| Acquisition  costs                                                       |   | (650                                 | )      | — |   |
| Net  cash used in investing activities                                   |   | (18,339                              | )      | (1,642 | ) |
|                                                                     |   |                                 |   |   |   |
| Cash  flows from financing activities:                                   |   |                                 |   |   |   |
| Proceeds  from issuance of Common Stock, net                             |   | 1,612                                |   | 3,856 |   |
| Installment  payment on purchased core technology                        |   | (1,500                               | )      | — |   |
| Net  cash provided by financing activities                               |   | 112                                  |   | 3,856 |   |
|                                                                     |   |                                 |   |   |   |
| Net  increase (decrease) in cash and cash equivalents                    |   | (14,502                              | )      | 6,647 |   |
|                                                                     |   |                                 |   |   |   |
| Cash  and cash equivalents at beginning of period                        |   | 31,607                               |   | 20,287 |   |
|                                                                     |   |                                 |   |   |   |
| Cash  and cash equivalents at end of period                              |   | $                                    | 17,105 |   | $ | 26,934 |   |

 

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

 

5

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**ZORAN CORPORATION**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(unaudited)**

** **

**1.             Basis ofPresentation**

 

The accompanyingunaudited condensed consolidated financial statements contain all adjustments(consisting only of normal recurring adjustments) which, in the opinion ofmanagement, are necessary to present fairly the financial information includedtherein.  While the Company believesthat the disclosures are adequate to make the information not misleading, it issuggested that these financial statements be read in conjunction with theaudited consolidated financial statements and accompanying notes included inthe Company’s Annual Report on Form 10-K for the year ended December 31,2002.  Results for the interim periodspresented are not necessarily indicative of the results to be expected for thefull year.

 

**2.             FairValue Disclosures**

** **

In December 2002,the FASB issued Statement of Financial Account Standards No. 148, “Accountingfor Stock-Based Compensation – Transition and Disclosure an Amendment of FASBStatement No. 123” (SFAS No. 148). SFAS No. 148 provides alternative methods oftransition for companies making a voluntary change to fair value basedaccounting for stock-based employee compensation. The Company continues toaccount for stock-based compensation using the intrinsic value methodprescribed in Accounting Principles Board Opinion No. 25 (“APB 25”), “Accountingfor Stock Issued to Employees” and related interpretations. Under APB 25,compensation expense is recognized based on the difference, if any, on the dateof grant between the fair value of the Company’s stock and the amount anemployee must pay to acquire the stock. The compensation expense is recognized over the periods the employeeperforms the related services, generally the vesting period of four years,consistent with the multiple option method described in FASB Interpretation No.28 (“FIN 28”). Except for options assumed in connection with the Company’sacquisition of Nogatech, Inc. in 2000, no stock-based employee compensationcost is reflected in net income as all other options granted under theCompany’s plans had an exercise price equal to the market value of theunderlying common stock on the date of grant. Effective for interim periodsbeginning after December 15, 2002, SFAS No. 148 also requires disclosureof pro-forma results on a quarterly basis as if the Company had applied thefair value recognition provisions of SFAS No. 123.

 

Had compensation cost for the Company’s option andstock purchase plans been determined based on the fair value at the grantdates, as prescribed in SFAS 123, the Company’s net income (loss) and netincome (loss) per share for each of the three and six month periods endedJune 30, 2003 and 2002, would have been as follows (in thousands, exceptper share data):

 
|                                                                                                                                          |   | **Three  Months Ended June 30,** |   | **Six Months  Ended June 30,** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|-------------------------------------|--------|
|                                                                                                                                          |   | **2003**                              |   | **2002**                            |   | **2003** |   | **2002** |   |
|                                                                                                                                          |   |                                  |   |                                |   |   |   |   |   |
| Net  income as reported                                                                                                                       |   | $                                     | 4,233  |                                | $      | 1,030 |   | $ | 4,426 |   | $ | 795 |   |
| Add:  Stock-based employee compensation expense included in reported net income net  of related tax effects                                   |   | 10                                    |   | 136                                 |   | 20 |   | 272 |   |
| Deduct:  Total stock-based employee compensation expense determined under fair value  based methods for all awards net of related tax effects |   | (6,794                                | )      | (5,617                              | )      | (13,078 | ) | (11,185 | ) |
| Pro  forma loss                                                                                                                               |   | $                                     | (2,551 | )                                   | $      | (4,451 | ) | $ | (8,632 | ) | $ | (10,118 | ) |
|                                                                                                                                          |   |                                  |   |                                |   |   |   |   |   |
| Net  income (loss) per share:                                                                                                                 |   |                                  |   |                                |   |   |   |   |   |
| As  reported                                                                                                                                  |   |                                  |   |                                |   |   |   |   |   |
| Basic                                                                                                                                         |   | $                                     | 0.15   |                                | $      | 0.04 |   | $ | 0.16 |   | $ | 0.03 |   |
| Diluted                                                                                                                                       |   | $                                     | 0.15   |                                | $      | 0.04 |   | $ | 0.15 |   | $ | 0.03 |   |
| Pro  forma                                                                                                                                    |   |                                  |   |                                |   |   |   |   |   |
| Basic                                                                                                                                         |   | $                                     | (0.09  | )                                   | $      | (0.16 | ) | $ | (0.31 | ) | $ | (0.38 | ) |
| Diluted                                                                                                                                       |   | $                                     | (0.09  | )                                   | $      | (0.16 | ) | $ | (0.31 | ) | $ | (0.38 | ) |

 

6

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For purposes of thedisclosure required under SFAS 123, the fair value of each option grant isestimated on the date of grant using the Black-Scholes model with the followingassumptions used for options and purchase grants during the applicable periods.

 
|                      |   | **Three and  Six Months Ended June 30,** |   |
|---------------------------|--------|-----------------------------------------------|--------|
|                      |   | **2003**                                      |   | **2002** |   |
|                      |   |                                          |   |   |   |
| Dividend  rate            |   | 0.0                                           | %      | 0.0 | % |
| Risk-free  interest rates |   | 2.5 to 4.2                                    | %      | 2.9 to 4.7 | % |
| Volatility                |   | 92.0                                          | %      | 92.0 | % |
| Expected  life            |   |                                          |   |   |   |
| Option  plans             |   | 5 years                                       |   | 5 years |   |
| Purchase  plan            |   | 0.5 years                                     |   | 0.5 years |   |
|                           |        |                                               |        |  |  |  |

 

The Black-Scholes optionpricing model was developed for use in estimating the value of traded optionsthat have no vesting restrictions and are fully transferable. In addition,option pricing models require the input of highly subjective assumptionsincluding the expected stock price volatility. The Company uses projected datafor expected volatility and expected life of its stock options based uponhistorical and other economic data trended into future years. Because theCompany’s employee stock options have characteristics significantly differentfrom those of traded options, and because changes in the subjective inputassumptions can materially affect the estimate, in management’s opinion,existing valuation models, including the Black-Scholes model, do notnecessarily provide a reliable measure of the fair value of the Company’s stockoptions.

 

**3.             ComprehensiveIncome**

 

The Company appliesStatement of Financial Accounting Standards No. 130, Reporting ComprehensiveIncome.

 

The following are thecomponents of comprehensive income (loss) (in thousands):

 
|                                      |   | **Three  Months Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|-------------------------------------------|--------|----------------------------------------|--------|--------------------------------------|--------|
|                                      |   | **2003**                               |   | **2002**                             |   | **2003** |   | **2002** |   |
|                                      |   |                                   |   |                                 |   |   |   |   |   |
| Net income                                |   | $                                      | 4,233  |                                 | $      | 1,030 |   | $ | 4,426 |   | $ | 795 |   |
| Unrealized loss on marketable investments |   | (341                                   | )      | (1,183                               | )      | (216 | ) | (1,670 | ) |
| Comprehensive  income (loss)              |   | $                                      | 3,892  | )                                    | $      | (153 | ) | $ | 4,210 |   | $ | (875 | ) |

 

Thecomponents of accumulated other comprehensive income are unrealized gain (loss)on short-term and long-term marketable securities.

 

**4.             BalanceSheet Components**(in thousands):

 
|            |   | **June 30,  2003** |   | **December 31,  2002** |   |
|-----------------|--------|-------------------------|--------|-----------------------------|--------|
| **Inventory:**  |   |                    |   |                        |   |
| Work-in-process |   | $                       | 3,617  |                        | $      | 6,365 |   |
| Finished  goods |   | 9,928                   |   | 6,321                       |   |
|            |   |                    |   |                        |   |
|            |   | $                       | 13,545 |                        | $      | 12,686 |   |

 

 

7

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**5.             Goodwilland Other Intangible Assets**

 

The Company adopted SFASNo. 142 “Goodwill and Other Intangible Assets” (“SFAS 142”) as ofJanuary 1, 2002. SFAS 142 changed the accounting for goodwill from anamortization method to an impairment only approach. Under SFAS 142, goodwill isrequired to be tested annually and whenever events or circumstances occurindicating that goodwill might be impaired. In connection with the adoption ofSFAS 142, the Company performed a transitional goodwill impairment assessment basedon its structure as one reporting unit and determined that no impairmentexisted at January 1, 2002. The Company also conducted its annualimpairment assessment in 2002, and again determined that no impairment existed.The Company has not yet conducted its annual assessment for 2003 but does notcurrently anticipate that the completion of the assessment will have a materialimpact on its financial position, results of operations or cash flows.

