**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

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**FORM 10-K**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**ForThe Fiscal Year Ended December 31, 2006**

**Or**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe transition period from             to            **

**CommissionFile Number: 0-27246**

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**ZORAN CORPORATION**

(Exact Name of registrantas specified in its charter)

| **Delaware**                               |   | **94-2794449**       |
|--------------------------------------------|--------|----------------------|
| (State or other  jurisdiction of           |   | (I.R.S. Employer     |
| incorporation or  organization)            |   | Identification  No.) |
| **1390 Kifer Road, Sunnyvale, California** |   | **94086**            |
| (Address of  principal executive offices)  |   | (Zip Code)           |

 

**Registrant’stelephone number, including area code: (408) 523 6500**

**Securitiesregistered pursuant to Section 12(b) of the Act: None**

**Securitiesregistered pursuant to Section 12(g) of the Act:**

|      | **Title of each class** | ** ** |   | ** ** | **Name of Exchange on which registered** | ** ** |
|------|----------------------------------------|------------|--------|------------|-------------------------------------------------------------------|------------|
| None |                                   | None       |

 

**Securitiesregistered pursuant to Section 12(g) of the Act:**

**Common Stock, $.001 parvalue**

(Title of Class)

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes o  No x

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act. Yes o  No x

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes x  No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. x

Indicateby check mark whether registrant is a large accelerated filer, an acceleratedfiler or a non-accelerated filer (as defined by Rule 12b-2 of theAct).

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

 

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

The aggregate market valueof registrant’s voting stock held by non-affiliates of registrant based uponthe closing sale price of the Common Stock on June 30, 2006, as reportedon the Nasdaq Global Select Market, was approximately $1,196,461,000.

Outstanding shares ofregistrant’s Common Stock, $0.001 par value, as of March 31, 2007:49,448,791.

**DOCUMENTS INCORPORATED BYREFERENCE**

Partsof the definitive proxy statement for registrant’s 2007 Annual Meeting ofStockholders, to be filed with the Commission pursuant to Regulation 14A,are incorporated by reference into Part III of this Report. Except withrespect to information specifically incorporated by reference in this Report,the Proxy Statement is not deemed to be filed as part hereof.

 

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**ZORANCORPORATIONINDEX TOANNUAL REPORT ON FORM 10-KFOR YEAR ENDED DECEMBER 31, 2006**
|            | ** ** | ** **                                                                                                          | ** ** | **Page**   | ** ** |
|------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| ** ** |       | Special  Note Regarding Forward-Looking Statements                                                                  | ** ** |       | ii         | ** ** |   |
| ** ** |       | Explanatory  Note Regarding Restatements                                                                            | ** ** |       | ii         | ** ** |   |
| ** ** |       | **PART I**                                                                                                     | ** ** |       | ** ** | ** ** |   |
| Item 1.    |       | Business                                                                                                            |       |       | 1          | ** ** |   |
| Item 1A.   |       | Risk  Factors                                                                                                       |       |       | 18         | ** ** |   |
| Item 1B.   |       | Unresolved  Staff Comments                                                                                          |       |       | 34         | ** ** |   |
| Item 2.    |       | Properties                                                                                                          |       |       | 34         | ** ** |   |
| Item 3.    |       | Legal  Proceedings                                                                                                  |       |       | 34         | ** ** |   |
| Item 4.    |       | Submission  of Matters to a Vote of Security Holders                                                                |       |       | 36         | ** ** |   |
|       |       | **PART II**                                                                                                    |       |       |       | ** ** |   |
| Item 5.    |       | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities |       |       | 37         | ** ** |   |
| Item 6.    |       | Selected  Financial Data                                                                                            |       |       | 37         | ** ** |   |
| Item 7.    |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         |       |       | 40         | ** ** |   |
| Item 7A.   |       | Quantitative  and Qualitative Disclosures About Market Risk                                                         |       |       | 59         | ** ** |   |
| Item 8.    |       | Financial  Statements and Supplementary Data                                                                        |       |       | 60         | ** ** |   |
| Item 9.    |       | Changes in  and Disagreements with Accountants on Accounting and Financial Disclosure                               |       |       | 115        | ** ** |   |
| Item 9A.   |       | Controls  and Procedures                                                                                            |       |       | 115        | ** ** |   |
| Item 9B.   |       | Other  Information                                                                                                  |       |       | 116        | ** ** |   |
|       |       | **PART III**                                                                                                   |       |       |       | ** ** |   |
| Item 10.   |       | Directors,  Executive Officers of the Registrant and Corporate Governance                                           |       |       | 117        | ** ** |   |
| Item 11.   |       | Executive  Compensation                                                                                             |       |       | 117        | ** ** |   |
| Item 12.   |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters     |       |       | 117        | ** ** |   |
| Item 13.   |       | Certain  Relationships and Related Transactions, and Director Independence                                          |       |       | 117        | ** ** |   |
| Item 14.   |       | Principal  Accountant Fees and Services                                                                             |       |       | 117        | ** ** |   |
|       |       | **PART IV**                                                                                                    |       |       |       | ** ** |   |
| Item 15.   |       | Exhibits  and Financial Statement Schedules                                                                         |       |       | 118        | ** ** |   |
| Signatures |       |                                                                                                                | 120        | ** ** |       |

