**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,D.C. 20549**

 

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### **FORM 10-Q**

### ** **

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

 

**For theQuarterly Period Ended September 30, 2005**

 

**OR**

 

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

 

**For the transition period from                                  to**

 

**CommissionFile No. 0-27246**

 

**ZORAN CORPORATION**

(Exact name of registrant as specified in its charter)

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

 

**1390 KiferRoad**

**Sunnyvale,California 94086**

(Address of principal executive offices, including zip code)

 

**(408) 523-6500**

(Registrant’s telephone 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 shorter periodthat the registrant was required to file such reports) and (2) has beensubject to such filing requirements for the past 90 days. Yes ýNo o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).

Yes ý No o

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act) Yes oNo ý

 

As of November 7, 2005, there were outstanding 45,290,268 sharesof the registrant’s Common Stock, par value $0.001 per share.

 

 

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**ZORANCORPORATION AND SUBSIDIARIES**

**FORM 10-Q**

**INDEX**

 

**For theQuarter Ended September 30, 2005**

 
| **PART I.  FINANCIAL INFORMATION** |                                                                                                                          |
|-----------------------------------------|-------------------------------------------------------------------------------------------------------------------------------|
|                                    |                                                                                                                          |   |
| **Item 1.**                             | Financial  Statements (Unaudited):                                                                                            |   |
|                                    |                                                                                                                          |   |
|                                    | Condensed Consolidated Balance Sheets as of  September 30, 2005 and December 31, 2004                               |   |
|                                    |                                                                                                                          |   |
|                                    | Condensed Consolidated Statements of  Operations for the Three Months and Nine Months Ended September 30, 2005  and 2004 |   |
|                                    |                                                                                                                          |   |
|                                    | Condensed Consolidated Statements of Cash Flows for the Nine Months  Ended September 30, 2005 and 2004                   |   |
|                                    |                                                                                                                          |   |
|                                    | Notes to Condensed Consolidated Financial  Statements                                                                         |   |
|                                    |                                                                                                                          |   |
| **Item  2.**                            | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                   |   |
|                                    |                                                                                                                          |   |
| **Item  3.**                            | Quantitative and Qualitative Disclosures  About Market Risk                                                                   |   |
|                                    |                                                                                                                          |   |
| **Item  4.**                            | Controls and Procedures                                                                                                       |   |
|                                    |                                                                                                                          |   |
| **PART II.  OTHER INFORMATION**    |                                                                                                                          |
|                                    |                                                                                                                          |   |
| **Item  1.**                            | Legal Proceedings                                                                                                             |   |
|                                    |                                                                                                                          |   |
| **Item  4.**                            | Submission of Matters to a Vote of Security  Holders                                                                          |   |
|                                    |                                                                                                                          |   |
| **Item  6.**                            | Exhibits                                                                                                                      |   |
|                                    |                                                                                                                          |   |
| Signatures                              |                                                                                                                          |

 

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**ZORANCORPORATIONCONDENSED CONSOLIDATED BALANCE SHEETS(in thousands, except share data)(unaudited)**

 
| ** **                                                                                                                                                                                                                                                                | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ASSETS                                                                                                                                                                                                                                                                    |       |                         |       |                        |       |
| Current assets:                                                                                                                                                                                                                                                           |       |                         |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                 |       | $                            | 64,782     |                        | $          | 37,435 |   |
| Short-term investments                                                                                                                                                                                                                                                    |       | 65,412                       |       | 32,978                      |       |
| Accounts receivable, net                                                                                                                                                                                                                                                  |       | 80,735                       |       | 59,863                      |       |
| Inventories                                                                                                                                                                                                                                                               |       | 27,331                       |       | 50,033                      |       |
| Prepaid expenses and other current assets                                                                                                                                                                                                                                 |       | 13,151                       |       | 14,130                      |       |
| Total current assets                                                                                                                                                                                                                                                      |       | 251,411                      |       | 194,439                     |       |
|                                                                                                                                                                                                                                                                      |       |                         |       |                        |       |
| Property and equipment, net                                                                                                                                                                                                                                               |       | 16,627                       |       | 17,190                      |       |
| Other assets and investments                                                                                                                                                                                                                                              |       | 12,461                       |       | 68,619                      |       |
| Goodwill                                                                                                                                                                                                                                                                  |       | 185,456                      |       | 150,151                     |       |
| Intangible assets, net                                                                                                                                                                                                                                                    |       | 139,993                      |       | 168,882                     |       |
| Total assets                                                                                                                                                                                                                                                              |       | $                            | 605,948    |                        | $          | 599,281 |   |
|                                                                                                                                                                                                                                                                      |       |                         |       |                        |       |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                                |       |                         |       |                        |       |
| Current liabilities:                                                                                                                                                                                                                                                      |       |                         |       |                        |       |
| Accounts payable                                                                                                                                                                                                                                                          |       | $                            | 37,800     |                        | $          | 34,017 |   |
| Accrued expenses and other liabilities                                                                                                                                                                                                                                    |       | 59,306                       |       | 51,102                      |       |
| Total current liabilities                                                                                                                                                                                                                                                 |       | 97,106                       |       | 85,119                      |       |
|                                                                                                                                                                                                                                                                      |       |                         |       |                        |       |
| Other long-term liabilities                                                                                                                                                                                                                                               |       | 11,538                       |       | 13,535                      |       |
|                                                                                                                                                                                                                                                                      |       |                         |       |                        |       |
| Stockholders’ equity:                                                                                                                                                                                                                                                |       |                         |       |                        |       |
| Common stock, $0.001 par value; 105,000,000  shares authorized at September 30, 2005 and December 31, 2004;  45,011,293 shares issued and outstanding as of September 30, 2005; and  43,195,432 shares issued and outstanding as of December 31, 2004 |       | 45                           |       | 43                          |       |
| Additional paid-in capital                                                                                                                                                                                                                                                |       | 723,671                      |       | 705,661                     |       |
| Deferred stock-based compensation                                                                                                                                                                                                                                         |       | (957                         | )          | (2,791                      | )          |
| Accumulated other comprehensive income                                                                                                                                                                                                                                    |       | 3,262                        |       | 1,538                       |       |
| Accumulated deficit                                                                                                                                                                                                                                                       |       | (228,717                     | )          | (203,824                    | )          |
| Total stockholders’ equity                                                                                                                                                                                                                                           |       | 497,304                      |       | 500,627                     |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                                           |       | $                            | 605,948    |                        | $          | 599,281 |   |

 

The accompanying notes are anintegral part of these unaudited condensed consolidated financial statements.

 

3

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**ZORANCORPORATIONCONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS(in thousands, except per share data)(unaudited)**

 
| ** **                                                  | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                  | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                        |       |                                       |       |                                      |       |   |   |   |   |
| Revenues:                                                   |       |                                       |       |                                      |       |   |   |   |   |
| Hardware product revenues                                   |       | $                                          | 104,208    |                                      | $          | 99,427 |   | $ | 244,107 |   | $ | 257,137 |   |
| Software and other revenues                                 |       | 13,276                                     |       | 20,320                                    |       | 42,340 |   | 46,963 |   |
| Total revenues                                              |       | 117,484                                    |       | 119,747                                   |       | 286,447 |   | 304,100 |   |
|                                                        |       |                                       |       |                                      |       |   |   |   |   |
| Costs and expenses:                                         |       |                                       |       |                                      |       |   |   |   |   |
| Cost of hardware product revenues                           |       | 53,660                                     |       | 66,557                                    |       | 135,860 |   | 170,723 |   |
| Research and development                                    |       | 23,469                                     |       | 21,620                                    |       | 64,890 |   | 61,402 |   |
| Selling, general and administrative                         |       | 21,817                                     |       | 18,819                                    |       | 69,309 |   | 50,121 |   |
| Amortization of intangible assets                           |       | 12,757                                     |       | 12,342                                    |       | 37,518 |   | 33,028 |   |
| Deferred stock compensation                                 |       | 344                                        |       | 910                                       |       | 1,318 |   | 3,309 |   |
| In process research and development                         |       | —                                     |       | —                                    |       | 2,650 |   | — |   |
| Total costs and expenses                                    |       | 112,047                                    |       | 120,248                                   |       | 311,545 |   | 318,583 |   |
|                                                        |       |                                       |       |                                      |       |   |   |   |   |
| Operating income (loss)                                     |       | 5,437                                      |       | (501                                      | )          | (25,098 | ) | (14,483 | ) |
|                                                        |       |                                       |       |                                      |       |   |   |   |   |
| Interest income                                             |       | 689                                        |       | 14                                        |       | 1,796 |   | 797 |   |
|                                                        |       |                                       |       |                                      |       |   |   |   |   |
| Other income (loss), net                                    |       | 32                                         |       | (279                                      | )          | (391 | ) | (165 | ) |
|                                                        |       |                                       |       |                                      |       |   |   |   |   |
| Income (loss) before income taxes                           |       | 6,158                                      |       | (766                                      | )          | (23,693 | ) | (13,851 | ) |
|                                                        |       |                                       |       |                                      |       |   |   |   |   |
| Provision for income taxes                                  |       | 1,200                                      |       | 1,873                                     |       | 1,200 |   | 3,373 |   |
|                                                        |       |                                       |       |                                      |       |   |   |   |   |
| Net income (loss)                                           |       | $                                          | 4,958      |                                      | $          | (2,639 | ) | $ | (24,893 | ) | $ | (17,224 | ) |
|                                                        |       |                                       |       |                                      |       |   |   |   |   |
| Basic net income (loss) per share                           |       | $                                          | 0.11       |                                      | $          | (0.06 | ) | $ | (0.57 | ) | $ | (0.40 | ) |
|                                                        |       |                                       |       |                                      |       |   |   |   |   |
| Diluted net income (loss) per share                         |       | $                                          | 0.11       |                                      | $          | (0.06 | ) | $ | (0.57 | ) | $ | (0.40 | ) |
|                                                        |       |                                       |       |                                      |       |   |   |   |   |
| Shares used to compute basic net income  (loss) per share   |       | 44,877                                     |       | 42,969                                    |       | 43,942 |   | 42,688 |   |
|                                                        |       |                                       |       |                                      |       |   |   |   |   |
| Shares used to compute diluted net income  (loss) per share |       | 46,622                                     |       | 42,969                                    |       | 43,942 |   | 42,688 |   |

 

The accompanying notes are anintegral part of these unaudited condensed consolidated financial statements.

 

4

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**ZORANCORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(inthousands)**

**(unaudited)**

 
| ** **                                                             | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                             | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| Cash flows  from operating activities:                                 |       |                                      |       |   |   |
| Net loss                                                               |       | $                                         | (24,893    | ) | $ | (17,224 | ) |
| Adjustments to reconcile net loss to net  cash provided by operations: |       |                                      |       |   |   |
| Depreciation, amortization and other                                   |       | 9,922                                     |       | 7,660 |   |
| Amortization of intangible assets                                      |       | 37,518                                    |       | 33,028 |   |
| Amortization of stock based compensation                               |       | 1,432                                     |       | 3,309 |   |
| In process research and development                                    |       | 2,650                                     |       | — |   |
| Changes in current assets and liabilities:                             |       |                                      |       |   |   |
| Accounts receivable                                                    |       | (20,496                                   | )          | (18,503 | ) |
| Inventory                                                              |       | 22,915                                    |       | (44,649 | ) |
| Prepaid expenses and other current assets  and other assets            |       | 179                                       |       | (3,525 | ) |
| Accounts payable                                                       |       | 3,238                                     |       | 41,933 |   |
| Accrued expenses and other liabilities and  long-term liabilities      |       | 2,909                                     |       | 7,236 |   |
| Net cash provided by operating activities                              |       | 35,374                                    |       | 9,265 |   |
|                                                                   |       |                                      |       |   |   |
| Cash flows from investing activities:                                  |       |                                      |       |   |   |
| Capital expenditures for property and  equipment                       |       | (8,143                                    | )          | (7,208 | ) |
| Purchases of investments                                               |       | (15,723                                   | )          | (132,835 | ) |
| Proceeds from sales and maturities of  investments                     |       | 37,808                                    |       | 172,840 |   |
| Acquisition of Oren, net of cash acquired                              |       | (27,567                                   | )          | — |   |
| Acquisition of Emblaze Semiconductor, net  of cash acquired            |       | —                                    |       | (54,161 | ) |
| Net cash used in investing activities                                  |       | (13,625                                   | )          | (21,364 | ) |
|                                                                   |       |                                      |       |   |   |
| Cash flows from financing activities:                                  |       |                                      |       |   |   |
| Proceeds from issuance of common stock                                 |       | 5,598                                     |       | 5,745 |   |
| Net cash provided by financing activities                              |       | 5,598                                     |       | 5,745 |   |
|                                                                   |       |                                      |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                  |       | 27,347                                    |       | (6,354 | ) |
|                                                                   |       |                                      |       |   |   |
| Cash and cash equivalents at beginning of  period                      |       | 37,435                                    |       | 47,994 |   |
|                                                                   |       |                                      |       |   |   |
| Cash and cash equivalents at end of period                             |       | $                                         | 64,782     |   | $ | 41,640 |   |

 

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

 

5

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**ZORANCORPORATIONNOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS(unaudited)**

 

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

 

The accompanying unaudited condensed consolidated financial statementsof Zoran Corporation and its subsidiaries (“Zoran” or the “Company”) have beenprepared in conformity with accounting principles generally accepted in theUnited States of America.  However,certain information or footnote disclosures normally included in financialstatements prepared in accordance with accounting principles generally acceptedin the United States of America have been condensed or omitted pursuant to the rules andregulations of the Securities and Exchange Commission (the “SEC”).  In the opinion of management, the condensedconsolidated financial statements reflect all adjustments considered necessary,consisting only of normal recurring adjustments, for a fair statement of theconsolidated financial position, operating results and cash flows for theperiods presented.  The results ofoperations for the interim periods presented are not necessarily indicative ofthe results that may be expected for the full fiscal year or in any futureperiod.  This quarterly report on Form 10-Qshould be read in conjunction with the audited consolidated financialstatements and notes thereto for the year ended December 31, 2004,included in the Zoran Corporation 2004 Annual Report on Form 10-K filedwith the SEC.

