**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C.  20549**

 

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**FORM 10-K**

 

| **ý** | ** ** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**                                                                                                        |
|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                       |
| ** ** | ** ** | **For The Fiscal Year Ended December 31,  2004**                                                                                                                                            |
| ** ** | ** ** | ** **                                                                                                                                                                                       |
| ** ** | ** ** | **Or**                                                                                                                                                                                           |
| ** ** | ** ** | ** **                                                                                                                                                                                       |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**                                                                                                    |
| ** ** | ** ** | ** **                                                                                                                                                                                       |
| ** ** | ** ** | **For the transition period from             to             ** |

 

**Commission File Number: 0-27246**

 

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**ZORAN CORPORATION**

(Exact Name of registrant as specified in itscharter)

 
| **Delaware**                                                                      |       | **94-2794449**                           |
|-----------------------------------------------------------------------------------|------------|------------------------------------------|
| (State or other jurisdiction of  incorporation or organization)                   |       | (I.R.S. Employer  Identification No.)    |
|                                                                              |       |                                     |
| **1390 Kifer Road, Sunnyvale, California**                                        |       | **94086**                                |
| (Address of principal executive offices)                                          | ** ** | (Zip Code)                               |
|                                                                              |       |                                     |
| Registrant’s telephone number, including  area code: **(408) 523-6500** |
|                                                                              |       |                                     |
| Securities registered pursuant to  Section 12(b) of the Act: **None**        |
|                                                                              |       |                                     |
| Securities registered pursuant to  Section 12(g) of the Act:                 |
|                                                                              |
| **Title of each class**                                                           | ** ** | **Name of Exchange on which registered** |
| None                                                                              |       | None                                     |
|                                                                              |       |                                     |
| Securities registered pursuant to  Section 12(g) of the Act:                 |
| **Common Stock, $.001 par value**                                                 |
| (Title of Class)                                                                  |

 

Indicate by check mark whether registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the Securities Actof 1934 during the preceding 12 months (or for such shorter period thatthe registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  Yes ý  No o

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not becontained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of thisForm 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether registrant is an accelerated filer (asdefined by Rule 12b-2 of the Act).  Yes ý  No o

 

The aggregate market value of registrant’s voting stock held bynon-affiliates of registrant based upon the closing sale price of the CommonStock on June 30, 2004, as reported on the Nasdaq National Market, wasapproximately $783,000,000.  Shares ofCommon Stock held by each officer, director and holder of 10% or more of theoutstanding Common Stock have been excluded in that such persons may be deemedto be affiliates.  This determination ofaffiliate status is not necessarily a conclusive determination for otherpurposes.

 

Outstanding shares of registrant’s Common Stock, $0.001 par value, asof March 29, 2005: 43,243,810

 

DOCUMENTS INCORPORATED BY REFERENCE

Parts of the definitive proxy statement for registrant’s 2004 AnnualMeeting of Stockholders to be filed with the Commission pursuant toRegulation 14A not later than 120 days after the end of the fiscalyear covered by this Report are incorporated by reference into Part III ofthis Report.

 

 

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**ZORAN CORPORATION**

**INDEX TO**

**ANNUAL REPORT ON FORM 10-K**

**FOR YEAR ENDED DECEMBER 31, 2004**

** **
| **PART I**   |
|--------------|
| Item 1.      | Business |   |
| Item 2.      | Properties |   |
| Item 3.      | Legal Proceedings |   |
| Item 4.      | Submission of Matters to a Vote of Security  Holders |   |
| **PART II**  |
| Item 5.      | Market for Registrant’s Common Equity,  Related Stockholder Matters and Issuer Purchases of Equity Securities |   |
| Item 6.      | Selected Financial Data |   |
| Item 7.      | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |   |
| Item 7A.     | Quantitative and Qualitative Disclosures  About Market Risk |   |
| Item 8.      | Financial Statements and Supplementary Data |   |
| Item 9.      | Changes in and Disagreements with  Accountants on Accounting and Financial Disclosure |   |
| Item 9A.     | Controls and Procedures |   |
| **PART III** |
| Item 10.     | Directors and Executive Officers of the  Registrant |   |
| Item 11.     | Executive Compensation |   |
| Item 12.     | Security Ownership of Certain Beneficial  Owners and Management and Related Stockholder Matters |   |
| Item 13.     | Certain Relationships and Related  Transactions |   |
| Item 14.     | Principal Accountant Fees and Services |   |
| **PART IV**  |
| Item 15.     | Exhibits and Financial Statement Schedules |   |
| Signatures   |   |   |

 

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**PART I**

 

***This report includesa number of forward-looking statements which reflect the Company’s currentviews with respect to future events and financial performance.  These forward-looking statements are subjectto certain risks and uncertainties, including those discussed in “Item7—Management’s Discussion and Analysis of Financial Condition and Results ofOperations—Future Performance and Risk Factors” and elsewhere in this report,that could cause actual results to differ materially from historical results orthose currently anticipated.  In thisreport, the words “anticipates,” “believes,” “expects,” “intends,” “future” andsimilar expressions identify forward-looking statements.  Readers are cautioned not to place unduereliance on these forward-looking statements, which speak only as of the datehereof.***

 

**Item1—Business**

 

**Restatement of Financial Results for Quarters EndedMarch 31, June 30 and September 30, 2004**

 

In connection with the review and evaluation of the effectiveness ofour internal control over financial reporting undertaken pursuant to Section404 of the Sarbanes-Oxley Act of 2002, management discovered that excess stockcompensation expenses had been recognized during the quarters ended March 31,June 30 and September 30, 2004.  Thecompensation expense was related to options that we had assumed as part of ouracquisition of Oak Technology, Inc. in 2003. Under purchase accounting, part of the cost relating to the acquisitionwas attributed to the assumed options and was to be recognized over time as theoptions continued to vest, based on each option holder’s continued employmentwith Zoran.  If an option holder’semployment terminated before the option was fully vested, vesting would cease,and we would no longer recognize compensation expense related to thatoption.  At the time of the acquisition,a schedule was prepared detailing the terms of each assumed option; however,the names of the option holders were omitted from the schedule for reasons ofconfidentiality.  After the acquisitionwas completed, we did not update our personnel or financial records to includethe omitted information. As a result, the Company improperly recognizeddeferred stock compensation expenses relating to options that had been held byformer Oak employees after the vesting of such options had ceased, and did notreverse stock based compensation expense recognized in excess of amounts thatactually vested.

 

To correct this error, we have restated the financial results that wepreviously reported for the quarters ended March 31, June 30 and September 30,2004.  For information about the effectsof the restatement, see Selected Quarterly Financial Information included in Item8 of this annual report. The effect of the error on periods in 2003 was notmaterial, and therefore, no adjustment was made for such periods.  The financial information included in Form10-Q and Form 8-K reports previously filed or furnished by Zoran for theseperiods should not be relied upon and are superceded by the information in thisForm 10-K.

 

**Company Overview**

 

We develop and marketintegrated circuits, or ICs, integrated circuit cores and embedded softwareused by original equipment manufacturers, or OEMs, in digital video and audioproducts for commercial and consumer markets. We also provide complete, copy-ready system reference designs based onour technology that help our customers produce commercial and consumer productsmore quickly and cost-effectively.  Ourintegrated circuits are used in a variety of products, including digitalversatile disc, or DVD, players and recorders, and digital cameras.  As a result of our acquisition of OakTechnology, Inc., or Oak, in August 2003, we also offer integratedcircuits and related software used in digital televisions (DTVs), and set-topboxes and in multi-function digital print devices.  Subsequent to our acquisition ofEmblaze Semiconductor Ltd. in July 2004, we also provide highperformance, low-power application processors, technology and products for themultimedia mobile telephone market.

 

We were incorporated in California in December 1981 andreincorporated in Delaware in November 1996.  Our corporate headquarters are located at1390 Kifer Road, Sunnyvale, California 94086, and our telephone number is(408) 523-6500.  Our website can befound at *www.zoran.com*.  Our annual reports on Form 10-K,quarterly reports on Form 10-Q, current reports on Forms 8-K, and anyamendments to those reports, are available free of charge on our website under “InvestorRelations / SEC Documents” as soon as reasonably practicable after they arefiled with the Securities and Exchange Commission.

 

**Industry Background**

 

Until the mid-1990s, video images and audio soundtracks weretransmitted, edited and stored almost exclusively using analog formats.  Since then, however, advances in technologyhave allowed audio and video to be processed and stored in digital form.  Unlike analog formats, which are inherentlyunstable and difficult to edit and enhance, digital formats permit themanipulation of audio and video signals through digital signal processing andoffer a number of fundamental advantages over analog technologies.  Through complex digital signal processingoperations, digital audio and video signals may be compressed, providingsignificant storage and transmission efficiencies.  They also may be filtered, allowing for noisereduction, and they may be transmitted and reproduced without perceptible imageor sound

 

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degradation.  Digital formatsprovide users with additional benefits, including random access to data,superior editing capabilities and enhanced security features such as protectionagainst unauthorized copying and controlled and secure access.

 

One of the most significant barriers to the widespread adoption ofdigital technology had been the huge amount of data required to representimages and sounds in a digital format, making cost-effective storage or transmissionimpractical.  Through digital compressiontechniques, a substantial number of the redundancies inherent in audio andvideo data can be identified and eliminated, significantly reducing the overallamount of data which needs to be retained. Compression techniques introduced in the early 1990s allowed a two-hourmovie to be compressed and stored on only two video CDs with video resolutioncomparable to that of a standard VHS tape. More recent techniques allow the storage of a full-length movie of morethan three hours on a single DVD, with substantially improved audio and videoquality and the incorporation of additional data, such as additional languages,scenes and director and actor commentary. Additionally, digital compression of video data allows previouslyunmanageable amounts of data to be stored in the memory of a disk drive,thereby permitting the data to be accessed and edited easily.  It also allows for easier transmission ofsharper resolution pictures through a standard definition or high definitiontelevision or set-top box.  Digital audiocompression allows efficient storage and delivery of multi-channel audio,making possible high-quality special effects such as multi-channel surroundsound, virtual surround sound and wireless audio delivery via two speakers orheadphones.  In the field of stillphotography, digital compression allows dozens or hundreds of digital picturesto be stored on a single memory card, depending on the resolution desired.

 

To drive the implementation and speed the adoption of products based ondigital formats, industry participants organized committees to defineinternational compression standards.  Theprincipal standards in use today include the following:

 

•                  TheJoint Photographic Experts Group, or JPEG, standard for the high qualitycompression of still images and the real-time, low-cost compression anddecompression of moving images;

 

•                  TheMPEG 1 standard, adopted by the Moving Pictures Experts Group, or MPEG, for thecompression of both audio and video data at the high compression ratiosnecessary for the limited storage capacity of the CD-ROM format;

 

•                  TheMPEG 2 standard, subsequently adopted by the Motion Pictures Experts Group, forthe compression of both audio and video data, designed to provide improvedquality in broadcast and video playback applications;

 

•                  TheMPEG 4 standard, which is an extension of MPEG 1 and MPEG 2 that provides theability to view, access and manipulate objects rather than pixels, which isespecially significant in video streaming, digital television, modulemultimedia and video game applications.  MPEG4 part 10 standard, also known as Advanced Video Codec (AVC) or H.264,  is a recent addition to the MPEG 4 standard,offering significantly improved compression efficiencies;

 

•                  DivX standard, which is a proprietary codecsimilar to MPEG-4 used for encoding high quality digital video at low bit rates.  DivX encoded content can be viewed on the PCwith a software player, on select DVD Players, portable media players and isused by some internet-based video on demand services;

 

•                  WindowsMedia, Microsoft’s standard digital media software platform for developingdigital media products and services; and

 

•                  DolbyDigital, developed by Dolby Laboratories, an industry standard for the compressionof audio for use in multi-channel digital surround sound systems.

 

These industry standard techniques have enabled the dramatic growth indigital multimedia markets, including the following:

 

*DVD Players and Recorders. *DVD players andrecorders primarily use MPEG 2 video compression and Dolby Digital audiotechnology to provide significantly higher quality playback or recording thanis possible with VCR or video CD technology. According to International Data Corporation, or IDC, sales of DVD playerstotaled approximately 115 million units in 2004 and will approach132 million units in 2005.  Accordingto IDC, shipments of DVD recorders increased over 100% during 2004 toapproximately 9 million units, from a base of 4.2 million units in 2003.  DVD recorders are expected to graduallyovertake the DVD player in combination products, such as DVD+VCR, DVD+HtiB andTV+DVD.

 

*Standard Definition and High DefinitionTelevision and Set Top Boxes. *Digitaltelevisions receive digital content and process that content to display apicture which has far greater resolution and sharper, more clearly definedimages than televisions based on the older analog technology.  Standard definition televisions generallycontain 480 lines with 720 pixels per line. High definition television, or HDTV, television sets contain 1280 to1920 pixels per line and up to 1080 lines. Likewise, the aspect ratio of standard definition sets is 4:3, comparedto 16:9 for HDTV.  The lines may bedisplayed using different techniques, often referred to as interlacing oralternatively progressive scan.  Thefunctionality to receive and process digital television signals can becontained in a set-top box which then drives a

 

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television display that is capable of displaying digital content.  Alternatively, this functionality can beintegrated into a digital television that does not require a set-top box.  Digital content is broadcast via satellite,cable networks or over the air (terrestrial broadcast) in various marketsthroughout the world.  Intex Management Services,LTD. or IMS, estimates that over 63 million digital televisions and set-topboxes were shipped worldwide in 2004 and that over 80 million units willbe shipped in 2005.

 

*Mobile Products. *Digital cameras useJPEG compression technology to capture high resolution still images that can beviewed, edited and stored on a computer system on recordable DVD andtransmitted over telephone lines and computer networks.  Recently, digital cameras have beenintroduced that are capable of capturing and playing back quality video, usingthe MPEG 4 algorithm.  According to IDC,sales of mega pixel digital cameras exceeded 55 million units in 2004 andare expected to exceed 65 million units during 2005.  The digital camera has also become a keyfeature of mobile telephones.  Shipmentsof telephones that include a camera exceeded 178 million units worldwide in2004, according to Infotrends.

 

Additional products and markets are developing based on theseestablished compression standards and additional compression technologies suchas Meridian Lossless PCM, or MLP, a new standard for DVD audio, Super Audio, orSACD, Microsoft Windows Media Audio, or WMA, Advanced Audio Codec (AAC) used inconjunction with the MPEG-4 video standard and MP3, a compression standard forthe download of audio recordings from the Internet.

 

These established and emerging compression standards specify dataformats in which compressed data must be presented in order to enable productsfrom different vendors to interact and permit the capture, transmission,storage and display of audio and video data in digital format.  These standards do not specify thecompression methodologies to be employed or additional functionality which maybe used to enhance or manipulate digital signals.  These standards, therefore, do not determineimage or sound quality or compression efficiency.  For example, data compression may comply withrelevant standards despite being poorly processed and containing artifactswhich result in image degradation in video applications or poor sound qualityin audio applications.  As a result,there can be significant differences in overall image or sound quality betweentwo solutions based on the same standard. Therefore, integrated circuit manufacturers can differentiate theirproducts on the basis of the quality of their compression solution.

 

Historically, as system vendors sought compression solutions, the cost,complexity and time required to compress and decompress data have imposedsignificant limitations on the use of digital compression.  Over the last several years, ascost-effective compression solutions have emerged, product manufacturers haveincreasingly sought to design and market lower-cost digital audio and videosystems and products to address an increasing number of high volume consumerapplications.  In addition, productmanufacturers are facing competitive pressure to introduce their products morerapidly.  To address these issues,OEMs continually seek to integrate more and more functions on individualchips in order to reduce their costs, speed time-to-market and produce smallerproducts with reduced power consumption. They also seek solutions that can be easily integrated into theircommercial and consumer products.  Thecurrent challenge to manufacturers of compression integrated circuits is,therefore, to provide product manufacturers with high-quality, cost-effective,standards-based solutions that deliver flexible control, image enhancement, audioeffects and other functions in addition to high quality compression solutions.

 

**Zoran Solutions**

 

We provide feature-rich, cost-effective, standards-based solutions fora broad range of digital video, audio and imaging applications.  We were a pioneer in the development of highperformance digital signal processor products, and have developed expertise inintegrated mixed signal circuit design, mathematical algorithms and softwaredevelopment, as well as proprietary digital signal processing, and video andaudio compression technologies.  We applyour multi-disciplinary expertise and proprietary technologies to thedevelopment of fully-integrated solutions for high-growth multimedia markets.  The key elements of our solutions are thefollowing:

 

*Standards-Plus Methodology. *We have leveragedour broad multi-disciplinary expertise and proprietary digital signalprocessing and compression technologies to develop what we refer to as “standards-plus”solutions.  We have enabled OEMs toimprove image and sound quality and deliver superior products to end users byadding more features around compression standards, such as more efficient useof memory, processing and communication resources, as well as audio and imageenhancement algorithms.  We have alsoprovided OEMs the ability to include OEM-programmable effects andfeatures, as well as variable compression ratios for video.  These “standards-plus” features allow ourcustomers to differentiate their products from those of their competitors.

 

*Expandable and Programmable Architectures. *We design ourintegrated circuits to enable easy adaptation for a broad range of specificapplications.  We can vary thearchitecture of our chips by adding or deleting modules, and we can also modifythe software embedded in the chips themselves to address specific applications.  We also license ready-to-manufacture “cores”—buildingblocks of integrated circuits—that can be integrated into our customers’ chips.  Combined with the enhanced functionality ofour “standards-plus” technology, our expandable and programmable architecturefacilitates product design, upgrades and customization, substantiallyaccelerating our customers’ time to market with differentiated products.

 

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*Integrated System Solutions. *We help ourcustomers meet their total system requirements by providing integrated productsthat combine hardware and software to address required system functions andfeatures on a single integrated circuit or chip set, reducing the number ofintegrated circuits, and in some cases providing a complete solution on asingle chip.  As a result, our customers’total system cost can be reduced and they can concentrate on differentiatingtheir products from those of their competitors. For example, we introduced the Camera On A CHip, or COACH, whichincludes most of the electronics of a digital camera on a single chip.

 

*Cost-Effective Products. *We focus on reducingthe feature size, power requirements and number of integrated circuits necessaryto perform required system functions, including compression functions.  This reduces our customers’ manufacturingcosts for their products which incorporate our integrated circuits, and alsoreduces the operating costs for these products, enabling the use of ourproducts in a broader range of high volume applications.  The modular nature of our architecturereduces our new product development costs, and enables our design engineers tomeet our customers’ new product specifications and cost parameters.

 

*Near Production Ready System ReferenceDesigns. *Weprovide our customers with a broad range of engineering reference boards andproducts complete with device driver software, embedded software and detailedschematics.  These products substantiallyshorten our customers’ product design time.

 

**Strategy**

 

We provide cost-effective, high-performance digital audio, video andimaging solutions addressing selected high-growth applications enabled bycompression in evolving multimedia markets. Key elements of our strategy include the following:

 

*Focus on High-Growth and High VolumeApplications. *Ourstrategy is to focus on providing digital video, audio and imaging solutionsfor high-growth consumer electronics and printing applications.  Our current focus markets include DVD playersand recorders, digital cameras, digital television, multimedia portable devicesand multifunction digital print devices.

 

*Leverage Existing Technology and Expertise. *We intend tocontinue to identify those markets that we believe have the highest growthpotential for our products and to actively pursue those markets.  Our proprietary digital signal processing andcompression technologies can be used to serve a number of emerging markets fordigital video and audio.  Potentialmarkets include home network audio and video appliances, as well as personaldigital video, audio and imaging devices.

 

*Further Penetrate Key International Markets. *Between 1998 and2001, we opened offices in Shenzen, China, Taiwan, Japan, Korea and Hong Kong.  We now have a total of 294 employees workingin these offices.  We believe that byopening and expanding our presence in these offices we are better able toprovide marketing and application support for these growing consumerelectronics markets.

 

*Extend Technological Leadership. *Our years ofexperience in the fields of digital signal processing, integrated circuitdesign, algorithms and software development have enabled us to become a leaderin the development of digital audio and video solutions enabled by compression.  Using our multi-disciplinary expertise, wehave developed new technologies for compression of digital audio, video andimaging.  In August of 2004, we acquiredEmblaze Semiconductor which provided us important technologies for extendingour capabilities into the growing multimedia mobile telephone market.  We intend to continue to invest in ourresearch and development, and to evaluate opportunities to acquire additionaltechnologies in order to maintain and extend our technological leadership.

 

*Expand Strategic Partnerships. *We work closely inthe product development process with leading manufacturers of products thatincorporate our integrated circuits.  Wealso work closely with key customers and provide them early access to ourtechnologies.  Potential products aredesigned to meet customer-driven product requirements defined jointly by us andour partners with the partner providing technological input and, in selectedcases, a portion of the development funding. This strategy has enabled us to develop products with substantialfinancial and other assistance while retaining ownership of the technology andensuring an established customer for the product once development is completed.  In some cases, our strategic partners alsoprovide sales and marketing support.  Wehave also established long-term relationships with strategic partners thatprovide manufacturing capacity and will seek to develop additional strategicrelationships with manufacturers.

 

**Markets and Applications**

 

Our products are currently used in a variety of consumer multimediaapplications, including the following:

 

*Consumer Video Playback Systems*

 

DVD players, the latest generation of video playback systems, primarilyuse MPEG 2 video compression and Dolby Digital or similar audio technology toprovide significantly higher quality playback than is possible with earliergeneration products such as VCRs, Video CD or Super Video CD players.  DVD players are sold as stand-alone productsand are also bundled with other functions including

 

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DVD+VCR combinations, DVD-receivers and DVD+TV combinations.  In addition, the DVD player can act as aplatform for playback and editing of digital still images from digital camerasthrough integrated memory card slots or via direct connection to digitalcameras.  The growth in the DVD market isdemonstrated by the rapidly growing sales of DVD players, the increasing numberof models and manufacturers, and the increasing number of DVD titles availablefor purchase and rent.

 

*Digital Video Recording Systems*

 

Digital video recording systems are aimed at replacing the analog VCR.  Digital video recording systems not onlystore home movies and TV programs but allow them to be easily edited.  In addition, digital video recording systemsenable high quality time shifting of TV program viewing by recording theprogram so that it can be watched simultaneously or on a delayed basis.  The recording media used in digital videorecording systems includes DVD recordable media and hard disks.  Digital video recording systems use MPEG 2 asthe video compression format and Dolby Digital or MPEG audio as the audioformat.

 

*Digital Television*

 

The digital television market represents the most significanttechnological shift in the television segment of the consumer electronicsmarket since color televisions were introduced in the late 1950s.  In the digital television market, digitalcontent providers broadcast programming via satellite, cable or terrestrial(over-the-air) networks.  The mix ofbroadcast networks varies by geographic region. For example, most digital television content in Japan and Korea isbroadcast via terrestrial networks, while cable networks currently predominatein the United States.  Satellite networksoffer an alternative source of content to consumers and are continuing to growin each of these markets.  Eachgeographic market is subject to regulation that requires compliance withdifferent standards applicable to broadcast technology and the form of content.  In each market, individual broadcasters alsohave developed their own proprietary standards for content, security andconditional access.  The digitaltelevision market requires television products, set-top boxes, personal videorecorders and other digital consumer appliances that include sophisticatedintegrated circuits and embedded software that address the emergingrequirements of multiple broadcast networks throughout the world.  The recent requirement by the U.S. FederalCommunications Commission, or FCC, that all new televisions with screen sizesgreater than 13 inches will contain a built-in digital receiver startingJuly 2007, has accelerated the growth of the digital television market,which we expect to continue over the next several years.

 

*Digital Imaging Print Products*

 

The market for personal printers is beginning to undergo a shift fromtraditional PC-centric peripherals toward new PC-independent printingappliances.  Fueling this shift is therapid growth of digital photography, home Internet and wireless connectivity.  As these new technologies make their way intothe home, they are creating demand for a new class of appliance-type printersthat allow image rich content such as web pages, digital photos, and scanneddocuments to be printed without using a PC. According to IDC, IC controllers for multifunction print devices areaddressing a market estimated at 31 million units in 2004 and growing toover 46 million units in 2007.

 

The market for embedded software for page description languages issomewhat more mature than other areas of the imaging market.  It is characterized by a small number ofsuppliers selling to very large OEM customers designing print devices that needto be connected to a network.  The pagedescription language, or PDL, enables the printer to receive a file or job froma PC and translate that file into a set of instructions that the printer canunderstand and lay down on paper with a great deal of precision.  In general, applications are designed to sendjobs to printers using one or both of two major protocols or languages.  Print Control Language, or PCL, originated asa Hewlett Packard developed protocol for page printers and has become anindustry standard in office environments. In addition, the application may also use postscript-based protocolsoriginally developed by Adobe, which tend to be focused more on graphic artsand Apple operating system environments.

 

*Mobile Products*

 

Digital cameras allow the capture of high resolution images, the viewing,editing and storage of such images on a computer system and their transmissionover telephone lines and computer networks. High quality copies of these images can be printed using color printers.  Recently, digital cameras have added videocapture and compression capability enabling them to provide basic camcorderfunctionality.  Digital cameras can beconnected directly to a PC for downloading of pictures or movies and to atelevision for display.  The originaldigital cameras were developed for the professional market and currently sellat prices of $1,000 to $3,000.  Astechnology has advanced and manufacturing costs have decreased, digital camerasfor the consumer market have been introduced in the $69 to $600 price range.

 

Many mobile telephones now incorporate digital still camerafunctionality, including high resolution still pictures and sometimes evenvideo clips.  These phones can be connectedto a PC for downloading the pictures or video clips or they can be transmittedover the mobile phone network to another mobile phone or sent to an e-mailaccount.  The digital camerafunctionality was originally included in mobile phones that sold for $500 to$800.  With the spread of the technologyand decreased manufacturing costs, digital camera enabled mobile phones now areavailable in the $200 to $400 price range.

 

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**Image and Video Technology**

 

*The JPEG Standard. *In 1991, the JointPhotographic Experts Group, or JPEG, Committee of the International StandardsOrganization completed a technical specification for a standard to compressindividual digitized images, which may consist of still images or consecutiveframes of video data.  JPEG has beenwidely adopted for video editing applications, since each frame in the video isindividually compressed, allowing cutting and pasting of sequences as well asmodification of individual frames.  Imagesare compressed through elimination of spatial redundancies within an image andthe filtering of high frequency areas to which the eye is less sensitive.  Using these techniques, the JPEG compressionstandard is able to reduce the data necessary to represent an image withoutsignificant degradation of image quality. Still images or motion video can be compressed to varying degrees usingJPEG, with greater compression resulting in lower quality.  Typically, four-to-one or five-to-onecompression yields broadcast image quality while 20-to-1 compression is similarto VHS quality.

 

*Zoran JPEG Technology. *Our JPEG technologyincorporates a proprietary bit rate control algorithm that enables ourJPEG-based products to compress any image to a predetermined size whileoptimizing video quality using pre-selected parameters.  Without this feature, the JPEG compressionprocess results in compressed data files of various sizes based on the actualcontent of the original image given a constant degree of compression.  An image with large amounts of visual detailwill generate a larger data file than that generated from an image with lessdetail.  Performance of many videoapplications is hampered by variability in the size of the compressed images ina video sequence, which can result in inefficient use of available memory, busspeed or communication channel capacity or even the loss of images.  Our bit rate control is a “standards-plus”solution that uses real-time digital signal processing algorithms to optimizevideo quality based on pre-selected parameters, which can be programmed byOEMs, without the loss of any image or video frame.  Our bit rate control has been incorporated inour JPEG-based devices that are used in digital cameras, video editing systems,color scanners, PC-based security systems, video conferencing and otherapplications.  Other features of ourJPEG-based products include their ability to handle a wide range of compressionratios, to perform a “lossless” compression algorithm in the same JPEG device,to rapidly scan or browse a large number of images and utilize advanced imageprocessing algorithms that enable bit rate control of USB data, vertical blankinterval detection, infrared remote control detection and scene analysis forcomputer control applications.  Weimplement these functions in a single integrated circuit while we believe mostother manufacturers either offer fewer functions or require multiple chips,resulting in higher manufacturing costs and greater power consumption.

 

*The MPEG Standards. *In 1991, the MovingPictures Expert Group, or MPEG, Committee of the International StandardsOrganization completed a technical specification for a standard to compressmoving audio and video into a single data stream.  Like JPEG, MPEG 1 removes spatialredundancies from single frames of video data. MPEG 1 improves on JPEG by also removing redundancies that occur betweenconsecutive video frames.  Because videorepresents movement, it is possible to detect and estimate the movement ofsimilar picture elements between video frames, a process called motionestimation.  MPEG motion estimation usesthe content of previous and future frames to predict the content of the currentframe without using its full content.  MPEG1 implements audio compression by exploiting psycho-acoustic masking, takingadvantage of the fact that the ear is less sensitive to a quiet note at onefrequency when a much louder note is present at a nearby frequency.  MPEG 1 often achieves audio compressionratios of six-to-one and video compression ratios of over 100-to-1.  MPEG 1 is particularly suitable for low-costCD-ROM applications due to its low-cost implementation.

 

In 1993, the MPEG 2 video committee completed a technical specificationto address the more stringent requirements of the broadcast industry.  MPEG 2 provides more sophisticated predictiontechniques, enabling a compression solution to comprehend video as interlacedfields of data, rather than individual frames. MPEG 2 also allows for operation at higher resolution and at higher bitrates than MPEG 1, resulting in improved image quality for high motion, highdetail video.  MPEG 2 typically achievescompression ratios of 50-to-1.  Becauseof its higher bit rate, MPEG 2 technology cannot be used in standard CD-ROMapplications, but can be used in DVD players.

 

MPEG 4 builds on the experience of the MPEG 1 and MPEG 2 standards,which are currently used in digital video applications.  MPEG 4 is rich in features, and can becustomized to serve the needs of specific industries while preserving a highlevel of interoperability across a variety of applications.  It allows a new level of interaction withvisual content, providing the ability to view, access and manipulate objectsrather than pixels.  MPEG 4’s impact isespecially significant in video streaming, digital television, mobilemultimedia and game applications.

 

*DivX*.  DivX is a proprietary codec similar to MPEG-4used for encoding high quality digital video at low bit rates.  DivX encoded content can be viewed on the PCwith a software player, on select DVD Players, portable media players and isused by some internet-based video on demand services.

 

*Zoran MPEG Technology. *Beginning in 1997,we established ourselves as a leading provider of MPEG 2 technology for DVD andSuper Video CD applications.  Anotherimportant technology is MPEG 4 decoding, which is embodied in the DivX and XVIDfile formats.  These files are commonlyused for file sharing of video content on the PC.  We have added to the MPEG 2 decoders used onthe PC, the capability to decode MPEG 4 files, allowing consumers to displaycontent stored on their PCs using a television. We have also introduced

 

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MPEG 2 encoding ICs.  Thistechnology is an important part of the DVD recorder system.  With the acquisition of Oak Technologies weobtained the MPEG-2 technologies required for high definition televisionapplications including set-top boxes and televisions.  We have also developed MPEG 4 technology-bothfor compression and decompression-enabling the capture and playback of highquality video clips for portable applications including, digital still camerasand digital tape-less camcorders  Withthe acquisition of Emblaze Semiconductor, we obtained MPEG-4 part 10compression and decompression technologies, also known as the Advanced VideoCodec, or AVC, that are used in mobile telephone applications for videoconferencing and video capture.

 

**Audio Technology**

 

*The Dolby Digital Standard. *In 1992, DolbyLaboratories launched Dolby Digital, an audio compression technique which hasemerged as an industry standard.  DolbyDigital was developed as a successor to Dolby’s Pro Logic analog technique foruse in multi-channel digital surround sound systems.  It is currently used in movie theaterscomprising over 24,000 screens worldwide and is also used in home theater andcomputer multimedia applications.  Digitalcompression of audio data allows the storage of full quality multi-channelaudio playback in the limited space allocated for audio in video-orientedformats.  It also facilitates theseamless integration of sound with compressed video.  The Dolby Digital audio compression standardis currently the principal audio compression technique used in DVD players.  Dolby Digital has also been adopted as astandard for use in high-definition television and digital cable systems.

 

*Other Audio Standards. *Other digital audiocompression standards currently in use include: DTS, an audio compressionstandard that competes with Dolby Digital; MLP, a compression standard for DVDaudio; Windows Media Audio, or WMA, a standard developed by Microsoft; AdvanceAudio Codec, or AAC, a compression standard used in HDTV and MP3, used for thedownload of audio recordings from the Internet.