 

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**Special Note Regarding Forward-LookingStatements**

***TheBusiness section and other parts of this Annual Report on Form 10-K(“Form 10-K”) contain forward-looking statements that involve risksand uncertainties. Many of the forward-looking statements are located in “Item7—Management’s Discussion and Analysis of Financial Condition and Results ofOperations.” Forward-looking statements provide current expectations of futureevents based on certain assumptions and include any statement that does notdirectly relate to any historical or current fact. Forward-looking statementscan also be identified by words such as “anticipates,” “believes,” “estimates,”“expects,” “intends,” “plans,” “predicts,” and similar terms. Forward-lookingstatements are not guarantees of future performance and the Company’s actualresults may differ significantly from the results discussed in theforward-looking statements. Factors that might cause such differences include,but are not limited to, those discussed in the subsection entitled “RiskFactors” under “Item 1A—Risk Factors” of this Annual Report on Form 10-K.The Company assumes no obligation to revise or update any forward-lookingstatements for any reason, except as required by law.***

**Explanatory Note Regarding Restatement**

In this AnnualReport on Form 10-K, we are restating prior fiscal periods toreflect additional stock-based compensation expense relating to stock optiongrants made during the period January 1, 1997 to December 31, 2003. Weare also restating the pro forma disclosures for stock-based compensationexpense required under Statement of Financial Accounting Standards (“SFAS”) No. 123,“Accounting for Stock-Based Compensation,” and SFAS No. 148, “Accountingfor Stock-Based Compensation—Transition and Disclosure.” The effects of theserestatements are reflected in the consolidated financial statements, selectedfinancial data and other financial data, including quarterly data, included inthis report. For additional information, see “Note 2—Restatement ofConsolidated Financial Statements” in Notes to Consolidated FinancialStatements. We have also included restated financial information under “Item 6.Selected Financial Data,” for the periods 2002-2006. “Item 7. Management’sDiscussion and Analysis of Financial Condition and Results of Operations,”includes the income statement impact of the restatements during the period 1997to 2005,   “Item 8. FinancialStatements and Supplementary Data—Selected Quarterly Information (Unaudited),”includes restated quarterly financial information for each interim periodduring the years 2005 and 2006. We have not amended any of our other previouslyfiled Annual Reports on Form 10-K for the periods affected by therestatement or our Quarterly Reports on Form 10-Q filed prior to December 31,2005. For this reason, the consolidated financial statements and relatedfinancial information contained in such previously filed reports should nolonger be relied upon.

On July 3,2006, we announced that, at the recommendation of the Audit Committee, theBoard of Directors had created a special committee of independent directors (“SpecialCommittee”) to conduct a review of our historical stock option practices. Basedon the results of the review, we have concluded that certain stock options grantedduring the period January 1, 1997 to December 31, 2003 were notcorrectly accounted for in accordance with accounting principles generallyaccepted in the United States applicable at the time those grants were made. Asa result, we are restating our historical financial statements to recordadjustments for additional stock-based compensation expense relating to paststock option grants in accordance with APB No. 25, “Accounting for StockIssued to Employees,” to record additional stock-based compensation expenseassociated with options granted to a consultant and to record additionaladjustments that were previously considered to be immaterial.

