**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 the Quarterly Period Ended March31, 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                    **

 

**Commission File No. 0-27246**

 

**ZORAN CORPORATION**

**(Exact name of registrant asspecified in its charter)**

** **

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

 

**1390 Kifer Road**

**Sunnyvale, California 94086**

(Address of principalexecutive offices, including zip code)

 

**(408) 523-6500**

(Registrant’s telephonenumber, including area code)

 

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Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports) and (2) has been subject to suchfiling requirements for the past 90 days. Yes ýNo o

 

Indicate by check mark whether theregistrant is an accelerated filer (as defined in Rule 12b-2 of the ExchangeAct).

Yes ý No o

 

As of May 6, 2005, there were outstanding 43,513,169 shares of theregistrant’s Common Stock, par value $0.001 per share.

 

 

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**ZORAN CORPORATION ANDSUBSIDIARIES**

**FORM 10-Q**

**INDEX**

 

**For the Quarter Ended March 31,2005**

 
| ** **   | **PART I. FINANCIAL  INFORMATION**                                                                   | ** ** |
|--------------|------------------------------------------------------------------------------------------------------|------------|
|         |                                                                                                 |       |
| **Item 1.**  | Financial  Statements (Unaudited):                                                                   |       |
|         |                                                                                                 |       |
|         | Condensed  Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004                    |       |
|         |                                                                                                 |       |
|         | Condensed  Consolidated Statements of Operations for the Three Months Ended March 31,  2005 and 2004 |       |
|         |                                                                                                 |       |
|         | Condensed  Consolidated Statements of Cash Flows for the Three Months Ended March 31,  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 6.**  | Exhibits                                                                                             |       |
|         |                                                                                                 |       |
| Signatures   |                                                                                                 |       |

 

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**ZORAN CORPORATION**

**CONDENSED CONSOLIDATED BALANCESHEETS**

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

**(unaudited)**

 
| ** **                                                                                                                                                                                                                                     | ** ** | **March 31,  2005** | ** ** | **December 31,   2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|-------------------------|------------|
| ASSETS                                                                                                                                                                                                                                         |       |                |       |                    |       |
| Current assets:                                                                                                                                                                                                                                |       |                |       |                    |       |
| Cash and cash  equivalents                                                                                                                                                                                                                     |       | $                   | 31,025     |                    | $          | 37,435 |   |
| Short-term  investments                                                                                                                                                                                                                        |       | 50,311              |       | 32,978                  |       |
| Accounts  receivable, net                                                                                                                                                                                                                      |       | 68,023              |       | 59,863                  |       |
| Inventories                                                                                                                                                                                                                                    |       | 34,207              |       | 50,033                  |       |
| Prepaid expenses  and other current assets                                                                                                                                                                                                     |       | 17,995              |       | 14,130                  |       |
| Total current  assets                                                                                                                                                                                                                          |       | 201,561             |       | 194,439                 |       |
|                                                                                                                                                                                                                                           |       |                |       |                    |       |
| Property and  equipment, net                                                                                                                                                                                                                   |       | 16,270              |       | 17,190                  |       |
| Other assets and  investments                                                                                                                                                                                                                  |       | 54,108              |       | 68,619                  |       |
| Goodwill                                                                                                                                                                                                                                       |       | 150,151             |       | 150,151                 |       |
| Intangible assets,  net                                                                                                                                                                                                                        |       | 156,416             |       | 168,882                 |       |
| Total assets                                                                                                                                                                                                                                   |       | $                   | 578,506    |                    | $          | 599,281 |   |
|                                                                                                                                                                                                                                           |       |                |       |                    |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                                                                                     |       |                |       |                    |       |
| Current  liabilities:                                                                                                                                                                                                                          |       |                |       |                    |       |
| Accounts payable                                                                                                                                                                                                                               |       | $                   | 27,955     |                    | $          | 34,017 |   |
| Accrued expenses  and other liabilities                                                                                                                                                                                                        |       | 53,797              |       | 51,102                  |       |
| Total current  liabilities                                                                                                                                                                                                                     |       | 81,752              |       | 85,119                  |       |
|                                                                                                                                                                                                                                           |       |                |       |                    |       |
| Other long-term  liabilities                                                                                                                                                                                                                   |       | 13,064              |       | 13,535                  |       |
|                                                                                                                                                                                                                                           |       |                |       |                    |       |
| Stockholders’  equity:                                                                                                                                                                                                                    |       |                |       |                    |       |
| Common stock,  $0.001 par value; 105,000,000 shares authorized at March 31, 2005 and  December 31, 2004; 43,253,892 shares  issued and outstanding as of March 31, 2005; and 43,195,432 shares issued and outstanding as of December 31,  2004 |       | 43                  |       | 43                      |       |
| Additional paid-in  capital                                                                                                                                                                                                                    |       | 705,761             |       | 705,661                 |       |
| Deferred stock-based  compensation                                                                                                                                                                                                             |       | (1,999              | )          | (2,791                  | )          |
| Accumulated  other comprehensive income                                                                                                                                                                                                        |       | 2,505               |       | 1,538                   |       |
| Accumulated  deficit                                                                                                                                                                                                                           |       | (222,620            | )          | (203,824                | )          |
| Total  stockholders’ equity                                                                                                                                                                                                               |       | 483,690             |       | 500,627                 |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                               |       | $                   | 578,506    |                    | $          | 599,281 |   |

 

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

 

3

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**ZORAN CORPORATION**

**CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS**

**(in thousands, except per sharedata)**

**(unaudited)**

 
| ** **                                         | ** ** | **Three  Months Ended  March 31,** | ** **      |
|----------------------------------------------------|------------|------------------------------------|-----------------|
| ** **                                         | ** ** | **2005**                           | ** **      | **2004** | ** ** |
| Revenues:                                          |       |                               |            |   |   |
| Hardware product  revenues                         |       | $                                  |  

59,002  |   | $ |  

68,029 |   |
| Software and  other revenues                       |       | 14,882                             |            | 12,608 |   |
| Total revenues                                     |       | 73,884                             |            | 80,637 |   |
|                                               |       |                               |            |   |   |
| Costs and  expenses:                               |       |                               |            |   |   |
| Cost of hardware  product revenues                 |       | 36,964                             |            | 45,328 |   |
| Research and  development                          |       | 20,100                             |            | 18,646 |   |
| Selling, general  and administrative               |       | 23,174                             |            | 14,817 |   |
| Amortization of  intangible assets                 |       | 12,330                             |            | 10,343 |   |
| Deferred stock  compensation                       |       | 517                                |            | 1,827 |   |
| Total costs and  expenses                          |       | 93,085                             |            | 90,961 |   |
|                                               |       |                               |            |   |   |
| Operating loss                                     |       | (19,201                            | )               | (10,324 | ) |
|                                               |       |                               |            |   |   |
| Interest income                                    |       | 535                                |            | 400 |   |
|                                               |       |                               |            |   |   |
| Other income  (loss), net                          |       | (130                               | )               | 325 |   |
|                                               |       |                               |            |   |   |
| Loss before  income taxes                          |       | (18,796                            | )               | (9,599 | ) |
|                                               |       |                               |            |   |   |
| Provision for  income taxes                        |       | —                             |            | 386 |   |
|                                               |       |                               |            |   |   |
| Net loss                                           |       | $                                  |  

(18,796 | ) | $ |  

(9,985 | ) |
|                                               |       |                               |            |   |   |
| Basic net loss  per share                          |       | $                                  |  

(0.43   | ) | $ |  

(0.23 | ) |
|                                               |       |                               |            |   |   |
| Diluted net loss  per share                        |       | $                                  |  

(0.43   | ) | $ |  

(0.23 | ) |
|                                               |       |                               |            |   |   |
| Shares used to  compute basic net loss per share   |       | 43,213                             |            | 42,522 |   |
|                                               |       |                               |            |   |   |
| Shares used to  compute diluted net loss per share |       | 43,213                             |            | 42,522 |   |

 

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

 