 

**Components of Acquired IntangibleAssets** (in thousands):

 
|                         |   |                             |   | **June 30,  2003**     |   | **December 31,  2002**   |   |
|------------------------------|--------|----------------------------------|--------|-----------------------------|--------|-------------------------------|--------|
|                         |   | **Weighted  Avg.  Life (Years)** |   | **Gross  carrying  Amount** |   | **Accumulated  Amortization** |   | **Gross  carrying  Amount** |   | **Accumulated  Amortization** |   |
| Amortized  intangible assets |   |                             |   |                        |   |                          |   |   |   |   |   |
| Covenant  not to compete     |   | 3                                |   | $                           | 800    |                          | $      | 800 |   | $ | 800 |   | $ | 667 |   |
| Patents                      |   | 3                                |   | 900                         |   | 900                           |   | 900 |   | 750 |   |
| Core  technology             |   | 3                                |   | 8,060                       |   | 7,217                         |   | 8,060 |   | 5,874 |   |
| Completed  technology        |   | 2                                |   | 10,760                      |   | 10,760                        |   | 10,760 |   | 10,760 |   |
| Customer  base               |   | 3                                |   | 1,560                       |   | 1,397                         |   | 1,560 |   | 1,137 |   |
| Purchased  core technology   |   | 4                                |   | 5,582                       |   | 650                           |   | 5,582 |   | 63 |   |
| Total                        |   |                             |   | $                           | 27,662 |                          | $      | 21,724 |   | $ | 27,662 |   | $ | 19,251 |   |

 

During the quarters endedJune 30, 2003 and June 30, 2002, the Company incurred $1.3 millionand $2.3 million, respectively, in charges related to the amortization ofacquired intangible assets associated with the acquisitions of PixelCam Inc.and Nogatech Inc. and purchased core technologies. For the six months endedJune 30, 2003 and June 30, 2002, the Company incurred $2.4 millionand $4.6 million, respectively, in amortization charges related to theseacquired intangible assets. The Company will incur additional amortizationcharges of approximately $1.7 million for the balance of 2003.

 

**6.             OtherIncome (Loss), Net**

** **

During the six monthsended June 30, 2002, Roxio Inc. (“Roxio”) acquired MGI Software Inc(“MGI”). As of the date of acquisition, the Company held approximately 373,000shares of MGI common stock. Upon consummation of the acquisition, the Company’sMGI common stock was exchanged for 18,843 shares of Roxio common stock. Inconnection with the exchange, the Company recorded a realized loss of $696,000included as other loss for the quarter ended March 31, 2002, andestablished a new cost basis of its Roxio common stock equal to the fair valueof the stock on the date of the exchange.

 

**7.             IncomeTaxes**

** **

The provision for incometaxes reflects the estimated annualized effective tax rate applied to earningsexcluding charges for amortization of goodwill and other intangibles for theinterim periods.  The effective tax ratediffers from the U.S. statutory rate due to utilization of net operatinglosses, adjustments for the nondeductible amortization of goodwill and otherintangibles and income tax rate differences on foreign earnings.  The Company has provided for tax on incomein excess of net operating loss carryforwards for U.S. federal and stateearnings.  The Company has also providedfor tax on its foreign earnings.

 

8

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** **

**8.             EarningsPer Share**

** **

Computation of basic and dilutedearnings per share is as follows:

** **
|                                         |   | **Three  Months Ended June 30,** |   |
|----------------------------------------------|--------|----------------------------------|--------|
|                                         |   | **2003**                         |   | **2002** |   |
|                                         |   | **Income  (Numerator)**          |   | **Shares  (Denominator)** |   | **Per Share  Amount** |   | **Income  (Numerator)** |   | **Shares  (Denominator)** |   | **Per Share  Amount** |   |
|                                         |   |                             |   |   |   |   |   |   |   |   |   |   |   |
| Basic  and Diluted EPS:                      |   |                             |   |   |   |   |   |   |   |   |   |   |   |
| Net  income available to common stockholders |   | $                                | 4,233  |   | 27,481 |   | $ | 0.15 |   | $ | 1,030 |   | 27,054 |   | $ | 0.04 |   |
|                                         |   |                             |   |   |   |   |   |   |   |   |   |   |   |
| Effects  of Dilutive Securities:             |   |                             |   |   |   |   |   |   |   |   |   |   |   |
| Stock  options                               |   | —                           |   | 1,510 |   |   |   | — |   | 1,834 |   |   |   |
| Warrants                                     |   | —                           |   | — |   |   |   | — |   | 35 |   |   |   |
|                                         |   |                             |   |   |   |   |   |   |   |   |   |   |   |
| Diluted  EPS:                                |   |                             |   |   |   |   |   |   |   |   |   |   |   |
| Income  available to common stockholders     |   | $                                | 4,233  |   | 28,991 |   | $ | 0.15 |   | $ | 1,030 |   | 28,923 |   | $ | 0.04 |   |

 
|                                         |   | **Six Months  Ended June 30,** |   |
|----------------------------------------------|--------|--------------------------------|--------|
|                                         |   | **2003**                       |   | **2002** |   |
|                                         |   | **Income  (Numerator)**        |   | **Shares  (Denominator)** |   | **Per Share  Amount** |   | **Income  (Numerator)** |   | **Shares  (Denominator)** |   | **Per Share  Amount** |   |
|                                         |   |                           |   |   |   |   |   |   |   |   |   |   |   |
| Basic  and Diluted EPS:                      |   |                           |   |   |   |   |   |   |   |   |   |   |   |
| Net  Income available to common stockholders |   | $                              | 4,426  |   | 27,452 |   | $ | 0.16 |   | $ | 795 |   | 26,949 |   | $ | 0.03 |   |
|                                         |   |                           |   |   |   |   |   |   |   |   |   |   |   |
| Effects  of Dilutive Securities:             |   |                           |   |   |   |   |   |   |   |   |   |   |   |
| Stock  options                               |   | —                         |   | 1,136 |   |   |   | — |   | 1,879 |   |   |   |
| Warrants                                     |   | —                         |   | — |   |   |   | — |   | 34 |   |   |   |
|                                         |   |                           |   |   |   |   |   |   |   |   |   |   |   |
| Diluted  EPS:                                |   |                           |   |   |   |   |   |   |   |   |   |   |   |
| Income  available to common stockholders     |   | $                              | 4,426  |   | 28,588 |   | $ | 0.15 |   | $ | 795 |   | 28,862 |   | $ | 0.03 |   |

** **

**9.             StockSplit**

** **

On April 21, 2002,the Company’s Board of Directors approved a three-for-two split of our commonstock which was effected in the form of a 50 percent stock dividend, paid onMay 22, 2002 to stockholders of record on May 7, 2002. All share andper share information for all periods presented in this report are on apost-split basis.

** **

**10.          RecentlyIssued Accounting Standard**

** **

In November 2002,the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 00-21,“Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21provides guidance on how to account for arrangements that involve the deliveryor performance of multiple products, services and/or rights to use assets. Theprovisions of EITF Issue No. 00-21 will apply to revenue arrangements enteredinto in fiscal periods beginning after June 15, 2003. The Company does notexpect that this will have a material impact on its financial position, resultsof operations, or cash flows.

 

In January 2003, theFASB issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of VariableInterest Entities, an Interpretation of ARB No. 51.”  FIN 46 requirescertain variable interest entities to be consolidated by the primary beneficiaryof the entity if the equity investors in the entity do not have thecharacteristics of a controlling financial interest or do not have sufficientequity at risk for the entity to finance its activities without additionalsubordinated financial support from other parties. FIN 46 is effectiveimmediately for all new variable interest entities created or acquired afterJanuary 31, 2003. For variable interest entities created or acquired priorto February 1, 2003, the provisions of FIN 46 must be applied for thefirst interim or annual period beginning after June 15, 2003. The Companydoes not expect that the adoption of FIN 46 will have a material impact on itsfinancial position, results of operations, or cash flows.

 

 

**11.          Subsequent Events**

** **

On August 11, 2003,the Company acquired Oak Technology, Inc. (“Oak”), a publicly-held company thatprovides integrated circuit solutions for the HDTV and digital imaging markets,through the merger of Oak

 

9

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with a wholly-owned subsidiaryof the Company. In the merger, each outstanding share of Oak’s common stock wasconverted into the right to receive 0.2323 of a share of Zoran common stock and$1.78 in cash, for total merger consideration of approximately 13.2 millionshares of Zoran common stock with a fair value of approximately $227.5 millionand approximately $101.0 million in cash. In addition, the Company assumedoutstanding options to purchased Oak common stock which were converted intooptions to purchase an aggregate of  approximately4.0 million shares of Zoran common stock and granted new options to purchase anadditional 561,000 shares of Zoran common stock. The total fair value of theoptions was approximately $57.4 million. The common stockwas valued using the average of the market price per share of Zoran’s commonstock on the date the proposed merger was announced and the two trading daysbefore and two trading days subsequent to the date of the announcement.  The options were valued using theBlack-Scholes valuation model. The acquisition will be accounted for under thepurchase method of accounting, and the results of operations of Oak, beginningAugust 12, 2003, will be included in the Company’s consolidated financialstatements beginning with the quarter ending September 30, 2003.

