** **

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

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### **FORM 10-Q**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF1934

**For theQuarterly Period Ended June 30, 2006**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF1934

**For the transition 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) |

 

**1390 Kifer Road**

**Sunnyvale, California 94086**

(Address ofprincipal executive offices, including zip code)

**(408) 523-6500**

(Registrant’stelephone number, including area code)

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Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  Yes o   No  x

Indicate by check mark whetherregistrant is a large accelerated filer, an accelerated filer or anon-accelerated filer.  See definition of“accelerated and large accelerated filer” in Rule 12b-2 of the ExchangeAct.  (Check one):

Large accelerated filer  x   Accelerated filer   o   Non accelerated-filer  o

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act) Yes oNo x

As of August 7, 2006, there were outstanding 49,331,986 shares of theregistrant’s Common Stock, par value $0.001 per share.

 

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**ZORAN CORPORATION ANDSUBSIDIARIES**

**FORM 10-Q**

**INDEX**
|              | ** ** | ** **                                                                                                                     | ** ** | **Page**   |
|--------------|------------|--------------------------------------------------------------------------------------------------------------------------------|------------|------------|
|         |       | Explanatory  Note Regarding Restatements                                                                                       |       | ii         |
|         |       |                                                                                                                           |       |       |
|         |       |                                                                                                                           |       |       |
|         |       | **PART  I. FINANCIAL INFORMATION**                                                                                             |       |       |
|         |       |                                                                                                                           |       |       |
| **Item 1.**  |       | Financial  Statements (Unaudited):                                                                                             |       | 1          |
|         |       |                                                                                                                           |       |       |
|         |       | Condensed Consolidated Balance Sheets as of June 30,  2006 and December 31, 2005, as restated                                  |       | 1          |
|         |       |                                                                                                                           |       |       |
|         |       | Condensed Consolidated Statements of Operations for  the Three Months and Six Months Ended June 30, 2006 and 2005, as restated |       | 2          |
|         |       |                                                                                                                           |       |       |
|         |       | Condensed Consolidated Statements of Cash Flows for  the Six Months Ended June 30, 2006 and 2005, as restated                  |       | 3          |
|         |       |                                                                                                                           |       |       |
|         |       | Notes to Condensed Consolidated Financial Statements                                                                           |       | 4          |
|         |       |                                                                                                                           |       |       |
| **Item 2.**  |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                    |       | 24         |
|         |       |                                                                                                                           |       |       |
| **Item 3.**  |       | Quantitative  and Qualitative Disclosures About Market Risk                                                                    |       | 34         |
| ** **   |       |                                                                                                                           |       |       |
| **Item 4.**  |       | Controls and  Procedures                                                                                                       |       | 35         |
| ** **   |       |                                                                                                                           |       |       |
|         |       |                                                                                                                           |       |       |
| ** **   | ** ** | **PART  II. OTHER INFORMATION**                                                                                                | ** ** | ** ** |
|         |       |                                                                                                                           |       |       |
| **Item 1.**  |       | Legal Proceedings                                                                                                              |       | 37         |
|         |       |                                                                                                                           |       |       |
| **Item 1A.** |       | Risk  Factors                                                                                                                  |       | 39         |
| ** **   |       |                                                                                                                           |       |       |
| **Item 4.**  |       | Submission of  Matters to a Vote of Security Holders                                                                           |       | 52         |
| ** **   |       |                                                                                                                           |       |       |
| **Item  6.** |       | Exhibits                                                                                                                       |       | 53         |
| ** **   |       |                                                                                                                           |       |       |
| Signatures   |       |                                                                                                                           |       | 54         |

 

i

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**EXPLANATORY NOTE REGARDINGRESTATEMENTS**

In this Quarterly Report on Form 10-Q for the quarter ended June 30,2006 we have restated our condensed consolidated financial statements for thethree and six months ended June 30, 2005, and the related disclosures. Therestatements reflected in this report include adjustments arising from anindependent investigation of Zoran’s historical stock option practices andrelated accounting for option grants. For more information on these matters, including a detailed discussionof the effect of the restatement, please refer to Note 2, “Restatement ofCondensed Consolidated Financial Statements” of the Notes to CondensedConsolidated Financial Statements.

ii

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**PART I. FINANCIALINFORMATION**

**Item 1.**                          FinancialStatements (Unaudited):

**ZORANCORPORATIONCONDENSED CONSOLIDATED BALANCE SHEETS(in thousands, except share data)(unaudited)**
| ** **                                                                                                                                                                                                                                             | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                             | ** ** | ** **              | ** ** | **(Restated)(1)**           | ** ** |
| ASSETS                                                                                                                                                                                                                                                 |       |                    |       |                        |       |
| Current assets:                                                                                                                                                                                                                                        |       |                    |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                                                                                             |       | $                       | 89,357     |                        | $          | 78,856 |   |
| Short-term  investments                                                                                                                                                                                                                                |       | 175,634                 |       | 70,490                      |       |
| Accounts  receivable, net                                                                                                                                                                                                                              |       | 60,615                  |       | 70,174                      |       |
| Inventories                                                                                                                                                                                                                                            |       | 47,940                  |       | 32,616                      |       |
| Prepaid expenses  and other current assets                                                                                                                                                                                                             |       | 9,546                   |       | 11,746                      |       |
| Total current  assets                                                                                                                                                                                                                                  |       | 383,092                 |       | 263,882                     |       |
| Property and  equipment, net                                                                                                                                                                                                                           |       | 14,537                  |       | 16,057                      |       |
| Other assets and  investments                                                                                                                                                                                                                          |       | 22,180                  |       | 20,799                      |       |
| Goodwill                                                                                                                                                                                                                                               |       | 178,662                 |       | 182,662                     |       |
| Intangible  assets, net                                                                                                                                                                                                                                |       | 93,761                  |       | 119,231                     |       |
|                                                                                                                                                                                                                                                   |       | $                       | 692,232    |                        | $          | 602,631 |   |
|                                                                                                                                                                                                                                                   |       |                    |       |                        |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                                                                                             |       |                    |       |                        |       |
| Current  liabilities:                                                                                                                                                                                                                                  |       |                    |       |                        |       |
| Accounts payable                                                                                                                                                                                                                                       |       | $                       | 45,429     |                        | $          | 38,999 |   |
| Accrued expenses  and other liabilities                                                                                                                                                                                                                |       | 50,563                  |       | 54,769                      |       |
| Total current  liabilities                                                                                                                                                                                                                             |       | 95,992                  |       | 93,768                      |       |
| Other long-term  liabilities                                                                                                                                                                                                                           |       | 12,828                  |       | 11,939                      |       |
| Commitments and  Contingencies (Note 12)                                                                                                                                                                                                               |       |                    |       |                        |       |
| Stockholders’ equity:                                                                                                                                                                                                                             |       |                    |       |                        |       |
| Common stock,  $0.001 par value; 105,000,000 shares authorized at June 30, 2006 and  December 31, 2005; 49,304,376 shares issued and outstanding as of June  30, 2006; and 45,426,912 shares issued and outstanding as of December 31,  2005 |       | 49                      |       | 45                          |       |
| Additional paid-in  capital                                                                                                                                                                                                                            |       | 799,252                 |       | 738,253                     |       |
| Deferred stock-based  compensation                                                                                                                                                                                                                     |       | —                  |       | (593                        | )          |
| Accumulated  other comprehensive income                                                                                                                                                                                                                |       | 2,488                   |       | 3,057                       |       |
| Accumulated  deficit                                                                                                                                                                                                                                   |       | (218,377                | )          | (243,838                    | )          |
| Total  stockholders’ equity                                                                                                                                                                                                                       |       | 583,412                 |       | 496,924                     |       |
|                                                                                                                                                                                                                                                   |       | $                       | 692,232    |                        | $          | 602,631 |   |

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(1)             SeeNote 2, “Restatement of Condensed Consolidated Financial Statements” of theNotes to Condensed Consolidated Financial Statements.

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

1

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**ZORANCORPORATIONCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(in thousands, except per share data)(unaudited)**
| ** **                                                                     | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                     | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                                     | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                     | ** ** | ** **                       | ** ** | **(Restated)(1)**              | ** ** | ** ** | ** ** | **(Restated) (1)** | ** ** |
|                                                                           |       |                             |       |                           |       |   |   |   |   |
| Revenues:                                                                      |       |                             |       |                           |       |   |   |   |   |
| Hardware product revenues                                                      |       | $                                | 108,236    |                           | $          | 80,897 |   | $ | 207,405 |   | $ | 139,899 |   |
| Software and other revenues                                                    |       | 14,069                           |       | 14,182                         |       | 26,978 |   | 29,064 |   |
| License revenues related to litigation settlement                              |       | 5,624                            |       | —                         |       | 35,792 |   | — |   |
| Total revenues                                                                 |       | 127,929                          |       | 95,079                         |       | 270,175 |   | 168,963 |   |
|                                                                           |       |                             |       |                           |       |   |   |   |   |
| Costs and  expenses:                                                           |       |                             |       |                           |       |   |   |   |   |
| Cost of hardware product revenues                                              |       | 60,355                           |       | 45,376                         |       | 114,005 |   | 82,311 |   |
| Research and development.                                                      |       | 25,226                           |       | 21,523                         |       | 49,474 |   | 41,610 |   |
| Selling, general and administrative                                            |       | 30,109                           |       | 24,753                         |       | 55,010 |   | 47,594 |   |
| Amortization of intangible assets                                              |       | 12,735                           |       | 12,431                         |       | 25,470 |   | 24,761 |   |
| Amortization of stock-based compensation resulting  from business combinations |       | —                           |       | 457                            |       | — |   | 974 |   |
| In process research and development                                            |       | —                           |       | 2,650                          |       | — |   | 2,650 |   |
| Total costs and expenses                                                       |       | 128,425                          |       | 107,190                        |       | 243,959 |   | 199,900 |   |
|                                                                           |       |                             |       |                           |       |   |   |   |   |
| Operating income  (loss)                                                       |       | (496                             | )          | (12,111                        | )          | 26,216 |   | (30,937 | ) |
|                                                                           |       |                             |       |                           |       |   |   |   |   |
| Interest income                                                                |       | 2,867                            |       | 553                            |       | 4,460 |   | 1,080 |   |
|                                                                           |       |                             |       |                           |       |   |   |   |   |
| Other income  (loss), net                                                      |       | (416                             | )          | (217                           | )          | 777 |   | (641 | ) |
|                                                                           |       |                             |       |                           |       |   |   |   |   |
| Income (loss)  before income taxes                                             |       | 1,955                            |       | (11,775                        | )          | 31,453 |   | (30,498 | ) |
|                                                                           |       |                             |       |                           |       |   |   |   |   |
| Provision (benefit)  for income taxes                                          |       | (2,824                           | )          | —                         |       | 5,991 |   | — |   |
|                                                                           |       |                             |       |                           |       |   |   |   |   |
| Net income  (loss)                                                             |       | $                                | 4,779      |                           | $          | (11,775 | ) | $ | 25,462 |   | $ | (30,498 | ) |
|                                                                           |       |                             |       |                           |       |   |   |   |   |
| Basic net income  (loss) per share                                             |       | $                                | 0.10       |                           | $          | (0.27 | ) | $ | 0.54 |   | $ | (0.70 | ) |
|                                                                           |       |                             |       |                           |       |   |   |   |   |
| Diluted net  income (loss) per share                                           |       | $                                | 0.09       |                           | $          | (0.27 | ) | $ | 0.51 |   | $ | (0.70 | ) |
|                                                                           |       |                             |       |                           |       |   |   |   |   |
| Shares used to  compute basic net income (loss) per share                      |       | 48,461                           |       | 43,707                         |       | 47,341 |   | 43,460 |   |
|                                                                           |       |                             |       |                           |       |   |   |   |   |
| Shares used to compute  diluted net income (loss) per share                    |       | 51,311                           |       | 43,707                         |       | 50,028 |   | 43,460 |   |

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(1)             SeeNote 2, “Restatement of Condensed Consolidated Financial Statements” of theNotes to Condensed Consolidated Financial Statements.

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

2

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**ZORANCORPORATIONCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands)(unaudited)**
| ** **                                                                        | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                        | ** ** | **June 30,**              | ** ** |
| ** **                                                                        | ** ** | **2006**                       | ** ** | **2005** | ** ** |
| ** **                                                                        | ** ** | ** **                     | ** ** | **(Restated)(1)** | ** ** |
| Cash flows from  operating activities:                                            |       |                           |       |   |   |
| Net income (loss)                                                                 |       | $                              | 25,462     |   | $ | (30,498 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by operations:   |       |                           |       |   |   |
| Depreciation                                                                      |       | 4,763                          |       | 5,056 |   |
| Amortization                                                                      |       | 25,507                         |       | 24,788 |   |
| Stock-based compensation expense                                                  |       | 9,959                          |       | 1,692 |   |
| In process research and development                                               |       | —                         |       | 2,650 |   |
| Changes in current assets and liabilities:                                        |       |                           |       |   |   |
| Accounts receivable                                                               |       | 9,559                          |       | (8,215 | ) |
| Inventories                                                                       |       | (15,324                        | )          | 24,893 |   |
| Prepaid expenses and other current assets and other  assets                       |       | (123                           | )          | (1,036 | ) |
| Accounts payable                                                                  |       | 6,430                          |       | 4,275 |   |
| Accrued expenses and other liabilities, goodwill and  other long term liabilities |       | 682                            |       | 459 |   |
| Net cash provided by operating activities                                         |       | 66,915                         |       | 24,064 |   |
|                                                                              |       |                           |       |   |   |
| Cash flows from  investing activities:                                            |       |                           |       |   |   |
| Purchases of property and equipment                                               |       | (3,243                         | )          | (4,355 | ) |
| Purchases of investments                                                          |       | (237,756                       | )          | (4,300 | ) |
| Proceeds from sales and maturities of investments                                 |       | 132,948                        |       | 25,080 |   |
| Acquisition of Oren Semiconductor, Inc. net of cash  acquired                     |       | —                         |       | (27,567 | ) |
| Net cash used in investing activities                                             |       | (108,051                       | )          | (11,142 | ) |
|                                                                              |       |                           |       |   |   |
| Cash flows from  financing activities:                                            |       |                           |       |   |   |
| Proceeds from issuance of common stock                                            |       | 51,637                         |       | 3,068 |   |
| Net cash provided by financing activities                                         |       | 51,637                         |       | 3,068 |   |
|                                                                              |       |                           |       |   |   |
| Net increase in  cash and cash equivalents                                        |       | 10,501                         |       | 15,990 |   |
|                                                                              |       |                           |       |   |   |
| Cash and cash  equivalents at beginning of period                                 |       | 78,856                         |       | 37,435 |   |
|                                                                              |       |                           |       |   |   |
| Cash and cash  equivalents at end of period                                       |       | $                              | 89,357     |   | $ | 53,425 |   |

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(1)             SeeNote 2, “Restatement of Condensed Consolidated Financial Statements” of theNotes to Condensed Consolidated Financial Statements.

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

 

3

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**ZORANCORPORATIONNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(unaudited)**

**1.**                 Basis of Presentation

The accompanying unaudited condensed consolidatedfinancial statements of Zoran Corporation and its subsidiaries (“Zoran” or the “Company”)have been prepared in conformity with accounting principles generally acceptedin the United States of America. However, certain information or footnote disclosures normally includedin financial statements prepared in accordance with accounting principlesgenerally accepted in the United States of America have been condensed oromitted pursuant to the rules and regulations of the Securities and ExchangeCommission (“SEC”).  In the opinion ofmanagement, the condensed consolidated financial statements reflect all adjustmentsconsidered necessary, consisting only of normal recurring adjustments,considered necessary for a fair statement of the consolidated financialposition, operating results and cash flows for the periods presented.  The results of operations for the interimperiods presented are not necessarily indicative of the results that may beexpected for the full fiscal year or in any future period.  This Quarterly Report on Form 10-Q should beread in conjunction with the audited consolidated financial statements andnotes thereto for the year ended December 31, 2006, included in the Company’s2006 Annual Report on Form 10-K.

***Revenues***

Revenues for the three and six month periods endedJune 30, 2006 include $5.6 million and $35.8 million, respectively, in licensepayments related to the settlement of litigation, net of withholding tax andamounts paid to holders of rights under certain patents involved in thelitigation and amounts payable as legal fees. The license agreements providefor additional cash royalty payments of up to $30.0 million payable in elevenquarterly installments which are recorded as software and other revenues whenactual cash payments are received, net of amounts paid to holders of rightsunder certain patents involved in the litigation and amounts payable as legalfees. Accordingly, the Company recorded $1.0 million as software and otherrevenues during the three months ended June 30, 2006 and as of June 30, 2006,up to $14.3 million in future royalty payments were payable to Zoran underthese agreements.

***Recent Accounting Pronouncements***

In June 2006, the Financial Accounting Standards Board(“FASB”) published FIN 48, “Accounting for Uncertainty in Income Taxes—aninterpretation of FASB Statement No. 109,” which clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with SFAS No. 109, Accounting for Income Taxes. ThisInterpretation prescribes a recognition threshold and measurement attribute forthe financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. This Interpretation also providesguidance on derecognition, classification, interest and penalties, accountingin interim periods, disclosure, and transition. This Interpretation iseffective for the Company in fiscal years beginning January 1, 2007. Theimpact of the provisions of this Interpretation on the Company’s retainedearnings is expected to be less than $5 million.

In February 2006, the FASB issued Statement ofFinancial Accounting Standards (“SFAS”) No. 155, “Accounting for CertainHybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140”(“SFAS No.155”).  SFAS No. 155 permitsfair value remeasurement for hybrid financial instruments containing anembedded derivative which otherwise requires bifurcation.  This statement is effective for all financialinstruments acquired or issued by the Company after January 1, 2007.  The Company anticipates that the adoption ofSFAS No. 155 will not have a material impact on its condensed consolidatedfinancial statements.

In December 2004, the FASB issued SFASNo. 123(R), “Share-Based Payment,” an Amendment of SFAS 123 (“SFAS No. 123(R)”).  SFAS No. 123(R) requires the Company tomeasure all employee stock-based compensation awards using a fair value methodand record such expense in its consolidated financial statements.  InMarch 2005, the SEC issued Staff Accounting Bulletin (“SAB”) 107, whichprovides the Staff’s views regarding interactions between SFAS No. 123(R)and certain SEC rules and regulations and provides interpretations of thevaluation of share-based payments for public companies. Effective January 1,2006, the Company adopted SFAS No. 123(R) on a modified prospective basis.As a result, the Company began to include stock-based compensation costs in itsresults of operations beginning with the quarter ended March 31,2006.  See Note 3 “Stock-BasedCompensation”.

4

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**2.**                 Restatement of Condensed ConsolidatedFinancial Statements

**Independent Investigation**

On July 3, 2006, the Company announced that, at therecommendation of the Audit Committee, the Board of Directors had created aspecial committee of independent directors (“Special Committee”) to conduct areview of our historical stock option practices. As a result of itsinvestigation, the Special Committee found, among other things, that some ofthe original measurement dates used by the Company for option grants were notadequately supported by contemporaneous records, and therefore the measurementdates used by us for accounting purposes required adjustment. The SpecialCommittee concluded that the evidence did not establish that the errors whichit identified resulted from fraud or intentional misconduct by our currentsenior management.

Based on the Special Committee’s findings and its ownreview of the facts, the Board of Directors concluded that there was no fraudor intentional misconduct by any current member of senior management.  The Board also concluded that it hasconfidence in the integrity of the Company’s Chief Executive Officer, Dr. LevyGerzberg, and the Company’s Chief Financial Officer, Mr. Karl Schneider.

Based on information obtained from the SpecialCommittee’s review and additional work undertaken by the Company, managementhas concluded, and the Audit Committee has agreed, that the Company shouldrestate certain previously filed financial statements, to reflect additionalstock-based compensation expense with regard to certain past stock optiongrants. The corrections made in the restatements relate to options coveringapproximately 3.6 million shares. These adjustments, after tax, amounted to anadditional stock-based compensation expense of $180,000 and $652,000 in thethree months ended June 30, 2006 and 2005 and $360,000 and $718,000 in the sixmonths ended June 30, 2006 and 2005 respectively. There was no tax impact ofthese additional expenses due to full valuation allowance on our tax assets.

In connection with the restatement, the Company isrecording additional non-cash adjustments that were previously considered to beimmaterial relating to the timing of revenue recognition, accrued expenses,amortization of premiums and discounts on investments and the amortization ofstock-based compensation relating to a business combination in 2003.  The Company is also recording losses underAccounting Principles Board (“APB”) Opinion No. 18 (“APB No. 18”), “TheEquity Method of Accounting for Investments in Common Stock,” to record thelosses on investment of the prior 17% ownership of Oren Semiconductor, Inc.under the equity method of accounting which was subsequently acquired by Zoranin 2005.  These additional adjustmentsresulted in a cumulative expense of $1.3 million, including $0.2 millionof tax expense, for the periods 2000 through 2005.

Through 2005, we applied APB Opinion No. 25,“Accounting for Stock Issued to Employees” (“APB No. 25”) and its relatedinterpretations, and provided the required pro forma disclosures underStatement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting forStock-Based Compensation,” and SFAS No. 148, “Accounting for Stock-Based,Compensation-Transition and Disclosure.” Under APB No. 25, non-cash, stock-based compensation expense wasrecognized for any option for which the exercise price was below the marketprice on the actual grant date. Because each of the options identified below(other than those which we have determined should be accounted for variably)was deemed to have an exercise price below the market price on the appropriatemeasurement date, we should have recognized a charge for each of those optionsunder APB No. 25, in an amount equal to the number of shares covered by suchoptions, multiplied by the difference between the exercise price and the marketprice on the appropriate measurement date. That expense should have beenamortized over the vesting periods of the options. Starting in 2006, we adoptedSFAS No. 123(R).  As a result, for 2006,the additional stock-based compensation expense required to be recorded foreach of the options identified below was equal to the incremental fair value ofthose options on the appropriate measurement date over the remaining vestingperiods of those options.  We did notrecord such stock-based compensation expenses under APB No. 25 or SFASNo. 123(R) in our previously issued financial statements, and that is thereason for the restatement in this report. To correct our past accounting for stock options, we recorded additionalpre-tax, non-cash, stock-based compensation expense of (a) $11.7 million forthe periods 1997 to 2005 under APB No. 25 and (b) $180,000 and $360,000 for thethree months and six months ended June 30, 2006 under SFAS No. 123(R). Thefair value of the options is being recorded using the accelerated amortizationmethod under FIN 28 over the respective vesting periods of the awards.