4

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**ZORAN CORPORATION**

**CONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS**

**(in thousands)**

**(unaudited)**

 
| ** **                                                             | ** ** | **Three  Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                             | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| Cash flows from  operating activities:                                 |       |                               |       |   |   |
| Net loss                                                               |       | $                                  | (18,796    | ) | $ | (9,985 | ) |
| Adjustments to  reconcile net loss to net cash provided by operations: |       |                               |       |   |   |
| Depreciation and  amortization                                         |       | 3,144                              |       | 2,492 |   |
| Amortization of  intangible assets                                     |       | 12,330                             |       | 10,343 |   |
| Amortization of  deferred stock compensation                           |       | 517                                |       | 1,827 |   |
| Changes in  current assets and liabilities:                            |       |                               |       |   |   |
| Accounts  receivable                                                   |       | (8,160                             | )          | (587 | ) |
| Inventories                                                            |       | 15,826                             |       | (1,194 | ) |
| Prepaid expenses  and other current assets and other assets            |       | (4,969                             | )          | 494 |   |
| Accounts payable                                                       |       | (6,062                             | )          | 4,620 |   |
| Accrued expenses  and other liabilities                                |       | 2,224                              |       | (556 | ) |
| Net cash  provided by (used in) operating activities                   |       | (3,946                             | )          | 7,454 |   |
|                                                                   |       |                               |       |   |   |
| Cash flows from  investing activities:                                 |       |                               |       |   |   |
| Purchases of  property and equipment                                   |       | (1,489                             | )          | (1,922 | ) |
| Purchases of  investments                                              |       | (4,883                             | )          | (59,444 | ) |
| Proceeds from  sales and maturities of investments                     |       | 4,103                              |       | 69,339 |   |
| Purchases of  intellectual property                                    |       | (570                               | )          | — |   |
| Net cash  provided by (used in) investing activities                   |       | (2,839                             | )          | 7,973 |   |
|                                                                   |       |                               |       |   |   |
| Cash flows from  financing activities:                                 |       |                               |       |   |   |
| Proceeds from  issuance of common stock                                |       | 375                                |       | 2,138 |   |
| Net cash  provided by financing activities                             |       | 375                                |       | 2,138 |   |
|                                                                   |       |                               |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                  |       | (6,410                             | )          | 17,565 |   |
|                                                                   |       |                               |       |   |   |
| Cash and cash  equivalents at beginning of period                      |       | 37,435                             |       | 47,994 |   |
|                                                                   |       |                               |       |   |   |
| Cash and cash  equivalents at end of period                            |       | $                                  | 31,025     |   | $ | 65,559 |   |

 

The accompanying notes arean integral part of these unaudited condensed consolidated financialstatements.

 

5

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**ZORAN CORPORATION**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(unaudited)**

 

**1.             Basisof Presentation**

 

The accompanying unaudited condensed consolidated financial statementsof Zoran Corporation and 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 therules and regulations of the Securities and Exchange Commission (the “Commission”).  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 the consolidatedfinancial position, operating results and cash flows for the periodspresented.  The results of operations forthe interim periods presented are not necessarily indicative of the resultsthat may be expected for the full fiscal year or in any future period.  This quarterly report on Form 10-Q should beread in conjunction with the audited consolidated financial statements andnotes thereto for the year ended December 31, 2004, included in theZoran Corporation 2004 Annual Report on Form 10-K filed with the Commission.

 

***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 of 2002,management discovered that excess stock compensation expenses had beenrecognized during the quarters ended March 31, June 30 and September 30, 2004.  The compensation expense was related tooptions that we had assumed as part of our acquisition of Oak Technology, Inc.in 2003.  Under purchase accounting, partof the cost relating to the acquisition was attributed to the assumed optionsand was to be recognized over time as the options continued to vest, based oneach option holder’s continued employment with Zoran.  If an option holder’s employment terminatedbefore the option was fully vested, vesting would cease, and we would no longerrecognize compensation expense related to that option.  At the time of the acquisition, a schedulewas prepared detailing the terms of each assumed option; however, the names ofthe option holders were omitted from the schedule for reasons of confidentiality.  After the acquisition was completed, we didnot update our personnel or financial records to include the omittedinformation. As a result, the Company improperly recognized deferred stockcompensation expenses relating to options that had been held by former Oakemployees after the vesting of such options had ceased, and did not reversestock based compensation expense recognized in excess of amounts that actuallyvested.  The amounts presented in thisForm 10-Q for the three month period ended March 31, 2004 have been restated tocorrect this error.

 

For the quarters ended March 31, 2004, June30, 2004 and September 30, 2004, the previously recorded deferred stockcompensation expense was reduced by $704,000, $1,545,000 and $880,000,respectively, as a result of the restatement.

 

The following table shows 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 | ) |
|                                      |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Recentaccounting pronouncements***

 

In December 2004, the FASB issued FASB Statement No. 123R, “Share-BasedPayment, an Amendment of FASB Statement No. 123” (“FAS No. 123R”).  On April 14, 2005, the U.S. Securitiesand Exchange Commission adopted a new rule amending the compliance dates forFAS 123R.  In accordance with the newrule, the accounting provisions of FAS 123R will be effective for the Companyin

 

6

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2006.  FAS No. 123R requirescompanies to recognize in the statement of operations the grant-date fair valueof stock options and other equity-based compensation issued to employees.  SFAS No. 123R requires the use ofan option pricing model for estimating fair value, which is amortized toexpense over the service periods. SFAS No. 123R allows for either prospective recognition of compensationexpense or retrospective recognition, which may be back to the originalissuance of SFAS No. 123, or only to interim periods in the year ofadoption.  Management is currentlyevaluating the impact of adopting SFAS 123R; however, it believes the adoptionof SFAS No. 123R will have a significant impact on net income (loss)and net income (loss) per share.  Theimpact on our financial statements will be dependent on the transition method,the option-pricing model used to compute fair value and the inputs to thatmodel such as volatility and expected life. The pro-forma disclosures of the impact of SFAS 123 provided in Note 2to the Consolidated Financial Statements may not be representative of theimpact of adopting SFAS 123R.

 

On March 29, 2005, the Securities and Exchange Commission issued StaffAccounting Bulletin No. 107 (“SAB 107”).   This staffaccounting bulletin expresses views of the staff regarding the interactionbetween Statement of Financial Accounting Standards Statement No. 123 (revised2004), Share-Based Payment (“Statement 123R” or the “Statement”) and certainSecurities and Exchange Commission (“SEC”) rules and regulations and providesthe staff’s views regarding the valuation of share-based payment arrangementsfor public companies.   The Company doesnot expect the adoption of SAB 107 to have a material impact on itsconsolidated financial position, results of operations or cash flows.

 

**2.             StockBased 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 2000 andOak Technology, Inc. during 2003, the Company recorded deferred stock-basedcompensation which is being amortized over the vesting period of theoptions.  Amortization of deferred stockcompensation expense recognized as a result of the amortization of theseoptions during the quarters ended March 31, 2005 and 2004 was approximately $517,000and $1,827,000, respectively.

 

7

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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 Compensation” (“SFAS 123”), the Company’s net loss and net lossper share for the three month periods ended March 31, 2005 and 2004 would havebeen as follows (in thousands, except per share data):

 
| ** **                                                                              | ** ** | **Three  Months Ended  March 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                              | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| Net loss  attributable to common stockholders, as reported                              |       | $                                  | (18,796    | ) | $ | (9,985 | ) |
|                                                                                    |       |                               |       |   |   |
| Add:                                                                                    |       |                               |       |   |   |
| Employee  stock-based compensation expense included in net loss                         |       | 517                                |       | 1,827 |   |
|                                                                                    |       |                               |       |   |   |
| Total employee  stock-based compensation expense determined under the fair value method |       | (6,804                             | )          | (11,140 | ) |
|                                                                                    |       |                               |       |   |   |
| Pro forma net  loss attributable to common stockholders                                 |       | $                                  | (25,083    | ) | $ | (19,298 | ) |
|                                                                                    |       |                               |       |   |   |
| Pro forma net  loss per share attributable to common stockholders:                      |       |                               |       |   |   |
| Basic                                                                                   |       | $                                  | (0.58      | ) | $ | (0.45 | ) |
| Diluted                                                                                 |       | $                                  | (0.58      | ) | $ | (0.45 | ) |
|                                                                                    |       |                               |       |   |   |
| Net loss per  share as reported attributable to common stockholders:                    |       |                               |       |   |   |
| Basic                                                                                   |       | $                                  | (0.43      | ) | $ | (0.23 | ) |
| Diluted                                                                                 |       | $                                  | (0.43      | ) | $ | (0.23 | ) |

 

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  March 31, 2005** | ** ** | **Three  Months  Ended  March 31, 2004** | ** ** |
| Expected life (years)   |       | 4.0                                      |       | 5.0 |   |
| Expected volatility     |       | 72                                       | %          | 85 | % |
| Risk-free interest rate |       | 3.7                                      | %          | 3.0 | % |

 
| ** **              | ** ** | **Employee Stock Purchase Plan**         | ** ** |
|-------------------------|------------|------------------------------------------|------------|
| ** **              | ** ** | **Three  Months  Ended  March 31, 2005** | ** ** | **Three  Months  Ended  March 31, 2004** | ** ** |
| Expected life (years)   |       | 0.5                                      |       | 0.5 |   |
| Expected volatility     |       | 55                                       | %          | 91 | % |
| Risk-free interest rate |       | 2.9                                      | %          | 1.0 | % |

 

8

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The Black-Scholes option pricing model was developed for use inestimating the value of traded options that have no vesting restrictions andare fully transferable. In addition, option pricing models require the input ofhighly subjective assumptions including the expected stock price volatility.The Company uses projected data for expected volatility and expected life ofits stock options based upon historical and other economic data trended intofuture years. Because the Company’s employee stock options have characteristicssignificantly different from those of traded options, and because changes inthe subjective input assumptions can materially affect the estimate, inmanagement’s opinion, existing valuation models, including the Black-Scholesmodel, do not necessarily provide a reliable measure of the fair value of theCompany’s stock options.