 

*Zoran Audio Technology. *Working closely withDolby Laboratories, we have developed a programmable audio digital signalprocessing engine with an architecture optimized for Dolby Digital and otherdemanding audio applications, and we were the first to develop a single-chipsolution for Dolby Digital decoding.  Ourfamily of Vaddis® DVD decoders and audio processors now incorporate this engineto allow systems manufacturers to replace system components with softwaremodules, differentiate their products from their competition, use Zoran’sSiliconSoftware® library of advanced audio algorithms, and reduce system costsand time to market.  In addition to DolbyDigital, our DVD decoders and audio processors support all principal audiocompression standards, including DTS, MLP and MP3.  Zoran’s integrated circuits also includeadditional functions such as Virtual Multi Channel Digital, surround sound forheadphones, high definition CD, karaoke processing and speaker equalization.  Our audio technology is integrated with ourvideo technology in many of our products. Multiple audio algorithms like AAC, Dolby Digital and others areembedded in our DTV ICs, and other algorithms are included in our digitalcamera ICs.

 

**Printing Technology**

 

*Zoran Controller Technology. *As a result of ouracquisition of Oak in August 2003, we obtained Oak’s IC-based controllertechnology that enables users of our customers’ computer peripheral productssuch as printers, copiers and multi function peripherals, or MFPs, that performdocument imaging function to print, scan, copy, process and transmit documents.  For hardware-based printing solutions, ourImaging division designs high-performance, full-featured compressionapplication specific integrated circuits, or ASICs, imaging DSP ICs, resolution-enhancementASICs and system-on-a-chip, or SOC, solutions for digital copiers, printers,scanners, fax machines and MFPs.

 

*Zoran Digital Page Processing Technology. *Also as a result ofthe Oak acquisition, we obtained Oak’s digital page processing technology, usedto create software for processing page description languages such as Postscriptand PCL.  For software-based printingsolutions, our Imaging Division offers integrated, modular, embedded softwareproducts, intended to provide the performance, output, quality, compatibilityand network connectivity required for today’s printing peripheral market.  In addition, we provide complementarypersonal computer software products, including printer drivers and standards-basedtechnology to enable manufacturers of peripherals to design and developdifferentiated products.

 

**Products**

 

Our product offerings consist of four principal product families:

 

•                  DVD—videoand audio compression and decompression products based on MPEG, Dolby Digitaland DTS standards for use in DVD players and DVD recorders.

 

•                  DTV—high-performance,highly integrated ASICs and system-on-a-chip, or SOC, solutions for standardand high definition digital television products including televisions, set topboxes, personal video recorders, digital video recorders, and recordable DVDs,as well as platforms, drivers and software stacks for a variety of operatingsystems required for these digital television applications.

 

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•                  Mobile—imageand video compression and decompression products based on JPEG and MPEG 4technologies.

 

•                  DigitalImaging—IC-based controller products and digital page processing software forthe digital imaging, production and printing market.

 

The following table lists our principal multimedia integrated circuitscurrently in production, including the months in which initial production unitswere first made available to customers:

 
| **Product Family** | ** ** | **Products**                                                                                 | ** ** | **Initial  Commercial  Shipment** | ** ** | **Principal  Applications**                            |
|--------------------|------------|----------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|--------------------------------------------------------|
| DVD                |       | Vaddis® V integrated DVD decoder (ZR36750)                                              |       | May 2001                          |       | DVD players and recorders                              |
|               |       | Vaddis® 6  integrated DVD decoder (ZR36768)                                             |       | December  2002                    |       | DVD players                                            |
|               |       | Vaddis® 5R  video playback chip (ZR36750)                                               |       | July 2003                         |       | DVD players  and recorders                             |
|               |       | ActivaTM 100—MPEG  2 encoder (ZR35100)                                              |       | February  2004                    |       | DVD  recorders                                         |
|               |       | Vaddis® 7  integrated DVD decoder (ZR36776)                                             |       | March 2004                        |       | DVD players                                            |
|               |       | HDXtremeTM  (ZR36721)                                                                    |       | March 2004                        |       | DVD players  and recorders                             |
|               |       | Vaddis® 8  integrated DVD decoder (ZR36868)                                             |       | August 2004                       |       | DVD players                                            |
|               |       |                                                                                         |       |                              |       |                                                   |
| DTV                |       | Graphics accelerator (TL751)                                                                 |       | January 2003                      |       | HD set-top boxes                                       |
|               |       | Multistream management, security decryption —companion to 851 (TL811)                   |       | September 2000                    |       | HDTV and HD set-top boxes                              |
|               |       | HD decoder display processing, graphics acceleration (TL851)                                 |       | June 2001                         |       | HDTV and HD set-top boxes                              |
|               |       | Gen 9® integrated HD decoder with 64 Bit CPU and Audio DSP Core (TL  955)               |       | June 2002                         |       | HDTV and HD set-top boxes                              |
|               |       | Gen 9® integrated HD decoder with 64 bit CPU and audio DSP core (TL  945)               |       | July 2002                         |       | HDTV and HD set-top boxes                              |
|               |       | SupraTV  integrated SD decoder with 32-bit CPU and audio DSP core (ZR39140)                  |       | September 2003                    |       | SDTV and SD set-top boxes                              |
|               |       | Gen 9 Elite® integrated HD decoder with dual 32 bit CPU and audio DSP  core (ZR 391055) |       | October 2004                      |       | HDTV and HD set-top boxes                              |
|               |       |                                                                                         |       |                              |       |                                                   |
| Mobile             |       | Digital camera processor—COACHTM-LC (ZR36420)                                       |       | March 2000                        |       | Digital cameras, security                              |
|               |       | Digital camera  processor—COACHTM-5 (ZR36430)                                       |       | June 2002                         |       | Digital  cameras, security                             |
|               |       | Digital  camera processor—COACHTM 6 (ZR36440)                                       |       | October 2003                      |       | Digital  cameras, security                             |
|               |       | Digital  camera processor—COACHTM 7 (ZR36450)                                       |       | July 2004                         |       | Digital  cameras, security                             |
|               |       | ApproachTM multimedia  application coprocessor- (ER4521)                                 |       | July 2004*                        |       | Wireless and  multi-media applications                 |
|               |       | ApproachTM  multimedia application accelerator- (ER4525)                                 |       | July 2004*                        |       | Wireless and  multi-media applications                 |
|               |       |                                                                                         |       |                              |       |                                                   |
| Digital Imaging    |       | 4110 Inkjet and laser high performance mid range print head  controller platform             |       | March 2003                        |       | Mid range inkjet MFP’s and laser printers         |
|               |       | 4100 Inkjet high performance low cost print head controller platform                         |       | October 2003                      |       | Low cost inkjet MFP’s                             |
|               |       | Integrated Print System (IPSTM) 6.0 Embedded Software                                    |       | April 2003                        |       | Print devices connected to a network                   |
|               |       | IPSTM/Conductor (IPSTM/DDK)                                                          |       | September 2004                    |       | Print devices connected to Microsoft operating systems |
|               |       | Integrated Print System (IPSTM) 7.0 Embedded Software                                    |       | November 2004                     |       | Print devices connected to a network                   |

 

----

|   |   | * - Available as a result of the acquisition of Emblaze  Semiconductor, Ltd. |   |   |
|--------|--------|------------------------------------------------------------------------------|--------|--------|

 

*DVD. *OurVaddis decoders perform all the audio and video decoding and displayrequirements of the DVD specification, including MPEG 2 audio and videodecoding, Dolby Digital, DTS and MLP audio decoding, on-screen display,decryption required for copyright

 

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protection and presentation of graphic information.  The Vaddis has additional computational powerthat can be utilized for customer differentiation features.  For example, it can incorporate virtualsurround sound algorithms without the addition of hardware.  This allows the user to enjoy thetheater-like sound obtained from six speakers using a system that includes onlytwo speakers and the Vaddis.  The Vaddis5 integrates the host controller and incorporates DVD audio capability andprogressive scan output features that are part of current high-end DVD playersystems.  The Vaddis 6 is a DVD system-on-a-chipwhich integrates the principal functionality of the Vaddis 5 family with theadditional functionality of the front-end servo and read channel, furtherreducing chip count and system cost for DVD player manufacturers.  The Vaddis 7 incorporates the Vaddis 6 withthe addition of MPEG 4 decode and an interface that can support high definitiontelevision.  The Vaddis 8 incorporatesthe Vaddis 7 with the addition of Super Audio CD, or SACD, upscaler and HDMItransmitter functionality.  In 2004, weintroduced HDXtreme technology that allows DVD play back and the viewing ofJPEG pictures on a HDTV with an HDMI interface. The Activa 100 is a full featured MPEG-2 video encoder.  The Vaddis 5R is a video playback chip thatis specifically designed to be a companion to the Activa 100 in a DVD recorder.  Vaddis decoders are used in DVD players.  In 2004, we began volume shipments of theActiva 100 and Vaddis 5R for use in DVD recorders from several manufacturers.  We also provide full reference designs of DVDplayers and DVD recorders based on our Vaddis and Activa chips that help ourcustomers accelerate the time to market for their products.

 

*DTV. *OurDTV Division, obtained by combining part of the Oak operations and existingactivities in Zoran, offers integrated circuit products for both highdefinition and standard definition digital television formats for televisions,set top boxes and related applications, including personal video recorders.  Our TL 8xx two-chip solution has been involume production since 2001.  In 2003,we began shipping its next generation of HDTV products, the Generation 9 systemon a chip.  In 2004 we began shipping theGeneration 9 Elite system on a chip which utilizes dual CPU’s resulting inhigher performance with lower power consumption compared to the Generation 9.  In 2004, we also began shipping productionvolumes of the SupraTV 140 and SupraTV 150 standard definition ICs for use inthe worldwide standard definition digital terrestrial, satellite and cablebroadcast markets.  Our DTV Division iscontinuing to develop products to address the needs of the emerging digitaltelevision market.

 

*Mobile. *Our JPEG technology is used in digital cameras.  In 1999, we introduced our first Camera On ACHip, or COACHTM—an integrated system on a chip solution that includes most ofthe electronics of a digital camera.  TheCOACHTM can be connected directly to a high-resolution CCD or CMOS sensor,process the video information in real time, compress the captured image in realtime, interface an LCD or micro display and interface to all types of flashmemory.  Among the unique capabilities ofthe COACH is the ability to transfer in real time, over a USB bus, high qualityvideo to the PC and function as a PC video camera.  The COACH also allows for direct connectionto a printer, including color correction and special effects, for the non-PCconsumer environment.  The COACH issupplemented by digital camera reference designs, “CamON” and “CamMini,”shortening the time to market for COACH customers.   In2004, we introduced our MPEG-4 Codec based COACH enabling digital cameras to incorporatebasic digital camcorder capabilities.  TheseMPEG-4 encoded video clips can be displayed on a PC or TV.  The clips can also be edited using a PC.  As a result of our acquisition of EmblazeSemiconductor in July 2004, our Mobile Products Division also offers mobilemultimedia telephone products.  In late2004, the Mobile Products Division discontinued its line of the CMOS sensor productsin order to increase its focus on digital camera and mobile multimedia telephoneproducts.

 

*Digital Imaging. *To address theconsumer market for personal printers and the increasing demand for PCindependent printing appliances, we have designed a scalable and extendablearchitecture, referred to as Quatro, which is a programmable SOC solution forconsumer oriented imaging and printing appliances.  These include multifunction color inkjet andlaser devices that feature print, copy, scan and fax capabilities and allowimage-rich content such as web pages, digital photos and scanned documents tobe printed without the use of a PC.  Atthe heart of the Quatro are four key elements: a 32 bit RISC CPU core; a QuatroSIMD DSP core; an industry-standard internal bus; and an easy to use C-basedprogramming environment.  The 4110 andthe 4100 ASIC’s are designed for mid-range and entry level inkjet printers,respectively.  The Integrated PrintSystem, or IPS 7.0, is a modular, scalable embedded software product thatprovides processing and control functions for a document imaging peripheraldevice.  IPS was developed based on along standing expertise in page description language interpreters like PCL andPostscript.  The IPS product line givesthe OEM the ability to build high performance, network enabled devices quicklyand cost effectively.

 

*Integrated Circuit Cores. *We offer multimediaintegrated circuit, or intellectual property (“IP”), cores which can beincorporated into our customers’ chips.  Forexample, we license a video decoder IP core for conversion of an NTSC, PAL, orSECAM TV signal into a format that allows the information in the TV signal tobe displayed on a TV monitor.  This IPcore enables the integration of TV functionality into integrated circuits forLCD panels, LCD-TVs, Plasma Display TVs, set-top boxes, DTVs, projectorsystems, PC video capture and other applications.  Our video encoder IP cores perform thereverse function, converting component video data into an NTSC, PAL or SECAM TVsignal.  This IP core has applications inICs for graphics displays, set-top boxes, digital cameras, DTVs, DVD players,gaming systems and other applications.

 

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**Customers**

 

The following table lists representative customers, as well as other OEMs whopurchase our products through our resellers. Each of these customers and OEMs purchased, directly or indirectly,at least $500,000 of our products from us during 2004:

 
| **Product Family** | ** ** | **Direct Customers**                                                                                                                                                                               | ** ** | **Other OEMs**                                                                                                                                                                                                                                                                     |
|--------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| DVD                |       | Alco Electronics LTD.

Anam Electronics Co. LTD.

Apex Digital, Inc.

Arcam

Argus

Dalian Golden Hualu Digital Tech. Co. LTD.

Everbest Industrial (HK) LTD.

Gigastorage Co.

Global Assets LTD. |       | Goodsino Technology Development LTD.

Mico Electric (HK) LTD.

Pacific Crown Industrial LTD.

Samsung Electronics

Shenzhen Kiaxinda Multi-Media Co. LTD.

Sichuan Changhong Electric. Co.

Vestel Komunikasyon Sanayi ve Ticareti

Anonim Serketi

Zhongshan Kenloon Lighting Co. |   | Orion  Sanyo  Sharp  Toshiba |
|               |       |                                                                                                                                                                                               |       |                                                                                                                                                                                                                                                                               |   |   |
| DTV                |       | 3S Digital  Digital Stream  TCL Thomson Electronics  Humax                                                                                                                                         |       | Marubun  Mico Electric (HK) LTD.  Motorola                                                                                                                                                                                                                                         |   | Funai  JVC  Mitsubishi  Mitsumi  Sony |
|               |       |                                                                                                                                                                                               |       |                                                                                                                                                                                                                                                                               |   |   |
| Mobile             |       | Chicony Electronics Co. LTD.

Concord Camera HK Limited

Olympus

Pentax Corporation                                                                                                               |       | Premier  Primax Electronics LTD.  Samsung Electronics  Zenitron Corporation                                                                                                                                                                                                        |   |   |
|               |       |                                                                                                                                                                                               |       |                                                                                                                                                                                                                                                                               |   |   |
| Digital Imaging    |       | Benq Co.

Canon

Celestica Co.

Epson

Fuji Xerox

Heidelberg

Hewlett Packard

Kyocera MITA                                                                                                       |       | Lexmark  Lite-On Technology Co.  OkiData Co.  Ricoh  Samsung Electronics  Sharp  Toshiba  Xerox                                                                                                                                                                                    |   |   |

 

In2004, Samsung Electronicsaccounted for 11% of our total revenues, while sales to our four largestcustomers accounted for 35% of our total revenues.   In 2003, Samsung Electronics and Fujifilm accounted for 17% and 14% ofour total revenues, respectively, while our four largest customers accountedfor 46% of our total revenues.

 

**Research and Development**

 

We believe that our future success depends on our ability to continueto enhance our existing products and to develop new products that maintaintechnological competitiveness and compliance with new standards in rapidlyevolving consumer-oriented digital audio and video markets.  We attempt to leverage our expertise in thefields of digital signal processing, integrated circuit design, algorithms andsoftware development to maintain our position as a leader in the development ofdigital audio, video and imaging solutions. Accordingly, we devote a significant portion of our resources tomaintaining and upgrading our products to reduce integrated circuit cost,feature size, power consumption and the number of integrated circuits requiredto perform compression and other functions necessary for the evolving digitalaudio, video and imaging application markets. In addition, we seek to design integrated circuits and cores, as well asnear production ready reference designs which can reduce the time needed bymanufacturers to integrate our products into their own products.

 

We have historically generated a portion of our revenues fromdevelopment contracts with our strategic partners.  These development contracts provide that wewill receive payments upon reaching certain development milestones and that wewill retain ownership of the intellectual property developed.  Development contracts have enabled us to fundportions of our product development efforts, to respond to the featurerequirements of our customers, to accelerate the incorporation of our productsinto our customers’ products and to accelerate the time-to-market of ourcustomers’ products.  We anticipate,however, that in the future development contracts with strategic partners will

 

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fund a smaller portion of our development efforts than in the past.

 

We are a party to research and development agreements with the ChiefScientist in Israel’s Ministry of Industry and Trade and the Israel-UnitedStates Bi-national Industrial Research and Development Foundation.  These organizations fund up to 50% ofincurred project costs for approved projects up to contract maximums.  The agreements require us to use our bestefforts to achieve specified results and to pay royalties at rates of 3% to 5%of resulting product sales and up to 30% of resulting license revenues, up to amaximum of 100% to 150% of the total funding received.  Reported research and development expensesare net of these grants, which fluctuate from period to period.  In 2004, we earned grants from theseorganizations totaling $1.5 million, and in 2003 we earned grants totaling$2.5 million.  The terms of IsraeliGovernment participation also contain restrictions on the location of researchand development activities, and the terms of the grants from the ChiefScientist prohibit the transfer of technology developed pursuant to thesegrants to any person without the prior written consent of the Chief Scientist.

 

As of December 31, 2004, we had a staff of 489 full-time and 139part-time research and development personnel for a total of 628 research anddevelopment personnel.

 

**Sales and Marketing**

 

Our sales and marketing strategy is to focus on providing solutions tomanufacturers seeking to design audio, video and imaging products for existingand emerging high volume consumer applications. In cooperation with leading manufacturers of audio, video and imagingequipment in the commercial and consumer markets, we attempt to identify marketsegments which have the potential for substantial growth.  To implement our strategy, we haveestablished a worldwide direct sales force in several sales and marketingoffices located near our key customers and strategic partners, and a worldwidenetwork of independent sales representatives and resellers.  In some cases, our strategic partners alsoprovide sales and marketing support.

 

We work closely in the product development process with strategicpartners to incorporate our integrated circuits and software into theirproducts.  Potential products aredesigned to meet customer-specific product requirements defined jointly by usand our strategic partners with our partners providing technological input, andin some cases, a portion of the development funding.  This strategy has permitted us to developproducts with substantial financial and other assistance, while retainingownership of the technology and ensuring an established customer for theproduct once development is completed.  Inaddition, our application engineers assist customers in designing theirproducts to incorporate our integrated circuits.

 

Our sales are generally made pursuant to purchase orders receivedbetween one and six months prior to the scheduled delivery date.  We sell our products primarily through our95-person direct sales staff, of whom 10 are located in the United States and85 are located internationally.  OurUnited States sales staff is primarily responsible for sales in North America,Europe and South America.  Salesmanagement and sales operations staff also reside in the United States.  Our marketing staffs in China, Japan, Koreaand Taiwan are responsible for marketing in their respective regions.  In addition, we sell our products indirectlythrough five commissioned sales representatives as well as selecteddistributors.  We typically warrant ourproducts for a 12-month period.  To date,we have not experienced material product returns or warranty expense.

 

We have opened offices in other parts of the world in order to betteraddress specific markets.  During 1998,we opened an office in Shenzhen, China as part of our effort to capture aleadership position in the Chinese digital audio and video markets.  During 2000, we opened an office in Taipei,Taiwan in an effort to better address the digital camera market.  As of December 31, 2004, we had a staffof 211 employees in our China office and 38 employees in our Taiwan office,including sales, applications and customer support employees.  In addition, in 2001 we opened offices inHong Kong and Korea, which had staffs of 3 employees and 17 employees,respectively, as of December 31, 2004. These offices also provide sales, applications and customer support.

 

We distribute our products in Japan primarily through resellers.  We also operate an office in Tokyo to helppromote our products in Japan, assist with the marketing of products not soldthrough resellers, such as integrated circuit cores and certain digital camera,digital video, digital television, imaging and JPEG products, and provideapplications support for some of our customers. At December 31, 2004, we had 25 employees in our Tokyo office.

 

We sell our Dolby technology enabled products under a perpetual,non-exclusive license from Dolby to sell products that incorporate the DolbyDigital algorithm.  We are not requiredto pay license fees or royalties to Dolby under this agreement.  Our customers enter into license agreementsdirectly with Dolby, pursuant to which they pay royalties to Dolby.  Under our agreement with Dolby, we may sellour Dolby Digital-based products only to customers who are licensees of Dolby.  To date, most potential customers for ourDolby Digital-based products are licensees of Dolby.  However, the failure or refusal of potentialcustomers to enter into license agreements with Dolby in the future could harmour sales.

 

We sell our DTS Technology-based products under a non-exclusive licensefrom DTS Technology LLC to sell products that incorporate

 

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the DTS algorithm.  We are notrequired to pay royalties to DTS Technology under this agreement.  Our customers enter into license agreementsdirectly with DTS, pursuant to which they pay royalties to DTS.  Under our agreement with DTS, we may sell ourDTS-based products only to customers who are licensees of DTS.  The failure or refusal of potential customersto enter into license agreements with DTS in the future could harm our sales.

 

**Backlog**

 

Sales of our products are made pursuant to firm purchase orders.  However, sometimes we allow customers tocancel or reschedule deliveries.  Inaddition, purchase orders are subject to price renegotiations and to changes inquantities of products ordered as a result of changes in customers’requirements and manufacturing availability. Our ability to order products can carry lead times of between four and16 weeks; however, most of our business is characterized by short lead timesand quick delivery schedules.  As aresult of these factors, we do not believe that backlog at any given time is ameaningful indicator of future sales.

 

**Manufacturing**

 

We contract our wafer fabrication, assembly and testing to independentfoundries and contractors, which enables us to focus on our design strengths,minimize fixed costs and capital expenditures and gain access to advancedmanufacturing facilities.  Our engineerswork closely with our foundry partners and subcontractors to increase yields,lower manufacturing costs and assure quality.

 

Our primary foundry is Taiwan Semiconductor Manufacturing Company, orTSMC, which has manufactured integrated circuits for us since 1987.  TSMC, Philips and Samsung are currentlymanufacturing our DVD, JPEG, DTV, imaging and some of our mobile products.  Fujitsu manufactures our USB multimediacontroller chips.  Our independentfoundries fabricate products for other companies and may also produce productsof their own design.

 

All of our devices are currently fabricated using standard complementarymetal oxide semiconductor process technology with 0.13 micron to 0.8 micronfeature sizes.  Most of our semiconductorproducts are currently being assembled by one of five independent contractorsand tested by those contractors or other independent contractors.

 

We currently purchase products from all of our foundries underindividually negotiated purchase orders. We do not currently have a long-term supply contract with TSMC, andtherefore TSMC is not obligated to manufacture products for us for any specificperiod, in any specific quantity or at any specified price, except as may beprovided in a particular purchase order.

 

**Competition**

 

Our existing and potential competitors include many large domestic andinternational companies that have substantially greater resources in thefollowing areas:

 

•                  finance;

 

•                  manufacturing;

 

•                  technology;

 

•                  marketing;and

 

•                  distribution.

 

Some of these competitors also have broader product lines and longerstanding relationships with customers than we do.  Some of our principal competitors maintaintheir own semiconductor foundries and may therefore benefit from capacity, costand technical advantages.  ALiCorporation, Cheertek, Cirrus Logic, ESS, LSI Logic, Matsushita, MediaTek,Sony, STMicroelectronics, Sunplus and Texas Instruments have introducedintegrated audio and video devices for DVD applications.  In the markets for JPEG-based products foruse in digital cameras, our principal competitors are in-house solutionsdeveloped and used by major Japanese OEMs, as well as products sold by Sunplusand Texas Instruments.  In the market forJPEG-based products for desktop video editing applications, our principalcompetitor is Sunplus.  Cirrus Logic(Crystal Semiconductor), Fujitsu, Motorola, STMicroelectronics and Yamaha arecurrently shipping Dolby Digital-based audio compression products.  Our principal competitors for digitalsemiconductor devices in the digital television market include ATITechnologies, Broadcom, Conexant and ST Microelectronics.  Others who also participate in this marketare Fujitsu, Genesis Microchip, IBM, LSI, Texas Instruments and TridentMicrosystems.  Our principal competitorsin the digital office market include Adobe Systems, Agilent, Electronics forImaging, Inc., Global Graphics, Oasis Semiconductor, Peerless Systems, TAKImaging and in-house captive suppliers.

 

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We believe that our ability to compete successfully in the rapidlyevolving markets for high performance audio, video and imaging technologydepends on a number of factors, including the following:

 

•                  price,quality, performance and features of our products;

 

•                  thetiming and success of new product introductions by itself, our customers and ourcompetitors;

 

•                  theemergence of new industry standards;

 

•                  itsability to obtain adequate foundry capacity;

 

•                  thenumber and nature of our competitors in a given market; and

 

•                  generalmarket and economic conditions.

 

The markets in which we compete are intensely competitive and arecharacterized by rapid technological change, declining average unit sellingprices and rapid product obsolescence.  Weexpect competition to increase in the future from existing competitors and fromother companies that may enter our existing or future markets with solutionswhich may be less costly or provide higher performance or more desirablefeatures than our products.

 

The DVD market is growing, and additional competitors are expected toenter the market for integrated circuits used in DVD players and DVD recorders.  We believe that several large consumerelectronics companies with headquarters in Asia may be planning to enter thismarket and may attempt to develop MPEG hardware or software to compete with ourproducts.  Some of these potentialcompetitors may develop captive implementations for use only with their own PC,commercial or consumer electronics products. This increased competition may result in price reductions, reducedprofit margins and loss of market share.

 

Historically, average unit selling prices in the semiconductor industryin general, and for our products in particular, have decreased over the life ofa particular product.  We expect that theaverage unit selling prices of our products will continue to be subject tosignificant pricing pressures.  In orderto offset expected declines in the average unit selling prices of our products,we will need to continually reduce the cost of our products and continue tointegrate additional functions into our ICs. We intend to accomplish this by implementing design changes thatintegrate additional functionality, lower the cost of manufacture, assembly andtesting, by negotiating reduced charges by our foundries as and if volumesincrease, and by successfully managing our manufacturing and subcontractingrelationships.  Since we do not operateour own manufacturing, assembly or testing facilities, we may not be able toreduce our costs as rapidly as companies that operate their own facilities.  If we fail to introduce lower cost versionsof our products in a timely manner or to successfully manage our manufacturing,assembly and testing relationships, our business would be harmed.

 

**Proprietary Rights and Licenses**

 

Our ability to compete successfully is dependent in part upon ourability to protect our proprietary technology and information.  Although we rely on a combination of patents,copyrights, trademarks, trade secret laws and licensing arrangements to protectsome of our intellectual property, we believe that factors such as thetechnological and creative skills of our personnel and the success of ourongoing product development efforts are more important in maintaining ourcompetitive position.  We generally enterinto confidentiality or license agreements with our employees, resellers,customers and potential customers and limits access to our proprietaryinformation.  We currently hold approximately250 patents worldwide, and have additional patent applications pending.  Our intellectual property rights, ifchallenged, may not be upheld as valid, may not be adequate to preventmisappropriation of our technology or may not prevent the development ofcompetitive products.  Additionally, wemay not be able to obtain patents or other intellectual property protection inthe future.  In particular, the existenceof several consortiums that license patents relating to the MPEG standard hascreated uncertainty with respect to the use and enforceability of patentsimplementing that standard.  Furthermore,the laws of certain foreign countries in which our products are or may bedeveloped, manufactured or sold, including various countries in Asia, may notprotect our products or intellectual property rights to the same extent as dothe laws of the United States and thus make the possibility of piracy of our technologyand products more likely in these countries.

 

We sell our Dolby Digital-based products under a perpetualnon-exclusive license from Dolby which permits us to incorporate the DolbyDigital algorithm into our products.  Ourcustomers enter into license agreements with Dolby pursuant to which they payroyalties directly to Dolby.  Under ouragreement with Dolby, we may sell our Dolby Digital-based products only tocustomers who are licensees of Dolby.  Todate, most potential customers for our Dolby Digital- based products arelicensees of Dolby.  However, the failureor refusal of potential customers to enter into license agreements with Dolbyin the future could harm our business.  Wesell our DTS Technology-based

 

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products under a non-exclusive license from DTS Technology LLC to sellproducts that incorporate the DTS algorithm. We are not required to pay royalties to DTS under this agreement.  Our customers enter into license agreementsdirectly with DTS, pursuant to which they pay royalties to DTS.  Under our agreement with DTS, we may sell ourDTS-based products only to customers who are licensees of DTS.  The failure or refusal of potential customersto enter into license agreements with Dolby in the future could harm our sales.

 

The semiconductor industry is characterized by vigorous protection andpursuit of intellectual property rights, which have resulted in significant andoften protracted and expensive litigation. We or our foundries from time to time are notified of claims that we maybe infringing patents or other intellectual property rights owned by thirdparties.  We have been subject tointellectual property claims and litigation in the past, and we and our Oaksubsidiary are currently engaged in such litigation.  See Item 3—Legal Proceedings.  We may be subject to additional claims andlitigation in the future.  In particular,given the uncertainty discussed above regarding patents relating to the MPEGstandard, it is difficult for us to assess the possibility that our activitiesin the MPEG field may give rise to future patent infringement claims.  Litigation by or against us relating topatent infringement or other intellectual property matters could result insignificant expense to us and divert the efforts of our technical andmanagement personnel, whether or not such litigation results in a determinationfavorable to us.  In the event of anadverse result in any such litigation, we could be required to pay substantialdamages, cease the manufacture, use and sale of infringing products, expendsignificant resources to develop non-infringing technology, discontinue the useof certain processes or obtain licenses to the infringing technology.  Licenses may not be offered or the terms ofany offered licenses may not be acceptable to us.  If we fail to obtain a license from a thirdparty for technology that it uses, we could incur substantial liabilities andbe forced to suspend the manufacture of products, or the use by our foundriesof certain processes.

 

**Employees**

 

As of December 31, 2004, we had 932 full-time and 139 part-timeand contract employees, including 628 full-time employees,  part-time and contract employees primarilyinvolved in research and development activities, 338 in marketing and sales, 66in finance, human resources, information systems, legal and administration, and39 in manufacturing control and quality assurance.  We have 210 full-time employees and 53part-time and contract employees based in Israel, of which 226 employees, includingboth full time and contract employees, are involved in engineering and researchand development.  We have 187 full timeemployees at our facilities in Sunnyvale, California, 146 employees at ourfacility in Woburn Massachusetts, and 178 full-time employees and 41 part-timecontract employees at our facilities in Shenzhen and Shanghai, China.  The remaining employees are located in ourinternational offices in Canada, Germany, England, Hong Kong, Japan, Korea andTaiwan.  We believe that our futuresuccess will depend in large part on our ability to attract and retain highly-skilled,engineering, managerial, sales and marketing personnel.  Competition for such personnel is intense.  Our employees are not represented by anycollective bargaining unit, and we have never experienced a work stoppage.  We believe that our employee relations aregood.

 

**Item2—Properties**

 

Our executive offices and principal marketing, sales and productdevelopment operations are located in approximately 89,000 square feet ofleased space in Sunnyvale, California, under a lease that expires inNovember 2006.  A significantportion of our research and development and engineering facilities and ouradministration, marketing and sales operations are located in approximately 61,350square feet of leased space in an industrial park in Haifa, Israel under alease expiring in May 2005.  We leasefacilities, primarily for sales, product development, and technical support, inWoburn, Massachusetts; Phoenix, Arizona; Manchester, England; Dortmund,Germany; Tokyo, Japan; Seoul, Korea; Taipei, Taiwan; and Shenzhen, Shanghai andHong Kong, China.  We believe that ourcurrent facilities are adequate for our needs for the foreseeable future andthat, should it be needed, suitable additional space in each of the locationsin which we operate will be available to accommodate expansion of ouroperations on commercially reasonable terms.

 

**Item3—Legal Proceedings**

 

We and our Oak subsidiaryhave initiated two legal actions against MediaTek, Inc. and customers ofMediaTek alleging that products incorporating certain MediaTek componentsinfringe three patents co-owned by Zoran and Oak relating to optical drivecontroller design and integrated CD/DVD controller design.

 

On March 11, 2004,Zoran and Oak filed a complaint with****theUnited States International Trade Commission (“ITC”) alleging that certainMediaTek DVD player and optical disk controller chips and chipsets, andproducts in which they are used, infringe Zoran’s and Oak’s patents.  In addition to MediaTek, the complaint named10 other proposed respondents that sell products, including DVD players and PCoptical storage devices that use MediaTek’s chips and chipsets.  The other proposed respondents were ASUSTekComputer.  Inc., Creative Labs, Inc.,Creative Technology, Ltd., 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.  The complaintrequested that the ITC institute an investigation of the accused products andissue exclusion and cease and desist orders prohibiting the importation intothe United States of the infringing MediaTek devices and products that containthem.  On April 8, 2004, the ITCinstituted an investigation based on Zoran’s complaint.  On

 

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April 28, 2004,Zoran and Oak reached a settlement with respondents Creative Technology, Ltd. andCreative Labs, Inc., and these respondents were subsequently dismissed from theinvestigation pursuant to the terms of the settlement agreement.  On July 13, 2004, the ITC granted Zoran’srequest that nine additional respondents be added to the investigation.  These additional respondents are ArtronixTechnology, ASUS Computer International, Audiovox Corporation, EPO Science andTechnology, Inc., Initial Technology, Inc., Micro-Star International Co., Ltd.,MSI Computer Corp., Shinco Digital Technology Ltd. and Ultima ElectronicsCorporation.  On October 26, 2004,MediaTek filed a motion for summary determination seeking an order that two ofthe asserted patents were invalid.  Thismotion was denied on November 18, 2004. On December 13, 2004, MediaTek filed another motion for summarydetermination seeking a similar order on different grounds.  This motion was denied on December 22,2004.  The hearing took place in February2005, and the target date for completion of the investigation isSeptember 14, 2005.