Consistent with the accounting literature and recentguidance from the Securities and Exchange Commission (“SEC”), the Company hasorganized the grants with respect to which an accounting adjustment is requiredinto categories based on grant type and process by which the grant wasfinalized.  Based on the relevant factsand circumstances, the Company applied the relevant accounting standards todetermine the measurement date for every grant within each category. TheCompany recorded accounting adjustments as required, resulting in stock-basedcompensation expense and related tax effects. The Company organized the grants where adjustments were required asfollows:

·                    *Company-wide option grants where optionees were addedor grant amounts were changed after the option list was complete, or whereinsufficient contemporaneous documentation of the grant date exists.* For seven Company-wide refresh and retentiongrants made between 1998 and 2003, the Company determined that some employeeswho were omitted from the option grant list were added to the list after thestated grant date, and that the number of shares covered by option grants tosome employees was not finally determined until after the stated grantdate.  Further, in 2001 and 2002,insufficient contemporaneous documentation of the stated grant dateexisted.  As a result of these issues,the Company restated its historical financial statements to increasestock-based compensation expense by approximately $6.3 million, recognized overthe vesting periods of the relevant options.

·                    *Re-priced options. *In August 2002, after consideration of relevant information,the Compensation Committee rescinded its April 2002 grant, and its June 2002 grant,to executives and other key employees.  TheCompany thereafter reissued the grants in August 2002.  At the time, in consultation with ourexternal advisors, we determined that these transactions

5

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did not require variable accounting.  As a result of the Special Committee reviewof our historical stock option practices, we have reassessed the circumstancessurrounding these transactions with our external advisors and have determinedthat the grants should have been accounted for variably.  As a result, the Company restated itshistorical financial statements to increase stock-based compensation expense bya cumulative net amount of approximately $3.8 million, recognized over thevesting periods of these options.

·                    *Acquisition-related options*.  The Company determined a grant given toretain employees hired in connection with an acquisition in October 2000 shouldhave been accounted for variably.  As aresult, the Company restated its historical financial statements to increasestock-based compensation expense by approximately $0.3 million, recognizedover the vesting periods of these options.

·                    *Improper measurement dates for non-refresh stockoption grants. *The Companyrevised the measurement dates for**certaingrants made to new hires and for promotional and other miscellaneousnon-refresh grants made between 1997 and 2003 as a result of approvals thatwere obtained subsequent to the stated grant dates or as a result ofadministrative delays or errors and a small number of stock option grants tonon-executives that were determined to have been established retrospectively.As a result, the Company restated its historical financial statements toincrease stock-based compensation expense by approximately $1.3 million,recognized over the vesting periods of these options.

In the aggregate, we have recorded additionalstock-based compensation expense for the periods 1997 through 2005 ofapproximately $11.7 million on stock option grants made from 1997 through 2003.

The incrementalimpact from recognizing stock-based compensation expense resulting from theinvestigation of past stock option grants is as follows (dollars in thousands):

| **Fiscal Year**                             | ** ** | **Expense  (Benefit)** | ** ** |
|---------------------------------------------|------------|------------------------|------------|
| 1997                                        |       | $                      | 190        |   |
| 1998                                        |       | 223                    |       |
| 1999                                        |       | 123                    |       |
| 2000                                        |       | 120                    |       |
| 2001                                        |       | 1,385                  |       |
| 2002                                        |       | 3,182                  |       |
| 2003                                        |       | 5,299                  |       |
| Cumulative effect at December 31, 2003 |       | 10,522                 |       |
| 2004                                        |       | (1,476                 | )          |
| 2005                                        |       | 2,623                  |       |
|                                        |       | $                      | 11,669     |   |

 

The cumulative effect of all of the restatementsthrough December 31, 2003 increased additional paid-in capital by $10.7 millionfrom $703.8 million to $714.5 million, increased accumulated deficit by $9.0million from $156.4 million to $165.4 million, and decreased total stockholders’equity by $0.7 million from $534.3 million to $533.6 million. All therestatements of financial statements, financial data and related disclosuresdescribed in this report are collectively referred to in this report as the “restatements.”

In December 2006, the Company amended options topurchase approximately 218,000 shares of common stock held by Dr. Gerzberg andMr. Schneider, to increase the exercise price of those options to the fairmarket value of the Company’s common stock on the revised measurement date sothat these options are no longer subject to IRC Section 409A.

6

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We have not amended, and we do not intend to amend,any of our previously filed Annual Reports on Form 10-K.  We have amended our Quarterly Report for theperiod ended March 31, 2006 concurrent with the filing of our Annual Report onForm 10-K, and we do not intend to amend any of our other previously filedQuarterly Reports on Form 10-Q for the periods affected by the restatements.

The impact of the restatements on the interim periodsof each of the first three quarters of 2006 and each of the quarters of 2005are disclosed in “Selected Quarterly Financial Information (Unaudited)”included in this report.

*Restatement andImpact on Financial Statements*

The income statement impact of the restatements are asfollows (in thousands):
|                                                                                                                           | ** ** | **Cumulative  effect at  December,  31, 2005**                                           | ** ** | **Year Ended  December 31  2005**                                                        | ** ** | **Year  Ended  December  31, 2004** | ** ** | **Cumulative  effect at  December,  31, 2003** | ** ** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|----------------------------------------------------------|------------|------------|
| Net loss, as previously reported                                                                                          |       |                                                                                               |       | $                                                                                                  | (26,971    | )                                        | $          | (47,354                                                  | )          |       |   |   |
| Additional  compensation (expense) benefit resulting from improper measurement dates for  stock option grants, net of tax |       | $                                                                                                  | (11,669    | )                                                                                                  | (2,623     | )                                        | 1,476      |                                                     | $          | (10,522    | ) |   |
| Other adjustments, net of tax                                                                                             |       | (1,374                                                                                             | )          | (678                                                                                               | )          | (2,230                                   | )          | 1,534                                                    |       |       |
| Total increase  to net loss                                                                                               |       |                 (13,043 | )          | (3,301                                                                                             | )          | (754                                     | )          | (8,988                                                   | )          |       |
| Net loss, as restated                                                                                                     |       |                                                                                               |       |                 (30,272 | )          | (48,108                                  | )          |                                                     |       |       |
|                                                                                                                           |            |                                                                                                    |            |                                                                                                    |            |                                          |            |                                                          |            |            |  |  |  |  |

 
| ** **                                                                                            | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                            | ** ** | **2003**                    | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** | **1999** | ** ** | **1998** | ** ** | **1997** | ** ** |
| Stock based  compensation expense, as previously reported                                             |       | $                           | (6,281     | ) | $ | (292 | ) | $ | (544 | ) | $ | (99 | ) | $ | — |   | $ | — |   | $ | — |   |
| Additional  compensation (expense) resulting from improper measurement dates for stock  option grants |       | (5,299                      | )          | (3,182 | ) | (1,385 | ) | (120 | ) | (123 | ) | (223 | ) | (190 | ) |
| Stock based  compensation expense, as restated                                                        |       | $                           | (11,580    | ) | $ | (3,474 | ) | $ | (1,929 | ) | $ | (219 | ) | $ | (123 | ) | $ | (223 | ) | $ | (190 | ) |

 

7

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In addition, the Company evaluated the impact of therestatements on its global tax provision. The Company and its subsidiaries filetax returns in multiple tax jurisdictions around the world. In certainjurisdictions, including, but not limited to, the United States and Israel, theCompany is able to claim a tax deduction relative to stock options. In thosejurisdictions, where a tax deduction is claimed, the Company has recordeddeferred tax assets relative to the book compensation now recorded on the restatedoptions.  As with our other deferred taxassets, the company recorded a full valuation allowance on all deferred taxassets relating to restated options.  TheCompany also believes that it should not have taken a United States taxdeduction of $0.6 million in prior years for stock option related amountspertaining to certain executives under Internal Revenue Code (IRC) Section162(m) which limits the deductibility of compensation above certain thresholds.The deferred tax asset and related valuation allowance have been adjustedaccordingly.  The cumulative tax effectof all components of the restatements for 1997 to 2005 is an increase in taxexpense of $200,000.

On February 27, 2007, the Company elected to: (i)participate in the Internal Revenue Service remediation program 2007-18 and payto the IRS, on behalf of affected and eligible employees (not includingexecutive officers), their IRC 409A tax liabilities and penalties; (ii)participate in any similar remediation program that may be offered by any statefor applicable state tax liabilities and penalties; (iii) act directly with anystate not offering a similar remediation program to address any applicable taxliabilities and penalties on behalf of employees; and (iv) pay to suchemployees a “gross-up” payment to offset the associated federal and stateincome tax consequences.   The Companytook this action because the vast majority of the holders of stock optionsissued by the Company that are now subject to re-measurement as a result of theCompany’s option investigation were not involved in or aware of the stockoption pricing determination.  Employeeswho exercised such options in 2006, other than executive officers at the timeof option grant or entering into this program, will participate in thisprogram.  The Company estimates that thetotal cash payments needed to deal with the adverse tax consequences of previouslyexercised discount priced options granted to non-officers will be approximately$0.8 million, which is expected to be recorded in 2007.

In addition, the Company may consider taking action tominimize the adverse tax consequences that may be incurred by the holders of unexerciseddiscount options. Discount-priced stock options vesting after December 31, 2004(“409A Affected Options”) subject U.S. option holders to a penalty tax underIRC Section 409A (and to similar penalty taxes under California and other statetax laws, as applicable). The Company may consider offering to amend the 409AAffected Options held by persons other than directors and executive officers toincrease the exercise prices of those options to the market price of our commonstock on the revised measurement date. The amended options would not be subjectto taxation under IRC Section 409A. Under IRS regulations, the amendments fornon-executives cannot be offered until after this Report is filed and do notneed to be completed until December 31, 2007. The Company may also considerapproving the payment of bonuses to holders of those amended options tocompensate them for the resulting increase in their option exercise price. Theamount of these bonuses would be effectively repaid to the Company if and whenthe options are exercised and the increased exercise price is paid (but thereis no assurance that the options will be exercised).  The Company has not estimated the expense ofany such bonus payments.

The restatement adjustments did not affect the Company’spreviously reported cash and cash equivalents and investments balances. Thefollowing presents the effect of the restatement adjustments by financialstatement line item for the Condensed Consolidated Balance Sheets as ofDecember 31, 2005, and Statements of Operations and Statements of Cash Flowsfor the three and six months ended June 30, 2005.

8

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**ZORANCORPORATIONCONDENSED CONSOLIDATED BALANCE SHEETS(in thousands, except share data)(unaudited)**
| ** **                                                                                                                                                       | ** ** | **December 31,  2005** | ** ** | **Adjustments  (Note 1)** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|--------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                       | ** ** | **(As reported)**      | ** ** | ** **                     | ** ** | **(As restated)**      | ** ** |
| ASSETS                                                                                                                                                           |       |                        |       |                           |       |                        |       |
| Current assets:                                                                                                                                                  |       |                        |       |                           |       |                        |       |
| Cash and cash  equivalents                                                                                                                                       |       | $                           | 78,856     |                           | $          | —                      |       | $ | 78,856 |   |
| Short-term  investments                                                                                                                                          |       | 70,490                      |       | —                         |       | 70,490                      |       |
| Accounts  receivable, net                                                                                                                                        |       | 70,174                      |       | —                         |       | 70,174                      |       |
| Inventories                                                                                                                                                      |       | 32,616                      |       | —                         |       | 32,616                      |       |
| Prepaid expenses  and other current assets                                                                                                                       |       | 11,746                      |       | —                         |       | 11,746                      |       |
| Total current  assets                                                                                                                                            |       | 263,882                     |       | —                         |       | 263,882                     |       |
| Property and  equipment, net                                                                                                                                     |       | 16,057                      |       | —                         |       | 16,057                      |       |
| Other assets and  investments                                                                                                                                    |       | 20,799                      |       | —                         |       | 20,799                      |       |
| Goodwill                                                                                                                                                         |       | 184,254                     |       | (1,592                         | )          | 182,662                     |       |
| Intangible  assets, net                                                                                                                                          |       | 119,231                     |       | —                         |       | 119,231                     |       |
|                                                                                                                                                             |       | $                           | 604,223    |                           | $          | (1,592                      | )          | $ | 602,631 |   |
|                                                                                                                                                             |       |                        |       |                           |       |                        |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                       |       |                        |       |                           |       |                        |       |
| Current  liabilities:                                                                                                                                            |       |                        |       |                           |       |                        |       |
| Accounts payable                                                                                                                                                 |       | $                           | 38,999     |                           | $          | —                      |       | $ | 38,999 |   |
| Accrued expenses  and other liabilities                                                                                                                          |       | 53,937                      |       | 832                            |       | 54,769                      |       |
| Total current  liabilities                                                                                                                                       |       | 92,936                      |       | 832                            |       | 93,768                      |       |
| Other long-term  liabilities                                                                                                                                     |       | 11,939                      |       | —                         |       | 11,939                      |       |
| Stockholders’  equity:                                                                                                                                      |       |                        |       |                           |       |                        |       |
| Common stock,  $0.001 par value; 105,000,000 shares authorized at December 31, 2005;  45,426,912 shares issued and outstanding as of December 31, 2005 |       | 45                          |       | —                         |       | 45                          |       |
| Additional paid-in  capital                                                                                                                                      |       | 727,597                     |       | 10,656                         |       | 738,253                     |       |
| Deferred stock-based  compensation                                                                                                                               |       | (593                        | )          | —                         |       | (593                        | )          |
| Accumulated  other comprehensive income                                                                                                                          |       | 3,094                       |       | (37                            | )          | 3,057                       |       |
| Accumulated  deficit                                                                                                                                             |       | (230,795                    | )          | (13,043                        | )          | (243,838                    | )          |
| Total  stockholders’ equity                                                                                                                                 |       | 499,348                     |       | (2,424                         | )          | 496,924                     |       |
|                                                                                                                                                             |       | $                           | 604,223    |                           | $          | (1,592                      | )          | $ | 602,631 |   |

 

----

(1)                                  The restated consolidated balancesheet for the fiscal year ended 2005 reflects a $13.0 million increase toaccumulated deficit and a $10.7 million increase to additional paid-in capitalprimarily due to additional stock-based compensation recorded in connectionwith this restatement to correct prior year stock option-related accountingerrors as described above and to reflect the cumulative impact of otheradjustments that were previously considered to be immaterial. The $1.6 milliondecrease to goodwill is the impact of recording losses associated with ourinvestment in Oren Semiconductor under the equity method of accounting and $0.8million increase to accrued expenses and other liabilities relates to theaccrual of royalty obligations that were previously not recorded at December31, 2005.

9

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**CONSOLIDATEDSTATEMENTS OF OPERATIONS(in thousands, except per share data)**
| ** **                                                                     | ** ** | **Three months Ended** | ** ** | **Six months Ended** | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                     | ** ** | **June 30, 2005**      | ** ** | **June 30, 2005**    | ** ** |
| ** **                                                                     | ** ** | **As  previously  reported**     | ** ** | **Adjust-  ments (1)**         | ** ** | **As  restated** | ** ** | **As  previously  reported** | ** ** | **Adjust-  ments (1)** | ** ** | **As  restated** | ** ** |
|                                                                           | ** ** | ** **                       |       |                           |       |   |   |   |   |   |   |   |   |
| Revenues:                                                                      |       |                             |       |                           |       |   |   |   |   |   |   |   |   |
| Hardware product revenues                                                      |       | $                                | 80,897     |                           | $          | — |   | $ | 80,897 |   | $ | 139,899 |   | $ | — |   | $ | 139,899 |   |
| Software and other revenues                                                    |       | 14,182                           |       | —                         |       | 14,182 |   | 29,064 |   | — |   | 29,064 |   |
| Total revenues                                                                 |       | 95,079                           |       | —                         |       | 95,079 |   | 168,963 |   | — |   | 168,963 |   |
| Costs and  expenses:                                                           |       |                             |       |                           |       |   |   |   |   |   |   |   |   |
| Cost of hardware product revenues*                                             |       | 45,236                           |       | 140                            |       | 45,376 |   | 82,200 |   | 111 |   | 82,311 |   |
| Research and development*                                                      |       | 21,321                           |       | 202                            |       | 21,523 |   | 41,421 |   | 189 |   | 41,610 |   |
| Selling, general and administrative*                                           |       | 24,318                           |       | 435                            |       | 24,753 |   | 47,492 |   | 102 |   | 47,594 |   |
| Amortization of intangible assets                                              |       | 12,431                           |       | —                         |       | 12,431 |   | 24,761 |   | — |   | 24,761 |   |
| Amortization of stock-based compensation resulting  from business combinations |       | 457                              |       | —                         |       | 457 |   | 974 |   | — |   | 974 |   |
| In-process research and development                                            |       | 2,650                            |       | —                         |       | 2,650 |   | 2,650 |   | — |   | 2,650 |   |
| Total costs and expenses                                                       |       | 106,413                          |       | 777                            |       | 107,190 |   | 199,498 |   | 402 |   | 199,900 |   |
| Operating loss                                                                 |       | (11,334                          | )          | (777                           | )          | (12,111 | ) | (30,535 | ) | (402 | ) | (30,937 | ) |
| Interest income                                                                |       | 572                              |       | (19                            | )          | 553 |   | 1,107 |   | (27 | ) | 1,080 |   |
| Other income  (loss), net                                                      |       | (293                             | )          | 76                             |       | (217 | ) | (423 | ) | (218 | ) | (641 | ) |
| Loss before  income taxes                                                      |       | (11,055                          | )          | (720                           | )          | (11,775 | ) | (29,851 | ) | (647 | ) | (30,498 | ) |
| Provision for  income taxes                                                    |       | —                           |       | —                         |       | — |   | — |   | — |   | — |   |
| Net loss                                                                       |       | $                                | (11,055    | )                              | $          | (720 | ) | $ | (11,775 | ) | $ | (29,851 | ) | $ | (647 | ) | $ | (30,498 | ) |
| Basic net loss  per share                                                      |       | $                                | (0.25      | )                              | $          | (0.02 | ) | $ | (0.27 | ) | $ | (0.69 | ) | $ | (0.01 | ) | $ | (0.70 | ) |
| Diluted net loss  per share                                                    |       | $                                | (0.25      | )                              | $          | (0.02 | ) | $ | (0.27 | ) | $ | (0.69 | ) | $ | (0.01 | ) | $ | (0.70 | ) |
| Shares used to  compute basic net loss per share                               |       | 43,707                           |       |                           |       | 43,707 |   | 43,460 |   |   |   | 43,460 |   |
| Shares used to compute  diluted loss per share                                 |       | 43,707                           |       |                           |       | 43,707 |   | 43,460 |   |   |   | 43,460 |   |

----

*                    includes thefollowing amounts related to employee equity awards
| Cost of hardware  product revenues   |   | $ | — |   | $ | 14  |   | $ | 14  |   | $ | — |   | $ | 16  |   | $ | 16  |   |
|--------------------------------------|--------|---|--------|--------|---|-----|--------|---|-----|--------|---|--------|--------|---|-----|--------|---|-----|--------|
| Research and  development            |   | $ | — |   | $ | 203 |   | $ | 203 |   | $ | — |   | $ | 223 |   | $ | 223 |   |
| Selling, general and  administrative |   | $ | — |   | $ | 435 |   | $ | 435 |   | $ | — |   | $ | 479 |   | $ | 479 |   |

 

(1)             Inaddition to restating the consolidated financial statements in response to theSpecial Committee’s findings, the Company has recorded additional non-cashadjustments that were considered to be immaterial to our previously filedconsolidated financial statements relating to the timing of revenuerecognition, accrued expenses, amortization of premiums and discountson investments, additional expense related to options granted to a consultant,and the amortization of stock-based compensation relating to a business combinationin 2003.  In addition, the Company is also recording lossesunder APB No. 18 (“APB No. 18”), “The Equity Method of Accounting forInvestments in Common Stock,” to record the losses on investment ofthe prior 17% ownership of Oren Semiconductor, Inc. under the equity methodof accounting which was subsequently acquired by Zoran in 2005.