 

The final allocation ofthe purchase price will be based on the value of the net tangible assets of Oakas of August 11, 2003, and the valuation of the in-process research anddevelopment and the intangible assets acquired. The Company anticipatescompleting its valuation analysis of these assets during the quarter endingSeptember 30, 2003.

 

10

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

** **

***The following discussion includes forward-looking statementswith respect to the Company’s future financial performance.  Actual results may differ materially fromthose currently anticipated depending upon a variety of factors, includingthose described below under the sub-heading, “Future Performance and RiskFactors” and discussed more fully in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2002.***

 

**Overview**

** **

From our inception in1981 through 1991, we derived the substantial majority of our revenue fromdigital filter processors and vector signal processors used principally inmilitary, industrial and medical applications. In 1989, we repositioned ourbusiness to develop and market data compression products for the evolving multimediamarkets and discontinued development of digital filter processor and vectorsignal processor products. In 1994, we discontinued production of theseproducts. Our current lines of digital audio and video products includeintegrated circuits and related products used in digital versatile discplayers, or DVDs, movie and home theater systems, filmless digital cameras andvideo editing systems.

 

We derive most of ourrevenues from the sale of our integrated circuit products. Historically,average selling prices in the semiconductor industry in general, and for ourproducts in particular, have decreased over the life of a particular product.Average selling prices for our hardware products have fluctuated substantiallyfrom period to period, primarily as a result of changes in our customer mix oforiginal equipment manufacturer, or OEM, sales versus sales to resellers andthe transition from low-volume to high-volume production. In the past, we havereduced the prices of some of our products in order to better penetrate theconsumer market. We believe that, as our product lines continue to mature andcompetitive markets evolve, we are likely to experience further declines in theaverage selling prices of our products, although we cannot predict the timing andamount of such future changes with any certainty.

 

Our cost of product salesconsists primarily of fabrication costs, assembly and test costs, and the costof materials and overhead from operations. If we are unable to reduce our costof product sales to offset anticipated decreases in average selling prices, ourproduct gross margins will decrease. Our product gross margin is also dependenton product mix and on the percentage of products sold directly to our OEMcustomers versus indirectly through our marketing partners who purchase ourproducts at lower prices but absorb most of the associated marketing and salessupport expenses, maintain inventories and provide customer support andtraining. Lower gross margins on sales to resellers are partially offset byreduced selling and marketing expenses related to such sales. Product sales inJapan are primarily made through Fujifilm, our strategic partner and resellerin Japan. Fujifilm provides more sales and marketing support than our otherresellers. We expect both product and customer mix to continue to fluctuate infuture periods, causing further fluctuations in margins.

 

We also derive revenuefrom licensing our software and other intellectual property. Licensing revenueincludes one-time license fees and royalties based on the number of unitsdistributed by the licensee. In addition, we have historically generated asignificant percentage of our total revenues from development contracts,primarily with key customers, although development revenue has declinedsubstantially as a percentage of total revenues over the past several years.These development contracts have provided us with partial funding for thedevelopment of some of our products. These development contracts provide forlicense and milestone payments which are recorded as development revenue. Weclassify all development costs, including costs related to these developmentcontracts, as research and development expenses. We retain ownership of theintellectual property developed by us under these development contracts. Whilewe intend to continue to enter into development contracts with certainstrategic partners, we expect development revenue to continue to decline as apercentage of total revenues.

 

Our research anddevelopment expenses consist of salaries and related costs of employees engagedin ongoing research, design and development activities and costs of engineeringmaterials and supplies. We are also a party to research and developmentagreements with the Chief Scientist in Israel’s Ministry of Industry and Tradeand the Israel-United States Binational Industrial Research and DevelopmentFoundation, which fund up to 50% of incurred project costs for approvedproducts up to specified contract maximums. These agreements require us to useour best efforts to achieve specified results and require us to pay royaltiesat rates of 3% to 5% of resulting product sales, and up to 30% of resultinglicense revenues, up to a maximum of 100% to 150% of total funding received.Reported research and development expenses are net of these grants, whichfluctuate from period to period. We believe that significant investments inresearch and development are required for us to remain competitive and weexpect to continue to devote significant resources to product development,although such expenses as a percentage of total revenues may fluctuate.

 

Our selling, general andadministrative expenses consist primarily of employee-related expenses,royalties, sales commissions, product promotion and other professional services.We expect that selling, general and administrative expenses will continue toincrease to support our anticipated growth.

 

11

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

 

Our effective income taxrate has benefited from the availability of net operating losses which we haveutilized to reduce taxable income for U.S. federal income tax purposes and byour Israeli subsidiary’s status as an “Approved Enterprise” under Israeli law,which provides a ten-year tax holiday for income attributable to a portion ofour operations in Israel. Our U.S. federal net operating losses expire atvarious times between 2003 and 2020, and the benefits from our subsidiary’sApproved Enterprise status expire at various times beginning in 2003.

 

On April 21, 2002,our Board of Directors approved a three-for-two split of our common stock whichwas effected in the form of a fifty percent stock dividend, paid onMay 22, 2002 to stockholders of record on May 7, 2002. All share andper share information for all periods presented in this report are on apost-split basis.

 

**Recent Development**

** **

On May 4, 2003, weentered into an agreement to acquire Oak Technology, Inc. (“Oak”) apublicly-held company that provides integrated circuit solutions for the HDTVand digital imaging markets. The acquisition was completed on August 11,2003.  Under the agreement, Oak mergedwith a wholly-owned subsidiary of Zoran, and each outstanding share of Oak’scommon stock was converted into the right to receive 0.2323 of a share of Zorancommon stock and $1.78 in cash, for total merger consideration of approximately13.2 million shares with a fair value of approximately $227.5 million andapproximately $101.0 million in cash. In addition, Zoran assumed outstandingoptions to purchase Oak common stock which were converted into options topurchase an aggregate of approximately 4.0 million shares of Zoran common stockand granted new options to purchase an additional 561,000 shares of Zorancommon stock.  The total fair value ofthese options was approximately $57.4 million. The common stockwas valued using the average of the market price per share of Zoran’s commonstock on the date the proposed merger was announced and the two trading daysbefore and two trading days subsequent to the date of the announcement.  The options were valued using theBlack-Scholes valuation model. The acquisition will be accounted for under thepurchase method of accounting.

 

The final allocation ofthe purchase price will be based on the value of the net tangible assets of Oakas of August 11, 2003, and the valuation of the in-process research anddevelopment and the intangible assets acquired. We anticipate completing ourvaluation analysis of these assets during the quarter ending September 30,2003.

 

We currently expect thatOak will add between $12.7 million and $14.0 million to our total revenues inthe quarter ending September 30, 2003 and between $23.5 million and $24.7million in the quarter ending December 31, 2003, although we expect theacquisition to be dilutive to our earnings during those quarters. We currentlyexpect the acquisition of Oak to be accretive to our earnings (beforeamortization of intangible assets) in the first half of 2004.  However, the operating results of thecombined company will be affected by our success in achieving our strategicobjectives and realizing potential operating benefits, including cost savings.  We will face a number of significantchallenges in integrating the technologies, operations and personnel of the twocompanies in a timely and efficient manner, and our failure to do soeffectively could have a material adverse effect on the business and operatingresults of the combined company.

 

The results of operationsof Oak, beginning August 12, 2003, will be included in our consolidatedfinancial statements beginning with the quarter ending September 30, 2003. Thefollowing discussion of our results of operations for the three and six monthperiods ended June 30, 2003 reflects only Zoran’s historical operations.

 

**Results ofOperations**

** **

*Revenues*

 

Total revenues were $44.7million and $82.6 million for the three and six month periods endedJune 30, 2003, compared to $34.0 million and $65.1 million for the same periodsof 2002, representing increases of 31.6% and 26.9% for the respectiveperiods.  For the three and six monthperiods ended June 30, 2003, product revenues were $41.5 million and $78.6million, compared to $32.2 million and $61.3 million for the same periods in2002, increases of 28.9% and 28.2%, respectively.  The increase in product sales for the quarter was primarilydriven by increased sales in our digital camera and DVD product lines of $4.6million and $4.3 million, respectively. The increased sales for both productlines were due to increased unit shipments. DVD

 

12

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products again accountedfor the majority of our total product sales, representing 80% of the total forthe quarter. We expect DVD sales to continue to comprise the majority of ourproduct sales for the balance of 2003. Software, licensing and developmentrevenues were $3.2 and $4.0 million, respectively, for the three and six monthperiods ended June 30, 2003, compared to $1.8 million and $3.8 million forthe same periods of 2002, representing increases of 79.4% and 4.7% for therespective periods. The increase for the quarter reflected two significant newlicensing agreements entered into during the quarter.