 

OnMarch 15, 2004, Zoran and Oak filed a complaint against MediaTek andMintek Digital in the United States District Court, Central District ofCalifornia alleging similar facts regarding infringement by MediaTek’s chipsand 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-ON Information Technology Corporation, Mintek Digital, ShincoInternational AV Co., Ltd., TEAC Corporation, TEAC America, Inc., TerapinTechnology 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 alleging that certain Zoran and Oak DVDplayer and optical disk controller chips and chipsets infringe two MediaTekpatents.  The complaint requested thatthe ITC institute an investigation into the accused products and issueexclusion and cease and desist orders prohibiting importation into the UnitedStates of allegedly infringing chips and products that contain them.  On August 26, 2004, the ITC institutedan investigation.  On September 24,2004, MediaTek filed a motion to amend the complaint to add one additionalpatent and to name Sunext Technology Co., Ltd. as a respondent.  This motion was granted on October 7,2004.  Discovery is currently underway.  On February 16, 2005, MediaTek filed amotion for leave to amend the complaint and notice of investigation to assertadditional claims of the MediaTek patents against Oak, Zoran and Sunext.  That motion was denied on March 4, 2005.  Discovery is currently open.  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 Zoran and Oak in the United StatesDistrict Court, District of Delaware alleging infringement of the same twopatents asserted in MediaTek’s ITC complaint and seeking monetary damages andinjunctive relief.  This action wasstayed by order of the court on October 4, 2004.

 

Based upon ourpreliminary review, we believe we have meritorious defenses to the two MediaTekcomplaints, which we believe were filed in response to the proceedings that wehave been prosecuting against MediaTek and its customers.  We intend to defend the MediaTek actionsvigorously.  However, the litigation isin the preliminary stage, and we cannot predict its outcome with certainty.  Patent litigation is particularly complex andcan extend for a protracted time, which can substantially increase litigationexpenses.

 

**Item 4—Submission of Matters to a Vote ofSecurity Holders**

 

We did not submit any mattersto a vote of our security holders during the fourth quarter of the year endedDecember 31, 2004.

 

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**Executive Officers**

 

The names of our executive officers and their ages as ofDecember 31, 2004 are as follows:

 
| **NAME**             | ** ** | **AGE** | ** ** | **POSITION**                                               |
|----------------------|------------|---------|------------|------------------------------------------------------------|
| Levy Gerzberg, Ph.D  |       | 60      |       | President, Chief Executive Officer and Director            |
| Camillo Martino      |       | 43      |       | Executive Vice President and Chief Operating Officer       |
| Karl Schneider       |       | 50      |       | Senior Vice President, Finance and Chief Financial Officer |
| Isaac Shenberg, Ph.D |       | 53      |       | Senior Vice President, Business and Strategic Development  |

 

*Levy Gerzberg* was aco-founder of Zoran in 1981 and has served as our President and Chief ExecutiveOfficer since December 1988 and as a director since 1981.  Dr.  Gerzbergalso served as our President from 1981 to 1984 and as our Executive VicePresident and Chief Technical Officer from 1985 to 1988.  Prior to co-founding Zoran, Dr. Gerzberg wasAssociate Director of Stanford University’s Electronics Laboratory.  Dr.  Gerzbergholds a Ph.D. in Electrical Engineering from Stanford University and an M.S. inMedical Electronics and a B.S. in Electrical Engineering from the Technion-IsraelInstitute of Technology in Haifa, Israel.

 

*Camillo Martino*joined Zoran as Executive Vice President and Chief Operating Officer inAugust 2001.  From January 2001through July 2001, Mr. Martino served as Chief Executive Officer ofMerinta Inc. engaged in the business of delivering integrated Linux-basedinternet appliance solutions to network operators.  From May 2000 to December 2000, Mr.Martino served as Marketing Director for National Semiconductor.  From February 2000 to May 2000, heserved as Vice President & General Manager—International Operationsfor Netpliance Inc., an internet appliance company.  From April 1987 throughFebruary 2000, Mr. Martino served in various marketing, applications engineering and business managementpositions for National Semiconductor.  Mr.Martino holds a Graduate Diploma in Digital Communications from MonashUniversity, and a B.App.Sc.  inElectrical Engineering from the University of Melbourne.

 

*Karl Schneider*joined Zoran as Corporate Controller in January 1998 and was elected VicePresident, Finance and Chief Financial Officer in July 1998 and SeniorVice President, Finance and Chief Financial Officer in July 2003.  From September 1996 through 1997, Mr. Schneiderserved as Controller for the Film Measurement and Robotics and IntegratedTechnologies divisions of KLA-Tencor, a semiconductor equipment company.  Mr. Schneider served as the CorporateController for SCM Microsystems, Inc. from October 1995 toSeptember 1996, Controller for Reply Corporation from January 1994 toSeptember 1995, Director of Finance for Digital F/X from October 1992to January 1994 and Controller for Flextronics from September 1987through June 1991.  Mr. Schneiderholds a B.S. in Business Administration from San Diego State University.

 

*Isaac Shenberg* hasserved as Senior Vice President, Business and Strategic Development sinceOctober 1998 and as Vice President, Sales and Marketing of Zoran fromJanuary 1995 through October 1998. From August 1990 to January 1995, Dr. Shenberg served as ourProduct Line Business Manager.  Prior tojoining Zoran, Dr. Shenberg was Images Processing Group manager and ElectroOptics Department manager at Rafael, a leading Aerospace provider in Israel.  Dr.  Shenbergholds a Ph.D. in Electrical Engineering from Stanford University and a B.S. andM.S. in Electrical Engineering from the Technion.

 

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**PART II**

 

**Item 5—Market for Registrant’s Common Stock and RelatedStockholder Matters**

 

We effected our initialpublic offering of our common stock on December 15, 1995.  Since that date, our common stock has beenquoted on the Nasdaq National Market under the symbol “ZRAN.” The followingtable sets forth the high and low closing sales price of our common stock asreported on The Nasdaq National Market for the periods indicated:

 
| ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| **2003**       |       |     |       |    |       |
| First Quarter  |       | $        | 17.47      |    | $          | 10.85 |   |
| Second Quarter |       | $        | 20.74      |    | $          | 12.65 |   |
| Third Quarter  |       | $        | 27.28      |    | $          | 19.57 |   |
| Fourth Quarter |       | $        | 20.94      |    | $          | 15.26 |   |
| **2004**       |       |     |       |    |       |
| First Quarter  |       | $        | 22.20      |    | $          | 15.70 |   |
| Second Quarter |       | $        | 18.89      |    | $          | 16.44 |   |
| Third Quarter  |       | $        | 18.50      |    | $          | 13.95 |   |
| Fourth Quarter |       | $        | 16.35      |    | $          | 9.85 |   |

 

As of December 31,2004, there were 342 holders of record of our common stock.

 

We have never paid cashdividends on our capital stock.  It isour present policy to retain earnings to finance the growth and development ofour business and, therefore, we do not anticipate paying any cash dividends inthe foreseeable future.

 

**Item6—Selected Financial Data**

 

The following selectedconsolidated financial data should be read in conjunction with the consolidatedfinancial statements and the notes thereto included elsewhere herein.

 
| ** **                                         | ** ** | **Year Ended December 31,**          | ** ** |
|----------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                         | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                         | ** ** | **(in thousands, except per share data)** | ** ** |
| **STATEMENT OF OPERATIONS DATA:**                  |       |                                      |       |   |   |   |   |   |   |   |   |
| Total revenues                                     |       | $                                         | 378,864    |   | $ | 216,528 |   | $ | 149,117 |   | $ | 107,709 |   | $ | 79,671 |   |
| Gross profit                                       |       | 152,629                                   |       | 85,477 |   | 62,213 |   | 42,969 |   | 41,678 |   |
| Operating income (loss)                            |       | (46,857                                   | )          | (72,004 | ) | 6,831 |   | (44,804 | ) | (27,867 | ) |
| Net income (loss)                                  |       | (47,354                                   | )          | (67,978 | ) | 5,698 |   | (36,065 | ) | (20,608 | ) |
| Diluted net income (loss) per share (1)            |       | $                                         | (1.11      | ) | $ | (2.05 | ) | $ | 0.20 |   | $ | (1.38 | ) | $ | (0.91 | ) |
| Shares used in diluted per share  calculations (1) |       | 42,788                                    |       | 33,231 |   | 28,629 |   | 26,190 |   | 22,605 |   |

 
| ** **                                         | ** ** | **As of December 31,** | ** ** |
|----------------------------------------------------|------------|-----------------------------|------------|
| ** **                                         | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                         | ** ** | **(in thousands)**          | ** ** |
| **BALANCE SHEET DATA:**                            |       |                        |       |   |   |   |   |   |   |   |   |
| Cash, cash equivalents and short-term  investments |       | $                           | 70,413     |   | $ | 126,366 |   | $ | 137,075 |   | $ | 110,105 |   | $ | 175,638 |   |
| Working capital                                    |       | 109,320                     |       | 146,810 |   | 159,732 |   | 130,777 |   | 197,719 |   |
| Total assets                                       |       | 599,281                     |       | 622,237 |   | 345,848 |   | 331,344 |   | 359,466 |   |
| Accumulated deficit                                |       | (203,824                    | )          | (156,470 | ) | (88,492 | ) | (94,190 | ) | (58,125 | ) |
| Total stockholders’ equity                    |       | $                           | 500,627    |   | $ | 534,279 |   | $ | 311,012 |   | $ | 297,838 |   | $ | 331,454 |   |

 

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(1)                                  See Note 2 of Notes to ConsolidatedFinancial Statements for a description of the computation of the number ofshares and net income (loss) per share.

 

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**Item 7—Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

**Restatement of Financial Results for Quarters EndedMarch 31, June 30 and September 30, 2004**

 

In connection with the review and evaluation of the effectiveness ofour internal control over financial reporting undertaken pursuant to Section404 of the Sarbanes-Oxley Act of 2002, management discovered that excess stockcompensation expenses had been recognized during the quarters ended March 31,June 30 and September 30, 2004.  Thecompensation expense was related to options that we had assumed as part of ouracquisition of Oak Technology, Inc. in 2003. Under purchase accounting, part of the cost relating to the acquisitionwas attributed to the assumed options and was to be recognized over time as theoptions continued to vest, based on each option holder’s continued employmentwith Zoran.  If an option holder’semployment terminated before the option was fully vested, vesting would cease,and we would no longer recognize compensation expense related to thatoption.  At the time of the acquisition,a schedule was prepared detailing the terms of each assumed option; however,the names of the option holders were omitted from the schedule for reasons ofconfidentiality.  After the acquisitionwas completed, we did not update our personnel or financial records to includethe omitted information. As a result, the Company improperly recognizeddeferred stock compensation expenses relating to options that had been held byformer Oak employees after the vesting of such options had ceased, and did notreverse stock based compensation expense recognized in excess of amounts thatactually vested.

 

To correct this error, we have restated the financial results that wepreviously reported for the quarters ended March 31, June 30 and September 30,2004.  For information about the effectsof the restatement, see Selected Quarterly Financial Information included inItem 8 of this annual report. The effect of the error on periods in 2003 wasnot material, and therefore, no adjustment was made for such periods.  The financial information included in Form10-Q and Form 8-K reports previously filed or furnished by Zoran for theseperiods should not be relied upon and are susperceded by the information inthis Form 10-K.

 

**Overview**

 

Prior to the acquisition of Oak Technology,Inc. on August 11, 2003, our products consisted of integrated circuits andrelated products used in digital versatile disc players, or DVDs, movie andhome theater systems, digital cameras and video editing systems.  As a result of the acquisition of Oak, we nowalso provide integrated circuits, software and platforms for digital televisionapplications that enable the delivery and display of digital video contentthrough a set-top box or television as well as digital imaging productsconsisting of semiconductor hardware and software that enable users to print,scan, process and transmit documents to computer peripherals that performprinting functions.  Subsequent to ouracquisition of Emblaze on July 8, 2004, we also provide highperformance, low-power application processors, technology and products for themultimedia mobile telephone market.

 

We derive most of our revenues from the saleof our integrated circuit products. Historically, average selling prices in the semiconductor industry ingeneral, and for our products in particular, have decreased over the life of aparticular product.  Average sellingprices for our hardware products have fluctuated substantially from period toperiod, primarily as a result of changes in our customer mix of originalequipment manufacturer, or OEM, sales versus sales to resellers and thetransition from low-volume to high-volume production.  In the past, we have periodically reduced theprices of some of our products in order to better penetrate the consumermarket.  We believe that, as our productlines continue to mature and competitive markets evolve, we are likely toexperience further declines in the average selling prices of our products,although we cannot predict the timing and amount of such future changes withany certainty.

 

Our cost of hardware product revenuesconsists primarily of fabrication costs, assembly and test costs, and the costof materials and overhead from operations. If we are unable to reduce our cost of hardware product revenues tooffset anticipated decreases in average selling prices, our product grossmargins will decrease.  Our hardwareproduct gross margin is also dependent on product mix and on the proportion ofproducts sold directly to our OEM customers versus indirectly through ourmarketing partners.  These marketingpartners purchase our products at lower prices but absorb most of theassociated marketing and sales support expenses, maintain inventories andprovide customer support and training. As a result, lower gross margins on sales to these resellers arepartially offset by reduced selling and marketing expenses related to suchsales.  We expect both product andcustomer mix to continue to fluctuate in future periods, causing furtherfluctuations in margins.

 

We also derive revenue from licensing oursoftware and other intellectual property. Licensing revenue includes one-time license fees and royalties based onthe number of units distributed by the licensee.  Quarterly licensing revenue can besignificantly affected by the timing of a small number of licensing transactions,each accounting for substantial revenues. Accordingly, licensing revenues have fluctuated, and will continue tofluctuate, on a quarterly basis.  Inaddition, we have historically generated a portion of our total revenues fromdevelopment contracts, primarily with key customers, although developmentrevenue has declined substantially as a percentage of total revenues over thepast several years.  These developmentcontracts have provided us with partial funding for the development of some ofour products.  These developmentcontracts provide for license and milestone payments which are recorded asdevelopment revenue.  We classify alldevelopment costs, including costs related to these development contracts, asresearch and

 

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development expenses.  We retain ownership of the intellectualproperty developed by us under these development contracts.  While we intend to continue to enter intodevelopment contracts with certain strategic partners, we expect developmentrevenue to continue to decline as a percentage of total revenues.

 

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

 

Our selling, general and administrativeexpenses consist primarily of employee-related expenses, sales commissions,product promotion and other professional services.  We expect that selling, general andadministrative expenses will continue to increase to support our anticipatedgrowth.

 

We conduct a material amount of our researchand development and certain sales and marketing and administrative operationsin our foreign subsidiary offices.  As aresult, some of our expenses are incurred in foreign currency.  To date, substantially all of our hardwareproduct revenues and our software and other revenues have been denominated inU.S. dollars and most costs of hardware product revenues have been incurred inU.S. dollars.  We expect that most of ourrevenues and costs of revenue will continue to be denominated and incurred inU.S. dollars for the foreseeable future. We have not experienced material losses or gains as a result of currencyexchange rate fluctuations and have not engaged in hedging transactions toreduce our exposure to such fluctuations. We may in the future elect to take action to reduce our foreign exchangerisk.

 

Our effective income tax rate has benefitedfrom the availability of net operating losses which we have utilized to reducetaxable income for U.S.  federal incometax purposes and by our Israel based subsidiary’s status as an “ApprovedEnterprise” under Israeli law, which provides a ten-year tax holiday for incomeattributable to a portion of our operations in Israel.  Our U.S. federal net operating losses expireat various times between 2004 and 2025, and the benefits from our subsidiary’sApproved Enterprise status expire at various times beginning in 2004.

 

On May 22, 2002, weeffected a three-for-two split of our common stock in the form of a fiftypercent stock dividend, paid to stockholders of record on May 7,2002.  All share and per shareinformation for all periods presented in this report are on a post-split basis.

 

**Statement Regarding Use ofNon-GAAP Financial Measures**

 

To supplement the consolidated financialresults prepared under generally accepted accounting principles (“GAAP”) weinclude non-GAAP financial measures in our Management’s Discussion andAnalysis, our quarterly press releases regarding operating results and ourpresentations to investors.  These non-GAAPfinancial measures consist of GAAP financial measures adjusted to include orexclude certain revenues, costs, expenses and gains associated withacquisitions.  The purpose of suchadjustment is to give an indication of our baseline performance before gains,losses or other charges that are considered by management to be outside of ourcore operating results.  In someinstances, we use financial measures that exclude the effects of the Oakacquisition to provide a meaningful comparison of results in periods occurringbefore and after that acquisition. Management uses these non-GAAP measures as a basis for planning andforecasting future periods.  Thesenon-GAAP measures may differ materially from the non-GAAP measures used byother companies and should not be regarded as a replacement for correspondingGAAP measures.

 

**Acquisitions**

 

*EmblazeSemiconductor Ltd.*

 

On July 8, 2004, we completed our acquisitionof Emblaze Semiconductor Ltd. (“Emblaze”), a wholly-owned subsidiary of Emblaze Ltd. for $54.2 millionin cash.  The acquisition was accountedfor under the purchase method of accounting.

 

Following the completion of the acquisition,the results of operations of Emblaze have been included in our consolidatedfinancial statements.  Accordingly, ourresults of operations for the year ended December 31, 2004 includesEmblaze’s operations from July 8, 2004, while such operations are not reflectedin our results of operations for the years ended December 31, 2002 and 2003.

 

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*OakTechnology, Inc.*

 

On August 11, 2003, we completed ouracquisition of Oak through the merger of Oak with a wholly-owned subsidiary ofZoran.  The acquisition was accounted forunder the purchase method of accounting.

 

Following the completion of the acquisition,the results of operations of Oak have been included in our consolidatedfinancial statements.  Accordingly, ourresults of operations for the year ended December 31, 2004 includes Oak’soperations for the full period, while our results of operations for the yearended December 31, 2003 only reflect Oak’s results of operations between August12, 2003 and December 31, 2003, and our results of operations for the yearended December 31, 2002 reflect only Zoran’s historical operations.

 

**Segments**

 

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

 

**Critical Accounting Policies and Estimates**

 

This discussion and analysisof our financial condition and results of operations are based upon ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States of America.  The preparation of these financial statementsrequires us to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosure ofcontingent assets and liabilities.  On anon-going basis, we evaluate our estimates, including bad debt, inventories,investments, intangible assets and income taxes.  We base these estimates on historicalexperience and on various other assumptions that we believe to be reasonableunder the circumstances.  The results ofthese estimates form the basis for making judgments about the carrying valuesof assets and liabilities that are not readily apparent from othersources.  Actual results may differ fromthese estimates under different assumptions or conditions.

 

We believe the followingcritical accounting policies affect our more significant judgments andestimates used in the preparation of our consolidated financial statements:

 

•                  We generally recognize product sales todistributors at the time of delivery. However, in some cases we grant rights of return or provide priceprotection arrangements.  When we areable to estimate the effect of such an arrangement, we establish a reserve forthe estimated adjustment and recognize the balance of the product revenueassociated with that arrangement upon shipment. When we cannot reasonably estimate the effect of such an arrangement, wedefer all revenue subject to the arrangement until the return right has lapsedor the price has become fixed.

 

•                  Revenue from development contracts isgenerally recognized as the services are performed based on the specificdeliverables outlined in each contract. Amounts received in advance of performance under contracts are recordedas deferred revenue and are generally recognized within one year fromreceipt.  Costs associated withdevelopment revenues are included primarily in research and development expenses.

 

•                  Inventories are recorded at the lower ofstandard cost, which approximates actual cost on a first-in-first-out basis, ormarket value.  We write down inventoriesto net realizable value based on forecasted demand and market conditions.  Actual demand and market conditions may bedifferent from those projected by our management.  This could have a material effect on ouroperating results and financial position. Inventory write-downs are not reversed and permanently reduce the costbasis of the affected inventory until such inventory is sold or scrapped.

 

•                  We maintain allowances for doubtful accountsfor estimated losses resulting from the inability of certain of our customersto make required payments.  Theseallowances are estimated based on both specific identification and facts andcircumstances with respect to each doubtful account as well as generalallowances estimated based on historical patterns of billing corrections,returned material authorizations and time lags in the realization of doubtfulaccounts and bad debts.  If the financialcondition of our customers were to deteriorate, resulting in an impairment oftheir ability to make payments, additional allowances may be required.

 

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•                  We hold minority interests in privatecompanies having operations or technology in areas within our strategicfocus.  At December 31, 2004, theseinvestments totaled $4.7 million. We record an investment impairment charge when we believe an investmenthas experienced a decline in value.  Weassess the value of this investment principally by using information acquiredfrom the investee, including historical and projected financial performance andrecent funding events.  Future adversechanges in market conditions or poor operating results of underlying investmentscould result in losses or an inability to recover the carrying value of theinvestments that may not be reflected in an investment’s current carrying valuethereby possibly requiring an impairment charge in the future.  In 2002, we recorded non-cash investmentimpairment charges of $2.4 million in conjunction with investments inprivate companies.

 

•                  We assess the impairment of goodwillannually, or more frequently if events or changes in circumstances indicatethat the carrying value of such assets exceeds their fair value.  We assess the carrying value of our longlived assets if events or circumstances indicate the carrying value of theassets exceeds the future undiscounted cash flows attributable to suchassets.  With respect to both goodwilland long lived assets, factors, which could trigger an impairment review,include significant negative industry or economic trends, exiting an activityin conjunction with a restructuring of operations, current, historical orprojected losses that demonstrate continuing losses associated with an asset ora significant decline in our market capitalization for an extended period oftime, relative to net book value. Impairment evaluations involve management estimates of asset usefullives and future cash flows.  Theseestimates include assumptions about future conditions such as future revenues,gross margins, operating expenses, the fair values of certain assets based onappraisals, and industry trends.  Actualuseful lives and cash flows could be different from those estimated by ourmanagement.  This could have a materialeffect on our operating results and financial position.

 

•                  We follow the liability method of accountingfor income taxes which requires recognition of deferred tax liabilities andassets for the expected future tax consequence of temporary differences betweenthe financial statement carrying amounts and the tax bases of assets andliabilities.  In the event actual resultsdiffer from these expectations, then the resulting impact to income would beassessed in the period such determination was made.  If it becomes likely that some portion or allof a deferred tax asset will not be realized, a valuation allowance isestablished.  This determination includesa process for providing estimates for future taxable income, and requires theuse of significant judgment.  Any futurerelease or adjustment to the valuation allowance is only made based upon achange in circumstances that triggers a change in judgment, about therealizability, with reasonable assurance, of the related deferred tax asset infuture years.

 

•                  With respect to, mergers and acquisitions weassess the technological feasibility of in process research and developmentprojects and determine the number of alternative future uses for the technologybeing developed.  To the extent there areno alternative future uses we allocate a portion of the purchase price toin-process R&D.  This expense isgenerally estimated based upon the projected fair value of the technology, asdetermined by a discounted future cash flow reduced by the cost tocomplete.  This includes certainestimates and assumptions made by management. For larger acquisitions, the company has historically hired an externalappraiser to assist with the assumptions and models used in this type ofanalysis.

 

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**Results of Operations**

 

The following table setsforth certain consolidated statement of operations data as a percentage oftotal revenues for the periods indicated and percentage changes from period toperiod:

 
| ** **                          | ** ** | ** **                        | ** ** | **Percentage change** | ** ** |
|-------------------------------------|------------|-----------------------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **Years ended December 31,** | ** ** | **2004 to  2003**     | ** ** | **2003 to  2002** | ** ** |
| ** **                          | ** ** | **2004**                          | ** ** | **2003**              | ** ** | **2002** | ** ** | ** ** | ** ** |
|                                |       |                              |       |                  |       |   |   |   |   |   |   |
| Revenues:                           |       |                              |       |                  |       |   |   |   |   |   |   |
| DVD hardware products               |       | 58.5                              | %          | 69.2                  | %          | 84.1 | % | 48.1 | % | 19.5 | % |
| DTV hardware products               |       | 7.5                               | %          | 5.9                   | %          | — |   |   | * |   | * |
| Mobile hardware products            |       | 8.3                               | %          | 13.4                  | %          | 10.7 | % | 8.5 | % | 81.4 | % |
| Imaging hardware products           |       | 9.0                               | %          | 4.0                   | %          | — |   |   | * |   | * |
| Total hardware product revenues     |       | 83.3                              | %          | 92.5                  | %          | 94.8 | % | 57.7 | % | 41.7 | % |
| Imaging software                    |       | 13.3                              | %          | 2.8                   | %          | — |   |   | * |   | * |
| Licensing, development and other    |       | 3.4                               | %          | 4.7                   | %          | 5.2 | % | 24.8 | % | 32.3 | % |
| Total software and other revenues   |       | 16.7                              | %          | 7.5                   | %          | 5.2 | % | 287.8 | % | 108.8 | % |
| Total revenues                      |       | 100.0                             | %          | 100.0                 | %          | 100.0 | % | 75.0 | % | 45.2 | % |
| Cost and expenses:                  |       |                              |       |                  |       |   |   |   |   |   |   |
| Cost of product sales               |       | 59.7                              | %          | 60.5                  | %          | 58.3 | % | 72.6 | % | 50.8 | % |
| Research and development            |       | 21.7                              | %          | 18.7                  | %          | 14.8 | % | 103.6 | % | 83.0 | % |
| Selling and administrative          |       | 17.7                              | %          | 19.3                  | %          | 16.7 | % | 60.7 | % | 68.0 | % |
| Amortization of intangible assets   |       | 12.0                              | %          | 8.8                   | %          | 5.6 | % | 139.4 | % | 132.5 | % |
| Deferred stock compensation         |       | 1.1                               | %          | 2.9                   | %          | — |   | (35.5 | )% |   | * |
| Restructuring expense               |       | 0.2                               | %          | —                |       | — |   | — |   | — |   |
| In-process research and development |       | —                            |       | 23.1                  | %          | — |   | — |   | — |   |
| Total costs and expenses            |       | 112.4                             | %          | 133.3                 | %          | 95.4 | % | 47.5 | % |   | * |
| Operating income (loss)             |       | (12.4                             | )%         | (33.3                 | )%         | 4.6 | % | (34.9 | )% |   | * |
| Interest income                     |       | 0.3                               | %          | 2.5                   | %          | 4.7 | % | (75.7 | )% | (23.6 | )% |
| Other income (loss), net            |       | —                            |       | —                |       | (4.4 | )% |   | * |   | * |
| Income (loss) before income taxes   |       | (12.1                             | )%         | (30.8                 | )%         | 4.9 | % | (31.2 | )% |   | * |
| Provision for income taxes          |       | 0.4                               | %          | 0.6                   | %          | 1.1 | % | 13.0 | % |   | * |
| Net income (loss)                   |       | (12.5                             | )%         | (31.4                 | )%         | 3.8 | % | (30.3 | )% |   | * |
|                                |       |                              |       |                  |       |   |   |   |   |   |   |
| Supplemental                        |       |                              |       |                  |       |   |   |   |   |   |   |
| Product gross margin                |       | 28.3                              | %          | 34.6                  | %          | 38.5 | % | 29.3 | % | 27.2 | % |

 

----

(*)  not meaningful

 

*Year Ended December 31, 2004 Compared to Year EndedDecember 31, 2003*

 

*Revenues. *Total revenues increased by $162.4 million,or 75%, to $378.9 million in 2004 from $216.5 million in 2003.  The increase in total revenues resultedprimarily from an increase in DVD segment revenues of $70.5 million, or 44.5%,and Imaging segment revenues of $69.7 million, or 473.5%.  DTV and Mobile segment revenues also grew in2004 by $15.3 million, or 109.8%, and $6.9 million, or 23.8%,respectively.  The increase in DVDsegment revenues was due to an increase in hardware product revenues of $72.0million due to increased unit sales of DVD products partially offset by adecrease in software and other revenues of $1.4 million.  The increase in revenues for both the Imagingand DTV segments were primarily due to the inclusion of these revenues from theformer Oak operations for the entire year in 2004, compared to approximatelyfour and a half months for 2003, subsequent to the Oak acquisition in August2003.  The increase in Mobile segmentrevenues was due to an increase in software and other revenues of $4.4 millionand increases in hardware product revenues of $2.5 million.  The increase in Mobile segment software andother revenues was primarily due to the Emblaze Semiconductor acquisition inJuly 2004.  The increase in Mobilesegment hardware product revenues was due to increased sales of Mobileproducts.

 

Hardware product revenuesincreased by $115.4 million, or 57.7%, to $315.7 million in 2004 from $200.3million in 2003.  The increase inhardware product revenues resulted from increases in the DVD segment of $72.0million, Imaging segment of $25.3 million, DTV

 

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segment of $15.7 million andthe Mobile segment of $2.5 million.  Boththe DVD and Mobile segments’ hardware product revenue increases were due to increasedunit shipments.  The increase in hardwareproduct revenues for both Imaging and DTV segments were primarily due to theinclusion of these revenues from the former Oak operations for the entire year,compared to approximately four and a half months for 2003.

 

Software and other revenuesincreased by $46.9 million, or 287.8%, to $63.2 million in 2004 from $16.3million in 2003.  The increase insoftware and other revenues resulted from an increase in the Imaging segment of$44.3 million, and the Mobile segment of $4.4 million partially offset bydecreases in the DVD segment of $1.4 million and the DTV segment of$400,000.  The increase in Imagingsegment software and other revenues was primarily due to the inclusion ofImaging revenues for the entire fiscal 2004 period as compared to approximatelyfour and a half months for 2003 subsequent to the Oak acquisition in August of2003.  The increase in Mobile segmentrevenues resulted from IP licensing agreements due to the Emblaze Semiconductoracquisition in July 2004.  The decreasefor the DVD segment was due to a reduction in IP licensing revenue.

 

*Cost of Hardware Product Revenues. *Cost of hardware product revenues was $226.2 million in 2004 comparedto $131.1 million in 2003.  The increasedcosts were primarily due to increased unit shipments.  As a percent of hardware product revenues,hardware product costs were 71.7% in 2004 compared with 65.4% for 2003.  The increase was primarily due to charges of$14.7 million for inventory write-downs of which $14.0 million was attributableto excess inventory of DVD products, $508,000 was attributable to products fromour discontinued CMOS image sensor product line and $200,000 from our otherproducts.

 

*Research and Development. *Research anddevelopment (“R&D”) expenses increased to $82.2 million in 2004 from$40.4 million in 2003, an increase of 103.6%.  This increase was driven primarily by themerger with Oak as well as the acquisition of Emblaze during July 2004.  Actual R&D expenses were offset in partby $1.5 million of research grants received from the Chief Scientist inIsrael which is recorded as an offset to R&D expense.  These grants are provided by the Israeligovernment to fund specific R&D projects. We are not obligated to repay the grants; however, future royalties maybe owed to the government if the R&D activities result in commercialproduct sales.  We remain committed toinvesting in research and development to enhance our technology and developmentcapabilities.

 

*Selling, General and Administrative. *Selling, general and administrative (“SG&A”) expenses increased to$67.1 million in 2004 from $41.8 million in 2003 representing a 60.7%increase.  This increase was primarily aresult of the inclusion of the Oak and Emblaze operations, increased legal feesrelated to our pending patent litigation with Mediatek, Inc., costs ofcompliance with provisions of the Sarbanes-Oxley Act of 2002 and continuedincreases in marketing and field application support expenses to supportrevenue growth in our Asia Pacific markets.

 

*Amortizationof Intangible Assets. *Amortization of intangible assets increasedto $45.4 million in 2004 from $19.0 million in 2003, an increase of139.4%.  This increase was due to theaddition of approximately $198 million of amortizable intangible assetsacquired in the Oak acquisition in August 2003, and $24.2 million ofamortizable intangible assets acquired in the Emblaze acquisition in July2004.  At December 31, 2004, we hadapproximately $160.3 million in net intangible assets acquired through the Oakand Emblaze acquisitions which we will continue to amortize on a straight linebasis through 2008.

 

*DeferredStock Compensation. *Deferred stock compensation was recordedprimarily as a result of stock options granted in connection with the Oakacquisition.  For the year ended December31, 2004, these charges were $4.1 million compared to $6.3 million during theprior year.  The 35.5% decrease forfiscal 2004 was due to the cancellation of options held by employees whoterminated their employment during the year and the lower amortizationassociated with the graded vesting under the FIN 28 model.  As of December 31, 2004, we had a deferredstock compensation balance of $2.8 million which will be amortized over theremaining vesting period using the multiple option approach through the quarterending September 30, 2007.