10

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**CONSOLIDATEDSTATEMENTS OF CASH FLOWS(in thousands)**
| ** **                                                                        | ** ** | **Six Months Ended June 30, 2005** | ** ** |
|-----------------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                                                        | ** ** | **As previously  reported**                            | ** ** | **Adjustments** | ** ** | **As restated** | ** ** |
| Cash flows from  operating activities:                                            | ** ** | ** **                                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss                                                                          |       | $                                                           | (29,851    | ) | $ | (647 | ) | $ | (30,498 | ) |
| Adjustments to reconcile net loss to net cash  provided by (used in) operations:  |       |                                                        |       |   |   |   |   |
| Depreciation                                                                      |       | 5,056                                                       |       | — |   | 5,056 |   |
| Amortization                                                                      |       | 24,761                                                      |       | 27 |   | 24,788 |   |
| Stock-based compensation expense                                                  |       | 974                                                         |       | 718 |   | 1,692 |   |
| In-process research and development                                               |       | 2,650                                                       |       | — |   | 2,650 |   |
| Changes in assets and liabilities, net of effect of  acquisitions:                |       |                                                        |       |   |   |   |   |
| Accounts receivable                                                               |       | (8,215                                                      | )          | — |   | (8,215 | ) |
| Inventory                                                                         |       | 24,893                                                      |       | — |   | 24,893 |   |
| Prepaid expenses and other current assets and other  assets                       |       | (1,124                                                      | )          | 88 |   | (1,036 | ) |
| Accounts payable                                                                  |       | 4,275                                                       |       | — |   | 4,275 |   |
| Accrued expenses and other liabilities, goodwill and  other long term liabilities |       | 645                                                         |       | (186 | ) | 459 |   |
| Net cash provided by operating activities                                         |       | 24,064                                                      |       | — |   | 24,064 |   |
| Cash flows from  investing activities:                                            |       |                                                        |       |   |   |   |   |
| Purchases of property and equipment                                               |       | (4,355                                                      | )          | — |   | (4,355 | ) |
| Purchases of investments                                                          |       | (4,300                                                      | )          |   |   | (4,300 | ) |
| Proceeds from sales and maturities of investments                                 |       | 25,080                                                      |       | — |   | 25,080 |   |
| Acquisition of Oren Semiconductor, Inc., net of cash  acquired                    |       | (27,567                                                     | )          | — |   | (27,567 | ) |
| Net cash used in investing activities                                             |       | (11,142                                                     | )          | — |   | (11,142 | ) |
| Cash flows from  financing activities:                                            |       |                                                        |       |   |   |   |   |
| Proceeds from issuance of common stock                                            |       | 3,068                                                       |       | — |   | 3,068 |   |
| Net cash  provided by financing activities                                        |       | 3,068                                                       |       |   |   | 3,068 |   |
| Net increase in  cash and cash equivalents                                        |       | 15,990                                                      |       | — |   | 15,990 |   |
| Cash and cash  equivalents at beginning of period                                 |       | 37,435                                                      |       | — |   | 37,435 |   |
| Cash and cash  equivalents at end of period                                       |       | $                                                           | 53,425     |   | $ | — |   | $ | 53,425 |   |

 

**3.**                  Stock-Based Compensation

Effective January 1, 2006, Zoran adopted SFAS No. 123(R),using the modified prospective application transition method, which establishesaccounting for stock-based awards exchanged for employee services.  Accordingly, stock-based compensation cost ismeasured at grant date, based on the fair value of the award, over therequisite service period.  The Companypreviously applied APB No. 25 and related interpretations and provided thepro forma disclosures required by SFAS No. 123, “Accounting forStock-Based Compensation” (“SFAS No. 123”).

11

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***Periods Prior tothe Adoption of SFAS No. 123(R)***

Prior to the adoption ofSFAS No. 123(R), the Company provided the disclosures required under SFAS No. 123,as amended by SFAS No. 148, “Accounting for Stock-Based Compensation —Transition and Disclosures.”

The pro formaeffect of recognizing compensation expense pursuant to SFAS No. 123 forthe three and six month periods ended June 30, 2005 was as follows (inthousands except per-share amounts):

|                                                                                | ** ** | **Three Months**       | ** ** | **Six Months**         | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                                                     | ** ** | **Ended**                   | ** ** | **Ended**                   | ** ** |
| ** **                                                                     | ** ** | **June 30, 2005** | ** ** | **June 30, 2005** | ** ** |
| ** **                                                                     | ** ** | **(Restated)**              | ** ** | **(Restated)**              | ** ** |
|                                                                           |       |                        |       |                        |       |
| Net loss attributable  to common stockholders                                  |       | $                           | (11,775    | )                           | $          | (30,498 | ) |
|                                                                           |       |                        |       |                        |       |
| Add:                                                                           |       |                        |       |                        |       |
| Stock-based  compensation expense included in loss                             |       | 1,109                       |       | 1,692                       |       |
|                                                                           |       |                        |       |                        |       |
| Total stock-based  compensation expense determined under the fair value method |       | (7,907                      | )          | (15,167                     | )          |
|                                                                           |       |                        |       |                        |       |
| Pro forma net loss  attributable to common stockholders                        |       | $                           | (18,573    | )                           | $          | (43,973 | ) |
|                                                                           |       |                        |       |                        |       |
|                                                                           |       |                        |       |                        |       |
| Pro forma net loss per  share attributable to common stockholders:             |       |                        |       |                        |       |
| Basic                                                                          |       | $                           | (0.42      | )                           | $          | (1.01 | ) |
| Diluted                                                                        |       | $                           | (0.42      | )                           | $          | (1.01 | ) |
|                                                                           |       |                        |       |                        |       |
| Net loss per share as  restated attributable to common stockholders:           |       |                        |       |                        |       |
| Basic                                                                          |       | $                           | (0.27      | )                           | $          | (0.70 | ) |
| Diluted                                                                        |       | $                           | (0.27      | )                           | $          | (0.70 | ) |

 

For purposes of this proforma disclosure, the expense recognized 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 ofAdoption of SFAS No. 123(R)***

During the three and six month periods endedJune 30, 2006, the Company recorded stock-based compensation expense for awardsgranted prior to but not yet vested as of January 1, 2006 as if the fair valuemethod required for pro forma disclosure under SFAS No. 123 were in effectfor expense recognition purposes adjusted for estimated forfeitures. For theseawards, the Company has continued to recognize compensation expense using theaccelerated amortization method. For stock-based awards granted after January1, 2006, the Company recognized compensation expense based on the grant datefair value required under SFAS No. 123(R). For these awards, the Companyrecognized compensation expense using a straight-line amortization method. AsSFAS No. 123(R) requires that stock-based compensation expense be based onawards that are ultimately expected to vest, estimated stock-based compensationfor the three and six month periods ended June 30, 2006 has been reduced forestimated forfeitures.  The adoption ofSFAS No. 123(R) resulted in a one-time benefit of $314,000 related tounvested awards for which compensation expense had already been recorded.

12

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The following table summarizes stock-basedcompensation expense related to employee stock options, employee stockpurchases and restricted stock unit grants for the three and six month periodsended June 30, 2006 as recorded in accordance with SFAS No. 123(R)(including the effect of the restatements) (in thousands):

|                                      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                           | ** ** | **June 30, 2006**      | ** ** | **June 30, 2006**    | ** ** |
| Cost of hardware  product revenues   |       | $                                | 138        |                           | $          | 291 |   |
| Research and  development            |       | 1,444                            |       | 3,054                          |       |
| Selling, general and  administrative |       | 3,564                            |       | 6,614                          |       |
| Total costs and  expenses            |       | $                                | 5,146      |                           | $          | 9,959 |   |

 

**The effect of recording stock-based compensation expense onbasic and diluted net income (loss) per share was $0.10 and $0.09 for the threemonths ended June 30, 2006 and $0.20 and $0.18 per share for the six monthsended June 30, 2006.**

***ValuationAssumptions***

For purposes of thedisclosure requirements of SFAS No. 123 and the requirements of SFAS No. 123(R),the Company estimates the fair value of stock options using the Black-Scholesvaluation model using the following weighted-average assumptions (as restated):
| ** **                     | ** ** | **Stock Option Plans**                | ** ** |
|--------------------------------|------------|-------------------------------------------------|------------|
| ** **                     | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
| ** **                     | ** ** | **2006**                                        | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Average  expected term (years) |       | 5.7                                             |       | 3.9 |   | 5.7 |   | 4.0 |   |
| Expected  volatility           |       | 72                                              | %          | 70 | % | 72 | % | 71 | % |
| Risk-free  interest rate       |       | 5.0                                             | %          | 3.8 | % | 4.8 | % | 3.8 | % |
| Dividend yield                 |       | 0                                               | %          | 0 | % | 0 | % | 0 | % |

 
| ** **                     | ** ** | **Employee Stock Purchase Plans** | ** ** |
|--------------------------------|------------|--------------------------------------------------|------------|
| ** **                     | ** ** | **Three Months EndedJune 30,**    | ** ** | **Six Months Ended  June 30,** | ** ** |
| ** **                     | ** ** | **2006**                                         | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
|                           |       |                                             |       |   |   |   |   |   |   |
| Average  expected term (years) |       | 1.25                                             |       | 1.25 |   | 1.25 |   | 1.25 |   |
| Expected  volatility           |       | 57                                               | %          | 41 | % | 57 | % | 48 | % |
| Risk-free  interest rate       |       | 2.3                                              | %          | 3.2 | % | 2.3 | % | 3.1 | % |
| Dividend yield                 |       | 0                                                | %          | 0 | % | 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 and six months ended June 30, 2006,the Company used historical volatility in deriving its volatilityassumption.  Management believes thathistorical 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:*When estimating forfeitures, the Companyconsiders voluntary termination behavior based on actual historicalinformation.

13

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***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                      |       | 286,770                                              |       | $                                              | 21.79      |   |
| Exercised                    |       | (3,613,491                                           | )          | $                                              | 13.62      |   |
| Canceled*                    |       | (1,317,881                                           | )          | $                                              | 24.37      |   |
| Balances, June 30, 2006      |       | 8,310,983                                            |       | $                                              | 16.40      |   |

----

* Includes 1,060,536underwater options exchanged for restricted shares and restricted stock units.See “RestrictedShares and Restricted Stock Units” below.

Significant option groups outstanding as of June 30, 2006and the related weighted average exercise price and contractual lifeinformation, are as follows:
| ** **               | ** ** | **Options Outstanding**                                 | ** ** | **Options Exercisable**                                 | ** ** |
|--------------------------|------------|--------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| **Exercise Prices** | ** ** | **Shares  Underlying  Options at  June 30,  2006** | ** ** | **Weighted  Average  Remaining  Contractual  Life  (Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Aggregate  Intrinsic  value (‘000)** | ** ** | **Shares  Underlying  Options at  June 30,  2006** | ** ** | **Weighted  Average  Remaining  Contractual  Life  (Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Aggregate  Intrinsic  value (‘000)** | ** ** |
|                     |       |                                                         |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| $0.00 to $9.99           |       | 612,620                                                      |       | 5.45                                                         |       | $ | 6.23 |   | $ | 11,092 |   | 447,949 |   | 4.98 |   | $ | 6.41 |   | $ | 8,030 |   |
| $10.00 to $11.99         |       | 1,431,648                                                    |       | 7.91                                                         |       | $ | 10.56 |   | 19,723 |   | 1,431,648 |   | 7.91 |   | $ | 10.56 |   | 19,723 |   |
| $12.00 to $14.99         |       | 1,660,797                                                    |       | 6.84                                                         |       | $ | 13.00 |   | 18,826 |   | 1,279,018 |   | 6.18 |   | $ | 12.80 |   | 14,758 |   |
| $15.00 to $19.99         |       | 2,412,127                                                    |       | 7.54                                                         |       | $ | 17.09 |   | 17,477 |   | 1,934,823 |   | 7.40 |   | $ | 17.10 |   | 14,016 |   |
| $20.00 to $25.99         |       | 1,799,195                                                    |       | 7.14                                                         |       | $ | 24.06 |   | 973 |   | 1,566,531 |   | 6.76 |   | $ | 24.21 |   | 649 |   |
| $26.00 to $46.53         |       | 394,596                                                      |       | 4.29                                                         |       | $ | 28.59 |   | — |   | 385,631 |   | 4.16 |   | $ | 28.61 |   | — |   |
|                     |       |                                                         |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                    |       | 8,310,983                                                    |       | 7.07                                                         |       | $ | 16.40 |   | $ | 68,091 |   | 7,045,600 |   | 6.81 |   | $ | 16.52 |   | $ | 57,176 |   |

 

The weighted average grant date fair value ofoptions, as determined under SFAS No. 123(R), granted during the threemonths and six months ended June 30, 2006 was $12.65 and $12.21 per share,respectively.

The aggregate intrinsicvalue in the table above represents the total pretax intrinsic value, based onthe Company’s closing stock price of $24.34 as of June 30, 2006, which wouldhave been received by the option holders had all option holders exercised theiroptions as of that date.  The totalnumber of shares of common stock underlying in-the-money options exercisable asof June 30, 2006 was 5.6 million.

The total intrinsic valueof options exercised during the three months and six months ended June 30, 2006was $31.3 million and $40.2 million, respectively.  The total cash received from employees as aresult of employee stock option exercises during the three months and sixmonths ended June 30, 2006 was approximately $32.0 million and $49.2 million,respectively.  In connection with theseexercises, there was no tax benefit realized by the Company due to the Company’scurrent loss position.

As of June 30, 2006, thetotal unrecognized compensation cost related to stock options not yetrecognized was $14.7 million after estimated forfeitures which are expected tobe recognized over an estimated amortization period of four years.

The Company settles employee stock optionexercises with newly issued common shares.

***Stock OptionPlans***

As of June 30, 2006, theCompany had outstanding options for the purchase of 8.3 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 June 30, 2006,3,988,798 shares remained available for future grants and awards. Options andstock appreciation rights granted under the 2005 Plan must have exercise pricesper share not less than the fair market value of Zoran common stock on the dateof grant and may not be repriced without stockholder approval.  Such awards will vest and become exercisableupon conditions established by the Compensation Committee and may not have aterm exceeding 10 years.

***RestrictedShares and Restricted Stock Units***

Restricted shares and restricted stock units aregranted under the 2005 Plan. On January 6, 2006, the Company filed a TenderOffer Statement with the Securities and Exchange Commission and commenced anoffer to current employees to exchange outstanding options with exercise pricesper share that were more than the greater of $20.00 and the closing sale priceof Zoran common stock on the offer expiration date of February 6, 2006.  The exchange offer was approved by Zoran’sstockholders at their 2005 annual meeting. On February 6, 2006, the Companyaccepted for exchange options to purchase an aggregate of 1,060,536 shares ofZoran common stock having an exercise price greater than $22.48. Subject to theterms and conditions of the exchange, the Company granted 197,433 restrictedshares of common stock or restricted stock units in exchange for the tenderedoptions.  The shares of restricted stockand restricted stock units granted as part of this exchange vest over a periodof two years.  None of the directors orexecutive officers was eligible for participation in the exchange offer.  This exchange was accounted as a modificationunder SFAS No. 123(R).  As of 

14

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June30, 2006, there was $0.5 million of total unreocgnized stock-based compensationexpense related to restricted shares and restricted stock units. This cost isexpected to be recognized over the vesting period of two to four years.

The following is asummary of restricted shares and restricted stock units activities:

|                              | ** ** | **Outstanding  restricted shares  and stock units** | ** ** | **Weighted  average grant-  date fair value** | ** ** |
|------------------------------|------------|--------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
|                         |       |                                                               |       |                                                         |       |
|                         |       |                                                               |       |                                                         |       |
| Balances, December 31,  2005 |       | 65,333                                                             |       | $                                                            | 13.59      |   |
| Granted                      |       | 197,433                                                            |       | $                                                            | 21.56      |   |
| Vested                       |       | —                                                             |       | —                                                       |       |
| Forfeited                    |       | (2,889                                                             | )          | $                                                            | (21.56     | ) |
| Balances, June 30, 2006      |       | 259,877                                                            |       | $                                                            | 19.56      |   |

 

***EmployeeStock Purchase Plan***

The Company’s 1995 Employee Stock Purchase Plan(“ESPP”) was adopted by the Company’s Board of Directors in October 1995,and approved by its stockholders in December 1995.  The ESPP enables employees to purchase sharesthrough payroll deductions at approximately 85% of the lesser of the fair valueof common stock at the beginning of a 24-month offering period or the end ofeach six-month segment within such offering period.  The ESPP is intended to qualify as an “employeestock purchase plan” under Section 423 of the U.S. Internal RevenueCode.  During the quarter ended June 30,2006, 263,349 shares were purchased by employees under the terms of the planagreements at a weighted average price of $9.16 per share.  As of June 30, 2006, 2,311,447 shares werereserved and available for issuance under this plan.

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

The following table presents the calculation of comprehensive income(loss) as required by SFAS No. 130 (“Reporting Comprehensive Income”).  The components of comprehensive income(loss), net of tax, are as follows (in thousands):
| ** **                                            | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                            | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                            | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                            | ** ** | ** **                       | ** ** | **(restated)**                 | ** ** | ** ** | ** ** | **(restated)** | ** ** |
|                                                  |       |                             |       |                           |       |   |   |   |   |
| Net income (loss)                                     |       | $                                | 4,779      |                           | $          | (11,775 | ) | $ | 25,462 |   | $ | (30,498 | ) |
| Change in  unrealized gain (loss) on investments, net |       | 309                              |       | 602                            |       | (569 | ) | 1,577 |   |
| Total comprehensive income (loss)                     |       | $                                | 5,088      |                           | $          | (11,173 | ) | $ | 24,893 |   | $ | (28,921 | ) |

The components ofaccumulated other comprehensive income (loss) are unrealized gain (loss) onmarketable securities.

**4.****             ****Short-term investments**

The Company’s portfolio ofshort-term investments at June 30, 2006 was as follows (in thousands):

15

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| ** **                         | ** ** | **Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|------------------------------------|------------|----------|------------|-----------------------|------------|------------------------|------------|----------------------------|------------|
| Corporate debt                     |       | $        | 50,451     |                  | $          | 2                      |       | $                          | (219       | ) | $ | 50,234 |   |
| U.S. government  securities        |       | 19,069   |       | 6                     |       | (67                    | )          | 19,008                     |       |
| Auction rate securities            |       | 88,525   |       | —                |       | —                 |       | 88,525                     |       |
| Foreign bonds                      |       | 13,481   |       | —                |       | (37                    | )          | 13,444                     |       |
| Total fixed income  securities     |       | 171,526  |       | 8                     |       | (323                   | )          | 171,211                    |       |
| Publicly traded equity  securities |       | 1,619    |       | 2,804                 |       | —                 |       | 4,423                      |       |
|                               |       |     |       |                  |       |                   |       |                       |       |
| Total                              |       | $        | 173,145    |                  | $          | 2,812                  |       | $                          | (323       | ) | $ | 175,634 |   |

 

The Company’s portfolio of marketablesecurities at December 31, 2005 was as follows (in thousands):
| ** **                         | ** ** | **Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|------------------------------------|------------|----------|------------|-----------------------|------------|------------------------|------------|----------------------------|------------|
| Corporate debt                     |       | $        | 26,211     |                  | $          | —                 |       | $                          | (151       | ) | $ | 26,060 |   |
| U.S. government  securities        |       | 20,000   |       | —                |       | (151                   | )          | 19,849                     |       |
| Auction rate securities            |       | 15,125   |       | —                |       | —                 |       | 15,125                     |       |
| Foreign bonds                      |       | 4,474    |       | —                |       | (6                     | )          | 4,468                      |       |
| Total fixed income  securities     |       | 65,810   |       | —                |       | (308                   | )          | 65,502                     |       |
| Publicly traded equity  securities |       | 1,623    |       | 3,365                 |       | —                 |       | 4,988                      |       |
|                               |       |     |       |                  |       |                   |       |                       |       |
| Total                              |       | $        | 67,433     |                  | $          | 3,365                  |       | $                          | (308       | ) | $ | 70,490 |   |

 

The following tablesummarizes the maturities of the Company’s fixed income securities at June 30,2006 (in thousands):

|                                | ** ** | **Cost** | ** ** | **Estimated  Fair  Value** | ** ** |
|--------------------------------|------------|----------|------------|----------------------------|------------|
| Less than 1 year               |       | $        | 59,219     |                       | $          | 59,008 |   |
| Due in 1 to 2 years            |       | 14,528   |       | 14,457                     |       |
| Due in 2 to 5 years            |       | 9,254    |       | 9,221                      |       |
| Greater than 5 years*          |       | 88,525   |       | 88,525                     |       |
|                           |       |     |       |                       |       |
| Total fixed income  securities |       | $        | 171,526    |                       | $          | 171,211 |   |

----

*Comprised of auction rate securities which have resetdates of 90 days or less but final expiration dates over 5 years.

**5.****             ****Inventories**

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

|                                      | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **2006**          | ** ** | **2005**              | ** ** |
|                                 |       |              |       |                  |       |
| Purchased parts and  work in process |       | $                 | 24,509     |                  | $          | 14,904 |   |
| Finished goods                       |       | 23,431            |       | 17,712                |       |
|                                 |       | $                 | 47,940     |                  | $          | 32,616 |   |

 

16

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**6.****             ****Goodwill and Other Intangible Assets**

In accordance with SFAS No. 142, goodwill is not amortized.  The Company monitors the recoverability ofgoodwill recorded in connection with acquisitions, by reporting unit, annually,or sooner if events or changes in circumstances indicate that the carryingamount may not be recoverable.  TheCompany performed the annual analysis as of September 30, 2005 and concludedthat goodwill was not impaired, as the fair value of each reporting unitexceeded its carrying value, including goodwill.

***Componentsof Acquired Intangible Assets****(in thousands):*
| ** **                    | ** ** | ** **        | ** ** | **June 30, 2006** | ** ** | **December 31, 2005 (restated)** | ** ** |
|-------------------------------|------------|-------------------|------------|-----------------------------|------------|-------------------------------------------------|------------|
| ** **                    | ** ** | **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    |                                            | $          | (124,313 | ) | $ | 71,192 |   | $ | 195,505 |   | $ | (105,088 | ) | $ | 90,417 |   |
| Patents                       |       | 3-5               |       | 40,265                      |       | (24,739                                         | )          | 15,526 |   | 40,265 |   | (19,978 | ) | 20,287 |   |
| Customer base                 |       | 3-5               |       | 13,860                      |       | (8,353                                          | )          | 5,507 |   | 13,860 |   | (7,123 | ) | 6,737 |   |
| Tradename and  others         |       | 3-5               |       | 3,350                       |       | (1,814                                          | )          | 1,536 |   | 3,350 |   | (1,560 | ) | 1,790 |   |
|                          |       |              |       |                        |       |                                            |       |   |   |   |   |   |   |   |   |
| Total                         |       |              |       | $                           | 252,980    |                                            | $          | (159,219 | ) | $ | 93,761 |   | $ | 252,980 |   | $ | (133,749 | ) | $ | 119,231 |   |

----

Estimated future intangibleamortization expense, based on current balances, as of June 30, 2006 is asfollows (in thousands):

| Remaining six months of 2006   |   | $      | 24,592 |   |
|--------------------------------|--------|--------|--------|--------|
| Year ending December  31, 2007 |   | 43,224 |   |
| Year ending December  31, 2008 |   | 23,315 |   |
| Year ending December  31, 2009 |   | 1,820  |   |
| Year ending December  31, 2010 |   | 810    |   |
|                           |   | $      | 93,761 |   |

 

Goodwill by reporting units wasas follows (in thousands):

|            | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------|------------|-------------------|------------|-----------------------|------------|
| ** ** | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| ** ** | ** ** | ** **        | ** ** | **(restated)**        | ** ** |
| ** ** | ** ** | ** **        | ** ** | ** **            | ** ** |
| Consumer   |       | $                 | 173,023    |                  | $          | 176,623 |   |
| Imaging    |       | 5,639             |       | 6,039                 |       |
|       |       |              |       |                  |       |
|       |       | $                 | 178,662    |                  | $          | 182,662 |   |

 

**7.****             ****Income Taxes**

The provision forincome taxes reflects the effective tax rate applied to earnings, excludingcharges for amortization of intangible assets for the interim periods, aone-time charge of $4.3 million relating to the MediaTek settlement and abenefit of $0.7 million related to the closure of a domestic income taxaudit.  The effective tax rate differsfrom the U.S. statutory rate due to utilization of previously unbenefittedoperating losses and State of Israel tax benefits on foreign earnings.  The provision is due primarily to domesticincome offset by previously unbenefitted purchased NOLs which when utilizedreduce goodwill and not tax expense.