 

***Restatement ofFinancial Results for the Quarters Ended March 31, June 30 and September 30,2004***

 

During the fourth quarter of 2004, in connection with the review andevaluation of the effectiveness of our internal control over financialreporting undertaken pursuant to Section 404 of the Sarbanes-Oxley Act of2002, management discovered that excess stock compensation expenses had beenrecognized during the quarters ended March 31, June 30 and September 30,2004.  The compensation expense wasrelated to options that we had assumed as part of our acquisition of OakTechnology, Inc. in 2003.  Underpurchase accounting, part of the cost relating to the acquisition wasattributed to the assumed options and was to be recognized over time as theoptions continued to vest, based on each option holder’s continued employmentwith Zoran.  If an option holder’semployment terminated before the option was fully vested, vesting would cease,and we would no longer recognize compensation expense related to thatoption.  At the time of the acquisition,a schedule was prepared detailing the terms of each assumed option;however, the names of the option holders were omitted from the schedule forreasons of confidentiality.  After theacquisition was completed, we did not update our personnel or financial recordsto include the omitted information. As a result, the Company improperlyrecognized deferred stock compensation expenses relating to options that hadbeen held by former Oak employees after the vesting of such options had ceased,and did not reverse stock based compensation expense recognized in excess ofamounts that actually vested.

 

The amounts presented in this Form 10-Q for the three and ninemonth periods ended September 30, 2004 have been restated to correct thiserror.  For the quarters ended March 31,2004, June 30, 2004 and September 30, 2004, the previously recordeddeferred stock compensation expense was reduced by $704,000, $1,545,000 and$880,000, respectively, as a result of the restatement.

 

The following tables show the effect of therestatement:

 
| ** **                           | ** ** | **Three Months Ended**                    | ** ** |
|--------------------------------------|------------|-------------------------------------------|------------|
| ** **                           | ** ** | **March 31, 2004**                        | ** ** | **June 30, 2004** | ** ** | **September 30, 2004** | ** ** |
| ** **                           | ** ** | **As reported**                           | ** ** | **As restated** | ** ** | **As reported** | ** ** | **As restated** | ** ** | **As reported** | ** ** | **As restated** | ** ** |
| ** **                           | ** ** | **(In Thousands, Except Per Share Data)** | ** ** |
| ** **                           | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Deferred  stock compensation expense |       | $                                         | 2,531      |   | $ | 1,827 |   | $ | 2,117 |   | $ | 572 |   | $ | 1,790 |   | $ | 910 |   |
| Operating  loss                      |       | $                                         | (11,028    | ) | $ | (10,324 | ) | $ | (5,203 | ) | $ | (3,658 | ) | $ | (1,381 | ) | $ | (501 | ) |
| Net loss                             |       | $                                         | (10,689    | ) | $ | (9,985 | ) | $ | (6,145 | ) | $ | (4,600 | ) | $ | (3,519 | ) | $ | (2,639 | ) |
| Basic net  loss per share            |       | $                                         | (0.25      | ) | $ | (0.23 | ) | $ | (0.14 | ) | $ | (0.11 | ) | $ | (0.08 | ) | $ | (0.06 | ) |
| Diluted net  loss per share          |       | $                                         | (0.25      | ) | $ | (0.23 | ) | $ | (0.14 | ) | $ | (0.11 | ) | $ | (0.08 | ) | $ | (0.06 | ) |

 

6

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| ** **                           | ** ** | **Nine Months Ended  September 30, 2004**  | ** ** |
|--------------------------------------|------------|--------------------------------------------|------------|
| ** **                           | ** ** | **As reported**                            | ** ** | **As restated** | ** ** |
| ** **                           | ** ** | **(In Thousands, Except Per  Share Data)** | ** ** |
| ** **                           | ** ** | ** **                                 | ** ** | ** ** | ** ** |
| Deferred  stock compensation expense |       | $                                          | 6,438      |   | $ | 3,309 |   |
| Operating  loss                      |       | $                                          | (17,612    | ) | $ | (14,483 | ) |
| Net loss                             |       | $                                          | (20,353    | ) | $ | (17,224 | ) |
| Basic net  loss per share            |       | $                                          | (0.48      | ) | $ | (0.40 | ) |
| Diluted net  loss per share          |       | $                                          | (0.48      | ) | $ | (0.40 | ) |

 

***Recent AccountingPronouncements***

 

In December 2004, the Financial Accounting Standards Board (“FASB”),issued Statement of Financial Accounting Standards No. 123R, “Share-BasedPayment, an Amendment of Statement of Financial Accounting Standards 123 (“SFAS123R”).  On April 14, 2005, the SECadopted a new rule extending the compliance dates for SFAS 123R.  In accordance with the new rule, theaccounting provisions of SFAS 123R will be effective for the Company in2006.  SFAS 123R requires companies torecognize in the statement of operations the grant-date fair value of stockoptions and other equity-based compensation issued to employees.  SFAS 123R requires the use of an optionpricing model for estimating fair value, which is amortized to expense over theservice periods.  SFAS 123R allowsfor either prospective recognition of compensation expense or retrospectiverecognition, which may be back to the original issuance of SFAS No. 123,or only to interim periods in the year of adoption.  Management is currently evaluating the impactof adopting SFAS 123R; however, it believes the adoption of SFAS 123R willhave a significant impact on net income (loss) and net income (loss) pershare.  The impact on our financialstatements will be dependent on the transition method, the option-pricing modelused to compute fair value and the inputs to that model such as volatility andexpected life.  The pro-forma disclosuresof the impact of SFAS 123 provided in Note 2 to the Consolidated FinancialStatements may not be representative of the impact of adopting SFAS 123R.

 

On March 29, 2005, the SEC issued Staff Accounting Bulletin No. 107(“SAB107”).  This staff accounting bulletinexpresses views of the staff regarding the interaction between SFAS 123R andcertain SEC rules and regulations and provides the staff’s views regardingthe valuation of share-based payment arrangements for public companies.  The Company does not expect the adoption ofSAB 107 to have a material impact on its consolidated financial position,results of operations or cash flows.

 

In May 2005, the FASB issued Statement of Financial Accountingstandards No. 154, “Accounting Changes and Error Corrections” (“SFAS 154”).  SFAS 154 replaces APB Opinion No. 20, “AccountingChanges”, and SFAS No. 3, “Reporting Accounting Changes in InterimFinancial Statements”. SFAS 154 requires retrospective application to priorperiods’ financial statements of changes in accounting principles, unless it isimpracticable to determine either the period-specific effects or the cumulativeeffect of the change. SFAS 154 will be effective for all periods beginningafter December 15, 2005. The impact of adopting SFAS 154 will depend onthe nature and amount of any future accounting change or error, if any.

 

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

 

Zoran applies Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees,” and related interpretations in accounting forits stock plans.  Stock options aregenerally granted with exercise prices equivalent to fair market value of theunderlying common stock on the date of grant, and no compensation cost isrecognized.  As a result of stock optionsgranted in connection with the acquisition of Nogatech, Inc. during 2000and Oak Technology, Inc. during 2003, the Company recorded deferredstock-based compensation which is being amortized over the vesting period ofthe options.  Amortization of deferredstock compensation expense recognized as a result of the amortization of theseoptions was $344,000 and $1,318,000 during the three and nine month periodsended September 30, 2005, respectively, and $910,000 (as restated) and$3,309,000 (as restated) during the three and nine month periods ended September 30,2004, respectively.

 

Had compensation cost for the Company’s option and stock purchase plansbeen determined based on the fair value of the options at the grant date, asprescribed in Statement of Financial Accounting Standards No. 123 “Accountingfor Stock Based

 

7

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Compensation” (“SFAS 123”), theCompany’s net loss and net loss per share for the three month and nine monthperiods ended September 30, 2005 and 2004 would have been as follows (inthousands, except per share data):

 
| ** **                                                                              | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                              | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                    |       |                                       |       |                                      |       |   |   |   |   |
| Net income (loss) attributable to common  stockholders, as reported                     |       | $                                          | 4,958      |                                      | $          | (2,639 | ) | $ | (24,893 | ) | $ | (17,224 | ) |
|                                                                                    |       |                                       |       |                                      |       |   |   |   |   |
| Add:                                                                                    |       |                                       |       |                                      |       |   |   |   |   |
| Employee stock-based compensation expense  included in income (loss)                    |       | 458                                        | *          | 910                                       |       | 1,432 | * | 3,309 |   |
|                                                                                    |       |                                       |       |                                      |       |   |   |   |   |
| Total employee stock-based compensation  expense determined under the fair value method |       | (5,849                                     | )          | (9,491                                    | )          | (20,089 | ) | (30,563 | ) |
|                                                                                    |       |                                       |       |                                      |       |   |   |   |   |
| Pro forma net loss attributable to common  stockholders                                 |       | $                                          | (433       | )                                         | $          | (11,220 | ) | $ | (43,550 | ) | $ | (44,478 | ) |
|                                                                                    |       |                                       |       |                                      |       |   |   |   |   |
| Pro forma net loss per share attributable  to common stockholders:                      |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                                                                   |       | $                                          | (0.01      | )                                         | $          | (0.26 | ) | $ | (0.99 | ) | $ | (1.04 | ) |
| Diluted                                                                                 |       | $                                          | (0.01      | )                                         | $          | (0.26 | ) | $ | (0.99 | ) | $ | (1.04 | ) |
|                                                                                    |       |                                       |       |                                      |       |   |   |   |   |
| Net income (loss) per share as reported  attributable to common stockholders:           |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                                                                   |       | $                                          | 0.11       |                                      | $          | (0.06 | ) | $ | (0.57 | ) | $ | (0.40 | ) |
| Diluted                                                                                 |       | $                                          | 0.11       |                                      | $          | (0.06 | ) | $ | (0.57 | ) | $ | (0.40 | ) |

 

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(*)  Amount includes a charge of$114,000 related to the issuance of 65,333 restricted stock units during thequarter ended September 30, 2005 which is reported as part of selling,general and administrative expense. These restricted stock units vest over a 48 month period and wereoutstanding as of September 30, 2005.

 

For purposes of the disclosure required under SFAS 123, the fair valueof each option grant is estimated on the date of grant using the Black-Scholesoption pricing model with the following assumptions used for options andpurchase grants during the applicable periods:

 
| ** **              | ** ** | **Stock Option Plans**                             | ** ** |
|-------------------------|------------|----------------------------------------------------|------------|
| ** **              | ** ** | **Three Months****Ended  September 30, 2005** | ** ** | **Three Months****Ended  September 30, 2004** | ** ** | **Nine Months****Ended  September 30, 2005** | ** ** | **Nine Months****Ended  September 30, 2004** | ** ** |
|                    |       |                                               |       |   |   |   |   |   |   |
| Expected life (years)   |       | 3.8                                                |       | 5.2 |   | 3.9 |   | 5.2 |   |
| Expected volatility     |       | 66                                                 | %          | 81 | % | 69 | % | 83 | % |
| Risk-free interest rate |       | 4.0                                                | %          | 3.5 | % | 3.8 | % | 3.4 | % |

 
| ** **              | ** ** | **Employee Stock Purchase Plans**                  | ** ** |
|-------------------------|------------|----------------------------------------------------|------------|
| ** **              | ** ** | **Three Months****Ended  September 30, 2005** | ** ** | **Three Months****Ended  September 30, 2004** | ** ** | **Nine Months****Ended  September 30, 2005** | ** ** | **Nine Months****Ended  September 30, 2004** | ** ** |
|                    |       |                                               |       |   |   |   |   |   |   |
| Expected life (years)   |       | 0.5                                                |       | 0.5 |   | 0.5 |   | 0.5 |   |
| Expected volatility     |       | 45                                                 | %          | 64 | % | 47 | % | 75 | % |
| Risk-free interest rate |       | 3.7                                                | %          | 1.8 | % | 3.3 | % | 1.4 | % |

 

The Black-Scholes option pricing model wasdeveloped for use in estimating the value of traded options that have novesting restrictions and are fully transferable. In addition, option pricingmodels require the input of highly subjective assumptions including theexpected stock price volatility. The Company uses projected data for expectedvolatility and expected life of its stock options based

 

8

----

 

upon historical and other economic data trendedinto future years. Because the Company’s employee stock options havecharacteristics significantly different from those of traded options, andbecause changes in the subjective input assumptions can materially affect theestimate, in management’s opinion, existing valuation models, including theBlack-Scholes model, do not necessarily provide a reliable measure of the fairvalue of the Company’s stock options.

 

***2005 Equity Incentive Plan***

 

At the Company’s 2005 AnnualMeeting of Stockholders held on July 29, 2005, the stockholders approved the2005 Equity Incentive Plan (the “2005 Plan”). The 2005 Plan was adopted by the Board of Directors on May 26, 2005 andis intended to replace the 1993 Stock Option Plan, which expired in 2003, andthe 2000 Nonstatutory Stock Option Plan, which was terminated by the Board ofDirectors upon stockholder approval of the 2005 Plan.  A total of 1,800,000 shares of the Company’scommon stock is authorized for issuance pursuant to awards granted under the2005 Plan.  Such awards may include stockoptions, stock appreciation rights, restricted stock, restricted stock units,performance shares, performance units, deferred stock units and otherstock-based or cash-based awards.  Up toan additional 1,250,000 shares may be issued upon settlement of restrictedstock units issued under the 2005 Plan in replacement of stock optionscancelled in an option exchange program approved by the stockholders.  The 2005 Plan is generally administered bythe Compensation Committee of the Board of Directors and has a term of 10years.  Participation in the 2005 Plan islimited to employees and consultants of Zoran and its subsidiaries and otheraffiliates.

 

Options and stock appreciationrights granted under the 2005 Plan must have exercise prices per share not lessthan the fair market value of Zoran common stock on the date of grant and maynot be repriced without stockholder approval. Such awards will vest and become exercisable upon conditions establishedby the Compensation Committee and may not have a term exceeding 10 years.

 

Except with respect to 5% ofthe number of shares authorized under the 2005 Plan, awards of restrictedstock, restricted stock units, performance shares, performance units and otherfull value awards granted under the 2005 Plan generally must have service-basedvesting schedules of at least three years or a performance period of at least12 months.  However, restricted stockunits issued pursuant to a stockholder-approved option exchange program whichvest based on service must have a vesting schedule of at least two years.  Performance share and performance unit awardsvest to the extent that pre-established performance goals based on one or moremeasures of business and financial performance authorized by the 2005 Plan areattained during a performance period established by the CompensationCommittee.  The grant or vesting of othertypes of awards under the 2005 Plan may similarly be based on the attainment ofone or more such performance goals.  The2005 Plan provides that the number of shares remaining available for issuancewill be reduced by 1.3 shares for each one share of Zoran common stock subjectto a full value award granted under the 2005 Plan.