 

**3.             ComprehensiveLoss**

 

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

 
| ** **                                            | ** ** | **Three  Months Ended  March 31,** | ** ** |
|-------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                            | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| Net loss                                              |       | $                                  | (18,796    | ) | $ | (9,985 | ) |
| Change in  unrealized gain on investments, net of tax |       | 967                                |       | 2,464 |   |
| Total  comprehensive loss                             |       | $                                  | (17,829    | ) | $ | (7,521 | ) |

 

The components of accumulated other comprehensive loss are unrealizedgain (loss) on short-term and long-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):

 
| ** **                           | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------------|------------|---------------------|------------|------------------------|------------|
| Purchased parts  and work in process |       | $                   | 16,689     |                   | $          | 23,959 |   |
| Finished goods                       |       | 17,518              |       | 26,074                 |       |
|                                 |       | $                   | 34,207     |                   | $          | 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.  For theyear ended December 31, 2004, the Company performed the annual analysis as ofSeptember 30, 2004 and concluded that goodwill was not impaired, as the fairvalue of each reporting unit exceeded its carrying value, including goodwill.

 

9

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

 
| ** **                    | ** ** | ** **        | ** ** | **March 31, 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               |       | $                          | 188,505    |                          | $          | (76,452 | ) | $ | 112,053 |   | $ | 188,505 |   | $ | (67,139 | ) | $ | 121,366 |   |
| Patents                       |       | 3-5               |       | 40,265                     |       | (12,837                       | )          | 27,428 |   | 40,265 |   | (10,457 | ) | 29,808 |   |
| Customer base                 |       | 3-5               |       | 13,010                     |       | (5,311                        | )          | 7,699 |   | 13,010 |   | (4,739 | ) | 8,271 |   |
| Tradename and  others         |       | 3-5               |       | 2,100                      |       | (1,226                        | )          | 874 |   | 2,100 |   | (1,161 | ) | 939 |   |
| Purchased core  technology    |       | 4-5               |       | 13,249                     |       | (4,887                        | )          | 8,362 |   | 12,679 |   | (4,181 | ) | 8,498 |   |
| Total                         |       |              |       | $                          | 257,129    |                          | $          | (100,713 | ) | $ | 156,416 |   | $ | 256,559 |   | $ | (87,677 | ) | $ | 168,882 |   |

----

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

 

Estimated future intangible amortization expense,based on current balances, as of March 31, 2005 is as follows (in thousands):

 
| Remaining nine  months of 2005 |   | $      | 39,207  |   |
|--------------------------------|--------|--------|---------|--------|
| Year ending  December 31, 2006 |   | 50,976 |    |
| Year ending  December 31, 2007 |   | 43,730 |    |
| Year ending  December 31, 2008 |   | 22,503 |    |
|                           |   | $      | 156,416 |   |

 

Goodwill by reporting unit at March 31, 2005 andDecember 31, 2004 were as follows (in thousands):

 
| DVD     |   | $      | 63,855  |   |
|---------|--------|--------|---------|--------|
| Imaging |   | 6,177  |    |
| Mobile  |   | 62,131 |    |
| DTV     |   | 17,988 |    |
|    |   | $      | 150,151 |   |

 

**6.             IncomeTaxes**

 

The provision for income taxes reflects the estimated annualizedeffective tax rate and consideration of the need for a valuation allowance . The effective tax rate differs from the U.S. statutory rate due toutilization of net operating losses, adjustments for the nondeductibleamortization of goodwill and other intangibles and income tax rate differenceson foreign earnings along with the impact of recorded a valuation allowance forthe non-benefited losses.   The Company believes that reasonableuncertainly exists regarding future results such that no benefit has beenrecorded for the losses during the quarter.

 

**7.             SegmentReporting**

 

SFAS No. 131 establishes standards for the reporting by public businessenterprises of information about operating segments, products and services,geographic areas, and major customers. The method for determining what information to report is based on theway that management organizes the operating segments within the Company formaking operational decisions and assessments of financial performance.  The Company’s chief operating decision-makeris 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 Emblaze acquisition in July2004, the Digital Camera segment was combined with the Emblaze Mobile businessunit and was renamed the Mobile segment. Each

 

 

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segment’s primary products are based on highly integratedapplication-specific integrated circuits, or ASICs, and system-on-a-chip, orSOC, solutions.  The DVD, Imaging and DTVsegments also license certain software and other intellectual property.  The DVD group provides products for use inDVD players and recordable DVD players. The Imaging group provides products used in digital copiers, laser andinkjet printers as well as multifunction peripherals.  The Mobile group focuses on solutions formultimedia mobile phone products and digital camera products.  The DTV group provides products for standardand high definition digital television products including televisions, set topboxes 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 lossis as follows for the three months ended March 31, 2005 and 2004 (inthousands):

 
| ** **            | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------|------------|-----------------------------------|------------|
| ** **            | ** ** | **2005**                          | ** ** | **2004** | ** ** |
| Net revenues:         |       |                              |       |   |   |
| DVD                   |       | $                                 | 32,182     |   | $ | 47,223 |   |
| Imaging               |       | 20,908                            |       | 18,188 |   |
| Mobile                |       | 13,002                            |       | 7,855 |   |
| DTV                   |       | 7,792                             |       | 7,371 |   |
|                  |       | $                                 | 73,884     |   | $ | 80,637 |   |
|                  |       |                              |       |   |   |
| Operating  expenses:  |       |                              |       |   |   |
| DVD                   |       | $                                 | 38,696     |   | $ | 48,062 |   |
| Imaging               |       | 14,916                            |       | 10,508 |   |
| Mobile                |       | 14,270                            |       | 7,900 |   |
| DTV                   |       | 12,356                            |       | 12,321 |   |
|                  |       | 80,238                            |       | $ | 78,791 |   |
|                  |       |                              |       |   |   |
| Contribution  margin: |       |                              |       |   |   |
| DVD                   |       | $                                 | (6,514     | ) | $ | (839 | ) |
| Imaging               |       | 5,992                             |       | 7,680 |   |
| Mobile                |       | (1,268                            | )          | (45 | ) |
| DTV                   |       | (4,564                            | )          | (4,950 | ) |
|                  |       | $                                 | (6,354)    |   | $ | 1,846 |   |

 

A reconciliation of the totals reported for theoperating segments to the applicable line items in the consolidated financialstatements for the three months ended March 31, 2005 and 2004 is asfollows (in thousands):

 
| ** **                                   | ** ** | **Three  Months Ended**

**March  31,** | ** ** |
|----------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                   | ** ** | **2005**                                | ** ** | **2004** | ** ** |
| Contribution margin  from operating segments |       | $                                       | (6,354     | ) | $ | 1,846 |   |
| Amortization of  intangibles                 |       | 12,330                                  |       | 10,343 |   |
| Amortization of  deferred stock compensation |       | 517                                     |       | 1,827 |   |
| Total operating  loss                        |       | $                                       | (19,201    | ) | $ | (10,324 | ) |

 

Zoran maintains operations in the United States, Israel,Canada, the United 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.

 

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The distribution of total revenues for the threemonths ended March 31, 2005 and 2004 was as follows (in thousands):

 
| ** **                                                 | ** ** | **Three  Months Ended  March 31,** | ** **     |
|------------------------------------------------------------|------------|------------------------------------|----------------|
| ** **                                                 | ** ** | **2005**                           | ** **     | **2004** | ** ** |
| **Revenue  from unaffiliated customers originating from:** |       |                               |           |   |   |
| China                                                      |       | $                                  |  

27,965 |   | $ |  

28,807 |   |
| Japan                                                      |       | 24,046                             |           | 23,837 |   |
| Korea                                                      |       | 3,910                              |           | 10,438 |   |
| Taiwan                                                     |       | 5,403                              |           | 4,786 |   |
| United States                                              |       | 5,610                              |           | 7,465 |   |
| North America                                              |       | 693                                |           | 1,359 |   |
| Other                                                      |       | 6,257                              |           | 3,945 |   |
|                                                       |       | $                                  |  

73,884 |   | $ |  

80,637 |   |

 

For the three months ended March 31, 2005, one customer accounted for 13%of total revenues.   For the same period of 2004, two customerseach accounted for 11% of total revenues, respectively.