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**PART I**

**Item 1—Business**

**CompanyOverview**

ZoranCorporation is a leading provider of digital solutions in the digitalentertainment and digital imaging market.

Ourproducts consist of integrated circuits and related products used in digitalversatile disc, or DVD, players, movie and home theater systems, digitalcameras and video editing systems. We also provide integrated circuits, softwareand platforms for digital television applications that enable the delivery anddisplay of digital video content through a set-top box or television as well asdigital imaging products consisting of semiconductor hardware and software thatenable users to print, scan, process and transmit documents to computerperipherals that perform printing functions. Subsequent to our acquisition ofEmblaze Semiconductor Ltd. on July 8, 2004, we also provide highperformance, low-power application processors, technology and products for themultimedia mobile phone market. Through the acquisition of Oren Semiconductor, Inc.on June 10, 2005, we obtained Oren’s demodulator IC technology for theglobal high definition television market. We sell our products to originalequipment manufacturers, or OEMs that incorporate them into digital video andaudio products for consumer and commercial applications.

Wewere incorporated in California in December 1981 and reincorporated inDelaware in November 1986. Our corporate headquarters are located at 1390Kifer Road, Sunnyvale, California 94086, and our telephone number is(408) 523-6500. Our website can be found at *www.zoran.com*. Our Annual Reports on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K,and any amendments to those reports, are available free of charge on ourwebsite under “Investors / SEC Filings” as soon as reasonably practicable afterthey are filed with the Securities and Exchange Commission. Additionally, thesefilings may be obtained by visiting the Public Reference Room of the SECat 100 F Street, NE, Washington, DC 20549 or by calling the SEC at 1-800-SEC-0330,by sending an electronic message to the SEC at publicinfo@sec.gov or by sendinga fax to the SEC at 1-202-777-1027. In addition, the SECmaintains a website (www.sec.gov) that contains reports, proxy and informationstatements, and other information regarding issuers that file electronically.

**IndustryBackground**

Untilthe mid-1990s, video images and audio soundtracks were transmitted,edited and stored almost exclusively using analog formats. Since then, advancesin technology have allowed audio and video to be processed and stored indigital form. Unlike analog formats, which are inherently unstable anddifficult to edit and enhance, digital formats permit the manipulation of audioand video signals through digital signal processing and offer a number offundamental advantages over analog technologies. Through complex digital signalprocessing operations, digital audio and video signals may be compressed,providing significant storage and transmission efficiencies. They also may befiltered, allowing for noise reduction, and they may be transmitted andreproduced without perceptible image or sound degradation. Digital formatsprovide users with additional benefits, including higher quality audio andvideo, random access to data, superior editing capabilities and enhancedsecurity features such as protection against unauthorized copying andcontrolled and secure access.

Oneof the most significant barriers to the widespread adoption of digitaltechnology had been the huge amount of data required to represent images andsounds in a digital format, making cost-effective storage or transmissionimpractical. Through digital compression techniques, a substantial number ofthe redundancies inherent in audio and video data can be identified andeliminated, significantly reducing the overall amount of data which needs to beretained. Compression techniques introduced in the early 1990s allowed atwo-hour movie to be compressed and stored on only two video CDs with videoresolution 

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comparableto that of a standard VHS tape. More recent techniques allow the storage of afull-length movie of more than three hours on a single DVD, with substantiallyimproved audio and video quality and the incorporation of additional data, suchas additional languages, scenes and director and actor commentary. Additionally,digital compression of video data allows previously unmanageable amounts ofdata to be stored in the memory of a disk drive, thereby permitting the data tobe 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 audio compression allows efficientstorage and delivery of multi-channel audio, making possible high-qualityspecial effects such as multi-channel surround sound, virtual surroundsound and wireless audio delivery via two speakers or headphones. In the fieldof still photography, digital compression allows dozens or hundreds of digitalpictures to be stored on a single memory card, depending on the resolutiondesired.