**8.****             ****Segment Reporting**

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 determiningwhat information to report is based on the manner in which management organizesthe operating segments within the Company for making operational decisions andassessments of financial performance. The Company’s chief operating decision-maker is considered to be theChief Executive Officer.

17

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The Company’s productsare based on highly integrated application-specific integrated circuits, orASICs, and system-on-a-chip, or SOC, solutions. The Company also licenses certain software and other intellectualproperty.  During the first quarter of2006, the Company reorganized its operating structure to bring together itsconsumer electronic product lines under a single operating group, inrecognition of the accelerating convergence of consumer products and theCompany’s strategy of sharing technology among its various product lines.  The new Consumer group combines the formerDigital Versatile Disc (DVD), Digital Television (DTV) and Mobile productgroups whose operations were previously reported separately.  The Company will continue to report the operationsof its Imaging group as a separate 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.  TheImaging group provides products used in digital copiers, laser and inkjetprinters as well as multifunction peripherals.

The chief operatingdecision maker allocates resources to and evaluates operating segmentperformance based on net revenues and operating expenses of thesesegments.  The accounting policies of theoperating segments are the same as those described in the summary of accountingpolicies.  No reportable segments havebeen aggregated.

Information about reported segment income or loss is asfollows for the three and six months ended June 30, 2006 and 2005 (inthousands):
| ** **           | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **           | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **           | ** ** | ** **                                      | ** ** | **(restated)**                                | ** ** | ** ** | ** ** | **(restated)** | ** ** |
| Net revenues:        |       |                                            |       |                                          |       |   |   |   |   |
| Consumer             |       | $                                               | 109,760    |                                          | $          | 72,110 |   | $ | 233,316 |   | $ | 125,086 |   |
| Imaging              |       | 18,169                                          |       | 22,969                                        |       | 36,859 |   | 43,877 |   |
|                 |       | $                                               | 127,929    |                                          | $          | 95,079 |   | $ | 270,175 |   | $ | 168,963 |   |
|                 |       |                                                 |       |                                          |       |  |   |   |   |
| Operating expenses:  |       |                                            |       |                                          |       |   |   |   |   |
| Consumer             |       | $                                               | 99,360     |                                          | $          | 75,681 |   | $ | 186,975 |   | $ | 140,610 |   |
| Imaging              |       | 16,330                                          |       | 15,971                                        |       | 31,514 |   | 30,905 |   |
|                 |       | $                                               | 115,690    |                                          | $          | 91,652 |   | $ | 218,489 |   | $ | 171,515 |   |
|                 |       |                                                 |       |                                          |       |  |   |   |   |
| Contribution margin: |       |                                            |       |                                          |       |   |   |   |   |
| Consumer             |       | $                                               | 10,400     |                                          | $          | (3,571 | ) | $ | 46,341 |   | $ | (15,524 | ) |
| Imaging              |       | 1,839                                           |       | 6,998                                         |       | 5,345 |   | 12,972 |   |
|                 |       | $                                               | 12,239     |                                          | $          | 3,427 |   | $ | 51,686 |   | $ | (2,552 | ) |

 

A reconciliation of the totalsreported for the operating segments to the applicable line items in theconsolidated financial statements for the three and six months ended June 30,2006 and 2005 is as follows (in thousands):
| ** **                                                               | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                               | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                               | ** ** | ** **                                      | ** ** | **(restated)**                                | ** ** | ** ** | ** ** | **(restated)** | ** ** |
| Contribution margin from operating segments                              |       | $                                               | 12,239     |                                          | $          | 3,427 |   | $ | 51,686 |   | $ | (2,552 | ) |
| Amortization of intangibles                                              |       | 12,735                                          |       | 12,431                                        |       | 25,470 |   | 24,761 |   |
| Amortization of stock compensation resulting from business  combinations |       | —                                          |       | 457                                           |       | — |   | 974 |   |
| In process research and development                                      |       | —                                          |       | 2,650                                         |       | — |   | 2,650 |   |
| Total operating income (loss)                                            |       | $                                               | (496       | )                                             | $          | (12,111 | ) | $ | 26,216 |   | $ | (30,937 | ) |

 

18

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Zoran maintainsoperations in Canada, China, Germany, Israel, Japan, Korea, Taiwan, UnitedKingdom and the United States. Activities in Israel and the United States consist of corporateadministration, product development, logistics and worldwide sales management.  Other foreign operations consist of sales,product development and technical support.

The geographic distribution of total revenues for the three and sixmonths ended June 30, 2006 and 2005 was as follows (in thousands):
| ** **                                                 | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                 | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Revenue from unaffiliated  customers originating from:** |       |                                            |       |                                          |       |   |   |   |   |
| China                                                      |       | $                                               | 46,948     |                                          | $          | 40,584 |   | $ | 86,553 |   | $ | 68,549 |   |
| Japan                                                      |       | 27,631                                          |       | 27,667                                        |       | 54,995 |   | 51,713 |   |
| Korea                                                      |       | 6,756                                           |       | 4,434                                         |       | 15,318 |   | 8,344 |   |
| Taiwan                                                     |       | 28,380                                          |       | 9,929                                         |       | 82,088 |   | 15,332 |   |
| United States                                              |       | 11,077                                          |       | 6,770                                         |       | 18,195 |   | 12,380 |   |
| North America  (excluding United States)                   |       | 26                                              |       | 419                                           |       | 38 |   | 1,112 |   |
| Other                                                      |       | 7,111                                           |       | 5,276                                         |       | 12,988 |   | 11,533 |   |
| **Total revenues**                                         |       | $                                               | 127,929    |                                          | $          | 95,079 |   | $ | 270,175 |   | $ | 168,963 |   |

 

For the three months ended June 30, 2006, twocustomers accounted for 11% and 13% of total revenues, respectively.  For the same period of 2005, one customeraccounted for 11% of total revenues.  Forthe six months ended June 30, 2006, one customer accounted for 14% of totalrevenues attributable to the license revenues related to litigation settlementand one other customer accounted for 10% of total revenues.  For the same period of 2005, no customeraccounted for more than 10% of total revenues.

As of June 30, 2006, onecustomer accounted for approximately 16% of total net accounts receivable, andas of December 31, 2005 one customeraccounted for approximately 14% of the net accounts receivable balance.

** 9. Employee Benefit Plans**

Under Israeli law, theCompany is required to make severance payments to its retired or dismissedIsraeli employees and Israeli employees leaving its employment in certain othercircumstances. The Company’s severance pay liability to its Israeli employees,which is calculated based on the salary of each employee multiplied by theyears of such employee’s employment, is reflected in the Company’s balancesheet in other long-term liabilities on an accrual basis, and is partiallyfunded by the purchase of insurance policies in the name of the employees. Thesurrender value of the insurance policies is recorded in other non-currentassets. The severance pay expenses for the three and six months ended June 30,2006 were $489,000 and $535,000 respectively. The severance pay expenses for the three and six months ended June 30,2005 were $ Nil and $62,000 respectively.

**10.  Acquisition**

**OrenSemiconductor, Inc.**

On June 10,2005, Zoran completed the acquisition of Oren Semiconductor, Inc. (“Oren”),a privately-held provider of demodulator ICs for the global high definitiontelevision market.  Prior to thisacquisition, Zoran had made investments in Oren that represented a 17%ownership interest with a net book value of $3.4 million at the time ofacquisition.  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.  Aspart of the restatement, the Company considered the requirements underAccounting Principles Board Opinion No. 18 (“APB No. 18”), “TheEquity Method of Accounting for Investments in Common Stock,” to record thegains or losses on investment of the prior 17% ownership under the equity methodof accounting.  Based on the Company’sanalysis, the prior financial results of the Company were restated to recordthe loss on investment.

The primary purpose ofthe acquisition was to obtain Oren’s demodulator ICtechnology for the global high definition television market.  This technology was combined with Zoran’sdigital television technology to deliver a complete and cost-effective system 

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solution for digitaltelevision makers. Asof June 30, 2006, there have been no material variations from the underlyingassumptions that were used in the original computation of the value of theacquired entity.

Thetransaction was accounted for under SFAS No. 141, “Business Combinations,”using the purchase method of accounting. The Company incurred approximately $375,000 for acquisition-relatedexpenses consisting of financial advisory, legal and other consultingservices.  The Company completed avaluation analysis and purchase price allocation. The results of operations ofOren have been included in the consolidated financial statements from the dateof acquisition. The acquisition resulted in goodwill of approximately$33.9 million. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,”goodwill will not be amortized and will be tested for impairment at leastannually.  The Company does not expectgoodwill to be deductible for tax purposes.

Allocation of the purchase price is as follows(restated) (in thousands):

| Net liabilities acquired             |   | $      | (941   | )      |
|--------------------------------------|--------|--------|--------|--------|
| In process research and  development |   | 2,650  |   |
| Intangible assets                    |   | 9,100  |   |
| Goodwill                             |   | 33,897 |   |
|                                 |   | $      | 44,706 |   |

 

Tangible assets were valued at estimates of their current fairvalues.  The purchase priceexceeded the net assets acquired resulting in the recognition of goodwill andother intangible assets.  The amountsallocated to intangible assets include purchased technology totaling $7.0million, trade name and other intangible assets totaling $1.25 million andcustomer base totaling $850,000 which are being amortized over their estimateduseful lives of five years.

Approximately $2.7 million of the purchase price wasallocated to in-process research and development which had not yet reachedtechnological feasibility and had no alternative future use.  Accordingly, this amount was immediatelyexpensed upon the acquisition date.  Thisamount was determined using management’s estimates including consultation withan independent appraiser.  The value ofthe in-process research and development was determined using a discounted cashflow method and factors including projected financial results, relative risk ofsuccessful development, time-value of money and level of completion.

**Pro Forma Financial Information**

The following unaudited pro forma financial informationpresents the combined results of operations of Zoran and Oren as if theacquisition had occurred as of the beginning of the period presented, aftergiving effect to certain adjustments, including amortization of intangibles.The unaudited pro forma financial information does not necessarily reflect theresults of operations that would have occurred had the combined companies constituteda single entity during such periods, and is not necessarily indicative ofresults which may be obtained in the future.

|                                              | ** ** | **Year Ended  December 31, 2005** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                   | ** ** | **(restated)**                                   | ** ** |
|                                         |       |                                             |       |
| **In thousands except for per  share data:** |       |                                             |       |
| Pro forma revenues                           |       | $                                                | 396,737    |   |
|                                         |       |                                                  |       |
| Pro forma net income  (loss)                 |       | $                                                | (33,024    | ) |
|                                         |       |                                                  |       |
| Pro forma net income  (loss) per share:      |       |                                             |       |
| Basic                                        |       | $                                                | (0.75      | ) |
|                                         |       |                                                  |       |
| Diluted                                      |       | $                                                | (0.75      | ) |

 

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**11.   Net Income (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 and six month periods ended June 30, 2006 is reflected in dilutednet income per share by application of the treasury stock method, whichincludes consideration of stock-based compensation required by SFAS No. 123(R).

The followingtable provides a reconciliation of the components of the basic and diluted netincome (loss) per share computations (in thousands, except per share data):
| ** **                                             | ** ** | **Three Months EndedJune 30,** | ** ** | **Six Months EndedJune 30,** | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                             | ** ** | **2006**                                      | ** ** | **2005**                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                             | ** ** | ** **                                    | ** ** | **(restated)**                              | ** ** | ** ** | ** ** | **(restated)** | ** ** |
|                                                   | ** ** | ** **                                    | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income  (loss)                                     |       | $                                             | 4,779      |                                        | $          | (11,775 | ) | $ | 25,462 |   | $ | (30,498 | ) |
|                                                   |       |                                          |       |                                        |       |   |   |   |   |
| Weighted average  shares outstanding                   |       | 48,461                                        |       | 43,707                                      |       | 47,341 |   | 43,460 |   |
| Effect of  dilutive options and restricted stock units |       | 2,850                                         |       | —                                      |       | 2,687 | ** ** | **—** | ** ** |
| Dilutive  weighted average shares                      |       | 51,311                                        |       | 43,707                                      |       | 50,028 |   | 43,460 |   |
|                                                   |       |                                          |       |                                        |       |   |   |   |   |
| Net income  (loss) per share:                          |       |                                          |       |                                        |       |   |   |   |   |
| Basic                                                  |       | $                                             | 0.10       |                                        | $          | (0.27 | ) | $ | 0.54 |   | $ | (0.70 | ) |
| Diluted                                                |       | $                                             | 0.09       |                                        | $          | (0.27 | ) | $ | 0.51 |   | $ | (0.70 | ) |

----

** **

**Options to purchase 1,606,000 and10,656,000 shares of common stock were excluded from the computation of dilutednet income (loss) per share for the three months ended June 30, 2006 and 2005,respectively, as these shares would have had an anti-dilutive effect.**

**Options to purchase 2,398,000shares and 10,837,000 shares of common stock were excluded from the computationof diluted net income (loss) per share for the six months ended June 30, 2006and 2005, respectively, as these shares would have had an anti-dilutive effect**

**12.    Legal Proceedings**

*U.S.Attorney and SEC Investigations:* On July 3, 2006, Zoran disclosed in a pressrelease that it received a grand jury subpoena from the office of the U.S.attorney for the Northern District of California requesting documents from 1995through the present referring to, relating to or involving stock options, andalso received an informal inquiry from the SEC requesting documents related toZoran’s stock option grants.  Zoranintends to cooperate fully in all government investigations.  These inquiries likely will require theCompany to expend significant management time and incur significant legal andother expenses, and could result in civil and criminal actions seeking, amongother things, injunctions against the Company and its officers and directorsand the payment of significant fines and penalties by the Company and itsofficers and directors, which may adversely affect its results of operationsand cash flow.  The Company cannotpredict how long it will take to or how much more time and resources it willhave to expend to resolve these government inquiries, nor can it predict theoutcome of these inquiries. Also, there can be no assurance that otherinquiries, investigations or actions will not be started by other United Statesfederal or state regulatory agencies or by foreign governmental agencies.

*Late SEC Filings and Nasdaq Delisting Proceedings* Dueto the Special Committee investigation and the resulting restatements, theCompany did not file on time its Quarterly Reports on Form 10-Q for thequarters ended June 30, 2006 and September 30, 2006, or its Annual Reporton Form 10-K for the year ended December 31, 2006. As a result, theCompany received Nasdaq Staff Determination letters dated August 14, 2006,November 15, 2006 and March 20, 2007 stating that the Company was not in compliancewith the filing requirements of Marketplace Rule 4310(c)(14) and, therefore,that the Company’s stock was subject to delisting from the Nasdaq Global SelectMarket. A hearing before a Nasdaq Listing Qualifications Panel was held onSeptember 27, 2006 and a decision to grant the Company’s request for continuedlisting on Nasdaq subject to certain conditions 

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occurred on December 28, 2006. The Company has appealed this decision, and the Nasdaq Listing Councilhas determined to stay the December 28, 2006 Panel decision, and any futurePanel determinations to suspend Zoran’s securities from trading, pendingfurther action from the Listing Council. On March 2, 2007, the Company provided the Listing Council with anadditional submission for its consideration regarding continued listing.  The Listing Council will review the matter onthe basis of the written record.

*Shareholder Class Actions and Derivative Litigation Relating toHistorical Stock Option Practices:*****As discussed further below, certain persons and entities identifying themselves asshareholders of Zoran have filed litigation purporting to assert claims arisingout of the historical accounting for stock options.

*Zucker v. Zoran Corporation, et al..*  On August 10, 2006, a securities class actioncomplaint was filed against Zoran and certain of its officers and directors inthe United States District Court, Northern District of California, allegingviolations of federal securities laws. The Court selected Middlesex Pension Fund as lead plaintiff and approvedlead plaintiff’s selection of counsel for the class.  Plaintiff filed an amended complaint onFebruary 1, 2007 and a second amended complaint on February 20, 2007.  On March 8, 2007, Defendants filed a motionto dismiss.  On March 20, 2007, leadplaintiff filed a notice voluntarily dismissing the action with prejudice as tothe lead plaintiff.

*NCEA-IBEW Pension Fund (The Decatur Plan) v. Galil,et al.*  On June 12,2006, a purported shareholder derivative action was filed by the Decatur Planagainst Zoran as a nominal defendant and certain of its  officers and directors in the United StatesDistrict Court, Northern District of California, alleging, inter alia,violations of federal and state securities laws and breaches of fiduciaryduty.  On December 4, 2006, Decatur Planfiled a notice of voluntary dismissal.

*Pfeiffer v. Zoran Corporation et al.*  On September 7, 2006, a purported shareholderderivative action was filed by Milton Pfeiffer against Zoran as a nominaldefendant and certain of its officers and directors in the United StatesDistrict Court, Northern District of California, alleging, inter alia,violations of federal securities laws and breaches of fiduciary duties.

*Gerald del Rosario v. Aharon et al.** *OnSeptember 26, 2006, a purported shareholder derivative action was filed byGerald del Rosario against Zoran as a nominal defendant and certain of itscurrent and former officers and directors in the United States District Court,Northern District of California, alleging, inter alia, violations of federalsecurities laws and breaches of fiduciary duty. On December 8, 2006, the Court issued an order consolidating the *Del Rosario* action with the *Pfeiffer*action.  The Court selected del Rosarioas lead plaintiff and approved lead plaintiff’s selection of counsel for theconsolidated derivative action. Plaintiffs filed a consolidated amended complaint on March 14, 2007.

*Barone v. Gerzberg et al.; Durco v. Gerzberg et al.* On October 23, 2006,two purported shareholder derivative actions were filed by Moshe Barone andJohn Durco against Zoran as a nominal defendant and certain of its current andformer officers and directors in the California Superior Court of Santa ClaraCounty, alleging, inter alia, violations of state securities laws and breachesof fiduciary duty.  On January 24, 2007the Court consolidated the *Barone*and *Durco*actions, appointed Messrs. Barone and Durco as co-leadplaintiffs and approved their selection of counsel for the consolidatedderivative action.  Co-Lead Plaintiffsfiled a consolidated amended complaint on March 26, 2007.

On February 20, 2007, the Company filed a complaintagainst ArcSoft Inc. in the California Superior Court for the County of Alameda,seeking payment of $4 million in principal, together with accrued interest thenin the amount of approximately $525,000, under four separate convertiblepromissory notes.  On February 28,2007, the Company filed an application with the Court seeking to attach assetsof ArcSoft as security for the payment of its obligations under the notes.  The notes represent amounts loaned by theCompany to ArcSoft in 2004 in connection with a transaction involving thetransfer to ArcSoft of rights related to a software product then under developmentand related agreements regarding the continued development andcommercialization of the product.  OnMarch 28, 2007, ArcSoft filed an answer denying liability under the notesand asserting various affirmative defenses. ArcSoft also filed a cross complaint alleging fraud in the inducement ofthe business arrangement, fraudulent and negligent misrepresentation, breach ofcontract and of the implied covenant of good faith and fair dealing, and unjustenrichment and seeking monetary damages of more than $6.9 million.  The hearing on our application for anattachment is currently scheduled for May 14, 2007.

*Indemnification Obligations***.** Subject to certain limitations, theCompany is obligated to indemnify its current and former directors, officersand employees in connection with the investigation of the Company’s historicalstock option practices and related government inquiries and litigation. Theseobligations arise under the terms of the Company’s certificate ofincorporation, its bylaws, applicable contracts, and Delaware and Californialaw. The obligation to indemnify generally means that the Company is requiredto pay or reimburse the individuals’ reasonable legal expenses and possiblydamages and other liabilities incurred in connection with these matters. TheCompany is currently paying or reimbursing legal expenses being incurred inconnection with these matters by a number of its current and former directors,officers and employees.

*Other Legal Matters.*The Company is named from time to time as a party to lawsuits in the normalcourse of its business. Litigation, in general, and intellectual property andsecurities litigation in particular, can be expensive and disruptive to normalbusiness operations. Moreover, the results of legal proceedings are difficultto predict.

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**13.****            Subsequent Events**

On February 27, 2007, theCompany elected to: (i) participate in the Internal Revenue Service remediationprogram 2007-18 and pay to the IRS, on behalf of affected and eligibleemployees (not including executive officers), their IRC 409A tax liabilitiesand penalties; (ii) participate in any similar remediation program that may beoffered by any state for applicable state tax liabilities and penalties; (iii),act directly with any state not offering a similar remediation program toaddress any applicable tax liabilities and penalties on behalf of employees;and (iv) pay to such employees a “gross-up” payment to offset the associatedfederal and state income tax consequences.  The Company took this action because the vast majority of the holders ofstock options issued by the Company that are now subject to re-measurement as aresult of the Company’s option investigation were not involved in or aware ofthe stock option pricing determination. Employees who exercised such options in 2006, other than executiveofficers at the time of option grant or entering into this program, willparticipate in this program.  The Companyestimates that the total cash payments needed to deal with the adverse taxconsequences of previously exercised discount priced options guaranteed to non-officerswill be approximately $0.8 million, which is expected to be recognized in2007.

