**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

** **

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** **

### **FORM 10-Q**

 

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

 

**For theQuarterly Period Ended March 31, 2006**

 

**OR**

 

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

 

**For thetransition period from            to             **

 

**CommissionFile No. 0-27246**

 

**ZORAN CORPORATION**

(Exact name ofregistrant as specified in its charter)

 

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

 

**1390Kifer Road**

**Sunnyvale,California 94086**

(Address ofprincipal executive offices, including zip code)

 

**(408)523-6500**

(Registrant’stelephone number, including area code)

 

----

 

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 thepreceding 12 months (or for such shorter period that the registrant was requiredto file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes ý  No  ̈

 

Indicate by check markwhether registrant is a large accelerated filer, an accelerated filer or anon-accelerated filer. See definition of “accelerated and large acceleratedfiler” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large acceleratedfiler  ý   Accelerated filer   o   Non accelerated-filer  o

 

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

 

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

 

** **

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**ZORANCORPORATION AND SUBSIDIARIES**

**FORM 10-Q**

**INDEX**

 

**For theQuarter Ended March 31, 2006**

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

 

----

 

**ZORANCORPORATION**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(inthousands, except share data)**

**(unaudited)**

 
| ** **                                                                                                                                                                                                                                                    | ** ** | **March 31,   2006** | ** ** | **December 31,   2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|-----------------------------------|------------|
| ASSETS                                                                                                                                                                                                                                                        |       |                           |       |                              |       |
| Current assets:                                                                                                                                                                                                                                               |       |                           |       |                              |       |
| Cash and cash  equivalents                                                                                                                                                                                                                                    |       | $                              | 113,752    |                              | $          | 78,856 |   |
| Short-term  investments                                                                                                                                                                                                                                       |       | 104,124                        |       | 70,490                            |       |
| Accounts  receivable, net                                                                                                                                                                                                                                     |       | 62,431                         |       | 70,174                            |       |
| Inventories                                                                                                                                                                                                                                                   |       | 38,663                         |       | 32,616                            |       |
| Prepaid expenses  and other current assets                                                                                                                                                                                                                    |       | 9,800                          |       | 11,746                            |       |
| Total current  assets                                                                                                                                                                                                                                         |       | 328,770                        |       | 263,882                           |       |
| Property and  equipment, net                                                                                                                                                                                                                                  |       | 14,905                         |       | 16,057                            |       |
| Other assets and  investments                                                                                                                                                                                                                                 |       | 14,179                         |       | 12,943                            |       |
| Goodwill                                                                                                                                                                                                                                                      |       | 180,254                        |       | 184,254                           |       |
| Intangible  assets, net                                                                                                                                                                                                                                       |       | 113,944                        |       | 127,087                           |       |
|                                                                                                                                                                                                                                                          |       | $                              | 652,052    |                              | $          | 604,223 |   |
|                                                                                                                                                                                                                                                          |       |                           |       |                              |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                    |       |                           |       |                              |       |
| Current  liabilities:                                                                                                                                                                                                                                         |       |                           |       |                              |       |
| Accounts payable                                                                                                                                                                                                                                              |       | $                              | 44,737     |                              | $          | 38,999 |   |
| Accrued expenses  and other liabilities                                                                                                                                                                                                                       |       | 53,562                         |       | 53,937                            |       |
| Total current  liabilities                                                                                                                                                                                                                                    |       | 98,299                         |       | 92,936                            |       |
| Other long-term  liabilities                                                                                                                                                                                                                                  |       | 12,770                         |       | 11,939                            |       |
| Stockholders’  equity:                                                                                                                                                                                                                                   |       |                           |       |                              |       |
| Common stock,  $0.001 par value; 105,000,000 shares authorized at March 31, 2006 and  December 31, 2005; 46,716,431 shares issued and outstanding as of March  31, 2006; and 45,426,912 shares issued and outstanding as of  December 31, 2005 |       | 47                             |       | 45                                |       |
| Additional  paid-in capital                                                                                                                                                                                                                                   |       | 748,792                        |       | 727,597                           |       |
| Deferred  stock-based compensation                                                                                                                                                                                                                            |       | —                         |       | (593                              | )          |
| Accumulated  other comprehensive income                                                                                                                                                                                                                       |       | 2,179                          |       | 3,094                             |       |
| Accumulated  deficit                                                                                                                                                                                                                                          |       | (210,035                       | )          | (230,795                          | )          |
| Total  stockholders’ equity                                                                                                                                                                                                                              |       | 540,983                        |       | 499,348                           |       |
|                                                                                                                                                                                                                                                          |       | $                              | 652,052    |                              | $          | 604,223 |   |

 

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

 

3

----

 

**ZORANCORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

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

**(unaudited)**

 
| ** **                                                  | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                  | ** ** | **March 31,**               | ** ** |
| ** **                                                  | ** ** | **2006**                         | ** ** | **2005** | ** ** |
|                                                        |       |                             |       |   |   |
| Revenues:                                                   |       |                             |       |   |   |
| Hardware product  revenues                                  |       | $                                | 99,169     |   | $ | 59,002 |   |
| Software and  other revenues                                |       | 12,909                           |       | 14,882 |   |
| License revenues  related to litigation settlement          |       | 30,168                           |       | — |   |
| Total revenues                                              |       | 142,246                          |       | 73,884 |   |
|                                                        |       |                             |       |   |   |
| Costs and  expenses:                                        |       |                             |       |   |   |
| Cost of hardware  product revenues                          |       | 54,466                           |       | 36,964 |   |
| Research and  development                                   |       | 24,151                           |       | 20,100 |   |
| Selling, general  and administrative                        |       | 24,755                           |       | 23,174 |   |
| Amortization of  intangible assets                          |       | 12,735                           |       | 12,330 |   |
| Deferred stock  compensation                                |       | —                           |       | 517 |   |
| Total costs and  expenses                                   |       | 116,107                          |       | 93,085 |   |
|                                                        |       |                             |       |   |   |
| Operating income  (loss)                                    |       | 26,139                           |       | (19,201 | ) |
|                                                        |       |                             |       |   |   |
| Interest income                                             |       | 1,630                            |       | 535 |   |
|                                                        |       |                             |       |   |   |
| Other income  (loss), net                                   |       | 1,193                            |       | (130 | ) |
|                                                        |       |                             |       |   |   |
| Income (loss)  before income taxes                          |       | 28,962                           |       | (18,796 | ) |
|                                                        |       |                             |       |   |   |
| Provision for  income taxes                                 |       | 8,202                            |       | — |   |
|                                                        |       |                             |       |   |   |
| Net income  (loss)                                          |       | $                                | 20,760     |   | $ | (18,796 | ) |
|                                                        |       |                             |       |   |   |
| Basic net income  (loss) per share                          |       | $                                | 0.45       |   | $ | (0.43 | ) |
|                                                        |       |                             |       |   |   |
| Diluted net  income (loss) per share                        |       | $                                | 0.43       |   | $ | (0.43 | ) |
|                                                        |       |                             |       |   |   |
| Shares used to  compute basic net income (loss) per share   |       | 46,207                           |       | 43,213 |   |
|                                                        |       |                             |       |   |   |
| Shares used to  compute diluted net income (loss) per share |       | 48,487                           |       | 43,213 |   |

 

The accompanying notesare an integral part of these unaudited condensed consolidated financialstatements.

 

4

----

 

**ZORANCORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(inthousands)**

**(unaudited)**

 
| ** **                                                                                | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                | ** ** | **March 31,**               | ** ** |
| ** **                                                                                | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Cash flows from  operating activities:                                                    |       |                             |       |   |   |
| Net income  (loss)                                                                        |       | $                                | 20,760     |   | $ | (18,796 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operations: |       |                             |       |   |   |
| Depreciation and  amortization                                                            |       | 2,962                            |       | 3,144 |   |
| Amortization of  intangible assets                                                        |       | 12,735                           |       | 12,330 |   |
| Stock based  compensation expense                                                         |       | 4,562                            |       | 517 |   |
| Changes in  current assets and liabilities:                                               |       |                             |       |   |   |
| Accounts  receivable                                                                      |       | 7,743                            |       | (8,160 | ) |
| Inventories                                                                               |       | (6,047                           | )          | 15,826 |   |
| Prepaid expenses  and other current assets and other assets                               |       | (232                             | )          | (4,969 | ) |
| Accounts payable                                                                          |       | 5,738                            |       | (6,062 | ) |
| Accrued expenses  and other liabilities, goodwill and other long term liabilities         |       | 4,456                            |       | 2,224 |   |
| Net cash  provided by (used in) operating activities                                      |       | 52,677                           |       | (3,946 | ) |
|                                                                                      |       |                             |       |   |   |
| Cash flows from  investing activities:                                                    |       |                             |       |   |   |
| Purchases of  property and equipment                                                      |       | (1,402                           | )          | (2,059 | ) |
| Purchases of  investments                                                                 |       | (90,952                          | )          | (4,883 | ) |
| Proceeds from  sales and maturities of investments                                        |       | 57,345                           |       | 4,103 |   |
| Net cash used in  investing activities                                                    |       | (35,009                          | )          | (2,839 | ) |
|                                                                                      |       |                             |       |   |   |
| Cash flows from  financing activities:                                                    |       |                             |       |   |   |
| Proceeds from  issuance of common stock                                                   |       | 17,228                           |       | 375 |   |
| Net cash  provided by financing activities                                                |       | 17,228                           |       | 375 |   |
|                                                                                      |       |                             |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                                     |       | 34,896                           |       | (6,410 | ) |
|                                                                                      |       |                             |       |   |   |
| Cash and cash  equivalents at beginning of period                                         |       | 78,856                           |       | 37,435 |   |
|                                                                                      |       |                             |       |   |   |
| Cash and cash  equivalents at end of period                                               |       | $                                | 113,752    |   | $ | 31,025 |   |

 

The accompanying notesare an integral part of these unaudited condensed consolidated financialstatements.

 

5

----

 

**ZORANCORPORATION**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(unaudited)**

 

**1.****                   Basisof Presentation**

 

The accompanyingunaudited condensed consolidated financial statements of Zoran Corporation and itssubsidiaries (“Zoran” or the “Company”) have been prepared in conformity withaccounting principles generally accepted in the United States of America. However,certain information or footnote disclosures normally included in financialstatements prepared in accordance with accounting principles generally acceptedin the United States of America have been condensed or omitted pursuant to therules and regulations of the Securities and Exchange Commission (the “SEC”). Inthe opinion of management, the condensed consolidated financial statements reflectall adjustments considered necessary, consisting only of normal recurringadjustments, for a fair statement of the consolidated financial position,operating results and cash flows for the periods presented. The results ofoperations for the interim periods presented are not necessarily indicative ofthe results that may be expected for the full fiscal year or in any futureperiod. This quarterly report on Form 10-Q should be read in conjunction withthe audited consolidated financial statements and notes thereto for the yearended December 31, 2005, included in the Zoran Corporation 2005Annual Report on Form 10-K filed with the SEC.

 

**Revenue**

 

Revenue for the three months ended March 31, 2006 includes$30.2 million in license payment, net of withholding tax and amounts paid toholders of rights under certain patents involved in the litigation and amountspayable as legal fees. The license agreements provided for additional net cashpayments of $11.0 million during the three months ending June 30, 2006 and $30.0million payable in eleven quarterly installments which will be recorded asrevenue when actual cash payments are received.

 

***Recent Accounting Pronouncements***

 

InDecember 2004, the Financial Accounting Standards Board (“FASB”), issuedStatement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-BasedPayment”, an Amendment of SFAS 123 (“SFAS 123R”). SFAS 123(R) requires theCompany to measure all employee stock-based compensation awards using a fairvalue method and record such expense in its consolidated financialstatements.  In March 2005, the SEC issued Staff Accounting Bulletin (“SAB”)107, which provides the Staff’s views regarding interactions between SFAS123(R) and certain SEC rules and regulations and provides interpretations ofthe valuation of share-based payments for public companies. EffectiveJanuary 1, 2006, the Company adopted SFAS 123(R) on a modified prospectivebasis. As a result, the Company began to include stock-based compensation costsin its results of operations beginning with the quarter ended March 31, 2006. SeeNote 2 “Stock-Based Compensation”.