To drive the implementation and speed the adoption ofproducts based on digital formats, industry participants organized committeesto define international compression standards. The principal standards in usetoday include the following:

·       The Joint Photographic Experts Group, orJPEG, standard for the high quality compression of still images and thereal-time, low-cost compression and decompression of moving images;

·       The MPEG 1 standard, adopted by theMoving Pictures Experts Group, or MPEG, for the compression of both audio andvideo data at the high compression ratios necessary for the limited storagecapacity of the CD-ROM format;

·       The MPEG 2 standard, subsequently adoptedby the Motion Pictures Experts Group, for the compression of both audio andvideo data, designed to provide improved quality in broadcast and videoplayback applications;

·       The MPEG 4 standard, which is anextension of MPEG 1 and MPEG 2 that provides the ability to view, access andmanipulate objects rather than pixels, which is especially significant in videostreaming, digital television, mobile multimedia and video game applications. MPEG4 part 10 standard, also known as Advanced Video Codec (AVC) or H.264, is anaddition to the MPEG 4 standard, offering significantly improved compressionefficiencies;

·       DivX standard, which is a proprietarycodec similar to MPEG-4 used for encoding high quality digital video atlow bit rates. DivX encoded content can be viewed on the PC with a softwareplayer, on select DVD Players, portable media players and is used by someInternet-based video on demand services;

·       Windows Media, Microsoft’s standarddigital media software platform for developing digital media products andservices; and

·       Dolby Digital, developed by DolbyLaboratories, an industry standard for the compression of audio for use inmulti-channel digital surround sound systems.

Theseindustry standard techniques have enabled the dramatic growth in digitalmultimedia markets, including the following:

*DVDPlayers and Recorders.** *DVD players and recorders primarily useMPEG 2 video compression and Dolby Digital audio technology to providesignificantly higher quality playback or recording than is possible with VCR orvideo CD technology. According to In-Stat, sales of DVD players are estimatedto be 140 million units in 2006 and expected to remain flat to slightly upin 2007 and shipments of DVD recorders are expected to increase from 18 millionunits in 2006 to 23 million units in 2007.

*StandardDefinition and High Definition Televisions and Set Top Boxes.** *Digital televisions receive digitalcontent and process it to display a picture which has far greater resolutionand sharper, more clearly 

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definedimages than televisions based on the older analog technology. Standarddefinition televisions generally contain 480 lines with 720 pixels per line. Highdefinition television, or HDTV, television sets contain 1280 to 1920 pixels perline and up to 1080 lines. The aspect ratio of standard definition sets is 4:3,compared to 16:9 for HDTV. The lines may be displayed using differenttechniques, often referred to as interlacing or alternatively progressive scan.The functionality to receive and process digital television signals can becontained in a set-top box which then drives a television display that iscapable 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 markets throughout the world. IntexManagement Services, LTD., or IMS, estimates that over 140 million digitaltelevisions and set-top boxes were shipped worldwide in 2006 and that over 177million units will be shipped in 2007.

*MobileProducts.** *Digital cameras use JPEG compression technology to capturehigh resolution still images that can be viewed, edited and stored on acomputer system on a recordable DVD and transmitted over telephone lines andcomputer networks. Recently, digital cameras have been introduced that arecapable of capturing and playing back quality video, using the MPEG 4 algorithm.According to IDC, sales of digital cameras are expected to exceed105 million units in 2006 and 113 million units during 2007. Themultimedia mobile phone market segment is expected to grow from 151 millionunits in 2006 to 463 million units in 2010, representing 37 percent ofworldwide mobile phone shipments in 2010, according to IDC.

Additionalproducts and markets are developing based on these established compressionstandards and additional compression technologies such as Meridian LosslessPCM, or MLP, a new standard for DVD audio, Super Audio, or SACD, MicrosoftWindows Media Audio, or WMA, Advanced Audio Codec (AAC) used in conjunctionwith the MPEG-4 video standard and MP3, a compression standard for thedownload of audio recordings from the Internet.

Theseestablished and emerging compression standards specify data formats whichenable products from different vendors to interact and permit the capture,transmission, storage and display of audio and video data in digital format. Thesestandards do not specify the compression methodologies to be employed oradditional functionality that may be used to enhance or manipulate digitalsignals. These standards, therefore, do not determine image or sound quality orcompression efficiency. For example, data compression may comply with relevantstandards despite being poorly processed and containing artifacts that resultin image degradation in video applications or poor sound quality in audioapplications. As a result, there can be significant differences in overallimage or sound quality between two solutions based on the same standard. Therefore,integrated circuit manufacturers can differentiate their products on the basisof the quality of their compression solution.