 

*RestructuringExpense. *During the year ended December 31, 2004, werecorded restructuring charges of $746,000 due to the discontinuation of theSensor product line of the Mobile group. This charge included $523,000 related to the reduction in force of 15employees for severance and other termination expenses, $173,000 for leaselosses on abandoned office space and other miscellaneous legal and consultingfees of approximately $50,000.  Therewere no payments made prior to December 31, 2004 related to these charges.  All remaining balances at December 31, 2004are expected to be paid out in cash. Amounts related to facilities will be paid over the lease terms throughJune 2007 and the remaining amounts are expected to be paid by the end of thefirst quarter of 2005.

 

*In-Process Research and Development. *There were no charges recorded for in-process research and developmentduring 2004.   In 2003, approximately$50.1 million of the purchase price of Oak was allocated to in-processresearch and development for five R&D projects in various product divisionswhich had not yet reached technological feasibility and had no alternativefuture use.  Accordingly, this amount wasimmediately expensed upon the acquisition date. This amount was determined using management’s estimates includingconsultation with an independent appraiser. The value of in-process research and development was determined usingthe multi-period excess earnings method by estimating the expected net cashflows from the projects once commercially viable and discounting the net cashflows back to their present value using a discount rate of 22%.  This rate was based on the industry segmentfor the technology, nature of the products to

 

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be developed, length of timeto complete the project and overall maturity and history of the developmentteam.  The net cash flows from theidentified projects were based on estimates of revenue, cost of revenue,research and development expenses, selling general and administrative expenses,and applicable income taxes.  Theseestimates did not take into account any potential synergies that could berealized as a result of the acquisition. Revenues for the incremental core technologies developed are expected tocommence in the fourth quarter of 2005 and extend through 2011.  Revenue projections were based on estimatesof market size and growth, expected trends in technology and the expectedtiming of new product introductions.  AtDecember 31, 2004, there have been no material variations from the underlyingassumptions that were used in the original computation of the value of theacquired in-process research and development. We expect that the in-process technologies will be successfullycompleted by the third quarter of calendar 2005 with approximately$3.4 million in costs remaining as of December 31, 2004.

 

*Operating Loss. *The significant operating loss of $46.9million in 2004 was primarily driven by the amortization of intangible assetsof $45.4 million, deferred stock compensation expense of $4.1 million, and the$14.7 million charge taken in the fourth quarter for inventory write downs ofwhich $508,000 was attributable to products from the discontinued CMOS imagesensor product line and $14.2 million attributable to excess inventoryprimarily related to DVD products. Absent these charges, the Company would have recorded operating incomeof $17.3 million for fiscal 2004.  Forfiscal 2003, the operating loss of $72.0 million was primarily the resultof a $50.1 million charge for in-process research and development expense,amortization of intangible assets of $19.0 million, deferred stockcompensation of $6.3 million and other non recurring acquisition relatedexpenses of $1.3 million (see SG&A discussion below).  Excluding these items, our operating incomewould have been $4.7 million for fiscal 2003.

 

*Interest Income. *Interest income decreased by $4.1 million to$1.3 million in 2004 compared to $5.4 million in 2003.  The reduction was a result of the loweraverage cash balances during 2004 due to the use of cash in the Oak acquisitionin August 2003 and in the Emblaze acquisition in July 2004.

 

*Provision for Income Taxes. *Excludingcharges related to the amortization of goodwill and the one time write down ofinventory of $14.5 million, our estimated effective tax rate was approximately9% for fiscal 2004 compared to the 10% recorded in 2003 based on net incomeexcluding the amortization of goodwill and write-off of acquired in-processresearch and development.  We currentlyanticipate that our effective tax rate will remain approximately 10% in 2005.

 

*Year Ended December 31, 2003 Compared to Year EndedDecember 31, 2002*

 

*Revenues. *Total revenues increased by $67.4 million, or45.2%, to $216.5 million in 2003 from $149.1 million in 2002.  The increase in total revenues resultedprimarily from an increase in DVD segment revenues of $26.6 million, or 20.1%,Imaging segment revenues of $14.7 million, DTV segment revenues of $13.1million and Mobile segment revenues of $13.0 million, or 80%.  The increase in DVD segment revenues was dueto an increase in hardware product revenues of $24.5 million and an increase insoftware and other revenues of $2.1 million. The increase in DVD hardware product revenues was due to increased salesof DVD products.  The revenues for boththe Imaging and DTV segments were the result of our acquisition of Oak inAugust 2003.  The increase in the Mobilesegment revenues was due to an increase in hardware product revenues based onincreased sales of Mobile products.

 

Hardware product revenuesincreased by $58.9 million, or 41.7%, to $200.2 million in 2003 from $141.3million in 2002.  The increase in hardwareproduct revenues resulted from an increase in the DVD segment of $24.5 million,Mobile segment of $13.0 million, DTV segment of $12.8 million and the Imagingsegment of $8.7 million.  Both the DVDand Mobile segments’ hardware product revenue increases were due to increasedunit shipments.  The hardware productrevenues for both the Imaging and DTV segments were the result of ouracquisition of Oak in August 2003.

 

Software and other revenuesincreased by $8.5 million, or 108.8%, to $16.3 million in 2003 from $7.8million in 2002.  The increase insoftware and other revenues resulted from increases in the Imaging segment of$6.0 million, and the DVD segment of $2.1 million.  The increase in Imaging segment software andother revenues was a result of our acquisition of Oak in August 2003.  The increase in DVD segment revenues was dueto increased royalty revenue.

 

*Cost of Hardware Product Revenues. *Cost of hardware product revenues was $131.1 million in 2003 comparedto $86.9 million in 2002.  The increasedcosts were primarily due to increased unit shipments.  As a percent of hardware product revenues,hardware product costs were 65.4% in 2003 compared with 61.5% for 2002.  The increase in hardware product costs as apercent of hardware product revenues was primarily due to lower average sellingprices for our DVD products partially offset by lower costs as a percent ofrevenue for our Mobile, Imaging and DTV products.

 

*Research and Development. *R&Dexpenses increased to $40.4 million in 2003 from $22.1 million in2002.  This increase was driven almostentirely by the merger with Oak including its investment in the emerging DTVbusiness.  With only 3% of this netincrease related to the legacy Zoran business, legacy R&D spending remainedrelatively flat in terms of absolute spending. Actual increases in R&D

 

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expenses were offset in partby $2.5 million of research grants received from the Chief Scientist inIsrael which is recorded as an offset to R&D expense.  These grants are provided by the Israeligovernment to fund specific R&D projects. We are not obligated to repay the grants; however, future royalties maybe owed to the government if the R&D activities result in commercialproduct sales.

 

*Selling, General and Administrative. *SG&A expenses increased to $41.8 million in 2003 from$24.8 million in 2001.  About 60% ofthis increase was due to the acquisition of Oak, and about 40% was due toincreases in our customer and application support in the Asia Pacific regionduring 2003.  A portion of the Oakspending was the result of non-recurring acquisition related expense of$1.3 million related to previous acquisition obligations of Oak assumed byZoran.  In general, these commitmentswere made to ensure the proper transfer of employee knowledge and intellectualproperty during the integration of the companies.  Excluding the effect of the Oak acquisition,the SG&A spending level of the legacy Zoran business was consistent atapproximately 17% of total revenues which was in line with revenue growth.

 

*Amortization of Intangible Assets. *Amortization of intangible assets increased from $8.2 million in2002 to $19.0 million in 2003.  Theamortization in 2002 related to intangible assets related to Zoran’s acquisitionof Nogatech and Pixelcam in 2000.  Theincrease during 2003 is due to the amortization of intangible assets acquiredfrom Oak.

 

*Deferred Stock Compensation. *These amountswere recorded primarily as a result of the Oak acquisition and arise due to aremeasurement of the intrinsic value of the assumed outstanding options of thetarget company at the date of the acquisition in accordance with purchaseaccounting and consistent with the multi-option method described in FASBInterpretation 28.  The fair value of theunvested options is then capitalized and amortized as deferred stockcompensation expense over the remaining respective vesting periods.

 

*In-Process Research and Development. *Approximately $50.1 million of the purchase price of Oak was allocatedto in-process research and development for five R&D projects in variousproduct divisions which had not yet reached technological feasibility and hadno alternative future use.  Accordingly,this amount was immediately expensed upon the acquisition date.  This amount was determined using management’sestimates including consultation with an independent appraiser.  The value of in-process research anddevelopment was determined using the multi-period excess earnings method byestimating the expected net cash flows from the projects once commerciallyviable and discounting the net cash flows back to their present value using adiscount rate of 22%.  This rate wasbased on the industry segment for the technology, nature of the products to bedeveloped, length of time to complete the project and overall maturity andhistory of the development team.  The netcash flows from the identified projects were based on estimates of revenue,cost of revenue, research and development expenses, selling general and administrativeexpenses, and applicable income taxes. These estimates did not take into account any potential synergies thatcould be realized as a result of the acquisition.  Revenues for the incremental coretechnologies developed are expected to commence in the fourth quarter of 2005and extend through 2011.  Revenueprojections were based on estimates of market size and growth, expected trendsin technology and the expected timing of new product introductions.

 

*Operating Loss. *The significant operating loss of$72.0 million in 2003 was driven primarily by a $50.1 million chargefor in-process research and development expense.  Excluding this charge and other acquisition-relatedexpenses including amortization of intangible assets of $19 million,deferred stock based compensation of $6.3 million, and other non recurringacquisition related expenses of $1.3 million, our operating income would havebeen $4.7 million, or 2.2% of total revenues.  This compares with an adjusted operatingincome of $15.3 million, or 10.2% of total revenues, in 2002 afterexcluding charges related to the amortization of intangibles of$8.2 million and deferred stock compensation of $300,000.

 

The decrease in operatingincome was due in large part to the acquisition of Oak and the negativeoperating contribution of $9.9 million made by the DTV segment, which wasin the early stages of commercial sales, and temporary operating losses (seebelow) of the Imaging division of $3.0 million.  Within the legacy Zoran business, the declinein DVD gross margins was partly offset by improved efficiencies in operatingexpenses and the $2.5 million in research and development grants from theChief Scientist in Israel.

 

*Interest Income. *Interest income decreased by$1.7 million to $5.4 million in 2003 compared to $7.1 million in2002.  The reduction was due to a declinein market interest rates and lower average cash balances due to the use of cashin the Oak acquisition in August.

 

*Provision for Income Taxes. *Excludingcharges related to the amortization of goodwill and the write-off of acquiredin-process research and development, our estimated effective tax rate was 10%for 2003 unchanged from 2002.

 

**Liquidity and Capital Resources**

 

At December 31, 2004,we had $37.4 million of cash and cash equivalents, $33.0 million ofshort-term investments and $52.8 million of investments that have maturitydates that are beyond one year and therefore are classified as otherassets.  At December 31, 2004, wehad $109.3 million of working capital.

 

Our operating activitiesused cash of $15.0 million during 2004, primarily due to an increase innet inventory of $32.3 million which was

 

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partially offset by$11.8 million of net income before non-cash related expenses includingamortization of intangibles, deferred stock compensation and depreciation.  The cash used in operations was also impactedby the increase in prepaid expenses and other assets of $6.6 million which wasoffset by increases in accounts payable, accrued expenses and other liabilitiestotaling $6.7 million as well as the reduction of net accounts receivable by$5.4 million.

 

Cash used in investingactivities was $3.5 million during 2004, principally reflecting the netproceeds from sales and maturities of investments totaling $58.0 millionoffset by the use of $54.2 million in the Emblaze acquisition.  In addition we spent $8.4 million forproperty and equipment which was offset by proceeds of approximately $978,000from the sale of a building in Taiwan.

 

Cash provided by financingactivities was $8.0 million during 2004 and consisted of proceeds receivedfrom issuances of common stock through exercises of employee stock options andemployee stock purchase programs.

 

Our operating activities providedcash of $8.8 million during 2003, primarily due to our $13.7 millionof net income before non-cash related expenses including amortization ofintangibles and deferred stock compensation, in-process research anddevelopment and depreciation.  The cashprovided from operations was reduced by net changes in current assets andliabilities of $7.2 million.  Theincrease in accounts receivable of $23.1 million was offset by decreases inprepaid expenses and other current assets of $11.4 million and net increases inaccounts payable, accrued expenses and other liabilities of $6.6 million.

 

Cash used in investingactivities was $9.6 million during 2003, principally reflecting thepurchase of short-term and long-term marketable investments, net of proceedsfrom sales and maturities of $40.7 million offset by the use of$40.8 million in the Oak acquisition. In addition we spent $9.4 million for property and equipment andintellectual property.

 

Cash provided by financingactivities was $17.2 million during 2003 and primarily consisted of$19.9 million received from issuances of common stock through exercises ofemployee stock options and employee stock purchase programs offset by$2.7 million paid on an installment note related to a previous technologyacquisition.

 

At December 31, 2004and 2003, we did not have any relationships with unconsolidated entities orfinancial partnerships, such as entities often referred to as structuredfinance or special purpose entities, established for the purpose of facilitatingoff-balance sheet arrangements or other contractually narrow or limitedpurposes.  Accordingly, we are notexposed to the type of financing, liquidity, market or credit risk that couldarise if we had engaged in such relationships.

 

The following is a summary offixed payments related to certain contractual obligations (in thousands):

 
| **Contractual  Obligation** | ** ** | **Total** | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** |
|-----------------------------|------------|-----------|------------|----------|------------|----------|------------|----------|------------|
|                        |       |      |       |     |       |     |       |     |       |
| Operating leases            |       | $         | 16,865     |     | $          | 8,255    |       | $        | 6,907      |   | $ | 1,703 |   |
| Purchase commitments        |       |      | 46,045     |     |       | 46,045   |       | —   |       | — |   |
| Total                       |       | $         | 62,910     |     | $          | 54,300   |       | $        | 6,907      |   | $ | 1,703 |   |

 

We believe that our current balances of cash,cash equivalents and short-term investments, and anticipated cash flow fromoperations, will satisfy our anticipated working capital and capitalexpenditure requirements at least through the next 12 months.  Nonetheless, our future capital requirementsmay vary materially from those now planned and will depend on many factorsincluding, but not limited to:

 

•                  the levels at which we maintain inventory andaccounts 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, capital expenditureand research and development plans and technology roadmap;

 

•                  volume pricing concessions;

 

•                  capital improvements to new and existingfacilities;

 

•                  technological advances;

 

•                  the response of competitors to our products;and

 

•                  our relationships with our suppliers andcustomers.

 

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

 

To the extent thatour existing resources and cash generated from operations are insufficient tofund our future activities, we may need to raise additional funds throughpublic or private financings or borrowings. If additional funds are raised through the issuance of debt securities,these securities could have rights, preferences and privileges senior toholders of common stock, and the terms of this debt could impose restrictionson our operations.  The sale ofadditional equity or convertible debt securities could result in additional

 

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dilution to ourstockholders.  We cannot be certain thatadditional financing will be available in amounts or on terms acceptable to us,if at all.  If we are unable to obtainthis additional financing, we may be required to reduce the scope of ourplanned product development and sales and marketing efforts, which could harmour business, financial condition and operating results.

 

**Future Performance and Risk Factors**

 

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

 

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

 

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

 

•                  fluctuation in demand for our products;

 

•                  the timing of new product introductions orenhancements 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 large customerorders;

 

•                  the length and variability of the sales cyclefor our products;

 

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

 

•                  the cyclical nature of the semiconductorindustry;

 

•                  the availability of development funding andthe timing of development revenue;

 

•                  changes in the mix of products sold;

 

•                  seasonality in demand for our products;

 

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

 

•                  the evolving and unpredictable nature of themarkets for products incorporating our integrated circuits and embeddedsoftware.

 

We expect that our operating results willcontinue to fluctuate in the future as a result of these factors and a varietyof other factors, including:

 

•                  the cost and availability of adequate foundrycapacity;

 

•                  fluctuations in manufacturing yields;

 

•                  changes in or the emergence of new industrystandards;

 

•                  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.

 

The operating results of the combined companycould also be harmed by:

 

•                  economic conditions generally or in variousgeographic 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;

 

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•                  changes in governmental regulations thatcould affect our products; or

 

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

 

These factors are difficult or impossible toforecast.  We place orders withindependent foundries several months in advance of the scheduled delivery date,often in advance of receiving 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 commonto the semiconductor industry are historically characterized by periods ofmanufacturing capacity shortages immediately followed by periods ofovercapacity, which are caused by the addition of manufacturing capacity inlarge increments.  We cannot predictwhether we will achieve timely, cost-effective access to that capacity whenneeded, or when there will be a capacity shortage again in the future.

 

As a result of these factors, our operatingresults may vary significantly from quarter to quarter.  Any shortfall in revenues or net income fromlevels expected by the investment community could cause a decline in thetrading price of our stock.

 

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

 

Because the markets that our customers serveare characterized by numerous new product introductions and rapid productenhancements, our operating results may vary significantly from quarter toquarter.  During the final production ofa mature product, our customers typically exhaust their existing inventory ofour products.  Consequently, orders forour products 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 to recoverthe lost sales from the discontinuation of the related mature product.  Our customers also experience significantseasonality in the sales of their consumer products, which affects their ordersof our products.  Typically, the secondhalf of the calendar year represents a disproportionate percentage of sales forour customers due to the holiday shopping period for consumer electronicsproducts, and therefore, a disproportionate percentage of our sales.  We expect these seasonal sales fluctuationsto continue for the foreseeable future.

 

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

 

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

 

**Our successfor the foreseeable future will be dependent on growth in demand for integratedcircuits for a limited number of applications.**

 

In recent years, we have derived asubstantial majority of our product revenues from the sale of integratedcircuits for DVD and digital camera applications.  We expect that sales of our products forthese applications will continue to account for a significant portion of ourrevenues for the foreseeable future.  Thefuture financial performance of the former Oak operations will depend on ourability to successfully develop and market new products in the digitaltelevision, HDTV and digital imaging markets. If the markets for these products and applications decline or fail todevelop as expected, or we are not successful in our efforts to market and sellour products to manufacturers who incorporate integrated circuits into theseproducts, our financial results will be harmed.

 

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

 

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

 

In the consumer electronic market, ourperformance has been dependent on our successful development and timelyintroduction of integrated circuits for DVD players, DVD recorders, digitalcameras, broadband digital television and HDTV. These markets are characterized by the incorporation of a steadilyincreasing level of integration and numbers of features on a chip at the sameor lower system cost, enabling original equipment manufacturers, or OEMs, tocontinually improve the features or reduce the prices of the systems theysell.  If we are unable to continuallydevelop and introduce integrated circuits with increasing levels of integrationand new features at competitive prices, our operating results will suffer.

 

In the digital office market, our performancehas been dependant on our ability to successfully develop embedded imageprocessing system on a chip, or SOC, solutions for the digital office market,in particular, embedded digital color copier technology and image processingchips for a variety of imaging peripherals, including printers andmulti-function peripherals, or MFPs. Among other technological changes, embedded PDF and color capability arerapidly emerging as market requirements for printers and other imaging devices.  Some of our competitors have the capacity tosupply these solutions, and some of their solutions have been well received inthe marketplace.  We face the challengeof developing new imaging products with the capability to handle greater colorand image complexity, including web-based documents, and work withhigher-performing devices in networked environments.  If we are unable to meet these challengeswith the development of products that can effectively compete in the OEMsoftware and solutions market, our future operating results could suffer.

 

**We mustkeep pace with rapid technological changes and evolving industry standards toremain competitive.**

** **

Our future success will depend on our abilityto anticipate and adapt to changes in technology and industry standards and ourcustomers’ changing demands.  Theconsumer electronics market, in particular, is characterized by rapidlychanging technology, evolving industry standards, frequent new productintroductions, short product life cycles and increasing demand for higherlevels of integration.  Our ability toadapt to these changes and to anticipate future standards, and the rate ofadoption and acceptance of those standards, will be a significant factor inmaintaining or improving our competitive position and prospects forgrowth.  If new industry standardsemerge, our products or the products of our customers could become unmarketableor obsolete, and we could lose market share or be required to incur substantialunanticipated costs to comply with these new standards.

 

Our success will also depend on thesuccessful development of new markets and the application and acceptance of newtechnologies and products in those new markets. For example, our success will depend on the ability of our customers todevelop new products and enhance existing products in the recordable DVD playermarket and products for the broadband digital television and HDTV markets andto introduce and promote those products successfully.  These markets may not continue to develop tothe extent or in the time periods that we currently anticipate due to factorsoutside our control, such as delays in implementation of FCC 02-320 requiringall new televisions to include a digital receiver.  If new markets do not develop as we anticipate,or if our products do not gain widespread acceptance in these markets, ourbusiness, financial condition and results of operations could be materially andadversely affected.  The emergence of newmarkets for our products is also dependent in part upon third partiesdeveloping and marketing content in a format compatible with commercial andconsumer 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 onindependent foundries and contractors for the manufacture, assembly and testingof our integrated circuits and other hardware products, and the failure of anyof these third parties to deliver products or otherwise perform as requestedcould damage our relationships with our customers and harm our sales andfinancial results.**

 

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

 

Our reliance on independent foundriesinvolves a number of risks, including:

 

•                  the inability to obtain adequatemanufacturing capacity;

 

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•                  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 yields andcost; and

 

•                  potential misappropriation of ourintellectual property.

 

In addition, TSMC and some of our otherfoundries are located in areas of the world that are subject to naturaldisasters such as earthquakes.  While the1999 earthquake in Taiwan did not have a material impact on our independentfoundries, a similar event centered near TSMC’s facility could severely reduceTSMC’s ability to manufacture our integrated circuits.  The loss of any of our manufacturers as asupplier, our inability to expand the supply of their products in response toincreased demand, or our inability to obtain timely and adequate deliveriesfrom our current or future suppliers due to a natural disaster or any otherreason could delay or reduce shipments of our products.  Any of these circumstances could damage ourrelationships with current and prospective customers and harm our sales andfinancial results.

 

We also rely on a limited number ofindependent contractors for the assembly and testing of our products.  Our reliance on independent assembly and testinghouses limits our control over delivery schedules, quality assurance andproduct cost.  Disruptions in theservices provided by our assembly or testing houses or other circumstances thatwould require them to seek alternative sources of assembly or testing couldlead to supply constraints or delays in the delivery of our products.  These constraints or delays could damage ourrelationships with current and prospective customers and harm our financialresults.

 

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

 

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

 

•                  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 sucharrangement in a timely fashion or at all, and such arrangements, if any, maynot be on terms favorable to us. Moreover, if we are able to secure foundry capacity, we may be obligatedto utilize all of that capacity or incur penalties.  Such penalties may be expensive and couldharm our financial results.

 

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**If ourindependent foundries do not achieve satisfactory yields, our relationshipswith our customers may be harmed.**

 

The fabrication of silicon wafers is acomplex process.  Minute levels ofcontaminants in the manufacturing environment, defects in photo masks used toprint circuits on a wafer, difficulties in the fabrication process or otherfactors can cause a substantial portion of the integrated circuits on a waferto be non-functional.  Many of theseproblems are difficult to detect at an early stage of the manufacturing processand may be time consuming and expensive to correct.  As a result, foundries often experienceproblems achieving acceptable yields, which are represented by the number ofgood integrated circuits as a proportion of the number of total integratedcircuits on any particular wafer.  Pooryields from our independent foundries would reduce our ability to deliver ourproducts to customers, harm our relationships with our customers and harm ourbusiness.

 

**We facecompetition or potential competition from companies with greater resources thanours, and if we are unable to compete effectively with these companies, ourmarket share may decline and our business could be harmed.**

 

We face intense competition in the markets inwhich we compete.  We expect that thelevel of competition will increase in the future from existing competitors andfrom other companies that may enter our existing or future markets withsolutions that may be less costly or provide higher performance or additionalfeatures.

 

Competition in Zoran’s core compressiontechnology market has historically been dominated by large companies, such asST Microelectronics, and companies that develop and use their ownintegrated circuits, such as Sony and Matsushita.  As this market continues to develop, we facecompetition from other large semiconductor vendors.

 

The DVD market continues to expand, andadditional competitors are expected to enter the market for DVD players andsoftware.  Some of these potentialcompetitors may develop captive implementations for use only with their own PCand consumer electronics products.  It isalso possible that application software vendors, such as Microsoft, may attemptto enter the DVD application market in the future.  This increased competition may result inprice reductions, reduced profit margins and loss of market share.

 

We face competition from several largesemiconductor companies in the broadband digital television and set-top boxmarkets.  We expect competition tocontinue to increase in these markets as industry standards become well knownand as other competitors enter these markets.

 

We also face significant competition in thedigital office market.  The future growthof the digital office market is highly dependent on OEMs continuing tooutsource an increasing portion of their product development work.  While the trend toward outsourcing on thepart of our OEM customers in this market has accelerated in recent years, anyreversal of this trend, or a change in the way they outsource, could seriouslyharm our business.

 

Many of our existing competitors, as well asOEM customers that are expected to compete with us in the future, havesubstantially greater financial, manufacturing, technical, marketing,distribution and other resources, broader product lines and longer standingrelationships with customers than we have. In addition, much of our future success is dependent on the success ofour OEM customers.  If we or our OEMcustomers are unable to compete successfully against current and futurecompetitors, we could experience price reductions, order cancellations andreduced gross margins, any one of which could harm our business.

 

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

 

Average selling prices for our productsdecline over relatively short time periods, while many of our manufacturingcosts are fixed.  When our averageselling prices decline, our revenues decline unless we are able to sell moreunits, and our gross margins decline unless we are able to reduce ourmanufacturing costs by a commensurate amount. Our operating results suffer when gross margins decline.  We have experienced these problems, and weexpect to continue to experience them in the future, although we cannot predictwhen they may occur or how severe they will be.

 

**We derivemost of our revenue from sales to a small number of large customers, and if weare not able to retain these customers, or they reschedule, reduce or cancelorders, our revenues would be reduced and our financial results would suffer.**

 

Our largest customers have accounted for asubstantial percentage of our revenues. In 2004, one customer accounted for 11% of our total revenues whilesales to our four largest customers accounted for 35% of our totalrevenues.   In 2003, two customersaccounted for 17% and 14% of our total revenues, respectively, while our fourlargest customers accounted for 46% of our total revenues.  Sales to these large customers have variedsignificantly from year to year and will continue to fluctuate in thefuture.  These sales also may fluctuatesignificantly from quarter to quarter. We may not be able to retain our key customers, or these customers maycancel purchase orders or reschedule or decrease their level of purchases fromus.  Any substantial decrease or delay insales to one or more of our key customers could harm our sales and financialresults.  In addition, any difficulty incollecting amounts due from one or more

 

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key customers could harm our financialresults.

 

**Ourproducts generally have long sales cycles and implementation periods, which increasesour costs in obtaining orders and reduces the predictability of our operatingresults.**

 

Our products are technologicallycomplex.  Prospective customers generallymust make a significant commitment of resources to test and evaluate ourproducts and to integrate them into larger systems.  As a result, our sales processes are oftensubject to delays associated with lengthy approval processes that typicallyaccompany the design and testing of new products.  The sales cycles of our products often lastfor many months or even years.  Longersales cycles require us to invest significant resources in attempting to makesales and delay the generation of revenue.

 

Long sales cycles also subject us to otherrisks, including customers’ budgetary constraints, internal acceptance reviewsand cancellations.  In addition, ordersexpected in one quarter could shift to another because of the timing ofcustomers’ purchase decisions.  The time requiredfor our customers to incorporate our products into their own can varysignificantly with the needs of our customers and generally exceeds severalmonths, which further complicates our planning processes and reduces thepredictability of our operating results.

 

**We are notprotected by long-term contracts with our customers.**

 

We generally do not enter into long-termpurchase contracts with our customers, and we cannot be certain as to futureorder levels from our customers. Customers generally purchase our products subject to cancelable short-termpurchase orders.  We cannot predictwhether our current customers will continue to place orders, whether existingorders will be canceled, or whether customers who have ordered products willpay invoices for delivered products. When we do enter into a long-term contract, the contract is generallyterminable at the convenience of the customer. In the event of an early termination by one of our major customers, itis unlikely that we will be able to rapidly replace that revenue source, whichwould harm our financial results.

 

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

 

The Federal Communications Commission, orFCC, has broad jurisdiction over our target markets in the digital televisionbusiness.  Various international entitiesor organizations may also regulate aspects of our business or the business ofour customers.  Although our products arenot directly subject to regulation by any agency, the transmission pipes, aswell as much of the equipment into which our products are incorporated, aresubject to direct government regulation. For example, before they can be sold in the United States, advancedtelevisions and emerging interactive displays must be tested and certified byUnderwriters Laboratories and meet FCC regulations.  Accordingly, the effects of regulation on ourcustomers or the industries in which our customers operate may in turn harm ourbusiness.  FCC regulatory policiesaffecting the ability of cable operators or telephone companies to offercertain services and other terms on which these companies conduct theirbusiness may impede sales of our products. In addition, our digital television business may also be adverselyaffected by the imposition of tariffs, duties and other import restrictions onour suppliers or by the imposition of export restrictions on products that wesell internationally.  Changes in currentlaws or regulations or the imposition of new laws or regulations in the UnitedStates or elsewhere could harm our business. For example, any delays by the FCC in imposing its pending requirementthat all new televisions have a digital receiver could have an adverse effecton our HDTV business.

 

**We aredependent upon our international sales and operations; economic, political ormilitary events in a country where we make significant sales or havesignificant operations could interfere with our success or operations there andharm our business.**

 

During 2004, only 9% of our total revenueswere derived from North America sales.  Weanticipate that international sales will continue to account for the majorityof our total revenues for the foreseeable future.  In addition, substantially all of oursemiconductor products are manufactured, assembled and tested outside of theUnited States by independent foundries and subcontractors.

 

We are subject to a variety of risks inherentin doing business internationally, including:

 

•                  unexpected changes in regulatoryrequirements;

 

•                  fluctuations in exchange rates;

 

•                  political and economic instability;

 

•                  imposition of tariffs and other barriers andrestrictions;

 

•                  the burdens of complying with a variety offoreign laws; and

 

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•                  health risks in a particular region.

 

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

 

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

 

The significant concentration of ourmanufacturing activities with third party foundries in Taiwan exposes us to therisk of political instability in Taiwan, including the potential for conflictbetween Taiwan and China.  We haveseveral significant OEM customers in Japan, Korea and other parts of Asia.  Adverse economic circumstances in Japan andelsewhere in Asia could affect these customers’ willingness or ability to dobusiness with us in the future or their success in developing and launching devicescontaining our products.

 

**Our businessand future operating results could be harmed by terrorist activity or armedconflict.**

 

Our business and operating results aresubject to uncertainties arising out of possible terrorist attacks on theUnited States and other regions of the world including locations where wemaintain operations and by armed conflict in the Middle East and relatedeconomic instability.  Our operationscould 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 in theMiddle East which could adversely affect our operations in Israel.

 

**The pricesof our products may become less competitive due to foreign exchangefluctuations.**

 

Foreign currency fluctuations may affect theprices of our products.  Prices for ourproducts are currently denominated in U.S. dollars for sales to our customersthroughout the world.  If there is asignificant devaluation of the currency in a specific country, the prices ofour products will increase relative to that country’s currency, and ourproducts may be less competitive in that country.  Also, we cannot be sure that ourinternational customers will continue to be willing to place orders denominatedin U.S. dollars.  If they do not, ourrevenue and operating results will be subject to foreign exchange fluctuations.

 

**Our abilityto compete could be jeopardized if we are unable to protect our intellectualproperty rights.**

 

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

 

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

 

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

 

**We areinvolved 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, management time has been, and will continue to be, expended.  In addition, both Oak and Zoran haveincurred, and we expect to continue to incur, substantial legal and otherexpenses in connection with these pending lawsuits.  No provision for any liability that mayresult upon adjudication of these lawsuits has been made in our financialstatements.

 

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

 

In recent years, there has been significantlitigation in the United States involving patents and other intellectualproperty rights.  In the past, Zoran andOak have been subject to claims and litigation regarding alleged infringementof other parties’ intellectual property rights, and both Oak and Zoran arecurrently parties to a number of patent-related lawsuits, both as plaintiff anddefendant.  We could become subject toadditional litigation in the future, either to protect our intellectualproperty or as a result of allegations that we infringe others’ intellectualproperty rights.  Claims that ourproducts infringe proprietary rights would force us to defend ourselves andpossibly our customers or manufacturers against the alleged infringement.  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 and wouldmanagement time and attention.  Pendingor future intellectual property litigation could force us to do one or more ofthe following:

 

•                  stop selling products that incorporate thechallenged 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 semiconductorindustry have often been settled through cross-licensing arrangements, we maynot be able in any or every instance to settle an alleged patent infringementclaim through a cross-licensing arrangement. We have a more limited patent portfolio than many of ourcompetitors.  If a successful claim ismade against us or any of our customers and a license is not made available tous on commercially reasonable terms or we are required to pay substantialdamages or awards, our business, financial condition and results of operationswould be materially adversely affected.