 

***2005 Outside Directors EquityPlan***

 

At the Company’s 2005 AnnualMeeting, the stockholders also approved the 2005 Outside Directors Equity Plan(the “Directors Plan”).  The DirectorsPlan was adopted by the Board of Directors on May 26, 2005 and is intended toreplace the 1995 Outside Directors Stock Option Plan, which was terminated bythe Board of Directors upon stockholder approval of the Directors Plan.  A total of 600,000 shares of the Company’scommon stock is authorized for issuance pursuant to awards granted under theDirectors Plan.  Such awards may includestock options, stock appreciation rights, restricted stock units and deferredstock units.  The Directors Plan isgenerally administered by the Board of Directors and has a term of 10years.  Participation in the DirectorsPlan is limited to non-employee members of the Zoran Board of Directors(“outside directors”).  The DirectorsPlan provides that the number of shares remaining available for issuance willbe reduced by 1.3 shares for each one share of Zoran common stock subject to afull value award granted under the Directors Plan.

 

Awards under the Directors Planare granted by the Board of Directors to all outside directors on a periodic,nondiscriminatory basis within limits prescribed by the Directors Plan.  Subject to appropriate adjustment for anychange in the Company’s capital structure, awards granted to any outsidedirector in any fiscal year may not exceed 20,000 shares, increased by one ormore of the following: 40,000 shares upon an outside director’s initialelection, 10,000 shares for service as Chairman of the Board or Lead Director,5,000 shares for service on a Board committee as chairman and 2,500 shares forservice on a Board committee other than as chairman.  Stock options, stock appreciation rights,restricted stock units and deferred stock units granted under the DirectorsPlan are generally subject to terms substantially similar to those applicableto the same type of award granted under the 2005 Plan.

 

**3.****                                      ComprehensiveIncome (Loss)**

 

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

 
| ** **                                            | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                            | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                  |       |                                       |       |                                      |       |   |   |   |   |
| Net income  (loss)                                    |       | $                                          | 4,958      |                                      | $          | (2,639 | ) | $ | (24,893 | ) | $ | (17,224 | ) |
| Change in unrealized gain on investments,  net of tax |       | 174                                        |       | 265                                       |       | 1,724 |   | 1,050 |   |
| Total  comprehensive income (loss)                    |       | $                                          | 5,132      |                                      | $          | (2,374 | ) | $ | (23,169 | ) | $ | (16,174 | ) |

 

The components of accumulated othercomprehensive income (loss) are unrealized gain (loss) on short-term andlong-term marketable securities.

 

**4.****                                      Inventories**

 

Inventories are stated at the lower of cost (first in, first out) ormarket and consisted of the following (in thousands):

 
| ** **                           | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **2005**               | ** ** | **2004**              | ** ** |
|                                 |       |                   |       |                  |       |
| Purchased  parts and work in process |       | $                      | 10,384     |                  | $          | 23,959 |   |
| Finished goods                       |       | 16,947                 |       | 26,074                |       |
|                                 |       | $                      | 27,331     |                  | $          | 50,033 |   |

 

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

 

In accordance with SFAS 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 andconcluded that goodwill was not impaired, as the fair value of each reportingunit exceeded its carrying value, including goodwill.

 

9

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***Components ofAcquired Intangible Assets****(in thousands):*

 
| ** **                   | ** ** | ** **        | ** ** | **September 30, 2005** | ** ** | **December 31, 2004**    | ** ** |
|------------------------------|------------|-------------------|------------|-----------------------------|------------|-------------------------------|------------|
| ** **                   | ** ** | **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    |                          | $          | (95,475 | ) | $ | 100,030 |   | $ | 188,505 |   | $ | (67,139 | ) | $ | 121,366 |   |
| Patents                      |       | 3-5               |       | 40,265                      |       | (17,599                       | )          | 22,666 |   | 40,265 |   | (10,457 | ) | 29,808 |   |
| Customer base                |       | 3-5               |       | 13,860                      |       | (6,508                        | )          | 7,352 |   | 13,010 |   | (4,739 | ) | 8,271 |   |
| Tradename and others         |       | 3-5               |       | 3,350                       |       | (1,432                        | )          | 1,918 |   | 2,100 |   | (1,161 | ) | 939 |   |
| Purchased core technology *  |       | 4-5               |       | 14,403                      |       | (6,376                        | )          | 8,027 |   | 12,679 |   | (4,181 | ) | 8,498 |   |
|                         |       |              |       |                        |       |                          |       |   |   |   |   |   |   |   |   |
| Total                        |       |              |       | $                           | 267,383    |                          | $          | (127,390 | ) | $ | 139,993 |   | $ | 256,559 |   | $ | (87,677 | ) | $ | 168,882 |   |

 

----

(*) TheCompany records the amortization of purchased core technology as cost of productsales.

 

Estimated future intangible amortization expense, based on currentbalances, as of September 30, 2005 is as follows (in thousands):

 
| Remaining three months of 2005      |   | $      | 13,469  |   |
|-------------------------------------|--------|--------|---------|--------|
| Year ending  December 31, 2006 |   | 52,843 |    |
| Year ending  December 31, 2007 |   | 45,909 |    |
| Year ending  December 31, 2008 |   | 24,730 |    |
| Year ending  December 31, 2009 |   | 2,232  |    |
| Year ending  December 31, 2010 |   | 810    |    |
|                                |   | $      | 139,993 |   |

 

Goodwill by reporting units was as follows (in thousands):

 
| ** ** | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------|------------|------------------------|------------|-----------------------|------------|
| ** ** | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| ** ** | ** ** | ** **             | ** ** | ** **            | ** ** |
| DVD        |       | $                      | 63,855     |                  | $          | 63,855 |   |
| Imaging    |       | 6,177                  |       | 6,177                 |       |
| Mobile     |       | 62,131                 |       | 62,131                |       |
| DTV        |       | 53,293                 |       | 17,988                |       |
|       |       | $                      | 185,456    |                  | $          | 150,151 |   |

 

**6.****                                      IncomeTaxes**

 

The provision for income taxes reflects the estimated annualizedeffective tax rate applied to earnings excluding charges for amortization ofgoodwill and other intangibles for the interim periods.  The effective tax rate differs from the U.S.statutory rate due to utilization of net operating losses, adjustments fornondeductible acquisition related items and income tax rate differences onforeign earnings.  The Company has alsoprovided for tax on its foreign earnings.

 

10

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**7.****                                      SegmentReporting**

 

SFAS No. 131 establishes standards for the reporting by publicbusiness enterprises of information about operating segments, products andservices, geographic areas, and major customers.  The method for determining what informationto report is based on the way that management organizes the operating segmentswithin the Company for making operational decisions and assessments offinancial performance.  The Company’schief operating decision-maker is considered to be the Chief Executive Officer.

 

Subsequent to the acquisition of Oak Technology, Inc. in 2003, theCompany determined it had four reportable segments: Digital Versatile Disc(DVD), Imaging, Digital Camera (DC) and Digital Television (DTV).  Subsequent to the acquisition of EmblazeSemiconductor Ltd. in July 2004, the Digital Camera segment was combinedwith the Emblaze Mobile business unit and renamed the Mobile segment.  Each segment’s primary products are based onhighly integrated application-specific integrated circuits, or ASICs, andsystem-on-a-chip, or SOC, solutions.  TheDVD, Imaging and DTV segments also license certain software and otherintellectual property.  The DVD groupprovides products for use in DVD players and recordable DVD players.  The Imaging group provides products used indigital copiers, laser and inkjet printers as well as multifunctionperipherals.  The Mobile group focuses onsolutions for multimedia mobile phone products and digital cameraproducts.  The DTV group providesproducts for standard and high definition digital television products includingtelevisions, set top boxes and personal video recorders.

 

The Company evaluates operating segment performance based on netrevenues and operating expenses of these segments.  The accounting policies of the operatingsegments are the same as those described in the summary of accountingpolicies.  No reportable segments havebeen aggregated.

 

Information about reported segment income or loss is as follows for thethree and nine months ended September 30, 2005 and 2004 (in thousands):

 
| ** **            | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **            | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Total  revenues:      |       |                                       |       |                                      |       |   |   |   |   |
| DVD                   |       | $                                          | 44,070     |                                      | $          | 77,284 |   | $ | 113,202 |   | $ | 191,660 |   |
| Imaging               |       | 21,659                                     |       | 23,841                                    |       | 65,536 |   | 63,723 |   |
| Mobile                |       | 35,299                                     |       | 10,420                                    |       | 71,925 |   | 25,559 |   |
| DTV                   |       | 16,456                                     |       | 8,202                                     |       | 35,784 |   | 23,158 |   |
|                  |       | $                                          | 117,484    |                                      | $          | 119,747 |   | $ | 286,447 |   | $ | 304,100 |   |
|                  |       |                                       |       |                                      |       |   |   |   |   |
| Operating  expenses:  |       |                                       |       |                                      |       |   |   |   |   |
| DVD                   |       | $                                          | 39,427     |                                      | $          | 67,704 |   | $ | 117,614 |   | $ | 176,976 |   |
| Imaging               |       | 13,989                                     |       | 13,831                                    |       | 44,698 |   | 37,672 |   |
| Mobile                |       | 24,671                                     |       | 12,521                                    |       | 57,582 |   | 28,438 |   |
| DTV                   |       | 20,859                                     |       | 12,940                                    |       | 50,165 |   | 39,160 |   |
|                  |       | $                                          | 98,946     |                                      | $          | 106,996 |   | $ | 270,059 |   | $ | 282,246 |   |
|                  |       |                                       |       |                                      |       |   |   |   |   |
| Contribution  margin: |       |                                       |       |                                      |       |   |   |   |   |
| DVD                   |       | $                                          | 4,643      |                                      | $          | 9,580 |   | $ | (4,412 | ) | $ | 14,684 |   |
| Imaging               |       | 7,670                                      |       | 10,010                                    |       | 20,838 |   | 26,051 |   |
| Mobile                |       | 10,628                                     |       | (2,101                                    | )          | 14,343 |   | (2,879 | ) |
| DTV                   |       | (4,403                                     | )          | (4,738                                    | )          | (14,381 | ) | (16,002 | ) |
|                  |       | $                                          | 18,538     |                                      | $          | 12,751 |   | $ | 16,388 |   | $ | 21,854 |   |

 

11

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A reconciliation of the totals reported for the operating segments tothe applicable line items in the consolidated financial statements for thethree and nine months ended September 30, 2005 and 2004 is as follows (inthousands):

 
| ** **                                   | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                   | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Contribution  margin from operating segments |       | $                                          | 18,538     |                                      | $          | 12,751 |   | $ | 16,388 |   | $ | 21,854 |   |
| Amortization  of intangibles                 |       | 12,757                                     |       | 12,342                                    |       | 37,518 |   | 33,028 |   |
| Amortization  of deferred stock compensation |       | 344                                        |       | 910                                       |       | 1,318 |   | 3,309 |   |
| In process  research and development         |       | —                                     |       | —                                    |       | 2,650 |   | — |   |
| Total  operating income (loss)               |       | $                                          | 5,437      |                                      | $          | (501 | ) | $ | (25,098 | ) | $ | (14,483 | ) |

 

Zoran maintains operations in the United States, Israel, Canada, theUnited Kingdom, Germany, China, Taiwan, Korea and Japan.  Activities in the United States and Israelconsist of corporate administration, product development, logistics andworldwide sales management.  Otherforeign operations consist of sales, product development and technical support.

 

The distribution of total revenues for the three and nine months ended September 30,2005 and 2004 was as follows (in thousands):

 
| ** **                                                 | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                 | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Revenue from unaffiliated customers  originating from:** |       |                                       |       |                                      |       |   |   |   |   |
| China                                                      |       | $                                          | 46,330     |                                      | $          | 49,471 |   | $ | 114,879 |   | $ | 115,711 |   |
| Japan                                                      |       | 31,415                                     |       | 31,180                                    |       | 83,128 |   | 83,544 |   |
| Taiwan                                                     |       | 19,519                                     |       | 9,006                                     |       | 34,851 |   | 31,219 |   |
| Korea                                                      |       | 7,267                                      |       | 5,503                                     |       | 15,611 |   | 27,412 |   |
| United States                                              |       | 5,598                                      |       | 9,860                                     |       | 17,978 |   | 22,823 |   |
| North America (other than the United  States)              |       | 63                                         |       | 1,014                                     |       | 1,175 |   | 2,613 |   |
| Other                                                      |       | 7,292                                      |       | 13,713                                    |       | 18,825 |   | 20,778 |   |
|                                                       |       | $                                          | 117,484    |                                      | $          | 119,747 |   | $ | 286,447 |   | $ | 304,100 |   |

 

For the three months ended September 30, 2005, nocustomer accounted for more than 10% of total revenues.  For the same period of 2004, one customeraccounted for 10% of total revenues.  Forthe nine months ended September 30, 2005 and 2004, no customer accountedfor more than 10% of total revenues.

 

As of September 30, 2005, one customer accounted for 16% of totalnet accounts receivable, and as of December 31, 2004, two customersaccounted for 27% and 13% of total net accounts receivable, respectively.

 

**8.****                                      Acquisitions**

 

**Oren Semiconductor, Inc.**

 

On June 10, 2005, Zoran completed the acquisition of OrenSemiconductor, Inc. (“Oren”), a privately-held provider of demodulator ICsfor the global high definition television market.  Prior to this acquisition, Zoran had madeinvestments in Oren that represented a 17% ownership interest.  Under the terms of the acquisition agreement,Zoran acquired the remaining 83% of Oren’s outstanding stock by means of amerger of Oren with a wholly-owned subsidiary of Zoran, in consideration forwhich Zoran paid an aggregate of $28.4 million in cash and issued1,188,061 shares of Zoran common stock valued at $12.9 million, for totalconsideration of $41.3 million, to the other stockholders of Oren and toemployees holding Oren options.  TheCompany considered the requirements under Accounting Principles Board Opinions18 (“APB 18”), “The Equity Method of Accounting for Investments in CommonStock,” to retroactively record the gains or losses on investment of the prior17% ownership under the equity basis. Based on the Company’s analysis, such adjustments were considered to beimmaterial to the prior financial results of the Company and, accordingly, suchadjustments are not reflected in the Company’s previously reported results ofoperations.