 

As of March 31, 2005, three customers accounted for 24%, 13% and 12% oftotal net accounts receivable, respectively, and as of December 31, 2004, twocustomers accounted for 27% and 13% of total net accounts receivable,respectively.

 

**8.             Acquisitions**

 

**EmblazeSemiconductor 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 ofthe acquisition was to gain high performance, low-power application processors,technology and products for the fast growing multimedia mobile phonemarket.  This technology will be combinedwith Zoran’s image processing technology to deliver reliable, cost-effectivesystem solutions for mobile phone makers.

 

The transaction was accounted for under SFAS No. 141, “BusinessCombinations,” using the purchase method of accounting.  The Company incurred approximately $180,000for acquisition-related expenses consisting of financial advisory, legal andother consulting services.  The Companycompleted a valuation analysis and purchase price allocation with theassistance of a third party appraiser. The results of operations of Emblaze have been included in theconsolidated financial statements from the date of acquisition.  The historical operations of Emblaze are notmaterial to the financial position or results of operations of the Company;therefore, no pro forma information is presented.  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 the purchase 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 assetsacquired resulting in the recognition of goodwill and other intangibleassets.  The amounts allocated to intangible assets includepurchased technology totaling $11.8 million and patents totaling $12.4 millionwhich are being amortized over their estimated useful lives of three years.

 

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**9.             NetLoss Per Share**

 

Basic and diluted net loss per share have been computed using theweighted average number of shares of common stock and dilutive potential sharesfrom stock options and warrants outstanding during the period in accordancewith Statement of Financial Accounting Standards (SFAS) No. 128, “Earnings perShare.”  The following table provides areconciliation of the components of the basic and diluted net loss per sharecomputations (in thousands, except per share data):

 
| ** **                           | ** ** | **Three  Months Ended  March 31,** | ** ** |
|--------------------------------------|------------|------------------------------------|------------|
| ** **                           | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| Net loss from  continuing operations |       | $                                  | (18,796    | ) | $ | (9,985 | ) |
|                                 |       |                               |       |   |   |
| Basic common  shares                 |       | 43,213                             |       | 42,522 |   |
| Effect of  dilutive securities:      |       |                               |       |   |   |
| Common stock  options                |       | —                             |       | — |   |
| Dilutive  weighted average shares    |       | 43,213                             |       | 42,522 |   |
|                                 |       |                               |       |   |   |
| Net loss per  share:                 |       |                               |       |   |   |
| Basic                                |       | $                                  | (0.43      | ) | $ | (0.23 | ) |
| Diluted                              |       | $                                  | (0.43      | ) | $ | (0.23 | ) |

 

Stock options to purchase 13,932,000 sharesof common stock were outstanding during the three months ended March 31, 2005,but were not included in the computation of diluted net loss per share as theCompany had a net loss for the three months ended March 31, 2005.  Stock options to purchase 13,426,000 sharesof common stock were outstanding during the three months ended March 31, 2004,but were not included in the computation of diluted net loss per share as theCompany had a net loss for the three months ended March 31, 2004.

 

**10.          LegalProceedings**

 

We and our Oak subsidiary have initiated two legal actions againstMediaTek, Inc. and customers of MediaTek alleging that products incorporatingcertain MediaTek components infringe three patents co-owned by Zoran and Oakrelating to optical drive controller design and integrated CD/DVD controllerdesign.

 

On March 11, 2004, Zoran and Oak filed a complaint with****the United States International TradeCommission (“ITC”) alleging that certain MediaTek DVD player and optical diskcontroller chips and chipsets, and products in which they are used, infringeZoran’s and Oak’s patents.  In additionto MediaTek, the complaint named 10 other proposed respondents that sellproducts, including DVD players and PC optical storage devices that useMediaTek’s chips and chipsets.  The otherproposed respondents were ASUSTek Computer. Inc., Creative Labs, Inc., Creative Technology, Ltd., Jiangsu ShincoElectronic Group Co., Ltd., LITE-ON Information Technology Corporation, MintekDigital, Shinco International AV Co., Ltd., TEAC Corporation, TEAC America,Inc., Terapin Technology Corporation and Terapin Technology.  The complaint requested that the ITCinstitute an investigation of the accused products and issue exclusion andcease and desist orders prohibiting the importation into the United States ofthe infringing MediaTek devices and products that contain them.  On April 8, 2004, the ITC instituted aninvestigation based on Zoran’s complaint. On April 28, 2004, Zoran and Oak reached a settlement withrespondents Creative Technology, Ltd. and Creative Labs, Inc., and theserespondents were subsequently dismissed from the investigation pursuant to theterms of the settlement agreement.  OnJuly 13, 2004, the ITC granted Zoran’s request that nine additionalrespondents be added to the investigation. These additional respondents are Artronix Technology, ASUS ComputerInternational, Audiovox Corporation, EPO Science and Technology, Inc., InitialTechnology, Inc., Micro-Star International Co., Ltd., MSI Computer Corp.,Shinco Digital Technology Ltd. and Ultima Electronics Corporation.  On October 26, 2004, MediaTek filed amotion for summary determination seeking an order that two of the assertedpatents were invalid.  This motion wasdenied on November 18, 2004.  OnDecember 13, 2004, MediaTek filed another motion for summary determinationseeking a similar order on different grounds. This motion was denied on December 22, 2004.  The hearing took place in February 2005, andthe target date for completion of the investigation is September 14, 2005.

 

On March 15, 2004, Zoran and Oak filed a complaint againstMediaTek and Mintek Digital in the United States District Court, CentralDistrict of California alleging similar facts regarding infringement by MediaTek’schips and chipsets and products in which they are

 

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used.  The lawsuit seeks bothmonetary damages and an injunction to stop the importation and sale ofinfringing products.  Zoran subsequentlyamended the complaint to name ASUSTek Computer, Inc., Jiangsu Shinco ElectronicGroup Co., Ltd., LITE-ON Information Technology Corporation, Mintek Digital,Shinco International AV Co., Ltd., TEAC Corporation, TEAC America, Inc.,Terapin Technology Corporation and Terapin Technology as defendants.  On June 17, 2004, pursuant tostipulation of the parties, the case was transferred to the United StatesDistrict Court, Northern District of California.  On July 2, 2004, 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.  OnJuly 22, 2004, Zoran and Oak moved to dismiss certain of defendants’defenses and counterclaims and, on July 30, 2004, MediaTek filed a motionfor summary judgment as to two of the three patents asserted by Zoran and Oakagainst MediaTek.  On December 9,2004, the Court granted Zoran and Oak’s motion, in part, and dismissed certainof defendant’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.  This motion is nearly identical to the motionfiled by MediaTek on October 26, 2004 in the ITC.  The hearing on this motion was held onDecember 10, 2004.  The Court hasnot ruled on this motion.  OnOctober 29, 2004, Zoran and Oak voluntarily dismissed two of their threeclaims against defendants without prejudice and refiled those two claims as aseparate lawsuit against the defendants. The parties have stipulated, and the Court has agreed, that the newlyfiled action will be consolidated for all purposes with the first filed action,including for purposes of trial and all pre-trial scheduling.  On January 3, 2005, defendants AudiovoxCorporation, Artronix Technology, Inc., ASUS Computer International, Inc.,Initial Technology, Inc., Changzhou Shinco Digital Technology Co., Ltd., EPOScience and Technology Co., Inc., Micro-Star International, Co., Ltd., MSIComputer Corp., Shinco International AV Co. and Ultima Electronics Corp. wereadded to this case by stipulation of the parties.  No trial date has yet been set in theseconsolidated actions.

 

On July 23, 2004, MediaTek filed a complaint with the ITC allegingthat certain Zoran and Oak DVD player and optical disk controller chips andchipsets infringe two MediaTek patents. The complaint requested that the ITC institute an investigation into theaccused products and issue exclusion and cease and desist orders prohibitingimportation into the United States of allegedly infringing chips and productsthat contain them.  On August 26,2004, the ITC instituted an investigation. On September 24, 2004, MediaTek filed a motion to amend thecomplaint to add one additional patent and to name Sunext Technology Co., Ltd.as a respondent.  This motion was grantedon October 7, 2004.  Discovery iscurrently underway.  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.  That motion was deniedon March 4, 2005.  The hearing isscheduled to begin on June 27, 2005 and the target date for completion of theinvestigation is November 15, 2005.

 

Also on July 23, 2004, MediaTek filed a complaint against Zoranand Oak in the United States District Court, District of Delaware alleginginfringement of the same two patents asserted in MediaTek’s ITC complaint andseeking monetary damages and injunctive relief. This action was stayed by order of the court on October 4, 2004.

 

Based upon our preliminary review, we believe we have meritoriousdefenses to the two MediaTek complaints, which we believe were filed inresponse to the proceedings that we have been prosecuting against MediaTek andits customers.  We intend to defend theMediaTek actions vigorously.  However,the litigation is in the preliminary stage, and we cannot predict its outcomewith certainty.  Patent litigation isparticularly complex and can extend for a protracted time, which cansubstantially increase litigation expenses.