 

*Product Gross Margin*

* *

Product gross marginswere 36.8% and 32.7% of product revenues for the three and six month periodsended June 30, 2003, compared to 36.2% and 35.7% for the same periods of2002. The decrease in product gross margin for the six months endedJune 30, 2003 was due to the erosion of the average selling prices for ourolder multi-chip DVD solutions which were sold during the first quarter of2003. We have substantially depleted the inventory of these older products andtransitioned most of our customer base to our newer DVD products that do notrequire our DVD CPU companion chips which, historically, were sold at lowmargins.

 

*Research and Development*

* *

Research and development(“R&D”) expenses were $6.2 million and $10.7 million for the three and sixmonth periods ended June 30, 2003, compared to $5.5 million and $11.0million for the same periods of 2002. R&D expenses increasedquarter-over-quarter as a result of increased project spending includingtape-out expenses. The decrease in the year-over-year spending is the result ofdevelopment grants of $2.0 million related to R&D expenditures in previousperiods that were received and recorded as offsets to R&D expense duringthe six months ended June 30, 2003. As a percentage of revenues, R&Dexpenses decreased to 13.9% and 13.0% for the three and six month periods endedJune 30, 2003, compared to 16.2% and 17.0% for the same periods of 2002primarily as a result of increased revenues.

 

*Selling, General and Administrative*

* *

Selling, general andadministrative (“SG&A”) expenses were $7.8 million and $14.7 million forthe three and six month periods ended June 30, 2003, compared to $5.9million and $11.6 million for the same periods of 2002. The increasequarter-over-quarter was principally due to $648,000 of increased marketing andapplication expenses to support planned revenue growth in our Asia Pacificmarkets and $525,000 of increased product marketing expenses related to thedevelopment of our new DVD and digital camera products. The increaseyear-over-year was driven by these same factors comprising of $1.9m andapproximately $1.2 million respectively. As a percentage of revenues, SG&Aexpenses were 17.4% and 17.9% for the three and six month periods endedJune 30, 2003, as well as for the comparable periods ended June 30,2002.

 

*Amortization of Intangibles Assets*

 

During the three and sixmonths ended June 30, 2003, we incurred charges of $1.3 million and $2.4million, respectively, related to the amortization of intangible assets. Thiscompares to $2.3 million and $4.6 million in amortization charges of intangibleassets for the three and six months ended June 30, 2002. The reduction wasdue to the full amortization of the completed technology acquired as part ofthe Nogatech Inc. acquisition by the end of 2002.

 

*Interest Income*

* *

Interest income was $1.4million and $3.0 million for the three and six month periods endedJune 30, 2003, compared to $1.8 million and $3.8 million for the sameperiods of 2002. The reduction was due to a decline in market interest rates.

 

*Other Income (Loss), Net*

 

Other loss for the threemonths ended June 30, 2003 was $149,000 compared to other income of$86,000 for the same period in 2002 and was associated with net foreignexchange losses. Other loss for the six months ended June 30, 2003 was$171,000 compared to $512,000 for the same period in 2002. This decrease inother loss was primarily the result of a non-cash loss of $696,000 realized inthe first quarter of 2002, upon

 

13

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the exchange of shares ofMGI Software Inc. (“MGI”) common stock held by us for shares of Roxio Inc.(“Roxio”) common stock in conjunction with Roxio’s acquisition of MGI.

 

*Provision for Income Taxes*

* *

Excluding charges relatedto the amortization of goodwill and other intangibles our estimated effectivetax rate was 10% for the three and six month periods ended June 30, 2003,consistent with the effective tax rate for the same periods of 2002. TheCompany has booked a tax rate commensurate with the jurisdictional distributionof profits between the U.S. and Israel and the underlying tax positions as aresult of the approved enterprise status in Israel.

 

**Liquidity and Capital Resources**

** **

At June 30, 2003, wehad $17.1 million of cash and cash equivalents, $125.6 million of short-terminvestments and $172.1 million of working capital. In addition, we had $71.3million of investments in long-term marketable securities which are included inother investments in our consolidated balance sheet.

 

Our operating activitiesprovided cash of $3.7 million during the six months ended June 30, 2003,primarily due to our net income of $4.4 million adjusted for the cash impactassociated with an increase of $16.3 million in accounts payable and theadjustment related to depreciation and amortization of $2.4 million. Partiallyoffsetting the increase in accounts payable was the cash impact of a $19.3million increase in accounts receivable. The increase in accounts payable wasdue to normal timing differences in our payment patterns while the increase inaccounts receivable was due to the increase in revenue.

 

Cashused in investing activities was $18.3 million during the six months endedJune 30, 2003, principally reflecting the purchases of short-term andlong-term marketable investments net of proceeds from sales and maturities of$14.5 million and capital expenditures for property and equipment of $3.2million.

 

Cash provided byfinancing activities was $112,000 for the six months ended June 30, 2003,reflecting $1.6 million in proceeds from the issuance of common stock offset byinstallment payments of $1.5 million on core technology.

 

AtJune 30, 2003, 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.

 

Subsequent to June 30, 2003, we completed the acquisition of Oak. Aportion of the merger consideration consisted of approximately $101.0 millionin cash, payable to the former Oak stockholders. In addition, we incurredapproximately $6 million in merger-related transaction expenses.  These cash payments were offset in part by cash and cash equivalents onOak’s balance sheet as of August 11, 2003, at the date of the acquisition.Although the preparation of this balance sheet is still in progress, weestimate that Oak’s cash and cash equivalents were approximately $68 million onthat date.

 

We had inventory purchase commitments of $15.2 million at June 30,2003. In addition, we have lease commitments (including commitments withrespect to Oak facilities) of $4.6 million, $8.4 million, $7.2 million, $5.7million and $1.4 million for the balance of 2003, 2004, 2005, 2006 and 2007,respectively. 

 

We believe that ourcurrent balances of cash, cash equivalents and short-term investments(including balances received in the Oak acquisition), 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 maintaininventory and accounts receivable;

 

•                  the market acceptance of ourproducts;

 

•                  unanticipated expenses associatedwith the recently completed acquisition of Oak;

 

•                  the levels of promotion andadvertising required to launch our new products or to enter markets and attaina competitive position in the marketplace;

 

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

 

•                  volume pricing concessions;

 

•                  capital improvements to new andexisting facilities;

 

•                  technological advances;

 

14

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•                  the response of competitors to ourproducts; and

 

•                  our relationships with our suppliersand customers.

 

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

 

To the extent that ourexisting resources and cash generated from operations are insufficient to fundour future activities, we may need to raise additional funds through public orprivate financings or borrowings. If additional funds are raised through theissuance of debt securities, these securities could have rights, preferencesand privileges senior to holders of common stock, and the terms of this debtcould impose restrictions on our operations. The sale of additional equity 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**

 

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

 

# **Weare subject to a number of special risks as a result of our recent acquisitionof Oak Technology, Inc.**

 

On May 4, 2003, weentered into an agreement to acquire Oak Technology, Inc. (“Oak”), apublicly-held company that provides integrated circuit solutions for the HDTVand digital imaging markets.  Theacquisition was completed on August 11, 2003.  As a result of the recently completed acquisition of Oak, we aresubject to a number of risks and uncertainties, including the following:

 

•                  We will face a number of significantchallenges in integrating the technologies, operations and personnel of Zoranand Oak in a timely and efficient manner, and our failure to do so effectivelycould have a material adverse effect on the business and operating results ofthe combined company.

 

•                  We may not achieve the strategicobjectives, cost savings and other anticipated potential benefits of themerger, and our failure to achieve these strategic objectives could have amaterial adverse effect on our revenues, expenses and operating results.

 

•                  Transaction costs associated with themerger will be included as part of the total purchase cost for accountingpurposes.  In addition, we may incurcharges to operations, which amounts are not currently estimable, in thequarter in which the merger was completed or following quarters, to reflectcosts associated with integrating the two companies.  These costs could adversely affect our future liquidity andoperating results.

 

•                  Historically, Oak has dependedlargely on its optical storage business, which during its 2002 fiscal yearaccounted for approximately 67% of Oak’s revenues.  Following the recent sale of certain assets of its opticalstorage business, Oak’s digital imaging and digital television businesses willrepresent the primary source of revenue from the ongoing Oak operations, andrevenues from these emerging businesses are difficult to forecast.  As a result, it is not possible to use Oak’shistorical financial information to predict its contribution to the futureoperating results of the combined company.

 

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

# ** **

Our historical operatingresults, and those of Oak, have varied significantly from quarter to quarterdue to a number of factors, including:

 

15

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•                  fluctuation in demand for theirproducts;

 

•                  the timing of new productintroductions or enhancements by Zoran, Oak and their competitors;

 

•                  the level of market acceptance of newand enhanced versions of their products and their customers’ products;

 

•                  the timing or cancellation of largecustomer orders;

 

•                  the length and variability of thesales cycle for their products;

 

•                  pricing policy changes by Zoran, Oakand their competitors and suppliers;

 

•                  the cyclical nature of thesemiconductor industry;

 

•                  the availability of developmentfunding and the timing of development revenue;

 

•                  changes in the mix of products sold;

 

•                  seasonality in demand for theirproducts;

 

•                  increased competition in productlines, and competitive pricing pressures; and

 

•                  the evolving and unpredictable natureof the markets for products incorporating Zoran’s and Oak’s integrated circuitsand embedded software.