 

12

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The primary purpose of the acquisitionwas to obtain Oren’s demodulator IC technology for theglobal high definition television market.  The Company intends to combine thistechnology with Zoran’s digital television technology to deliver a complete andcost-effective system solution for digital television makers.

 

The transaction wasaccounted for under SFAS No. 141, “Business Combinations,” using thepurchase method of accounting.  TheCompany incurred approximately $375,000 for acquisition-related expensesconsisting of financial advisory, legal and other consulting services.  The Company completed a valuation analysisand purchase price allocation.  Theresults of operations of Oren have been included in the consolidated financialstatements from the date of acquisition. The acquisition resulted in goodwill of approximately $35.3 million.  In accordance with SFAS 142, goodwill willnot be amortized and will be tested for impairment at least annually.

 

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

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

 

The purchase price exceeded the net assets acquired resulting in therecognition of goodwill.  The amountsallocated to intangible assets include purchased technology totaling $7.0million, trade name and others totaling $1.25 million and customer basetotaling $850,000 which are being amortized over their estimated useful livesof five years.

 

**Emblaze Semiconductor Ltd.**

 

On July 8,2004, Zoran acquired Emblaze Semiconductor Ltd.  (“Emblaze”), a subsidiary of Emblaze Ltd. anda provider of semiconductor-based solutions for high volume manufacturers ofmultimedia mobile telephones.  Under theterms of the agreement, Zoran’s wholly-owned Israel based subsidiary, ZoranMicroelectronics Ltd., acquired all of the outstanding common shares of Emblazefor approximately $54.2 million in cash.

 

The primary purpose of the acquisitionwas to gain high performance, low-power application processors, technology andproducts for the fast growing multimedia mobile phone market.  This technology will be combined with Zoran’simage processing technology to deliver reliable, cost-effective systemsolutions for mobile phone makers.

 

The transactionwas accounted for under SFAS No. 141, “Business Combinations,” using thepurchase method of accounting.  TheCompany incurred approximately $180,000 for acquisition-related expensesconsisting of financial advisory, legal and other consulting services.  The Company completed a valuation analysisand purchase price allocation.  Theresults of operations of Emblaze have been included in the consolidatedfinancial statements from the date of acquisition.  The acquisition resulted in goodwill ofapproximately $30.9 million.  Inaccordance with SFAS 142, goodwill will not be amortized and will be tested forimpairment at least annually.

 

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

 
| Net liabilities acquired |   | $      | (649   | )      |
|--------------------------|--------|--------|--------|--------|
| Intangible  assets       |   | 24,150 |   |
| Goodwill                 |   | 30,879 |   |
|                     |   | $      | 54,380 |   |

 

The purchase price exceeded the net assets acquired resulting in therecognition of goodwill.  The amountsallocated to intangible assets include purchased technology totaling $11.8million and patents totaling $12.4 million which are being amortized over theirestimated useful lives of three years.

 

13

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**Pro Forma Financial Information**

 

The following unaudited pro forma financial information presents thecombined results of operations of Zoran, Oren and Emblaze as if the acquisitionshad occurred as of the beginning of each of the previous periods presented,after giving effect to certain adjustments, including amortization ofintangibles.  The in-process research anddevelopment charge of $2.65 million related to the Oren acquisition is notreflected in the unaudited pro forma combined condensed statement ofoperations. The unaudited pro forma financial information does not necessarilyreflect the results of operations that would have occurred had the combinedcompanies constituted a single entity during such periods, and is notnecessarily indicative of results which may be obtained in the future.

 
| ** **                                   | ** ** | **Nine Months Ended September 30,** | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------|------------|------------------------------------------|------------|----------------------------------|------------|
| ** **                                   | ** ** | **2005**                                 | ** ** | **2004**                         | ** ** |
|                                         |       |                                     |       |                             |       |
| **In  thousands except for per share data:** |       |                                     |       |                             |       |
| Pro forma  revenues                          |       | $                                        | 287,426    |                             | $          | 383,131 |   |
|                                         |       |                                     |       |                             |       |
| Pro forma  net loss                          |       | $                                        | (27,863    | )                                | $          | (62,453 | ) |
|                                         |       |                                     |       |                             |       |
| Pro forma  net loss per share:               |       |                                     |       |                             |       |
| Basic                                        |       | $                                        | (0.62      | )                                | $          | (1.46 | ) |
|                                         |       |                                     |       |                             |       |
| Diluted                                      |       | $                                        | (0.62      | )                                | $          | (1.46 | ) |

 

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

 

Basic and diluted net income (loss) per share have been computed usingthe weighted average number of shares of common stock and dilutive potentialshares from stock options and warrants outstanding during the period inaccordance with Statement of Financial Accounting Standards (SFAS) No. 128,“Earnings per Share.”  The followingtable provides a reconciliation of the components of the basic and diluted netloss per share computations (in thousands, except per share data):

 
| ** **                                    | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                    | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                    | ** ** | ** **                                 | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income (loss) from continuing  operations |       | $                                          | 4,958      |                                      | $          | (2,639 | ) | $ | (24,893 | ) | $ | (17,224 | ) |
|                                          |       |                                       |       |                                      |       |   |   |   |   |
| Basic common shares                           |       | 44,877                                     |       | 42,969                                    |       | 43,942 |   | 42,688 |   |
| Effect of dilutive securities:                |       |                                       |       |                                      |       |   |   |   |   |
| Common stock options                          |       | 1,745                                      |       | —                                    |       | — |   | — |   |
| Dilutive weighted average shares              |       | 46,622                                     |       | 42,969                                    |       | 43,942 |   | 42,688 |   |
|                                          |       |                                       |       |                                      |       |   |   |   |   |
| Net income (loss) per share:                  |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                         |       | $                                          | 0.11       |                                      | $          | (0.06 | ) | $ | (0.57 | ) | $ | (0.40 | ) |
| Diluted                                       |       | $                                          | 0.11       |                                      | $          | (0.06 | ) | $ | (0.57 | ) | $ | (0.40 | ) |

 

**Options to purchase 7,411,861 and7,613,000 shares of common stock were excluded from the computation of dilutednet loss per share for the three months ended September 30, 2005 and 2004respectively, as these shares would have had an anti-dilutive effect.**

** **

**Options to purchase 10,024,582shares and 65,333 restricted stock units were excluded from the computation ofdiluted net loss per share for the nine months ended September 30, 2005 asthese shares would have had an anti-dilutive effect.**

** **

**Options to purchase 5,202,000shares of common stock were excluded from the computation of diluted net lossper share for the nine months ended September 30, 2004 as these shareswould have had an anti-dilutive effect.**

 

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**10.****                               LegalProceedings**

 

Zoran and itssubsidiary, Oak Technology, Inc., have initiated two legal actions againstMediaTek, Inc. and customers of MediaTek alleging that productsincorporating certain MediaTek components infringe three patents co-owned byZoran and Oak relating to optical drive controller design and integrated CD/DVDcontroller design.

 

On March 11,2004, Zoran and Oak filed a complaint with****theUnited States International Trade Commission (“ITC”) alleging that certainMediaTek DVD player and optical disk controller chips and chipsets, andproducts in which they are used, infringe Zoran’s and Oak’s patents.  In addition to MediaTek, the complaint nameda number of other proposed respondents that sell products, including DVDplayers and PC optical storage devices that use MediaTek’s chips andchipsets.  The complaint requested thatthe ITC institute an investigation of the accused products and issue exclusionand cease and desist orders prohibiting the importation into the United Statesof the infringing MediaTek devices and products that contain them.  The hearing on Zoran’s complaint took placein February 2005.  On September 28,2005, the ITC issued its final ruling finding one of Zoran’s patents to be validand infringed by optical disk controller chips and chipsets sold by MediaTekand by products using the infringing chips and chipsets sold by a number ofMediaTek customers.  The ITC also issuedan exclusion order prohibiting MediaTek and specified MediaTek customers fromimporting into the United States any optical disk controller chip or chipsetthat infringes the Zoran patent, or any optical disk storage product containingsuch a chip or chipset.  The ITC’sexclusion order covered products using MediaTek chips manufactured by ArtronixTechnology, Inc., ASUSTek Computer, Inc., ASUS ComputerInternational, EPO Science & Technology Co., Inc., LITE-ONInformation Technology Corp., Micro-Star International Co., Ltd., MSI ComputerCorporation, TEAC America, Inc., TEAC Corp., Ultima Electronics Corp., andany of these companies’ contractors or related or affiliated companies.  The ITC also issued cease and desist ordersto the affected companies located in the United States prohibiting them fromimporting or selling infringing products in the United States.

 

On March 15,2004, Zoran and Oak filed a complaint against MediaTek and Mintek Digital inthe United States District Court, Central District of California allegingsimilar facts regarding infringement by MediaTek’s chips and chipsets andproducts in which they are used.  Thelawsuit seeks both monetary damages and an injunction to stop the importationand sale of infringing products.  Zoransubsequently amended the complaint to name ASUSTek Computer, Inc., JiangsuShinco Electronic Group Co., Ltd., LITE-ON Information Technology Corporation,Mintek Digital, Shinco International AV Co., Ltd., TEAC Corporation, TEACAmerica, Inc., Terapin Technology Corporation and Terapin Technology asdefendants.  On September 17, 2004,pursuant to stipulation of the parties, the case was transferred to the UnitedStates District Court, Northern District of California.  On July 2, 2004, the defendants filed afirst amended answer which included counterclaims for declaration of noninfringement,declaration of invalidity, declaration of unenforceability, breach of covenantnot to sue, breach of covenant of good faith and fair dealing and unfaircompetition.  On July 22, 2004,Zoran and Oak moved to dismiss certain of the defendants’ defenses andcounterclaims and, on July 30, 2004, MediaTek filed a motion for summaryjudgment as to two of the three patents asserted by Zoran and Oak againstMediaTek.  On December 9, 2004, theCourt granted Zoran and Oak’s motion, in part, and dismissed certain ofdefendant’s counterclaims and affirmative defenses.  The Court also denied MediaTek’s motion forsummary judgment.  On October 15,2004, MediaTek filed a second motion for summary judgment seeking summaryjudgment on alternate grounds as to the same two patents.  On October 17, 2005, the Court deniedthis motion.  On January 3, 2005,defendants Audiovox Corporation, Artronix Technology, Inc., ASUS ComputerInternational, Inc., Initial Technology, Inc., Changzhou ShincoDigital Technology Co., Ltd., EPO Science and Technology Co., Inc.,Micro-Star International, Co., Ltd., MSI Computer Corp., Shinco InternationalAV Co. and Ultima Electronics Corp. were added to this case by stipulation ofthe parties.  On July 25, 2005,MediaTek filed a third motion for summary judgment seeking summary judgment ofinvalidity as to two of the Zoran patents based on alleged improperinventorship.  The Court has not ruled onthis motion.  Discovery is currentlyunderway, and trial of this case is presently set to begin May 15, 2006.

 

On July 23,2004, MediaTek filed a complaint with the ITC alleging that certain Zoran andOak DVD player and optical disk controller chips and chipsets infringe twoMediaTek patents.  The complaintrequested that the ITC institute an investigation into the accused products andissue exclusion and cease and desist orders prohibiting importation into theUnited States of allegedly infringing chips and products that containthem.  On August 26, 2004, the ITCinstituted an investigation.  On September 24,2004, MediaTek filed a motion to amend the complaint to add one additionalpatent and to name Sunext Technology Co., Ltd. as a respondent.  This motion was granted on October 7,2004.  On February 16, 2005,MediaTek filed a motion for leave to amend the complaint and notice ofinvestigation to assert additional claims of the MediaTek patents against Oak,Zoran and Sunext.  This motion was deniedon March 4, 2005.  The hearing onMediaTek’s complaint took place in June and July 2005.  On September 30, 2005, the ITCAdministrative Law Judge issued his initial determination finding that none ofZoran’s optical disk controller chips infringe any claim of the two patentsasserted against Zoran; that one of the two patents is invalid; that Oak’s devicesdo not infringe one of the two patents asserted against Oak and that the otherpatent is invalid; and that MediaTek has failed to establish that it has adomestic

 

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industry in theUnited States related to the patents at issue – a basic requirement forobtaining relief from the ITC.  Theinitial determination is subject to review by the full ITC.  The target date for completion of theinvestigation is January 30, 2006.

 

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

 

On February 2,2005, MediaTek filed a complaint against Zoran and Zoran Digital Technologies(Shenzhen) Ltd. (Zoran’s local Chinese operations) in the Shenzhen People’sRepublic of China court alleging infringement of the Chinese counterpart patentof one of the two patents asserted in MediaTek’s ITC complaint and seekingmonetary damages.  Because Zoran DigitalTechnologies (Shenzhen) Ltd. had been improperly identified in the originalcomplaint, it was not until July 22, 2005 that Zoran Digital Technologies(Shenzhen) Ltd. was formally served with the complaint.  At this time, Zoran has not been served withthe complaint.  The initiation of thefull proceeding is stayed until all parties are formally served.

 

Based upon itspreliminary review, Zoran believes that it has meritorious defenses to thethree MediaTek complaints, which Zoran believes were filed in response to theproceedings that Zoran has been prosecuting against MediaTek and its customers.  Zoran intends to defend the MediaTek actionsvigorously.  However, the litigation isin the preliminary stage, and Zoran cannot predict its outcome withcertainty.  Patent litigation is particularlycomplex and can extend for a protracted time, which can substantially increaselitigation expenses.