 

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

 

In November 2005, the FASB issued FASBStaff Position (“FSP”) Nos. FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application toCertain Investments.”  This FSPaddresses the determination as to when an investment is considered impaired,whether that impairment is other than temporary, and the measurement of animpairment loss. This FSP also includes accounting considerations subsequent tothe recognition of other-than-temporary impairments. The guidance in this FSPis effective for all periods beginning after December 15, 2005. Theadoption of this FSP did not have a material effect on the Company’sconsolidated financial position, results of operations or cash flows.

 

In February 2006, theFASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments,an amendment of FASB Statements No. 133 and 140 (“SFAS No.155”). SFAS No. 155permits fair value remeasurement for hybrid financial instruments containing anembedded derivative which otherwise requires bifurcation. This statement iseffective for all financial instruments acquired or issued by the Company afterJanuary 1, 2007. The Company anticipates that the adoption of SFAS No. 155 willnot have a material impact on its condensed consolidated financial statements.

 

6

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**2.****                  ****Stock-Based Compensation**

 

EffectiveJanuary 1, 2006, Zoran adopted SFAS 123(R), using themodified prospective application transition method, which establishesaccounting for stock-based awards exchanged for employee services. Accordingly,stock-based compensation cost is measured at grant date, based on the fairvalue of the award, over the requisite service period. The Company previouslyapplied Accounting Principles Board Opinion No. 25, “Accounting for StockIssued to Employees” (“APB 25”), and related interpretations and provided thepro forma disclosures required by SFAS No. 123, “ Accounting forStock-Based Compensation” (“SFAS 123”).

 

PeriodsPrior to the Adoption of SFAS 123(R) 

 

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

 

The pro-forma effect of recognizingcompensation expense pursuant to SFAS 123 for the three months ended March 31,2005 was as follows (in thousands except per-share amounts):

 
| ** **                                                                              | ** ** | **Three Months   Ended   March 31, 2005** | ** ** |
|-----------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| Net loss  attributable to common stockholders, as reported                              |       | $                                                                  | (18,796    | ) |
|                                                                                    |       |                                                               |       |
| Stock-based  compensation expense included in net loss                                  |       | 517                                                                |       |
|                                                                                    |       |                                                               |       |
| Total employee  stock-based compensation expense determined under the fair value method |       | (6,804                                                             | )          |
|                                                                                    |       |                                                               |       |
| Pro forma net  loss attributable to common stockholders                                 |       | $                                                                  | (25,083    | ) |
|                                                                                    |       |                                                               |       |
| Pro forma net  loss per share attributable to common stockholders:                      |       |                                                               |       |
| Basic                                                                                   |       | $                                                                  | (0.58      | ) |
| Diluted                                                                                 |       | $                                                                  | (0.58      | ) |
|                                                                                    |       |                                                               |       |
| Net loss per  share as reported attributable to common stockholders:                    |       |                                                               |       |
| Basic                                                                                   |       | $                                                                  | (0.43      | ) |
| Diluted                                                                                 |       | $                                                                  | (0.43      | ) |

 

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

 

Impact of Adoption of SFAS 123(R) 

 

Duringthe three months ended March 31, 2006 the Company recorded stock-basedcompensation expense for awards granted prior to but not yet vested as ofJanuary 1, 2006 as if the fair value method required for pro forma disclosureunder SFAS 123 were in effect for expense recognition purposes adjusted forestimated forfeitures. For these awards the Company has continued to recognizecompensation expense using the accelerated amortization method. For stock-basedawards granted after January 1, 2006, the Company recognized compensationexpense based on the grant date fair value required under SFAS 123(R). Forthese awards the Company recognized compensation expense using a straight-lineamortization method. As SFAS 123(R) requires that stock-based compensationexpense be based on awards that are ultimately expected to vest, estimatedstock-based compensation for the three-month period ended March 31, 2006 hasbeen reduced for estimated forfeitures. The adoption of SFAS 123(R) resulted ina one-time cumulative benefit of $314,000 related to unvested awards for whichcompensation expense had already been recorded.

 

7

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Thefollowing table summarizes stock-based compensation expense related to employeestock options, employee stock purchases and restricted stock unit grants forthe three months ended March 31, 2006 as recorded in accordance with SFAS123(R)   (in thousands):

 
| ** **                           | ** ** | **Three Months Ended   March 31, 2006** | ** ** |
|--------------------------------------|------------|------------------------------------------------------------------|------------|
|                                 |       |                                                             |       |
| Cost of hardware  product revenues   |       | $                                                                | 145        |   |
| Research and  development            |       | 1,513                                                            |       |
| Selling, general  and administrative |       | 2,904                                                            |       |
| Total costs and  expenses            |       | $                                                                | 4,562      |   |

 

Due to the valuation allowance provided on ourdeferred tax assets, the Company has not recorded any tax benefits attributableto stock-based compensation. Results for prior periods have not been restated.

 

ValuationAssumptions

 

Forpurposes of the disclosure requirements of SFAS 123 and the requirements ofSFAS 123(R), the Company estimates the fair value of stock options using theBlack-Scholes valuation model using the following weighted-average assumptions:

 
| ** **                    | ** ** | **Stock Option Plans**                             | ** ** |
|-------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                    | ** ** | **Three Months  Ended   March 31, 2006** | ** ** | **Three Months  Ended   March 31, 2005** | ** ** |
|                          |       |                                                         |       |   |   |
| Average Expected term (years) |       | 5.7                                                          |       | 4.0 |   |
| Expected volatility           |       | 55                                                           | %          | 72 | % |
| Risk-free interest rate       |       | 4.6                                                          | %          | 3.7 | % |
| Dividend yield                |       | 0                                                            | %          | 0 | % |

 
| ** **                    | ** ** | **Employee Stock Purchase Plan**                    | ** ** |
|-------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                    | ** ** | **Three Months   Ended   March 31, 2006** | ** ** | **Three Months   Ended   March 31, 2005** | ** ** |
|                          |       |                                                               |       |   |   |
| Average Expected term (years) |       | 0.5                                                                |       | 0.5 |   |
| Expected volatility           |       | 55                                                                 | %          | 55 | % |
| Risk-free interest rate       |       | 2.3                                                                | %          | 2.9 | % |
| Dividend yield                |       | 0                                                                  | %          | 0 | % |

 

*Expected Term:*  The expected term represents the period thatthe Company’s stock-based awards are expected to be outstanding and wasdetermined based on the Company’s historical experience with similar awards,giving consideration to the contractual terms of the stock-based awards andvesting schedules.

 

*Expected Volatility*:  For the three months ended March 31, 2006,the Company modified its volatility assumption to use implied volatility foroptions granted during the quarter. Previously, the Company used onlyhistorical volatility in deriving its volatility assumption. Management believesthat implied volatility appropriately reflects the market’s expectations offuture volatility.

 

*Risk-Free Interest Rate*:  Management bases its assumptions regardingthe risk-free interest rate on U.S. Treasury zero-coupon issues with anequivalent remaining term.

 

*Expected Dividend:*TheCompany has not paid and does not anticipate paying any dividends in the nearfuture.

 

*Estimated Pre-vesting Forfeitures:*Whenestimating forfeitures, the Company considers voluntary termination behaviorbased on actual historical information.

 

8

----

 

Stock Option Activity

 

The following is asummary of stock option activities:

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

 

Significant option groupsoutstanding as of March 31, 2006 and the related weighted average exerciseprice and contractual life information, are as follows:

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

 

 The weighted average grant date fair value ofoptions, as determined under SFAS 123(R), granted during the three months endedMarch 31, 2006 was $11.09 per share.

 

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

 

The total intrinsic valueof options exercised during the three month period ended March 31, 2006 was $8.9million. The total cash received from employees as a result of employee stockoption exercises during the three months ended March 31, 2006 wasapproximately $17.3 million. In connection with these exercises, there was notax benefit realized by the Company due to the Company’s current loss position.

 

As of March 31, 2006, the total unamortized compensationcost related to stock options not yet recognized was $16.2 million afterestimated forfeitures which are expected to be recognized over an estimatedamortization period of four years.

 

TheCompany settles employee stock option exercises with newly issued commonshares.

 

9

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 Stock Option Plans

 

As of March 31, 2006, theCompany had outstanding options for the purchase of 10.5 million shares ofcommon stock held by employees and directors under the Company’s 2005 EquityIncentive Plan (the “2005” Plan), 2005 Outside Directors Equity Plan, 2002Stock Option Plan, 1995 Outside Directors Stock Option Plan, the 1993 StockOption Plan and other various plans the Company assumed as a result ofacquisitions. As of March 31, 2006, 1,673,272 shares remained available for thefuture grants and awards. Options and stock appreciation rights granted underthe 2005 Plan must have exercise prices per share not less than the fair marketvalue of Zoran common stock on the date of grant and may not be repricedwithout stockholder approval. Such awards will vest and become exercisable uponconditions established by the Compensation Committee and may not have a termexceeding 10 years.

 

 Restricted Shares and Restricted Stock Units

 

Restrictedshares and restricted stock units are granted under the 2005 Equity IncentivePlan. On January 6, 2006, the Company filed a Tender Offer Statement with theSecurities and Exchange Commission and commenced an offer to current employeesto exchange outstanding options with exercise prices per share that were morethan the greater of $20.00 and the closing sale price of Zoran common stock onthe offer expiration date of February 6, 2006. The exchange offer was approvedby Zoran’s stockholders at their 2005 annual meeting. On February 6, 2006, theCompany accepted for exchange options to purchase an aggregate of 1,060,536shares of Zoran common stock having an exercise price greater than $22.48.Subject to the terms and conditions of the exchange, the Company granted197,433 restricted shares of common stock or restricted stock units in exchangefor the tendered options. The shares of restricted stock and restricted stockunits granted as part of this exchange vest over a period of two years. None ofthe directors or executive officers was eligible for participation in theexchange offer. This exchange was accounted for under the modification rules ofFAS 123(R). As of March 31, 2006, therewas $0.7 million of total unamortized stock-based compensation expense relatedto restricted shares and restricted stock units. This cost is expected to berecognized over the vesting period of two to four years.

 

The following is a summaryof restricted shares and restricted stock units activities:

 
| ** **                   | ** ** | **Outstanding   restricted shares  and stock units** | ** ** | **Weighted-  average grant-  date fair value** | ** ** | **Aggregate   intrinsic value ** | ** ** |
|------------------------------|------------|--------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                   | ** ** | ** **                                                               | ** ** | ** **                                                    | ** ** | **(‘000)**                                 | ** ** |
|                         |       |                                                                     |       |                                                          |       |                                            |       |   |
| Balances,  December 31, 2005 |       | 65,333                                                                   |       | $                                                             | 13.59      |                                            | $          | 888 |   |
| Granted                      |       | 197,433                                                                  |       | $                                                             | 21.56      |                                            | 4,257      |   |
| Vested                       |       | —                                                                   |       | —                                                        |       | —                                          |       |
| Forfeited                    |       | —                                                                   |       | —                                                        |       | —                                          |       |
| Balances, March  31, 2006    |       | 262,766                                                                  |       | $                                                             | 19.58      |                                            | $          | 5,145 |   |

 

Employee StockPurchase Plan

 

TheCompany’s 1995 Employee Stock Purchase Plan (“ESPP”) was adopted by the Company’sBoard of Directors in October 1995, and approved by its stockholders inDecember 1995. The ESPP enables employees to purchase shares throughpayroll deductions at approximately 85% of the lesser of the fair value of commonstock at the beginning of a 24-month offering period or the end of eachsix-month segment within such offering period. The ESPP is intended to qualifyas an “employee stock purchase plan” under Section 423 of the U.S.Internal Revenue Code. There were no purchases during the quarter ended March31, 2006. As of March 31, 2006, 1,574,596 shares were reserved and availablefor issuance under this plan.