 

We expect that theoperating results of the combined company will continue to fluctuate in thefuture as a result of these factors and a variety of other factors, including:

 

•                  the cost and availability of adequatefoundry capacity;

 

•                  fluctuations in manufacturing yields;

 

•                  changes in or the emergence of newindustry standards;

 

•                  failure to anticipate changingcustomer product requirements;

 

•                  the loss or gain of importantcustomers;

 

•                  product obsolescence; and

 

•                  the amount of research anddevelopment expenses associated with new product introductions.

 

The operating results ofthe combined company could also be harmed by:

 

•                  economic conditions generally or invarious geographic areas where we or our customers do business;

 

•                  acts of terrorism and internationalconflicts or crises, such as the recent outbreak of Severe Acute RespiratorySyndrome, or SARS;

 

•                  other conditions affecting the timingof customer orders;

 

•                  changes in governmental regulationsthat could affect our products; or

 

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

 

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These factors aredifficult or impossible to forecast.  Weplace orders with independent foundries several months in advance of thescheduled delivery date, often in advance of receiving non-cancelable ordersfrom our customers.  This limits ourability to react to fluctuations in demand for their products.  If anticipated shipments in any quarter arecanceled or do not occur as quickly as expected, or if we fail to foresee a technologychange that could render a product obsolete, expense and inventory levels couldbe disproportionately high.  Ifanticipated license revenues in any quarter are canceled or do not occur, grossmargins may be reduced.  A significantportion of our expenses are relatively fixed, and the timing of increases inexpenses is based in large part on our forecast 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.

 

Product supply and demandfluctuations common to the semiconductor industry are historicallycharacterized by periods of manufacturing capacity shortages immediatelyfollowed by periods of overcapacity, which are caused by the addition ofmanufacturing capacity in large increments. The industry has moved from a period of capacity shortages in 2000 tothe current condition of excess capacity. We cannot predict whether we will achieve timely, cost-effective accessto that capacity when needed, or if there will be a capacity shortage again inthe future.

 

As a result of thesefactors, our operating results may vary significantly from quarter toquarter.  These fluctuations may be morepronounced in the future as a result of the challenges we face in integratingthe operations of Zoran and Oak.  Anyshortfall in revenues or net income from levels expected by the investmentcommunity could cause a decline in the trading price of our stock.

 

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

 

Because the markets thatour customers serve are characterized by numerous new product introductions andrapid product enhancements, our operating results may vary significantly fromquarter to quarter.  During the finalproduction of a mature product, our customers typically exhaust their existinginventory of our products.  Consequently,orders for our products may decline in those circumstances, even if the productsare incorporated into both mature products and replacement products.  A delay in the customer’s transition tocommercial production of a replacement product would delay our ability torecover the lost sales from the discontinuation of the related matureproduct.  Our customers also experiencesignificant seasonality in the sales of their consumer products, which affectstheir orders of our products. Typically, the second half of the calendar year represents adisproportionate percentage of sales for our customers due to the holidayshopping period for consumer electronics products, and therefore, adisproportionate percentage of our sales. We expect these sales fluctuations to continue for the foreseeable future.

 

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

# ** **

The semiconductorindustry is subject to cyclical variations in product supply and demand.  Downturns in the industry often occur inconnection with, or anticipation of, maturing product cycles for bothsemiconductor companies and their customers and declines in general economicconditions.  These downturns have beencharacterized by abrupt fluctuations in product demand, productionover-capacity and accelerated decline of average selling prices.  In some cases, these downturns have lastedmore than one year.  A downturn in thesemiconductor industry could harm our sales and revenues if demand drops, orour gross margins if average selling prices decline.

 

# **Oursuccess for the foreseeable future will be dependent on growth in demand forintegrated circuits for a limited number of applications.**

# ** **

In recent years, we havederived a substantial majority of our product revenues from the sale ofintegrated circuits for DVD and digital camera applications.  We expect that sales of our products forthese applications will continue to account for a significant portion of itsrevenues for the foreseeable future.  Asa result of Oak’s recent sale of its optical storage business, the futurefinancial performance of the former Oak operations will depend on our abilityto successfully develop and market new products in the digital television, HDTVand digital imaging markets.  If themarkets for these products and applications decline or fail to develop asexpected, or we are not successful in our efforts to market and sell ourproducts to manufacturers who incorporate integrated circuits into theseproducts, our financial results will be harmed.

 

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

 

Our financial performancedepends in large part on our ability to successfully develop and marketnext-generation and new products in a rapidly changing technologicalenvironment.  If we fail to successfullyidentify new product opportunities and timely develop and introduce newproducts that achieve market acceptance, we may lose our market share and ourfuture revenue and earnings may suffer. In recent years, our success has been dependent on our successfuldevelopment and timely introduction of integrated circuits for DVD players, DVDrecorders and digital cameras.  Thesemarkets are characterized by the incorporation of a steadily increasing levelof integration and numbers of features on a chip at the same or lower systemcost, enabling original equipment manufacturers, or OEMs, to continuallyimprove the features or reduce the prices of the systems they sell.  If we are unable to continually develop andintroduce integrated circuits with increasing levels of integration and newfeatures at competitive prices, our operating results will suffer.

 

In the consumerelectronics market, Oak’s performance has been highly dependent upon thesuccessful development and timely introduction of new products and solutionsfor broadband digital television and HDTV. In the digital office market, Oak’s performance has been dependant onits ability to successfully develop embedded image processing system on a chip,or SOC, solutions for the digital office market, in particular, embeddeddigital color copier technology and image processing chips for a variety ofimaging peripherals, including printers and multi-function peripherals, orMFPs.  Among other technologicalchanges, embedded PDF and color capability are rapidly emerging as marketrequirements for printers and other imaging devices.  Some of Oak’s competitors have the capacity to supply thesesolutions, and some of their solutions have been well received in the marketplace.  We face the challenge of continuing Oak’sdevelopment of digital television and HDTV solutions as well as developing newimaging products with the capability to handle greater color and imagecomplexity, including web-based documents, and work with higher-performingdevices in networked environments.  Ifwe are unable to meet these challenges with the development of products thatcan effectively compete in the OEM software and solutions market, our futureoperating results could suffer.

 

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

# ** **

Our future success willdepend on our ability to anticipate and adapt to changes in technology andindustry standards and our customers’ changing demands.  The consumer electronics market, inparticular, is characterized by rapidly changing technology, evolving industrystandards, frequent new product introductions, short product life cycles andincreasing demand for higher levels of integration.  Our ability to adapt to these changes and to anticipate futurestandards, and the rate of adoption and acceptance of those standards, will bea significant factor in maintaining or improving our competitive position andprospects for growth.  If new industrystandards emerge, our products or the products of our customers could becomeunmarketable or obsolete, and we could lose market share or be required toincur substantial unanticipated costs to comply with these new standards.

 

Our success will alsodepend on the successful development of new markets and the application andacceptance of new technologies and products in those new markets.  For example, our success will depend on theability of our customers to develop new products and enhance existing productsin the recordable DVD player market and products for the broadband digitaltelevision and HDTV markets and to introduce and promote those productssuccessfully.  These markets may notcontinue to develop to the extent or in the time periods that we currentlyanticipate due to factors outside our control, such as delays in implementationof FCC 02-320 requiring all new televisions to include a digitalreceiver.  If new markets do not developas we anticipate, or if our products do not gain widespread acceptance in thesemarkets, our business, financial condition and results of operations could bematerially and adversely affected.  Theemergence of new markets for our products is also dependent in part upon thirdparties developing and marketing content in a format compatible with commercialand consumer products that incorporate our products.  If this content is not available, manufacturers may not be ableto sell products incorporating our products, and our sales would suffer.

 

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

# ** **

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We do not operate anymanufacturing facilities, and we rely on independent foundries to manufacturesubstantially all of our products. These independent foundries fabricate products for other companies andmay also produce products of their own design. From time to time, there are manufacturing capacity shortages in thesemiconductor industry.  We do not havelong-term supply contracts with any of our suppliers, including our principalsupplier, Taiwan Semiconductor Manufacturing Company, or TSMC.  Therefore, TSMC and our other suppliers arenot obligated to manufacture products for us for any specific period, in anyspecific quantity or at any specified price, except as may be provided in aparticular purchase order.

 

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

 

•                  the inability to obtain adequatemanufacturing capacity;

 

•                  the unavailability of or interruptionin access to certain process technologies necessary for manufacture of ourproducts;

 

•                  lack of control over deliveryschedules;

 

•                  lack of control over qualityassurance;

 

•                  lack of control over manufacturingyields and cost; and

 

•                  potential misappropriation of ourintellectual property.

 

In addition, TSMC andsome of our other foundries are located in areas of the world that are subjectto natural disasters such as earthquakes. While the 1999 earthquake in Taiwan did not have a material impact on ourindependent foundries, a similar event centered near TSMC’s facility couldseverely reduce TSMC’s ability to manufacture our integrated circuits.  The loss of any of our manufacturers as asupplier, our inability to expand the supply of their products in response toincreased demand, or our inability to obtain timely and adequate deliveriesfrom our current or future suppliers due to a natural disaster or any otherreason could delay or reduce shipments of our products.  Any of these circumstances could damage ourrelationships with current and prospective customers and harm our sales andfinancial results.