 

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

 

From time to time, we may be required tolicense technology from third parties to develop new products or productenhancements.  Third party licenses maynot be available on commercially reasonable terms, if at all.  If we are unable to obtain any third-partylicense required to develop new products and product enhancements, we may haveto obtain substitute technology of lower quality or performance standards or atgreater cost, either of which could seriously harm the competitiveness of ourproducts.

 

Certain technology used in our products islicensed from third parties, and in connection with these licenses, we arerequired to fulfill confidentiality obligations and, in some cases, payroyalties.  Some of our products requirevarious types of copy protection software that we must license from thirdparties.  If we are unable to obtain ormaintain our right to use the necessary copy protection software, we would beunable to sell and market these products.

 

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**If we arenot able to apply our net operating losses against taxable income in futureperiods, our financial results will be harmed.**

 

Our future net income and cash flow will beaffected by our ability to apply our net operating losses, or NOLs, againsttaxable income in future periods.  OurNOLs totaled approximately $271 million for federal and $93 millionfor state tax reporting purposes as of December 31, 2004.  As a result of the change of controlresulting from our initial public offering in 1995, the amount of NOLs that wecan use to reduce future taxable income for federal tax purposes is limited toapproximately $3.0 million per year. The Internal Revenue Code contains a number of provisions that couldlimit the use of NOLs against income of the combined company as a result of themerger or as a result of the combination of these transactions.  Our utilization of Oak’s NOLs may be furtherlimited due to prior Oak transactions. No opinion or IRS ruling has been sought regarding the potentialapplication of any of these provisions. Changes in tax laws in the United States may further limit our abilityto utilize these NOLs.  Any furtherlimitation on our ability to utilize these respective NOLs could harm ourfinancial condition.

 

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

 

We have made investments in, and acquisitionsof other complementary companies, products and technologies, and we may acquireadditional businesses, products or technologies in the future.  In the event of any future acquisitions, wecould:

 

•                  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 immediately orin the future.

 

Our operation of any other acquired businesswill also involve numerous risks, including:

 

•                  problems combining the purchased operations,technologies or products;

 

•                  unanticipated costs;

 

•                  diversion of management’s attention from ourcore 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, particularlythose of the purchased organizations.

 

We may not be able to successfully completethe integration of the business, products or technologies or personnel that wemight acquire in the future, and any failure to do so could disrupt ourbusiness and seriously harm our financial condition.

 

In addition, we have made minority equityinvestments in early-stage companies, and we expect to continue to reviewopportunities to make additional investments in such companies where we believesuch investments will provide us with opportunities to gain access to importanttechnologies or otherwise enhance important commercial relationships.  We have little or no influence over theearly-stage companies in which we have made or may make strategic, minority equityinvestments.  Each of these investmentsinvolves a high degree of risk.  We maynot be successful in achieving the technological or commercial advantage uponwhich any given investment is premised, and failure by the early-stage companyto achieve its own business objectives could result in a loss of all or part ofour invested capital and require us to write off all or a portion of suchinvestment.

 

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

 

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

 

36

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integration issues or other performanceproblems in our products could result in financial or other damages tocustomers or could damage market acceptance of such products.  Our customers could also seek damages from usfor their losses.  A product liabilityclaim brought against us, even if unsuccessful, would likely be time consumingand costly to defend.

 

**If we donot maintain current development contracts or are unable to enter into newdevelopment contracts, our business could be harmed.**

 

We historically have generated a portion ofour total revenues from development 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 needadditional funds to execute our business plan, and if we are unable to obtainsuch funds, we will not be able to expand our business as planned.**

 

We may require substantial additional capitalto finance our future growth, secure additional foundry capacity and fund ourongoing research and development activities beyond 2005.  Our capital requirements will depend on manyfactors, including:

 

•                  acceptance of and demand for our products;

 

•                  the types of arrangements that we may enterinto with our independent foundries;

 

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

 

•                  any additional acquisitions that we may make.

 

To the extent that our existing sources ofliquidity and cash flow from operations are insufficient to fund ouractivities, we may need to raise additional funds.  If we raise additional funds through theissuance of equity securities, the percentage ownership of our existingstockholders would be reduced.  Further,such equity securities may have rights, preferences or privileges senior tothose of our common stock.  Additionalfinancing may not be available to us when needed or, if available, it may notbe available on terms favorable to us.

 

**If we failto manage our future growth, if any, our business would be harmed.**

 

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

 

**We rely onthe services of our executive officers and other key personnel, whose knowledgeof our business and industry would be extremely difficult to replace.**

 

Our success depends to a significant degreeupon the continuing contributions of our senior management.  Management and other employees may voluntarilyterminate their employment 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.

 

37

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**The Israelirate of inflation may negatively impact our costs if it exceeds the rate ofdevaluation of the new Israeli shekel against the United States dollar.**

 

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 bearthe risk that the rate of inflation in Israel will exceed the rate ofdevaluation of the new Israeli shekel in relation to the United States dollar,which will increase our costs as expressed in United States dollars.  To date, we have not engaged in hedgingtransactions.  In the future, we mayenter into currency hedging transactions to decrease the risk of financialexposure from fluctuations in the exchange rate of the United States dollar againstthe new Israeli shekel.  These measuresmay not adequately protect us from the impact of inflation in Israel.

 

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

 

Historically, we have financed a portion ofour research and development activities with grants for research anddevelopment from the Chief Scientist in Israel’s Ministry of Industry and Trade.  We earned proceeds from such grants in 2003and 2004 and we plan to seek additional grants from the Chief Scientist in thefuture.  To be eligible for these grants,our development projects must be approved by the Chief Scientist on acase-by-case basis.  If our developmentprojects are not approved by the Chief Scientist, we will not receive grants tofund these projects, which would increase our research and 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.

 

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

 

Our certificate of incorporation and bylawsand Delaware law contain provisions that could make it more difficult for athird party to acquire us, even if doing so would be beneficial to our stockholders.  These include provisions:

 

•                  prohibiting a merger with a party that hasacquired 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 to 3,000,000shares of “blank check” preferred stock;

 

•                  eliminating stockholders’ rights to call aspecial meeting of stockholders; and

 

•                  requiring advance notice of any stockholdernominations of candidates for election to our board of directors.

 

**Our stockprice has fluctuated and may continue to fluctuate widely.**

 

The market price of our common stock hasfluctuated significantly since our initial public offering in 1995.  Between January 1, 2004 and December 31,2004, the closing sale price of our common stock, as reported on The NasdaqNational Market, ranged from a low of $9.85 to a high of $22.20.  The market price of our common stock issubject to significant fluctuations in the future in response to a variety offactors, including:

 

•                  announcements concerning our business or thatof our competitors or customers;

 

•                  quarterly variations in operating results;

 

•                  changes in analysts’ earnings estimates;

 

•                  announcements of technological innovations;

 

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

 

•                  loss of key personnel;

 

•                  proprietary rights or other litigation;

 

38

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•                  general conditions in the semiconductorindustry; and

 

•                  developments in the financial markets.

 

In addition, the stock market has, from timeto time, experienced extreme price and volume fluctuations that haveparticularly affected the market prices for semiconductor companies ortechnology companies generally and which have been unrelated to the operatingperformance of the affected companies.  Broadmarket fluctuations of this type may reduce the future market price of ourcommon stock.

 

**Item7A****—Quantitativeand Qualitative Disclosures about Market Risks**

 

We are exposedto financial market risks including changes in interest rates and foreigncurrency exchange rates.

 

The fair valueof our investment portfolio or related income would not be significantlyimpacted by either a 10% increase or decrease in interest rates due mainly tothe short-term nature of the major portion of our investment portfolio.

 

A majority ofour revenue and capital spending is transacted in U.S. dollars, although aportion of the cost of our operations, relating mainly to our personnel andfacilities in Israel, is incurred in New Israeli 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 hedging transactions to reduce ourexposure to fluctuations that may arise from changes in foreign exchange rates.  Based on our overall currency rate exposureat December 31, 2004, a near-term 10% appreciation or depreciation of theNew Israeli Shekel would have an immaterial affect on our financial condition.

 

39

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**Item8****—FinancialStatements and Supplemental Data**

 

**Index to Consolidated Financial Statements**

 
| Report of Independent Registered Public  Accounting Firm                                               |   |
|--------------------------------------------------------------------------------------------------------|--------|
| Consolidated Balance Sheets as of December 31, 2004 and 2003                                           |   |
| Consolidated Statements of Operations for  each of the three years ended December 31, 2004        |   |
| Consolidated Statements of Stockholders’  Equity for the three years ended December 31, 2004 |   |
| Consolidated Statements of Cash Flows for  each of the three years ended December 31, 2004        |   |
| Notes to Consolidated Financial Statements                                                             |   |

 

40

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

 

 

To****the Board ofDirectors and Stockholders of Zoran Corporation

 

We have completed an integrated audit ofZoran Corporation’s 2004 consolidated financial statements and of its internalcontrol over financial reporting as of December 31, 2004 and audits of its 2003and 2002 consolidated financial statements in accordance with the standards ofthe Public Company Accounting Oversight Board (United States).  Ouropinions, based on our audits, are presented below.

 

Consolidated financial statements 

 

In our opinion, the consolidated financial statements listed in the accompanying index, present fairly,in all material respects, the financial position of Zoran Corporation and its subsidiariesat December 31, 2004 and 2003, and the results of their operations and theircash flows for each of the three years in the period ended December 31, 2004****in conformity with accounting principles generally acceptedin the United States of America. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements based on our audits.  Weconducted our audits of these statements in accordance with the standards ofthe Public Company Accounting Oversight Board (United States).  Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit of financial statements includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements,assessing the accounting principles used and significant estimates made bymanagement, and evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

Internal control over financial reporting

 

Also, in our opinion, management’s assessment, included in Management’sReport on Internal Control Over Financial Reporting appearing under Item 9A,that the Company maintained effective internal control over financial reportingas of December 31, 2004 based on criteria established in *InternalControl - Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO), is fairly stated, in allmaterial respects, based on those criteria. Furthermore, in our opinion, theCompany maintained, in all material respects, effective internal control overfinancial reporting as of December 31, 2004, based on criteria established in *Internal Control - Integrated Framework* issued by the COSO.  The Company’s management is responsible formaintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financialreporting.  Our responsibility is toexpress opinions on management’s assessment and on the effectiveness ofthe Company’s internal control over financial reporting based on our audit. Weconducted our audit of internal control over financial reporting in accordancewith the standards of the Public Company Accounting Oversight Board (UnitedStates).  Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects.  An audit of internalcontrol over financial reporting includes obtaining an understanding ofinternal control over financial reporting, evaluating management’s assessment,testing and evaluating the design and operating effectiveness of internalcontrol, and performing such other procedures as we consider necessary in thecircumstances.  We believe that our auditprovides a reasonable basis for our opinions.

 

A company’s internal control over financialreporting is a process designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with generally accepted accountingprinciples.  A company’s internal controlover financial reporting includes those policies and procedures that(i) pertain to the maintenance of records that, in reasonable detail,accurately and fairly reflect the transactions and dispositions of the assetsof the company; (ii) provide reasonable assurance that transactions arerecorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that receipts andexpenditures of the company are being made only in accordance withauthorizations of management and directors of the company; and(iii) provide reasonable assurance regarding prevention or timelydetection of unauthorized acquisition, use, or disposition of the company’sassets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internalcontrol over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

 

 

PRICEWATERHOUSECOOPERS LLP

 

San Jose, California

March 31, 2005

 

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**ZORAN CORPORATION**

**CONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                                                                                                                                                                                              | ** ** | **December 31,  2004** | ** ** | **December 31,  2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ASSETS                                                                                                                                                                                                                                                                  |       |                   |       |                   |       |
| Current assets:                                                                                                                                                                                                                                                         |       |                   |       |                   |       |
| Cash and cash equivalents                                                                                                                                                                                                                                               |       | $                      | 37,435     |                   | $          | 47,994 |   |
| Short-term investments                                                                                                                                                                                                                                                  |       | 32,978                 |       | 78,372                 |       |
| Accounts receivable, net of allowance for  doubtful accounts of $1,409 and $1,234, respectively                                                                                                                                                                         |       | 59,863                 |       | 65,224                 |       |
| Inventory                                                                                                                                                                                                                                                               |       | 50,033                 |       | 16,805                 |       |
| Prepaid expenses and other current assets                                                                                                                                                                                                                               |       | 14,130                 |       | 12,151                 |       |
| Total current assets                                                                                                                                                                                                                                                    |       | 194,439                |       | 220,546                |       |
| Property and equipment, net                                                                                                                                                                                                                                             |       | 17,190                 |       | 20,029                 |       |
| Other assets and investments                                                                                                                                                                                                                                            |       | 68,619                 |       | 73,686                 |       |
| Goodwill                                                                                                                                                                                                                                                                |       | 150,151                |       | 119,091                |       |
| Intangible assets, net                                                                                                                                                                                                                                                  |       | 168,882                |       | 188,885                |       |
|                                                                                                                                                                                                                                                                    |       | $                      | 599,281    |                   | $          | 622,237 |   |
|                                                                                                                                                                                                                                                                    |       |                   |       |                   |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                               |       |                   |       |                   |       |
| Current liabilities:                                                                                                                                                                                                                                                    |       |                   |       |                   |       |
| Accounts payable                                                                                                                                                                                                                                                        |       | $                      | 34,017     |                   | $          | 29,038 |   |
| Accrued expenses and other liabilities                                                                                                                                                                                                                                  |       | 51,102                 |       | 44,698                 |       |
| Total current liabilities                                                                                                                                                                                                                                               |       | 85,119                 |       | 73,736                 |       |
| Other long-term liabilities                                                                                                                                                                                                                                             |       | 13,535                 |       | 14,222                 |       |
| Stockholders’ equity:                                                                                                                                                                                                                                              |       |                   |       |                   |       |
| Common stock, $0.001 par value; 105,000,000  shares authorized at December 31, 2004 and December 31, 2003;  43,195,432 shares issued and outstanding as of December 31, 2004; and  42,347,584 shares issued and outstanding as of December 31, 2003 |       | 43                     |       | 42                     |       |
| Additional paid-in capital                                                                                                                                                                                                                                              |       | 705,661                |       | 703,812                |       |
| Deferred stock-based compensation                                                                                                                                                                                                                                       |       | (2,791                 | )          | (13,014                | )          |
| Accumulated other comprehensive income  (loss)                                                                                                                                                                                                                          |       | 1,538                  |       | (91                    | )          |
| Accumulated deficit                                                                                                                                                                                                                                                     |       | (203,824               | )          | (156,470               | )          |
| Total stockholders’ equity                                                                                                                                                                                                                                         |       | 500,627                |       | 534,279                |       |
|                                                                                                                                                                                                                                                                    |       | $                      | 599,281    |                   | $          | 622,237 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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**ZORAN CORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

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

 
| ** **                                                  | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                  | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                        |       |                        |       |   |   |   |   |
| Revenues:                                                   |       |                        |       |   |   |   |   |
| Hardware product revenues                                   |       | $                           | 315,697    |   | $ | 200,239 |   | $ | 141,314 |   |
| Software and other revenues                                 |       | 63,167                      |       | 16,289 |   | 7,803 |   |
| Total revenues                                              |       | 378,864                     |       | 216,528 |   | 149,117 |   |
| Costs and expenses:                                         |       |                        |       |   |   |   |   |
| Cost of hardware product revenues                           |       | 226,235                     |       | 131,051 |   | 86,904 |   |
| Research and development                                    |       | 82,245                      |       | 40,402 |   | 22,083 |   |
| Selling, general and administrative                         |       | 67,086                      |       | 41,748 |   | 24,856 |   |
| Amortization of intangible assets                           |       | 45,358                      |       | 18,950 |   | 8,151 |   |
| Deferred stock compensation                                 |       | 4,051                       |       | 6,281 |   | 292 |   |
| Restructuring expense                                       |       | 746                         |       | — |   | — |   |
| In-process research and development                         |       | —                      |       | 50,100 |   | — |   |
| Total costs and expenses                                    |       | 425,721                     |       | 288,532 |   | 142,286 |   |
| Operating income (loss)                                     |       | (46,857                     | )          | (72,004 | ) | 6,831 |   |
| Interest income                                             |       | 1,307                       |       | 5,388 |   | 7,053 |   |
| Other income (loss), net                                    |       | (264                        | )          | 1 |   | (6,614 | ) |
| Income (loss) before income taxes                           |       | (45,814                     | )          | (66,615 | ) | 7,270 |   |
| Provision for income taxes                                  |       | 1,540                       |       | 1,363 |   | 1,572 |   |
| Net income (loss)                                           |       | $                           | (47,354    | ) | $ | (67,978 | ) | $ | 5,698 |   |
|                                                        |       |                        |       |   |   |   |   |
| Basic net income (loss) per share                           |       | $                           | (1.11      | ) | $ | (2.05 | ) | $ | 0.21 |   |
|                                                        |       |                        |       |   |   |   |   |
| Diluted net income (loss) per share                         |       | $                           | (1.11      | ) | $ | (2.05 | ) | $ | 0.20 |   |
|                                                        |       |                        |       |   |   |   |   |
| Shares used to compute basic net income  (loss) per share   |       | 42,788                      |       | 33,231 |   | 27,095 |   |
|                                                        |       |                        |       |   |   |   |   |
| Shares used to compute diluted net income  (loss) per share |       | 42,788                      |       | 33,231 |   | 28,629 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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**ZORAN CORPORATION**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’EQUITY**

**(in thousands)**

 
| ** **                                                                             | ** ** | ** **        | ** ** | ** **  | ** ** | ** **     | ** ** | ** **      | ** ** | ** **        | ** ** | **Accumulated**    | ** ** | ** **  | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------------------------|------------|-------------------|------------|-------------|------------|----------------|------------|-----------------|------------|-------------------|------------|--------------------|------------|-------------|------------|------------|------------|
| ** **                                                                             | ** ** | ** **        | ** ** | ** **  | ** ** | **Additional** | ** ** | ** **      | ** ** | **Deferred**      | ** ** | **Other**          | ** ** | ** **  | ** ** | ** ** | ** ** |
| ** **                                                                             | ** ** | **Common  Stock** | ** ** | **Paid-In** | ** ** | ** **     | ** ** | **Stock-Based** | ** ** | **Comprehensive** | ** ** | **Accumulated**    | ** ** | ** **  | ** ** |
| ** **                                                                             | ** ** | **Shares**        | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Warrants**    | ** ** | **Compensation**  | ** ** | **Income  (Loss)** | ** ** | **Deficit** | ** ** | **Total**  | ** ** |
|                                                                                   |       |              |       |        |       |           |       |            |       |              |       |               |       |        |       |       |       |
| Balance at  December 31, 2001                                                          |       | 26,703            |       | $           | 27         |           | $          | 391,665         |       | $                 | 717        |               | $          | (375        | )          | $          | (6         | ) | $ | (94,190 | ) | $ | 297,838 |   |
| Issuance of  common stock                                                              |       | 692               |       | —      |       | 6,670          |       | —          |       | —            |       | —             |       | —      |       | 6,670      |       |
| Expiration of  warrant                                                                 |       | —            |       | —      |       | 717            |       | (717            | )          | —            |       | —             |       | —      |       | —     |       |
| Amortization of  deferred stock-based compensation                                     |       | —            |       | —      |       | —         |       | —          |       | 292               |       | —             |       | —      |       | 292        |       |
| Change in  unrealized gain (loss) on securities available for sale                     |       | —            |       | —      |       | —         |       | —          |       | —            |       | 514                |       | —      |       | 514        |       |
| Net Income                                                                             |       | —            |       | —      |       | —         |       | —          |       | —            |       | —             |       | 5,698       |       | 5,698      |       |
| Balance at  December 31, 2002                                                          |       | 27,395            |       | 27          |       | 399,052        |       | —          |       | (83               | )          | 508                |       | (88,492     | )          | 311,012    |       |
| Issuance of  common stock                                                              |       | 1,773             |       | 2           |       | 19,865         |       | —          |       | —            |       | —             |       | —      |       | 19,867     |       |
| Issuance of  common stock in conjunction with the acquisition of Oak Technology, Inc.  |       | 13,180            |       | 13          |       | 227,449        |       | —          |       | —            |       | —             |       | —      |       | 227,462    |       |
| Issuance of stock  options in conjunction with the acquisition of Oak Technology, Inc. |       | —            |       | —      |       | 57,446         |       | —          |       | (19,212           | )          | —             |       | —      |       | 38,234     |       |
| Amortization of  deferred stock-based compensation                                     |       | —            |       | —      |       | —         |       | —          |       | 6,281             |       | —             |       | —      |       | 6,281      |       |
| Change in  unrealized gain (loss) on securities available for sale                     |       | —            |       | —      |       | —         |       | —          |       | —            |       | (599               | )          | —      |       | (599       | )          |
| Net loss                                                                               |       | —            |       | —      |       | —         |       | —          |       | —            |       | —             |       | (67,978     | )          | (67,978    | )          |
| Balance at  December 31, 2003                                                          |       | 42,348            |       | 42          |       | 703,812        |       | —          |       | (13,014           | )          | (91                | )          | (156,470    | )          | 534,279    |       |
| Issuance of  common stock                                                              |       | 847               |       | 1           |       | 8,021          |       | —          |       | —            |       | —             |       | —      |       | 8,022      |       |
| Amortization of  deferred stock-based compensation, net                                |       | —            |       | —      |       | (6,172         | )          | —          |       | 10,223            |       | —             |       | —      |       | 4,051      |       |
| Change in unrealized  gain (loss) on securities available for sale                     |       | —            |       | —      |       | —         |       | —          |       | —            |       | 1,629              |       | —      |       | 1,629      |       |
| Net loss                                                                               |       | —            |       | —      |       | —         |       | —          |       | —            |       | —             |       | (47,354     | )          | (47,354    | )          |
| Balance at  December 31, 2004                                                          |       | 43,195            |       | $           | 43         |           | $          | 705,661         |       | $                 | —     |               | $          | (2,791      | )          | $          | 1,538      |   | $ | (203,824 | ) | $ | 500,627 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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**ZORAN CORPORATION**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**

 
| ** **                                                                            | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                            | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                                                  |       |                        |       |   |   |   |   |
| Cash flows from operating activities:                                                 |       |                        |       |   |   |   |   |
| Net income (loss)                                                                     |       | $                           | (47,354    | ) | $ | (67,978 | ) | $ | 5,698 |   |
| Adjustments to reconcile net income (loss)  to net cash provided by operations:       |       |                        |       |   |   |   |   |
| Depreciation and amortization                                                         |       | 9,754                       |       | 6,367 |   | 3,247 |   |
| Amortization of intangible assets                                                     |       | 45,358                      |       | 18,950 |   | 8,151 |   |
| Amortization of deferred stock compensation                                           |       | 4,051                       |       | 6,281 |   | 292 |   |
| In-process research and development                                                   |       | —                      |       | 50,100 |   | — |   |
| Investment impairment charges                                                         |       | —                      |       | — |   | 6,045 |   |
| Allowance for doubtful accounts                                                       |       | 175                         |       | 640 |   | 125 |   |
| Allowance for inventory                                                               |       | 14,680                      |       | 1,653 |   | 790 |   |
| Realized loss on exchange of marketable  securities                                   |       | —                      |       | — |   | 696 |   |
| Changes in current assets and liabilities,  net of effect of acquisitions:            |       |                        |       |   |   |   |   |
| Accounts receivable                                                                   |       | 5,188                       |       | (23,126 | ) | (2,218 | ) |
| Inventory                                                                             |       | (47,022                     | )          | (2,096 | ) | 2,205 |   |
| Prepaid expenses and other current assets  and other assets                           |       | (6,600                      | )          | 11,416 |   | (1,349 | ) |
| Accounts payable                                                                      |       | 4,595                       |       | 11,942 |   | (7,816 | ) |
| Accrued expenses and other liabilities                                                |       | 2,135                       |       | (5,370 | ) | 2,812 |   |
| Net cash provided by (used in) operating  activities                                  |       | (15,040                     | )          | 8,779 |   | 18,678 |   |
| Cash flows from investing activities:                                                 |       |                        |       |   |   |   |   |
| Capital expenditures for property and  equipment                                      |       | (8,401                      | )          | (6,165 | ) | (1,983 | ) |
| Proceeds from sale of property and  equipment                                         |       | 978                         |       | — |   | — |   |
| Purchases of investments                                                              |       | (117,209                    | )          | (161,028 | ) | (155,354 | ) |
| Proceeds from sales and maturities of  investments                                    |       | 175,252                     |       | 205,192 |   | 144,990 |   |
| Purchases of intellectual property                                                    |       | —                      |       | (3,218 | ) | (1,681 | ) |
| Purchases of long-term equity investments                                             |       | —                      |       | (3,500 | ) | — |   |
| Acquisition of Emblaze, net of cash  acquired                                         |       | (54,161                     | )          | — |   | — |   |
| Acquisition of Oak Technology, Inc., net of  cash acquired                            |       | —                      |       | (40,840 | ) | — |   |
| Net cash used in investing activities                                                 |       | (3,541                      | )          | (9,559 | ) | (14,028 | ) |
| Cash flows from financing activities:                                                 |       |                        |       |   |   |   |   |
| Proceeds from issuance of common stock                                                |       | 8,022                       |       | 19,867 |   | 6,670 |   |
| Installment payment on purchased core  technology                                     |       | —                      |       | (2,700 | ) | — |   |
| Net cash provided by financing activities                                             |       | 8,022                       |       | 17,167 |   | 6,670 |   |
| Net increase in cash and cash equivalents                                             |       | (10,559                     | )          | 16,387 |   | 11,320 |   |
| Cash and cash equivalents at beginning of  period                                     |       | 47,994                      |       | 31,607 |   | 20,287 |   |
| Cash and cash equivalents at end of period                                            |       | $                           | 37,435     |   | $ | 47,994 |   | $ | 31,607 |   |
|                                                                                  |       |                        |       |   |   |   |   |
| **Supplemental information:**                                                         |       |                        |       |   |   |   |   |
| Fair value of stock options assumed in Oak  acquisition                               |       | $                           | —     |   | $ | 57,446 |   | $ | — |   |
|                                                                                  |       |                        |       |   |   |   |   |
| Fair value of stock issued in Oak  acquisition                                        |       | $                           | —     |   | $ | 227,462 |   | $ | — |   |
|                                                                                  |       |                        |       |   |   |   |   |
| Purchases of intellectual property included  in accounts payable and accrued expenses |       | $                           | —     |   | $ | — |   | $ | 3,900 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

45

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**ZORAN CORPORATION**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1—THE COMPANY**

 

ZoranCorporation (“Zoran” or the “Company”) was incorporated in California inDecember 1981 and reincorporated in Delaware in November 1986.  Zoran develops and markets integratedcircuits, integrated circuit cores and embedded software used by originalequipment manufacturers, or OEMs, in digital audio and video products forcommercial and consumer markets, digital television applications as well asdigital imaging products.  Currentapplications incorporating Zoran’s products and IP include digital versatiledisc, or DVD, players and recorders, digital cameras, professional and consumervideo editing systems, digital speakers and audio systems, applications thatenable the delivery and display of digital video content through a set top boxor television as well as digital imaging products consisting of semiconductorhardware and software that enable users to print, scan, process and transmitdocuments to computer peripherals that perform printing functions.  The Company operates in four industry segments;DVD, Imaging, Mobile and Digital Television.

 

**Restatement**

 

In connection with the reviewand evaluation of the effectiveness of our internal control over financialreporting undertaken pursuant to Section 404 of the Sarbanes-Oxley Act of2002, management discovered  that excessstock compensation expenses had been recognized during the quarters ended March 31,June 30 and September 30, 2004. The compensation expense was related to options that we had assumed aspart of our acquisition of Oak Technology, Inc. in 2003.  Under purchase accounting, part of the costrelating to the acquisition was attributed to the assumed options and was to berecognized over time as the options continued to vest, based on each optionholder’s continued employment with Zoran. If an option holder’s employment terminated before the option was fullyvested, vesting would cease, and we would no longer recognize compensationexpense related to that option.  At thetime of the acquisition, a schedule was prepared detailing the terms ofeach assumed option; however, the names of the option holders were omitted fromthe schedule for reasons of confidentiality.  After the acquisition was completed, we didnot update our personnel or financial records to include the omitted information.As a result, the Company improperly recognized deferred stock compensationexpenses relating to options that had been held by former Oak employees afterthe vesting of such options had ceased, and did not reverse stock basedcompensation expense recognized in excess of amounts that actually vested.

 

To correct this error, we haverestated the financial results that we previously reported for the quartersended March 31, June 30 and September 30, 2004.  For information about the effects of therestatement, see Selected Quarterly Financial Information included in Item 8 ofthis annual report. The effect of the error on periods in 2003 was notmaterial, and therefore, no adjustment was made for such periods.  The financial information included in Form 10-Qand Form 8-K reports previously filed or furnished by Zoran forthese periods should not be relied upon and are superceded by the informationin this Form 10-K.

 

*Risk and Uncertainties*

 

The Companyperforms research and development and generates a significant portion of itssales from its operations located in the State of Israel.  A significant number of the Company’sfull-time employees are located in Israel, including a portion of the Company’sresearch and development personnel.  Therefore,the Company is directly affected by the political, economic and militaryconditions to which that country is subject.

 

Thesemiconductor business is highly cyclical and has been subject to significantdownturns at various times that have been characterized by diminished productdemand, decreased production, overcapacity, and accelerated erosion of averageselling prices.  As such, the sellingprice that the Company is able to command for its products is highly dependenton industry-wide production capacity and demand.  Both of these factors could result in rapiddeviations in product pricing and, therefore, could adversely affect theCompany’s operating results.

 

The Company’s revenuesmay be impacted by its ability to obtain adequate wafer supplies from itsfoundries.  The foundries with which theCompany currently has arrangements, together with any additional foundry atwhich capacity might be obtained, may not be willing or able to satisfy all of theCompany’s manufacturing requirements on a timely basis at favorable prices.  In addition, the Company could experiencedelays in qualifying new products and in ramping-up new product production.  The Company is also subject to the risks ofservice disruptions, raw material shortages and price increases by itsfoundries.

 

The Company dependson independent subcontractors to assemble and test our products.  The Company’s reliance on thesesubcontractors involves the following significant risks:

 

•                  Reducedcontrol over delivery schedules and quality;

 

•                  Thepotential lack of adequate capacity during periods of strong demand;

 

•                  Difficultiesselecting and integrating new subcontracts;

 

•                  Potentialincrease in prices due to capacity shortages and other factors; and

 

•                  Potentialmisappropriation of the Company’s intellectual property.

 

*Principles of consolidation and basis ofpresentation*

 

Theconsolidated financial statements include the accounts of Zoran and all of itssubsidiaries.  Intercompany transactionsand balances have been eliminated in consolidation.

 

46

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*Reclassifications*

 

Certain priorperiod amounts have been reclassified to conform to the current periodpresentation.

 

**NOTE 2—SIGNIFICANT ACCOUNTING POLICIES**

 

Zoran hasadopted accounting policies which are generally accepted in the industry inwhich it operates.  The following is asummary of the Company’s significant accounting policies.

 

*Use of estimates*

 

Thepreparation of these financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the amounts reported in the financial statements and accompanyingnotes.  Actual results could differ fromthose estimates, although such differences are not expected to be material tothe consolidated financial statements.

 

*Translation of foreign currencies*

 

The majorityof the Company’s purchasing and sales transactions are denominated in USdollars, which is considered to be the functional currency of the Company andits subsidiaries.  The Company has notexperienced material losses or gains as a result of currency exchange ratefluctuations and has not engaged in hedging transactions to reduce its exposureto such fluctuations.  The Company maytake action in the future to reduce its foreign exchange risk.  Monetary assets and liabilities of theCompany’s foreign subsidiaries are remeasured into U.S. dollars from the localcurrency at rates in effect at period-end and non-monetary assets andliabilities are remeasured at historical rates. Revenues and expenses are remeasured at average rates during the period.  In accordance with Statement of FinancialAccounting Standards No. 52, gains and losses arising from the remeasurement oflocal currency financial statements are included in other income (loss), netand have not been significant for all periods presented.

 

*Revenue recognition*

 

The Company’spolicy is to recognize revenue from product sales upon shipment, provided thatpersuasive evidence of an arrangement exists, the price is fixed and determinable,collectibility is reasonably assured and legal title and risk of ownership hastransferred.  A provision for estimatedfuture returns and potential warranty liability is recorded at the time revenueis recognized.  Warranty expenses in 2004,2003 and 2002, were immaterial.  Developmentrevenue under development contracts is recognized as the services are performedbased on the specific deliverables outlined in each contract.  Amounts received in advance of performanceunder contracts are recorded as deferred revenue and are recognized when ourobligations have been met.  Costsassociated with development revenues are included primarily in research anddevelopment expenses.  Revenue resultingfrom the licensing of the Company’s technology is recognized when significantcontractual obligations have been fulfilled and the customer has indicatedacceptance.  Periodic service andmaintenance fees which provide customers access to technical support and minorenhancements to licensed releases are recognized ratably over the service ormaintenance period.  Royalty revenue isrecognized in the period licensed sales are reported to the Company whichtypically ranges between one month to one quarter in arrears.