 

10

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

 

The following tablepresents the calculation of comprehensive income (loss) as required by SFAS 130(“Reporting Comprehensive Income”). The components of comprehensive income (loss),net of tax, are as follows (in thousands):

 
| ** **                                            | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                            | ** ** | **March 31,**               | ** ** |
| ** **                                            | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Net income  (loss)                                    |       | $                                | 20,760     |   | $ | (18,796 | ) |
| Change in  unrealized gain (loss) on investments, net |       | (915                             | )          | 967 |   |
| Total  comprehensive income (loss)                    |       | $                                | 19,845     |   | $ | (17,829 | ) |

 

The components of accumulated othercomprehensive income (loss) are unrealized gain (loss) on marketablesecurities.

 

**4.****              Inventories**

 

Inventories are stated atthe lower of cost (first in, first out) or market and consisted of thefollowing (in thousands):

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

 

**5.****              Goodwilland Other Intangible Assets**

 

In accordance withSFAS 142, goodwill is not amortized. The Company monitors therecoverability of goodwill recorded in connection with acquisitions, byreporting unit, annually, or sooner if events or changes in circumstancesindicate that the carrying amount may not be recoverable. The Company performedthe annual analysis as of September 30, 2005 and concluded that goodwill wasnot impaired, as the fair value of each reporting unit exceeded its carryingvalue, including goodwill.

 

***Components of Acquired Intangible Assets****(in thousands):*

 
| ** **                    | ** ** | ** **              | ** ** | **March 31, 2006**            | ** ** | **December 31, 2005** | ** ** |
|-------------------------------|------------|-------------------------|------------|-----------------------------------------|------------|---------------------------------|------------|
| ** **                    | ** ** | **Life   (Years)** | ** ** | **Gross   Carrying   Amount** | ** ** | **Accumulated  Amortization**   | ** ** | **Net   Balance** | ** ** | **Gross   Carrying   Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net   Balance** | ** ** |
| Amortized  intangible assets: |       |                    |       |                                    |       |                            |       |   |   |   |   |   |   |   |   |
| Purchased  technology         |       | 2-3                     |       | $                                       | 195,505    |                            | $          | (114,700 | ) | $ | 80,805 |   | $ | 195,505 |   | $ | (105,088 | ) | $ | 90,417 |   |
| Patents                       |       | 3-5                     |       | 40,265                                  |       | (22,359                         | )          | 17,906 |   | 40,265 |   | (19,978 | ) | 20,287 |   |
| Customer base                 |       | 3-5                     |       | 13,860                                  |       | (7,738                          | )          | 6,122 |   | 13,860 |   | (7,123 | ) | 6,737 |   |
| Tradename and  others         |       | 3-5                     |       | 3,350                                   |       | (1,687                          | )          | 1,663 |   | 3,350 |   | (1,560 | ) | 1,790 |   |
| Purchased core  technology *  |       | 4-5                     |       | 15,162                                  |       | (7,714                          | )          | 7,448 |   | 14,969 |   | (7,113 | ) | 7,856 |   |
| Total                         |       |                    |       | $                                       | 268,142    |                            | $          | (154,198 | ) | $ | 113,944 |   | $ | 267,949 |   | $ | (140,862 | ) | $ | 127,087 |   |

 

----

* The Company records the amortization of purchasedcore technology as cost of product sales.

 

11

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Estimated futureintangible amortization expense, based on current balances, as of March 31, 2006is as follows (in thousands):

 
| Remaining nine  months of 2006 |   | $      | 39,579  |   |
|--------------------------------|--------|--------|---------|--------|
| Year ending  December 31, 2007 |   | 46,159 |    |
| Year ending  December 31, 2008 |   | 24,982 |    |
| Year ending  December 31, 2009 |   | 2,409  |    |
| Year ending  December 31, 2010 |   | 815    |    |
|                           |   | $      | 113,944 |   |

 

Goodwill by reportingunits was as follows (in thousands):

 
| ** ** | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------|------------|--------------------|------------|-----------------------|------------|
| ** ** | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| ** ** | ** ** | ** **         | ** ** | ** **            | ** ** |
| Consumer   |       | $                  | 174,597    |                  | $          | 178,197 |   |
| Imaging    |       | 5,657              |       | 6,057                 |       |
|       |       | $                  | 180,254    |                  | $          | 184,254 |   |

 

**6.****              IncomeTaxes**

 

The provision for incometaxes reflects the effective tax rate applied to earnings, excluding chargesfor amortization of intangible assets for the interim periods. The effectivetax rate differs from the U.S. statutory rate due to utilization of netoperating losses and State of Israel tax benefits on foreign earnings. Theprovision includes primarily taxes on income in excess of net operating losscarryover limitations and foreign withholding taxes.

 

**7.****              SegmentReporting**

 

SFAS No. 131 establishesstandards for the reporting by public business enterprises of information aboutoperating segments, products and services, geographic areas, and majorcustomers. The method for determining what information to report is based onthe manner in which management organizes the operating segments within theCompany for making operational decisions and assessments of financialperformance. The Company’s chief operating decision-maker is considered to bethe Chief Executive Officer.

 

The Company’s products arebased on highly integrated application-specific integrated circuits, or ASICs,and system-on-a-chip, or SOC, solutions. The Company also licenses certainsoftware and other intellectual property. During the first quarter of 2006, theCompany reorganized its operating structure to bring together its consumerelectronic product lines under a single operating group, in recognition of theaccelerating convergence of consumer products and the Company’s strategy ofsharing technology among its various product lines. The new Consumer groupcombines the former Digital Versatile Disc (DVD), Digital Television (DTV) andMobile product groups whose operations were previously reported separately. TheCompany will continue to report the operations of its Imaging group as aseparate operating segment.

 

The Consumer groupprovides products for use in DVD players, recordable DVD players, standard andhigh definition digital television products, digital camera products andmultimedia mobile phone products. The Imaging group provides products used indigital copiers, laser and inkjet printers as well as multifunctionperipherals.

 

The chief operatingdecision maker allocates resources to and evaluates operating segmentperformance based on net revenues and operating expenses of these segments. Theaccounting policies of the operating segments are the same as those describedin the summary of accounting policies. No reportable segments have beenaggregated.

 

12

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Information about reportedsegment income or loss is as follows for the three months ended March 31,2006 and 2005 (in thousands):

 

 
| ** **            | ** ** | **Three Months Ended   March 31,** | ** ** |
|-----------------------|------------|--------------------------------------------------------|------------|
| ** **            | ** ** | **2006**                                               | ** ** | **2005** | ** ** |
| Net revenues:         |       |                                                   |       |   |   |
| Consumer              |       | $                                                      | 123,556    |   | $ | 52,976 |   |
| Imaging               |       | 18,690                                                 |       | 20,908 |   |
|                  |       | $                                                      | 142,246    |   | $ | 73,884 |   |
|                  |       |                                                   |       |   |   |
| Operating  expenses:  |       |                                                   |       |   |   |
| Consumer              |       | $                                                      | 88,257     |   | $ | 65,322 |   |
| Imaging               |       | 15,115                                                 |       | 14,916 |   |
|                  |       | $                                                      | 103,372    |   | $ | 80,238 |   |
|                  |       |                                                   |       |   |   |
| Contribution  margin: |       |                                                   |       |   |   |
| Consumer              |       | $                                                      | 35,299     |   | $ | (12,346 | ) |
| Imaging               |       | 3,575                                                  |       | 5,992 |   |
|                  |       | $                                                      | 38,874     |   | $ | (6,354 | ) |

 

A reconciliation of thetotals reported for the operating segments to the applicable line items in theconsolidated financial statements for the three months ended March 31,2006 and 2005 is as follows (in thousands):

 
| ** **                                   | ** ** | **Three Months Ended   March 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                   | ** ** | **2006**                                               | ** ** | **2005** | ** ** |
| Contribution  margin from operating segments |       | $                                                      | 38,874     |   | $ | (6,354 | ) |
| Amortization of  intangibles                 |       | 12,735                                                 |       | 12,330 |   |
| Amortization of  deferred stock compensation |       | —                                                 |       | 517 |   |
| Total operating  income (loss)               |       | $                                                      | 26,139     |   | $ | (19,201 | ) |

 

Zoran maintainsoperations in the Canada, China, Germany, Israel, Japan, Korea, Taiwan, theUnited Kingdom and United States. Activities in the Israel and United Statesconsist of corporate administration, product development, logistics andworldwide sales management. Other foreign operations consist of sales, productdevelopment and technical support.

 

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

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

 

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

 

13

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

 

**8.****              Acquisitions**

 

**OrenSemiconductor, Inc.**

 

On June 10, 2005, Zorancompleted the acquisition of Oren Semiconductor, Inc. (“Oren”), aprivately-held provider of demodulator ICs for the global high definitiontelevision market. Prior to this acquisition, Zoran had made investments inOren that represented a 17% ownership interest. Under the terms of theacquisition agreement, Zoran acquired the remaining 83% of Oren’s outstandingstock by means of a merger of Oren with a wholly-owned subsidiary of Zoran, inconsideration for which Zoran paid an aggregate of $28.4 million in cashand issued 1,188,061 shares of Zoran common stock valued at $12.9 million,for total consideration of $41.3 million, to the other stockholders of Oren andto employees holding Oren options. The Company considered the requirementsunder Accounting Principles Board Opinions 18 (“APB 18”), “The Equity Method ofAccounting for Investments in Common Stock,” to retroactively record the gainsor losses on investment of the prior 17% ownership under the equity basis. Basedon the Company’s analysis, such adjustments were considered to be immaterial tothe prior financial results of the Company and, accordingly, such adjustmentsare not reflected in the Company’s previously reported results of operations.

 

Theprimary purpose of the acquisition was to obtain Oren’s demodulatorIC technology for the global high definition television market.The Company intends to combine this technology with Zoran’s digital televisiontechnology to deliver a complete and cost-effective system solution for digitaltelevision makers.

 

Allocation of thepurchase price is as follows (in thousands):

 
| Net liabilities  acquired            |   | $      | (941   | )      |
|--------------------------------------|--------|--------|--------|--------|
| In process  research and development |   | 2,650  |   |
| Intangible  assets                   |   | 9,100  |   |
| Goodwill                             |   | 35,305 |   |
|                                 |   | $      | 46,114 |   |

 

The purchase priceexceeded the net assets acquired resulting in the recognition of goodwill. Theamounts allocated to intangible assets include purchased technology totaling $7.0million, tradename and others totaling $1.25 million and customer base totaling$850,000 which are being amortized over their estimated useful lives of fiveyears.

 

14

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**ProForma Financial Information**

 

The following unauditedpro forma financial information presents the combined results of operations ofZoran and Oren as if the acquisition had occurred as of the beginning of the periodpresented, after giving effect to certain adjustments, including amortizationof intangibles. The unaudited pro forma financial information does notnecessarily reflect the results of operations that would have occurred had thecombined companies constituted a single entity during such periods, and is notnecessarily indicative of results which may be obtained in the future.

 
| ** **                                   | ** ** | **Year Ended   December 31,** | ** ** |
|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                   | ** ** | **2005**                                     | ** ** |
|                                         |       |                                         |       |
| **In  thousands except for per share data:** |       |                                         |       |
| Pro forma  revenues                          |       | $                                            | 396,737    |   |
|                                         |       |                                         |       |
| Pro forma net income (loss)                  |       | $                                            | (29,941    | ) |
|                                         |       |                                         |       |
| Pro forma net  income (loss) per share:      |       |                                         |       |
| Basic                                        |       | $                                            | (0.68      | ) |
|                                         |       |                                         |       |
| Diluted                                      |       | $                                            | (0.68      | ) |

 

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

 

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

 

The following tableprovides a reconciliation of the components of the basic and diluted net income(loss) per share computations (in thousands, except per share data):

 
| ** **                                             | ** ** | **Three Months Ended   March 31,** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                             | ** ** | **2006 **                                         | ** ** | **2005** | ** ** |
| ** **                                             | ** ** | ** **                                             | ** ** | ** ** | ** ** |
| Net income  (loss)                                     |       | $                                                      | 20,760     |   | $ | (18,796 | ) |
|                                                   |       |                                                   |       |   |   |
| Weighted average  shares outstanding                   |       | 46,207                                                 |       | 43,213 |   |
| Effect of  dilutive options and restricted stock units |       | 2,280                                                  |       | — |   |
| Dilutive  weighted average shares                      |       | 48,487                                                 |       | 43,213 |   |
|                                                   |       |                                                   |       |   |   |
| Net income  (loss) per share:  (1)                |       |                                                   |       |   |   |
| Basic                                                  |       | $                                                      | 0.45       |   | $ | (0.43 | ) |
| Diluted                                                |       | $                                                      | 0.43       |   | $ | (0.43 | ) |

 

----

**(1)Net income for the three months ended March31, 2006 includes $4.6 million of stock-based compensation expense, net of tax.The effect of recording stock-based compensation expense on basic and dilutednet income per share was $0.10 and $0.08 per share, respectively, for the threemonths ended March 31, 2006.**

 

15

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

** **

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

** **

**10.****                   LegalProceedings**

 

Zoran and itssubsidiary, Oak Technology, Inc., have been involved in five separatelegal actions against MediaTek, Inc. and customers of MediaTek based onclaims of patent infringement.