Historically,as system vendors sought compression solutions, the cost, complexity and timerequired to compress and decompress data imposed significant limitations on theuse of digital compression. Over the last several years, as cost-effectivecompression solutions have emerged, product manufacturers have increasinglysought to design and market lower-cost digital audio and video systems andproducts to address an increasing number of high volume consumer applications. Inaddition, product manufacturers are facing competitive pressure to introducetheir products more rapidly. To address these issues, OEMs continuallyseek to integrate more and more functions on individual chips in order toreduce their costs, time-to-market and power consumption. They also seeksolutions that can easily be integrated into their commercial and consumerproducts. The challenge to manufacturers of compression integrated circuits is,therefore, to provide product manufacturers with high-quality, cost-effective,standards-based solutions that enable flexible control, imageenhancement, audio effects and other functions in addition to high qualitycompression solutions.

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**ZoranSolutions**

We provide feature-rich, cost-effective, standards-basedsolutions for a broad range of digital video, audio and imaging applications. Wewere a pioneer in the development of high performance digital signal processor(DSP) products, and have developed expertise in integrated mixed signal circuitdesign, mathematical algorithms and software development, as well asproprietary digital signal processing, and video and audio compressiontechnologies. We apply our multi-disciplinary expertise and proprietarytechnologies to the development of fully-integrated solutions forhigh-growth multimedia markets. The key elements of our solutions include thefollowing:

*Standards-PlusMethodology.** *We have leveraged our broad multi-disciplinaryexpertise and proprietary digital signal processing and compressiontechnologies to develop what we refer to as “standards-plus” solutions. We haveenabled OEMs to improve image and sound quality and deliver superiorproducts to end users by adding more features around compression standards,such as more efficient use of memory, processing and communication resources,as well as audio and image enhancement algorithms. We have also providedOEMs the ability to include OEM-programmable effects and features, as wellas variable compression ratios for video. These “standards-plus” features allowour customers to differentiate their products from those of their competitors.

*Expandableand Programmable Architectures.** *We design our integrated circuits toenable easy adaptation for a broad range of specific applications. We can varythe architecture of our chips by adding or deleting modules, and we can alsomodify the software embedded in the chips themselves to address specificapplications. We also license ready-to-manufacture “cores”—building blocks ofintegrated circuits—that can be integrated into our customers’ chips. Combinedwith the enhanced functionality of our “standards-plus” technology, ourexpandable and programmable architecture facilitates product design, upgradesand customization, substantially accelerating our customers’ time to marketwith differentiated products.

*IntegratedSystem Solutions.** *We help our customers meet their totalsystem requirements by providing integrated products that combine hardware andsoftware to address required system functions and features on a singleintegrated circuit or chip set, reducing the number of integrated circuits, andin some cases providing a complete solution on a single chip. As a result, ourcustomers’ total system cost is reduced and they can concentrate on differentiatingtheir products from those of their competitors. For example, our COACH ICincludes most of the electronics of a digital camera on a single chip.

*Cost-EffectiveProducts.** *We focus on reducing the feature size, power requirementsand number of integrated circuits necessary to perform required systemfunctions, including compression functions. This reduces our customers’manufacturing costs for their products which incorporate our integratedcircuits, and also reduces the costs of operating those products so that ourproducts can be used in a broader range of high volume applications. Themodular nature of our architecture reduces our new product development costs,and enables our design engineers to meet our customers’ new productspecifications and cost parameters.

*NearProduction Ready System Reference Designs.** *We provide our customers with a broadrange of engineering reference boards and products complete with device driversoftware, embedded software and detailed schematics. These productssubstantially shorten our customers’ product design time.