 

*Research and development costs*

 

Costs relatedto the conceptual formation and design of internally developed software areexpensed as research and development as incurred.  It is the Company’s policy that certaininternal software development costs incurred after technological feasibilityhas been demonstrated and which meet recoverability tests are capitalized andamortized over the estimated economic life of the product.  To date, the Company has incurred nosignificant internal software development costs which meet the criteria forcapitalization.

 

*Cash equivalents and investments*

 

All highlyliquid investments purchased with an original maturity of 90 days or lessare considered to be cash equivalents.

 

All of Zoran’sinvestments in marketable securities are classified as available-for-sale and,therefore, are reported at fair value with unrealized gains and losses, net ofrelated tax, if any, included as accumulated other comprehensive income (loss),a component of stockholders’ equity.  Gainsand losses realized upon sales of all such securities are reported in interestincome.  See Note 3.

 

When the fairvalue of an investment declines below its amortized cost, we consider allavailable evidence to evaluate whether an other-than-temporary decline in valuehas occurred.  Among other things, weconsider the duration and extent to which the market value has declinedrelative to our cost basis, the economic factors influencing the markets, therelative performance of the investee and its near-term prospects.

 

47

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AtDecember 31, 2004, the Company’s marketable securities included commercialpaper with maturities of less than one year and marketable equity securities.  Investments in marketable securities also includedbonds and medium term notes with maturities greater than one year, which areincluded in other assets and investments, and amounted to $52.8 millionand $63.8 million at December 31, 2004 and 2003, respectively.  See Note 3.

 

Other assetsand investments also include investments in non-marketable securities which areaccounted for on the cost basis and amounted to $4.7 million atDecember 31, 2004 and 2003.  TheCompany records an investment impairment charge when the fair value of aninvestment declines below its cost basis. In making this determination the Company considers all availableevidence including the historical and projected financial performance andrecent funding events which are ascertained from an investee.  In 2002, the Company recorded$2.4 million in such impairment charges. There were no such charges in 2004 or 2003.

 

*Concentration of credit risk of financialinstruments*

 

Financialinstruments that potentially subject the Company to significant concentrationsof credit risk consist principally of cash and cash equivalents, investments inmarketable securities, non-marketable equity securities and trade accountsreceivable.  The Company places its cashin banks and cash equivalents consist primarily of certificates of deposit andcommercial paper.  The Company’smarketable securities portfolio consists primarily of auction rate securities,stock, corporate bonds, short and medium term notes, Euro dollar bonds and US Governmentsecurities.  The Company, by policy,limits the amount of its credit exposure through diversification and restrictingits investments to highly rated securities. Individual securities are limited to comprising no more than 5% of theportfolio value.  Highly rated securitiesare defined as having a minimum Moody or Standard & Poor’s rating ofA1 or A+, respectively.  The averagematurity of the portfolio is restricted to less than 365 days.  The Company has not experienced anysignificant losses on its cash equivalents or short-term investment.

 

The Companymarkets integrated circuits and technology to manufacturers and distributors ofelectronic equipment primarily in North America, Europe and the Pacific Rim.  The Company performs ongoing creditevaluations of its customers’ financial condition and limits the amount ofcredit extended when deemed necessary, but generally does not requirecollateral.  Management believes that anyrisk of loss is significantly reduced due to the diversity of its customers andgeographic sales areas.  As ofDecember 31, 2004, two customers accounted for approximately 27% and 13%of the net accounts receivable balance, respectively.  As of December 31, 2003, two customersaccounted for approximately 14% and 10% of the net accounts receivable balance,respectively.

 

*Inventory*

 

Inventories are stated at the lower ofstandard cost (which approximates actual cost on a first-in, first-out basis)or market.  Market is based on estimatednet realizable value.  The Company writesdown inventories to net realizable value based on forecasted demand and marketconditions.  Inventory write-downs arenot reversed and permanently reduce the cost basis of the affected inventoryuntil such inventory is sold or scrapped.

 

*Property and equipment*

 

Property andequipment are recorded at cost.  Depreciationis computed using the straight-line method over the estimated useful lives ofthree to five years.  Leaseholdimprovements are amortized on a straight-line basis over the shorter of theestimated useful lives of the assets or the remaining term of the lease.

 

*Goodwill*

 

The Companyadopted Financial Accounting Standards Board (“FASB”) Statement No.  142 “Goodwill and Other Intangible Assets” (“SFAS 142”)as of January 1, 2002.  SFAS 142changed the accounting for goodwill from an amortization method to animpairment only approach.  In connectionwith the adoption of SFAS 142, the Company conducted a transitionalgoodwill impairment assessment based on its structure as one reporting unit anddetermined that no impairment existed at January 1, 2002.  Following the acquisition of Oak Technology,Inc. in the third quarter of 2003, the Company restructured its operations intofour reporting units.  During 2004, 2003and 2002, the Company also completed its annual impairment assessments anddetermined that no impairment existed.

 

*Other intangibles*

 

Acquiredtechnology is amortized to expense on a straight-line basis over two to fiveyears.  Other intangible assets recordedin connection with the acquisitions of PixelCam, Inc.,Nogatech, Inc., Oak Technology, Inc. and Emblaze Semiconductor, Ltd. areamortized on a

 

48

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straight-linebasis over the estimated periods of benefit, which range between three and fiveyears.

 

*Long-lived assets*

 

The Companyevaluates the recoverability of its long-lived assets, other than goodwill,whenever events or changes in circumstance indicate the carrying amounts of theassets may not be recoverable.  TheCompany evaluates assets by comparing expected undiscounted cash flows to thecarrying value of the related assets.  Ifthe expected undiscounted cash flows are less than the carrying value of theassets, the Company recognizes an impairment charge based on the fair value ofthe assets.  To date, the Company has notrecorded any impairment charges against the value of its long-lived assets.

 

*Fair value of financial instruments*

 

The fair valueof a financial instrument is the amount at which the instrument could beexchanged in a current transaction between willing parties.  The carrying amounts for cash and cashequivalents, short-term investments, accounts receivable, accounts payable andaccrued liabilities approximate their respective fair values because of theshort-term maturity of these items.

 

*Research and Development*

 

Research anddevelopment expenses are charged to operations as incurred.

 

*Income taxes*

 

The Companyfollows the liability method of accounting for income taxes which requiresrecognition of deferred tax liabilities and assets for the expected future taxconsequence of temporary differences between the financial statement carryingamounts and the tax bases of assets and liabilities.

 

For the yearsended December 31, 2004 and 2003, the provision for income taxes reflectsthe effective tax rate applied to earnings, excluding charges related to theamortization of goodwill and the write-off of acquired in-process research anddevelopment, for the periods.  Theeffective tax rate differs from the U.S. statutory rate due to utilization ofnet operating losses and State of Israel tax benefits on foreign earnings.  The provision includes primarily taxes onincome in excess of net operating loss carryover limitations and foreignwithholding taxes.

 

*Earnings per share*

 

In accordancewith Statement of Financial Accounting Standards No. 128, Zoran reportsEarnings per Share (“EPS”), both basic and diluted, on the statement ofoperations.  Basic EPS is based upon theweighted average number of common shares outstanding.  Diluted EPS is computed using the weightedaverage common shares outstanding plus any potential common stock, except whentheir effect is anti-dilutive.  Potentialcommon stock includes common stock issuable upon the exercise of stock optionsand warrants.  See Note 13.

 

*Stock compensation*

 

The Companyaccounts for stock-based compensation using the intrinsic value methodprescribed in Accounting Principles Board Opinion No.  25 (“APB 25”), “Accounting for Stock Issuedto Employees” and related interpretations. Under APB 25, compensation expense is recognized based on thedifference, if any, on the date of grant between the fair value of the Company’sstock and the amount an employee must pay to acquire the stock.  The compensation expense is recognized overthe periods the employee performs the related services, generally the vestingperiod of four years, consistent with the multiple option method described inFASB Interpretation No. 28 (“FIN 28”).  Exceptfor options assumed as part of acquisitions, no other stock-based employeecompensation cost is reflected in net income as all other options granted underour plans had an exercise price equal to the market value of the underlyingcommon stock on the date of grant.

 

49

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*Fair Value Disclosures*

 

Hadcompensation cost for the Company’s option and stock purchase plans been determinedbased on the fair value at the grant dates, as prescribed in SFAS 123, theCompany’s net loss and net loss per share for each of the three years endedDecember 31, 2004, would have been as follows (in thousands, except pershare data):

 
| ** **                                                                        | ** ** | **Year ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                        | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2003** | ** ** |
|                                                                              |       |                        |       |   |   |   |   |
| Net income (loss) as reported                                                     |       | $                           | (47,354    | ) | $ | (67,978 | ) | $ | 5,698 |   |
| Adjustments:                                                                      |       |                        |       |   |   |   |   |
| Stock-based employee compensation expense  included in net loss                   |       | 4,051                       |       | 6,281 |   | 292 |   |
| Stock-based employee compensation expense  determined under the fair value method |       | (39,693                     | )          | (34,714 | ) | (24,681 | ) |
| Pro forma net loss                                                                |       | $                           | (82,996    | ) | $ | (96,411 | ) | $ | (18,691 | ) |
|                                                                              |       |                        |       |   |   |   |   |
| Pro forma net loss per share:                                                     |       |                        |       |   |   |   |   |
| Basic                                                                             |       | $                           | (1.94      | ) | $ | (2.90 | ) | $ | (0.69 | ) |
|                                                                              |       |                        |       |   |   |   |   |
| Diluted                                                                           |       | $                           | (1.94      | ) | $ | (2.90 | ) | $ | (0.69 | ) |
|                                                                              |       |                        |       |   |   |   |   |
| Net income (loss) per share as reported:                                          |       |                        |       |   |   |   |   |
| Basic                                                                             |       | $                           | (1.11      | ) | $ | (2.05 | ) | $ | 0.21 |   |
|                                                                              |       |                        |       |   |   |   |   |
| Diluted                                                                           |       | $                           | (1.11      | ) | $ | (2.05 | ) | $ | 0.20 |   |

 

The Companyprovides information regarding the methodology and assumptions used for theabove pro forma disclosure in Note 11.

 

*Segment reporting*

 

Statement ofFinancial Accounting Standards No. 131 (“SFAS 131”), “Disclosures aboutSegments of an Enterprise and Related Information,” designates the internalorganization that is used by management for making operating decisions andassessing performance as the source of the Company’s reportable segments.  SFAS 131 also requires disclosures aboutproducts and services, geographic areas, and major customers.  The Company operates in four reportablesegments offering different product lines to each of its target markets:Digital Versatile Disc (DVD), Digital Television (DTV), Imaging and Mobile.

 

*Comprehensive income ( loss)*

 

Comprehensive income(loss) is defined as the change in equity of a business enterprise during aperiod from transactions and other events and circumstance from non-ownersources.  Comprehensive income (loss)includes unrealized gains and losses on available-for-sale securities.

 

The followingare the components of comprehensive income (loss) (in thousands):

 
| ** **                                            | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                            | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                  |       |                        |       |   |   |   |   |
| Net loss                                              |       | $                           | (47,354    | ) | $ | (67,978 | ) | $ | 5,698 |   |
| Change in unrealized gain (loss) on  investments, net |       | 1,629                       |       | (599 | ) | 514 |   |
| Total comprehensive income (loss)                     |       | $                           | (45,725    | ) | $ | (68,577 | ) | $ | 6,212 |   |

 

50

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The componentsof accumulated other comprehensive income (loss) as of December 31, 2004,2003 and 2002 consisted of the unrealized gain (loss) on marketable securities,net of related taxes.

 

*Recent accounting pronouncements*

 

In March 2004, the FASB issued EITF Issue No. 03-1, “The Meaningof Other-Than-Temporary Impairment and Its Application to Certain Investments,”which provides new guidance for assessing impairment losses on debt and equityinvestments.  Additionally, EITF Issue No.03-1 includes new disclosure requirements for investments that are deemed to betemporarily impaired.  InSeptember 2004, the FASB delayed the accounting provisions of EITF IssueNo. 03-1.  The Company will evaluate theeffect, if any, of EITF Issue No. 03-1 when final guidance is released.

 

In June 2004, the FASB issued EITF Issue No. 02-14, “Whether anInvestor Should Apply the Equity Method of Accounting to Investments Other ThanCommon Stock.” EITF Issue No. 02-14 addresses whether the equity method ofaccounting applies when an investor does not have an investment in votingcommon stock of an investee but exercises significant influence through othermeans.  EITF Issue No. 02-14 states thatan investor should only apply the equity method of accounting when it hasinvestments in either common stock or in-substance common stock of acorporation, provided that the investor has the ability to exercise significantinfluence over the operating and financial policies of the investee.  The accounting provisions of EITF Issue No. 02-14are effective for the first quarter of fiscal 2005.  The Company is still addressing this issue,but does not expect the adoption of EITF Issue No. 02-14 to have a materialimpact on its consolidated financial position, results of operations or cashflows.

 

In November 2004, the FASB issued FASB Statement No. 151, “InventoryCosts, an Amendment of ARB No. 43, Chapter 4” (“FAS No. 151”).  The amendments made by FAS No. 151 areintended to improve financial reporting by clarifying that abnormal amounts ofidle facility expense, freight, handling costs, and wasted materials (spoilage)should be recognized as current-period charges and by requiring the allocationof fixed production overheads to inventory based on the normal capacity of theproduction facilities.  The guidance iseffective for inventory costs incurred during fiscal years beginning after June15, 2005.  Earlier application ispermitted for inventory costs incurred during fiscal years beginning afterNovember 23, 2004.  The provisions of FASNo. 151 will be applied prospectively.  TheCompany does not expect the adoption of FAS No. 151 to have a material impacton its consolidated financial position, results of operations or cash flows.

 

In December 2004, the FASB issued FASB Statement No. 123R, “Share-BasedPayment, an Amendment of FASB Statement No. 123” (“FAS No. 123R”).  FAS No. 123R requires companies to recognizein the statement of operations the grant-date fair value of stock options andother equity-based compensation issued to employees.  SFAS No. 123R requires the use ofan option pricing model for estimating fair value, which is amortized to expenseover the service periods.  FAS No. 123Ris effective for fiscal periods beginning after June 15, 2005.  SFAS No. 123R allows for eitherprospective recognition of compensation expense or retrospective recognition,which may be back to the original issuance of SFAS No. 123, or onlyto interim periods in the year of adoption. Management is currently evaluating the impact of adopting SFAS 123R;however, it believes the adoption of SFAS No. 123R will have asignificant impact on net income (loss) and net income (loss) per share.  The impact on our financial statements willbe dependent on the transition method, the option-pricing model used to computefair value and the inputs to that model such as volatility and expected life.The pro-forma disclosures of the impact of SFAS 123 provided in Note 1 to the ConsolidatedFinancial Statements may not be representative of the impact of adopting SFAS123R.

 

In December 2004, the FASB issued FASB Statement No. 153, “Exchanges ofNonmonetary Assets.”  The Statement is anamendment of APB Opinion No.  29 toeliminate the exception for nonmonetary exchanges of similar productive assetsand replaces it with a general exception for exchanges of nonmonetary assetsthat do not have commercial substance.  TheCompany believes that the adoption of this standard will not have a materialimpact on its consolidated financial position, results of operations or cashflows.

 

51

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**NOTE 3—MARKETABLE SECURITIES**

 

The Company’sportfolio of marketable securities at December 31, 2004 was as follows (inthousands):

 
| ** **                                  | ** ** | **Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|---------------------------------------------|------------|----------|------------|------------------------------|------------|-------------------------------|------------|----------------------------|------------|
| Corporate bonds                             |       | $        | 22,612     |                         | $          | —                        |       | $                          | (377       | ) | $ | 22,235 | ** ** |
| Short/medium term notes                     |       | 8,630    |       | 1                            |       | (42                           | )          | 8,589                      |       |
| U.S. government securities                  |       | 38,690   |       | —                       |       | (428                          | )          | 38,262                     |       |
| Foreign bonds                               |       | 9,709    |       | 9                            |       | (99                           | )          | 9,619                      |       |
| Auction rate securities                     |       | 2,700    |       | —                       |       | —                        |       | 2,700                      |       |
| Marketable equity securities                |       | 1,624    |       | 2,744                        |       | —                        |       | 4,368                      |       |
| Total marketable securities                 |       | 83,965   |       | 2,754                        |       | (946                          | )          | 85,773                     |       |
| Less amounts classified as long term assets |       | (53,403  | )          | (10                          | )          | 618                           |       | (52,795                    | )          |
| Total                                       |       | $        | 30,562     |                         | $          | 2,744                         |       | $                          | (328       | ) | $ | 32,978 |   |

 

The Company’sportfolio of marketable securities at December 31, 2003 was as follows (inthousands):

 
| ** **                                  | ** ** | **Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|---------------------------------------------|------------|----------|------------|------------------------------|------------|-------------------------------|------------|----------------------------|------------|
| Corporate bonds                             |       | $        | 87,147     |                         | $          | 89                            |       | $                          | (1,274     | ) | $ | 85,962 | ** ** |
| Short/medium term notes                     |       | 15,462   |       | 41                           |       | (13                           | )          | 15,490                     |       |
| U.S. government securities                  |       | 11,800   |       | 30                           |       | —                        |       | 11,830                     |       |
| Foreign bonds                               |       | 7,245    |       | 13                           |       | —                        |       | 7,258                      |       |
| Auction rate securities                     |       | 18,925   |       | —                       |       | —                        |       | 18,925                     |       |
| Marketable equity securities                |       | 1,709    |       | 1,013                        |       | —                        |       | 2,722                      |       |
| Total marketable securities                 |       | 142,288  |       | 1,186                        |       | (1,287                        | )          | 142,187                    |       |
| Less amounts classified as long term assets |       | (64,099  | )          | (55                          | )          | 339                           |       | (63,815                    | )          |
| Total                                       |       | $        | 78,189     |                         | $          | 1,131                         |       | $                          | (948       | ) | $ | 78,372 |   |

 

Gross realizedgains on the sales of marketable securities were $ 94,000, $43,000 and $165,000in 2004, 2003 and 2002, respectively.  Grossrealized losses on sales of marketable securities were $104,000, $20,000 and$104,000 in 2004, 2003 and 2002, respectively.

 

In 2002, theCompany recorded a non-cash loss of $696,000 realized upon the conversion ofequity securities in conjunction with the acquisition of an investee as aresult of the acquisition by Roxio, Inc. of MGI Software Inc.  As of the date of the acquisition, theCompany held approximately 373,000 shares of MGI common stock.  Upon consummation of the acquisition, theCompany’s MGI common stock was exchanged for 18,843 shares of Roxio commonstock.  In connection with the exchange, theCompany recorded a realized loss of $696,000 and established a new cost basisof the Roxio common stock equal to its fair value on the date of the exchange.  During 2004, the Roxio common stock was soldresulting in a gain of $85,000 which was recorded as a component of otherincome.

 

At the end of2002, the Company recorded $3.6 million in non-cash impairment charges formarketable equity securities that were determined to be other than temporarilyimpaired as the quoted market price of the related securities dropped below itscarrying value for an extended period of time. There were no such impairment charges in 2004 or 2003.

 

Interestincome on marketable securities was $1.3 million, $5.4 million, $7.1 millionfor the years ended December 31, 2004, 2003 and 2002, respectively.

 

52

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**NOTE 4—BALANCE SHEET COMPONENTS (inthousands)**

 
| ** **                | ** ** | **December 31,** | ** ** |
|---------------------------|------------|------------------|------------|
| **Accounts  receivable:** | ** ** | **2004**         | ** ** | **2003** | ** ** |
| Trade                     |       | $                | 61,272     |   | $ | 66,253 |   |
| Unbilled                  |       | —           |       | 205 |   |
| Less: allowance           |       | (1,409           | )          | (1,234 | ) |
|                      |       | $                | 59,863     |   | $ | 65,224 |   |

 

Unbilledaccounts receivable consists of development revenue recognized, but not yetbilled.  The Company bills developmentrevenue when contract milestones are achieved. During 2003 and 2002, we wrote-off $989,000 and $180,000, respectively,against the allowance for doubtful accounts.  There were no such write-offsduring 2004.

 
| ** **                          | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|------------------|------------|
| **Inventory:**                      | ** ** | **2004**         | ** ** | **2003** | ** ** |
| Purchased parts and work in process |       | $                | 23,959     |   | $ | 5,701 |   |
| Finished goods                      |       | 26,074           |       | 11,104 |   |
|                                |       | $                | 50,033     |   | $ | 16,805 |   |

 
| ** **                                       | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|------------------|------------|
| **Property  and equipment:**                     | ** ** | **2004**         | ** ** | **2003** | ** ** |
| Computer equipment                               |       | $                | 17,492     |   | $ | 17,556 |   |
| Office equipment and furniture                   |       | 2,102            |       | 1,733 |   |
| Machinery and equipment                          |       | 3,293            |       | 2,059 |   |
| Software                                         |       | 19,307           |       | 13,602 |   |
| Building and leasehold improvements              |       | 3,301            |       | 3,822 |   |
|                                             |       | 45,495           |       | 38,772 |   |
| Less: accumulated depreciation and  amortization |       | (28,305          | )          | (18,743 | ) |
|                                             |       | $                | 17,190     |   | $ | 20,029 |   |

 
| ** **                                   | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|------------------|------------|
| **Accrued  expenses and other liabilities:** | ** ** | **2004**         | ** ** | **2003** | ** ** |
| Accrued payroll and related expenses         |       | $                | 10,052     |   | $ | 8,720 |   |
| Accrued royalties                            |       | 4,400            |       | 2,466 |   |
| Taxes payable                                |       | 13,220           |       | 14,596 |   |
| Deferred revenue                             |       | 7,334            |       | 3,398 |   |
| Note payable                                 |       | —           |       | 4,000 |   |
| Other accrued liabilities                    |       | 16,096           |       | 11,518 |   |
|                                         |       | $                | 51,102     |   | $ | 44,698 |   |

 

**NOTE 5—OTHER INCOME (LOSS), NET**

 

The followingtable provides the components of other income (loss), net (in thousands):

 
| ** **                                                         | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                         | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                               |       |                        |       |   |   |   |   |
| Investment impairment charges on marketable  equity securities     |       | $                           | —     |   | $ | — |   | $ | (3,595 | ) |
| Investment impairment charges on non-marketable  equity securities |       | —                      |       | — |   | (2,450 | ) |
| Realized loss on marketable equity  securities                     |       | —                      |       | — |   | (696 | ) |
| Other                                                              |       | (264                        | )          | 1 |   | 127 |   |
|                                                               |       | $                           | (264       | ) | $ | 1 |   | $ | (6,614 | ) |

 

53

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SeeNote 3 regarding investment impairment charges on marketable equitysecurities and realized loss on marketable equity securities.  See Note 2 regarding investmentimpairment charges on non-marketable equity securities.

 

**NOTE 6—GOODWILL AND OTHER INTANGIBLE ASSETS**

 

In accordancewith 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.  Foreach of the years ended December 31, 2004, 2003 and 2002, the Companyperformed the annual analysis and concluded that goodwill was not impaired, asthe fair value of each reporting unit exceeded its carrying value, includinggoodwill.

 

**Components of Acquired Intangible Assets**(inthousands):

 
| ** **                   | ** ** | ** **        | ** ** | **December 31, 2004**       | ** ** | **December 31, 2003**         | ** ** |
|------------------------------|------------|-------------------|------------|-----------------------------|------------|-------------------------------|------------|
| ** **                   | ** ** | **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    |                          | $          | (67,139 | ) | $ | 121,366 |   | $ | 176,720 |   | $ | (31,792 | ) | $ | 144,928 |   |
| Patents                      |       | 3-5               |       | 40,265                      |       | (10,457                       | )          | 29,808 |   | 27,900 |   | (2,996 | ) | 24,904 |   |
| Customer base                |       | 3-5               |       | 13,010                      |       | (4,739                        | )          | 8,271 |   | 13,010 |   | (2,450 | ) | 10,560 |   |
| Tradename and others         |       | 3-5               |       | 2,100                       |       | (1,161                        | )          | 939 |   | 2,100 |   | (900 | ) | 1,200 |   |
| Purchased core technology *  |       | 4-5               |       | 12,679                      |       | (4,181                        | )          | 8,498 |   | 8,799 |   | (1,506 | ) | 7,293 |   |
| Total                        |       |              |       | $                           | 256,559    |                          | $          | (87,677 | ) | $ | 168,882 |   | $ | 228,529 |   | $ | (39,644 | ) | $ | 188,885 |   |

 

----

(*)                                 The Company recordsthe amortization of purchased core technology as cost of product sales.

 

Estimatedfuture intangible amortization expense, based on current balances, as ofDecember 31, 2004 is as follows (in thousands):

 
| **Year ending December 31,** | ** ** | **Amount** | ** ** |
|------------------------------|------------|------------|------------|
|                         |       |       |       |
| 2005                         |       | $          | 53,005     |   |
| 2006                         |       | 51,194     |       |
| 2007                         |       | 43,112     |       |
| 2008                         |       | 21,571     |       |
| Total                        |       | $          | 168,882    |   |

 

Changes in thecarrying amount of goodwill for the year ended December 31, 2004 are asfollows (in thousands):

 
| ** **                                             | ** ** | **Amount** | ** ** |
|--------------------------------------------------------|------------|------------|------------|
|                                                   |       |       |       |
| Balance at December 31, 2002                           |       | $          | 59,131     |   |
| Acquisition of Oak Technology, Inc.                    |       | 59,960     |       |
| Balance at December 31, 2003                           |       | 119,091    |       |
| Adjustment to goodwill related to  acquisition of Oak. |       | 181        |       |
| Acquisition of Emblaze Semiconductor                   |       | 30,879     |       |
| Balance at December 31, 2004                           |       | $          | 150,151    |   |

 

54

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Goodwill byreporting unit at December 31, 2004 and 2003 were as follows (inthousands):

 
| ** ** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|------------|------------|------------------|------------|------------------|------------|
| ** ** | ** ** | **2004**         | ** ** | **2003**         | ** ** |
|       |       |             |       |             |       |
| DVD        |       | $                | 63,855     |             | $          | 63,855 |   |
| Imaging    |       | 6,177            |       | 5,996            |       |
| Mobile     |       | 62,131           |       | 31,252           |       |
| DTV        |       | 17,988           |       | 17,988           |       |
|       |       | $                | 150,151    |             | $          | 119,091 |   |

 

**NOTE 7—RESEARCH AND DEVELOPMENTARRANGEMENTS**

 

The Company isa party to certain research and development agreements with the Chief Scientistin Israel’s Ministry of Industry and Trade Department (the “Chief Scientist”)and the Israel-United States Binational Industrial Research and DevelopmentFoundation (“BIRDF”), which fund up to 50% of incurred project costs forapproved products up to specified contract maximums.  The Company is not obligated to repay fundingregardless of the outcome of its development efforts; however, these agreementsrequire the Company to use its best efforts to achieve specified results andrequire the Company to pay royalties at rates of 3% to 5% of resulting productssales, and up to 30% of resulting license revenues, up to a maximum of 100% to150% of the total funding received.  Reportedresearch and development expenses incurred in Israel are net of these grants,which fluctuate from period to period.

 

Gross researchand development expenses that qualify for the grants and the related grants areas follows:

 
| ** **                              | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------|------------|-----------------------------|------------|
| ** **                              | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                              | ** ** | **(in thousands)**          | ** ** |
| Research and development expenses:      |       |                        |       |   |   |   |   |
| Gross research and development expenses |       | $                           | 38,461     |   | $ | 22,271 |   | $ | 19,062 |   |
| Less: grants earned                     |       | (1,460                      | )          | (2,500 | ) | — |   |
|                                    |       | $                           | 37,001     |   | $ | 19,771 |   | $ | 19,062 |   |

 

Royaltyexpenses related to these grants were $654,000, $40,600 and $260,000 in 2004,2003 and 2002, respectively.

 

**NOTE 8—DEVELOPMENT CONTRACTS**

 

The Companyhas generated a portion of its total revenues from development contracts,primarily with key customers.  Thesedevelopment contracts have provided the Company with partial funding for the developmentof certain of its products.  The Companyclassifies costs related to these development contracts as research anddevelopment expenses.  The Company is notobligated to repay funding regardless of the outcome of its developmentefforts; however, the agreements require the Company to use its best efforts toachieve specified results as per the agreements.  The Company retains ownership of theintellectual property developed under the contracts; however, some contractslimit the product markets in which the Company may directly sell the developedproduct.  Revenues generated under thesecontracts were $1.6 million in 2004 and $1.4 million in both 2003 and 2002.

 

**NOTE 9—COMMITMENTS AND CONTINGENCIES**

 

From time totime, the Company may have certain contingent liabilities that arise in theordinary course of its business activities. The Company accrues contingent liabilities when it is probable thatfuture expenditures will be made and such expenditures can be reasonablyestimated.  In the opinion of management,there are no pending claims of which the outcome is expected to result in amaterial adverse effect in the financial position, results of operations orcash flows of the Company.

 

*Lease commitments*

 

The Companyrents facilities and equipment under various lease agreements expiring through2007.  Rent expense for 2004, 2003 and

 

55

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2002 totaledapproximately $4.4 million, $3.1 million and $1.7 million,respectively.  Future minimum leasepayments required under non-cancelable leases at December 31, 2004 are asfollows: (in thousands)

 
| **Year ending December 31,** | ** ** | **Amount** | ** ** |
|------------------------------|------------|------------|------------|
|                         |       |       |       |
| 2005                         |       | $          | 8,255      |   |
| 2006                         |       | 6,907      |       |
| 2007                         |       | 1,703      |       |
| Total                        |       | $          | 16,865     |   |

 

*Legal proceedings*

 

We and our Oak subsidiaryhave initiated two legal actions against MediaTek, Inc. and customers ofMediaTek alleging that products incorporating certain MediaTek componentsinfringe three patents co-owned by Zoran and Oak relating to optical drivecontroller design and integrated CD/DVD controller design.

 

On March 11, 2004,Zoran and Oak filed a complaint with****theUnited States International Trade Commission (“ITC”) alleging that certainMediaTek DVD player and optical disk controller chips and chipsets, andproducts in which they are used, infringe Zoran’s and Oak’s patents.  In addition to MediaTek, the complaint named10 other proposed respondents that sell products, including DVD players and PCoptical storage devices that use MediaTek’s chips and chipsets.  The other proposed respondents were ASUSTekComputer.  Inc., Creative Labs, Inc.,Creative Technology, Ltd., 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.  The complaintrequested that the ITC institute an investigation of the accused products andissue exclusion and cease and desist orders prohibiting the importation intothe United States of the infringing MediaTek devices and products that containthem.  On April 8, 2004, the ITCinstituted an investigation based on Zoran’s complaint.  On April 28, 2004, Zoran and Oak reacheda settlement with respondents Creative Technology, Ltd. and Creative Labs,Inc., and these respondents were subsequently dismissed from the investigationpursuant to the terms of the settlement agreement.  On July 13, 2004, the ITC granted Zoran’srequest that nine additional respondents be added to the investigation.  These additional respondents are ArtronixTechnology, ASUS Computer International, Audiovox Corporation, EPO Science andTechnology, Inc., Initial Technology, Inc., Micro-Star International Co., Ltd.,MSI Computer Corp., Shinco Digital Technology Ltd. and Ultima ElectronicsCorporation.  On October 26, 2004,MediaTek filed a motion for summary determination seeking an order that two ofthe asserted patents were invalid.  Thismotion was denied on November 18, 2004. On December 13, 2004, MediaTek filed another motion for summarydetermination seeking a similar order on different grounds.  This motion was denied on December 22,2004.  The hearing took place in February2005, and the target date for completion of the investigation isSeptember 14, 2005.