In addition, the Companymay consider taking action to minimize the adverse tax consequences that may beincurred by the holders of unexercised discount options. Discount-priced stockoptions vesting after December 31, 2004 (“409A Affected Options”) subject U.S.option holders to a penalty tax under IRC Section 409A (and to similar penaltytaxes under California and other state tax laws, as applicable). The Company mayconsider offering to amend the 409A Affected Options held by persons other thandirectors and executive officers to increase the exercise prices of thoseoptions to the market price of our common stock on the revised measurementdate. The amended options would not be subject to taxation under IRC Section409A. Under IRS regulations, the amendments for non-executives cannot beoffered until after this Report is filed and do not need to be completed untilDecember 31, 2007. The Company may also consider approving the payment ofbonuses to holders of those amended options to compensate them for theresulting increase in their option exercise price. The amount of these bonuseswould be effectively repaid to the Company if and when the options areexercised and the increased exercise price is paid (but there is no assurancethat the options will be exercised).  TheCompany has not estimated the expense of any such bonus payments.

Two executive officeroption holders were subject to a December 31, 2006 deadline to accomplish anyamendment of 409A Affected Options in accordance with IRS guidelines.Accordingly, in December 2006, the Company amended the 409A Affected Optionsheld by Dr. Gerzberg and Mr. Schneider to increase the exercise price of thoseoptions to the fair market value of the Company’s common stock on the revisedmeasurement date so that these options are no longer subject to a penalty taxunder IRC Section 409A.

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

*This report includes a number offorward-looking statements which reflect the Company’s current views withrespect to future events and financial performance. These forward-lookingstatements are subject to certain risks and uncertainties, including thosediscussed in “Part II, Item 1A. Risk factors” below. In this report, the words “anticipates,”“believes,” “expects,” “intends,” “future” and similar expressions identifyforward-looking statements. Readers are cautioned not to place unduereliance on these forward-looking statements, which speak only as of thedate hereof.*

The following informationhas been adjusted to reflect the restatement of the Company’s financialresults, which is more fully described in the “Explanatory Note” immediatelypreceding Part I, Item 1 and in Note 2, “Restatement of CondensedConsolidated Financial Statements” of the Notes to Condensed ConsolidatedFinancial Statements.

**Restatements**

On July 3, 2006, theCompany announced that, at the recommendation of the Audit Committee, the Boardof Directors had created a special committee of independent directors (“SpecialCommittee”) to conduct a review of our historical stock option practices. As aresult of its investigation, the Special Committee found, among other things,that some of the original measurement dates used by the Company for optiongrants were not adequately supported by contemporaneous records, and thereforethe measurement dates used by us for accounting purposes required adjustment.The Special Committee concluded that the evidence did not establish that theerrors which it identified resulted from fraud or intentional misconduct by ourcurrent senior management.

Based on the SpecialCommittee’s findings and its own review of the facts, the Board of Directorsconcluded that there was no fraud or intentional misconduct by any currentmember of senior management.  The Boardalso concluded that it has confidence in the integrity of the Company’s ChiefExecutive Officer, Dr. Levy Gerzberg, and the Company’s Chief FinancialOfficer, Mr. Karl Schneider.

Based on informationobtained from the Special Committee’s review and additional work undertaken bythe Company, management has concluded, and the Audit Committee has agreed, thatthe Company should restate certain previously filed financial statements, toreflect additional stock-based compensation expense with regard to certain paststock option grants. The corrections made in the restatements relate to optionscovering approximately 3.6 million shares. These adjustments, after tax,amounted to an additional stock-based compensation expense of $180,000 and$652,000 in the three months ended June 30, 2006 and 2005 and $360,000 and $718,000in the six months ended June 30, 2006 and 2005 respectively. There was no taximpact of these additional stock-based compensation expenses due to the fullvaluation allowance on our tax assets.

In connection with therestatement, the Company is recording additional non-cash adjustments that werepreviously considered to be immaterial relating to the timing of revenuerecognition, accrued expenses, amortization of premiums and discounts oninvestments, additional expense related to options granted to a consultant andthe amortization of stock-based compensation relating to a business combinationin 2003.  The Company is also recordinglosses under Accounting Principles Board (“APB”) Opinion No. 18 (“APB No. 18”),“The Equity Method of Accounting for Investments in Common Stock,” to recordthe losses on investment of the prior 17% ownership of Oren Semiconductor, Inc.under the equity method of accounting which was subsequently acquired by Zoranin 2005.   These additional adjustmentsresulted in a cumulative expense of $1.3 million, including $0.2 million of taxexpense, for the periods 2000 through 2005.

Through 2005, we appliedAPB No. 25, “Accounting for Stock Issued to Employees,” and its relatedinterpretations, and provided the required pro forma disclosures underStatement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting forStock-Based Compensation,” and SFAS No. 148, “Accounting for Stock-Based,Compensation-Transition and Disclosure.” Under APB Opinion No. 25 (“APB No. 25”), non-cash, stock-basedcompensation expense was recognized for any option for which the exercise pricewas below the market price of our Common Stock on the actual grant date.Because each of the options identified below (other than those which we havedetermined should be accounted for variably) was deemed to have an exerciseprice below the market price on the appropriate measurement date, we shouldhave recognized a charge for each of those options under APB Opinion No. 25, inan amount equal to the number of shares covered by such options, multiplied bythe difference between the exercise price and the market price on theappropriate measurement date. That expense should have been amortized over thevesting periods of the options. Starting in 2006, we adopted SFAS No. 123(R),“Share-Based Payment.” As a result, for 2006, the additional stock-basedcompensation expense required to be recorded for each of the options identifiedbelow was equal to the incremental fair value of those options on the appropriatemeasurement date over the remaining vesting periods of those options.  We did not record such stock-basedcompensation expenses under APB No. 25 or SFAS No. 123(R) in ourpreviously issued financial statements, and that is the reason for the restatementin this report.  To correct our pastaccounting for stock options, we recorded additional pre-tax, non-cash,stock-based compensation expense of (a) $11.7 million for the periods 1997 to2005 under APB No. 25 and (b) $180,000 and $360,000 for the three months andsix months ended June 30, 2006 under SFAS No. 123(R).  The fair value of the options is beingrecorded using the accelerated amortization method under FIN 28 over therespective vesting periods of the awards.

Consistent with theaccounting literature and recent guidance from the Securities and ExchangeCommission (“SEC”), the Company has organized the grants with respect to whichan accounting adjustment is required into categories based on grant type andprocess by which the grant was finalized. Based on the relevant facts and circumstances, the Company applied thecontrolling accounting standards to determine the measurement date for everygrant within each category. The Company made accounting adjustments asrequired, resulting in stock-based compensation expense and related taxeffects.  The Company organized thegrants where adjustments were required as follows:

·      *Company-wide option grantswhere optionees were added or grant amounts were changed after the option listwas complete, or where insufficient contemporaneous documentation of the grantdate exists*.  For

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        seven Company-wide refresh and retentiongrants made between 1998 and 2003, the Company determined that some employeeswho were omitted from the option grant list were added to the list after thestated grant date, and that the number of shares covered by option grants tosome employees was not finally determined until after the stated grantdate.  Further, in 2001 and 2002,insufficient contemporaneous documentation of the stated grant dateexisted.  As a result of these issues,the Company restated its historical financial statements to increasestock-based compensation expense by approximately $6.3 million, recognized overthe vesting periods of the relevant options.

·      *Re-priced options*.  In August 2002, after consideration ofrelevant information, the Compensation Committee rescinded its April 2002grant, and its June 2002 grant, to executives and other key employees.  The Company thereafter reissued the grants inAugust 2002.  At the time, inconsultation with our external advisors, we determined that these transactions didnot require variable accounting.  As aresult of the Special Committee review of our historical stock optionpractices, we have reassessed the circumstances surrounding these transactions withour external advisors and have determined that the grants should have beenaccounted for variably.  As a result, theCompany restated its historical financial statements to increase stock-based compensationexpense by a cumulative net amount of approximately $3.8 million, recognizedover the vesting periods of these options.

·      *Acquisition-relatedoptions*.  The Companydetermined a grant given to retain employees hired in connection with an acquisitionin October 2000 should have been accounted for variably.  As a result, the Company restated itshistorical financial statements to increase stock-based compensation expense byapproximately $0.3 million, recognized over the vesting periods of these options.

·      *Improper measurement datesfor non-refresh stock option grants*. The Company revised the measurement dates for certain grants made to newhires and for promotional and other miscellaneous non-refresh grants madebetween 1997 and 2003 as a result of approvals that were obtained subsequent tothe stated grant dates or as a result of administrative delays or errors and asmall number of stock option grants to non-executives that were determined tohave been established retrospectively. As a result, the Company restated itshistorical financial statements to increase stock-based compensation expense byapproximately $1.3 million, recognized over the vesting periods of theseoptions.

In the aggregate, we haverecorded additional stock-based compensation expense for the periods 1997through 2005 of approximately $11.7 million on stock option grants made from1997 through 2003.

The incremental impactfrom recognizing stock-based compensation expense resulting from theinvestigation of past stock option grants is as follows (dollars in thousands):

 
| **Fiscal Year**                    | ** ** | **Expense  (Benefit)** | ** ** |
|-----------------------------------------|------------|------------------------|------------|
| 1997                                    |       | $                      | 190        |   |
| 1998                                    |       | 223                    |       |
| 1999                                    |       | 123                    |       |
| 2000                                    |       | 120                    |       |
| 2001                                    |       | 1,385                  |       |
| 2002                                    |       | 3,182                  |       |
| 2003                                    |       | 5,299                  |       |
| Cumulative  effect at December 31, 2003 |       | 10,522                 |       |
| 2004                                    |       | (1,476                 | )          |
| 2005                                    |       | 2,623                  |       |
|                                    |       | $                      | 11,669     |   |

 

The cumulative effect ofall of the restatements up through December 31, 2003 increased additionalpaid-in capital by $10.7 million from $703.8 million to $714.5 million,increased accumulated deficit by $9.0 million from $156.4 million to $165.4million, and decreased total stockholders’ equity by $0.7 million from $534.3million to $533.6 million. All the restatements of financial statements,financial data and related disclosures described in this report arecollectively referred to in this report as the “restatements.”

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In December 2006, theCompany amended options to purchase approximately 218,000 shares of commonstock held by Dr. Gerzberg and Mr. Schneider, to increase theexercise price of those options to the fair market value of the Company’s commonstock on the revised measurement date so that these options are no longersubject to IRC Section 409A.

We have not amended, andwe do not intend to amend, any of our other previously filed Annual Reports onForm 10-K.  We have amended our QuarterlyReport for the period ended March 31, 2006 concurrent with the filing of ourAnnual Report on Form 10-K, and we do not intend to amend, any of our otherpreviously filed Quarterly Reports on Form 10-Q for the periods affected by therestatements.  We presented restatedquarterly financial information for each of the quarters in 2006 and 2005 in “SelectedQuarterly Financial Information (Unaudited)” included in the Company’s Annual Reporton Form 10-K for 2006.

The impact of therestatements is disclosed in Note 2, “Restatement of Condensed ConsolidatedFinancial Statements” of Notes to Consolidated Financial Statements. Therestatements did not have a material impact on our analysis of results ofoperations, financial position and changes in financial position included inManagement’s Discussion and Analysis of Financial Condition and Results ofOperations of our previously filed Quarterly Reports on Form 10-Q. Accordingly,we have not updated those discussions and analyses.

**Internal Controls**

Based on the definitionof “material weakness” in the Public Company Accounting Oversight Board’sAuditing Standard No. 2, *An Audit of InternalControl Over Financial Reporting Performed in Conjunction With an Audit ofFinancial Statements*, the restatement of financial statements inprior filings with the SEC is a strong indicator of the existence of a “materialweakness” in the design or operation of internal control over financialreporting. However, the Company has concluded that the control deficienciesthat resulted in the restatement of the previously issued consolidatedfinancial statements did not constitute a material weakness as of June 30, 2006because management determined that as of June 30, 2006 the Company’s internalcontrols were effective.

For a more completediscussion of remedial measures and our controls and procedures, please referto Item 4 — Controls and Procedures.

The SEC may disagree withthe manner in which we have accounted for and reported, or not reported, thefinancial impact of past option grant measurement date errors, and there is arisk that its inquiry could lead to circumstances in which we may have tofurther restate our prior financial statements, amend prior filings with theSEC, or otherwise take other actions not currently contemplated. In addition,the SEC may issue guidance on disclosure requirements related to the financialimpact of past option grant measurement date errors that may require us toamend this filing or prior filings with the SEC to provide additionaldisclosures pursuant to this guidance. Any such circumstance could also lead tofuture delays in filing our subsequent SEC reports and delisting of our commonstock from the NASDAQ Global Select Market.

As a result of the investigation of itshistorical option practices, we analyzed Zoran’s internal control overfinancial reporting for periods before January 1, 2003, and determined that theCompany did not have sufficient safeguards in place to monitor its controlpractices regarding stock option pricing and related financial reporting and tofoster an effective flow of information between those responsible for stockoption pricing and those responsible for financial reporting. Inadequatetraining, communication and coordination in and among the Company’s humanresources, stock administration, legal and finance functions prevented theCompany from assuring that stock options were priced and accounted forcorrectly, primarily for the years 1997 through 2002.

 

From 2003 through 2005, in compliance withthe Sarbanes-Oxley Act of 2002 and evolving accounting guidance, the Companyimplemented improved procedures, processes and systems to provide additionalsafeguards and greater internal control over its stock option granting andadministration. These improvements included:

 

·                  Documenting and assessing the design andoperation of internal controls;

·                  Segregating responsibilities, addingreviews and reconciliations, and redefining roles and responsibilities;

·                  Implementing a new equity accountingsystem and a new stock administration function; and

·                  Implementing, prior to the adoption ofSFAS No. 123(R), the practice of using the receipt of the final Board or CompensationCommittee approval as the grant and measurement date for stock option grants.

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As a result of the recommendations of the SpecialCommittee of our Board of Directors and deliberations of the CompensationCommittee of our Board of Directors, we have adopted the following policiesgoverning all stock option grants:

·                  All option grants must be approved by theCompensation Committee or the Board of Directors; the authority to approveoption grants may not be delegated. 

·                  Option grants (including officer, vicepresident, rank and file, promotional and new hire grants) are generallyconsidered at regularly scheduled quarterly meetings of the CompensationCommittee or the Board of Directors, and action may not be taken by unanimouswritten consent.  

·                  Grants are generally effective as of thelater of (i) the second trading day following the Company’s public announcementof its financial results for the preceding quarter or (ii) the date of theBoard or committee meeting.   

·                  Grants should be recorded promptly in theCompany’s option accounting database, and grantees should receive promptwritten notification of their grants.

·                  The annual focal review process willidentify a specific date to complete the process of generating recommendedgrant amounts, after which the recommendations will be submitted to theCompensation Committee or the Board of Directors for approval. 

·                  Board or committee minutes are to be drafted and circulatedto directors for comment as soon as reasonably possible.

 

The Special Committee investigation andthe Company’s related activities discovered no stock option grant afterDecember 31, 2003 that required accounting adjustments.

 

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**Related Proceedings**

*U.S.Attorney and SEC Requests.* On July 3, 2006, Zoran disclosed in a pressrelease that it received a grand jury subpoena from the office of the U.S.attorney for the Northern District of California requesting documents from 1995through the present referring to, relating to or involving stock options, andalso received an informal inquiry from the SEC requesting documents related toZoran’s stock option grants.  Zoranintends to cooperate fully in all government inquiries or investigations.  There is no assurance that we will not besubject to inquiries related to our stock option grant practices by otherfederal, state or foreign regulatory agencies. All such inquiries are likely torequire us to continue to expend significant management time and incursignificant legal and other expenses, and could result in civil and criminalactions seeking injunctions, fines or other sanctions that could adverselyaffect our business and financial results.

*ShareholderClass Actions and Derivative Litigation Relating to Historical Stock OptionPractices:*****Asdiscussed under Part II — Item 1 — Legal Proceedings above, certain persons and entitiesidentifying themselves as shareholders of Zoran have filed class actioncomplaints against the Company and derivative actions purporting to assertclaims on behalf of and in the name of the Company against various of theCompany’s current and former directors and officers relating to Zoran’shistorical accounting for and disclosures related to stock options. There maybe additional lawsuits of this nature filed in the future.  We cannot predict the outcome of any suchlitigation, or the amount of time and expenses that will be required to resolvethem.  If these lawsuits become timeconsuming and expensive, or if there are unfavorable outcomes in any of thesecases, there could be a material adverse effect on our business, financialcondition and results of operations.

*Cost ofRelated Proceedings and Restated Financial Statements*. Wehave incurred substantial expenses for legal, accounting, tax and otherprofessional services in connection with the Special Committee investigation,our own related review work, the preparation of the restated financialstatements, the SEC and Department of Justice matters and inquiries from othergovernment agencies, and the related litigation. We have recorded expenses of$5.8 million in aggregate through 2006 and we expect to incur additionalcosts in the future.

*Restatement and Impact on FinancialStatements*

The following informationhas been adjusted to reflect the restatement of the Company’s financialresults, which is more fully described in the “Explanatory Note” immediatelypreceding Part I, Item 1 and in Note 2, “Restatement of ConsolidatedFinancial Statements” in Notes to Consolidated Financial Statements of thisAnnual Report on Form 10-K.

In connection with therestatement, the Company is recording additional non-cash adjustments that werepreviously considered to be immaterial relating to the timing of revenuerecognition, accrued expenses, amortization of premiums and discounts oninvestments, additional expense related to options granted to a consultant, andthe calculation of amortization of stock-based compensation relating to abusiness combination in 2003.

Foradditional information, refer to “Note 2 — Restatement of ConsolidatedFinancial Statements,” in Notes to Consolidated Financial Statements.

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Theincome staement impact of the restatements are as follows (in thousands):

|                                                                                                                           | ** ** | **Cumulative**                                     | ** ** | ** **                                         | ** ** | **Year**          | ** ** | **Cumulative**     | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|-------------------|------------|--------------------|------------|
| ** **                                                                                                                | ** ** | **effect at**                                 | ** ** | **Year Ended**                                | ** ** | **Ended**         | ** ** | **effect at** | ** ** |
| ** **                                                                                                                | ** ** | **December**                                       | ** ** | **December 31,**                              | ** ** | **December**      | ** ** | **December**       | ** ** |
| ** **                                                                                                                | ** ** | **31, 2005**                                  | ** ** | **2005**                                           | ** ** | **31, 2004** | ** ** | **31, 2003**  | ** ** |
| Net loss, as  previously reported                                                                                         |       |                                               |       | $                                             | (26,971    | )                 | $     | (47,354            | )          |   | ** ** |
| Additional  compensation (expense) benefit resulting from improper measurement dates for stock  option grants, net of tax |       | $                                             | (11,669    | )                                                  | (2,623     | )                 | 1,476      |               | $     | (10,522 | **)** |
| Other  adjustments, net of tax                                                                                            |       | (1,374                                             | )          | (678                                               | )          | (2,230            | )          | 1,534              | ** ** |
| Total increase  to net loss                                                                                               |       |         (13,043 | )          | (3,301                                             | )          | (754              | )          | (8,988             | **)**      |
| Net loss, as restated                                                                                                     |       |                                               |       |         (30,272 | )          | (48,108           | )          |               | ** ** |
|                                                                                                                           |            |                                                    |            |                                                    |            |                   |            |                    |            |  |  |  |  |

** **
| ** **                                                                                         | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                         | ** ** | **2003**                                   | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** | **1999** | ** ** | **1998** | ** ** | **1997** | ** ** |
| Stock based compensation expense, as previously  reported                                          |       | $                                     | (6,281     | ) | $  | (292 | ) | $  | (544 | ) | $  | (99 | ) | $  | — |   | $  | — |   | $  | — | ** ** |
| Additional compensation expense resulting from improper  measurement dates for stock option grants |       | (5,299                                     | )          | (3,182 | ) | (1,385 | ) | (120 | ) | (123 | ) | (223 | ) | (190 | **)** |
| Stock based  compensation expense, as restated                                                     |       | $                                     | (11,580    | ) | $  | (3,474 | ) | $  | (1,929 | ) | $  | (219 | ) | $  | (123 | ) | $  | (223 | ) | $  | (190 | **)** |

** **

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**Overview**

Our productsconsist of integrated circuits and related products used in digital versatiledisc players, or DVDs, movie and home theater systems, digital cameras andvideo editing systems.  We also provideintegrated circuits, software and platforms for digital television applicationsthat enable the delivery and display of digital video content through a set-topbox or television as well as digital imaging products consisting ofsemiconductor hardware and software that enable users to print, scan, processand transmit documents to computer peripherals that perform printingfunctions.  Subsequent to our acquisitionof Emblaze Semiconductor Ltd. on July 8, 2004, we also provide highperformance, low-power application processors, technology and products for themultimedia mobile telephone market. Through the acquisition of Oren Semiconductor, Inc. onJune 10, 2005, we obtained Oren’s demodulator ICtechnology for the global high definition television market.

We derive most ofour revenues from the sale of our integrated circuit products.  Historically, average selling prices in thesemiconductor industry in general, and for our products in particular, havedecreased over the life of a particular product.  Average selling prices for our hardwareproducts have fluctuated substantially from period to period, primarily as aresult of changes in our customer mix of original equipment manufacturer, orOEM, sales versus sales to resellers and the transition from low-volume tohigh-volume production.  In the past, wehave periodically reduced the prices of some of our products in order to betterpenetrate the consumer market.  Webelieve that, as our product lines continue to mature and competitive marketsevolve, we are likely to experience further declines in the average sellingprices of our products, although we cannot predict the timing and amount ofsuch future changes with any certainty.