 

On March 11,2004, Zoran and Oak filed a complaint with****theUnited States International Trade Commission (the “ITC”) alleging that certainMediaTek DVD player and optical disk controller chips and chipsets, andproducts in which they are used, infringe Zoran’s and Oak’s patents. Inaddition to MediaTek, the complaint named a number of other proposedrespondents that sell products, including DVD players and PC optical storagedevices that use MediaTek’s chips and chipsets. On September 28, 2005, theITC issued its final ruling finding one of Zoran’s patents to be valid andinfringed by optical disk controller chips and chipsets sold by MediaTek and byproducts using the infringing chips and chipsets sold by a number of MediaTekcustomers. The ITC also issued an exclusion order prohibiting MediaTek andspecified MediaTek customers from importing into the United States any opticaldisk controller chip or chipset that infringes the Zoran patent, or any opticaldisk storage product containing such a chip or chipset and cease and desistorders to the affected companies located in the United States prohibiting themfrom importing or selling infringing products in the United States. In November2005, both parties filed notices of appeal with the United States Court ofAppeals for the Federal Circuit. On January 19, 2006, the court issued anorder temporarily staying enforcement of the ITC’s orders.

 

On March 15,2004, Zoran and Oak filed a complaint against MediaTek and one of its customersin the United States District Court, Central District of California allegingsimilar facts regarding infringement by MediaTek’s chips and chipsets andproducts in which they are used. The lawsuit sought both monetary damages andan injunction to stop the importation and sale of infringing products. Thecomplaint was subsequently amended to name additional MediaTek customers asdefendants. Trial of this case was set to begin May 15, 2006.

 

On July 23,2004, MediaTek filed a complaint with the ITC alleging that certain Zoran andOak DVD player and optical disk controller chips and chipsets infringe twoMediaTek patents. The complaint requested that the ITC institute aninvestigation into the accused products and issue exclusion and cease anddesist orders prohibiting importation into the United States of allegedlyinfringing chips and products that contain them. On September 30, 2005,the ITC Administrative Law Judge issued his initial determination finding thatnone of Zoran’s optical disk controller chips infringe any claim of the twopatents asserted against Zoran; that one of the two patents is invalid; thatOak’s devices do not infringe one of the two patents asserted against Oak andthat the other patent is invalid; and that MediaTek has failed to establishthat it has a domestic industry in the United States related to the patents atissue – a basic requirement for obtaining relief from the ITC. The initialdetermination was subject to review by the full ITC. The target date forcompletion of the investigation was March 1, 2006.

 

On July 23,2004, MediaTek filed a complaint against Zoran and Oak in the United StatesDistrict Court, District of Delaware alleging infringement of the same twopatents asserted in MediaTek’s ITC complaint and seeking monetary damages andinjunctive relief. This action was stayed by order of the court onOctober 4, 2004.

 

OnFebruary 2, 2005, MediaTek filed a complaint against Zoran and ZoranDigital Technologies (Shenzhen) Ltd. (Zoran’s local Chinese operations) in theShenzhen People’s Republic of China court alleging infringement of the Chinesecounterpart patent of one of the two patents asserted in MediaTek’s ITC complaintand seeking monetary damages. Because Zoran had not been served with thecomplaint, the initiation of the proceeding has been stayed.

 

OnJanuary 25, 2006, Zoran and Oak entered into an agreement with MediaTek tosettle the litigation. Under the agreement, each party agreed to dismiss itsrespective claims and counterclaims under all of the pending lawsuits. Theparties also agreed to dismiss all proceedings pending against each otherbefore the ITC, including all appeals and enforcement proceedings pendingbefore the ITC, United States Customs and Border Protection and the UnitedStates Court of Appeals for the Federal Circuit related to the ITC’sSeptember 28, 2005 order excluding the importation into the United Statesof certain MediaTek chips and products incorporating those chips.

 

16

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In connection withthe settlement, Zoran, Oak and MediaTek entered into agreements granting eachother non-exclusive licenses under the patents that were the subject of thelitigation, and additional patents used in the design and manufacture ofoptical storage devices for personal computer products. In consideration forlicenses granted by Zoran, MediaTek agreed to make a cash payment of$55 million to Zoran, $44 million of which was paid in February 2006 and$11 million of which was paid in April 2006. In addition, MediaTek will berequired to make royalty payments of up to $30 million over the 30-monthperiod commencing on the date of the agreement based on future sales of coveredMediaTek products. Net of amounts payable by Zoran to a holder of rights underthe Oak patents involved in the litigation, and amounts payable as legal fees,Zoran will realize approximately $28.1 million of the cash payment and upto approximately $15.3 million of the future royalty payments.

 

On February 9,2006, Zoran and Oak entered into an agreement to settle separate litigationbetween Oak, on the one hand, and MediaTek and United MicroelectronicsCorporation, on the other hand. This litigation, which involved variouscontract-related claims and counterclaims, was instituted in 1997, prior toZoran’s acquisition of Oak. Under the agreement, the litigation was dismissed,and a subsidiary of MediaTek paid Zoran $15 million. Net of amounts payableby Zoran to a holder of rights under certain Oak patents, and amounts payableas legal fees, Zoran realized approximately $7.7 million of the payment. Inconnection with the settlement, Zoran and MediaTek also granted each othercross-licenses under certain of their patents.

 

17

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**Item 2. Management’s Discussion and Analysis of Financial Condition andResults of Operations**

 

*This report includesa number of forward-looking statements which reflect the Company’s currentviews with respect to future events and financial performance. These forward-lookingstatements are subject to certain risks and uncertainties, including thosediscussed below under the heading “Future Performance and Risk Factors” and in “Item7—Management’s Discussion and Analysis of Financial Condition and Results ofOperations—Future Performance and Risk Factors” included in the**Company’s Annual Report on Form 10-K for the year ended December 31,2005.In this report, the words “anticipates,” “believes,” “expects,” “intends,” “future”and similar expressions identify forward-looking statements. Readers arecautioned not to place undue reliance on these forward-looking statements,which speak only as of the date hereof.*

 

**Overview**

 

Our products consist of integrated circuits and related products usedin digital versatile disc players, or DVDs, movie and home theater systems,digital cameras and video editing systems. We also provide integrated circuits,software and platforms for digital television applications that enable thedelivery and display of digital video content through a set-top box ortelevision as well as digital imaging products consisting of semiconductorhardware and software that enable users to print, scan, process and transmitdocuments to computer peripherals that perform printing functions. Subsequentto our acquisition of Emblaze Semiconductor Ltd. on July 8, 2004, we alsoprovide high performance, low-power applicationprocessors, technology and products for the multimedia mobile telephone market.Through the acquisition of Oren Semiconductor, Inc. on June 10, 2005,Zoran obtained Oren’s demodulator IC technology forthe global high definition television market.

 

We derive most of our revenues from the sale of our integrated circuitproducts. Historically, average selling prices in the semiconductor industry ingeneral, and for our products in particular, have decreased over the life of aparticular product. Average selling prices for our hardware products havefluctuated substantially from period to period, primarily as a result ofchanges in our customer mix of original equipment manufacturer, or OEM, salesversus sales to resellers and the transition from low-volume to high-volumeproduction. In the past, we have periodically reduced the prices of some of ourproducts in order to better penetrate the consumer market. We believe that, asour product lines continue to mature and competitive markets evolve, we arelikely to experience further declines in the average selling prices of ourproducts, although we cannot predict the timing and amount of such futurechanges with any certainty.

 

Our cost of hardware product revenues consists primarily of fabricationcosts, assembly and test costs, and the cost of materials and overhead fromoperations. If we are unable to reduce our cost of hardware product revenues tooffset anticipated decreases in average selling prices, our product grossmargins will decrease. Our hardware product gross margin is also dependent onproduct mix and on the proportion of products sold directly to our OEMcustomers versus indirectly through our marketing partners. These marketingpartners purchase our products at lower prices but absorb most of theassociated marketing and sales support expenses, maintain inventories andprovide customer support and training. As a result, lower gross margins onsales to these resellers are partially offset by reduced selling and marketingexpenses related to such sales. We expect both product and customer mix tocontinue to fluctuate in future periods, causing further fluctuations inmargins.

 

We also derive revenue from licensing our software and otherintellectual property. Licensing revenue includes one-time license fees androyalties based on the number of units distributed by the licensee. Quarterlylicensing revenue can be significantly affected by the timing of a small numberof licensing transactions, each accounting for substantial revenues. Accordingly,licensing revenues have fluctuated, and will continue to fluctuate, on aquarterly basis. In addition, we have historically generated a portion of ourtotal revenues from development contracts, primarily with key customers,although development revenue has declined substantially as a percentage oftotal revenues over the past several years. These development contracts haveprovided us with partial funding for the development of some of our products. Thesedevelopment contracts provide for license and milestone payments which arerecorded as development revenue. We classify all development costs, includingcosts related to these development contracts, as research and developmentexpenses. We retain ownership of the intellectual property developed by usunder these development contracts. While we intend to continue to enter intodevelopment contracts with certain strategic partners, we expect developmentrevenue to continue to decline as a percentage of total revenues.

 

We recognize software license revenues in accordance with theprovisions of Statement of Position (SOP) 97-2, *Software Revenue Recognition,*as amended by SOP 98-9, *Modification of*SOP 97-2, *Software Revenue Recognition, With Respect to CertainTransactions.* Our software license agreements typically includeobligations to provide maintenance and other support over a fixed term andallow for renewal of maintenance services on an annual basis. We determine thefair value of our maintenance obligations with reference to substantive renewalrates within the agreement or objective evidence of fair value as requiredunder SOP 97-2. Maintenance and support revenue is recognized ratably over theterm of the arrangement. We also receive royalty revenues based on 

 

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per unit shipments of products embedding our software which werecognize upon receipt of a royalty report from the customer, typically onequarter in arrears.

 

Our research and development expenses consist of salaries and relatedcosts of employees engaged in ongoing research, design and developmentactivities and costs of engineering materials and supplies. We are a party toresearch and development agreements with the Chief Scientist in Israel’sMinistry of Industry and Trade and the Israel-United States BinationalIndustrial Research and Development Foundation, which fund up to 50% ofincurred project costs for approved products up to specified contract maximums.These agreements require us to use our best efforts to achieve specifiedresults and require us to pay royalties at rates of 3% to 5% of resultingproduct sales, and up to 30% of resulting license revenues, up to a maximum of100% to 150% of total funding received.

 

Reported research and development expenses are net of these grants,which fluctuate from period to period. We believe that significant investmentsin research 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 and administrative expenses consist primarily ofemployee-related expenses, sales commissions, product promotion and otherprofessional services. We expect that selling, general and administrativeexpenses will continue to increase to support our anticipated growth.

 

We conduct a material amount of our research and development andcertain sales and marketing and administrative operations in our foreignsubsidiary offices. As a result, some of our expenses are incurred in foreigncurrency. To date, substantially all of our hardware product revenues and oursoftware and other revenues have been denominated in U.S. dollars and mostcosts of hardware product revenues have been incurred in U.S. dollars. Weexpect that most of our revenues and costs of revenue will continue to bedenominated and incurred in U.S. dollars for the foreseeable future. We havenot experienced material losses or gains as a result of currency exchange ratefluctuations and have not engaged in hedging transactions to reduce ourexposure to such fluctuations. We may in the future elect to take action toreduce our foreign exchange risk.