 

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**Item 2.    Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

*This reportincludes a number of forward-looking statements which reflect the Company’scurrent views with respect to future events and financial performance. Theseforward-looking statements are subject to certain risks and uncertainties,including those discussed below under the heading “Future Performance and RiskFactors” and in “Item 7—Management’s Discussion and Analysis of FinancialCondition and Results of Operations—Future Performance and Risk Factors”included in the**Company’s Annual Report onForm 10-K for the year ended December 31, 2004. In this report,the words “anticipates,” “believes,” “expects,” “intends,” “future” and similarexpressions identify forward-looking statements. Readers are cautioned not toplace undue reliance on these forward-looking statements, which speak only asof the date hereof.*

 

**Restatement of Financial Results for QuartersEnded March 31, June 30 and September 30, 2004**

 

In connection with the review and evaluation of the effectiveness ofour internal control over financial reporting undertaken pursuant to Section 404of the Sarbanes-Oxley Act of 2002, management discovered that excess stockcompensation expenses had been recognized during the quarters ended March 31,June 30 and September 30, 2004.  The compensation expense wasrelated to options that we had assumed as part of our acquisition of OakTechnology, Inc. in 2003.  Under purchase accounting, part of thecost relating to the acquisition was attributed to the assumed options and wasto be recognized over time as the options continued to vest, based on eachoption holder’s continued employment with Zoran.  If an option holder’semployment terminated before the option was fully vested, vesting would cease,and we would no longer recognize compensation expense related to thatoption.  At the time of the acquisition, a schedule was prepareddetailing the terms of each assumed option; however, the names of the optionholders were omitted from the schedule for reasons ofconfidentiality.  After the acquisition was completed, we did not updateour personnel or financial records to include the omitted information. As aresult, the Company improperly recognized deferred stock compensation expensesrelating to options that had been held by former Oak employees after thevesting of such options had ceased, and did not reverse stock basedcompensation expense recognized in excess of amounts that actually vested.

 

To correct this error, we have restated the financial results that wepreviously reported for the quarters ended March 31, June 30 and September 30,2004.  For information about the effects of the restatement, see Note 1 toour condensed consolidated financial statements, contained in Item 1 of thisquarterly report.

 

**Overview**

 

Our products consist of integrated circuits and related products usedin digital versatile disc players, or DVDs, movie and home theater systems,digital cameras and video editing systems. We also provide integrated circuits, software and platforms for digitaltelevision applications that enable the delivery and display of digital videocontent through a set-top box or television as well as digital imaging productsconsisting of semiconductor hardware and software that enable users to print,scan, process and transmit documents to computer peripherals that performprinting functions.  Subsequent to ouracquisition of Emblaze Semiconductor Ltd. on July 8, 2004, we also providehigh performance, low-power applicationprocessors, technology and products for the multimedia mobile telephonemarket.  Through the acquisition of OrenSemiconductor, Inc. on June 10, 2005, Zoran obtained Oren’s demodulatorIC technology for the global high definition television market.

 

We derive most of our revenues from the sale of our integrated circuitproducts.  Historically, average sellingprices in the semiconductor industry in general, and for our products inparticular, have decreased 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 of hardware product revenues consists primarily of fabricationcosts, assembly and test costs, and the cost of materials and overhead fromoperations.  If we are unable to reduceour cost of hardware product revenues to offset anticipated decreases inaverage selling prices, our product gross margins will decrease.  Our hardware product gross margin is alsodependent on product mix and on the proportion of products sold directly to ourOEM customers versus indirectly through our marketing partners.  These marketing partners purchase ourproducts at lower prices but absorb most of the associated marketing and salessupport expenses, maintain inventories and provide customer support andtraining.  As a result, lower grossmargins on sales to these resellers are partially offset by reduced selling andmarketing expenses related to such sales. We expect both product and customer mix to continue to fluctuate infuture periods, causing further fluctuations in margins.

 

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We also derive revenue from licensing our software and otherintellectual property.  Licensing revenueincludes one-time license fees and royalties based on the number of unitsdistributed by the licensee.  Quarterlylicensing revenue can be significantly affected by the timing of a small numberof licensing transactions, each accounting for substantial revenues.  Accordingly, licensing revenues 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 development expenses.  We retain ownership of the intellectualproperty developed by us under these development contracts.  While we intend to continue to enter intodevelopment contracts with certain strategic partners, we expect developmentrevenue to continue to decline as a percentage of total revenues.

 

We recognize software license revenues in accordance with theprovisions of Statement of Position (SOP) 97-2, *Software Revenue Recognition,*as amended by SOP 98-9, *Modification of*SOP 97-2, *Software Revenue Recognition, With Respect to CertainTransactions.*  Softwarelicense agreements typically include obligations to provide maintenance andother support over a fixed term and allows for renewal of maintenance on anannual basis. We determine the fair value of maintenance obligations withreference to substantive renewal rates within the agreement or objectiveevidence of fair value as required under SOP 97-2. Maintenance and supportrevenue is recognized ratably over the term of the arrangement.  We also receive royalty revenues based on perunit shipments of products embedding our software which we recognize uponreceipt of a royalty report from the customer, typically one quarter inarrears.

 

Our research and development expenses consist of salaries and relatedcosts of employees engaged in ongoing research, design and developmentactivities and costs of engineering materials and supplies.  We are also a party to research anddevelopment agreements with the Chief Scientist in Israel’s Ministry ofIndustry and Trade and the Israel-United States Binational Industrial Researchand Development Foundation, which fund up to 50% of incurred project costs forapproved products up to specified contract maximums.  These agreements require us to use our bestefforts to achieve specified results and require us to pay royalties at ratesof 3% to 5% of resulting product sales, and up to 30% of resulting licenserevenues, up to a maximum of 100% to 150% of total funding received.  Reported research and development expensesare net of these grants, which fluctuate from period to period.  We believe that significant investments inresearch and development are required for us to remain competitive, and weexpect to continue to devote significant resources to product development,although such expenses as a percentage of total revenues may fluctuate.

 

Our selling, general and administrative expenses consist primarily ofemployee-related expenses, sales commissions, product promotion and otherprofessional services.  We expect thatselling, general and administrative expenses will continue to increase tosupport our anticipated growth.

 

We conduct a material amount of our research and development andcertain sales and marketing and administrative operations in our foreignsubsidiary offices.  As a result, some ofour expenses are incurred in foreign currency. To date, substantially all of our hardware product revenues and oursoftware and other revenues have been denominated in U.S. dollars and most costsof hardware product 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 effective income tax rate has benefited from the availability ofnet operating losses which we have utilized to reduce taxable income forU.S.  federal income tax purposes and byour Israel based subsidiary’s status as an “Approved Enterprise” under Israelilaw, which provides a ten-year tax holiday for income attributable to a portionof our operations in Israel.  Our U.S.federal net operating losses expire at various times between 2005 and 2025, andthe benefits from our subsidiary’s Approved Enterprise status expire at varioustimes beginning in 2005.

 

**Recent Acquisitions**

 

*Oren Semiconductor, Inc.*

 

On June 10, 2005, we completed our acquisition of OrenSemiconductor, Inc. (“Oren”), a privately-held provider of demodulator ICsfor the global high definition television market.  Prior to this acquisition, we had made investmentsin Oren that represented a 17% ownership interest. Under the terms of theacquisition agreement, we 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 we paid an aggregate of $28.4 million in cash andissued 1,188,061 shares of Zoran common stock valued at $12.9 million, fortotal consideration of $41.3 million, to the other stockholders of Oren and toemployees holding Oren options.  Theacquisition was accounted for under the purchase method of accounting.

 

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Following the completion of the acquisition, the results of operationsof Oren have been included in our consolidated financial statements.  Accordingly, our results of operations forthe three and nine month periods ended September 30, 2005 include Oren’soperations from acquisition date, while such operations are not reflected inour results of operations for the same periods of the prior year.

 

*Emblaze Semiconductor Ltd.*

 

On July 8, 2004, we completed our acquisition of EmblazeSemiconductor Ltd.  (“Emblaze”), awholly-owned subsidiary of Emblaze Ltd. for $54.2 million in cash.  The acquisition was accounted for under thepurchase method of accounting.

 

Following the completion of the acquisition, the results of operationsof Emblaze have been included in our consolidated financial statements.  Accordingly, our results of operations forthe three and nine month periods ended September 30, 2005 include Emblaze’soperations for the entire period, while such operations are reflected in ourresults of operations for the same periods of the prior year only from July 8,2004 through September 30, 2004.

 

**Segments**

 

Prior to July 2004, we had four reportable segments: DigitalVersatile Disc (DVD), Imaging, Digital Camera (DC) and Digital Television(DTV).  Subsequent to the Emblazeacquisition in July 2004, the Digital Camera group was combined with theEmblaze Mobile segment and renamed the Mobile segment.  Each segment’s primary products are based onhighly integrated application-specific integrated circuits, or ASICs, andsystem-on-a-chip, or SOC, solutions.  TheDVD, Imaging and DTV segments also license certain software and otherintellectual property.  The DVD groupprovides products for use in DVD players and recordable DVD players.  The Imaging group provides products used indigital copiers, laser and inkjet printers as well as multifunctionperipherals.  The Mobile group focuses onsolutions for multimedia mobile phone products and digital cameraproducts.  The DTV group providesproducts for standard and high definition digital television products includingtelevisions, set top boxes and personal video recorders.

 

**Resultsof Operations**

** **

*Revenues*

 

Total revenues decreased 1.8% to $117.5 million for the three monthsended September 30, 2005 compared to $119.7 million for the same period ofthe prior year.  For the nine monthsended September 30, 2005, total revenues decreased 5.8% to $286.4 millioncompared to $304.1 million recorded during the same period of 2004.  These decreases in total revenues wereprimarily the result of declining revenues in the DVD segment which recordeddecreases of $33.2 million in revenues for the three months ended September 30,2005 and $78.5 million for the nine month period ended September 30, 2005compared to the same periods of the prior year. These decreases were partially offset by increases of $24.9 million and$46.4 million in Mobile segment revenues for the three and nine month periodsended September 30, 2005, respectively, compared to the same periods ofthe prior year.   In addition, the DTVsegment recorded increases of $8.3 million and $12.6 million in revenues forthe three and nine month periods ended September 30, 2005, respectively,compared to the same periods in 2004. The decreases in DVD segment revenues were primarily the result of lowerhardware product revenues while the increases in Mobile and DTV segmentrevenues were associated with higher hardware product revenues.  Totalrevenues by segment for the three months ended September 30, 2005 were37.6% DVD, 18.4% Imaging, 30.0% Mobile and 14.0% DTV, compared to 64.5% DVD,19.9% Imaging, 8.7% Mobile and 6.9% DTV for the same period in 2004.  Total revenues by segment for the nine monthsended September 30, 2005 were 39.5% DVD, 22.9% Imaging, 25.1% Mobile and12.5% DTV, compared to 63.0% DVD, 21.0% Imaging, 8.4% Mobile and 7.6% DTV forthe same period in 2004. We expect that total revenues for the quarter ending December 31,2005 will decline slightly from the quarter ended September 30, 2005 dueto normal seasonal factors that have historically affected our third and fourthquarter revenues.

 

Hardware product revenues were $104.2 million for the three monthsended September 30, 2005 compared to $99.4 million for the comparableperiod of the prior year and $244.1 million and $257.1 million for the ninemonth periods ended September 30, 2005 and 2004, respectively.  The increase in hardware product revenues forthe three months ended September 30, 2005 was primarily due to theincrease of $27.3 million in Mobile segment revenues coupled with an increaseof $6.9 million in the DTV segment. Partially offsetting these increases was a decrease of $28.9 million inhardware product revenues for the DVD segment for the three months ended September 30,2005 compared to the same period of the prior year.  For the nine months ended September 30,2005, DVD segment hardware product revenues decreased $72.8 million from thecomparable 2004 period.  This decreasewas partially offset by increases in the Mobile, DTV and Imaging segments’hardware product revenues of $47.8 million, $9.2 million and $2.7 million,respectively.  The decrease in DVDsegment hardware product revenues was due to decreased unit shipments. Theincreases in the Mobile, DTV and Imaging segment revenues were the result ofincreases in unit shipments.

 

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Software and other revenues were $13.3 million and $42.3 million forthe three and nine month periods ended September 30, 2005, respectively,compared to $20.3 million and $47.0 million for the same periods in 2004.  These decreases were primarily due todecreases in license and royalty revenues.

* *

*Cost of Hardware Product Revenues*

 

Cost of hardware product revenues was $53.7 million and $135.9 million,respectively, for the three and nine month periods ended September 30, 2005compared to $66.6 million and $170.7 million for the same periods of 2004.  This decrease was primarily a result ofchanges in product mix.  In addition, wereduced our inventory allowance by $5.8 million and $8.8 million for the threeand nine month periods ended September 30, 2005 as a result of the sale ordisposal of inventory that had been fully written down in previous periods. Thereduction in our inventory allowance was primarily the result of sales of ourVaddis 6 and an associated companion chip that had been previously written off.The revenue associated with selling these products written down in previousperiods was $8.6 million and $17.9 million for the three and nine month periodsended September 30, 2005. As a percentage of hardware product revenues,hardware product costs were 51.5% and 55.7%, respectively, for the three andnine month periods ended September 30, 2005, compared to 66.9% and 66.4% forthe three and nine month periods ended September 30, 2004. Excluding thebenefit of the net reduction in the inventory allowance, hardware product costsas a percentage of hardware product revenues would have been 57.1% and 59.2%,respectively, for the three and nine month periods ended September 30, 2005.The decreases in hardware product costs as a percentage of hardware productrevenues reflected a change in product mix as revenues from the lower marginDVD segment represented a smaller proportion of total hardware product revenuewith a relative increase in revenue from the higher margin Mobile and DTVsegments.

* *

*Research and Development*

 

Research and development (“R&D”) expenses were $23.5 million and$64.9 million for the three and nine month periods ended September 30,2005, respectively, compared to $21.6 million and $61.4 million for the sameperiods of 2004.  These increases wereprimarily a result of the inclusion of the Oren and Emblaze operations for thefull periods presented as well as continued investments in research anddevelopment across all of our segments. R&D expenses were 20.0% of total revenues for the three month periodended September 30, 2005 and 22.7% for the nine month period ended September 30,2005, compared to 18.1% and 20.2% for the three and nine month periods ended September 30,2004, respectively.  These increases werethe result of the lower revenues recorded during the three and nine monthperiods ended September 30, 2005 compared to the same periods of the prioryear.