Our cost ofhardware product revenues consists primarily of fabrication costs, assembly andtest costs, and the cost of materials and overhead from operations.  If we are unable to reduce our cost ofhardware product revenues to offset anticipated decreases in average sellingprices, our product gross margins will decrease.  We expect both product and customer mix tocontinue to fluctuate in future periods, causing fluctuations in margins.

We also deriverevenue from licensing our software and other intellectual property.  Licensing revenue includes one-time licensefees and royalties based on the number of units distributed by the licensee.  Quarterly licensing revenue can besignificantly affected by the timing of a small number of licensingtransactions, each accounting for substantial revenues.  Accordingly, licensing revenues havefluctuated, and will continue to fluctuate, on a quarterly basis.  In addition, we have historically generated aportion of our total revenues from development contracts, primarily with keycustomers, although development revenue has declined substantially as apercentage of total revenues over the past several years.  These development contracts have provided uswith partial funding for the development of some of our products.  These development contracts provide forlicense and milestone payments which are recorded as development revenue.  We classify all development costs, includingcosts related to these development contracts, as research and developmentexpenses.  We retain ownership of theintellectual property developed by us under these development contracts.  While we intend to continue to enter into developmentcontracts with certain strategic partners, we expect development revenue tocontinue to decline as a percentage of total revenues.

We recognizesoftware license revenues in accordance with the provisions of Statement ofPosition (SOP) No. 97-2, “SoftwareRevenue Recognition, as amended by SOP No. 98-9, Modification of SOP No. 97-2, Software Revenue Recognition, With Respectto Certain Transactions.”  Oursoftware license agreements typically include obligations to providemaintenance and other support over a fixed term and allow for renewal ofmaintenance services on an annual basis. We determine the fair value of ourmaintenance obligations with reference to substantive renewal rates within theagreement or objective evidence of fair value as required under SOP No. 97-2.Maintenance and support revenue is recognized ratably over the term of thearrangement.  We also receive royaltyrevenues based on per unit shipments of products embedding our software whichwe recognize upon receipt of a royalty report from the customer, typically onequarter in arrears.

Our research anddevelopment expenses consist of salaries and related costs of employees engagedin ongoing research, design and development activities and costs of engineeringmaterials and supplies.  We are a partyto research and development agreements with the Chief Scientist in Israel’sMinistry of Industry and Trade and the Israel-United States BinationalIndustrial Research and Development Foundation, which fund up to 50% ofincurred project costs for approved products up to specified contractmaximums.  These agreements require us touse our best efforts to achieve specified results and require us to payroyalties at rates of 3% to 5% of resulting product sales, and up to 30% ofresulting license revenues, up to a maximum of 100% to 150% of total fundingreceived.  Reported research anddevelopment expenses are net of these grants, which fluctuate from period toperiod.  We believe that significantinvestments in research and development are required for us to remaincompetitive, and we expect to continue to devote significant resources toproduct development, although such expenses as a percentage of total revenuesmay fluctuate.

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Our selling,general and administrative expenses consist primarily of employee-relatedexpenses, sales commissions, product promotion and other professionalservices.  We expect that selling,general and administrative expenses will continue to increase to support ouranticipated growth.

We conduct amaterial amount of our research and development and certain sales and marketingand administrative operations in our foreign subsidiary offices.  As a result, some of our expenses areincurred in foreign currency.  To date,substantially all of our hardware product revenues and our software and otherrevenues have been denominated in U.S. dollars and most costs of hardwareproduct revenues have been incurred in U.S. dollars.  We expect that most of our revenues and costsof revenue will continue to be denominated and incurred in U.S. dollars for theforeseeable future.  We have notexperienced 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 inthe future elect to take action to reduce our foreign exchange risk.

Our effectiveincome tax rate has benefited from the availability of previously unbenefittednet operating losses which we have utilized to reduce taxable income for U.S.federal income 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 net operating losses expireat various times between 2017 and 2024 and the benefits from our subsidiary’sApproved Enterprise status expire at various times beginning in 2008.

**RecentAcquisition**

On June 10,2005, we completed our acquisition of Oren Semiconductor, Inc. (“Oren”), aprivately-held provider of demodulator ICs for the global high definitiontelevision market.  Prior to thisacquisition, we had made investments in Oren that represented a 17% ownershipinterest. Under the terms of the acquisition agreement, we acquired theremaining 83% of Oren’s outstanding stock by means of a merger of Oren with awholly-owned subsidiary of Zoran, in consideration for which we paid anaggregate of $28.4 million in cash and issued 1,188,061 shares of Zorancommon stock valued at $12.9 million, for total consideration of $41.3million, to the other stockholders of Oren and to employees holding Orenoptions.  The acquisition was accountedfor under the purchase method of accounting.

Following thecompletion of the acquisition, the results of operations of Oren have beenincluded in our consolidated financial statements.  In addition, we recordedretroactive losses under Accounting Principles Board Opinion No. 18 (“APB No. 18”),“The Equity Method of Accounting for Investments in Common Stock,”to record the losses on investment of the prior 17% ownership ofOren Semiconductor, Inc. under the equity basis.  Accordingly, our results of operations forthe three and six months ended June 30, 2006 include Oren’s operations for thefull year; our results of operations for the three and six months ended June30, 2005 include Oren’s operations between June 10, 2005 and December 31, 2005and $218,000 representing our portion of the losses incurred by Oren betweenJanuary 1, 2005 and June 10, 2005; and our results of operations for the yearended December 31, 2004 do not include Oren’s operations.

**Segments**

Our products are based onhighly integrated application-specific integrated circuits, or ASICs, andsystem-on-a-chip, or SOC, solutions.  Wealso license certain software and other intellectual property.  During the first quarter of 2006, wereorganized our operating structure to bring together our consumer electronicproduct lines under a single operating group, in recognition of theaccelerating convergence of consumer products and our strategy of sharingtechnology among our various product lines. The new Consumer group combines the former Digital Versatile Disc (DVD),Digital Television (DTV) and Mobile product groups whose operations werepreviously reported separately.  We willcontinue to report the operations of our Imaging group as a separate operatingsegment.

**Resultsof Operations**

*Revenues*

Totalrevenues increased 34.5% to $127.9 million for the three months ended June 30,2006 compared to $95.1 million for the three months ended June 30, 2005.  For the six months ended June 30, 2006, totalrevenues increased 59.9% to $270.2 million compared to $169.0 million recordedduring the same period of 2005. Consumer segment revenues increased by $37.6million and $108.2 million for the three and six month periods ended June 30,2006, respectively, compared to the same periods in 2005. Imaging segment revenues decreased by $4.8million and $7.0 million for the three and six month periods ended June 30,2006, respectively, compared to the same periods in 2005 due to decrease inunit shipments.  Within the Consumersegment, license revenues related to the litigation settlement in the firstquarter of 2006 accounted for $5.6 million and $35.8 million of the increasefor the three and six month periods

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endedJune 30, 2006, respectively.  Theremaining increases of $32.0 million and $72.4 million in Consumer segmentrevenues for the three and six month periods ended June 30, 2006, respectively,were a result of increased revenues in allthree principal product lines.  Revenuesfor the Mobile, DTV and DVD product line increased by $14.9 million,$10.7 million and $6.4 million, respectively, for the three months and $38.5million, $23.7 million and $10.2 million, respectively, for the six monthsended June 30, 2006 compared to the same periods in 2005.

Hardwareproduct revenues for the three months ended June 30, 2006 were $108.2 millioncompared to $80.9 million for the comparable period of the prior year and$207.4 million and $139.9 million for the six month periods ended June 30, 2006and 2005, respectively.  Hardware productrevenues increased $32.3 million in the Consumer segment and decreased $5.0million in the Imaging segment due to decrease in unit shipments for the threemonths ended June 30, 2006 compared to the same period of the prior year.  Within the Consumer segment, hardware product revenues increased $15.1 millionin the Mobile product line, $11.0 million in the DTV product line and $6.2million in the DVD product line, in each case driven by increased unitshipments. For the six months ended June 30, 2006, hardware productrevenues increased $73.7 million in the Consumer segment and decreased $6.2million in the Imaging segment from the comparable 2005 period.  Within the Consumer segment, hardware product revenues increased $39.2 millionin the Mobile product line, $24.7 million in the DTV product line and $9.8million in the DVD product line, in each case driven by increased unitshipments.

Softwareand other revenues were $14.1 million and $27.0 million for the three and sixmonth periods ended June 30, 2006, respectively, compared to $14.2 million and$29.1 million for the same periods in 2005. Thedecrease in software and other revenues for the six months ended June 30, 2006reflected a $1.3 million decrease in Consumer segment revenues and a $0.8million decrease in Imaging segment revenues. These decreases were primarilydue to lower licensing revenue related to the timing of new agreements.

*Cost of Hardware Product Revenues*

Cost of hardware productrevenues was $60.4 million and $114.0 million, respectively, for the three andsix month periods ended June 30, 2006 compared to $45.4 million and $82.3million, respectively, for the same periods of 2005. The increase in costs wasprimarily a result of the corresponding increase in hardware productrevenues.  As a percentage of hardwareproduct revenues, hardware product costs decreased from 56.1% and 58.8%,respectively, for the three and six month periods ended June 30, 2005 to 55.8%and 55.0% for the three and six month periods ended June 30, 2006.  The decrease in hardware product costs as apercentage of hardware product revenues was primarily due to a change inproduct mix within the DVD product line to an increased percentage of lowercost products.

*Research and Development*

Researchand development expenses were $25.2 million and $49.5 million for the three andsix month periods ended June 30, 2006, respectively, compared to $21.5 millionand $41.6 million for the same periods of 2005. These increases were primarilya result of stock-based compensation expenses of $1.4 million and $3.0 millionrecorded in the three and six month periods ended June 30, 2006 as a result ofthe adoption of SFAS No. 123(R), compared with stock-based compensationexpense of $0.2 million in the three and six month periods ended June 30, 2005prior to the adoption of SFAS No. 123(R); and the inclusion of theoperations of Oren which was acquired in June 2005 for the full 2006 periods.

*Selling, General andAdministrative*

Selling, general andadministrative expenses were $30.1 million and $55.0 million for the three andsix month periods ended June 30, 2006, respectively, compared to $24.8 millionand $47.6 million for the three and six month periods ended June 30, 2005,respectively.  These increases wereprimarily attributed to stock-based compensation expenses of $3.6 million and$6.6 million recorded under SFAS No. 123(R) in the three and six monthperiods ended June 30, 2006, compared with stock-based compensation expense of$0.4 million and $0.5 million in the three and six month periods ended June 30,2005 prior to the adoption of SFAS No. 123(R); an increase in theallowance for doubtful accounts receivable by $3.4 million and $3.6 million inthe three and six month periods ended June 30, 2006 to cover slow payingaccounts and potential risk with increasing business in certain regions of theworld, offset by a decrease in legal fees as a result of the settlement of ourpatent litigation with Mediatek, Inc.

*Amortization of Intangible Assets*

During the three and sixmonth periods ended June 30, 2006, we incurred charges of $12.7 million and$25.5 million, respectively, related to the amortization of intangible assetscompared to $12.4 million and $24.8 million for the three and six months endedJune 30, 2005, respectively.  Themarginal increase was a result of the addition of $9.1 million of amortizableintangible assets acquired in

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the Oren acquisition inJune 2005.  At June 30, 2006, we had approximately $93.8 million in netintangible assets acquired through the Oak, Emblaze and Oren acquisitions whichwe will continue to amortize on a straight line basis through 2010.

*Amortizationof Stock Compensation Resulting From Business Combinations*

As a result of theadoption of SFAS No. 123(R) during the first quarter of 2006, we now record acharge for all stock-based compensation expenses as described in Note 2 toCondensed Consolidated Financial Statements. As a result, we no longer record a separate charge for amortization ofAmortization of stock compensation resulting from business combinations.  For the three and six months period endedJune 30, 2005, we recorded charges of $457,000 and $974,000, respectively,  related to the amortization of stockcompensation resulting from business combinations primarily as a result ofstock options granted in connection with the Oak acquisition.

*Interest and Other Income*

Interestand other income were $2.5 million and $5.2 million, respectively, for thethree and six month periods ended June 30, 2006, compared to $336,000 and$438,000 for the same periods of 2005. These increases were a result of net gains in investments of $1.0million recorded during the first quarter of 2006 as well as an increase ininterest income as a result of our higher average cash and short terminvestment balances.

*Provision for Income Taxes*

Werecorded a tax benefit of $2.8 million and a tax provision of $6.0 million forthe three and six month periods ended June 30, 2006. We did not record a taxprovision or benefit for the three and six month periods ended June 30, 2005.The provision for income taxes reflects the estimated annualized effective taxrate applied to earnings excluding charges for amortization of intangibleassets for the interim periods and a one time charge of $4.3 million for taxexpense related to the Media-Tek settlement. The effective tax rate differsfrom the U.S. statutory rate due to utilization of previously unbenefitted netoperating losses and State of Israel tax benefits on foreign earnings.  At June 30, 2006, we continue to carry a fullvaluation allowance against our net deferred tax assets as management hasdetermined that it is more likely than not that our deferred tax assets may notbe realized.

**Liquidity and Capital Resources**

At June 30, 2006, we had $89.4 million of cash and cashequivalents, $175.6 million of short-term investments and $287.1 million ofworking capital.

Our operating activities generated cash of $66.9 millionduring the first six months of 2006, primarily due to net income of $25.5million adjusted for non-cash items such as amortization of $25.6 million,depreciation of $4.8 million and stock-based compensation expense of $10.0million.  Cash provided by operationsalso increased due to a decrease of $9.6 million in accounts receivable due tothe timing of collections and a net increase in accounts payable, accruedexpenses and other liabilities, goodwill and other long term liabilitiestotaling $7.1 million.  These increaseswere partially offset by a $15.3 million increase in inventories to meet theincreasing demand for our products.

Cashused in investing activities was $108.0 million during the six months endedJune 30, 2006, principally reflecting the net purchase of investments of$104.8 million. In addition we spent $3.2 million for purchases of property andequipment.

Cash provided by financing activities during the sixmonths ended June 30, 2006 was $51.6 million consisting of proceedsreceived from issuances of common stock through exercises of employee stockoptions and proceeds from the sale of stock under our employee stock purchaseplan.

Net cash provided byoperating activities during the first six months of 2005 was $24.0million.  While we recorded a net loss of$30.5 million, this loss included non-cash charges for depreciation of propertyand equipment of $5.1 million, amortization of $24.8 million and stock-basedcompensation expense of $1.7 million. Additional cash from operating activities was provided by a $24.9million decrease in inventory and a $4.3 million increase in accounts payable,offset by $8.2 million increase in accounts receivable.

Cash used in investingactivities was $11.1 million during the six months ended June 30, 2005,reflecting $27.6 million used in the acquisition of Oren and purchases ofproperty and equipment totaling $4.4 million, partially offset by the net salesand maturities of investments of $20.8 million.

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Cash provided byfinancing activities was $3.1 million during the six months ended June 30, 2005attributable to the issuance of common stock during the period.

At June 30, 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 to the type of financing, liquidity,market or credit risk that could arise if we had engaged in such relationships.

We believe that ourcurrent balances of cash, cash equivalents and short-term investments, andanticipated cash flow from operations, will satisfy our anticipated workingcapital and capital expenditure requirements at least through the next 12months.  Nonetheless, our future capitalrequirements may vary materially from those now planned and will depend on manyfactors including, but not limited to:

·                  thelevels at which we maintain inventories and accounts receivable;

·                  themarket acceptance of our products;

·                  thelevels of promotion and advertising required to launch our new products or toenter markets and attain a competitive position in the marketplace;

·                  ourbusiness, product, capital expenditure and research and development plans andtechnology roadmap;

·                  volumepricing concessions;

·                  capitalimprovements to new and existing facilities;

·                  technologicaladvances;

·                  theresponse of competitors to our products; and

·                  ourrelationships with our suppliers and customers.

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

Tothe extent that our existing resources and cash generated from operations areinsufficient to fund our future activities, we may need to raise additionalfunds through public or 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 or convertible debt securities couldresult in additional dilution to our stockholders.  We cannot be certain that additionalfinancing will be available in amounts or on terms acceptable to us, if at all.  If we are unable to obtain this additionalfinancing, we may be required to reduce the scope of our planned productdevelopment and sales and marketing efforts, which could harm our business,financial condition and operating results.

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

We are exposed to financialmarket risks including changes in interest rates and foreign currency exchangerates.

The fair value of our investment portfolio or relatedincome would not be significantly impacted by either a 10% increase or decreasein interest rates due mainly to the short-term nature of the major portion ofour investment portfolio.

A majority of our revenue and capital spending istransacted in U.S. dollars, although a portion of the cost of our operations,relating mainly to our personnel and facilities in Israel, is incurred in NewIsraeli Shekels.  As a result, webear the risk that the rate of inflation in Israel or the decline in the valueof U.S. dollars compared to the New IsraeliShekel will increase our costs as expressed in U.S. dollars.  We have not engaged in hedging transactions toreduce our exposure to fluctuations that may arise from changes in foreignexchange rates.  Based on our overallcurrency rate exposure at June 30, 2006, a near-term 10% appreciation ordepreciation of the New Israeli Shekel would have an immaterial affect on ourfinancial condition.

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**Item 4.Controls and Procedures**

Disclosure Controls and Procedures

Under the supervision and with the participation ofthe Company’s management, including the Company’s Chief Executive Officer andChief Financial Officer, the Company conducted an evaluation of its disclosurecontrols and procedures as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934, as amended (“Exchange Act”).  Based on this evaluation, our Chief ExecutiveOfficer and Chief Financial Officer concluded that the Company’s disclosurecontrols and procedures were effective as of June 30, 2006. The Company'sdisclosure controls and procedures are designed to ensure that informationrequired to be disclosed by us in the reports we file under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the SEC's rules and forms and that such information is accumulated andcommunicated to management, including the Chief Executive Officer and ChiefFinancial Officer, to allow timely discussions regarding required disclosures.

Management's Consideration of the Restatement

As disclosed in Note 2,"Restatement ofConsolidated Financial Statements," to our consolidated financialstatements included in Item 8 of the Annual Report on Form 10-K, we restatedpreviously issued financial statements to record incremental non-cash stockbased compensation charges under APB No. 25 in the amount of $11.7 millionbetween 1997 and 2005 and an additional $0.4 million in 2006 under SFAS No. 123(R).  These accounting errors arose from the use ofincorrect stock option grant measurement dates for grants made during theperiod 1997 to 2003. 

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In coming to the conclusion that our disclosure controls and proceduresand our internal control over financial reporting were effective as of June 30,2006, management considered control deficiencies related to the stock optiongranting process that resulted in the need to restate our previously issuedfinancial statements.

 

During fiscal year 2004 in compliance with the Sarbanes-Oxley Act of2002, the Company implemented improved procedures, processes and systems toprovide additional safeguards and greater internal control over its stockoption granting and administration. These improvements included:

 

·                  Segregatingresponsibilities, adding reviews and reconciliations, and redefining roles andresponsibilities in the human resources function;

·                  Upgradingsystems and system controls that support the grant process and improving theaccuracy and timeliness of accounting for grants, including robustdocumentation of grant approvals and usage of a hosted stock administrationsystem; and

·                  Obtainingand training more qualified competent individuals in the human resources andstock administration function.

The Company believes that these changes remediated the historicalcontrol deficiency. Consequently, the stock option grant process did notconstitute a control deficiency as of December 31, 2006.

 

Changes to Internal Control Over Financial Reporting

 

There were no changes in the Company’s internal control over financialreporting during the quarter ended June 30, 2006 that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

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**PART II.OTHER INFORMATION**

**Item 1.Legal Proceedings**

*U.S.Attorney and SEC Investigations:* On July 3, 2006, Zoran disclosed in a pressrelease that it received a grand jury subpoena from the office of the U.S.attorney for the Northern District of California requesting documents from 1995through the present referring to, relating to or involving stock options, andalso received an informal inquiry from the SEC requesting documents related toZoran’s stock option grants.  Zoranintends to cooperate fully in all government investigations.  These inquiries likely will require theCompany to expend significant management time and incur significant legal andother expenses, and could result in civil and criminal actions seeking, amongother things, injunctions against the Company and its officers and directors andthe payment of significant fines and penalties by the Company and its officersand directors, which may adversely affect its results of operations and cashflow.  The Company cannot predict howlong it will take to or how much more time and resources it will have to expendto resolve these government inquiries, nor can it predict the outcome of theseinquiries. Also, there can be no assurance that other inquiries, investigationsor actions will not be started by other United States federal or stateregulatory agencies or by foreign governmental agencies.

*Late SEC Filings and NasdaqDelisting Proceedings* Due to the Special Committeeinvestigation and the resulting restatements, the Company did not file on timeits Quarterly Reports on Form 10-Q for the quarters ended June 30, 2006 andSeptember 30, 2006. As a result, the Company received Nasdaq StaffDetermination letters,  dated August 14,2006, November 15, 2006 and March 20, 2007 stating that it was not in compliancewith the filing requirements of Marketplace Rule 4310(c)(14) and, therefore,that the Company’s stock was subject to delisting from the Nasdaq Global SelectMarket. A hearing before a Nasdaq Listing Qualifications Panel was held onSeptember 27, 2006 and a decision to grant the Company’s request for continuedlisting on Nasdaq subject to certain conditions occurred on December 28,2006.  The Company has appealed thisdecision, and the Nasdaq Listing Council has determined to stay the December28, 2006 Panel decision, and any future Panel determinations to suspend Zoran’ssecurities from trading, pending further action from the Listing Council.  On March 2, 2007, the Company provided theListing Council with an additional submission for its consideration regardingcontinued listing.  The Listing Councilwill review the matter on the basis of the written record.