 

Our effective income tax rate has benefited from the availability ofnet operating losses which we have utilized to reduce taxable income for U.S. federalincome tax purposes and by our Israel based subsidiary’s status as an “ApprovedEnterprise” under Israeli law, which provides a ten-year tax holiday for incomeattributable to a portion of our operations in Israel. Our U.S. federal netoperating losses expire at various times between 2006 and 2025, and thebenefits from our subsidiary’s Approved Enterprise status expire at varioustimes beginning in 2006.

 

**Recent Acquisition**

 

On June 10, 2005, we completed our acquisition of OrenSemiconductor, Inc. (“Oren”), a privately-held provider of demodulator ICsfor the global high definition television market. Prior to this acquisition, wehad made investments in Oren that represented a 17% ownership interest. Underthe terms of the acquisition agreement, we acquired the remaining 83% of Oren’soutstanding stock by means of a merger of Oren with a wholly-owned subsidiaryof Zoran, in consideration for which we paid an aggregate of $28.4 millionin cash and issued 1,188,061 shares of Zoran common stock valued at$12.9 million, for total consideration of $41.3 million, to the otherstockholders of Oren and to employees holding Oren options. The acquisition wasaccounted for under the purchase method of accounting.

 

Following the completion of the acquisition, the results of operationsof Oren have been included in our consolidated financial statements. Accordingly,our results of operations for the three month period ended March 31, 2006include Oren’s operations, while such operations are not reflected in ourresults of operations for the same period of the prior year.

 

**Segments**

 

Our products are based on highly integrated application-specificintegrated circuits, or ASICs, and system-on-a-chip, or SOC, solutions. We alsolicense certain software and other intellectual property. During the firstquarter of 2006, we reorganized our operating structure to bring together ourconsumer electronic product lines under a single operating group, inrecognition of the accelerating convergence of consumer products and ourstrategy of sharing technology among its various product lines. The newConsumer group combines the former Digital Versatile Disc (DVD), DigitalTelevision (DTV) and Mobile product groups whose operations were previouslyreported separately. We will continue to report the operations of its Imaginggroup as a separate operating segment.

 

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**Results ofOperations**

** **

*Revenues*

 

Total revenues increased 92.4% to $142.2 million for the three monthsended March 31, 2006 compared to $73.9 million for the three months ended March31, 2005. Consumer segment revenues increased $70.6 million while Imagingsegment revenues decreased $2.2 million. Within the Consumer segment, licenserevenues related to the settlement of litigation in the first quarter of 2006accounted for $30.2 million of the increase. The remaining increase of $40.4million in Consumer segment revenues was a result of increased revenues in theMobile, DTV and DVD product lines of $23.1 million, $13.0 million and $4.3million, respectively.

 

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

 

Software and other revenues were $12.9 million and $14.9 million forthe three months ended March 31, 2006 and 2005, respectively. The decrease insoftware and other revenues was largely attributable to a $1.0 million decreasein the Imaging segment.

 

*Cost of Hardware Product Revenues*

 

Cost of hardware product revenues was $54.5 million for the quarterended March 31, 2006 compared to $37.0 million for the same period of 2005. Theincrease in costs was primarily a result of the corresponding increase inhardware product revenues. As a percentage of hardware product revenues,hardware product costs decreased from 62.6% for the three months ended March31, 2005 to 54.9% for the three months ended March 31, 2006. The decrease inhardware product costs as a percentage of hardware product revenues wasprimarily due to a change in product mix within the DVD product line to anincreased percentage of lower cost products. During the quarter ended March 31,2006, we recorded a charge of approximately $800,000 of royalty expensesattributable to products shipped during 2004 and 2005. We determined that theimpact of this excluded royalty expense on each of the affected prior quartersand the first quarter of 2006 was immaterial.

 

*Research and Development*

 

Research and development expenses were $24.1 million for the threemonths ended March 31, 2006, compared to $20.1 million for the same period of2005. This increase was primarily attributed to stock-based compensationexpenses of $1.5 million recorded in the current period as a result of theadoption of SFAS123(R) and the inclusion of the operations of Oren which wasacquired in June 2005.

 

*Selling, General and Administrative*

 

Selling, general and administrative expenses were $24.8 million for thethree months ended March 31, 2006 compared to $23.2 million for the same periodof 2005. This increase was primarily attributed to stock-based compensationexpenses of $2.9 million recorded under SFAS 123(R) in the current period,continued increases in marketing and field application support expenses tosupport revenue growth in our Asia Pacific markets and the inclusion of theOren operations. These increases were partially offset by a decrease in legalfees as a result of the settlement of our patent litigation with Mediatek, Inc.

 

*Amortization of Intangible Assets*

 

During the three months ended March 31, 2006, we incurred charges of$12.7 million related to the amortization of intangible assets compared to$12.3 million for the three months ended March 31, 2005. This increase was aresult of the addition of $9.1 million of amortizable intangible assetsacquired in the Oren acquisition in June 2005.  At March 31, 2006, we hadapproximately $106.5 million in net intangible assets acquired through the Oak,Emblaze and Oren acquisitions which we will continue to amortize on a straightline basis through 2010.

 

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*Amortization of Deferred Stock Compensation*

 

As a result of the adoption of SFAS No. 123(R) during the first quarterof 2006, we now record a charge for all stock-based compensation expenses asdescribed in Note 2 to Condensed Consolidated Financial Statements. As aresult, we no longer record a separate charge for amortization of deferredstock compensation. For the three months ended March 31, 2005, we recorded acharge of $517,000 related to the amortization of deferred stock compensationprimarily as a result of stock options granted in connection with the Oakacquisition.

 

*Interest and Other Income*

 

Interest and other income was $2.8 million for the three month periodended March 31, 2006, compared to $405,000 for the same period of 2005. Thisincrease was a result of net gains in investments of $1.0 million recordedduring the first quarter of 2006 as well as an increase in interest income as aresult of our higher average cash and short term investment balances.

 

*Provision for Income Taxes*

 

We recorded a tax provision of $8.2 million for the three month periodended March 31, 2006. We did not record a tax provision or benefit for thequarter ended March 31, 2005. The provision for income taxes reflects theestimated annualized effective tax rate applied to earnings excluding chargesfor amortization of intangible assets for the interim periods. The effectivetax rate differs from the U.S. statutory rate due to utilization of netoperating losses and State of Israel tax benefits on foreign earnings. Theprovision includes primarily taxes on income in excess of net operating losscarryover limitations and foreign withholding taxes. At March 31, 2006, wecontinue to carry a full valuation allowance against our net deferred taxassets as management has determined that it is more likely than not that ourdeferred tax assets may not be realized.

 

**Liquidity and Capital Resources**

 

At March 31, 2006, we had $113.8 million of cash and cash equivalentsand $104.1 million of short-term investments. At March 31, 2006, we had $230.5million of working capital.

 

Our operating activities generated cash of $52.7 million during thefirst quarter of 2006, primarily due to net income of $20.8 million andnon-cash items such as amortization of intangibles assets of $12.7 million,depreciation and amortization of $3.0 million and stock based compensationexpense of $4.6 million. Cash provided by operations also increased due to adecrease of $7.7 million in accounts receivable due to the timing ofcollections and a net increase in accounts payable, accrued expenses and otherliabilities, goodwill and other long term liabilities totaling $10.2 million. Theseincreases were partially offset by a $6.0 million increase in inventories tomeet the increasing demand for our products.

 

Cash used in investing activities was $35.0 million during the threemonths ended March 31, 2006, principally reflecting the net purchase ofinvestments of $33.6 million. In addition we spent $1.4 million for propertyand equipment.

 

Cash provided by financing activities was $17.2 million during thethree months ended March 31, 2006 due to proceeds received from issuances ofcommon stock through exercises of employee stock options.

 

Net cash used in operating activities during the first three months of2005 was $3.9 million. While we recorded a net loss of $18.8 million, this lossincluded non-cash charges of $3.1 million for depreciation of property andequipment, $12.3 million for amortization of intangible assets and$517,000 for amortization of deferred stock compensation. Additional cash usedin operating activities was a result of the changes in current assets andliabilities totaling $1.0 million.

 

Cash used in investing activities was $2.8 million during the threemonths ended March 31, 2005, reflecting the net purchase of investments of$780,000 and the purchases of $2.0 million of property and equipment.

 

Cash provided by financing activities was $375,000 during the threemonths ended March 31, 2005 attributable to the issuance of common stock duringthe period.

 

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

 

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

 

•                  the levels atwhich we maintain inventories and accounts receivable;

 

•                  the marketacceptance of our products;

 

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

 

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

 

•                  volume pricingconcessions;

 

•                  capitalimprovements to new and existing facilities;

 

•                  technologicaladvances;

 

•                  the response ofcompetitors to our products; and

 

•                  ourrelationships with our suppliers and customers.

 

In addition, we may require an increase in the level of working capitalto accommodate planned growth, hiring and infrastructure needs. Additionalcapital may also be required for additional acquisitions of businesses,products or technologies.

 

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

 

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

 

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

 

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

 

A majority of our revenue and capital spending is transacted in U.S.dollars, although a portion of the cost of our operations, relating mainly toour personnel and facilities in Israel, is incurred in New Israeli Shekels. Asa result, we bear the risk that the rate of inflation in Israel or the declinein the value of United States dollar compared to the Israeli shekel willincrease our costs as expressed in United States dollars. We have not engagedin hedging transactions to reduce our exposure to fluctuations that may arisefrom changes in foreign exchange rates. Based on our overall currency rateexposure at March 31, 2006, a near-term 10% appreciation or depreciation of theNew Israeli Shekel would have an immaterial affect on our financial condition.

 

**Item 4. Controls and Procedures**

 

***Disclosure Controls and Procedures****.*Under the supervision and with the participation of ourmanagement, including our Chief Executive Officer and our Chief FinancialOfficer, we evaluated the effectiveness of our disclosure controls andprocedures, as such term is defined under Rule 13a-15(e) promulgated underthe Securities Exchange Act of 1934, as amended. Based upon that evaluation,our Chief Executive Officer and Chief Financial Officer****concluded that our disclosure controls andprocedures were effective as of the end of the period covered by this quarterlyreport.

 

***Internal Controls Over Financial Reporting****.*There has been no change in our internalcontrol over financial reporting during the quarter ended March 31, 2006 thathas materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

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**PART II. OTHER INFORMATION**

 

**Item 1. Legal Proceedings**

 

Zoran and itssubsidiary, Oak Technology, Inc., have been involved in five separatelegal actions against MediaTek, Inc. and customers of MediaTek based onclaims of patent infringement.

 

On March 11,2004, Zoran and Oak filed a complaint with****theUnited States International Trade Commission (the “ITC”) alleging that certainMediaTek DVD player and optical disk controller chips and chipsets, andproducts in which they are used, infringe Zoran’s and Oak’s patents. Inaddition to MediaTek, the complaint named a number of other proposedrespondents that sell products, including DVD players and PC optical storagedevices that use MediaTek’s chips and chipsets. On September 28, 2005, theITC issued its final ruling finding one of Zoran’s patents to be valid andinfringed by optical disk controller chips and chipsets sold by MediaTek and byproducts using the infringing chips and chipsets sold by a number of MediaTekcustomers. The ITC also issued an exclusion order prohibiting MediaTek andspecified MediaTek customers from importing into the United States any opticaldisk controller chip or chipset that infringes the Zoran patent, or any opticaldisk storage product containing such a chip or chipset and cease and desistorders to the affected companies located in the United States prohibiting themfrom importing or selling infringing products in the United States. In November2005, both parties filed notices of appeal with the United States Court ofAppeals for the Federal Circuit. On January 19, 2006, the court issued anorder temporarily staying enforcement of the ITC’s orders.

 

On March 15,2004, Zoran and Oak filed a complaint against MediaTek and one of its customersin the United States District Court, Central District of California allegingsimilar facts regarding infringement by MediaTek’s chips and chipsets andproducts in which they are used. The lawsuit sought both monetary damages andan injunction to stop the importation and sale of infringing products. Thecomplaint was subsequently amended to name additional MediaTek customers asdefendants. Trial of this case was set to begin May 15, 2006.