 

*Selling, General and Administrative*

 

Selling, general and administrative (“SG&A”) expenses were $21.8million and $69.3 million for the three and nine month periods ended September 30,2005, respectively, compared to $18.8 million and $50.1 million for the threeand nine month periods ended September 30, 2004, respectively.  These increases were primarily due toincreased legal fees related to our pending patent litigation with Mediatek, Inc.,the inclusion of the Emblaze and Oren operations for the full periods presentedand the continued increases in marketing and field application support expensesto support our Asia Pacific markets. SG&A expenses were 18.6% and 24.2% of total revenues for the threeand nine months ended September 30, 2005, respectively, compared to 15.7%and 16.5% for the three and nine month periods ended September 30, 2004,respectively.

 

*Amortization of Intangible Assets*

 

During the three and nine month periods ended September 30, 2005,we incurred charges of $12.8 million and $37.5 million, respectively, relatedto the amortization of intangible assets compared to $12.3 million and $33.0million for the three and nine months ended September 30, 2004, respectively.  These increases were the result of theaddition of $24.2 million of amortizable intangible assets acquired in theEmblaze acquisition in July 2004 and $9.1 million of intangible assets asa result of the Oren acquisition in June 2005.  At September 30, 2005, we hadapproximately $140.0 million in net acquired intangible assets which will beamortized over various periods on a straight line basis through 2010.

 

*Amortization of Deferred Stock Compensation*

 

For the three and nine month periods ended September 30, 2005, weincurred charges of $344,000 and $1.3 million respectively, related to theamortization of deferred stock compensation compared to $910,000 and $3.3million during the three and nine month periods ended September 30, 2004,respectively.  This deferred stockcompensation expense was recorded primarily as a result of stock optionsgranted in connection with the Oak acquisition.  These decreases inexpense were due to the cancellation of options held by employees whoterminated their employment during the year and the lower amortizationassociated with the graded vesting under the FIN 28 model.  As of September 30,2005, the Company has a remaining deferred stock compensation balance of$957,000 which will continue to be amortized through the quarter ending September 30,2007.

 

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*Interest and Other Income*

 

Interest and other income was $721,000 and $1.4 million, respectively,for the three and nine month periods ended September 30, 2005, compared to$(265,000) and $632,000 for the same periods of 2004.  These fluctuations were primarily due tochanges in interest income as a result of fluctuations in interest rates aswell as the change in translation gains and losses recorded due to thefluctuation in the value of the United States dollar relative to the currencyof other countries in which we operate.

* *

*Provision for Income Taxes*

 

The Company has recorded a tax provision of $1.2 million for the threeand nine month periods ended September 30, 2005, compared to $1.9 millionand $3.4 million for the three and nine month periods ended September 30,2004, respectively.  The provision forincome taxes reflects the estimated annualized effective tax rate applied toearnings excluding charges for amortization of intangible assets for theinterim periods.  The effective tax ratediffers from the U.S. statutory rate due to adjustments for nondeductible acquisitionrelated items, changes in valuation allowance and income tax rate differenceson foreign earnings. At September 30, 2005, 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 September 30, 2005, we had $64.8 million of cash and cashequivalents, $65.4 million of short-term investments and $154.3 million ofworking capital.

 

Net cash provided by operating activities during the first nine monthsof 2005 was $35.4 million.  While werecorded a net loss of $24.9 million, this loss included non-cash charges fordepreciation of property and equipment of $9.9 million, amortization ofintangible assets of $37.5 million and amortization of stock based compensationof $1.4 million.  Changes in currentassets and liabilities resulted in additional cash totaling $8.7 million whichincluded a $22.9 million decrease in inventory and a $6.1 million increase inaccounts payable, accrued expenses and other liabilities, offset by a $20.5million increase in accounts receivable. The changes in inventory and accountsreceivable were primarily the result of an increase in shipments during thequarter ended September 30, 2005 due to normal seasonal factors.

 

Cash used in investing activities was $13.6 million during the ninemonths ended September 30, 2005, reflecting $27.6 million used in theacquisition of Oren and purchases of property and equipment totaling $8.1million, partially offset by the net sales and maturities of investments of$22.1 million.

 

Cash provided by financing activities was $5.6 million during the ninemonths ended September 30, 2005 attributable to the issuance of commonstock during the period.

 

Net cash provided by operating activities during the nine months ended September 30,2004 was $9.3 million.  While we recordeda net loss of $17.2 million, this loss included non-cash charges ofapproximately $43.9 million comprised of depreciation of property and equipmentof $7.7 million, amortization of intangible asset of $33.0 million andamortization of deferred stock compensation of $3.3 million.  Additional cash from operating activities wasprovided by a $41.9 million increase in accounts payable, offset by a $44.6million increase in inventory and $18.5 million increase in accountsreceivable.

 

Cash used in investing activities was $21.4 million duringthe nine months ended September 30, 2004, reflecting $54.2 million used inthe acquisition of Emblaze, net of cash acquired, and purchases of $7.2 millionof property and equipment. This cash flow was partially offset by $40 millionin proceeds from the net sale of investments.

 

Cash provided by financing activities was $5.7 million during the ninemonths ended September 30, 2004, attributable to the issuance of common stockduring the period.

 

At September 30, 2005, 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 our current balances of cash, cash equivalents andshort-term investments, and anticipated cash flow from operations, will satisfyour anticipated working capital and capital expenditure requirements at leastthrough the next 12 months.  Nonetheless,our 

 

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future capital requirements mayvary materially from those now planned and will depend on many factorsincluding, but not limited to:

 

•                  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.

 

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

 

To theextent 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.

 

**Future Performance and Risk Factors**

 

Our future business, operating results and financial condition aresubject to various risks and uncertainties, including those described below.

 

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

 

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

 

•                  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;

 

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•                  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 our operating results will continue to fluctuate in thefuture as a result of these factors 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, such as the outbreak of SevereAcute Respiratory Syndrome, or SARS, several years ago;

 

•                  otherconditions affecting the timing of customer orders;

 

•                  changesin governmental regulations that could affect our products; or

 

•                  adownturn in the markets for our customers’ products, particularly the consumerelectronics market.

 

These factors are difficult or impossible to forecast.  We place orders with independent foundriesseveral months in advance of the scheduled delivery date, often in advance ofreceiving non-cancelable orders from our customers.  This limits our ability to react tofluctuations in demand for their products. If anticipated shipments in any quarter are canceled or do not occur asquickly as expected, or if we fail to foresee a technology change that couldrender a product obsolete, expense and inventory levels could bedisproportionately high.  If anticipatedlicense revenues in any quarter are canceled or do not occur, gross margins maybe reduced.  A significant portion of ourexpenses are relatively fixed, and the timing of increases in expenses is basedin large part on our forecast of future revenues.  As a result, if revenues do not meet ourexpectations, we may be unable to quickly adjust expenses to levels appropriateto actual revenues, which could harm our operating results.

 

Product supply and demand fluctuations common to the semiconductorindustry are historically characterized by periods of manufacturing capacityshortages immediately followed by periods of overcapacity, which are caused bythe addition of manufacturing capacity in large increments.  We cannot predict whether we will achievetimely, cost-effective access to that capacity when needed, or when there willbe a capacity shortage again in the future.

 

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

 

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

 

Because the markets that our customers serve are characterized bynumerous new product introductions and rapid product enhancements, ouroperating results may vary significantly from quarter to quarter.  During the final production of a matureproduct, our customers typically exhaust their existing inventory of ourproducts.  Consequently, orders for ourproducts may decline in those circumstances, even if the products areincorporated into both mature products and replacement products.  A delay in a customer’s transition tocommercial production of a replacement product would delay our ability torecover the lost sales from the discontinuation of the related matureproduct.  Our customers also experiencesignificant seasonality in the sales of their consumer products, which affectstheir orders of our products.  Typically,the second half of the calendar year represents a disproportionate percentageof sales for our customers due to the holiday shopping period for consumerelectronics products, and therefore, a disproportionate percentage of oursales.  We expect these seasonal salesfluctuations to continue for the foreseeable future.

 

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

 

The semiconductor industry is subject to cyclical variations in productsupply and demand.  Downturns in theindustry often occur in connection with, or anticipation of, maturing productcycles for both semiconductor companies and their customers and declines ingeneral economic conditions.  Thesedownturns have been characterized by abrupt fluctuations in product demand,production over-capacity and accelerated decline of average sellingprices.  In some cases, these downturnshave lasted more than one year.  Adownturn in the semiconductor industry could harm our sales and revenues ifdemand drops, or our gross margins if average selling prices decline.

 

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

 

In recent years, we have derived a substantial majority of our productrevenues from the sale of integrated circuits for DVD and digital cameraapplications.  We expect that sales ofour products for these applications will continue to account for a significantportion of our revenues 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 successfulin our efforts to market and sell our products to manufacturers who incorporateintegrated circuits into these products, our financial results will be harmed.

 

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

 

Our financial performance depends in large part on our ability tosuccessfully develop and market next-generation and new products in a rapidlychanging technological environment.  Ifwe fail to successfully identify new product opportunities and timely developand introduce new products that achieve market acceptance, we may lose ourmarket share and our future revenues and earnings may suffer.

 

In the consumer electronic market, our performance has been dependenton our successful development and timely introduction of integrated circuitsfor DVD players, DVD recorders, digital cameras, broadband digital televisionand HDTV.  These markets arecharacterized by the incorporation of a steadily increasing level of integrationand numbers of features on a chip at the same or lower system cost, enablingoriginal equipment manufacturers, or OEMs, to continually improve the featuresor reduce the prices of the systems they sell. If we are unable to continually develop and introduce integratedcircuits with increasing levels of integration and new features at competitiveprices, our operating results will suffer.

 

In the digital office market, our performance has been dependant on ourability to successfully develop embedded image processing system on a chip, orSOC, solutions for the digital office market, in particular, embedded digitalcolor copier technology and image processing chips for a variety of imagingperipherals, including printers and multi-function peripherals, or MFPs.  Among other technological changes, embeddedPDF and color capability are rapidly emerging as market requirements forprinters and other imaging devices.  Someof our competitors have the capacity to supply these solutions, and some oftheir solutions have been well received in the marketplace.  We face the challenge of developing newimaging products with the capability to handle greater color and imagecomplexity, including web-based documents, and work with higher-performingdevices in networked environments.  If weare unable to meet these challenges with the development of products that caneffectively compete in the OEM software and solutions market, our futureoperating results could suffer.

 

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

 

Our future success will depend on our ability to anticipate and adaptto changes in technology and industry standards and our customers’ changingdemands.  The consumer electronicsmarket, in particular, is characterized by rapidly changing technology,evolving industry standards, frequent new product introductions, short productlife cycles and increasing 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 will also depend on the successful development of newmarkets and the application and acceptance of new technologies and products inthose new markets.  For example, oursuccess will depend on the ability of our customers to develop new products andenhance existing products in the recordable DVD player market and products forthe broadband digital television and HDTV markets and to introduce and promotethose products successfully.  Thesemarkets may not continue to develop to the extent or in the time periods thatwe currently anticipate due to factors outside our control, such as delays inimplementation of FCC 02-320 requiring all new televisions to include a digitalreceiver.  If new markets do not developas we anticipate, or if our products do not gain widespread acceptance in thesemarkets, our business, financial condition and results of operations could bematerially and adversely affected.  Theemergence of new markets for our products is also dependent in part upon thirdparties developing and marketing content in a format compatible with commercialand consumer products that incorporate our products.  If this content is not available,manufacturers may not be able to sell products incorporating our products, andour sales would suffer.

 

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

 

We do not operate any manufacturing facilities, and we rely onindependent foundries to manufacture substantially all of our products.  These independent foundries fabricateproducts for other companies and may also produce products of their owndesign.  From time to time, there aremanufacturing capacity shortages in the semiconductor industry.  We do not have long-term supply contractswith any of our suppliers, including our principal supplier, TaiwanSemiconductor Manufacturing Company, or TSMC. Therefore, TSMC and our other suppliers are not obligated to manufactureproducts for us for any specific period, in any specific quantity or at anyspecified price, except as may be provided in a particular purchase order.

 

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

 

•                  theinability to obtain adequate manufacturing capacity;

 

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

 

•                  lackof control over delivery schedules;

 

•                  lackof control over quality assurance;

 

•                  lackof control over manufacturing yields and cost; and

 

•                  potentialmisappropriation of our intellectual property.

 

In addition, TSMC and some of our other foundries are located in areasof the world that are subject to natural disasters such as earthquakes.  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 a limited number of independent contractors for theassembly and testing of our products. Our reliance on independent assembly and testing houses limits ourcontrol over delivery schedules, quality assurance and product cost.  Disruptions in the services provided by ourassembly or testing houses or other circumstances that would require them toseek alternative sources of

 

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assembly or testing could lead to supply constraints or delays in thedelivery of our products.  Theseconstraints or delays could damage our relationships with current andprospective customers and harm our financial results.

 

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

 

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

 

•                  optionpayments or other prepayments to a foundry;

 

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

 

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

 

•                  issuanceof our equity securities to a foundry;

 

•                  investmentin a foundry;

 

•                  jointventures; or

 

•                  otherpartnership relationships with foundries.

 

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

 

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

 

The fabrication of silicon wafers is a complex process.  Minute levels of contaminants in themanufacturing environment, defects in photo masks used to print circuits on awafer, difficulties in the fabrication process or other factors can cause asubstantial portion of the integrated circuits on a wafer to benon-functional.  Many of these problemsare difficult to detect at an early stage of the manufacturing process and maybe time consuming and expensive to correct. As a result, foundries often experience problems achieving acceptableyields, which are represented by the number of good integrated circuits as aproportion of the number of total integrated circuits on any particularwafer.  Poor yields from our independentfoundries would reduce our ability to deliver our products to customers, harmour relationships with our customers and harm our business.

 

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

 

We face intense competition in the markets in which we compete.  We expect that the level of competition willincrease in the future from existing competitors and from other companies thatmay enter our existing or future markets with solutions that may be less costlyor provide higher performance or additional features.

 

Competition in Zoran’s core compression technology market hashistorically been dominated by large companies, such as ST Microelectronics,and companies that develop and use their own integrated circuits, such as Sonyand Matsushita.  As this market continuesto develop, we face competition from other large semiconductor vendors.

 

The DVD market continues to expand, and additional competitors areexpected to enter the market for DVD players and software.  Some of these potential competitors maydevelop captive implementations for use only with their own PC and consumerelectronics products.  It is alsopossible that application software vendors, such as Microsoft, may attempt toenter the DVD application market in the future. This increased competition may result in price reductions, reducedprofit margins and loss of market share.