 

**11.          SubsequentEvent**

 

On May 8, 2005, we entered into an agreement to acquire OrenSemiconductor, Inc. (“Oren”), a privately-held provider of demodulator ICs forthe global high definition television market. Prior to entering into this agreement, we had made investments in Orenthat currently represent a 17% ownership stake. Under the terms of the agreement, we will acquire the remaining 83% ofOren by means of a merger of Oren with a wholly-owned subsidiary of Zoran, inconsideration for which we will pay an aggregate of $44.6 million to theother stockholders of Oren and to employees holding Oren options, of which$16 million will consist of Zoran Common Stock and the remainder will bepaid in cash. The total imputed value of the transaction, including our 17%stake, will be $53.3 million.  Thetransaction is expected to be completed later in the second quarter of 2005,and is subject to approval by the stockholders of Oren.

 

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

 

*This report includes a number of forward-lookingstatements which reflect the Company’s current views with respect to futureevents and financial performance. These forward-looking statements aresubject to certain risks and uncertainties, including those discussed belowunder the heading “Future Performance and Risk Factors” and in “Item7—Management’s Discussion and Analysis of Financial Condition and Results ofOperations—Future Performance and Risk Factors” included in the**Company’s Annual Report on Form10-K for the year ended December 31, 2003.**In this report, the words “anticipates,” “believes,” “expects,”“intends,” “future” and similar expressions identify forward-lookingstatements. Readers are cautioned not to place undue reliance on these forward-lookingstatements, which speak only as of the date hereof.*

 

**Restatementof Financial Results for Quarters Ended March 31, June 30 and September 30,2004**

 

In connection with the review and evaluationof the effectiveness of our internal control over financial reportingundertaken pursuant to Section 404 of the Sarbanes-Oxley Act of 2002,management discovered that excess stock compensation expenses had beenrecognized during the quarters ended March 31, June 30 and September 30,2004.  The compensation expense was related to options that we had assumedas part of our acquisition of Oak Technology, Inc. in 2003.  Underpurchase accounting, part of the cost relating to the acquisition was attributedto the assumed options and was to be recognized over time as the optionscontinued to vest, based on each option holder’s continued employment withZoran.  If an option holder’s employment terminated before the option wasfully vested, vesting would cease, and we would no longer recognizecompensation expense related to that option.  At the time of theacquisition, a schedule was prepared detailing the terms of each assumedoption; however, the names of the option holders were omitted from the schedulefor reasons of confidentiality.  After the acquisition was completed, wedid not update our personnel or financial records to include the omittedinformation. As a result, the Company improperly recognized deferred stockcompensation expenses relating to options that had been held by former Oakemployees after the vesting of such options had ceased, and did not reversestock based compensation expense recognized in excess of amounts that actuallyvested.

 

To correct this error, we have restated thefinancial results that we previously reported for the quarters ended March 31,June 30 and September 30, 2004.  For information about the effects of therestatement, see Note 1 of this quarterly 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, softwareand platforms for digital television applications that enable the delivery anddisplay of digital video content through a set-top box or television as well asdigital imaging products consisting of semiconductor hardware and software thatenable users to print, scan, process and transmit documents to computerperipherals that perform printing functions. Subsequent to our acquisition of Emblaze on July 8, 2004, we alsoprovide high performance, low-power applicationprocessors, technology and products for the multimedia mobile telephone 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.

 

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 have

 

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fluctuated, and will continue to fluctuate, on a quarterly basis.  In addition, we have historically generated aportion of our total revenues from development contracts, primarily with keycustomers, although development revenue has declined substantially as apercentage of total revenues over the past several years.  These development contracts have provided uswith partial funding for the development of some of our products.  These development contracts provide forlicense and milestone payments which are recorded as development revenue.  We classify all development costs, includingcosts related to these development contracts, as research and developmentexpenses.  We retain ownership of 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.

 

The Company recognizes 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* Software license agreements typically includeobligations to provide maintenance and other support over a fixed term andallows for renewal of maintenance on an annual basis. The Company determinesthat fair value of its maintenance obligations with reference to substantiverenewal rates within the agreement or objective evidence of fair value asrequired under SOP 97-2. Maintenance and support revenue is recognized ratablyover the term of the arrangement.  Inaddition, the Company also receives royalty revenues based on per unitshipments of products embedding our software which is recognized by the Companyupon receipt 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 mostcosts of 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 2004 and 2025, andthe benefits from our subsidiary’s Approved Enterprise status expire at varioustimes beginning in 2004.

 

**Acquisitions**

 

*Emblaze Semiconductor Ltd.*

 

On July 8, 2004, we completed our acquisition of Emblaze SemiconductorLtd.  (“Emblaze”), a wholly-ownedsubsidiary 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 month period ended March 31, 2005 includes Emblaze’s operations,while such operations are not reflected in our results of operations for the sameperiod of the prior year.

 

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*Oak Technology, Inc.*

 

On August 11, 2003, we completed our acquisition of Oak through themerger of Oak with a wholly-owned subsidiary of Zoran.  The acquisition was accounted for under thepurchase method of accounting.

 

Following the completion of the acquisition, the results of operationsof Oak have been included in our consolidated financial statements.  Accordingly, our results of operations for eachof the three month periods ended March 31, 2005 and 2004 includes Oak’soperations.

 

**Segments**

 

Zoran had four reportable segments: Digital Versatile Disc (DVD),Imaging, Digital Camera (DC) and Digital Television (DTV).  Subsequent to the Emblaze acquisition in July2004, the Digital Camera group was combined with the Emblaze Mobile segment andwas renamed the Mobile segment.  Eachsegment’s primary products are based on highly integrated application-specificintegrated circuits, or ASICs, and system-on-a-chip, or SOC, solutions.  The DVD, Imaging and DTV segments alsolicense certain software and other intellectual property.  The DVD group provides products for use inDVD players and recordable DVD players. The Imaging group provides products used in digital copiers, laser andinkjet printers as well as multifunction peripherals.  The Mobile group focuses on solutions formultimedia mobile phone products and digital camera products.  The DTV group provides products for standardand high definition digital television products including televisions, set topboxes and personal video recorders.

 

**Results of Operations**

 

*Revenues*

 

Total revenues decreased 8.3% to $73.9 million for the three monthsended March 31, 2005 compared to $80.6 million for the three months ended March31, 2004.  The decrease in total revenueswas primarily a result of a $15.0 million decrease in the DVD segment which waspartially offset by increases of $5.1 million, $2.7 million and $421,000 in theMobile, Imaging and DTV segments, respectively.  The decrease in DVD segment revenues wasprimarily the result of lower hardware product revenues.  The increase in Mobile segment revenues wereassociated with higher hardware product revenues while the increase in Imagingsegment revenues were due to increased software and other revenues.  Total revenues by segment for the three monthsended March 31, 2005 were 43.6% DVD, 28.3% Imaging, 17.6% Mobile and 10.5% DTV,compared to 58.6% DVD, 22.6% Imaging, 9.7% Mobile and 9.1% DTV for the sameperiod in 2004.  We believe that revenuesfor the DVD segment will increase in the quarter ending June 30, 2005 asprogress is being made in working through the over supply of inventory that hasaffected the worldwide DVD industry.

 

Hardware product revenues for the three months ended March 31, 2005were $59.0 million compared to $68.0 million for the comparable period of theprior year.  Hardware product revenues decreasedby $9.0 million, or 13.3%, primarily due to the decrease in hardware productrevenues for the DVD segment.  The DVDsegment hardware product revenues decreased $13.3 million from $45.4 millionrecorded during the three months ended March 31, 2004 to $32.1 million recordedin the same period of this year primarily due to decreased unit shipments.Partially offsetting the decrease in DVD hardware product revenues was anincrease of $4.6 million in hardware product revenues for the Mobile segmentdue to an increase in unit shipments.  Hardwareproduct revenues by segment for the three months ended March 31, 2005 were 54.4%DVD, 21.1% Mobile, 13.8% Imaging, and 10.7% DTV, compared to 66.7% DVD, 11.5%Mobile, 11.5% Imaging, and 10.3% DTV for the same period in 2004.

 

Software and other revenues were $14.9 million and $12.6 million forthe three months ended March 31, 2005 and 2004, respectively.  The increase was primarily due to increasedrevenues in the Imaging segment in which software and other revenues increasedfrom $10.4 million for the three months ended March 31, 2004 to $12.8 millionfor the same period of 2005.  Theincrease in the Imaging segment software and other revenues was mainly due toincrease royalty revenues.