 

On July 23,2004, MediaTek filed a complaint with the ITC alleging that certain Zoran andOak DVD player and optical disk controller chips and chipsets infringe twoMediaTek patents. The complaint requested that the ITC institute an investigationinto the accused products and issue exclusion and cease and desist ordersprohibiting importation into the United States of allegedly infringing chipsand products that contain them. On September 30, 2005, the ITCAdministrative Law Judge issued his initial determination finding that none ofZoran’s optical disk controller chips infringe any claim of the two patentsasserted against Zoran; that one of the two patents is invalid; that Oak’sdevices do not infringe one of the two patents asserted against Oak and thatthe other patent is invalid; and that MediaTek has failed to establish that ithas a domestic industry in the United States related to the patents atissue – a basic requirement for obtaining relief from the ITC. The initialdetermination was subject to review by the full ITC. The target date forcompletion of the investigation was March 1, 2006.

 

On July 23,2004, MediaTek filed a complaint against Zoran and Oak in the United StatesDistrict Court, District of Delaware alleging infringement of the same twopatents asserted in MediaTek’s ITC complaint and seeking monetary damages andinjunctive relief. This action was stayed by order of the court onOctober 4, 2004.

 

OnFebruary 2, 2005, MediaTek filed a complaint against Zoran and ZoranDigital Technologies (Shenzhen) Ltd. (Zoran’s local Chinese operations) in theShenzhen People’s Republic of China court alleging infringement of the Chinesecounterpart patent of one of the two patents asserted in MediaTek’s ITCcomplaint and seeking monetary damages. Because Zoran had not been served withthe complaint, the initiation of the proceeding has been stayed.

 

OnJanuary 25, 2006, Zoran and Oak entered into an agreement with MediaTek tosettle the litigation. Under the agreement, each party agreed to dismiss itsrespective claims and counterclaims under all of the pending lawsuits. Theparties also agreed to dismiss all proceedings pending against each otherbefore the ITC, including all appeals and enforcement proceedings pendingbefore the ITC, United States Customs and Border Protection and the UnitedStates Court of Appeals for the Federal Circuit related to the ITC’sSeptember 28, 2005 order excluding the importation into the United Statesof certain MediaTek chips and products incorporating those chips.

 

In connection withthe settlement, Zoran, Oak and MediaTek entered into agreements granting eachother non-exclusive licenses under the patents that were the subject of thelitigation, and additional patents used in the design and manufacture of opticalstorage devices for personal computer products. In consideration for licensesgranted by Zoran, MediaTek agreed to make a cash payment of $55 million toZoran, $44 million of which was paid in February 2006 and $11 million ofwhich was paid in April 2006. In addition, MediaTek will be required to makeroyalty payments of up to $30 million over the 30-month period commencingon the date of the agreement based on future sales of covered MediaTek products.Net of amounts payable by Zoran to a holder of rights under the Oak 

 

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patents involvedin the litigation, and amounts payable as legal fees, Zoran will realizeapproximately $28.1 million of the cash payment and up to approximately$15.3 million of the future royalty payments.

 

On February 9,2006, Zoran and Oak entered into an agreement to settle separate litigationbetween Oak, on the one hand, and MediaTek and United MicroelectronicsCorporation, on the other hand. This litigation, which involved variouscontract-related claims and counterclaims, was instituted in 1997, prior toZoran’s acquisition of Oak. Under the agreement, the litigation was dismissed,and a subsidiary of MediaTek paid Zoran $15 million. Net of amountspayable by Zoran to a holder of rights under certain Oak patents, and amountspayable as legal fees, Zoran realized approximately $7.7 million of thepayment. In connection with the settlement, Zoran and MediaTek also grantedeach other cross-licenses under certain of their patents.

 

**Item 1A. Risk Factors**

 

Our future business, operating results and financial condition aresubject to various risks and uncertainties, including those described below. Therisk factors described below do not contain any material changes from thosedisclosed in Item 1A of our annual report on Form 10-K for the yearended December 31, 2005.

 

**Our quarterly revenues and operating resultsfluctuate due to a variety of factors, which may result in volatility or adecline in the prices of our stock.**

 

Our historical operating results have varied significantly from quarterto quarter due to a number of factors, including:

 

•                  fluctuation indemand for our products;

 

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

 

•                  the level of marketacceptance of new and enhanced versions of our products and our customers’products;

 

•                  the timing orcancellation of large customer orders;

 

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

 

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

 

•                  the cyclicalnature of the semiconductor industry;

 

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

 

•                  changes in themix of products sold;

 

•                  seasonality indemand for our products;

 

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

 

•                  the evolving andunpredictable nature of the markets for products incorporating our integratedcircuits and embedded software.

 

We expect that our operating results will continue to fluctuate in thefuture as a result of these factors and a variety of other factors, including:

 

•                  the cost andavailability of adequate foundry capacity;

 

•                  fluctuations inmanufacturing yields;

 

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•                  changes in orthe emergence of new industry standards;

 

•                  failure toanticipate changing customer product requirements;

 

•                  the loss or gainof important customers;

 

•                  productobsolescence; and

 

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

 

Our operating results could also be harmed by:

 

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

 

•                  terrorism andinternational conflicts or other crises

 

•                  other conditionsaffecting the timing of customer orders;

 

•                  changes ingovernmental regulations that could affect our products; or

 

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

 

These factors are difficult or impossible to forecast. We place orderswith independent foundries several months in advance of the scheduled deliverydate, often in advance of receiving non-cancelable orders from our customers. Thislimits our ability to react to fluctuations in demand for their products. Ifanticipated shipments in any quarter are canceled or do not occur as quickly asexpected, or if we fail to foresee a technology change that could render aproduct obsolete, expense and inventory levels could be disproportionately high.If anticipated license revenues in any quarter are canceled or do not occur,gross margins may be reduced. A significant portion of our expenses arerelatively fixed, and the timing of increases in expenses is based in largepart on our forecast of future revenues. As a result, if revenues do not meetour expectations, we may be unable to quickly adjust expenses to levelsappropriate to actual revenues, which could harm our operating results.

 

Product supply and demand fluctuations common to the semiconductor industryare historically characterized by periods of manufacturing capacity shortagesimmediately followed by periods of overcapacity, which are caused by theaddition of manufacturing capacity in large increments. We cannot predictwhether we will achieve timely, cost-effective access to that capacity whenneeded, or when there will be a capacity shortage again in the future.

 

As a result of these factors, our operating results may varysignificantly from quarter to quarter. Any shortfall in revenues or net incomefrom levels expected by the investment community could cause a decline in thetrading price of our stock.

 

**Our customers experience fluctuating productcycles and seasonality, which causes their sales to fluctuate.**

 

Because the markets that our customers serve are characterized bynumerous new product introductions and rapid product enhancements, ouroperating results may vary significantly from quarter to quarter. During thefinal production of a mature product, our customers typically exhaust theirexisting inventories of our products. Consequently, orders for our products maydecline in those circumstances, even if the products are incorporated into bothmature products and replacement products. A delay in a customer’s transition tocommercial production of a replacement product would delay our ability torecover the lost sales from the discontinuation of the related mature product. Ourcustomers also experience significant seasonality in the sales of theirconsumer products, which affects their orders of our products. Typically, thesecond half of the calendar year represents a disproportionate percentage ofsales for our customers due to the holiday shopping period for consumerelectronics products, and therefore, a disproportionate percentage of our sales.We expect these seasonal sales fluctuations to continue for the foreseeablefuture.

 

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**Product supply and demand in thesemiconductor industry is subject to cyclical variations.**

 

The semiconductor industry is subject to cyclical variations in productsupply and demand. Downturns in the industry often occur in connection with, oranticipation of, maturing product cycles for both semiconductor companies andtheir customers and declines in general economic conditions. These downturnshave been characterized by abrupt fluctuations in product demand, productionover-capacity and accelerated decline of average selling prices. In some cases,these downturns have lasted more than one year. A downturn in the semiconductorindustry could harm our sales and revenues if demand drops, or our grossmargins if average selling prices decline.

 

**Our success for the foreseeable future willbe dependent on growth in demand for integrated circuits for a limited numberof applications.**

 

In recent years, we have derived a substantial majority of our productrevenues from the sale of integrated circuits for DVD and digital cameraapplications. We expect that sales of our products for these applications willcontinue to account for a significant portion of our revenues for theforeseeable future. Our future financial performance will also depend on ourability to successfully develop and market new products in the digitaltelevision, HDTV and digital imaging markets. If the markets for these productsand applications decline or fail to develop as expected, or we are notsuccessful in our efforts to market and sell our products to manufacturers whoincorporate integrated circuits into these products, our financial results willbe harmed.

 

**Our financial performance is highly dependenton the timely and successful introduction of new and enhanced products.**

 

Our financial performance depends in large part on our ability tosuccessfully develop and market next-generation and new products in a rapidlychanging technological environment. If we fail to successfully identify newproduct opportunities and timely develop and introduce new products thatachieve market acceptance, we may lose our market share and our future revenuesand earnings may suffer.

 

In the consumer electronic market, our performance has been dependenton our successful development and timely introduction of integrated circuitsfor DVD players, DVD recorders, digital cameras, broadband digital televisionand HDTV. These markets are characterized by the incorporation of a steadilyincreasing level of integration and numbers of features on a chip at the sameor lower system cost, enabling original equipment manufacturers, or OEMs, tocontinually improve the features or reduce the prices of the systems they sell.If we are unable to continually develop and introduce integrated circuits withincreasing levels of integration and new features at competitive prices, ouroperating results will suffer.

 

In the digital office market, our performance has been dependant on ourability to successfully develop embedded image processing system on a chip, orSOC, solutions for the digital office market, in particular, embedded digitalcolor copier technology and image processing chips for a variety of imagingperipherals, including printers and multi-function peripherals, or MFPs. Amongother technological changes, embedded PDF and color capability are rapidlyemerging as market requirements for printers and other imaging devices. Some ofour competitors have the capacity to supply these solutions, and some of theirsolutions have been well received in the marketplace. We face the challenge ofdeveloping new imaging products with the capability to handle greater color andimage complexity, including web-based documents, and work withhigher-performing devices in networked environments. If we are unable to meetthese challenges with the development of products that can effectively competein the OEM software and solutions market, our future operating results couldsuffer.

 

**We must keep pace with rapid technologicalchanges and evolving industry standards to remain competitive.**

 

Our future success will depend on our ability to anticipate and adaptto changes in technology and industry standards and our customers’ changingdemands. The consumer electronics market, in particular, is characterized byrapidly changing technology, evolving industry standards, frequent new productintroductions, short product life cycles and increasing demand for higherlevels of integration. Our ability to adapt to these changes and to anticipatefuture standards, and the rate of adoption and acceptance of those standards,will be a significant factor in maintaining or improving our competitiveposition and prospects for growth. If new industry standards emerge, ourproducts or the products of our customers could become unmarketable orobsolete, and we could lose market share or be required to incur substantialunanticipated costs to comply with these new standards.

 

Our success will also depend on the successful development of newmarkets and the application and acceptance of new technologies and products inthose new markets. For example, our success will depend on the ability of ourcustomers to develop new products and enhance existing products in therecordable DVD player market and products for the broadband digital televisionand HDTV markets and to introduce and promote those products successfully. Thesemarkets may not continue to develop to the extent or in the time periods thatwe currently anticipate due to factors outside our control, such as delays inimplementation of FCC 02-320 requiring all 

 

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new televisions to include a digital receiver. If new markets do notdevelop as we anticipate, or if our products do not gain widespread acceptancein these markets, our business, financial condition and results of operationscould be materially and adversely affected. The emergence of new markets forour products is also dependent in part upon third parties developing andmarketing content in a format compatible with commercial and consumer productsthat incorporate our products. If this content is not available, manufacturersmay not be able to sell products incorporating our products, and our saleswould suffer.