 

We also rely on a limitednumber of independent contractors for the assembly and testing of ourproducts.  Our reliance on independentassembly and testing houses limits our control over delivery schedules, qualityassurance and product cost.  Disruptionsin the services provided by our assembly or testing houses or othercircumstances that would require them to seek alternative sources of assemblyor testing could lead to supply constraints or delays in the delivery of ourproducts.  These constraints or delayscould damage our relationships with current and prospective customers and harmour financial results.

 

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

 

If we are not able toobtain additional foundry capacity as required, our relationships with ourcustomers would be harmed and our sales would likely be reduced.  In order to secure additional foundrycapacity, we have considered, and may in the future need to consider, variousarrangements with suppliers, which could include, among others:

 

•                  option payments or other prepaymentsto a foundry;

 

•                  nonrefundable deposits with or loansto foundries in exchange for capacity commitments;

 

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

 

•                  issuance of our equity securities toa foundry;

 

•                  investment in a foundry;

 

•                  joint ventures; or

 

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•                  other partnership relationships withfoundries.

 

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

 

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

# ** **

The fabrication ofsilicon wafers is a complex process. Minute levels of contaminants in the manufacturing environment, defectsin photomasks used to print circuits on a wafer, difficulties in thefabrication process or other factors can cause a substantial portion of theintegrated circuits on a wafer to be non-functional.  Many of these problems are difficult to detect at an early stageof the manufacturing process and may be time consuming and expensive tocorrect.  As a result, foundries oftenexperience problems achieving acceptable yields, which are represented by thenumber of good integrated circuits as a proportion of the number of total integratedcircuits on any particular wafer.  Pooryields from our independent foundries would reduce our ability to deliver ourproducts to customers, harm our relationships with our customers and harm ourbusiness.

 

# **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.**

# ** **

We face intensecompetition in the markets in which we compete.  We expect that the level of competition will increase in thefuture from existing competitors and from other companies that may enter itsexisting or future markets with solutions that may be less costly or providehigher performance or additional features.

 

Competition in Zoran’score compression technology market has historically been dominated by largecompanies, such as STMicroelectronics, and companies that develop and use theirown integrated circuits, such as Sony and Matsushita. As this market continuesto develop, we face competition from other large semiconductor vendors,including:

 

•                  ALi Corporation;

 

•                  Atmel Corporation;

 

•                  Cirrus Logic (Crystal Semiconductor);

 

•                  ESS Technology, Inc.;

 

•                  Fujitsu;

 

•                  LSI Logic;

 

•                  MediaTek Inc.;

 

•                  Motorola;

 

•                  Omnivision Technologies, Inc.;

 

•                  Sunplus Technology; and

 

•                  Texas Instruments.

 

The DVD market continuesto expand, and additional competitors are expected to enter the market for DVDplayers and software.  Some of thesepotential competitors may develop captive implementations for use only withtheir own PC and consumer electronics products.  It is also possible that application software vendors,

 

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such as Microsoft, mayattempt to enter the DVD application market in the future.  This increased competition may result inprice reductions, reduced profit margins and loss of market share.

 

Oak’s principalcompetitors in the broadband digital television and set top box marketsinclude:

 

•                  ATI Technologies;

 

•                  Broadcom;

 

•                  Genesis Microchip/Pixelworks;

 

•                  Sigma Designs;

 

•                  ST Microelectronics; and

 

•                  Trident Microsystems;

 

•                  in-house, captive suppliers.

 

We expect competition to continue to increase in thesemarkets as industry standards become well known and as other competitors enterthese markets.

 

Oak’s principal competitors in the digital officemarket include:

 

•                  Adobe;

 

•                  Agilent;

 

•                  Electronics for Imaging, Inc.

 

•                  Oasis Semiconductor;

 

•                  Peerless Systems Corporation;

 

•                  TAK ASIC; and

 

•                  in-house, captive suppliers.

 

The future growth of thedigital office market is highly dependent on OEMs continuing to outsource anincreasing portion of their product development work.  While the trend toward outsourcing on the part of Oak’s OEMcustomers has accelerated in recent years, any reversal of this trend, or achange in the way they outsource, could seriously harm our business.

 

Many of these existingcompetitors, as well as OEM customers that are expected to compete with us inthe future have substantially greater financial, manufacturing, technical,marketing, distribution and other resources, broader product lines and longerstanding relationships with customers than Zoran or Oak.  In addition, much of our future success isdependent on the success of our OEM customers. If we or our OEM customers are unable to compete successfully againstcurrent and future competitors, we could experience price reductions, ordercancellations and reduced gross margins, any one of which could harm ourbusiness.

 

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

 

Average selling pricesfor our products decline over relatively short time periods, while many of ourmanufacturing costs are fixed.  When ouraverage selling prices decline, our revenues decline unless we are able to sellmore units, and our gross margins decline unless we are able to reduce ourmanufacturing costs by a commensurate amount. Our operating results suffer when gross margins decline.  We have

 

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experienced theseproblems, and we expect to continue to experience them in the future, althoughwe cannot predict when they may occur or how severe they will be.

 

# **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.**

# ** **

Zoran’s and Oak’s largestcustomers have accounted for a substantial percentage of their revenues.  In 2002, sales to Fujifilm accounted forapproximately 37% of Zoran’s total revenues, and Zoran’s four largest customersaccounted for approximately 59% of its total revenues.  Similarly, during Oak’s fiscal 2002, LGElectronics accounted for 20% of Oak’s total revenues, and Oak’s top 10customers accounted for approximately 69% of its total revenues.  Sales to these large customers have variedsignificantly from year to year and will continue to fluctuate in thefuture.  These sales also may fluctuatesignificantly from quarter to quarter. 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 delayin sales to one or more of our key customers could harm our sales and financialresults.  In addition, any difficulty incollecting amounts due from one or more key customers could harm our financialresults.

 

Fujifilm has been ourlargest customer over the last five years. Fujifilm purchases our products primarily as a reseller.  Fujifilm acts as the primary reseller inJapan of products developed by us under development contracts withFujifilm.  We may sell these productsdirectly in Japan only to specified customers with Fujifilm’s consent.  Fujifilm provides more sales and marketingsupport than our other resellers. Fujifilm has also provided funding to support Zoran’s developmentefforts.  If our relationship withFujifilm were terminated, our business could be harmed.

 

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

# ** **

Our products aretechnologically complex.  Prospectivecustomers generally must make a significant commitment of resources to test andevaluate our products and to integrate them into larger systems.  As a result, our sales processes are oftensubject to delays associated with lengthy approval processes that typicallyaccompany the design and testing of new products.  The sales cycles of our products often last for many months oreven years. Longer sales cycles require us to invest significant resources inattempting to make sales and delay the generation of revenue.

 

Long sales cycles alsosubject us to other risks, including customers’ budgetary constraints, internalacceptance reviews and cancellations. In addition, orders expected in one quarter could shift to anotherbecause of the timing of customers’ purchase decisions.  The time required for our customers toincorporate our products into their own can vary significantly with the needsof our customers and generally exceeds several months, which furthercomplicates our planning processes and reduces the predictability of ouroperating results.

 

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

 

We generally do not enterinto long-term purchase contracts with our customers, and we cannot be certainas to future order levels from our customers. Customers generally purchase our products subject to cancelableshort-term purchase orders.  We cannotpredict whether our current customers will continue to place orders, whetherexisting orders will be canceled, or whether customers who have orderedproducts will pay invoices for delivered products.  When we do enter into a long-term contract, the contract isgenerally terminable at the convenience of the customer.  In the event of an early termination by oneof our major customers, it is unlikely that we will be able to rapidly replacethat revenue source, which would harm our financial results.

 

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

 

The FederalCommunications Commission, or FCC, has broad jurisdiction over our targetmarkets in the digital television business we acquired from Oak.  Various international entities ororganizations may also regulate aspects of our business or the business of ourcustomers.  Although our products arenot directly subject to regulation by any agency, the transmission pipes, aswell as much of the equipment into which our products are incorporated, aresubject to direct government regulation. For example, before they can be sold in the United States, advancedtelevisions and emerging interactive displays must be tested and certified by

 

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Underwriters Laboratoriesand meet FCC regulations.  Accordingly,the effects of regulation on our customers or the industries in which ourcustomers operate may in turn harm our business.  FCC regulatory policies affecting the ability of cable operatorsor telephone companies to offer certain services and other terms on which thesecompanies conduct their business may impede sales of our products.  In addition, our digital television businessmay also be adversely affected by the imposition of tariffs, duties and otherimport restrictions on systems of suppliers or by the imposition of exportrestrictions on products that we sell internationally.  Changes in current laws or regulations orthe imposition of new laws or regulations in the United States or elsewherecould harm our business.  For example,any delays by the FCC in imposing its requirement that all new televisions havea digital receiver could have an adverse effect on our HDTV business.