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**Strategy**

We provide cost-effective, high-performance digital audio,video and imaging solutions addressing selected high-growth applicationsenabled by compression in evolving multimedia markets. Key elements of ourstrategy include the following:

*Focuson High-Growth and High Volume Applications.** *Our strategy is to focus on providingdigital video, audio and imaging solutions for high-growth consumer electronicsand printing applications. Our current focus markets include: DVD players andrecorders, digital cameras, digital televisions and set-top boxes, portablemultimedia devices and multifunction printing devices.

*LeverageExisting Technology and Expertise.** *We intend to continue to identify thosemarkets that we believe have the highest growth potential for our products andto 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. Potential markets include home network audio and videoappliances, as well as personal digital video, audio and imaging devices.

*FurtherPenetrate Key International Markets.** *Between 1998 and 2006, we expandedoffices in Canada, England, Germany, Hong Kong, India, Japan, Korea, China andTaiwan. At the end of 2006 we had 476 full-time, part-time and contractemployees working in these offices. We believe that by opening and expandingour presence in these offices we are better able to provide marketing andapplication support for our customers in these growing consumer electronicsmarkets.

*ExtendTechnological Leadership.** *Our years of experience in the fields ofdigital signal processing, integrated circuit design, algorithms and softwaredevelopment have enabled us to become a leader in the development of digitalaudio and video solutions enabled by compression. Using our multi-disciplinaryexpertise, we have developed new technologies for compression of digital audio,video and imaging. In August 2004, we acquired Emblaze Semiconductor whichprovided us important technologies for extending our capabilities into thegrowing multimedia mobile phone market. In June 2005, we acquired OrenSemiconductor, Inc. which provided us demodulator IC technology for theglobal high definition television market. We intend to continue to invest inour research and development, and to evaluate opportunities to acquireadditional technologies in order to maintain and extend our technologicalleadership.

*ExpandStrategic Partnerships.** *We work closely in the productdevelopment process with leading manufacturers of products that incorporate ourintegrated circuits. We also work closely with key customers and provide themearly access to our technologies. Potential products are designed to meetcustomer-driven product requirements defined by us with our partners providingtechnological input and, in selected cases, a portion of the developmentfunding. 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 also provide sales and marketing support.We have also established long-term relationships with strategic partners thatprovide manufacturing capacity and we continually seek to develop additionalstrategic relationships with manufacturers.

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**Markets andApplications**

Our products are currently used in a variety of consumermultimedia applications, including the following:

*Consumer VideoPlayback Systems*

DVDplayers primarily use MPEG 2 video compression and Dolby Digital or similaraudio technology to provide significantly higher quality playback than ispossible with earlier generation products such as VCRs, Video CD or Super VideoCD players. DVD players are sold as stand-alone products and are alsobundled with other functions including DVD+VCRs, DVD-receivers and DVD+TVcombinations. In addition, the DVD player can act as a platform for playbackand editing of digital still images from digital cameras through integratedmemory card slots or via direct connection to digital cameras.

*Digital VideoRecording Systems*

Digitalvideo recording systems are expected to replace the analog VCR. Digital videorecording systems not only store home movies and TV programs but allow them tobe easily edited. In addition, digital video recording systems enable highquality time shifting of TV program viewing by recording the program so that itcan be watched simultaneously or on a delayed basis. The recording media usedin digital video recording systems includes DVD recordable media and hard disks.Digital video recording systems use MPEG 2 as the video compression format andDolby Digital or MPEG audio as the audio format.

*DigitalTelevisiosn*

Thedigital television market represents the most significant technological shiftin the consumer electronics market since color televisions were introduced inthe late 1950s. Today, digital content providers broadcast programming viasatellite, cable or terrestrial (over-the-air) networks. The mix of broadcastnetworks varies by geographic region. For example, most digital televisioncontent in Japan and Korea is broadcast via terrestrial networks, while cablenetworks currently predominate in the United States. Satellite networks offeran alternative source of content to consumers and are continuing to grow invarious regions. Each geographic market is subject to regulations that requirecompliance with different governmental standards applicable to broadcasttechnology and content format. In each region, individual broadcasters alsohave developed their own proprietary standards for content, security andconditional access. This market requires television products, set-top boxes,personal video recorders and other digital consumer appliances to includesophisticated integrated circuits and embedded software that address theemerging requirements of multiple broadcast networks throughout the world. Therequirement by the U.S. Federal Communications Commission, or FCC, that all newtelevisions contain a built-in digital receiver, has accelerated the growth ofthe digital television market in the U.S. We expect this growth to continueover the next several years.