 

**We rely on independent foundries andcontractors for the manufacture, assembly and testing of our integratedcircuits and other hardware products, and the failure of any of these thirdparties to deliver products or otherwise perform as requested could damage ourrelationships with our customers and harm our sales and financial results.**

 

We do not operate any manufacturing facilities, and we rely onindependent foundries to manufacture substantially all of our products. Theseindependent foundries fabricate products for other companies and may alsoproduce products of their own design. From time to time, there aremanufacturing capacity shortages in the semiconductor industry. We do not havelong-term supply contracts with any of our suppliers, including our principalsupplier, Taiwan Semiconductor Manufacturing Company, or TSMC. Therefore, TSMCand our other suppliers are not obligated to manufacture products for us forany specific period, in any specific quantity or at any specified price, exceptas may be provided in a particular purchase order.

 

Our reliance on independent foundries involves a number of risks,including:

 

•                  theinability to obtain adequate manufacturing capacity;

 

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

 

•                  lackof control over delivery schedules;

 

•                  lackof control over quality assurance;

 

•                  lackof control over manufacturing yields and cost; and

 

•                  potentialmisappropriation of our intellectual property.

 

In addition, TSMC and some of our other foundries are located in areasof the world that are subject to natural disasters such as earthquakes. Whilethe 1999 earthquake in Taiwan did not have a material impact on our independentfoundries, a similar event centered near TSMC’s facility could severely reduceTSMC’s ability to manufacture our integrated circuits. The loss of any of ourmanufacturers as a supplier, our inability to expand the supply of theirproducts in response to increased demand, or our inability to obtain timely andadequate deliveries from our current or future suppliers due to a naturaldisaster or any other reason could delay or reduce shipments of our products. Anyof these circumstances could damage our relationships with current andprospective customers and harm our sales and financial results.

 

We also rely on a limited number of independent contractors for theassembly and testing of our products. Our reliance on independent assembly andtesting houses limits our control over delivery schedules, quality assuranceand product cost. Disruptions in the services provided by our assembly ortesting houses or other circumstances that would require them to seekalternative sources of assembly or testing could lead to supply constraints ordelays in the delivery of our products. These constraints or delays coulddamage our relationships with current and prospective customers and harm ourfinancial results.

 

**Because foundry capacity is limited from timeto time, we may be required to enter into costly long-term supply arrangementsto secure foundry capacity.**

 

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

 

•                  optionpayments or other prepayments to a foundry;

 

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

 

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

 

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•                  issuanceof our equity securities to a foundry;

 

•                  investmentin a foundry;

 

•                  jointventures; or

 

•                  otherpartnership relationships with foundries.

 

We may not be able to make any such arrangement in a timely fashion orat all, and such arrangements, if any, may not be on terms favorable to us. Moreover,if we are able to secure foundry capacity, we may be obligated to utilize allof that capacity or incur penalties. Such penalties may be expensive and couldharm our financial results.

 

**If our independent foundries do not achievesatisfactory yields, our relationships with our customers may be harmed.**

 

The fabrication of silicon wafers is a complex process. Minute levelsof contaminants in the manufacturing environment, defects in photo masks usedto print circuits on a wafer, difficulties in the fabrication process or otherfactors can cause a substantial portion of the integrated circuits on a waferto be non-functional. Many of these problems are difficult to detect at anearly stage of the manufacturing process and may be time consuming andexpensive to correct. As a result, foundries often experience problemsachieving acceptable yields, which are represented by the number of goodintegrated circuits as a proportion of the number of total integrated circuitson any particular wafer. Poor yields from our independent foundries wouldreduce our ability to deliver our products to customers, harm our relationshipswith our customers and harm our business.

 

**We face competition or potential competitionfrom companies with greater resources than ours, and if we are unable tocompete effectively with these companies, our market share may decline and ourbusiness could be harmed.**

 

We face intense competition in the markets in which we compete. Weexpect that the level of competition will increase in the future from existingcompetitors and from other companies that may enter our existing or futuremarkets with solutions that may be less costly or provide higher performance oradditional features.

 

Competition in Zoran’s core compression technology market hashistorically been dominated by large companies, such asST Microelectronics, and companies that develop and use their ownintegrated circuits, such as Sony and Matsushita. As this market continues todevelop, we face competition from other large semiconductor vendors.

 

The DVD market continues to expand, and additional competitors areexpected to enter the market for DVD players and software. Some of thesepotential competitors may develop captive implementations for use only withtheir own PC and consumer electronics products. It is also possible thatapplication software vendors, such as Microsoft, may attempt to enter the DVDapplication market in the future. This increased competition may result inprice reductions, reduced profit margins and loss of market share.

 

We face competition from several large semiconductor companies in thebroadband digital television and set-top box markets. We expect competition tocontinue to increase in these markets as industry standards become well knownand as other competitors enter these markets.

 

We also face significant competition in the digital office market. Thefuture growth of the digital office market is highly dependent onOEMs continuing to outsource an increasing portion of their productdevelopment work. While the trend toward outsourcing on the part of our OEMcustomers in this market has accelerated in recent years, any reversal of thistrend, or a change in the way they outsource, could seriously harm ourbusiness.

 

Many of our existing competitors, as well as OEM customers that areexpected to compete with us in the future, have substantially greaterfinancial, manufacturing, technical, marketing, distribution and otherresources, broader product lines and longer standing relationships withcustomers than we have. In addition, much of our future success is dependent onthe success of our OEM customers. If we or our OEM customers are unable tocompete successfully against current and future competitors, we could experienceprice reductions, order cancellations and reduced gross margins, any one ofwhich could harm our business.

 

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**Our products are characterized by averageselling prices that decline over relatively short time periods; if we areunable to reduce our costs or introduce new products with higher averageselling prices, our financial results will suffer.**

 

Average selling prices for our products decline over relatively shorttime periods, while many of our manufacturing costs are fixed. When our averageselling prices decline, our revenues decline unless we are able to sell moreunits and our gross margins decline unless we are able to reduce ourmanufacturing costs by a commensurate amount. Our operating results suffer whengross margins decline. We have experienced these problems, and we expect tocontinue to experience them in the future, although we cannot predict when theymay occur or how severe they will be.

 

**We derive most of our revenue from sales to asmall number of large customers, and if we are not able to retain thesecustomers, or they reschedule, reduce or cancel orders, our revenues would bereduced and our financial results would suffer.**

 

Our largest customers have accounted for a substantial percentage ofour revenues. In 2005, no single customer accounted for more than 10% of ourtotal revenues, although sales to our four largest customers accounted for 29%of our total revenues. In 2004, one customer accounted for 11% of our totalrevenues while sales to our four largest customers accounted for 35% of ourtotal revenues. Sales to these large customers have varied significantly fromyear to year and will continue to fluctuate in the future. These sales also mayfluctuate significantly from quarter to quarter. We may not be able to retainour key customers, or these customers may cancel purchase orders or rescheduleor decrease their level of purchases from us. Any substantial decrease or delayin sales to one or more of our key customers could harm our sales and financialresults. In addition, any difficulty in collecting amounts due from one or morekey customers could harm our financial results.

 

**Our products generally have long sales cyclesand implementation periods, which increases our costs in obtaining orders andreduces the predictability of our operating results.**

 

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

 

Long sales cycles also subject us to other risks, including customers’budgetary constraints, internal acceptance reviews and cancellations. Inaddition, orders expected in one quarter could shift to another because of thetiming of customers’ purchase decisions. The time required for our customers 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.

 

**We are not protected by long-term contractswith our customers.**

 

We generally do not enter into long-term purchase contracts with ourcustomers, and we cannot be certain as to future order levels from ourcustomers. Customers generally purchase our products subject to cancelableshort-term purchase orders. We cannot predict whether our current customerswill continue to place orders, whether existing orders will be canceled, orwhether customers who have ordered products will pay invoices for deliveredproducts. When we do enter into a long-term contract, the contract is generallyterminable at the convenience of the customer. In the event of an earlytermination by one of our major customers, it is unlikely that we will be ableto rapidly replace that revenue source, which would harm our financial results.

 

**Regulation of our customers’ products mayslow the process of introducing new products and could impair our ability tocompete.**

 

The Federal Communications Commission, or FCC, has broad jurisdictionover our target markets in the digital television business. Variousinternational entities or organizations may also regulate aspects of ourbusiness or the business of our customers. Although our products are notdirectly subject to regulation by any agency, the transmission pipes, as wellas much of the equipment into which our products are incorporated, are subjectto direct government regulation. For example, before they can be sold in theUnited States, advanced televisions and emerging interactive displays must betested and certified by Underwriters Laboratories and 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 policiesaffecting the ability of cable operators or telephone companies to offercertain services and other terms on which these companies conduct theirbusiness may impede sales of our products. In addition, our digital television 

 

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business may also be adversely affected by the imposition of tariffs,duties and other import restrictions on our suppliers or by the imposition ofexport restrictions on products that we sell internationally. Changes incurrent laws or regulations or the imposition of new laws or regulations in theUnited States or elsewhere could harm our business. For example, any delays bythe FCC in imposing its pending requirement that all new televisions have adigital receiver could have an adverse effect on our HDTV business.

 

**We are dependent upon our international salesand operations; economic, political or military events in a country where wemake significant sales or have significant operations could interfere with oursuccess or operations there and harm our business.**

 

During 2005, only 6% of our total revenues were derived from NorthAmerica sales. We anticipate that international sales will continue to accountfor a substantial majority of our total revenues for the foreseeable future. Inaddition, substantially all of our semiconductor products are manufactured,assembled and tested outside of the United States by independent foundries andsubcontractors.

 

We are subject to a variety of risks inherent in doing businessinternationally, including:

 

•                        unexpectedchanges in regulatory requirements;

 

•                        fluctuationsin exchange rates;

 

•                        politicaland economic instability;

 

•                        impositionof tariffs and other barriers and restrictions;

 

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

 

•                        healthrisks in a particular region.

 

A material amount of our research and development personnel andfacilities and a portion of our sales and marketing personnel are located inIsrael. Political, economic and military conditions in Israel directly affectour operations. Some of our employees in Israel are obligated to perform up to39 days of military reserve duty annually. The absence of these employeesfor significant periods during the work week may cause us to operateinefficiently during these periods.

 

Our operations in China are subject to the economic and politicaluncertainties affecting that country. For example, the Chinese economy hasexperienced significant growth in the past decade, but such growth has beenuneven across geographic and economic sectors. This growth may decrease and anyslowdown may have a negative effect on our business. We also maintain officesin Taipei, Taiwan, Hong Kong and Seoul, Korea, and our operations are subjectto the economic and political uncertainties affecting these countries as well.

 

The significant concentration of our manufacturing activities withthird party foundries in Taiwan exposes us to the risk of political instabilityin Taiwan, including the potential for conflict between Taiwan and China. Wehave several significant OEM customers in Japan, Korea and other parts of Asia.Adverse economic circumstances in Japan and elsewhere in Asia could affectthese customers’ willingness or ability to do business with us in the future ortheir success in developing and launching devices containing our products.

 

**Our business and future operating results couldbe harmed by terrorist activity or armed conflict.**

 

Our business and operating results are subject to uncertainties arisingout of possible terrorist attacks on the United States and other regions of theworld including locations where we maintain operations and by armed conflict inthe Middle East and related economic instability. Our operations could beharmed due to:

 

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

 

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

 

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

 

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

 

**The prices of our products may become lesscompetitive due to foreign exchange fluctuations.**

 

Foreign currency fluctuations may affect the prices of our products. Pricesfor our products are currently denominated in U.S. dollars for sales to ourcustomers throughout the world. If there is a significant devaluation of thecurrency in a specific country, the prices of our products will increaserelative to that country’s currency, our products may be less competitive inthat country and our revenues may be adversely affected. Also, we cannot be surethat our international customers will continue to be willing to place ordersdenominated in U.S. dollars. If they do not, our revenue and operating resultswill be subject to foreign exchange fluctuations.

 

**Our ability to compete could be jeopardized ifwe are unable to protect our intellectual property rights.**

 

Our success and ability to compete depend in large part upon protectionof our proprietary technology. We rely on a combination of patent, tradesecret, copyright and trademark laws, non-disclosure and other contractualagreements and technical measures to protect our proprietary rights. Theseagreements and measures may not be sufficient to protect our technology fromthird-party infringement, or to protect us from the claims of others. Monitoringunauthorized use of our products is difficult, and we cannot be certain thatthe steps we have taken will prevent unauthorized use of our technology,particularly in foreign countries where the laws may not protect ourproprietary rights as fully as in the United States. The laws of certainforeign countries in which our products are or may be developed, manufacturedor sold, including various countries in Asia, may not protect our products orintellectual property rights to the same extent as do the laws of the UnitedStates and thus make the possibility of piracy of our technology and productsmore likely in these countries. If competitors are able to use our technology,our ability to compete effectively could be harmed.