 

We face competition from several large semiconductor companies in thebroadband digital television and set-top box markets.  We expect competition to continue to increasein these markets as industry standards become well known and as othercompetitors enter these markets.

 

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We also face significant competition in the digital office market.  The future growth of the digital officemarket is highly dependent on OEMs continuing to outsource an increasingportion of their product development work. While the trend toward outsourcing on the part of our OEM customers inthis market has accelerated in recent years, any reversal of this trend, or achange in the way they outsource, could seriously harm our business.

 

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

 

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

 

Average selling prices for our products decline over relatively shorttime periods, while many of our manufacturing costs are fixed.  When our average selling prices decline, ourrevenues decline unless we are able to sell more units and our gross marginsdecline unless we are able to reduce our manufacturing costs by a commensurateamount.  Our operating results sufferwhen gross margins decline.  We haveexperienced these problems, and we expect to continue to experience them in thefuture, although we cannot predict when they may occur or how severe they willbe.

 

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

 

Our largest customers have accounted for a substantial percentage ofour revenues.  In 2004, one customeraccounted for 11% of our total revenues while sales to our four largestcustomers accounted for 35% of our total revenues.   In 2003, two customers accounted for 17% and14% of our total revenues, respectively, while our four largest customersaccounted for 46% of our total revenues. Sales to these large customers have varied significantly from year toyear and will continue to fluctuate in the future.  These sales also may fluctuate significantlyfrom quarter to quarter.  We may not beable to retain our key customers, or these customers may cancel purchase ordersor reschedule or decrease their level of purchases from us.  Any substantial decrease or delay in sales toone or more of our key customers could harm our sales and financialresults.  In addition, any difficulty incollecting amounts due from one or more key customers could harm our financialresults.

 

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

 

Our products are technologically complex.  Prospective customers generally must make asignificant commitment of resources to test and evaluate our products and tointegrate them into larger systems.  As aresult, our sales processes are often subject to delays associated with lengthyapproval processes that typically accompany the design and testing of newproducts.  The sales cycles of ourproducts often last for many months or even years.  Longer sales cycles require us to investsignificant resources in attempting to make sales and delay the generation ofrevenue.

 

Long sales cycles also subject us to other risks, including customers’budgetary constraints, internal acceptance reviews and cancellations.  In addition, orders expected in one quartercould shift to another because of the timing of customers’ purchasedecisions.  The time required for ourcustomers to incorporate our products into their own can vary significantlywith the needs of our customers and generally exceeds several months, whichfurther complicates our planning processes and reduces the predictability ofour operating results.

 

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

 

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

 

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

 

The Federal Communications Commission, or FCC, has broad jurisdictionover our target markets in the digital television business.  Various international entities ororganizations may also regulate aspects of our business or the business of ourcustomers.  Although our products are notdirectly subject to regulation by any agency, the transmission pipes, as wellas much of the equipment into which our products are incorporated, are subjectto direct government regulation.  Forexample, before they can be sold in the United States, advanced televisions andemerging interactive displays must be tested and certified by UnderwritersLaboratories and meet FCC regulations. Accordingly, the effects of regulation on our customers or theindustries in which our customers 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.

 

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

 

During 2004, only 9% of our total revenues were derived from NorthAmerica sales.  We anticipate thatinternational sales will continue to account for the majority of our totalrevenues for the foreseeable future.  Inaddition, substantially all of our semiconductor products are manufactured,assembled and tested outside of the United States by independent foundries andsubcontractors.

 

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

 

•                  unexpectedchanges in regulatory requirements;

 

•                  fluctuationsin exchange rates;

 

•                  politicaland economic instability;

 

•                  impositionof tariffs and other barriers and restrictions;

 

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

 

•                  healthrisks in a particular region.

 

A material amount of our research and development personnel andfacilities and a portion of our sales and marketing personnel are located inIsrael.  Political, economic and militaryconditions in Israel directly affect our operations.  Some of our employees in Israel are obligatedto perform up to 39 days of military reserve duty annually.  The absence of these employees forsignificant periods during the work week may cause us to operate inefficientlyduring these periods.

 

Our operations in China are subject to the economic and politicaluncertainties affecting that country. For example, the Chinese economy has experienced significant growth inthe past decade, but such growth has been uneven across geographic and economicsectors.  This growth may decrease andany slowdown may have 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 andpolitical uncertainties affecting these countries as well.

 

The significant concentration of our manufacturing activities withthird party foundries in Taiwan exposes us to the risk of political instabilityin Taiwan, including the potential for conflict between Taiwan and China.  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.

 

**Our business and future operating resultscould be harmed by terrorist activity or armed conflict.**

 

Our business and operating results are subject to uncertainties arisingout of possible terrorist attacks on the United States and other 

 

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regions of the world includinglocations where we maintain operations and by armed conflict in the Middle Eastand related economic instability.  Ouroperations could be harmed due to:

 

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

 

•                  reduceddemand for 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 suchfacilities; or

 

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

 

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

 

Foreign currency fluctuations may affect the prices of ourproducts.  Prices for our products arecurrently denominated 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, and our products may be lesscompetitive in that country.  Also, wecannot be sure that our international customers will continue to be willing toplace orders denominated in U.S. dollars. If they do not, our revenue and operating results will be subject toforeign exchange fluctuations.

 

**Our ability to compete could be jeopardizedif we are unable to protect our intellectual property rights.**

 

Our success and ability to compete depend in large part upon protectionof our proprietary technology.  We relyon a combination of patent, trade secret, copyright and trademark laws,non-disclosure and other contractual agreements and technical measures to protectour proprietary rights.  These agreementsand measures may not be sufficient to protect our technology from third-partyinfringement, or to protect us from the claims of others.  Monitoring unauthorized use of our productsis difficult, and we cannot be certain that the steps we have taken willprevent unauthorized use of our technology, particularly in foreign countrieswhere the laws may not protect our proprietary rights as fully as in the UnitedStates.  The laws of certain foreigncountries in which our products are or may be developed, manufactured or sold,including various countries in Asia, may not protect our products orintellectual property rights to the same extent as do the laws of the UnitedStates and thus make the possibility of piracy of our technology and productsmore likely in these countries.  Ifcompetitors are able to use our technology, our ability to compete effectivelycould be harmed.

 

The protection offered by patents is subject to numerousuncertainties.  For example, ourcompetitors may be able to effectively design around our patents, or thepatents 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 ourproducts are based in part on standards, for which we do not hold patents orother intellectual property rights.

 

We have generally limited access to and distribution of the source andobject code of our software and other proprietary information.  With respect to its page descriptionlanguage software and drivers for the digital office market and in limitedcircumstances with respect to firmware and platforms for its HDTV products andImaging, Zoran has granted licenses that give its customers access to andrestricted use of the source code of Zoran’s software.  This access increases the likelihood ofmisappropriation or misuse of our technology.

 

**We are involved in several lawsuits.**

 

Zoran and Oak are parties to various legal proceedings, including anumber of patent-related lawsuits, both as plaintiff and defendant.  In connection with these lawsuits,substantial management time has been, and will continue to be, expended.  In addition, both Oak and Zoran haveincurred, and we expect to continue to incur, substantial legal and otherexpenses in connection with these pending lawsuits.  No provision for any liability that mayresult upon adjudication of these lawsuits has been made in our financialstatements.

 

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

 

In recent years, there has been significant litigation in the UnitedStates involving patents and other intellectual property rights.  In the past, Zoran and Oak have been subjectto claims and litigation regarding alleged infringement of other parties’intellectual property rights, and both Oak and Zoran are currently parties to anumber of patent-related lawsuits, both as plaintiff and defendant.  We could become subject to additionallitigation in the future, either to protect our intellectual property or as aresult of allegations that we infringe others’ intellectual propertyrights.  Claims that our productsinfringe proprietary rights would force us to defend ourselves and possibly ourcustomers or manufacturers against the alleged infringement.  Pending and future litigation against us, ifsuccessful, could subject us to significant liability for damages orinvalidation of our proprietary rights. These lawsuits, regardless of their success, are

 

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time-consuming and expensive to resolve and require significantmanagement time and attention.  Pendingor future intellectual property litigation could force us to do one or more ofthe following:

 

•                  stopselling products that incorporate the challenged intellectual property;

 

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

 

•                  paydamages; or

 

•                  redesignthose products that use such technology.

 

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

 

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

 

From time to time, we may be required to license technology from thirdparties to develop new products or product enhancements.  Third party licenses may not be available oncommercially reasonable terms, if at all. If we are unable to obtain any third-party license required to developnew products and product enhancements, we may have to obtain substitutetechnology of lower quality or performance standards or at greater cost, eitherof which could seriously harm the competitiveness of our products.

 

Certain technology used in our products is licensed from third parties,and in connection with these licenses, we are required to fulfillconfidentiality obligations and, in some cases, pay royalties.  Some of our products require various types ofcopy protection software that we must license from third parties.  If we are unable to obtain or maintain ourright to use the necessary copy protection software, we would be unable to selland market these products.

 

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

 

Our future net income and cash flow will be affected by our ability toapply our net operating losses, or NOLs, against taxable income in futureperiods.  Our NOLs totaled approximately$271 million for federal and $93 million for state tax reportingpurposes as of December 31, 2004. As a result of the change of control resulting from our initial publicoffering in 1995, the amount of NOLs that we can use to reduce future taxableincome for federal tax purposes is limited to approximately $3.0 millionper year.  The Internal Revenue Codecontains a number of provisions that could limit the use of NOLs against incomeof the combined company as a result of the merger or as a result of thecombination of these transactions.  Our utilizationof Oak’s NOLs may be further limited due to prior Oak transactions.  No opinion or IRS ruling has been soughtregarding the potential application of any of these provisions.  Changes in tax laws in the United States mayfurther limit our ability to utilize these NOLs.  Any further limitation on our ability toutilize these respective NOLs could harm our financial condition.

 

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

 

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

 

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

 

•                  incurdebt;

 

•                  assumeliabilities;

 

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

 

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

 

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

 

•                  problemscombining the purchased operations, technologies or products;

 

•                  unanticipatedcosts;

 

•                  diversionof management’s attention from our core business;

 

•                  adverseeffects on existing business relationships with customers;

 

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

 

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

 

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

 

In addition, we have made minority equity investments in early-stagecompanies, and we expect to continue to review opportunities to make additionalinvestments in such companies where we believe such investments will provide uswith opportunities to gain access to important technologies or otherwiseenhance important commercial relationships. We have little or no influence over the early-stage companies in whichwe have made or may make strategic, minority equity investments.  Each of these investments involves a highdegree of risk.  We may not be successfulin achieving the technological or commercial advantage upon which any giveninvestment is premised, and failure by the early-stage company to achieve itsown business objectives could result in a loss of all or part of our investedcapital and require us to write off all or a portion of such investment.

 

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

 

We develop complex and evolving products.  Despite testing by us and 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 otherperformance problems in our products could result in financial or other damagesto customers or could damage market acceptance of such products.  Our customers could also seek damages from usfor their losses.  A product liabilityclaim brought against us, even if unsuccessful, would likely be time consumingand costly to defend.

 

**If we do not maintain current development contractsor are unable to enter into new development contracts, our business could beharmed.**

 

We historically have generated a portion of our total revenues fromdevelopment contracts, primarily with key customers.  These development contracts have provided uswith partial funding for the development of some of our products.  Under these contracts, we receive paymentsupon reaching certain development milestones. If we fail to achieve the milestones specified in our existingdevelopment contracts, if our existing contracts are terminated or if we areunable to secure future development contracts, our ability to cost-effectivelydevelop new products would be reduced and our business would be harmed.

 

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

 

We may require substantial additional capital to finance our futuregrowth, secure additional foundry capacity and fund our ongoing research anddevelopment activities beyond 2005.  Ourcapital requirements will depend on many factors, including:

 

•                  acceptanceof and demand for our products;

 

•                  thetypes of arrangements that we may enter into with our independent foundries;

 

•                  theextent to which we invest in new technology and research and developmentprojects; and

 

•                  anyadditional acquisitions that we may make.

 

To the extent that our existing sources of liquidity and cash flow fromoperations are insufficient to fund our activities, we may need to raise additionalfunds.  If we raise additional fundsthrough the issuance of equity securities, the percentage ownership of ourexisting stockholders would be reduced. Further, such equity securities may have rights, preferences orprivileges senior to those of our

 

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common stock.  Additionalfinancing may not be available to us when needed or, if available, it may notbe available on terms favorable to us.

 

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

 

We anticipate that our future growth, if any, will require us torecruit and hire a substantial number of new engineering, managerial, sales andmarketing personnel.  Our ability tomanage growth successfully will also require us to expand and improveadministrative, operational, management and financial systems andcontrols.  Many of our key operations,including a material portion of our research and development operations and asignificant portion of our sales and administrative operations are located inIsrael.  A majority of our sales andmarketing and certain of our research and development and administrativepersonnel, including our President and Chief Executive Officer and otherofficers, are based in the United States. The geographic separation of these operations places additional strainon our resources and our ability to manage growth effectively.  If we are unable to manage growtheffectively, our business will be harmed.

** **

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

 

Our success depends to a significant degree upon the continuingcontributions of our senior management. Management and other employees may voluntarily terminate theiremployment with us at any time upon short notice.  The loss of key personnel could delay productdevelopment 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.

 

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

 

A portion of the cost of our operations, relating mainly to ourpersonnel and facilities in Israel, is incurred in new Israeli shekels.  As a result, we bear the risk that the rateof inflation in Israel will exceed the rate of devaluation of the new Israelishekel in relation to the United States dollar, which will increase our costsas expressed in United States dollars. To date, we have not engaged in hedging transactions.  In the future, we may enter into currencyhedging transactions to decrease the risk of financial exposure fromfluctuations in the exchange rate of the United States dollar against the newIsraeli shekel.  These measures may notadequately protect us from the impact of inflation in Israel.