*Shareholder Class Actions and Derivative Litigation Relating toHistorical Stock Option Practices:*****As discussed further below, certain persons and entities identifying themselves asshareholders of Zoran have filed litigation purporting to assert claims arisingout of the historical accounting for stock options.

*Zucker v. Zoran Corporation, et al..*  On August 10, 2006, a securities class actioncomplaint was filed against Zoran and certain of its officers and directors inthe United States District Court, Northern District of California, allegingviolations of federal securities laws. The Court selected Middlesex Pension Fund as lead plaintiff and approvedlead plaintiff’s selection of counsel for the class.  Plaintiff filed an amended complaint onFebruary 1, 2007 and a second amended complaint on February 20, 2007.  On March 8, 2007, Defendants filed a motionto dismiss.  On March 20, 2007, leadplaintiff filed a notice voluntarily dismissing the action with prejudice as tothe lead plaintiff.

*NCEA-IBEW Pension Fund (The Decatur Plan) v. Galil,et al.*  On June 12,2006, a purported shareholder derivative action was filed by the Decatur Planagainst Zoran as a nominal defendant and certain of its  officers and directors in the United StatesDistrict Court, Northern District of California, alleging, inter alia,violations of federal and state securities laws and breaches of fiduciaryduty.  On December 4, 2006, Decatur Planfiled a notice of voluntary dismissal.

*Pfeiffer v. Zoran Corporation et al.*  On September 7, 2006, a purported shareholderderivative action was filed by Milton Pfeiffer against Zoran as a nominaldefendant and certain of its officers and directors in the United StatesDistrict Court, Northern District of California, alleging, inter alia,violations of federal securities laws and breaches of fiduciary duties.

*Gerald del Rosario v. Aharon et al.** *OnSeptember 26, 2006, a purported shareholder derivative action was filed byGerald del Rosario against Zoran as a nominal defendant and certain of itscurrent and former officers and directors in the United States District Court,Northern District of California, alleging, inter alia, violations of federalsecurities laws and breaches of fiduciary duty. On December 8, 2006, the Court issued an order consolidating the *Del Rosario* action with the *Pfeiffer*action.  The Court selected del Rosarioas lead plaintiff and approved lead plaintiff’s selection of counsel for theconsolidated derivative action. Plaintiffs filed a consolidated amended complaint on March 14, 2007.

*Barone v. Gerzberg et al.; Durco v. Gerzberg et al.* On October 23, 2006,two purported shareholder derivative actions were filed by Moshe Barone andJohn Durco against Zoran as a nominal defendant and certain of its current andformer officers and directors in the California Superior Court of Santa ClaraCounty, alleging, inter alia, violations of state securities laws and 

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breaches of fiduciary duty.  OnJanuary 24, 2007 the Court consolidated the *Barone*and *Durco*actions, appointed Messrs. Barone and Durco as co-leadplaintiffs and approved their selection of counsel for the consolidatedderivative action.  Co-Lead Plaintiffsfiled a consolidated amended complaint on March 26, 2007.

On February 20, 2007, the Company filed a complaintagainst ArcSoft Inc. in the California Superior Court for the County of Alameda,seeking payment of $4 million in principal, together with accrued interestthen in the amount of approximately $525,000, under four separate convertiblepromissory notes.  On February 28,2007, the Company filed an application with the Court seeking to attach assetsof ArcSoft as security for the payment of its obligations under the notes.  The notes represent amounts loaned by theCompany to ArcSoft in 2004 in connection with a transaction involving thetransfer to ArcSoft of rights related to a software product then under developmentand related agreements regarding the continued development andcommercialization of the product.  OnMarch 28, 2007, ArcSoft filed an answer denying liability under the notesand asserting various affirmative defenses. ArcSoft also filed a cross complaint alleging fraud in the inducement ofthe business arrangement, fraudulent and negligent misrepresentation, breach ofcontract and of the implied covenant of good faith and fair dealing, and unjustenrichment and seeking monetary damages of more than $6.9 million.  The hearing on our application for anattachment is currently scheduled for May 14, 2007.

*Indemnification Obligations***.** Subject to certain limitations, theCompany is obligated to indemnify its current and former directors, officersand employees in connection with the investigation of the Company’s historicalstock option practices and related government inquiries and litigation. Theseobligations arise under the terms of the Company’s certificate ofincorporation, its bylaws, applicable contracts, and Delaware and Californialaw. The obligation to indemnify generally means that the Company is requiredto pay or reimburse the individuals’ reasonable legal expenses and possiblydamages and other liabilities incurred in connection with these matters. TheCompany is currently paying or reimbursing legal expenses being incurred inconnection with these matters by a number of its current and former directors,officers and employees.

*Other Legal Matters.*The Company is named from time to time as a party to lawsuits in the normalcourse of its business. Litigation, in general, and intellectual property andsecurities litigation in particular, can be expensive and disruptive to normalbusiness operations. Moreover, the results of legal proceedings are difficultto predict.

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**Item 1A.   RiskFactors**

Our future business, operating results and financialcondition are subject to various risks and uncertainties, including thosedescribed below.

Our future business, operating results and financialcondition are subject to various risks and uncertainties, including thosedescribed below.

**Thediscovery that the appropriate measurement dates for financial accountingpurposes of certain stock option grants differed from the recorded grant datesof those awards has had, and may continue to have, a material adverse effect onour financial results.**

We cannot predict the outcome of the pendinggovernment inquiries or stockholder lawsuits, and we may face additionalgovernment actions, stockholder lawsuits and other legal proceedings related toour historical stock option practices and the remedial actions we have taken.All of these events have required us, and will continue to require us, toexpend significant management time and incur significant accounting, legal, andother expenses. This could divert attention and resources from the operation ofour business and adversely affects our financial condition and results ofoperations.

**Theindependent investigation of our historical stock option practices andresulting restatements has been time consuming and expensive, and has had a materialadverse effect on our financial performance.**

The independent investigation of our historicalstock option practices and resulting restatement activities have required us toexpend significant management time and incur significant accounting, legal andother expenses totaling $5.8 million in 2006 and we expect to incur additionalcosts in the future periods.  The resultingrestatements have had a material adverse effect on our results of operations.We have recorded additional stock-based compensation expense of $11.7 million forstock option grants, recognized over the periods from 1997 to 2005.  There was no tax impact of these additional stock-basedcompensation expenses due to the full valuation allowance on our taxassets.  In addition, we have recordedother adjustments previously considered to be immaterial totaling$1.3 million (net of tax of $0.2 million).  As a result, our restated consolidatedfinancial statements reflect an overall decrease in net income of $13.0 millionfor the period of 1997 to 2005.  Theeffect of the restatement adjustments on our consolidated balance sheet atDecember 31, 2005 resulted in a $2.4 million decrease in stockholders’ equity.

**Ongoinggovernment inquiries relating to our historical stock option practices are timeconsuming and expensive and could result in injunctions, fines and penaltiesthat may have a material adverse effect on our financial condition and resultsof operations.**

The inquiries by the United States Attorney’sOffice for the Northern District of California (“USAO”) and the United StatesSecurities and Exchange Commission (“SEC”) into our historical stock optionpractices are ongoing. We have cooperated with the USAO and the SEC and intendto continue to do so. The period of time necessary to resolve these inquiriesis uncertain, and we cannot predict the outcome of these inquiries or whetherwe will face additional government inquiries, investigations or other actionsrelated to our historical stock option practices. These inquiries will likelyrequire us to continue to expend significant management time and incursignificant legal and other expenses, and could result in civil and criminalactions seeking, among other things, injunctions against the Company and thepayment of significant fines and penalties by the Company, which may have amaterial adverse effect on our financial condition, results of operations andcash flow.

**Wehave not been in compliance with SEC reporting requirements and Nasdaq listingrequirements and may continue to face compliance issues with both. If we areunable to remain in compliance with SEC reporting requirements and Nasdaqlisting requirements, there may be a material adverse effect on us and ourstockholders.**

Due to the independent investigation andresulting restatements, in recent periods we were unable to file our periodicreports with the SEC on time and faced the possibility of delisting of ourstock from the Nasdaq Global Select Market.  As a result of our delay in filing periodicreports on a timely basis, we will not be eligible to use a registrationstatement on Form S-3 to register offers and sales of our securities until allperiodic reports have been timely filed for at least 12 months.  If the Nasdaq Listing and Hearing ReviewCouncil concludes that we are not in compliance with applicable listingrequirements, then we may be unable to maintain an effective listing of ourstock on a national securities exchange. If this happens, the price of ourstock and the ability of our stockholders to trade in our stock could beadversely affected. In addition, we would be subject to a number ofrestrictions regarding the registration of our stock under federal securitieslaws, and we 

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would not be able to issue stock options orother equity awards to our employees or non-employees or allow them to exercisetheir outstanding options, which could adversely affect our business andresults of operations.

**Wehave been named as a party to stockholder derivative and class action lawsuitsrelating to our historical stock option practices, and we may be named inadditional lawsuits in the future. This litigation could become time consumingand expensive and could result in the payment of significant judgments andsettlements, which could have a material adverse effect on our financialcondition and results of operations.**

In connection with ourhistorical stock option practices and resulting restatements, a number ofderivative actions were filed against certain of our current and formerdirectors, officers and certain other individuals purporting to assert claimson Zoran’s behalf. In addition, a securities class action complaint was filedagainst us and certain of our current and former officers and our currentdirectors, seeking damages related to our historical stock option practices.There may be additional lawsuits of this nature filed in the future. We cannotpredict the outcome of these lawsuits, nor can we predict the amount of timeand expense that will be required to resolve these lawsuits. If these lawsuitsbecome time consuming and expensive, or if there are unfavorable outcomes inany of these cases, there could be a material adverse effect on our business,financial condition and results of operations.

Our insurance coverage will not cover our totalliabilities and expenses in these lawsuits, in part because we have asignificant deductible on certain aspects of the coverage. In addition,  we are obligated to indemnify our current andformer directors, officers and employees in connection with the investigationof our historical stock option practices and the related government inquiriesand litigation. We currently hold insurance policies for the benefit of ourdirectors and officers, although our insurance coverage may not be sufficientin some or all of these matters. Furthermore, the insurers may seek to deny orlimit coverage in some or all of these matters, in which case we may have toself-fund all or a substantial portion of our indemnification obligations.

**Weare subject to the risks of additional lawsuits from former officers andemployees in connection with our historical stock option practices, theresulting restatements, and the remedial measures we have taken.**

In addition to the possibilities that there maybe additional governmental actions and shareholder lawsuits against us, we maybe sued or taken to arbitration by former officers and employees in connectionwith their stock options and other matters. These lawsuits may be timeconsuming and expensive, and cause further distraction from the operation ofour business. The adverse resolution of any specific lawsuit could have amaterial adverse effect on our business, financial condition and results ofoperations.

**Failureto maintain effective internal controls may cause us to delay filing ourperiodic reports with the SEC, affect our Nasdaq listing, and adversely affectour stock price.**

We are required to include a report ofmanagement on internal control over financial reporting in our Annual Report onForm 10-K that contains an assessment by management of the effectiveness of ourinternal control over financial reporting. In addition, our independentregistered public accounting firm must attest to and report on management’sassessment of the effectiveness of the internal control over financialreporting.  The restatement of financialstatements in prior filings with the SEC is a strong indicator of the existenceof a “material weakness” in the design or operation of internal control overfinancial reporting. However, we have concluded that the control deficienciesthat resulted in the restatement of the previously issued consolidated financialstatements did not constitute a material weakness as of June 30, 2006 becausemanagement determined that as of June 30, 2006 there were effective controlsdesigned and in place to prevent or detect a material misstatement andtherefore the likelihood of stock-based compensation, deferred compensation anddeferred tax assets being materially misstated is not more than remote.

The SEC may disagree with the manner in which wehave accounted for and reported, or not reported, the financial impact of past optiongrant measurement date errors, and there is a risk that its inquiry could leadto circumstances in which we may have to further restate our prior financialstatements, amend prior filings with the SEC, or otherwise take other actionsnot currently contemplated. In addition, the SEC may issue guidance ordisclosure requirements related to the financial impact of past option grantmeasurement date errors that may require us to amend this filing or priorfilings with the SEC to provide additional disclosures pursuant to thisguidance. Any such circumstance could also lead to future delays in filing oursubsequent SEC reports and delisting of our common stock from the NASDAQ GlobalSelect Market.

**Itmay be difficult or costly to obtain director and officer liability insurancecoverage as a result of our stock options problems.**

We expect that the issues arising from ourhistorical stock option grant practices and the related accounting will make itmore difficult to obtain director and officer insurance coverage in thefuture.  If we are able to obtain this coverage, it could be significantlymore costly than in the past, which would have an adverse effect on ourfinancial results and cash flow. As a result of this and related factors, 

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our directors and officers could face increasedrisks of personal liability in connection with the performance of their duties.As a result, we may have difficultly attracting and retaining qualifieddirectors and officers, which could adversely affect our business.

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

Our historical operating results have variedsignificantly from period to period due to a number of factors, including:

·                  fluctuationin demand for our products;

·                  thetiming of new product introductions or enhancements by us and our competitors;

·                  thelevel of market acceptance of new and enhanced versions of our products and ourcustomers’ products;

·                  thetiming or cancellation of large customer orders;

·                  thelength and variability of the sales cycle for our products;

·                  pricingpolicy changes by us and by our competitors and suppliers;

·                  thecyclical nature of the semiconductor industry;

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

·                  changesin the mix of products sold;

·                  seasonalityin demand for our products;

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

·                  theevolving and unpredictable nature of the markets for products incorporating ourintegrated circuits and embedded software.

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

·                  thecost and availability of adequate foundry capacity;

·                  fluctuationsin manufacturing yields;

·                  changesin or the emergence of new industry standards;

·                  failureto anticipate changing customer product requirements;

·                  theloss or gain of important customers;

·                  productobsolescence; and

·                  theamount of research and development expenses associated with new productintroductions.

Our operating results could also be harmed by:

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

·                  terrorismand international conflicts or other crises;

·                  otherconditions affecting the timing of customer orders;

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·                  changesin governmental regulations that could affect our products;

·                  adownturn in the markets for our customers’ products, particularly the consumerelectronics market;

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

·                  reduced demandfor consumer electronic products due to a potential economic slowdown;

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

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

These factors aredifficult or impossible to forecast.  Weplace orders with independent foundries several months in advance of thescheduled delivery date, often in advance of receiving non-cancelable ordersfrom our customers.  This limits ourability to react to fluctuations in demand for their products.  If anticipated shipments in any quarter arecanceled or do not occur as quickly as expected, or if we fail to foresee atechnology change that could render a product obsolete, expense and inventorylevels could be disproportionately high. If anticipated license revenues in any quarter are canceled or do notoccur, gross margins may be reduced.

A significantportion of our expenses are relatively fixed, and the timing of increases inexpenses is based in large part on our forecast of future revenues.  As a result, if revenues do not meet ourexpectations, we may be unable to quickly adjust expenses to levels appropriateto actual revenues, which could harm our operating results.

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

Because themarkets that our customers serve are characterized by numerous new product introductionsand rapid product enhancements, our operating results may vary significantlyfrom quarter to quarter.  During thefinal production of a mature product, our customers typically exhaust theirexisting inventories of our products. Consequently, orders for our products may decline in thosecircumstances, even if the products are incorporated into both mature productsand replacement products.  A delay in acustomer’s transition to commercial production of a replacement product woulddelay our ability to recover the lost sales from the discontinuation of therelated mature product.  Our customersalso experience significant seasonality in the sales of their consumerproducts, which affects their orders of our products.  Typically, the second half of the calendaryear represents a disproportionate percentage of sales for our customers due tothe holiday shopping period for consumer electronics products, and therefore, adisproportionate percentage of our sales. We expect these seasonal sales fluctuations to continue for theforeseeable future.

Our ability to match production mix with the product mix needed to fillcurrent orders and orders to be delivered in the given quarter may affect ourability to meet that quarter’s revenue forecast.  In addition, when responding to customers’requests for shorter shipment lead times, we manufacture products based onforecasts of customers’ demands.  Theseforecasts are based on multiple assumptions. If we inaccurately forecast customer demand, we may hold inadequate,excess or obsolete inventory that would reduce our profit margins and adverselyaffect our results of operations and financial condition.

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

Average sellingprices for our products decline over relatively short time periods, while manyof our manufacturing costs are fixed. When our average selling prices decline,our revenues decline unless we are able to sell more units, and our grossmargins decline unless we are able to reduce our manufacturing costs by acommensurate amount.  Our operatingresults suffer when gross margins decline. We have experienced these problems, and we expect to continue toexperience them in the future, although we cannot predict when they may occuror how severe they will be.

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

The semiconductorindustry is subject to cyclical variations in product supply and demand.  Downturns in the industry often occur inconnection with, or anticipation of, maturing product cycles for bothsemiconductor companies and their customers and declines in general economicconditions.  These downturns have beencharacterized by abrupt fluctuations in product demand, productionover-capacity and accelerated decline of average selling prices.  In some cases, these downturns have lastedmore than one year. We cannot predict whether we will achieve timely,cost-effective access to that capacity when needed, or when there will be acapacity shortage again in the future.  Adownturn in the semiconductor industry could harm our sales and revenues ifdemand drops, or our gross margins if average selling prices decline.

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**Oursuccess for the foreseeable future will depend on demand for integratedcircuits for a limited number of applications.**

In recent years,we have derived a substantial majority of our product revenues from the sale ofintegrated circuits for DVD and digital camera applications.  We expect that sales of our products forthese applications will continue to account for a significant portion of ourrevenues for the foreseeable future. Our future financial performance will alsodepend on our ability to successfully develop and market new products in thedigital television, HDTV and digital imaging markets.  If the markets for these products andapplications decline or fail to develop as expected, or we are not successful inour efforts to market and sell our products to manufacturers who incorporateintegrated circuits into these products, our financial results will be harmed.

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

Our financialperformance depends in large part on our ability to successfully develop andmarket next-generation and new products in a rapidly changing technologicalenvironment.  If we fail to successfullyidentify new product opportunities and timely develop and introduce newproducts that achieve market acceptance, we may lose our market share and ourfuture revenues and earnings may suffer.

In the consumerelectronic market, our performance has been dependent on our successfuldevelopment and timely introduction of integrated circuits for DVD players, DVDrecorders, digital cameras, broadband digital television and HDTV.  These markets are characterized by theincorporation of a steadily increasing level of integration and numbers offeatures on a chip at the same or lower system cost, enabling originalequipment manufacturers, or OEMs, to continually improve the features or reducethe prices of the systems they sell.  Ifwe 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 Imaging market,our performance has been dependent on our successful development and timelyintroduction of integrated circuits for printers and multi-function peripherals.  These markets are characterized by theincorporation of a steadily increasing level of integration and higher speedson a chip at the same or lower system cost, enabling original equipmentmanufacturers, or OEMs, to continually improve the performance and features orreduce the prices of the systems they sell. If we are unable to develop and introduce integrated circuits withincreasing levels of integration, performance and new features at competitiveprices, our operating results will suffer. The performance of our softwarelicensing business is dependent on our ability to develop and introduce newreleases of our software, which incorporate new or enhanced printing standards,as well as performance enhancements required by our OEM customers. If we areunable to develop and release versions of our software supporting requiredstandards and offering enhanced performance, our operating results will suffer.

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

The markets in which we compete are intensely competitiveand are characterized by rapid technological change, declining average unitselling prices and rapid product obsolescence. We expect competition to increase in the future from existingcompetitors and from other companies that may enter our existing or futuremarkets with solutions which may be less costly or provide higher performanceor more desirable features than our products. Competition typically occurs at the design stage, when customersevaluate alternative design approaches requiring integrated circuits. Becauseof short product life cycles, there are frequent design win competitions fornext-generation systems.

Our existing and potential competitors include many largedomestic and international companies that have substantially greater financial,manufacturing, technological, market, distribution and other resources.  These competitors may also have broaderproduct lines and longer standing relationships with customers and suppliersthan we have.

Some of our principalcompetitors maintain their own semiconductor foundries and may thereforebenefit from capacity, cost and technical advantages. Our principal competitorsin the integrated audio and video devices for DVD applications includeCheertek, ESS, LSI Logic, Magnum Semiconductor, Matsushita, MediaTek, RenesasTechnology, Samsung and Sunplus. In the markets for JPEG-based products for usein digital cameras, our principal competitors are in-house solutions developedand used by major Japanese OEMs, as well as products sold by Sunplus and TexasInstruments.  In the market for JPEG-basedproducts for desktop video editing applications, our principal competitor isSunplus.  Cirrus Logic (CrystalSemiconductor), Fujitsu, Freescale Semiconductor, STMicroelectronics and Yamahaare currently shipping Dolby Digital-based audio compressionproducts.  Our principal competitors fordigital semiconductor devices in the digital television market include AdvancedMicro Devices, Broadcom, Renesas Technology, M-Star, Mediatek and STMicroelectronics.  Others who alsoparticipate in this market are ALi Corporation, Cheertek, Fujitsu, Genesis

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Microchip, NEC,Pixelworks and Trident Microsystems. Competitors in the Printer andMultifunction peripheral space include Sigmatel Inc., Marvell Semiconductor,TAK Imaging, Peerless Systems, Global Graphics and in-house captive suppliers.

Webelieve that growth of the DVD player market will be modest in the foreseeablefuture, and that continued strong competition will lead to further pricereductions, and reduced profit margins. We also face significantcompetition in the digital Imaging and digital camera markets.  The futuregrowth of both markets is highly dependent on OEMs continuing to outsourcean increasing portion of their product development work. Many of our existing competitors,as well as OEM customers that are expected to compete with us in the future,have substantially greater financial, manufacturing, technical, marketing,distribution and other resources, broader product lines and longer standingrelationships with customers than we have.  In addition, much of our futuresuccess is dependent on the success of our OEM customers.  If we or ourOEM customers are unable to compete successfully against current and futurecompetitors, we could experience price reductions, order cancellations andreduced gross margins, any one of which could harm our business.