 

*Cost of Hardware Product Revenues*

 

Cost of hardware product revenues was $37.0 million for the quarterended March 31, 2005 compared to $45.3 million for the same period of2004.  The decrease in costs wasprimarily a result of the decrease in corresponding hardware product revenuesduring the period.  As a percentage ofhardware product revenues, hardware product costs decreased from 66.6% for thethree months ended March 31, 2004 to 62.6% for the three months ended March 31,2005.  The decrease in hardware productcosts as a percentage of hardware product revenue was due to product mix as revenuesfrom the lower margin DVD segment, which has a higher percentage of hardwareproduct costs relative to its hardware product revenue, represented a smallerproportion of total hardware product revenue.

 

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*Research and Development*

 

Research and development (“R&D”) expenses were $20.1 million forthe three months ended March 31, 2005, compared to $18.6 million for the sameperiod of 2004.  This increase wasprimarily a result of the inclusion of the Emblaze operations as well ascontinued investments in research and development across all of oursegments.  R&D expenses were 27.2% oftotal revenues for the three month period ended March 31, 2005, compared to 23.1%for the same period of 2004.  This increaseis a result of the lower revenues recorded during the three month period endedMarch 31, 2005 compared to the same period of the prior year.

 

*Selling, General and Administrative*

 

Selling, general and administrative (“SG&A”) expenses were $23.2million for the three months ended March 31, 2005 compared to $14.8 million forthe same period of 2004.  This increasewas primarily a result of the inclusion of the Emblaze operations, increasedlegal fees related to our pending patent litigation with Mediatek, Inc.,continued costs of compliance with provisions of the Sarbanes-Oxley Act of 2002and continued increases in marketing and field application support expenses tosupport revenue growth in our Asia Pacific markets.  SG&A expenses were 31.4% of totalrevenues for the three months ended March 31, 2005 compared to 18.4% of totalrevenues for the three months ended March 31, 2004.

 

*Amortization of Intangible Assets*

 

During the three months ended March 31, 2005, we incurred charges of$12.3 million related to the amortization of intangible assets compared to$10.3 million for the three months ended March 31, 2004.  This increase was a result of the addition of$24.2 million of amortizable intangible assets acquired in the Emblazeacquisition in July 2004.  At March 31, 2005, we had approximately $156.4million in net acquired intangible assets which we will continue to amortize ona straight line basis through 2008.

 

*Amortization of Deferred Stock Compensation*

 

For the three months ended March 31, 2005, we incurred charges of $517,000related to the amortization of deferred stock compensation compared to $1.8 millionduring the same period of the prior year. This deferred stock compensation expense was recorded primarily as aresult of stock options granted in connection with the Oak acquisition.  Thedecrease in expense was due to the cancellation of options held by employeeswho terminated their employment during the year and the lower amortization associatedwith the graded vesting under the FIN 28 model.  As of March 31, 2005, theCompany has a remaining deferred stock compensation balance of $2.0 millionwhich will continue to be amortized through the quarter ending September 30,2007.

 

*Interest and Other Income*

 

Interest and other income was $405,000 for the three month period endedMarch 31, 2005, compared to $725,000 for the same period of 2004.  This decrease was primarily due to translationlosses recorded as a result of the decline in the United States dollar relativeto the currency of other countries in which we operate.

 

*Provision for Income Taxes*

 

The Company has not recorded a tax provision or benefit for the quarterended March 31, 2005.  The Company believes that reasonable uncertainlyexists regarding future results such that no benefit has been recorded for thelosses during the quarter.  The Company will continue to reassess thisposition in subsequent quarters during 2005.  The Company has determinedthat it is more likely than not the deferred tax assets will not be realizeddue to the uncertainty of future profit and as such, the Company continues tocarry a full valuation allowance as of March 31, 2005.  We will continueto evaluate our tax position commensurate with the jurisdictional distributionof profits between the U.S. and Israel and the underlying tax positions as aresult of the tax holiday in Israel.

 

**Liquidity and Capital Resources**

 

At March 31, 2005, we had $31.0 million of cash and cash equivalents,$50.3 million of short-term investments and $119.8 million of working capital.  In addition, we had $37.2 million ofinvestments in long-term marketable securities which are included in otherassets and investments on our consolidated balance sheet.

 

Net cash used in operating activities during the first three months of2005 was $3.9 million.  While we recordeda net loss of $18.8 million, this loss included non-cash for depreciation ofproperty and equipment of $3.1 million, amortization of intangible assets of $12.3million and amortization of deferred stock compensation of $517,000.  Additional cash used in operating activitieswas a result of the changes in current assets and liabilities totaling $1.0million.

 

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

 

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

 

Net cash provided by operating activities during the first three monthsof 2004 was $7.5 million.  While werecorded a net loss of $10.0 million, this loss included non-cash charges for depreciationof property and equipment of $2.5 million, amortization of intangible asset of$10.3 million and amortization of deferred stock compensation of $1.8 million.  Additional cash from operating activities wasprovided by a $4.6 million increase in accounts payable, partially offset by a$1.2 million increase in inventory.

 

Cash provided by investing activities was $8.0 million during the threemonths ended March 31, 2004, reflecting the net sale of investments of $9.9million offset by the purchase of $1.9 million of property and equipment.

 

Cash provided by financing activities was $2.1 million during the threemonths ended March 31, 2004 attributable to the issuance of common stock duringthe period.

 

At March 31, 2005, we did not have anyrelationships with unconsolidated entities or financial partnerships, such asentities often referred to as structured finance or special purpose entities,established for the purpose of facilitating off-balance sheet arrangements orother contractually 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 future capital requirements may vary materially from those now planned andwill depend on many factors including, but not limited to:

 

•                                          the levels at which we maintain inventoryand accounts receivable;

 

•                                          the market acceptance of our products;

 

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

 

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

 

•                                          volume pricing concessions;

 

•                                          capital improvements to new and existingfacilities;

 

•                                          technological advances;

 

•                                          the response of competitors to ourproducts; and

 

•                                          our relationships with our suppliers andcustomers.

 

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

 

To the extent that our existing resources and cash generated fromoperations are insufficient to fund our future activities, we may need to raiseadditional funds 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 atall.  If we are unable to obtain thisadditional financing, we may be required to reduce the scope of our plannedproduct development and sales and marketing efforts, which could harm ourbusiness, financial condition and operating results.

 

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**FuturePerformance and Risk Factors**

 

Our future business, operating results andfinancial condition are subject to various risks and uncertainties, includingthose described below.

 

**Our quarterly revenues and operatingresults fluctuate due to a variety of factors, which may result in volatilityor a decline in the prices of our stock.**

 

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

 

•                                          fluctuation in demand for our products;

 

•                                          the timing of new product introductionsor enhancements by us and our competitors;

 

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

 

•                                          the timing or cancellation of largecustomer orders;

 

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

 

•                                          pricing policy changes by us and by ourcompetitors and suppliers;

 

•                                          the cyclical nature of the semiconductorindustry;

 

•                                          the availability of development fundingand the timing of development revenue;

 

•                                          changes in the mix of products sold;

 

•                                          seasonality in demand for our products;

 

•                                          increased competition in product lines,and competitive pricing pressures; and

 

•                                          the evolving and unpredictable nature ofthe markets for products incorporating our integrated circuits and embeddedsoftware.

 

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

 

•                                          the cost and availability of adequatefoundry capacity;

 

•                                          fluctuations in manufacturing yields;

 

•                                          changes in or the emergence of newindustry standards;

 

•                                          failure to anticipate changing customerproduct requirements;

 

•                                          the loss or gain of important customers;

 

•                                          product obsolescence; and

 

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

 

Our operating results could also be harmed by:

 

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

 

•                                          terrorism and international conflicts orother crises, such as the outbreak of Severe Acute Respiratory Syndrome, orSARS, several years ago;

 

•                                          other conditions affecting the timing ofcustomer orders;

 

•                                          changes in governmental regulations thatcould affect our products; or

 

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

 

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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.

 

**Our customers experience fluctuatingproduct cycles 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 selling prices.  In some cases, these downturns have lastedmore than one year.  A downturn in thesemiconductor industry could harm our sales and revenues if demand drops, orour gross margins if average selling prices decline.

 

**Our success for the foreseeablefuture will be dependent on growth in demand for integrated circuits for alimited number of 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.  The future financial performance of theformer Oak operations will depend on our ability to successfully develop andmarket new products in the digital television, HDTV and digital imagingmarkets.  If the markets for theseproducts and applications decline or fail to develop as expected, or we are notsuccessful in our efforts to market and sell our products to manufacturers whoincorporate integrated circuits into these products, our financial results willbe harmed.

 

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**Our financial performance is highlydependent on the timely and successful introduction of new and enhancedproducts.**

 

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.