 

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

 

Historically, we have financed a portion of our research anddevelopment activities with grants for research and development from the ChiefScientist in Israel’s Ministry of Industry and Trade.  We earned proceeds from such grants in 2003and 2004 and we plan to seek additional grants from the Chief Scientist in thefuture.  To be eligible for these grants,our development projects must be approved by the Chief Scientist on acase-by-case basis.  If our developmentprojects are not approved by the Chief Scientist, we will not receive grants tofund these projects, which would increase our research and developmentcosts.  We also receive tax benefits, inparticular exemptions and reductions as a result of the “Approved Enterprise”status of our existing operations in Israel. To be eligible for these tax benefits, we must maintain our ApprovedEnterprise status by meeting conditions, including making specified investmentsin fixed assets located in Israel and investing additional equity in ourIsraeli subsidiary.  If we fail to meetthese conditions in the future, the tax benefits would be canceled and we couldbe required to refund the tax benefits already received.  These tax benefits may not be continued inthe future at their current levels or at any level.  Israeli governmental authorities haveindicated that the government may reduce or eliminate these benefits in thefuture, which would harm our business.

 

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

 

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

 

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

 

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

 

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

 

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

 

The market price of our common stock has fluctuated significantly sinceour initial public offering in 1995. Between January 1, 2004 and September 30, 2005, the closingsale price of our common stock, as reported on The Nasdaq National Market,ranged from a low of $8.97 to a high of $22.20. The market price of our common stock is subject to significant fluctuationsin the future in response to a variety of factors, including:

 

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

 

•                  quarterlyvariations in operating results;

 

•                  changesin analysts’ earnings estimates;

 

•                  announcementsof technological innovations;

 

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

 

•                  lossof key personnel;

 

•                  proprietaryrights or other litigation;

 

•                  generalconditions in the semiconductor industry; and

 

•                  developmentsin the financial markets.

 

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

 

**Item 3.****           Quantitative andQualitative Disclosures About Market Risk**

 

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

 

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

 

A majority of our revenue and capital spending is transacted in U.S.dollars, although a portion of the cost of our operations, relating mainly toour personnel and facilities in Israel, is incurred in New IsraeliShekels.  As a result, we bear the riskthat the rate of inflation in Israel will exceed the rate of devaluation of thenew Israeli shekel in relation to the United States dollar, which will increaseour costs as expressed in United States dollars.  We have not engaged in hedging transactionsto reduce our exposure to fluctuations that may arise from changes in foreignexchange rates.  Based on our overallcurrency rate exposure at September 30, 2005, a near-term 10% appreciationor depreciation of the New Israeli Shekel would have an immaterial affect onour financial condition.

 

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**Item 4.****           Controls and Procedures**

 

***Disclosure Controls and Procedures****.** ***Underthe supervision and with the participation of our management, including ourChief Executive Officer and our Chief Financial Officer, we evaluated theeffectiveness of our disclosure controls and procedures, as such term isdefined under Rule 13a-15(e) promulgated under the SecuritiesExchange Act of 1934, as amended.  Basedupon that evaluation, our Chief Executive Officer and Chief Financial Officer****concluded that our disclosure controls andprocedures were effective as of the end of the period covered by this quarterlyreport.

 

***Internal ControlsOver Financial Reporting****.*  There has been nochange in our internal control over financial reporting during the quarterended September 30, 2005 that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

 

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**PART II. OTHER INFORMATION**

 

**Item 1.****           Legal Proceedings**

 

Zoran and itssubsidiary, Oak Technology, Inc., have initiated two legal actions againstMediaTek, Inc. and customers of MediaTek alleging that productsincorporating certain MediaTek components infringe three patents co-owned byZoran and Oak relating to optical drive controller design and integrated CD/DVDcontroller design.

 

On March 11,2004, Zoran and Oak filed a complaint with****theUnited States International Trade Commission (“ITC”) alleging that certainMediaTek DVD player and optical disk controller chips and chipsets, andproducts in which they are used, infringe Zoran’s and Oak’s patents.  In addition to MediaTek, the complaint nameda number of other proposed respondents that sell products, including DVDplayers and PC optical storage devices that use MediaTek’s chips andchipsets.  The complaint requested thatthe ITC institute an investigation of the accused products and issue exclusionand cease and desist orders prohibiting the importation into the United Statesof the infringing MediaTek devices and products that contain them.  The hearing on Zoran’s complaint took placein February 2005.  On September 28,2005, the ITC issued its final ruling finding one of Zoran’s patents to bevalid and infringed by optical disk controller chips and chipsets sold byMediaTek and by products using the infringing chips and chipsets sold by anumber of MediaTek customers.  The ITCalso issued an exclusion order prohibiting MediaTek and specified MediaTekcustomers from importing into the United States any optical disk controllerchip or chipset that infringes the Zoran patent, or any optical disk storageproduct containing such a chip or chipset. The ITC’s exclusion order covered products using MediaTek chipsmanufactured by Artronix Technology, Inc., ASUSTek Computer, Inc.,ASUS Computer International, EPO Science & Technology Co., Inc.,LITE-ON Information Technology Corp., Micro-Star International Co., Ltd., MSIComputer Corporation, TEAC America, Inc., TEAC Corp., Ultima ElectronicsCorp., and any of these companies’ contractors or related or affiliatedcompanies.  The ITC also issued cease anddesist orders to the affected companies located in the United Statesprohibiting them from importing or selling infringing products in the UnitedStates.

 

On March 15,2004, Zoran and Oak filed a complaint against MediaTek and Mintek Digital inthe United States District Court, Central District of California allegingsimilar facts regarding infringement by MediaTek’s chips and chipsets andproducts in which they are used.  Thelawsuit seeks both monetary damages and an injunction to stop the importationand sale of infringing products.  Zoransubsequently amended the complaint to name ASUSTek Computer, Inc., JiangsuShinco Electronic Group Co., Ltd., LITE-ON Information Technology Corporation,Mintek Digital, Shinco International AV Co., Ltd., TEAC Corporation, TEACAmerica, Inc., Terapin Technology Corporation and Terapin Technology asdefendants.  On September 17, 2004,pursuant to stipulation of the parties, the case was transferred to the UnitedStates District Court, Northern District of California.  On July 2, 2004, the defendants filed afirst amended answer which included counterclaims for declaration ofnoninfringement, declaration of invalidity, declaration of unenforceability,breach of covenant not to sue, breach of covenant of good faith and fairdealing and unfair competition.  On July 22,2004, Zoran and Oak moved to dismiss certain of the defendants’ defenses andcounterclaims and, on July 30, 2004, MediaTek filed a motion for summaryjudgment as to two of the three patents asserted by Zoran and Oak againstMediaTek.  On December 9, 2004, theCourt granted Zoran and Oak’s motion, in part, and dismissed certain ofdefendant’s counterclaims and affirmative defenses.  The Court also denied MediaTek’s motion forsummary judgment.  On October 15,2004, MediaTek filed a second motion for summary judgment seeking summaryjudgment on alternate grounds as to the same two patents.  On October 17, 2005, the Court deniedthis motion.  On January 3, 2005,defendants Audiovox Corporation, Artronix Technology, Inc., ASUS ComputerInternational, Inc., Initial Technology, Inc., Changzhou ShincoDigital Technology Co., Ltd., EPO Science and Technology Co., Inc.,Micro-Star International, Co., Ltd., MSI Computer Corp., Shinco InternationalAV Co. and Ultima Electronics Corp. were added to this case by stipulation ofthe parties.  On July 25, 2005,MediaTek filed a third motion for summary judgment seeking summary judgment ofinvalidity as to two of the Zoran patents based on alleged improperinventorship.  The Court has not ruled onthis motion.  Discovery is currentlyunderway, and trial of this case is presently set to begin May 15, 2006.

 

On July 23,2004, MediaTek filed a complaint with the ITC alleging that certain Zoran andOak DVD player and optical disk controller chips and chipsets infringe twoMediaTek patents.  The complaintrequested that the ITC institute an investigation into the accused products andissue exclusion and cease and desist orders prohibiting importation into theUnited States of allegedly infringing chips and products that containthem.  On August 26, 2004, the ITCinstituted an investigation.  On September 24,2004, MediaTek filed a motion to amend the complaint to add one additionalpatent and to name Sunext Technology Co., Ltd. as a respondent.  This motion was granted on October 7,2004.  On February 16, 2005,MediaTek filed a motion for leave to amend the complaint and notice ofinvestigation to assert additional claims of the MediaTek patents against Oak,Zoran and Sunext.  This motion was deniedon March 4, 2005.  The hearing onMediaTek’s complaint took place in June and July 2005.  On September 30, 2005, the ITCAdministrative Law Judge issued his initial determination finding that none ofZoran’s optical disk controller chips infringe any claim of the two patents assertedagainst Zoran; that one of the two patents is invalid; that Oak’s devices donot infringe one of the two patents asserted against Oak and that the otherpatent is invalid; and that MediaTek has failed to establish that it has adomestic

 

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industry in theUnited States related to the patents at issue – a basic requirement forobtaining relief from the ITC.  Theinitial determination is subject to review by the full ITC.  The target date for completion of theinvestigation is January 30, 2006.

 

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

 

On February 2,2005, MediaTek filed a complaint against Zoran and Zoran Digital Technologies(Shenzhen) Ltd. (Zoran’s local Chinese operations) in the Shenzhen People’sRepublic of China court alleging infringement of the Chinese counterpart patentof one of the two patents asserted in MediaTek’s ITC complaint and seekingmonetary damages.  Because Zoran DigitalTechnologies (Shenzhen) Ltd. had been improperly identified in the originalcomplaint, it was not until July 22, 2005 that Zoran Digital Technologies(Shenzhen) Ltd. was formally served with the complaint.  At this time, Zoran has not been served withthe complaint.  The initiation of thefull proceeding is stayed until all parties are formally served.

 

Based upon itspreliminary review, Zoran believes that it has meritorious defenses to thethree MediaTek complaints, which Zoran believes were filed in response to theproceedings that Zoran has been prosecuting against MediaTek and itscustomers.  Zoran intends to defend theMediaTek actions vigorously.  However,the litigation is in the preliminary stage, and Zoran cannot predict itsoutcome with certainty.  Patentlitigation is particularly complex and can extend for a protracted time, whichcan substantially increase litigation expenses.

 

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

 

Our 2005 Annual Meeting of Stockholders was heldon July 29, 2005.  At the meeting, the following eight personsnominated by management were elected to serve as members of our Board ofDirectors:

 

| ** **                | ** ** | **Shares**    | ** ** |
|---------------------------|------------|---------------|------------|
| **Nominee**               | ** ** | **Voted For** | ** ** | **Withheld** | ** ** |
| Levy  Gerzberg            |       | 32,977,385    |       | 2,885,831 |   |
| Uzia Galil                |       | 32,038,291    |       | 3,824,925 |   |
| Raymond A.  Burgess       |       | 33,169,564    |       | 2,693,652 |   |
| James D.  Meindl          |       | 32,050,741    |       | 3,812,475 |   |
| James B.  Owens, Jr. |       | 33,113,412    |       | 2,749,804 |   |
| David Rynne               |       | 33,165,725    |       | 2,697,491 |   |
| Arthur B.  Stabenow       |       | 31,961,815    |       | 3,901,401 |   |
| Philip M.  Young          |       | 32,928,970    |       | 2,934,246 |   |

 

The following additional proposals were votedupon at the meeting:

 

1.                     A proposalto approve the adoption of our 2005 Equity Incentive Plan to replace the 1993Stock Option Plan and the 2000 Nonstatutory Stock Option Plan wasapproved.  The vote on this proposal wasof 16,821,732 shares for; 6,834,665 shares against; 76,053 shares abstaining;and 20,156,632 broker non-votes.

 

2.                     A proposalto approve the exchange of outstanding stock options for a lesser number ofrestricted stock units to be granted under the 2005 Equity Incentive Plan wasapproved.  The vote on this proposal was17,265,950 shares for; 6,395,296 shares against; 71,203 shares abstaining; and20,156,633 broker non-votes.

 

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3.                     A proposalto approve the adoption of our 2005 Outside Directors Equity Plan to replacethe 1995 Outside Directors Stock Option Plan was approved.  The vote on this proposal was 18,124,534shares for; 5,519,928 shares against; 87,988 shares abstaining; and 20,156,632broker non-votes.

 

4.                       A proposalto approve an amendment to our 1995 Employee Stock Purchase Plan to authorizethe sale of an additional 1,500,000 shares was approved.  The vote on this proposal was of 22,546,945shares for; 1,108,100 shares against; 77,406 shares abstaining; and 20,156,631broker non-votes.

 

5.                       A proposalto ratify the appointment of PricewaterhouseCoopers LLP as our independentaccountants for the fiscal year ending December 31, 2005 was approved by avote of 35,292,814 shares for; 527,106 shares against; 43,295 sharesabstaining; and 8,025,867 broker non-votes.

 

**Item 6.  Exhibits**

 
| 10.3(1)  |   | Zoran Corporation 1995 Employee Stock  Purchase Plan, As Amended                    |
|----------|--------|-------------------------------------------------------------------------------------|
| 10.52(2) |   | Zoran Corporation 2005 Equity Incentive  Plan                                       |
| 10.53(3) |   | Zoran Corporation 2005 Directors Equity Plan                                        |
| 31.1     |   | Certification of Chief Executive Officer  pursuant to Rule 13a-14(a).          |
| 31.2     |   | Certification of Chief Financial Officer  pursuant to Rule 13a-14(a).          |
| 32.1     |   | Certification of Chief Executive Officer,  pursuant to 18 U.S.C. Section 1350. |
| 32.2     |   | Certification of Chief Financial Officer,  pursuant to 18 U.S.C. Section 1350. |

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(1)Incorporated by reference to Exhibit 99.3 to Registrant's Form 8-K filed onAugust 3, 2005.

 

(2) Incorporatedby reference to Exhibit 99.1 to Registrant's Form 8-K filed on August 3, 2005.

 

(3)Incorporated by reference to Exhibit 99.2 to Registrant's Form 8-K filed onAugust 3, 2005.

 

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**SIGNATURES**

 

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

 

 
|                          | **ZORAN  CORPORATION**                        |
|-------------------------------|-----------------------------------------------|
|                          |                                          |
|                          |                                          |
| Date:  November 9 , 2005 | /s/ Karl  Schneider                           |   |
|                          | Karl  Schneider                               |
|                          | Senior Vice  President, Finance               |
|                          | and Chief  Financial Officer                  |
|                          | (Principal  Financial and Accounting Officer) |

 

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