 

OnMarch 15, 2004, Zoran and Oak filed a complaint against MediaTek andMintek Digital in the United States District Court, Central District ofCalifornia alleging similar facts regarding infringement by MediaTek’s chipsand 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-ON Information Technology Corporation, Mintek Digital, ShincoInternational AV Co., Ltd., TEAC Corporation, TEAC America, Inc., TerapinTechnology Corporation and Terapin Technology as defendants.  On June 17, 2004, pursuant to stipulationof the parties, the case was transferred to the United States District Court,Northern District of California.  OnJuly 2, 2004, Defendants filed a First Amended Answer which includedcounterclaims for declaration of noninfringement, declaration of invalidity,declaration of unenforceability, breach of covenant not to sue, breach ofcovenant of good faith and fair dealing and unfair competition.  On July 22, 2004, Zoran and Oak moved todismiss certain of defendants’ defenses and counterclaims and, on July 30,2004, MediaTek filed a motion for summary judgment as to two of the threepatents asserted by Zoran and Oak against MediaTek.  On December 9, 2004, the Court grantedZoran and Oak’s motion, in part, and dismissed certain of defendant’scounterclaims and affirmative defenses. The Court also denied MediaTek’s motion for summary judgment.  On October 15, 2004, MediaTek filed asecond motion for summary judgment seeking summary judgment on alternategrounds as to the same two patents.  Thismotion is nearly identical to the motion filed by MediaTek on October 26,2004 in the ITC.  The hearing on thismotion was held on December 10, 2004. The Court has not ruled on this motion. On October 29, 2004, Zoran and Oak voluntarily dismissed two oftheir three claims against defendants without prejudice and refiled those twoclaims as a separate lawsuit against the defendants.  The parties have stipulated, and the Courthas agreed, that the newly filed action will be consolidated for all purposeswith the first filed action, including for purposes of trial and all pre-trialscheduling.  On January 3, 2005,defendants Audiovox Corporation, Artronix Technology, Inc., ASUS ComputerInternational, Inc., Initial Technology, Inc., Changzhou Shinco DigitalTechnology Co., Ltd., EPO Science and Technology Co., Inc., Micro-StarInternational, Co., Ltd., MSI Computer Corp., Shinco International AV Co. andUltima Electronics Corp. were added to this case by stipulation of theparties.  No trial date has yet been setin these consolidated actions.

 

56

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On July 23, 2004,MediaTek filed a complaint with the ITC alleging that certain Zoran and Oak DVDplayer and optical disk controller chips and chipsets infringe two MediaTekpatents.  The complaint requested thatthe ITC institute an investigation into the accused products and issueexclusion and cease and desist orders prohibiting importation into the UnitedStates of allegedly infringing chips and products that contain them.  On August 26, 2004, the ITC institutedan investigation.  On September 24,2004, MediaTek filed a motion to amend the complaint to add one additionalpatent and to name Sunext Technology Co., Ltd. as a respondent.  This motion was granted on October 7,2004.  Discovery is currentlyunderway.  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.  Discovery is currentlyopen.  The hearing is scheduled to begin onJune 27, 2005 and the target date for completion of the investigation isNovember 15, 2005.

 

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

 

Based upon ourpreliminary review, we believe we have meritorious defenses to the two MediaTekcomplaints, which we believe were filed in response to the proceedings that wehave been prosecuting against MediaTek and its customers.  We intend to defend the MediaTek actionsvigorously.  However, the litigation isin the preliminary stage, and we cannot predict its outcome withcertainty.  Patent litigation isparticularly complex and can extend for a protracted time, which cansubstantially increase litigation expenses.

 

**NOTE 10—RESTRUCTURING**

 

During the year endedDecember 31, 2004, the Company recorded restructuring charges of $746,000 dueto the discontinuation of the Sensor product line of the Mobile group.  These charges included $523,000 related tothe reduction in force of 15 employees for severance and other terminationexpenses, $173,000 for lease losses on abandoned office space and othermiscellaneous legal and consulting fees of approximately $50,000.  There were no payments made prior to December31, 2004 related to these charges.  Allremaining balances at December 31, 2004 are expected to be paid out incash.  Amounts related to facilities willbe paid over the lease terms through June 2007 and the remaining amounts areexpected to be paid by the end of the first quarter of 2005.

 

**NOTE 11—STOCKHOLDERS’ EQUITY**

 

*Common Stock*

 

In August of 2003, the Company acquired Oak Technology, Inc.  As a result of the acquisition, 56,737,298shares of Oak common stock were converted into $101.0 million in cash and13,180,074 shares of Zoran common stock. Non-qualified options to purchase approximately 4.5 million sharesof Zoran common stock with a term of ten years were granted to Oak employees aspart of the acquisition.  Thisacquisition was accounted for under the purchase method of accounting (seeNote 16).

 

On April 21, 2002, the Company’s Board of Directors approved athree-for-two split of our common stock which was effected in the form of afifty percent stock dividend, paid on May 22, 2002 to stockholders ofrecord on May 7, 2002.  All shareand per share information for all periods presented in this report are on apost-split basis.

 

*Warrants*

 

In September 1997, in connection with a software licenseagreement, the Company issued a warrant to purchase 112,500 shares of itsCommon Stock at an exercise price of $16.21 per share.  The warrant was exercisable for a period offour years from a date beginning one year after the issuance date of thewarrant.  The $717,000 estimated value ofthe warrant was amortized over the four-year period of the licenseagreement.  In September 2002, thewarrant expired.

 

***Stock option plans***

 

*1993 Stock Option Plan*

 

The Company’s 1993 Stock Option Plan (the “1993 Option Plan”) wasadopted by the Board of Directors of the Company and approved by thestockholders of the Company in July 1993. A total of 7,755,000 shares of common stock were reserved for issuanceunder the 1993 Option Plan.  The 1993Option Plan provided for grants of options to employees, non-employee directorsand consultants.  The 1993 Stock OptionPlan expired during 2003 and no future shares will be granted under thisplan.  The option price for sharesgranted under the 1993 Option Plan was typically equal to the fair market valueof the common stock at the date of grant.

 

57

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Generally, options granted under the 1993 Option Plan are fullyexercisable on and after the date of grant, subject to the Company’s right torepurchase from an optionee, at the optionee’s original per share exerciseprice, any unvested shares which the optionee has purchased and holds in theevent of the termination of the optionee’s employment, with or withoutcause.  The Company’s right lapses asshares subject to the option become vested. Such shares generally vest in monthly installments over two or fouryears following the date of grant (as determined by the Compensation Committeeof the Board of Directors), subject to the optionee’s continuous service.  Options expire ten years from the date ofgrant and an option shall generally terminate three months after termination ofemployment.

 

*2000 Stock Option Plan*

 

The Company’s 2000 Nonstatutory Stock Option Plan (the “2000 OptionPlan”) was adopted by the Board of Directors of the Company inOctober 2000.  A total of 450,000shares of preferred stock were initially reserved for issuance under the 2000Option Plan.  The options to purchasepreferred stock automatically converted to options to purchase common stockupon the amendment of the Company’s certificate of incorporation to effect anincrease in the number of authorized shares of common stock to 55,000,000 inOctober 2000.  A total of 13,325,000shares of common stock have been reserved for issuance under the 2000 OptionPlan.  The 2000 Option Plan provides forgrants of options to employees or consultants. The 2000 Option Plan is currently being administered by the CompensationCommittee of the Board of Directors of the Company, which determines theoptionees and the terms of the options granted, including the exercise price,number of shares subject to the option plan and the exercisabilitythereof.  The 2000 Option Plan wasmodified in 2001 to allow for exercisability of stock options ahead of vestingsubject to the Company’s right to repurchase the associated stock at the optionexercise price through the original vesting schedule.  The option price for shares granted under the2000 Option Plan is typically equal to the fair market value of the commonstock at the date of grant.  Optionsexpire ten years from the date of grant and an option shall generally terminatethree months after termination of employment. The 2000 Option Plan will terminate in October 2010, unlessterminated sooner by the Board of Directors.

 

At December 31, 2004, options available for grant under this planwere 5,153,644.

 

*1995 Outside Directors Stock Option Plan*

 

The Company’s Outside Directors Stock Option Plan (the “Directors Plan”)was adopted by the Company’s Board of Directors in October 1995, and wasapproved by its stockholders in December 1995.  A total of 525,000 shares of Common Stockhave been reserved for issuance under the Directors Plan.  The Directors Plan provides for the grant ofnonstatutory stock options to nonemployee directors of the Company.  The Directors Plan provides that each newnonemployee director will automatically be granted an option to purchase 30,000shares on the date the optionee first becomes a nonemployee director (the “InitialGrant”).  Thereafter, on the dateimmediately following each annual stockholders’ meeting, each nonemployeedirector who is reelected at the meeting to an additional term shall be grantedan additional option to purchase 15,000 shares of Common Stock if, on suchdate, he or she shall have served on the Company’s Board of Directors for atleast six months (the “Annual Grant”). The Initial Grant is exercisable in four equal annual installments, andeach Annual Grant shall become exercisable in full one year after the date ofgrant, subject to the director’s continuous service.  The exercise price of all stock optionsgranted under the Directors Plan is equal to the fair market value of theCompany’s Common Stock on the date of grant. Options granted under the Directors Plan have a term of ten years.

 

At December 31, 2004 options available for grant under this planwere 7,800.

 

58

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The following table summarizes the Company’s stock option activity forthe years ended December 31, 2004, 2003 and 2002.  The weighted average exercise price for eachcategory presented is also shown in the table below:

 
| ** **                  | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|-----------------------------|------------|--------------------------|------------|----------------------------------------|------------|
| Balances, December 31, 2001 |       | 5,359,152                |       | $                                      | 15.44      |   |
| Granted                     |       | 2,722,500                |       | $                                      | 14.18      |   |
| Exercised                   |       | (584,740                 | )          | $                                      | 9.17       |   |
| Canceled                    |       | (443,370                 | )          | $                                      | 15.77      |   |
| Balances, December 31, 2002 |       | 7,053,542                |       | $                                      | 15.45      |   |
| Assumed                     |       | 4,528,965                |       | $                                      | 14.74      |   |
| Granted                     |       | 4,697,685                |       | $                                      | 19.92      |   |
| Exercised                   |       | (1,648,920               | )          | $                                      | 11.08      |   |
| Canceled                    |       | (962,108                 | )          | $                                      | 21.41      |   |
| Balances, December 31, 2003 |       | 13,669,164               |       | $                                      | 16.86      |   |
| Granted                     |       | 1,091,733                |       | $                                      | 16.80      |   |
| Exercised                   |       | (502,921                 | )          | $                                      | 8.57       |   |
| Canceled                    |       | (1,412,219               | )          | $                                      | 17.95      |   |
| Balances, December 31, 2004 |       | 12,845,757               |       | $                                      | 17.06      |   |

 

In connection with the Company’s acquisition of OakTechnology, Inc. in August 2003, the Company assumed all outstandingoptions granted by Oak Technology, Inc. prior to the acquisition datewhich were converted into options to purchase an aggregate of approximately 4.5million shares of the Company’s common stock.

 

Significant option groups outstanding as of December 31, 2004 andthe related weighted average exercise price and contractual life information,are as follows:

 
| ** **          | ** ** | **Options Outstanding**                 | ** ** | ** **                                                  | ** ** | **Options Exercisable**                | ** ** |
|---------------------|------------|-----------------------------------------|------------|-------------------------------------------------------------|------------|----------------------------------------|------------|
| **Exercise Prices** | ** ** | **Options at  December 31,  2004** | ** ** | **Weighted  Average  Remaining  Contractual Life  (Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Options at  December 31,  2004** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $0.09 to $11.52     |       | 2,456,903                               |       | 6.31                                                        |       | $                                      | 8.19       |   | 2,005,455 |   | $ | 8.76 |   |
| $11.54 to $12.36    |       | 1,506,846                               |       | 7.64                                                        |       | $                                      | 12.31      |   | 1,506,846 |   | $ | 12.31 |   |
| $12.74 to $20.57    |       | 5,027,100                               |       | 8.27                                                        |       | $                                      | 16.56      |   | 4,166,859 |   | $ | 16.53 |   |
| $20.63 to $27.33    |       | 3,642,128                               |       | 7.48                                                        |       | $                                      | 24.82      |   | 3,480,760 |   | $ | 24.87 |   |
| $27.50 to $46.54    |       | 212,780                                 |       | 5.70                                                        |       | $                                      | 31.94      |   | 212,668 |   | $ | 31.94 |   |
| Total               |       | 12,845,757                              |       | 7.56                                                        |       | $                                      | 17.06      |   | 11,372,588 |   | $ | 17.44 |   |

 

*1995 Employee Stock Purchase Plan*

 

The Company’s 1995 Employee Stock Purchase Plan (“ESPP”) was adopted bythe Company’s Board of Directors in October 1995, and approved by itsstockholders in December 1995.  TheESPP enables employees to purchase shares through payroll deductions atapproximately 85% of the lesser of the fair value of Common Stock at thebeginning of a 24-month offering period or the end of each six-month segmentwithin such offering period.  The ESPP isintended to qualify as an “employee stock purchase plan” under Section 423of the U.S. Internal Revenue Code. During the years ended December 31, 2004 and 2003, 344,927 and119,161 shares were purchased by employees under the terms of the planagreements at a weighted average price of $10.52 and $13.79 per share,respectively.  At December 31, 2004,563,109 shares were reserved and available for issuance under this plan.

 

The weighted average grant date fair value of options granted duringthe year ended December 31, 2004, 2003 and 2002 as defined bySFAS 123, was $11.08, $15.97, and $8.47 per share, respectively.

 

For purposes of the Fair Value disclosure in Note 2 and asrequired under Statement of Financial Accounting Standards No.  123

 

59

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(“SFAS 123”), Accounting for Stock-Based Compensation,” the fairvalue of each option grant is estimated on the date of grant using theBlack-Scholes model with the following assumptions used for options andpurchase grants during the applicable period.

 
| ** **              | ** ** | **Stock Option Plans** | ** ** | **Stock Purchase Plan** | ** ** |
|-------------------------|------------|------------------------|------------|-------------------------|------------|
| ** **              | ** ** | **2004**               | ** ** | **2003**                | ** ** | **2002** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|                    |       |                   |       |                    |       |   |   |   |   |   |   |   |   |
| Dividend rate           |       | —                 |       | —                  |       | — |   | — |   | — |   | — |   |
| Expected life (years)   |       | 5.1                    |       | 5.0                     |       | 5.0 |   | 0.50 |   | 0.50 |   | 0.50 |   |
| Expected volatility     |       | 75                     | %          | 90                      | %          | 92 | % | 59 | % | 90 | % | 92 | % |
| Risk-free interest rate |       | 3.0% to 3.7            | %          | 2.9% to 3.2             | %          | 2.9% to 4.7 | % | 1.0% to 2.3 | % | 1.0% to 2.9 | % | 2.9% to 4.7 | % |

 

**NOTE 12—RETIREMENT PLAN**

 

We maintain a 401(k) Plan that covers substantially all of the Company’sUS employees.  Participants may elect tocontribute a percentage of their compensation to this plan, up to the statutorymaximum amount prescribed by the Internal Revenue Code.  The Company has the ability to make adiscretionary matching contribution to the 401(k) Plan based on a uniformpercentage of the employee’s eligible contribution up to a maximum employermatch of $2,000 per year per employee. Approximately $384,000 and $434,000, in matching contributions wererecorded during 2004 and 2003, respectively. There were no matching contributions made during 2002.

 

**NOTE 13—EARNINGS PER SHARE**

 

The following is a reconciliation of the numerators and denominators ofthe basic and diluted net income (loss) per share computations for the periodspresented (in thousands except per share amounts):

 
| ** **                                               | ** ** | **Year ended December 31,** | ** ** |
|----------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                               | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net income (loss)                                        |       | $                           | (47,354    | ) | $ | (67,978 | ) | $ | 5,698 |   |
|                                                     |       |                        |       |   |   |   |   |
| Shares:                                                  |       |                        |       |   |   |   |   |
| Weighted average common shares                           |       | 42,788                      |       | 33,231 |   | 27,095 |   |
| Dilutive stock options and other potential  common stock |       | —                      |       | — |   | 1,534 |   |
| Dilutive potential common shares                         |       | 42,788                      |       | 33,231 |   | 28,629 |   |
|                                                     |       |                        |       |   |   |   |   |
| Net income (loss) per share:                             |       |                        |       |   |   |   |   |
| Basic                                                    |       | $                           | (1.11      | ) | $ | (2.05 | ) | $ | 0.21 |   |
|                                                     |       |                        |       |   |   |   |   |
| Diluted                                                  |       | $                           | (1.11      | ) | $ | (2.05 | ) | $ | 0.20 |   |

 

All stock options outstanding were excluded from the weighted averagediluted earnings per share calculation for 2004 and 2003 as they would have hadan anti-dilutive effect as the Company was in a loss position.  For 2002, stock options to purchase 1,963,439shares of common stock were excluded from the weighted average diluted earningsper share calculation as they would have had an anti-dilutive effect.

 

**NOTE 14—INCOME TAXES**

 

The components of income before income taxes are as follows:

 
| ** ** | ** ** | **December 31,** | ** ** |
|------------|------------|------------------|------------|
| ** ** | ** ** | **2004**         | ** ** | **2003** | ** ** | **2002** | ** ** |
| Current:   |       |             |       |   |   |   |   |
| Federal    |       | $                | (35,106    | ) | $ | (73,779 | ) | $ | 2,788 |   |
| Foreign    |       | (10,708          | )          | 7,164 |   | 4,482 |   |
|       |       | (45,814          | )          | (66,615 | ) | 7,270 |   |
|            |            |                  |            |  |  |  |  |  |  |  |

 

60

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The components of the provision for income taxes are as follows:

 
| ** **               | ** ** | **December 31,** | ** ** |
|--------------------------|------------|------------------|------------|
| ** **               | ** ** | **2004**         | ** ** | **2003** | ** ** | **2002** | ** ** |
| Current:                 |       |             |       |   |   |   |   |
| Federal                  |       | $                | (694       | ) | $ | 444 |   | $ | 179 |   |
| State                    |       | —           |       | 370 |   | 89 |   |
| Foreign                  |       | 2,234            |       | 549 |   | 1,304 |   |
|                     |       | 1,540            |       | 1,363 |   | 1,572 |   |
| Deferred                 |       | —           |       | — |   | — |   |
| Total income tax expense |       | $                | 1,540      |   | $ | 1,363 |   | $ | 1,572 |   |

 

The tax provision differs from the amounts obtained by applying thestatutory U.S.  Federal Income Tax Rateto income taxes as shown below.

 

*Tax provision difference*

 
| ** **                                    | ** ** | **December 31,** | ** ** |
|-----------------------------------------------|------------|------------------|------------|
| ** **                                    | ** ** | **2004**         | ** ** | **2003** | ** ** | **2002** | ** ** |
| Tax benefit at U.S. statutory rate            |       | $                | (15,577    | ) | $ | (22,656 | ) | $ | 4,408 |   |
| Utilization of net operating loss  carryovers |       | —           |       | — |   | (1,078 | ) |
| Foreign earnings                              |       | 3,240            |       | (1,887 | ) | (2,555 | ) |
| State taxes net of federal benefit            |       | —           |       | 370 |   | (152 | ) |
| Other differences not benefited               |       | 15,198           |       | 7,522 |   | 751 |   |
| Permanent differences                         |       | 59               |       | 33 |   | — |   |
| Alternative minimum tax                       |       | —           |       | — |   | 198 |   |
| In-process research and development           |       | —           |       | 17,034 |   | — |   |
| Research and development credits              |       | (1,380           | )          | (831 | ) | — |   |
| Other                                         |       | —           |       | 1,778 |   | — |   |
| Total income tax expense                      |       | $                | 1,540      |   | $ | 1,363 |   | $ | 1,572 |   |

 

Deferred income tax assets comprise the following:

 
| ** **                                          | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------|------------|------------------|------------|
| ** **                                          | ** ** | **2004**         | ** ** | **2003** | ** ** | **2002** | ** ** |
| Deferred tax assets:                                |       |             |       |   |   |   |   |
| Federal and state net operating loss  carryforwards |       | $                | 100,443    |   | $ | 96,161 |   | $ | 12,117 |   |
| Tax credits                                         |       | 33,570           |       | 30,208 |   | — |   |
| Nondeductible reserves and accruals                 |       | 9,212            |       | 12,180 |   | 2,855 |   |
| Total deferred tax assets                           |       | 143,225          |       | 138,549 |   | 14,972 |   |
| Deferred tax liabilities:                           |       |             |       |   |   |   |   |
| Intangible assets                                   |       | (46,904          | )          | (61,971 | ) | (1,889 | ) |
| Deferred tax assets                                 |       | 96,321           |       | 76,578 |   | 13,083 |   |
| Valuation allowance                                 |       | (96,321          | )          | (76,578 | ) | (13,083 | ) |
| Net deferred tax assets                             |       | $                | —     |   | $ | — |   | $ | — |   |

 

A significant portion of the deferred tax assets above relates topre-acquisition loss carryforwards and other attributes along with stock optionbenefits that will result in an adjustment to goodwill and paid in capital whenrealized.

 

As of December 31, 2004, the Company has NOLs of approximately$271 million for federal and $93 million for state tax reporting purposes.  The federal NOLs expire on various datesbetween 2005 and 2025.  The state NOLsexpire between 2005 and 2010.  As ofDecember 31, 2004 the Company had tax credits of approximately $20 million forfederal and $12 million for state tax purposes, which will expire beginning in2005.  Management has recorded a fullvaluation allowance against all U.S. deferred tax assets on the basis thatsignificant uncertainty exists regarding the realizeability of the assets.  Approximately $18 million of NOLs relate tostock option deductions, for which a full valuation allowance has beenrecorded.

 

61

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As of December 31, 2004, the Company had not accrued income taxes on$13.6 million of accumulated undistributed earnings of its foreign subsidiariesbecause the earnings are intended to be reinvested indefinitely.

 

The calculation of the Company’s tax liabilities involves dealing withuncertainties in the application of complex tax regulations.  The Company records liabilities foranticipated tax audit issues on its estimate of whether, and the extent towhich, additional taxes may be due. Actual tax liabilities may be differentthan the recorded estimates and could result in an additional charge or benefitto the tax provision in the period when the ultimate tax assessment isdetermined.

 

Pursuant to the Tax Reform Act of 1986, the amounts of and the benefitfrom NOLs that can be carried forward may be impaired or limited in certaincircumstances, including a cumulative stock ownership change of more than 50%over a three-year period.  Approximately$214 million of the federal NOL carryover and $75 million of state NOL carryoverrelate to recent acquisitions and are subject to certain limitations underInternal Revenue Code Section 382.

 

The Company’s Israeli subsidiary has been granted the status of anApproved Enterprise pursuant to the Israeli law for the Encouragement of CapitalInvestments, 1959, as amended.  TheCompany has seven approved programs pursuant to this law.  The first program was approved in 1984 andexpired in 1997.  The second program wasapproved in 1991.  Income subject to thisprogram is exempt from tax for two years from the first year in which theCompany has taxable income (net of NOLs) and is taxed at a rate of 10%thereafter.  Benefits under the secondprogram expired in 2003.  The thirdprogram was approved in 1995.  Incomesubject to this program is exempt from tax for four years from the first yearin which the Company has taxable income (net of NOLs) and is taxed at a rate of10% during the remaining period of six years. The fourth program was approved in 1997. Income subject to this program is exempt from tax for two years from thefirst year in which the Company has taxable income (net of NOLs) and is taxedat a rate of 10% during the remaining period of eight years.  Benefits under the third and fourth programare limited to fourteen years from approval or twelve years from commencementof production.  The fifth program wasapproved in 2000.  Income subject to thisprogram is exempt from tax for two years from the first year in which theCompany has taxable income (net of NOLs) and is taxed at a rate of 10% duringthe remaining period of eight years.  Thesixth program was approved in 2001. Income subject to this program is exempt from tax for two years from thefirst year in which the Company has taxable income (net of NOLs) and is taxedat a rate of 10% during the remaining period of eight years.  The seventh program was approved in2002.  Income subject to the seventhprogram is exempt from tax for two years from the first year in which theCompany has taxable income (net of NOLs) and is taxed at a rate of 10% duringthe remaining period of eight years.

 

The tax holidays had no impact on the Company’s net loss in 2004.  The net impact of the holiday was a$1.8 million decrease in net loss for 2003 and a $369,000 increase in netincome in 2002, respectively.

 

**NOTE 15—SEGMENT REPORTING**

 

SFASNo. 131 establishes standards for the reporting by public business enterprisesof information about operating segments, products and services, geographicareas, and major customers.  The methodfor determining what information to report is based on the way that managementorganizes the operating segments within the Company for making operationaldecisions and assessments of financial performance.  The Company’s chief operating decision-makeris considered to be the Chief Executive Officer.

 

Subsequentto the acquisition of Oak Technology, Inc. in 2003, the Company determinedit had four reportable segments: Digital Versatile Disc (DVD), Imaging, DigitalCamera (DC) and Digital Television (DTV). Subsequent to the Emblaze acquisition in July 2004, the Digital Camerasegment was combined with the Emblaze Mobile business unit and was renamed theMobile segment.  Each segment’s primaryproducts are based on highly integrated application-specific integratedcircuits, or ASICs, and system-on-a-chip, or SOC, solutions.  The DVD and Imaging segments also licensecertain 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.

 

TheCompany evaluates operating segment performance based on net revenues andoperating expenses of these segments. The accounting policies of the operating segments are the same as thosedescribed in the summary of accounting policies.  No reportable segments have been aggregated.

 

62

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Information about reported segment income or loss is as follows for theyears ended December 31, 2004, 2003 and 2002 (in thousands):

 
| ** **           | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------|------------|----------|------------|----------|------------|----------|------------|
| Net revenues:        |       |     |       |     |       |     |       |
| DVD                  |       | $        | 229,227    |     | $          | 158,682  |       | $ | 132,141 |   |
| Imaging              |       | 84,368   |       | 14,711   |       | —   |       |
| Mobile               |       | 36,104   |       | 29,227   |       | 16,211   |       |
| DTV                  |       | 29,165   |       | 13,908   |       | 765      |       |
|                 |       | $        | 378,864    |     | $          | 216,528  |       | $ | 149,117 |   |
|                 |       |     |       |     |       |     |       |
| Operating expenses:  |       |     |       |     |       |     |       |
| DVD                  |       | $        | 231,438    |     | $          | 142,671  |       | $ | 107,438 |   |
| Imaging              |       | 51,242   |       | 17,746   |       | —   |       |
| Mobile               |       | 42,039   |       | 27,622   |       | 23,054   |       |
| DTV                  |       | 50,847   |       | 23,793   |       | 3,351    |       |
|                 |       | $        | 375,566    |     | $          | 211,832  |       | $ | 133,843 |   |
|                 |       |     |       |     |       |     |       |
| Contribution Margin: |       |     |       |     |       |     |       |
| DVD                  |       | $        | (2,211     | )        | $          | 16,011   |       | $ | 24,703 |   |
| Imaging              |       | 33,126   |       | (3,035   | )          | —   |       |
| Mobile               |       | (5,935   | )          | 1,605    |       | (6,843   | )          |
| DTV                  |       | (21,682  | )          | (9,885   | )          | (2,586   | )          |
|                 |       | $        | 3,298      |     | $          | 4,696    |       | $ | 15,274 |   |

 

The following is a reconciliation of the totals reported for theoperating segments to the applicable line items in the consolidated financialstatements for the years ended December 31, 2004, 2003 and 2002 (inthousands):

 
| ** **                                    | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Contribution margin from operating segments   |       | $        | 3,298      |     | $          | 4,696    |       | $ | 15,274 |   |
| Amortization of intangibles                   |       | (45,358  | )          | (18,950  | )          | (8,151   | )          |
| Acquisition related expenses                  |       | —   |       | (1,369   | )          | —   |       |
| Deferred stock compensation                   |       | (4,051   | )          | (6,281   | )          | (292     | )          |
| Restructuring expense                         |       | (746     | )          | —   |       | —   |       |
| Acquired in-process research and  development |       | —   |       | (50,100  | )          | —   |       |
| Total operating income (loss)                 |       | $        | (46,857    | )        | $          | (72,004  | )          | $ | 6,831 |   |

 

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

 

The distribution of net revenues for the years ended December 31,2004, 2003 and 2002 was as follows (in thousands):

 
| ** **                                                                  | ** ** | **Year ended December 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                  | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Revenue from unaffiliated customers  originating from:**                  |       |                        |       |   |   |   |   |
| China                                                                       |       | $                           | 150,562    |   | $ | 78,542 |   | $ | 46,420 |   |
| Japan                                                                       |       | 101,792                     |       | 48,872 |   | 62,160 |   |
| Korea                                                                       |       | 28,353                      |       | 40,751 |   | 14,725 |   |
| Taiwan                                                                      |       | 36,631                      |       | 24,577 |   | 16,040 |   |
| Other (customers originating in the US is  less than 10% of total revenues) |       | 61,526                      |       | 23,786 |   | 9,772 |   |
|                                                                        |       | $                           | 378,864    |   | $ | 216,528 |   | $ | 149,117 |   |

 

63

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The distribution of identifiable assets by geographic areas andproperty and equipment as of December 31, 2004 and 2003 was as follows (inthousands):

 
| ** **                       | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|------------------|------------|
| ** **                       | ** ** | **2004**         | ** ** | **2003** | ** ** |
|                             |       |             |       |   |   |
| **Identifiable assets:**         |       |             |       |   |   |
| U.S.                             |       | $                | 465,192    |   | $ | 559,710 |   |
| Israel                           |       | 125,506          |       | 49,163 |   |
| Canada                           |       | 233              |       | 300 |   |
| United Kingdom                   |       | 1,220            |       | 890 |   |
| China                            |       | 1,057            |       | 646 |   |
| Japan                            |       | 2,068            |       | 4,318 |   |
| Korea                            |       | 211              |       | 305 |   |
| Taiwan                           |       | 3,454            |       | 6,402 |   |
| Other                            |       | 340              |       | 503 |   |
|                             |       | $                | 599,281    |   | $ | 622,237 |   |
|                             |       |             |       |   |   |
| **Property and equipment, net:** |       |             |       |   |   |
| U.S.                             |       | $                | 9,785      |   | $ | 12,739 |   |
| Israel                           |       | 5,486            |       | 4,911 |   |
| Canada                           |       | 37               |       | 49 |   |
| United Kingdom                   |       | 415              |       | 444 |   |
| China                            |       | 554              |       | 418 |   |
| Japan                            |       | 529              |       | 279 |   |
| Korea                            |       | 96               |       | 114 |   |
| Taiwan                           |       | 199              |       | 1,000 |   |
| Other                            |       | 89               |       | 75 |   |
|                             |       | $                | 17,190     |   | $ | 20,029 |   |

 

The following table summarizes the percentage contribution to netrevenues by customers when sales to such customers exceeded 10% of net revenuesand the associated percentage of total accounts receivable due from thesecustomers (in thousands):

 
| ** **                      | ** ** | **Year ended  December 31,** | ** ** |
|---------------------------------|------------|------------------------------|------------|
| ** **                      | ** ** | **2004**                     | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Percentage of net revenues:** |       |                         |       |   |   |   |   |
| A                               |       | —                       |       | 14 | % | 37 | % |
| B                               |       | —                       |       | — |   | — |   |
| C                               |       | 11                           | %          | 17 | % | — |   |
| D                               |       | —                       |       | — |   | — |   |

 
| ** **                                 | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|------------------|------------|
| ** **                                 | ** ** | **2004**         | ** ** | **2003** | ** ** |
| **Percentage of net accounts receivable:** |       |             |       |   |   |
| A                                          |       | —           |       | — |   |
| B                                          |       | 13               | %          | 14 | % |
| C                                          |       | —           |       | 10 | % |
| D                                          |       | 27               | %          | — |   |

 

64

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**NOTE 16—ACQUISITIONS**

 

**Emblaze Semiconductor Ltd.**

 

On July 8, 2004, Zoranacquired Emblaze Semiconductor Ltd.  (“Emblaze”),a subsidiary of Emblaze Ltd. and a provider of semiconductor-based solutionsfor high volume manufacturers of multimedia mobile telephones.  Under the terms of the agreement, Zoran’swholly-owned Israel based subsidiary, Zoran Microelectronics Ltd., acquired allof the outstanding common shares of Emblaze for approximately $54.2 million incash.

 

Theprimary purpose of the acquisition was to gain high performance, low-powerapplication processors, technology and products for the fast growing multimediamobile phone market.  This technologywill be combined with Zoran’s image processing technology to deliver reliable,cost-effective system solutions for mobile phone makers.

 

The transaction wasaccounted for under SFAS No. 141, “Business Combinations,” using the purchasemethod of accounting.  The Companyincurred approximately $180,000 for acquisition-related expenses consisting offinancial advisory, legal and other consulting services.  The Company completed a valuation analysisand purchase price allocation with the assistance of a third partyappraiser.  The results of operations ofEmblaze have been included in the consolidated financial statements from thedate of acquisition.  The historicaloperations of Emblaze are not material to the financial position or results ofoperations of the Company; therefore, no pro forma information ispresented.  The acquisition resulted ingoodwill of approximately $30.9 million. In accordance with SFAS 142, goodwill will not be amortized and will betested for impairment at least annually.

 

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

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

 

Thepurchase price exceeded the net assets acquired resulting in the recognition ofgoodwill and other intangible assets. The amounts allocated to intangible assets include purchased technologytotaling $11.8 million and patents totaling $12.4 million which are beingamortized over their estimated useful lives of three years.

 

**Oak Technology, Inc.**

 

OnAugust 11, 2003, pursuant to an Agreement and Plan of Reorganization datedas of May 4, 2003 (the “Merger Agreement”) among Zoran, a wholly-ownedsubsidiary of Zoran (“Merger Sub”), and Oak Technology, Inc., Oak wasmerged with and into Merger Sub.