 

**We must keep pace with rapidtechnological changes 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 integrated circuitsand other hardware products, and the failure of any of these third parties todeliver 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 own design.  From time to time, there are manufacturingcapacity 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:

 

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•                                          the inability to obtain adequatemanufacturing capacity;

 

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

 

•                                          lack of control over delivery schedules;

 

•                                          lack of control over quality assurance;

 

•                                          lack of control over manufacturing yieldsand cost; and

 

•                                          potential misappropriation of ourintellectual 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 assembly or testing could lead to supplyconstraints or delays in the delivery of our products.  These constraints or delays could damage ourrelationships with current and prospective customers and harm our financialresults.

 

**Because foundry capacity is limitedfrom time to time, we may be required to enter into costly long-term supplyarrangements to 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:

 

•                                          option payments or other prepayments to afoundry;

 

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

 

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

 

•                                          issuance of our equity securities to afoundry;

 

•                                          investment in a foundry;

 

•                                          joint ventures; or

 

•                                          other partnership relationships withfoundries.

 

We may not be able to 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.

 

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**If our independent foundries do notachieve satisfactory yields, our relationships with our customers may beharmed.**

 

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 potentialcompetition from companies with greater resources than ours, and if we areunable to compete effectively with these companies, our market share maydecline and our business 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.

 

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 OEMcustomers.  If we or our OEM customersare unable to compete successfully against current and future competitors, wecould experience price reductions, order cancellations and reduced grossmargins, any one of which could harm our business.

 

**Our products are characterized byaverage selling prices that decline over relatively short time periods; if weare unable 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 fromsales to a small number of large customers, and if we are not able to retainthese customers, or they reschedule, reduce or cancel orders, our revenueswould be reduced 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

 

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fluctuate significantly from quarter to quarter.  We may not be able to retain our keycustomers, or these customers may cancel purchase orders or reschedule ordecrease their level of purchases from us. Any substantial decrease or delay in sales to one or more of our keycustomers could harm our sales and financial results.  In addition, any difficulty in collectingamounts due from one or more key customers could harm our financial results.

 

**Our products generally have longsales cycles and implementation periods, which increases our costs in obtainingorders and reduces 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-termcontracts with 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 currentcustomers will continue to place orders, whether existing orders will becanceled, or whether customers who have ordered products will pay invoices fordelivered products.  When we do enterinto a long-term contract, the contract is generally terminable at theconvenience of the customer.  In theevent of an early termination by one of our major customers, it is unlikelythat we will be able to rapidly replace that revenue source, which would harmour financial results.

 

**Regulation of our customers’ productsmay slow the process of introducing new products and could impair our abilityto compete.**

 

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 the industriesin 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 sell internationally.  Changes in current laws or regulations or theimposition of new laws or regulations in the United States or elsewhere couldharm our business.  For example, any delaysby the FCC in imposing its pending requirement that all new televisions have adigital receiver could have an adverse effect on our HDTV business.

 

**We are dependent upon ourinternational sales and operations; economic, political or military events in acountry where we make significant sales or have significant operations couldinterfere with our success 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:

 

•                                          unexpected changes in regulatoryrequirements;

 

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•                                          fluctuations in exchange rates;

 

•                                          political and economic instability;

 

•                                          imposition of tariffs and other barriersand restrictions;

 

•                                          the burdens of complying with a varietyof foreign laws; and

 

•                                          health risks 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 for significantperiods during the work week may cause us to operate inefficiently during theseperiods.

 

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 operatingresults could 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 regions of theworld including locations where we maintain operations and by armed conflict inthe Middle East and related economic instability.  Our operations could be harmed due to:

 

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

 

•                                          reduced demand for consumer electronicproducts due to a potential economic slowdown;

 

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

 

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

 

**The prices of our products may becomeless competitive due to foreign exchange fluctuations.**

 

Foreign currency fluctuations may affect the prices of our products.  Prices for our products are currentlydenominated in U.S. dollars for sales to our customers throughout theworld.  If there is a significantdevaluation of the currency in a specific country, the prices of our productswill increase relative to that country’s currency, 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 bejeopardized if 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 toprotect our proprietary rights.  Theseagreements and measures may not be sufficient to protect our technology fromthird-party infringement, or to protect us from the claims of others.  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.

 

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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 our technology.  Moreover, while we hold, or have applied for,patents relating to the design of our products, some of our products are basedin part on standards, for which we do not hold patents or other intellectualproperty 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 description languagesoftware and drivers for the digital office market and in limited circumstanceswith respect to firmware and platforms for its HDTV products, Oak has grantedlicenses that give its customers access to and restricted use of the sourcecode of Oak’s software.  This accessincreases the likelihood of misappropriation or misuse of our technology.

 

**We are involved in several lawsuits.**

 

Zoran and Oak are parties to various legalproceedings, including a number of patent-related lawsuits, both as plaintiffand defendant.  In connection with theselawsuits, substantial management time has been, and will continue to be,expended.  In addition, both Oak andZoran have incurred, and we expect to continue to incur, substantial legal andother expenses in connection with these pending lawsuits.  No provision for any liability that mayresult upon adjudication of these lawsuits has been made in our financial statements.

 

**Claims and litigation regardingintellectual property rights could seriously harm our business and require usto incur significant 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, if successful,could subject us to significant liability for damages or invalidation of ourproprietary rights.  These lawsuits,regardless of their success, are time-consuming and expensive to resolve andwould management time and attention. Pending or future intellectual property litigation could force us to doone or more of the following:

 

•                                          stop selling products that incorporatethe challenged intellectual property;

 

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

 

•                                          pay damages; or

 

•                                          redesign those products that use suchtechnology.

 

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.

 

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**If we are not able to apply our netoperating losses against taxable income in future periods, our financialresults will be harmed.**

 

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 reporting purposesas of December 31, 2004.  As aresult of the change of control resulting from our initial public offering in1995, the amount of NOLs that we can use to reduce future taxable income forfederal tax purposes is limited to approximately $3.0 million peryear.  The Internal Revenue Code containsa number of provisions that could limit the use of NOLs against income of thecombined company as a result of the merger or as a result of the combination ofthese transactions.  Our utilization ofOak’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 makecould disrupt 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:

 

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

 

•                                          incur debt;

 

•                                          assume liabilities;

 

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

 

•                                          incur other large write-offs immediatelyor in the future.

 

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

 

•                                          problems combining the purchasedoperations, technologies or products;

 

•                                          unanticipated costs;

 

•                                          diversion of management’s attention fromour core business;

 

•                                          adverse effects on existing businessrelationships with customers;

 

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

 

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

 

We may not be able 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,which could 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, divert theattention of our engineering personnel from our product development efforts andharm 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,

 

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integration issues or other performance problems in our products couldresult in financial or other damages to customers or could damage marketacceptance of such products.  Our customerscould also seek damages from us for their losses.  A product liability claim brought against us,even if unsuccessful, would likely be time consuming and costly to defend.

 

**If we do not maintain currentdevelopment contracts or are unable to enter into new development contracts,our business could be harmed.**

 

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 toexecute our business plan, and if we are unable to obtain such funds, we willnot be able to 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:

 

•                                          acceptance of and demand for ourproducts;

 

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

 

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

 

•                                          any additional acquisitions that we maymake.

 

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

 

**If we fail to manage our futuregrowth, if any, our business would be harmed.**

 

We anticipate that our future growth, if any, will require us to recruitand 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 and controls.  Many of our key operations, including amaterial portion of our research and development operations and a significantportion of our sales and administrative operations are located in Israel.  A majority of our sales and marketing andcertain of our research and development and administrative personnel, includingour President and Chief Executive Officer and other officers, are based in theUnited States.  The geographic separationof these operations places additional strain on our resources and our abilityto manage growth effectively.  If we areunable to manage growth effectively, our business will be harmed.

 

**We rely on the services of ourexecutive officers and other key personnel, whose knowledge of our business andindustry would 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.

 

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**The Israeli rate of inflation maynegatively impact our costs if it exceeds the rate of devaluation of the newIsraeli shekel 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 and developmentactivities with grants for research and development from the Chief Scientist inIsrael’s Ministry of Industry and Trade. We earned proceeds from such grants in 2003 and 2004 and we plan to seekadditional grants from the Chief Scientist in the future.  To be eligible for these grants, ourdevelopment projects must be approved by the Chief Scientist on a case-by-casebasis.  If our development projects arenot approved by the Chief Scientist, we will not receive grants to fund theseprojects, which would increase our research and development costs.  We also receive tax benefits, in particularexemptions and reductions as a result of the “Approved Enterprise” status ofour existing operations in Israel.  To beeligible for these tax benefits, we must maintain our Approved Enterprisestatus by meeting conditions, including making specified investments in fixedassets located in Israel and investing additional equity in our Israelisubsidiary.  If we fail to meet theseconditions in the future, the tax benefits would be canceled and we could berequired to refund the tax benefits already received.  These tax benefits 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 documentsand Delaware 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:

 

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

 

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

 

•                                          eliminating stockholders’ rights to calla special meeting of stockholders; and

 

•                                          requiring advance notice of anystockholder nominations of candidates for election to our board of directors.