 

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

 

During 2002, 97% of ourtotal revenues and 89% of Oak’s total revenues were derived from internationalsales.  We anticipate that internationalsales will continue to represent a significant portion of our total revenuesfor the foreseeable future.  Inaddition, substantially all of our semiconductor products are manufactured, assembledand tested outside of the United States by independent foundries andsubcontractors.

 

We are subject to the risks inherent in doing businessinternationally, including:

 

•                  unexpected changes in regulatoryrequirements;

 

•                  fluctuations in exchange rates;

 

•                  political and economic instability;

 

•                  imposition of tariffs and otherbarriers and restrictions;

 

•                  the burdens of complying with avariety of foreign laws; and

 

•                  health risks in a particular region.

 

The majority of ourresearch and development personnel and facilities and a portion of our salesand marketing personnel are located in Israel. Political, economic and military conditions in Israel directly affectour operations.  Some of our officersand employees in Israel are obligated to perform up to 39 days of militaryreserve duty annually.  The absence ofthese employees for significant periods during the work week may cause us tooperate inefficiently during these periods.

 

Our operations in Chinaare subject to the economic and political uncertainties affecting thatcountry.  For example, the Chineseeconomy has experienced significant growth in the past decade, but such growthhas been uneven across geographic and economic sectors and has recently beenslowing.  This growth may continue todecrease and any slowdown may have a negative effect on our business.  During 2000 and 2001, we also opened officesin Taipei, Taiwan, Hong Kong and Seoul, Korea, and our operations are subjectto the economic and political uncertainties affecting these countries as well.

 

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

 

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

# ** **

Our business andoperating results are subject to uncertainties arising out of possibleterrorist attacks on the United States and other regions of the world includinglocations where we maintain operations and by armed conflict in the Middle Eastand related economic instability.  Ouroperations could be harmed due to:

 

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

 

•                  reduced demand for consumerelectronic products due to a potential extension of the global economicslowdown;

 

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

 

•                  potential expansion of armed conflictin the Middle East which could adversely affect our operations in Israel.

 

# **Therecent outbreak of SARS may adversely affect our business.**

 

The recent outbreak ofsevere acute respiratory syndrome, or SARS, in a number of Asian countriescould have a negative effect on our manufacturing production capabilities, onour ability to effectively market and sell our products due to SARS-relatedtravel restrictions and on the general financial markets and business activityin Asia.  The SARS outbreak has beensignificantly focused on Asia, where many of our current and prospectivecustomers are located.  In addition,most of our manufacturing activities are carried out by third party foundriesin Taiwan and Singapore.  Should theSARS illness spread to new regions in Asia or elsewhere or intensify inseverity in areas already affected, causing reduced demand by current andprospective customers or disrupting the manufacture of those companies’products, our operating results could be harmed.

 

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

 

Foreign currencyfluctuations may affect the prices of our products.  Prices for our products are currently denominated in U.S. dollarsfor sales to our customers throughout the world.  If there is a significant devaluation of the currency in aspecific country, the prices of our products will increase relative to thatcountry’s currency, and our products may be less competitive in that country.  Also, we cannot be sure that our internationalcustomers will continue to be willing to place orders denominated in U.S.dollars.  If the 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.**

 

Our success and abilityto compete depend in large part upon protection of our proprietarytechnology.  We rely on a combination ofpatent, trade secret, copyright and trademark laws, non-disclosure and othercontractual agreements and technical measures to protect our proprietaryrights.  These agreements and measuresmay not be sufficient to protect our technology from third-party infringement,or to protect us from the claims of others. Monitoring unauthorized use of our products is difficult, and we cannotbe certain that the steps we have taken will prevent unauthorized use of ourtechnology, particularly in foreign countries where the laws may not protectour proprietary rights as fully as in the United States.  The laws of certain foreign countries inwhich our products are or may be developed, manufactured or sold, includingvarious countries in Asia, may not protect our products or intellectualproperty rights to the same extent as do the laws of the United States and thusmake the possibility of piracy of our technology and products more likely inthese countries.  If competitors areable to use our technology, our ability to compete effectively could be harmed.

 

The protection offered bypatents is subject to numerous uncertainties. For example, our competitors may be able to effectively design aroundour patents, or the patents may be challenged, invalidated orcircumvented.  Those competitors mayalso independently develop technologies that are substantially equivalent orsuperior to our technology.  Moreover,while we hold, or have applied for, patents relating to the design of ourproducts, some of our products are based in part on standards, for which we donot hold patents or other intellectual property rights.

 

Oak has generally limitedaccess to and distribution of the source and object code of its software andother proprietary information.  Withrespect to its page description language software and drivers for the digitaloffice market and in limited circumstances with respect to firmware andplatforms for its HDTV products, Oak

 

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has granted licenses thatgive its customers access to and restricted use of the source code of Oak’ssoftware.  This access increases thelikelihood of misappropriation or misuse of our technology.

 

# **Oakis a defendant in several lawsuits.**

# ** **

Oak and various of itsformer directors and former officers are parties to a consolidated class actionlawsuit filed on behalf of all persons who purchased or acquired Oak commonstock for the period from July 27, 1995 to May 22, 1996, allegingstate securities law and other violations. Additionally, various of Oak’s directors and former officers aredefendants in three consolidated derivative actions which allege a breach offiduciary duty and a claim under California securities laws.  Based on information provided by Oak,including the California Supreme Court’s recent denial of the plaintiffs’ petitionfor review, we believe this litigation to be at an end, finally concluded infavor of Oak.  Oak is also a party tovarious other legal proceedings, including a number of patent-relatedmatters.  In connection with theselawsuits, management time has been, and will continue to be, expended.  In addition, while Oak has incurred, and weexpect to continue to incur, substantial legal and other expenses in connectionwith these pending lawsuits, an estimate of such loss or range of loss cannotbe made.  No provision for any liabilitythat may result upon adjudication has been made in our financial statements.

 

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

 

In recent years, therehas been significant litigation in the United States involving patents andother intellectual property rights.  Inthe past, Zoran and Oak have been subject to claims and litigation regardingalleged infringement of other parties’ intellectual property rights, and Oak iscurrently a party to a number of patent-related lawsuits.  We could become subject to additionallitigation in the future, either to protect our intellectual property or as aresult of allegations that we infringe others’ intellectual propertyrights.  Claims that our productsinfringe proprietary rights would force us to defend ourselves and possibly ourcustomers or manufacturers against the alleged infringement.  These claims and any resulting lawsuit, ifsuccessful, could subject us to significant liability for damages orinvalidation of our proprietary rights. These lawsuits, regardless of their success, would likely betime-consuming and expensive to resolve and would divert management time andattention.  Any potential intellectualproperty litigation could force us to do one or more of the following:

 

•                  stop selling products thatincorporate the challenged intellectual property;

 

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

 

•                  pay damages; or

 

•                  redesign those products that use suchtechnology.

 

Although patent disputesin the semiconductor industry have often been settled through cross-licensingarrangements, we may not be able in any or every instance, to settle an allegedpatent infringement claim through a cross-licensing arrangement.  We have a more limited patent portfolio thanmany of our competitors.  If asuccessful claim is made against we or any of our customers and a license isnot made available to us on commercially reasonable terms or we are required topay substantial damages or awards, our business, financial condition andresults of operations would be materially adversely affected.

 

# **Ifnecessary licenses of third-party technology are not available to Zoran, Oak orthe combined company or are very expensive, our products could become obsolete.**

 

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

 

Certain technology usedin our products is licensed from third parties, and in connection with theselicenses, we are required to fulfill confidentiality obligations and, in somecases, pay royalties.  Some of ourproducts require various types of copy protection software that we must licensefrom third parties.  If we are unable to

 

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obtain or maintain ourright to use the necessary copy protection software, we would be unable to selland market these products.

 

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

 

Our future net income andcash flow will be affected by our ability to apply our net operating losses, orNOLs, against taxable income in future periods.  Our NOLs totaled approximately $34.0 million for federal and$4.0 million for state tax reporting purposes as of December 31,2002.  Oak’s NOLs totaled approximately$212.0 million for federal and $60.0 million for state tax reportingpurposes as of December 31, 2002. As a result of the change of control resulting from Zoran’s initialpublic offering in 1995, the amount of NOLs that Zoran can use to reduce futuretaxable income for federal tax purposes is limited to approximately$3.0 million per year.  TheInternal Revenue Code contains a number of provisions that could limit the useof NOLs against income of the combined company following the merger as a resultof the merger or as a result of the combination of these transactions.  Our utilization of Oak’s NOLs may be furtherlimited due to prior Oak transactions. No opinion or IRS ruling has been sought regarding the potentialapplication of any of these provisions. Changes in tax laws in the United States may further limit our abilityto utilize these NOLs.  Any furtherlimitation on our ability to utilize these respective NOLs could harm ourfinancial condition.

 

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

 

We have made investmentsin, and acquisitions of, other complementary companies, products andtechnologies.  We have recentlycompleted the acquisition of Oak. During 2000, we acquired PixelCam and Nogatech, and we may acquireadditional businesses, products or technologies in the future.  In the event of any future acquisitions, we could:

 

•                  issue stock that would dilute itscurrent stockholders’ percentage ownership;

 

•                  incur debt;

 

•                  assume liabilities;

 

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

 

•                  incur other large write-offsimmediately or in the future.