 

Thetransaction was accounted for under SFAS No. 141, “Business Combinations,” using the purchase method of accountingand accordingly the results of operations of Oak have been included in theCompany’s financial statements since the date of acquisition.

 

TheCompany’s primary objectives in acquiring Oak were based on the Company’sbelief that the combined company would benefit from the following:

 

•      Oak’s complementary technologies and products, especially in thedigital TV and digital imaging markets, and the ability of the combined companyto expand its existing customer base and market share in the digital consumerelectronics market by integrating the product lines of each company;

 

•      Oak’s intellectual property portfolio and related expertise, especiallyintellectual property relating to front-end optical recording;

 

•      access to Oak’s customer relationships, providing cross-sellingopportunities to existing customers as well as opportunities to build newrelationships;

 

•      the opportunity to achieve synergies and realize significant cost savings,including operational efficiencies, such as acceleration of various productdevelopment activities by leveraging Oak’s intellectual property, reducedoverhead and, in geographic areas where the two companies overlap, increasedefficiency in the combined company’s sales channels;

 

•      Oak’s existing market position as a leading supplier of HDTV integratedcircuits, providing the combined company with access to this high-growth marketsegment; and

 

65

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•      Oak’s existing market position as a leading supplier of Digital Imagingrelated integrated circuit and software products.

 

Thepurchase price exceeded the net assets acquired resulting in the recognition ofgoodwill and other intangible assets.

 

Thefinancial statements reflect a purchase price of approximately$392.7 million, determined as follows (in thousands):

 
| Cash payments                       |   | $       | 100,992 |   |
|-------------------------------------|--------|---------|---------|--------|
| Fair value of common stock issued   |   | 227,462 |    |
| Fair value of stock options granted |   | 57,446  |    |
| Acquisition costs                   |   | 6,847   |    |
| Total consideration                 |   | $       | 392,747 |   |

 

Thecash payment and fair value of common stock issued represents the conversion ofeach outstanding share of Oak common stock into $1.78 in cash and 0.2323 of ashare of Zoran common stock.  As a resultof the acquisition, 56,737,298 shares of Oak common stock were converted into$101.0 million in cash and 13,180,074 shares of Zoran common stock with afair value of $227.5 million based on the fair market value of Zorancommon stock for the period two days before and after the date on which theterms of agreement were finalized and announced, May 5, 2003.

 

Non-qualifiedoptions to purchase approximately 4.5 million shares of Zoran common stockwith a term of ten years were granted to Oak employees as part of theacquisition.  The corresponding fairvalue of these options of $57.4 million was estimated based on the fairvalue of the Zoran common stock as of the acquisition date using the Black-Scholesoption pricing model applying the following assumptions: expected life of 50 months,risk-free interest rate of 3.65%, expected volatility of 93% and no expecteddividend yield.  The intrinsic value ofthe unvested options, totaling approximately $19.2 million, has beenrecorded as deferred stock compensation and will be amortized over the vestingperiod using the multiple option approach.

 

Acquisitioncosts included $3.3 million of investment banker fees, $1.7 millionof insurance costs, $1.1 million of legal and accounting fees and $700,000in other acquisition related expenses.

 

Thepurchase price allocation was as follows (in thousands):

 
| Net assets acquired                 |   | $       | 65,644  |   |
|-------------------------------------|--------|---------|---------|--------|
| Deferred stock compensation         |   | 19,212  |    |
| In-process research and development |   | 50,100  |    |
| Intangible assets                   |   | 197,650 |    |
| Goodwill                            |   | 60,141  |    |
|                                |   | $       | 392,747 |   |

 

Thefollowing table summarizes the estimated fair value of the tangible assetsacquired and liabilities assumed at the date of acquisition (in thousands):

 
| Cash and short-term investments |   | $       | 71,325 |   |
|---------------------------------|--------|---------|--------|--------|
| Accounts receivable             |   | 8,086   |   |
| Other current assets            |   | 17,090  |   |
| Inventory                       |   | 3,676   |   |
| Property, plant and equipment   |   | 13,075  |   |
| Other assets                    |   | 816     |   |
| Current liabilities             |   | (38,196 | )      |
| Non-current liabilities         |   | (10,228 | )      |
| Net assets acquired             |   | $       | 65,644 |   |

 

Tangibleassets were valued at estimates of their current fair values.  The valuation of the acquired intangibleassets, which was based on management’s estimates and considered variousfactors including appraisals, resulted in a value of purchased technology ofapproximately $157.9 million, patents of $27.0 million, customer baseof $11.5 million and trademarks and tradenames of approximately$1.3 million.  Purchased technologyis being amortized over a weighted average estimated useful life of4.8 years, and patents, customer base, trademarks and tradenames are beingamortized over their estimated useful lives of five years with no residualvalues.

 

66

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Duringthe period August 11, 2003 through March 31, 2004, management revised itsestimates related to certain assets and liabilities, and as a result, thepurchase price and goodwill were each decreased by $3.4 million.

 

Approximately$60.0 million of the purchase price was allocated to goodwill.  Goodwill represents the excess of thepurchase price over the fair value of the net tangible and identifiableintangible assets acquired.  Inaccordance with SFAS 142, “Goodwill and Other Intangible Assets”, goodwillwill not be amortized and will be tested for impairment at least annually.  We do not expect goodwill to be deductiblefor tax purposes.

 

Approximately$50.1 million of the purchase price was allocated to in-process researchand development which had not yet reached technological feasibility and had noalternative future use.  Accordingly,this amount was immediately expensed upon the acquisition date.  This amount was determined using management’sestimates including consultation with an independent appraiser.  The value of the in-process research anddevelopment was determined using a discounted cash flow method and factors includingprojected financial results, relative risk of successful development,time-value of money and level of completion.

 

TheCompany expects that the in-process technologies will be successfully completedby the third quarter of calendar 2005 with approximately $3.4 million incosts remaining as of December 31, 2004. At the time of acquisition, Oak had five material development projectsin process as follows:

 

•      Quatro 4100—a highly integrated, fully programmable system-on-a-chip(SOC) solution for the emerging class of appliance type printers.  The Quatro-4100 incorporates the RISC CPUcore and Quatro SIMD DSP core to provide an easy to program controllerplatform.

 

•      Quatro 4230—a programmable SOC solution that will complement theQuatro-4110 and Quatro-4100 in the inkjet market.  Quatro 4230 will provide a fully scalablesolution platform to cover much of the performance and feature range of an OEM’slaser offerings.

 

•      Integrated Print System—The Integrated Print System (“IPS”) is adynamic embedded scalable architecture providing peripheral manufacturers withhighly integrated modular controller and connectivity software for poweringsingle and multifunctional devices.

 

•      Generation 9—an integrated SOC that integrates a previous generation ofHDTV digital video technology with a new Audio-DSP Core as well as a MIPS 64bit processor and certain other video processing features.

 

•      A new lower cost highly integrated HDTV decoder—the first in a familyof highly integrated HDTV decoders specifically designed for the FCC mandateddigital television chassis market.  Thisdevice includes all the required interfacing to support digital cableapplications and is applicable to existing CRT and flat panel display devices.

 

Thevalue of in-process research and development was determined using the multi-periodexcess earnings method by estimating the expected net cash flows from theprojects once commercially viable and discounting the net cash flows back totheir present value using a discount rate of 22%.  This rate was based on the industry segmentfor the technology, nature of the products to be developed, length of time tocomplete the project and overall maturity and history of the developmentteam.  The net cash flows from theidentified projects were based on estimates of revenue, cost of revenue,research and development expenses, selling general and administrative expenses,and applicable income taxes.  Theseestimates did not take into account any potential synergies that could berealized as a result of the acquisition. Revenues for the incremental core technologies developed are expected tocommence in the fourth quarter of 2005 and extend through 2011.  Revenue projections were based on estimatesof market size and growth, expected trends in technology and the expectedtiming of new product introductions.  Asof December 31, 2004, there have been no material variations from theunderlying assumptions that were used in the original computation of the valueof the acquired in-process research and development.

 

67

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**Pro Forma Financial Information**

 

Thefollowing unaudited pro forma financial information presents the combinedresults of operations of Zoran, Oak and Emblaze as if the acquisitions hadoccurred as of the beginning of each period presented, after giving effect tocertain adjustments, including amortization of intangibles.  The in-process research and developmentcharge of $50.1 million is not reflected in the unaudited pro formacombined condensed statement of operations. The unaudited pro forma financial information does not necessarilyreflect the results of operations that would have occurred had the combinedcompanies constituted a single entity during such periods, and is notnecessarily indicative of results which may be obtained in the future.

 
| ** **                                  | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------|------------|-----------------------------|------------|
| ** **                                  | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                        |       |                        |       |   |   |   |   |
| **In thousands except for per share data:** |       |                        |       |   |   |   |   |
| Pro forma revenues                          |       | $                           | 380,000    |   | $ | 279,486 |   | $ | 288,455 |   |
|                                        |       |                        |       |   |   |   |   |
| Pro forma net loss                          |       | $                           | (55,879    | ) | $ | (89,893 | ) | $ | (98,753 | ) |
|                                        |       |                        |       |   |   |   |   |
| Pro forma net loss per share:               |       |                        |       |   |   |   |   |
| Basic                                       |       | $                           | (1.31      | ) | $ | (2.18 | ) | $ | (2.45 | ) |
|                                        |       |                        |       |   |   |   |   |
| Diluted                                     |       | $                           | (1.31      | ) | $ | (2.18 | ) | $ | (2.45 | ) |

 

**NOTE 17—RELATED PARTY TRANSACTIONS**

 

In January 1996, the Company spun off its wholly-owned subsidiary,Oren Semiconductor, to the Company’s stockholders.  One of the Company’s executive officers is amember of Oren’s board of directors.  InDecember 2002, the Company entered into a technology license agreementwith Oren.  Under the licensearrangement, the Company agreed to pay Oren a license fee totaling$675,000.  There are no royaltiesassociated with this agreement.  During2003, Zoran made a minority investment in Oren by acquiring capital stock for apurchase price of $3.5 million representing a 14.4% ownership of Oren.During 2004, Zoran loaned $700,000 to Oren pursuant to a convertible promissorynote bearing interest at an annual rate of LIBOR + 3%.

 

68

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**ZORANCORPORATIONSELECTED QUARTERLY FINANCIAL INFORMATION(Unaudited)**

 
| ** **                                        | ** ** | **Three Months Ended**                    | ** ** |
|---------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                        | ** ** | **Dec. 31,  2004**                        | ** ** | **Sep. 30,  2004  (restated)** | ** ** | **Jun. 30,  2004  (restated)** | ** ** | **Mar. 31,  2004  (restated)** | ** ** | **Dec. 31,  2003** | ** ** | **Sep. 30,  2003** | ** ** | **Jun. 30,  2003** | ** ** | **Mar. 31,  2003** | ** ** |
| ** **                                        | ** ** | **(In Thousands, Except Per Share Data)** | ** ** |
| Total revenues                                    |       | $                                         | 74,764     |   | $ | 119,747 |   | $ | 103,716 |   | $ | 80,637 |   | $ | 66,544 |   | $ | 67,420 |   | $ | 44,731 |   | $ | 37,833 |   |
| Gross profit                                      |       | $                                         | 19,252     |   | $ | 53,190 |   | $ | 44,878 |   | $ | 35,309 |   | $ | 28,824 |   | $ | 27,026 |   | $ | 18,504 |   | $ | 11,123 |   |
| Operating income (loss)                           |       | $                                         | (32,374    | ) | $ | (501 | ) | $ | (3,658 | ) | $ | (10,324 | ) | $ | (18,788 | ) | $ | (55,488 | ) | $ | 3,523 |   | $ | (1,251 | ) |
| Net income (loss)                                 |       | $                                         | (30,130    | ) | $ | (2,639 | ) | $ | (4,600 | ) | $ | (9,985 | ) | $ | (17,765 | ) | $ | (54,484 | ) | $ | 4,233 |   | $ | 193 |   |
| Basic net income (loss) per share(1)              |       | $                                         | (0.70      | ) | $ | (0.06 | ) | $ | (0.11 | ) | $ | (0.23 | ) | $ | (0.42 | ) | $ | (1.53 | ) | $ | 0.15 |   | $ | 0.01 |   |
| Diluted net income (loss) per share(1)            |       | $                                         | (0.70      | ) | $ | (0.06 | ) | $ | (0.11 | ) | $ | (0.23 | ) | $ | (0.42 | ) | $ | (1.53 | ) | $ | 0.15 |   | $ | 0.01 |   |
| Shares used in basic per share  calculations(1)   |       | 43,212                                    |       | 42,969 |   | 42,697 |   | 42,522 |   | 42,247 |   | 35,718 |   | 27,481 |   | 27,396 |   |
| Shares used in diluted per share  calculations(1) |       | 43,212                                    |       | 42,969 |   | 42,697 |   | 42,522 |   | 42,247 |   | 35,718 |   | 28,991 |   | 28,096 |   |

 

----

(1)           Computedon the basis described in Note 2 of Notes to Consolidated FinancialStatements.

 

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

 

Theselected quarterly financial information above reflects the restatement of thequarters ended March 31, 2004, June 30, 2004 and September 30, 2004 to correctan error in the calculation of deferred stock compensation expense.  Following the acquisition of Oak, the Companyfailed to update its personnel and financial records to reflect the forfeitureof unvested options held by former Oak employees that occurred when theemployment of any such employee terminated prior to vesting.  As a result, the Company improperlyrecognized deferred stock compensation expenses relating to options that hadbeen held by former Oak employees after the vesting of such options had ceaseddue to termination of employment and did not reverse stock based compensationexpense previously recognized for unvested awards that were forfeited.  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 financial information included on Form 10-Q and Form 8-K previouslyfiled or furnished by Zoran for these periods should not be relied upon and aresuperceded by the information in this Form 10-K.

 

Thefollowing table shows the effect of the restatement:

 
| ** **                          | ** ** | **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 | ) |

 

69

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**Item 9—Changes in and Disagreements withAccountants on Accounting and Financial Disclosure**

 

Not applicable.

 

**Item 9A—****Controls and Procedures**

 

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

 

Inconnection with the review and evaluation of the effectiveness of our internalcontrol over financial reporting undertaken pursuant to Section 404 of theSarbanes-Oxley Act of 2002, management discovered that excess stockcompensation expenses had been recognized during the quarters ended March 31,June 30 and September 30, 2004.  Thecompensation expense was related to options that we had assumed as part of ouracquisition of Oak Technology, Inc. in 2003. Under purchase accounting, part of the cost relating to the acquisitionwas attributed to the assumed options and was to be recognized over time as theoptions continued to vest, based on each option holder’s continued employmentwith Zoran.  If an option holder’semployment terminated before the option was fully vested, vesting would cease,and we would no longer recognize compensation expense related to thatoption.  At the time of the acquisition,a schedule was prepared detailing the terms of each assumed option; however,the names of the option holders were omitted from the schedule for reasons ofconfidentiality.  After the acquisitionwas completed, we did not update our personnel or financial records to includethe omitted information. As a result, the Company improperly recognizeddeferred stock compensation expenses relating to options that had been held byformer Oak employees after the vesting of such options had ceased, and did notreverse stock based compensation expense recognized in excess of amounts thatactually vested.

 

Tocorrect this error, we have restated the financial results that we previouslyreported for the quarters ended March 31, June 30 and September 30, 2004.  For information about the effects of therestatement, see Selected Quarterly Financial Information included in Item 8 ofthis annual report. The effect of the error on periods in 2003 was notmaterial, and therefore, no adjustment was made for such periods.

 

**Conclusion Regarding the Effectiveness of Disclosure Controlsand Procedures**

 

Underthe supervision and with the participation of our management, including ourprincipal executive officer and principal financial officer, we conducted anevaluation of our disclosure controls and procedures, as such term is defined underRule 13a-15(e) promulgated under the Securities Exchange Act of 1934, asamended (the “Exchange Act”).  As part ofthis evaluation, we considered the circumstances relating to the improperrecognition of stock compensation discussed above.  In light of the error, we believe that ourdisclosure controls and procedures were not effective as of the end of eachperiod affected. However, during the fourth quarter of 2004, we improveddisclosure controls and procedures by updating our database to include thenecessary information required to calculate the impact of cancelled options onan ongoing basis.  Accordingly, based on our evaluation, ourprincipal executive officer and our principal financial officer concluded thatour disclosure controls and procedures were effective as of the end of theperiod covered by this annual report.

 

**Management’s Report on Internal Control Over FinancialReporting**

 

Ourmanagement is responsible for establishing and maintaining adequate internalcontrol over financial reporting. Internal control over financial reporting isa process designed by, or under the supervision of, our Chief Executive Officerand Chief Financial Officer, and effected by our board of directors, managementand other personnel, to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles (“GAAP”),and includes those policies and procedures that:

 

(1)           pertain to the maintenance of records that inreasonable detail accurately and fairly reflect the transactions anddispositions of the assets of Zoran;

 

(2)           provide reasonable assurance thattransactions are recorded as necessary to permit preparation of financial statementsin accordance with GAAP, and that our receipts and expenditures are being madeonly in accordance with authorizations of our management and directors; and

 

(3)           provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use or dispositionof our assets that could have a material effect on our financial statements.

 

70

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Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements.  Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

 

Underthe supervision and with the participation of our management, including ourprincipal executive officer and principal financial officer, we conducted anevaluation of the effectiveness of our internal control over financialreporting based on the framework in *InternalControl - Integrated Framework*issued by the Committee of SponsoringOrganizations of the Treadway Commission. Based on our evaluation under the framework in *Internal Control — Integrated Framework*,our management concluded that our internal control over financial reporting waseffective as of December 31, 2004.

 

Ourmanagement’s assessment of the effectiveness of our internal control overfinancial reporting as of December 31, 2004 has been audited byPricewaterhouseCoopers LLP, an independent registered public accounting firm,as stated in their report which is included herein.

 

**Changes to Internal Control Over Financial Reporting**

 

Asdiscussed above, during the fourth quarter of 2004, the Company updated personneland financial records to ensure stock compensation expense relating to thevesting of assumed options held by former employees of Oak Technology, Inc. wasproperly accounted for.  Other than thatchange, during the quarter ended December 31, 2004 there were no changes in ourinternal control over financial reporting that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

71

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**PARTIII**

 

Certain information required by Part III is omitted from thisreport in that the Company intends to file its definitive proxy statementpursuant to Regulation 14A (the “Proxy Statement”) not later than120 days after the end of the fiscal year covered by this report andcertain information therein is incorporated herein by reference.

 

**Item 10—Directors and Executive Officers ofthe Registrant**

 

The information required by this Item is incorporated by reference toinformation set forth in the Proxy Statement under the heading “Proposal No.1—Election of Directors” and in Part I of this Report under the heading “ExecutiveOfficers of the Registrant.”

 

The information required by this Item with respect to compliance withSection 16(a) of the Securities Exchange Act of 1934 is incorporated byreference to information set forth in the Proxy Statement under the heading “Section 16(a)Beneficial Ownership Reporting Compliance.”

 

Theinformation required by this Item with respect to our code of ethics isincorporated by reference to information set forth in the Proxy Statement underthe heading “Code of Ethics.”

 

**Item 11—Executive Compensation**

 

The information required by this Item is incorporated by reference toinformation set forth in the Proxy Statement under the heading “ExecutiveCompensation.”

 

**Item 12—Security Ownership of CertainBeneficial Owners and Management and Related Stockholder Matters**

 

The information required by this Item is incorporated by reference toinformation set forth in the Proxy Statement under the headings “PrincipalStockholders and Share Ownership by Management” and “Equity Compensation PlanInformation.”

 

**Item 13—Certain Relationships and RelatedTransactions**

 

The information required by this Item is incorporated by reference toinformation set forth in the Proxy Statement under the heading “CertainTransactions.”

 

**Item 14—Principal Accounting Fees andServices**

 

The information required by this Item is incorporated by reference toinformation set forth in the proxy statement under the heading “Fees Paid toPricewaterhouseCoopers LLP.”

 

72

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**PART IV**

 

**Item 15—Exhibits and Financial StatementSchedules**

 

The followingdocuments are filed as a part of this report:

 

(1)           Financial Statements:

See Index to Consolidated FinancialStatements at page 40 of this report.

 

(2)           Financial StatementSchedules:

All financial statement schedules are omittedbecause they are not applicable or not required, or because the requiredinformation is included in the Consolidated Financial Statements and Notesthereto which are included herein.

 

(3)           Exhibits:

The exhibits listed on the accompanyingExhibit Index are filed as part of, or are incorporated by reference into, thisreport.

 

73

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.

 
| Dated: March 31, 2005 | ZORAN CORPORATION |
|-----------------------|-------------------|
|                  |              |
|                  | By:               | /s/ Levy Gerzberg |
|                  |              | Levy Gerzberg,  President and Chief Executive Officer |

 

Pursuant to the requirements of the Security Exchange Act of 1934, thisreport has been signed by the following persons on behalf of the registrant andin the capacities and on the dates indicated.

 
| **Signature**          | ** ** | **Title**                                                             | ** ** | **Date**       |
|------------------------|------------|-----------------------------------------------------------------------|------------|----------------|
| /s/ Levy Gerzberg      |       | President, Chief Executive Officer and  Director (Principal Executive |       | March 31, 2005 |
| Levy Gerzberg          |       | Officer)                                                              |       |           |
|                   |       |                                                                  |       |           |
| /s/ Karl Schneider     |       | Senior Vice President, Finance and Chief  Financial Officer           |       | March 31, 2005 |
| Karl Schneider         |       | (Principal Financial and Accounting  Officer)                         |       |           |
|                   |       |                                                                  |       |           |
| /s/ Uzia Galil         |       | Chairman of the Board of Directors                                    |       | March 31, 2005 |
| Uzia Galil             |       |                                                                  |       |           |
|                   |       |                                                                  |       |           |
| /s/ James D. Meindl    |       | Director                                                              |       | March 31, 2005 |
| James D. Meindl        |       |                                                                  |       |           |
|                   |       |                                                                  |       |           |
| /s/ James B. Owens     |       | Director                                                              |       | March 31, 2005 |
| James B. Owens, Jr.    |       |                                                                  |       |           |
|                   |       |                                                                  |       |           |
| /s/ David Rynne        |       | Director                                                              |       | March 31, 2005 |
| David Rynne            |       |                                                                  |       |           |
|                   |       |                                                                  |       |           |
| /s/ Arthur B. Stabenow |       | Director                                                              |       | March 31, 2005 |
| Arthur B. Stabenow     |       |                                                                  |       |           |
|                   |       |                                                                  |       |           |
| /s/ Philip M. Young    |       | Director                                                              |       | March 31, 2005 |
| Philip M. Young        |       |                                                                  |       |           |

 

74

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**EXHIBITINDEX**

 
| **Exhibit  Number** | ** ** | **Exhibit Title**                                                                                                                                                                                                                                                                                                              |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1(1)              |       | Form of Restated Certificate of  Incorporation of the Registrant.                                                                                                                                                                                                                                                              |
|                |       |                                                                                                                                                                                                                                                                                                                           |
| 3.2(2)              |       | Amended Bylaws of the Registrant.                                                                                                                                                                                                                                                                                              |
|                |       |                                                                                                                                                                                                                                                                                                                           |
| 4.1(3)              |       | Amended and Restated Stock Rights Agreement  dated July 30, 1993 among the Registrant and certain of its stockholders, as  amended.                                                                                                                                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                                           |
| *10.1(4)            |       | 1993 Stock Option Plan, as amended.                                                                                                                                                                                                                                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                                           |
| *10.2(4)            |       | 1995 Outside Directors Stock Option Plan.                                                                                                                                                                                                                                                                                      |
|                |       |                                                                                                                                                                                                                                                                                                                           |
| *10.3(4)            |       | Amended and Restated 1995 Employee Stock  Purchase Plan.                                                                                                                                                                                                                                                                       |
|                |       |                                                                                                                                                                                                                                                                                                                           |
| *10.4(3)            |       | Form of Indemnity Agreement for officers  and directors.                                                                                                                                                                                                                                                                       |
|                |       |                                                                                                                                                                                                                                                                                                                           |
| 10.7(3)             |       | Letter Agreement dated December 16, 1991  between the Registrant and Dolby Laboratories Licensing Corporation, as  amended.                                                                                                                                                                                                    |
|                |       |                                                                                                                                                                                                                                                                                                                           |
| 10.11(3)            |       | Lease Agreement dated October 1, 1992  between the Registrant’s subsidiary, Zoran Microelectronics Ltd. (“ZML”), and  Matam-Haifa Scientific Industries Center Ltd. (“Matam”).                                                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                           |
| †10.12(3)      |       | License Agreement for ZR33891 Digital  Filter Processor dated June 8, 1995 between the Registrant and Atmel  Corporation (“Atmel”).                                                                                                                                                                                  |
|                |       |                                                                                                                                                                                                                                                                                                                           |
| †10.13(3)      |       | License Agreement for ZR34325 Vector Signal  Processor dated June 8, 1995 between the Registrant and Atmel.                                                                                                                                                                                                                    |
|                |       |                                                                                                                                                                                                                                                                                                                           |
| †10.14(3)      |       | Cooperation and Project Funding Agreement  dated June 16, 1991 between ZML and the Israel-United States Binational  Industrial Research and Development Foundation (“BIRDF”).                                                                                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                           |
| †10.15(3)      |       | Cooperation and Project Funding Agreement  dated June 9, 1992 between ZML and BIRDF.                                                                                                                                                                                                                                           |
|                |       |                                                                                                                                                                                                                                                                                                                           |
| 10.16(3)            |       | Note of Approval No. 17391 dated September  5, 1994 issued to ZML by the Office of Chief Scientist, Head of the  Industrial Research and Development Administration of the Israeli Ministry of  Industry and Trade (the “Chief Scientist”), together with ZML’s Letter of  Undertaking dated September 4, 1994. |
|                |       |                                                                                                                                                                                                                                                                                                                           |
| 10.17(3)            |       | Note of Approval No. 17337 dated September  5, 1994 issued to ZML by the Chief Scientist, together with ZML’s Letter of  Undertaking dated September 4, 1994.                                                                                                                                                             |
|                |       |                                                                                                                                                                                                                                                                                                                           |
| 10.18(3)            |       | Loan Agreements dated July 25, 1995, August  1, 1995, August 15, 1995, August 31, 1995 and November 1, 1995 between ZML  and the Israel Discount Bank.                                                                                                                                                                         |
|                |       |                                                                                                                                                                                                                                                                                                                           |
| 10.29(5)            |       | Summary of Discussion dated April 23, 1996  between ZML and Matam regarding Lease Agreement dated October 1, 1992 between  ZML and Matam.                                                                                                                                                                                      |
|                |       |                                                                                                                                                                                                                                                                                                                           |
| 10.30(6)            |       | Memorandum of Understanding Dated April 23,  1996 between ZML and IBM Israel Ltd. regarding Lease Agreement dated October  1, 1992 between ZML and Matam.                                                                                                                                                                      |
|                |       |                                                                                                                                                                                                                                                                                                                           |
| 10.33(7)            |       | Sub-Sublease dated April 1, 1997 between  the Registrant and Integrated Silicon Solutions, Inc.                                                                                                                                                                                                                                |
|                |       |                                                                                                                                                                                                                                                                                                                           |
| 10.36(8)            |       | Unprotected Tenancy Agreement dated  September 16, 1997 between ZML and Matam, together with Appendix Addendum to  Unprotected Tenancy Agreement of 16.9.97.                                                                                                                                                                   |

 

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| **Exhibit  Number** | ** ** | **Exhibit Title**                                                                                                                                                                                                            |
|---------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.37(1)            |       | Addendum to sub-sublease dated April 1,  1997 between the Registrant Integrated Silicon Solution, Inc.                                                                                                                       |
|                |       |                                                                                                                                                                                                                         |
| *10.38(9)           |       | Form of Amendment of Nonstatutory Stock  Option Agreement for Outside Directors.                                                                                                                                             |
|                |       |                                                                                                                                                                                                                         |
| 10.39(10)           |       | 2000 Nonstatutory Stock Option Plan.                                                                                                                                                                                         |
|                |       |                                                                                                                                                                                                                         |
| *10.40(10)          |       | Executive Retention and Severence Plan.                                                                                                                                                                                      |
|                |       |                                                                                                                                                                                                                         |
| *10.41(11)          |       | Employment Agreement, dated as of  May 4, 2003, by and between Registrant and Young K. Sohn.                                                                                                                       |
|                |       |                                                                                                                                                                                                                         |
| 10.42(12)           |       | Sublease dated June 18, 2001 between  Yahoo! Inc. and Oak Technology, Inc.                                                                                                                                              |
|                |       |                                                                                                                                                                                                                         |
| *10.43(12)          |       | Amended and Restated 1995 Employee Stock  Purchase Plan.                                                                                                                                                                     |
|                |       |                                                                                                                                                                                                                         |
| 10.44(13)           |       | Oak Technology, Inc. 1994 Stock Option Plan  (as amended and restated).                                                                                                                                                      |
|                |       |                                                                                                                                                                                                                         |
| 10.45(14)           |       | Oak Technology, Inc. 1994 Outside  Directors’ Stock Option Plan (as Amended and Restated November 21,  2002).                                                                                                      |
|                |       |                                                                                                                                                                                                                         |
| *10.46(12)          |       | Form of Oak Technology, Inc. Outside  Directors’ Non-Qualified Stock Option Agreement for the 1994 Stock Option  Plan and 1994 Outside Director’s Stock Option Plan entered into by David  Rynne and Peter Simone. |
|                |       |                                                                                                                                                                                                                         |
| 10.47(15)           |       | Asset purchase agreement between Oak  Technology, Inc., and Sunplus Technology, Co. LTC. dated April 3, 2003.                                                                                                           |
|                |       |                                                                                                                                                                                                                         |
| *10.48              |       | Summary of Compensation Arrangements with  Named Executive Officers and Nonemployee Directors.                                                                                                                               |
|                |       |                                                                                                                                                                                                                         |
| 23.1                |       | Consent of PricewaterhouseCoopers LLP.                                                                                                                                                                                       |
|                |       |                                                                                                                                                                                                                         |
| 31.1                |       | Certification of Chief Executive Officer,  pursuant to Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302  of the Sarbanes-Oxley Act of 2002.                                                                   |
|                |       |                                                                                                                                                                                                                         |
| 31.2                |       | Certification of Chief Financial Officer,  pursuant to Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302  of the Sarbanes-Oxley Act of 2002.                                                                   |
|                |       |                                                                                                                                                                                                                         |
| 32.1                |       | Certification of Chief Executive Officer,  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                        |
|                |       |                                                                                                                                                                                                                         |
| 32.2                |       | Certification of Chief Financial Officer,  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                        |

 

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*              Constitutesa management contract or compensatory plan required to be filed pursuant toItem 14(c) of Form 10-K.

 

†              Confidentialtreatment has been granted as to a portion of this Exhibit.

 

(1)           Incorporatedby reference to identically numbered exhibit to Registrant’s Form 10-K AnnualReport for the year ended December 31, 2000.

 

(2)           Incorporatedby reference to Exhibit 3.3 to Registrant’s Form 10-Q Quarterly Report for thequarter ended September 30, 1998.

 

(3)           Incorporatedby reference to identically numbered exhibit to Registrant’s Form SB-2Registration Statement (No. 33-98630-LA), which became effective onDecember 14, 1995.

 

(4)           Incorporatedby reference to identically numbered exhibit to Registrant’s Form 10-QQuarterly Report for the quarter ended June 30, 2002.

 

76

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(5)           Incorporatedby reference to Exhibit 10.1 to the Registrant’s Form 10-Q Quarterly Report forthe quarter ended June 30, 1996 (the “June 1996 Form 10-Q”).

 

(6)           Incorporatedby reference to Exhibit 10.2 to the June 1996 Form 10-Q.

 

(7)           Incorporatedby reference to identically numbered exhibit to Registrant’s Form 10-QQuarterly Report for the quarter ended March 31, 1997.

 

(8)           Incorporatedby reference to identically numbered exhibit to Registrant’s Form 10-K AnnualReport for the year ended December 31, 1999.

 

(9)           Incorporatedby reference to identically numbered exhibit to Registrant’s Form 10-QQuarterly Report for the quarter ended June 30, 2001.

 

(10)         Incorporatedby reference to identically numbered exhibit to Registrant’s Form 10-K AnnualReport for the year ended December 31, 2002.

 

(11)         Incorporatedby reference to identically numbered exhibit to Registrant’s Form S-4Registration Statement (No. 333-105993, which became effective July 3,2003.

 

(12)         Incorporatedby reference to identically numbered exhibit to Registrant’s Form 10-QQuarterly report for the quarter ended September 30, 2003.

 

(13)         Incorporatedby reference to Exhibit 99.1 of Form S-8 filed by Oak Technology,Inc.  (“Oak”) on April 14, 2003.

 

(14)         Incorporatedby reference to Exhibit 10.01 of Form 10Q/A filed by Oak on June 27,2003.

 

(15)         Incorporatedby reference to Exhibit 2.2 of Form 8-K filed by Oak onApril 18, 2003.

 

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