 

**Our stock price has fluctuated andmay continue to fluctuate widely.**

 

The market price of our common stock has fluctuated significantly sinceour initial public offering in 1995. Between January 1, 2004 and March 31, 2005, the closing sale priceof our common stock, as reported on The Nasdaq National Market, ranged from alow of $9.63 to a high of $22.20.  Themarket price of our common stock is subject to significant fluctuations in thefuture in response to a variety of factors, including:

 

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

 

•                                          quarterly variations in operatingresults;

 

•                                          changes in analysts’ earnings estimates;

 

•                                          announcements of technologicalinnovations;

 

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

 

•                                          loss of key personnel;

 

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•                                          proprietary rights or other litigation;

 

•                                          general conditions in the semiconductorindustry; and

 

•                                          developments in 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 and Qualitative Disclosures About Market Risk**

 

We are exposed to financial market risks includingchanges in interest rates and foreign currency exchange rates.

 

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

 

A majority of our revenue and capital spending istransacted in U.S. dollars, although a portion of the cost of our operations,relating mainly to our personnel and facilities in Israel, is incurred in NewIsraeli Shekels.  As a result, we bear the risk that therate of inflation in Israel will exceed the rate of devaluation of the newIsraeli shekel in relation to the United States dollar, which will increase ourcosts as expressed in United States dollars. We have not engaged in hedgingtransactions to reduce our exposure to fluctuations that may arise from changesin foreign exchange rates.  Based on ouroverall currency rate exposure at March 31, 2005, a near-term 10%appreciation or depreciation of the New Israeli Shekel would have an immaterialaffect on our financial condition.

 

**Item 4.    Controlsand Procedures**

 

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

 

***Internal Controls Over FinancialReporting****.*  There has been no change in our internalcontrol over financial reporting during the quarter ended March 31, 2005 thathas materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

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**PART II. OTHER INFORMATION**

 

**Item 1.    Legal Proceedings**

 

We and our Oak subsidiary have initiated two legal actions againstMediaTek, Inc. and customers of MediaTek alleging that products incorporatingcertain MediaTek components infringe three patents co-owned by Zoran and Oakrelating to optical drive controller design and integrated CD/DVD controllerdesign.

 

On March 11, 2004, Zoran and Oak filed a complaint with****the United States International TradeCommission (“ITC”) alleging that certain MediaTek DVD player and optical diskcontroller chips and chipsets, and products in which they are used, infringeZoran’s and Oak’s patents.  In additionto MediaTek, the complaint named 10 other proposed respondents that sellproducts, including DVD players and PC optical storage devices that useMediaTek’s chips and chipsets.  The otherproposed respondents were ASUSTek Computer. Inc., Creative Labs, Inc., Creative Technology, Ltd., Jiangsu ShincoElectronic Group Co., Ltd., LITE-ON Information Technology Corporation, MintekDigital, Shinco International AV Co., Ltd., TEAC Corporation, TEAC America,Inc., Terapin Technology Corporation and Terapin Technology.  The complaint requested that the ITCinstitute an investigation of the accused products and issue exclusion andcease and desist orders prohibiting the importation into the United States ofthe infringing MediaTek devices and products that contain them.  On April 8, 2004, the ITC instituted aninvestigation based on Zoran’s complaint. On April 28, 2004, Zoran and Oak reached a settlement withrespondents Creative Technology, Ltd. and Creative Labs, Inc., and theserespondents were subsequently dismissed from the investigation pursuant to theterms of the settlement agreement.  OnJuly 13, 2004, the ITC granted Zoran’s request that nine additionalrespondents be added to the investigation. These additional respondents are Artronix Technology, ASUS ComputerInternational, Audiovox Corporation, EPO Science and Technology, Inc., InitialTechnology, Inc., Micro-Star International Co., Ltd., MSI Computer Corp.,Shinco Digital Technology Ltd. and Ultima Electronics Corporation.  On October 26, 2004, MediaTek filed amotion for summary determination seeking an order that two of the assertedpatents were invalid.  This motion wasdenied on November 18, 2004.  OnDecember 13, 2004, MediaTek filed another motion for summary determinationseeking a similar order on different grounds. This motion was denied on December 22, 2004.  The hearing took place in February 2005, andthe target date for completion of the investigation is September 14, 2005.

 

On March 15, 2004, Zoran and Oak filed a complaint againstMediaTek and Mintek Digital in the United States District Court, CentralDistrict of California alleging similar facts regarding infringement byMediaTek’s chips and chipsets and products in which they are used.  The lawsuit seeks both monetary damages andan injunction to stop the importation and sale of infringing products.  Zoran subsequently amended the complaint toname ASUSTek Computer, Inc., Jiangsu Shinco Electronic Group Co., Ltd., LITE-ONInformation Technology Corporation, Mintek Digital, Shinco International AVCo., Ltd., TEAC Corporation, TEAC America, Inc., Terapin Technology Corporationand Terapin Technology as defendants.  OnJune 17, 2004, pursuant to stipulation of the parties, the case wastransferred to the United States District Court, Northern District ofCalifornia.  On July 2, 2004,Defendants filed a First Amended Answer which included counterclaims fordeclaration of noninfringement, declaration of invalidity, declaration ofunenforceability, breach of covenant not to sue, breach of covenant of goodfaith and fair dealing and unfair competition. On July 22, 2004, Zoran and Oak moved to dismiss certain ofdefendants’ defenses and counterclaims and, on July 30, 2004, MediaTekfiled a motion for summary judgment as to two of the three patents asserted byZoran and Oak against MediaTek.  OnDecember 9, 2004, the Court granted Zoran and Oak’s motion, in part, anddismissed certain of defendant’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.  This motion is nearly identical to the motionfiled by MediaTek on October 26, 2004 in the ITC.  The hearing on this motion was held onDecember 10, 2004.  The Court hasnot ruled on this motion.  OnOctober 29, 2004, Zoran and Oak voluntarily dismissed two of their threeclaims against defendants without prejudice and refiled those two claims as aseparate lawsuit against the defendants. The parties have stipulated, and the Court has agreed, that the newlyfiled action will be consolidated for all purposes with the first filed action,including for purposes of trial and all pre-trial scheduling.  On January 3, 2005, defendants AudiovoxCorporation, Artronix Technology, Inc., ASUS Computer International, Inc.,Initial Technology, Inc., Changzhou Shinco Digital Technology Co., Ltd., EPOScience and Technology Co., Inc., Micro-Star International, Co., Ltd., MSIComputer Corp., Shinco International AV Co. and Ultima Electronics Corp. wereadded to this case by stipulation of the parties.  No trial date has yet been set in theseconsolidated actions.

 

On July 23, 2004, MediaTek filed a complaint with the ITC allegingthat certain Zoran and Oak DVD player and optical disk controller chips andchipsets infringe two MediaTek patents. The complaint requested that the ITC institute an investigation into theaccused products and issue exclusion and cease and desist orders prohibitingimportation into the United States of allegedly infringing chips and productsthat contain them.  On August 26,2004, the ITC instituted an investigation. On September 24, 2004, MediaTek filed a motion to amend thecomplaint to add one additional patent and to name Sunext Technology Co., Ltd.as a respondent.  This motion was grantedon October 7, 2004.  Discovery iscurrently underway.  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.

 

 

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That motion was denied on March 4, 2005.  The hearing is scheduled to begin on June 27,2005 and the target date for completion of the investigation is November 15,2005.

 

Also on July 23, 2004, MediaTek filed a complaint against Zoranand Oak in the United States District Court, District of Delaware alleginginfringement of the same two patents asserted in MediaTek’s ITC complaint andseeking monetary damages and injunctive relief. This action was stayed by order of the court on October 4, 2004.

 

Based upon our preliminary review, we believe we have meritoriousdefenses to the two MediaTek complaints, which we believe were filed inresponse to the proceedings that we have been prosecuting against MediaTek andits customers.  We intend to defend theMediaTek actions vigorously.  However,the litigation is in the preliminary stage, and we cannot predict its outcomewith certainty.  Patent litigation isparticularly complex and can extend for a protracted time, which cansubstantially increase litigation expenses.

 

**Item 6.    Exhibits**

 
| 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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**SIGNATURES**

 

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

 

 
| ** **         | **ZORAN CORPORATION**                                                                                     |
|--------------------|-----------------------------------------------------------------------------------------------------------|
|               |                                                                                                      |
|               |                                                                                                      |
| Date: May 10, 2005 | /s/ Karl Schneider                                                                                        |   |
|               | Karl Schneider                                                                                            |
|               | Senior Vice President, Finance  and Chief Financial Officer  (Principal Financial and Accounting Officer) |

 

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