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

Our future successwill depend on our ability to anticipate and adapt to changes in technology andindustry standards and our customers’ changing demands.  The consumer electronics market, inparticular, is characterized by rapidly changing technology, evolving industrystandards, frequent new product introductions, short product life cycles andincreasing demand for higher levels of integration.  Our ability to adapt to these changes and toanticipate future standards, and the rate of adoption and acceptance of thosestandards, will be a significant factor in maintaining or improving ourcompetitive position and prospects for growth. If new industry standards emerge, our products or the products of ourcustomers could become unmarketable or obsolete, and we could lose market shareor be required to incur substantial unanticipated costs to comply with thesenew standards**.**

Our success willalso depend on the successful development of new markets and the applicationand acceptance of new technologies and products in those new markets.  For example, our success will depend on theability of our customers to develop new products and enhance existing productsin the recordable DVD player market and products for the broadband digitaltelevision and HDTV markets and to introduce and promote those productssuccessfully.  These markets may not continueto develop to the extent or in the time periods that we currently anticipatedue to factors outside our control, such as delays in implementation of FCC02-320 requiring all new televisions to include a digital receiver by February2009. If new markets do not develop as we anticipate, or if our products do notgain widespread acceptance in these markets, our business, financial conditionand results of operations could be harmed. The emergence of new markets for our products is also dependent in partupon third parties developing and marketing content in a format compatible withcommercial and consumer products that incorporate our products.  If this content is not available,manufacturers may not be able to sell products incorporating our products, andour sales would suffer.

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

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

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

·                  the inability toobtain adequate manufacturing capacity;

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

·                  lack of controlover delivery schedules;

·                  lack of controlover quality assurance;

·                  lack of controlover manufacturing yields and cost; and

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·                  potentialmisappropriation of our intellectual property.

In addition, TSMCand some of our other foundries are located in areas of the world that aresubject to natural disasters such as earthquakes.  While the 1999 earthquake in Taiwan did nothave a material impact on our independent foundries, a similar event centerednear TSMC’s facility could severely reduce TSMC’s ability to manufacture ourintegrated circuits.  The loss of any ofour manufacturers 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 ourproducts.  Any of these circumstancescould damage our relationships with current and prospective customers and harmour sales and financial results.

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

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

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

·                  option paymentsor other prepayments to a foundry;

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

·                  contracts thatcommit us to purchase specified quantities of silicon wafers over extendedperiods;

·                  issuance of ourequity securities to a foundry;

·                  investment in afoundry;

·                  joint ventures;or

·                  otherpartnership relationships with foundries.

We may not be ableto make any such arrangement in a timely fashion or at all, and sucharrangements, if any, may not be on terms favorable to us.  Moreover, if we are able to secure foundrycapacity, we may be obligated to utilize all of that capacity or incurpenalties.  Such penalties may beexpensive and could harm our financial results.

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

The fabrication ofsilicon wafers is a complex process. Minute levels of contaminants in the manufacturing environment, defectsin photo masks used to print circuits on a wafer, difficulties in thefabrication process or other factors can cause a substantial portion of theintegrated circuits on a wafer to be non-functional.  Many of these problems are difficult todetect at an early stage of the manufacturing process and may be time consumingand expensive to correct.  As a result,foundries often experience problems achieving acceptable yields, which arerepresented by the number of good integrated circuits as a proportion of thenumber of total integrated circuits on any particular wafer.  Poor yields from our independent foundrieswould reduce our ability to deliver our products to customers, harm ourrelationships with our customers and harm our business.

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

During 2006, only 7% of our total revenues were derived from NorthAmerica sales.  We anticipate thatinternational sales will continue to account for a substantial majority of ourtotal revenues for the foreseeable future. In addition, substantially all of our semiconductor products aremanufactured, assembled and tested outside of the United States by independentfoundries and subcontractors.

We are subject to avariety of risks inherent in doing business internationally, including:

·                  unexpectedchanges in regulatory requirements;

·                  fluctuations inexchange rates;

·                  political andeconomic instability;

·                  imposition oftariffs and other barriers and restrictions;

·                  the burdens ofcomplying with a variety of foreign laws; and

·                  health risks ina particular region.

A material amount of ourresearch and development personnel and facilities and a portion of our salesand marketing personnel are located in Israel. Political, economic and military conditions in Israel directly affectour operations.  Some of our employees inIsrael are obligated to perform up to 39 days of military reserve dutyannually.  The absence of these employeesfor significant periods during the work week may cause us to operateinefficiently during these periods.

Our operations in Chinaare subject to the economic and political uncertainties affecting thatcountry.  For example, the Chineseeconomy has experienced significant growth in the past decade, but such growthhas been uneven across geographic and economic sectors.  This growth may decrease and any slowdown mayhave a negative effect on our business. We also maintain offices in Taipei, Taiwan, Hong Kong and Seoul, Korea,and our operations are subject to the economic and political uncertaintiesaffecting these countries as well.

The significantconcentration of our manufacturing activities with third party foundries inTaiwan exposes us to the risk of political instability in Taiwan, including thepotential for conflict between Taiwan and China.  We have several significant OEM customers inJapan, Korea and other parts of Asia. Adverse economic circumstances in Japan and elsewhere in Asia couldaffect these customers’ willingness or ability to do business with us in thefuture or their success in developing and launching devices containing ourproducts.

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

Foreign currencyfluctuations may affect the prices of our products.  Prices for our products are currentlydenominated in U.S. dollars for sales to our customers throughout theworld.  If there is a significantdevaluation of the currency in a specific country, the prices of our productswill increase relative to that country’s currency, our products may be lesscompetitive in that country and our revenues may be adversely affected.  Also, we cannot be sure that ourinternational customers will continue to be willing to place orders denominatedin U.S. dollars.  If they do not, ourrevenue and operating results will be subject to foreign exchange fluctuations.

**Becausewe have significant operations in Israel, our business and future operatingresults could be harmed by future terrorist activity or military conflict.**

We conduct a significant portion of our research anddevelopment and engineering activities at our design center in Haifa, Israel, a109,700 square foot facility where we employ approximately 390 people.  We also conduct a portion of our sales andmarketing operations at our Haifa facility. We have an additional 16,100 squarefoot facility in Kfar Netter, Israel, where we conduct research and developmentactivities.

Haifa was a principal target in the recent armedconflict in Northern Israel, and, accordingly, our facility and personnel inHaifa were at significant risk during that conflict.  Although we suffered no damage to ourfacilities or injury to our personnel during the recent conflicts, significantdamage to our facilities in Israel, injury of our employees working there, ordamage to the Israeli business or transportation infrastructure as a result offuture military conflict or terrorist activity could materially affect ouroperations in Israel and harm our business. In addition, some of our employees in Israel serve in the militaryreserve. Any prolonged absence of a substantial number of these employees couldmaterially harm our business.

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In addition to their impact on our operations inIsrael, military conflict in the Middle East or future terrorist activitiesthere or elsewhere in the world could harm our business as a result of adisruption in commercial activity affecting international commerce or a generaleconomic slowdown and reduced demand for consumer electronic products.

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

A portion of the cost ofour operations, relating mainly to our personnel and facilities in Israel, isincurred in New Israeli Shekels.  As aresult, we bear the risk that the rate of inflation in Israel or the decline inthe value of United States dollar compared to the New Israeli Shekel willincrease our costs as expressed in United States dollars.  To date, we have not engaged in hedgingtransactions.  In the future, we mayenter into currency hedging transactions to decrease the risk of financialexposure from fluctuations in the exchange rate of the United States dollaragainst the New Israeli Shekel.  Thesemeasures may not adequately protect us from the impact of inflation in Israel.

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

Our largest customershave accounted for a substantial percentage of our revenues.  In 2005, no single customer accounted formore than 10% of our total revenues, although sales to our four largestcustomers accounted for 29% of our total revenues.  In 2004, one customer accounted for 11% ofour total revenues while sales to our four largest customers accounted for 35%of our total revenues.  Sales to theselarge customers have varied significantly from year to year and will continueto fluctuate in the future.  These salesalso may fluctuate significantly from quarter to quarter.  We may not be able to retain our key customers,or these customers may cancel purchase orders or reschedule or decrease theirlevel of purchases from us.  Anysubstantial decrease or delay in sales to one or more of our key customerscould harm our sales and financial results. In addition, any difficulty in collecting amounts due from one or morekey customers could harm our financial results.

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

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

Long sales cycles alsosubject us to other risks, including customers’ budgetary constraints, internalacceptance 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 to incorporate our products intotheir own can vary significantly with the needs of our customers and generallyexceeds several months, which further complicates our planning processes andreduces the predictability of our operating results.

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

We generally do not enterinto long-term purchase contracts with our customers, and we cannot be certainas to future order levels from our customers. Customers generally purchase our products subject to cancelableshort-term purchase orders.  We cannotpredict whether our current customers will continue to place orders, whetherexisting orders will be canceled, or whether customers who have orderedproducts will pay invoices for delivered products.  When we do enter into a long-term contract,the contract is generally terminable at the convenience of the customer.  Early termination by one of our majorcustomers would harm our financial results.

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

We develop complex andevolving products.  Despite testing by usand our customers, errors may be found in existing or new products.  This could result in, among other things, adelay in recognition or loss of revenues, loss of market share or failure toachieve market acceptance.  These defectsmay cause us to incur significant warranty, support and repair costs, divertthe attention of our engineering personnel from our product development effortsand harm our relationships with customers. The occurrence of these problems could result in the delay or loss ofmarket acceptance of our products and would likely harm our business.  Defects, integration issues or other performanceproblems in our products could result in financial or other damages tocustomers or could

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damage market acceptanceof such products.  Our customers couldalso seek damages from us for their losses. A product liability claim brought against us, even if unsuccessful,would likely be time consuming and costly to defend.

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

The FederalCommunications Commission, or FCC, has broad jurisdiction over our targetmarkets in the digital television business. Various international entities or organizations may also regulateaspects of our business or the business of our customers.  Although our products are not directlysubject to regulation by any agency, the transmission pipes, as well as much ofthe equipment into which our products are incorporated, are subject to directgovernment regulation.  For example,before they can be sold in the United States, advanced televisions and emerginginteractive displays must be tested and certified by Underwriters Laboratoriesand meet FCC regulations.  Accordingly,the effects of regulation on our customers or the industries in which ourcustomers operate may in turn harm our business.  FCC regulatory policies affecting the abilityof cable operators or telephone companies to offer certain services and otherterms on which these companies conduct their business may impede sales of ourproducts.  In addition, our digitaltelevision business may also be adversely affected by the imposition oftariffs, duties and other import restrictions on our suppliers or by theimposition of export restrictions on products that we sellinternationally.  Changes in current lawsor regulations or the imposition of new laws or regulations in the UnitedStates or elsewhere could harm our business. For example, any delays by the FCC in imposing its pending requirementthat all new televisions have a digital receiver could have an adverse effecton our HDTV business.

**Ourability to compete could be jeopardized if we are unable to protect ourintellectual property rights.**

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

The protection offered bypatents is subject to numerous uncertainties. For example, our competitors may be able to effectively design aroundour patents, or the patents may be challenged, invalidated or circumvented.  Those competitors may also independentlydevelop technologies that are substantially equivalent or superior to ourtechnology.  Moreover, while we hold, orhave applied for, patents relating to the design of our products, some of our productsare based in part on standards, for which we do not hold patents or otherintellectual property rights.

We have generally limitedaccess to and distribution of the source and object code of our software andother proprietary information.  With respect to our page descriptionlanguage software, SOC platform firmware and drivers for the digital officemarket and in limited circumstances with respect to firmware on SCS products,firmware and platforms for our DTV, DVDR products, we grant licenses that giveour customers access to and restricted use of the source code of our****software.  This access increases thelikelihood of misappropriation or misuse of our technology.

**Claimsand litigation regarding intellectual property rights could seriously harm ourbusiness and require us to incur significant costs.**

In recent years, therehas been significant litigation in the United States involving patents andother intellectual property rights.  Inthe past, Zoran has been subject to claims and litigation regarding alleged infringementof other parties’ intellectual property rights, and both Oak and Zoran havebeen parties to a number of patent-related lawsuits, both as plaintiff anddefendant.  We could become subject toadditional litigation in the future, either to protect our intellectualproperty or as a result of allegations that we infringe others’ intellectualproperty rights.  Claims that ourproducts infringe proprietary rights would force us to defend ourselves andpossibly our customers or manufacturers against the alleged infringement.  Future litigation against us, if successful,could subject us to significant liability for damages or invalidation of ourproprietary rights.  These lawsuits,regardless of their success, are time-consuming and expensive to resolve andrequire significant management time and attention.  Future intellectual property litigation couldforce us to do one or more of the following:

·                  stopselling products that incorporate the challenged intellectual property;

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·                  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;

·                  pay damages; or

·                  redesign thoseproducts that use such technology.

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

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

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

We rely on licenses touse various technologies that are material to our products.  We do not ownthe patents that underlie this license.  Our rights to use thesetechnologies and employ the inventions claimed in the licensed patents aresubject to our abiding by the terms of the licenses.  Under the licenseagreements we must fulfill confidentiality obligations and pay royalties. If we fail to abide by the terms of the license, we would be unable to sell andmarket the products under license.  In addition, we do not control theprosecution of the patents subject to this license or the strategy fordetermining when such patents should be enforced.  As a result, we aredependent upon our licensor to determine the appropriate strategy forprosecuting and enforcing those patents.

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

Our future net income andcash flow will be affected by our ability to apply our net operating losses, orNOLs, against taxable income in future periods. Our NOLs totaled approximately$185 million for federal and $36 million for state tax reporting purposes as ofDecember 31, 2006. The Internal Revenue Code contains a number of provisionsthat limit the use of NOLs under certain circumstances.  During 2006 we reduced the NOL deferred taxasset for amounts which we believe will expire before they become available forutilization. Changes in tax laws in the United States may further limit ourability to utilize these NOLs.  Any further limitation on our ability toutilize these respective NOLs could harm our financial condition.

**Changes in, orinterpretations of, tax rules and regulations may adversely affect oureffective tax rates.**

Unanticipated changes in our tax rates couldaffect our future results of operations. Our future effective tax rates couldbe unfavorably affected by changes in tax laws or the interpretation of taxlaws, by unanticipated decreases in the amount of revenue or earnings incountries with low statutory tax rates, or by changes in the valuation of ourdeferred tax assets and liabilities. While we believe our tax reservesadequately provide for any tax contingencies, the ultimate outcomes of anyfuture tax audits are uncertain, and we can give no assurance as to whether anadverse result from one or more of them will have a material effect on ouroperating results and financial position.

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

We have made investmentsin, and acquisitions of other complementary companies, products andtechnologies, and we may acquire additional businesses, products ortechnologies in the future.  In the eventof any future acquisitions, we could:

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

·                  incur debt;

·                  use asignificant amount of our cash;

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·                  assumeliabilities;

·                  incur expensesrelated to the future impairment of goodwill and the amortization of otherintangible assets; or

·                  incur otherlarge write-offs immediately or in the future.

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

·                  problemscombining the purchased operations, technologies or products;

·                  unanticipatedcosts;

·                  diversion ofmanagement’s attention from our core business;

·                  adverse effectson existing business relationships with customers;

·                  risks associatedwith entering markets in which we have no or limited prior experience; and

·                  potential lossof key employees, particularly those of the purchased organizations.

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

**If ourgoodwill or amortizable intangible assets become impaired we may be required torecord a significant charge to earnings.**

Under generally accepted accounting principles,we review our amortizable intangible assets for impairment when events orchanges in circumstances indicate the carrying value may not be recoverable.Goodwill is required to be tested for impairment at least annually. Factorsthat may be considered a change in circumstances indicating that the carryingvalue of our goodwill or amortizable intangible assets may not be recoverableinclude a decline in stock price and market capitalization, future cash flows,and slower growth rates in our industry. We may be required to record asignificant charge to earnings in our financial statements during the period inwhich any impairment of our goodwill or amortizable intangible assets isdetermined resulting in an impact on our results of operations.

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

We may requiresubstantial additional capital to finance our future growth, secure additionalfoundry capacity and fund our ongoing research and development activitiesduring 2007 and beyond.  Our capitalrequirements will depend on many factors, including:

·                  thelevels at which we maintain inventory and accounts receivable;

·                  themarket acceptance of our products;

·                  thelevels of promotion and advertising required to launch our new products or toenter markets and attain a competitive position in the marketplace;

·                  ourbusiness, product, capital expenditure and research and development plans andtechnology roadmap;

·                  volumepricing concessions;

·                  capitalimprovements to new and existing facilities;

·                  technologicaladvances;

·                  theresponse of competitors to our products; and

·                  ourrelationships with our suppliers and customers.

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

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

We anticipate that ourfuture growth, if any, will require us to recruit and hire a substantial numberof new engineering, managerial, sales and marketing personnel.  Our ability to manage growth successfullywill also require us to expand and improve administrative, operational,management and financial systems and controls. Many of our key operations, including a material portion of our researchand development operations and a significant portion of our sales andadministrative operations are located in Israel.  A majority of our sales and marketing andcertain of our research and development and administrative personnel, includingour President and Chief Executive Officer and other officers, are based in theUnited States.  The geographic separationof these operations places additional strain on our resources and our abilityto manage growth effectively.  If we areunable to manage growth effectively, our business will be harmed.

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

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

**Provisionsin our charter documents and Delaware law could prevent or delay a change incontrol 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 include provisions:

·                  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;

·                  authorizing theissuance 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.

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

The market price of ourcommon stock has fluctuated significantly since our initial public offering in1995.  Between January 1, 2005 andJune 30, 2006, the closing sale price of our common stock, as reported on. TheNasdaq  Global Select Market, ranged froma low of $8.97 to a high of $29.13.  Themarket price of our common stock is subject to significant fluctuations in thefuture in response to a variety of factors, including:

·                  results ofregulatory investigations;

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

·                  annual  and quarterly variations in our operatingresults;

·                  changes inanalysts’ earnings estimates;

·                  announcements oftechnological innovations;

·                  the introductionof new products or changes in product pricing policies by Zoran or itscompetitors;

·                  loss of keypersonnel;

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·                  proprietaryrights or other litigation;

·                  generalconditions in the semiconductor industry; and

·                  developments inthe financial markets.

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

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

Our 2006 Annual Meetingof Stockholders was held on June 22, 2006.  At the meeting, the followingeight persons nominated by management were elected to serve as members of ourBoard of Directors:

 
| ** **           | ** ** | **Shares**         | ** ** |
|----------------------|------------|--------------------|------------|
| **Nominee**          | ** ** | **Voted For** | ** ** | **Withheld** | ** ** |
| Levy Gerzberg        |       | 44,804,378         |       | 1,171,285 |   |
| Uzia Galil           |       | 41,546,613         |       | 4,430,050 |   |
| Raymond A.  Burgess  |       | 45,153,082         |       | 822,581 |   |
| James D. Meindl      |       | 41,705,807         |       | 4,269,856 |   |
| James B. Owens,  Jr. |       | 45,112,158         |       | 863,505 |   |
| David Rynne          |       | 45,152,107         |       | 823,556 |   |
| Arthur B.  Stabenow  |       | 41,672,246         |       | 4,303,417 |   |
| Philip M. Young      |       | 44,738,394         |       | 1,237,269 |   |

The following additionalproposals were voted upon at the meeting:

1.                     Aproposal to amend our 2005 Equity Incentive Plan (the “2005 Plan”) to increasethe maximum number of shares of common stock that may be issued under the 2005Plan by 2,500,000 shares to a total of 4,556,663 shares was approved. The voteon this proposal was 22,342,163 shares for; 14,838,884 shares against; 46,753shares abstaining and 11,003,371 broker non-votes.

2.                     Aproposal to amend our 1995 Employee Stock Purchase Plan (the “Purchase Plan”)to increase the maximum number of shares of common stock that may be issuedunder the Purchase Plan by 1,000,000 shares to a total of 4,225,000 shares wasapproved.  The vote on this proposal was30,870,851 shares for; 6,297,685 shares against; 48,763 shares abstaining; and11,013,872 broker non-votes.

3.                     Aproposal to ratify the appointment of PricewaterhouseCoopers LLP as ourindependent registered public accounting firm for the fiscal year endingDecember 31, 2006 was approved by a vote of 45,447,361 shares for; 507,485shares against; 20,816 shares abstaining; and 2,255,509 broker non-votes.

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**Item 6. Exhibits**

 
| 10.13 (1) |   | Zoran Corporation 2005 Equity Incentive Plan, as  amended                                                                            |
|-----------|--------|--------------------------------------------------------------------------------------------------------------------------------------|
| 10.57 (1) |   | Zoran Corporation 1995 Employee Stock Purchase Plan,  as amended                                                                     |
| 10.58(1)  |   | Form of Notice of Grant of Nonstatutory Stock  Option (Initial Option) under the Zoran Corporation 2005 Directors Equity  Plan  |
| 10.59(1)  |   | Form of Notice of Grant of Nonstatutory Stock  Option (Annual Option) under Zoran Corporation’s 2005 Directors Equity Plan |
| 10.60(1)  |   | Form of Stock Option Agreement under Zoran  Corporation 2005 Directors Equity Plan                                              |
| 31.1      |   | Certification of Chief Executive Officer pursuant to  Rule 13a-14(a) or 15d-14(a).                                                   |
| 31.2      |   | Certification of Chief Financial Officer pursuant to  Rule 13a-14(a) or 15d-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 byreference to identically titled exhibit to Registrant’s Form 8-K filed on July 13,2006.

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**SIGNATURES**

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

**ZORANCORPORATION**

** **

 
| Dated: April 19, 2007 |   | /s/ Karl Schneider                                              |
|---------------------------------|--------|-----------------------------------------------------------------|
|                            |   | Karl Schneider                                                  |
|                            |   | Senior Vice President, Finance                                  |
|                            |   | and Chief Financial Officer                                     |
|                            |   | (principal financial officer and principal accounting  officer) |

 

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