 

The protection offered by patents is subject to numerous uncertainties.For example, our competitors may be able to effectively design around ourpatents, or the patents may be challenged, invalidated or circumvented. Thosecompetitors may also independently develop technologies that are substantiallyequivalent or superior to our technology. Moreover, while we hold, or haveapplied for, patents relating to the design of our products, some of ourproducts are based in part on standards, for which we do not hold patents orother intellectual property rights.

 

We have generally limited access to and distribution of the source andobject code of our software and other proprietary information. With respect toits page description language software and drivers for the digital officemarket and in limited circumstances with respect to firmware and platforms forits HDTV products, Oak has granted licenses that give its customers access toand restricted use of the source code of Oak’s software. This access increasesthe likelihood of misappropriation or misuse of our technology.

 

**Claims and litigation regarding intellectualproperty rights could seriously harm our business and require us to incursignificant costs.**

 

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

 

•                        stopselling products that incorporate the challenged intellectual property;

 

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

 

•                        paydamages; or

 

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•                        redesignthose products that use such technology.

 

Although patent disputes in the semiconductor industry have often beensettled through cross-licensing arrangements, we may not be able in any orevery instance to settle an alleged patent infringement claim through across-licensing arrangement. We have a more limited patent portfolio than manyof our competitors. If a successful claim is made against us or any of ourcustomers and a license is not made available to us on commercially reasonableterms or we are required to pay substantial damages or awards, our business,financial condition and results of operations would be materially adversely affected.

 

**If necessary licenses of third-partytechnology are not available to us or are very expensive, our products couldbecome obsolete.**

 

From time to time, we may be required to license technology from thirdparties to develop new products or product enhancements. Third party licensesmay not be available on commercially reasonable terms, if at all. If we areunable to obtain any third-party license required to develop new products andproduct enhancements, we may have to obtain substitute technology of lowerquality or performance standards or at greater cost, either of which couldseriously harm the competitiveness of our products.

 

Certain technology used in our products is licensed from third parties,and in connection with these licenses, we are required to fulfillconfidentiality obligations and, in some cases, pay royalties. Some of ourproducts require various types of copy protection software that we must licensefrom third parties. If we are unable to obtain or maintain our right to use thenecessary copy protection software, we would be unable to sell and market theseproducts.

 

**If we are not able to apply our net operatinglosses against taxable income in future periods, our financial results will beharmed.**

 

Our future net income and cash flow will be affected by our ability toapply our net operating losses, or NOLs, against taxable income in futureperiods. Our NOLs totaled approximately $268 million for federal and$85 million for state tax reporting purposes as of December 31, 2005.As a result of the change of control resulting from our initial public offeringin 1995, the amount of NOLs that we can use to reduce future taxable income forfederal tax purposes is limited to approximately $3.0 million per year forNOLs incurred prior to the initial public offering. The Internal Revenue Codecontains a number of provisions that could limit the use of NOLs against incomeof the combined company as a result of the merger or as a result of thecombination of these transactions. Our utilization of Oak’s NOLs may be furtherlimited due to prior Oak transactions. No opinion or IRS ruling has been soughtregarding the potential application of any of these provisions. Changes in taxlaws in the United States may further limit our ability to utilize these NOLs. Anyfurther limitation on our ability to utilize these respective NOLs could harmour financial condition.

 

**Any additional acquisitions we make coulddisrupt our business and severely harm our financial condition.**

 

We have made investments in, and acquisitions of other complementarycompanies, products and technologies, and we may acquire additional businesses,products or technologies in the future. In the event of any futureacquisitions, we could:

 

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

 

•                        incurdebt;

 

•                        assumeliabilities;

 

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

 

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

 

Our operation of any other acquired business will also involve numerousrisks, including:

 

•                        problemscombining the purchased operations, technologies or products;

 

•                        unanticipatedcosts;

 

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•                        diversionof management’s attention from our core business;

 

•                        adverseeffects on existing business relationships with customers;

 

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

 

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

 

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

 

In addition, we have made minority equity investments in early-stagecompanies, and we expect to continue to review opportunities to make additionalinvestments in such companies where we believe such investments will provide uswith opportunities to gain access to important technologies or otherwiseenhance important commercial relationships. We have little or no influence overthe early-stage companies in which we have made or may make strategic, minorityequity investments. Each of these investments involves a high degree of risk. Wemay not be successful in achieving the technological or commercial advantageupon which any given investment is premised, and failure by the early-stagecompany to achieve its own business objectives could result in a loss of all orpart of our invested capital and require us to write off all or a portion ofsuch investment.

 

**Our products could contain defects, whichcould reduce sales of those products or result in claims against us.**

 

We develop complex and evolving products. Despite testing by us and ourcustomers, errors may be found in existing or new products. This could resultin, among other things, a delay in recognition or loss of revenues, loss ofmarket share or failure to achieve market acceptance. These defects may causeus to incur significant warranty, support and repair costs, divert theattention of our engineering personnel from our product development efforts andharm our relationships with customers. The occurrence of these problems couldresult in the delay or loss of market acceptance of our products and wouldlikely harm our business. Defects, integration issues or other performanceproblems in our products could result in financial or other damages tocustomers or could damage market acceptance of such products. Our customerscould also seek damages from us for their losses. A product liability claimbrought against us, even if unsuccessful, would likely be time consuming andcostly to defend.

 

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

 

We historically have generated a portion of our total revenues fromdevelopment contracts, primarily with key customers. These developmentcontracts have provided us with partial funding for the development of some ofour products. Under these contracts, we receive payments upon reaching certaindevelopment milestones. If we fail to achieve the milestones specified in ourexisting development contracts, if our existing contracts are terminated or ifwe are unable to secure future development contracts, our ability tocost-effectively develop new products would be reduced and our business wouldbe harmed.

 

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

 

We may require substantial additional capital to finance our futuregrowth, secure additional foundry capacity and fund our ongoing research and developmentactivities beyond 2006. Our capital requirements will depend on many factors,including:

 

•                        acceptanceof and demand for our products;

 

•                        the typesof arrangements that we may enter into with our independent foundries;

 

•                        the extentto which we invest in new technology and research and development projects; and

 

•                        anyadditional acquisitions that we may make.

 

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To the extent that our existing sources of liquidity and cash flow fromoperations are insufficient to fund our activities, we may need to raiseadditional funds. If we raise additional funds through the issuance of equitysecurities, the percentage ownership of our existing stockholders would bereduced. Further, such equity securities may have rights, preferences orprivileges senior to those of our common stock. Additional financing may not beavailable to us when needed or, if available, it may not be available on termsfavorable to us.

 

**If we fail to manage our future growth, ifany, our business would be harmed.**

 

We anticipate that our future growth, if any, will require us torecruit and hire a substantial number of new engineering, managerial, sales andmarketing personnel. Our ability to manage growth successfully will alsorequire us to expand and improve administrative, operational, management andfinancial systems and controls. Many of our key operations, including amaterial portion of our research and development operations and a significantportion of our sales and administrative operations are located in Israel. Amajority of our sales and marketing and certain of our research and developmentand administrative personnel, including our President and Chief ExecutiveOfficer and other officers, are based in the United States. The geographicseparation of these operations places additional strain on our resources andour ability to manage growth effectively. If we are unable to manage growtheffectively, our business will be harmed.

 

**We rely on the services of our executiveofficers and other key personnel, whose knowledge of our business and industrywould be extremely difficult to replace.**

 

Our success depends to a significant degree upon the continuingcontributions of our senior management. Management and other employees mayvoluntarily terminate their employment with us at any time upon short notice. Theloss of key personnel could delay product development cycles or otherwise harmour business. We believe that our future success will also depend in large parton our ability to attract, integrate and retain highly-skilled engineering,managerial, sales and marketing personnel, located in the United States, Israeland China. Competition for such personnel is intense, and we may not besuccessful in attracting, integrating and retaining such personnel. Failure toattract, integrate and retain key personnel could harm our ability to carry outour business strategy and compete with other companies.

 

**The Israeli rate of inflation may negativelyimpact our costs if it exceeds the rate of devaluation of the new Israelishekel against the United States dollar.**

 

A portion of the cost of our operations, relating mainly to ourpersonnel and facilities in Israel, is incurred in new Israeli shekels. As aresult, we bear the risk that the rate of inflation in Israel or the decline inthe value of United States dollar compared to the Israeli shekel will increaseour costs as expressed in United States dollars. To date, we have not engagedin hedging transactions. In the future, we may enter into currency hedgingtransactions to decrease the risk of financial exposure from fluctuations inthe exchange rate of the United States dollar against the new Israeli shekel. Thesemeasures may not adequately protect us from the impact of inflation in Israel.

 

**The government programs in which weparticipate and tax benefits we receive require us to meet several conditionsand may be terminated or reduced in the future, which would increase our costs.**

 

Historically, we have financed a portion of our research and developmentactivities with grants for research and development from the Chief Scientist inIsrael’s Ministry of Industry and Trade. We earned proceeds from such grants in2004. Although we did not earn proceeds from such grants in 2005, we plan toseek additional grants from the Chief Scientist in the future. To be eligiblefor these grants, our development projects must be approved by the ChiefScientist 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 taxbenefits, in particular exemptions and reductions as a result of the “ApprovedEnterprise” status of our existing operations in Israel. To be eligible forthese tax benefits, we must maintain our Approved Enterprise status by meetingconditions, including making specified investments in fixed assets located inIsrael and investing additional equity in our Israeli subsidiary. These tax benefitsmay not be continued in the future at their current levels or at any level. Israeligovernmental authorities have indicated that the government may reduce oreliminate these benefits in the future, which would harm our business.

 

**Provisions in our charter documents andDelaware law could prevent or delay a change in control of Zoran.**

 

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

 

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

 

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

 

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

 

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

 

**Our stock price has fluctuated and maycontinue to fluctuate widely.**

 

The market price of our common stock has fluctuated significantly sinceour initial public offering in 1995. Between January 1, 2005 and March 31,2006, the closing sale price of our common stock, as reported on The NasdaqNational Market, ranged from a low of $8.97 to a high of $22.48. The marketprice of our common stock is subject to significant fluctuations in the futurein response to a variety of factors, including:

 

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

 

•                        annual andquarterly variations in our operating results;

 

•                        changes inanalysts’ earnings estimates;

 

•                        announcementsof technological innovations;

 

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

 

•                        loss ofkey personnel;

 

•                        proprietaryrights or other litigation;

 

•                        generalconditions in the semiconductor industry; and

 

•                        developmentsin the financial markets.

 

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

 

**Item 6. Exhibits**

 
| 10.48(1) |   | Amended Summary of Compensation  Arrangements with Named Executive officers and Non Employee Directors                                                                   |
|----------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.54*   |   | PC Optical Storage Patent Cross License  Agreement dated as of January 25, 2006 among Zoran, Zoran’s subsidiary Oak  Technology, Inc., and MediaTek, Inc.           |
| 10.55*   |   | PC Optical Storage Technology Patent  License Agreement dated as of January 25, 2006 among Zoran, Zoran’s  subsidiary Oak Technology, Inc., and MediaTek, Inc. |
| 31.1     |   | Certification of Chief Executive Officer  pursuant to Rule 13a-14(a).                                                                                                    |
| 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 Exhibit 99.1 to Registrant’s Form 8-KCurrent Report filed on March 31, 2006.

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

 

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**SIGNATURES**

 

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

 
|                      | **ZORAN CORPORATION**                        |
|---------------------------|----------------------------------------------|
|                      | ** **                                   |
|                      |                                         |
| Dated:  May 10, 2006 | /s/ Karl Schneider                           |   |
|                      | Karl Schneider                               |
|                      | Senior Vice President, Finance               |
|                      | and Chief Financial Officer                  |
|                      | (Principal Financial and Accounting Officer) |

 

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