 

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

 

•                  problems combining the purchasedoperations, technologies or products;

 

•                  unanticipated costs;

 

•                  diversion of management’s attentionfrom our core business;

 

•                  adverse effects on existing businessrelationships with customers;

 

•                  risks associated with enteringmarkets in which we have no or limited prior experience; and

 

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

 

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

 

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 noinfluence over the early-stage companies in which

 

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we have made or may makestrategic, minority equity investments. Each of these investments involves a high degree of risk.  We may not be successful in achieving thetechnological 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 andrequire us to write off all or a portion of such investment.

 

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

 

We develop complex andevolving products.  Despite testing byus and our customers, errors may be found in existing or new products.  This could result in, among other things, adelay in recognition or loss of revenues, loss of market share or failure toachieve market acceptance.  Thesedefects may cause us to incur significant warranty, support and repair costs,divert the attention of our engineering personnel from our product developmentefforts and harm our relationships with customers.  The occurrence of these problems could result in the delay orloss of market acceptance of our products and would likely harm ourbusiness.  Defects, integration issuesor other performance problems in our products could result in financial orother damages to customers or could damage market acceptance of suchproducts.  Our customers could also seekdamages from us for their losses.  Aproduct liability claim brought against us, even if unsuccessful, would likelybe time consuming and costly to defend.

 

# **Ifwe do not maintain current development contracts or are unable to enter intonew 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 have provided us with partial funding forthe development of some of our products. Under these contracts, we receive payments upon reaching certaindevelopment milestones.  If we fail toachieve the milestones specified in our existing development contracts, if ourexisting contracts are terminated or if we are unable to secure futuredevelopment contracts, our ability to cost-effectively develop new productswould 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 requiresubstantial additional capital to finance our future growth, secure additionalfoundry capacity and fund our ongoing research and development activitiesbeyond 2003.  Our capital requirementswill depend on many factors, including:

 

•                  acceptance of and demand for ourproducts;

 

•                  the types of arrangements that we mayenter into with our independent foundries; and

 

•                  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 raise additional funds through theissuance of equity securities, the percentage ownership of our existingstockholders would be reduced.  Further,such equity securities may have rights, preferences or privileges senior tothose of our common stock.  Additionalfinancing may not be available to us when needed or, if available, it may notbe 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 to manage growth successfullywill also require us to expand and improve administrative, operational,management and financial systems and controls. Many of our key operations, including the major portion of our researchand development operations and a significant portion of our sales andadministrative operations, are located in Israel.  A majority of our sales and marketing and certain of our researchand development and administrative personnel, including our President and ChiefExecutive Officer and other officers, are based in the United States.  The geographic separation of theseoperations places additional strain on our resources and our

 

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ability to manage growtheffectively.  If we are unable to managegrowth effectively, our business will be harmed.

 

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

 

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

 

# **TheIsraeli rate of inflation may negatively impact our costs if it exceeds therate of devaluation of the new Israeli shekel against the United States dollar.**

 

A portion of the cost ofour operations, relating mainly to our personnel and facilities in Israel, isincurred in new Israeli shekels.  As aresult, we bear the risk that the rate of inflation in Israel will exceed therate of devaluation of the new Israeli shekel in relation to the United Statesdollar, which will increase our costs as expressed in United Statesdollars.  To date, we have not engagedin 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 United Statesdollar against the new Israeli shekel. These measures may not adequately protect us from the impact ofinflation in Israel.

 

# **Thegovernment programs in which we participate and tax benefits we receive requireus to meet several conditions and may be terminated or reduced in the future,which would increase our costs.**

 

Historically, we havefinanced a portion of our research and development activities with grants forresearch and development from the Chief Scientist in Israel’s Ministry ofIndustry and Trade.  Although we did notreceive proceeds from such grants in 2001 or 2002, we did receive such proceedsin the first and second quarters of 2003, and we plan to seek additional grantsfrom the Chief Scientist in the future. To be eligible for these grants, our development projects must beapproved by the Chief Scientist on a case-by-case basis.  If our development projects are not approvedby the Chief Scientist, we will not receive grants to fund these projects,which would increase our research and development costs.  We also receive tax benefits, in particularexemptions and reductions as a result of the “Approved Enterprise” status ofour existing operations in Israel.  Tobe eligible for these tax benefits, we must maintain our Approved Enterprisestatus by meeting conditions, including making specified investments in fixedassets located in Israel and investing additional equity in its Israelisubsidiary.  If we fail to meet theseconditions in the future, the tax benefits would be canceled and we could be requiredto refund the tax benefits already received. These tax benefits may not be continued in the future at their currentlevels or at any level.  Israeligovernmental authorities have indicated that the government may reduce oreliminate these benefits in the future, which would harm our business.

 

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

 

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

 

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

 

•                  authorizing the issuance of up to3,000,000 shares of “blank check’ preferred stock;

 

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•                  eliminating stockholders’ rights tocall a special meeting of stockholders; and

 

•                  requiring advance notice of anystockholder nominations 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 June 30, 2002 andJune 30, 2003, the closing sale price of our common stock, as reported onThe NASDAQ National Market, ranged from a low of $9.11 to a high of$23.51.  The market price of our commonstock is subject to significant fluctuations in the future in response to avariety of factors, including:

 

•                  announcements concerning our businessor that of our competitors or customers;

 

•                  quarterly variations in operatingresults;

 

•                  changes in analysts’ earningsestimates;

 

•                  announcements of technologicalinnovations;

 

•                  the introduction of new products orchanges in product pricing policies by Zoran or its competitors;

 

•                  loss of key personnel;

 

•                  proprietary rights or otherlitigation;

 

•                  general conditions in thesemiconductor industry; and

 

•                  developments in the financialmarkets.

 

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

 

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

** **

We are exposed tofinancial market risks including changes in interest rates and foreign currencyexchange rates.

 

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

 

Amajority of our revenue and capital spending is transacted in U.S. dollars,although a portion of the cost of our operations, relating mainly to ourpersonnel and facilities in Israel, is incurred in New Israeli Shekels. We havenot engaged in hedging transactions to reduce our exposure to fluctuations thatmay arise from changes in foreign exchange rates. Based on our overall currencyrate exposure at September 30, 2002, a near-term 10% appreciation ordepreciation of the New Israeli Shekel would have an immaterial affect on ourfinancial condition.

 

**Item4.   Controls and Procedures**

 

Under the supervision andwith the participation of our management, including our Chief Executive Officerand our Chief Financial Officer, we conducted an evaluation of our disclosurecontrols and procedures (as defined in Rule 13a-14(c) under the SecuritiesExchange Act of 1934, as amended) as of June 30, 2003. Based on theirevaluation, our Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures are effective.

 

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**PART II. OTHER INFORMATION**

** **

**Item 6.**  Exhibits and Reports on Form 8-K

** **

(a)          Exhibits:

 
| 10.41 (1) |   | Employment Agreement,  dated as of May 4, 2003, by and between Registrant and Young K. Sohn.                                                        |
|-----------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.42 (2) |   | Agreement and Plan of  Reorganization, dated as of May 4, 2003, by and among the Registrant,  Zinc Acquisition Corporation and Oak Technology, Inc. |
| 31.1      |   | Certification of Chief  Executive Officer pursuant to Rule 13a-14(a).                                                                                    |
| 31.2      |   | Certification of Chief  Financial Officer pursuant to Rule 13a-14(a).                                                                                    |
| 32.1      |   | Certification of Chief  Executive Officer, pursuant to 18 U.S.C. Section 1350.                                                                           |
| 32.2      |   | Certification of Chief  Financial Officer, pursuant to 18 U.S.C. Section 1350.                                                                           |

 

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| (1) |   | Incorporated by  reference to identically numbered exhibit to Registrant’s Form S-4  Registration Statement filed on June 10, 2003. |
|-----|--------|-----------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Incorporated by  reference to Exhibit 2.1 to Registrant’s Form 8-K Current Report filed on  May 7, 2003.                            |

 

(b)         Reports on Form 8-K:

 

1.               OnApril 24, 2003, we filed a Report on Form 8-K, pursuant to Item 12thereof, relating to financial information for the quarter ended March 31,2003 and forward-looking statements relating to the second quarter andremainder of 2003 as presented in a press release dated April 24, 2003.

 

2.               OnMay 7, 2003, we filed a Report on Form 8-K, pursuant to Item 5 thereof,reporting that we had entered into an Agreement and Plan of Reorganization byand among Zoran Corporation, Zinc Acquisition Corporation, a wholly-ownedsubsidiary of Zoran, and Oak Technology, Inc.

 

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** **

**SIGNATURES**

 

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

 
|                             | **ZORAN CORPORATION**                                                                                      |
|----------------------------------|------------------------------------------------------------------------------------------------------------|
|                             |                                                                                                       |
|                             |                                                                                                       |
| Date:  August 14, 2003 | /s/  Karl Schneider                                                                                   |   |
|                             | Karl Schneider                                                                                             |
|                             | Senior Vice President,  Finance  and Chief Financial Officer  (Principal Financial and Accounting Officer) |

 

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