*DigitalImaging Print Products*

Themarket for personal printers is beginning to undergo a shift from traditionalPC-centric peripherals toward new PC-independent printing appliances. Fuelingthis shift is the rapid growth of digital photography, home Internet andwireless connectivity. As these new technologies make their way into the home,they are creating demand for a new class of appliance-type printers that allowimage rich content such as web pages, digital photos, and scanned documents tobe printed without using a PC. According to IDC, IC controllers formultifunction print devices, including ink jet for personal as well asmonochrome and color laser applications in the office, are addressing a marketestimated at 63 million units in 2006 and growing to 83 million unitsin 2010.

Themarket for embedded software for page description languages, or PDLs, issomewhat more mature than other areas of the imaging market. It ischaracterized by a small number of suppliers selling to very large OEMcustomers designing print devices that need to be connected to a network. The 

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page descriptionlanguage, or PDL, enables the printer to receive a file or job from a PC andtranslate that file into a set of instructions that the printer can understandand lay down on paper with a great deal of precision. In general, applicationsare designed to send jobs to printers using one or both of two major protocolor language families. Print Control Language, or PCL, originated as aHewlett-Packard developed protocol for page printers and has become anindustry standard in office environments. Both PCL 5 and PCL XL, or PCL 6, aresupported in office printers today. The application may also use the PostScriptlanguage originally developed by Adobe, which tends to be focused more ongraphic arts and Apple operating system environments. Recently, page printershave also offered support for portable digital document formats that support amore complex graphics model and are designed to be widely viewed and shared.These include PDF, originally developed by Adobe, and XML Paper Specification,or XPS, introduced by Microsoft in Windows Vista.

*MobileProducts*

Digitalcameras enable the capture of high resolution images, the viewing, editing andstorage of such images on a computer system and their transmission overtelephone lines and computer networks. High quality copies of these images canbe printed using color printers. Digital cameras have added video capture andcompression capability enabling them to provide basic camcorder functionality. Digitalcameras can be connected directly to a PC for downloading of pictures or moviesand to a television for display. The original digital cameras were developedfor the professional market, and sold at 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.

Manymobile phones now incorporate digital still camera functionality and even videoclips. These phones can be connected to a PC for downloading the pictures orvideo clips or the files can be transmitted over the mobile phone network toanother mobile phone or sent to an e-mail account. Digital camera functionalitywas originally included in mobile phones that sold for over $500. With thespread of the technology and decreased manufacturing costs, digital cameraenabled mobile phones now are available in every price range.

**Products**

Our product offerings consist of four principal productfamilies:

·       DVD—high-performance integratedsystem-on-a-chip solutions, including video and audio compression anddecompression products based on MPEG, Dolby Digital and DivX standards andfront-end technology for use in DVD players and DVD recorders.

·       DTV—high-performance, highly integratedASICs and system-on-a-chip  solutions forstandard and high definition digital television products including televisions,set top boxes, personal video recorders, digital video recorders, andrecordable DVDs, as well as platforms, drivers and software stacks for avariety of operating systems required for digital television applications.

·       Mobile—highly integrated digital cameraprocessor and multimedia mobile phone processors including image signalprocessing, image and video compression and decompression products based onJPEG, MPEG 4 and other technologies for the digital camera and multimediamobile phone markets.

·       Digital imaging—IC-based controllerproducts and digital page processing software for the digital imaging,production and printing market.

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The followingtable lists our principal multimedia integrated circuits currently inproduction, including the months in which initial production units were firstmade available to customers:

| **Product Family** | ** ** | ** **                                                                                               | **Products** | ** **          | **Initial Commercial   Shipment** | ** **                                   | **Principal Applications** |
|--------------------|------------|----------------------------------------------------------------------------------------------------------|--------------|---------------------|----------------------------------------|----------------------------------------------|---------------------------------|
| DVD                |       | Vaddis® 5R  video playback chip (ZR36750)                                                      |         | July 2003      |                                   | DVD recorders                                |
|               |       | Activa® 100—MPEG 2 encoder (ZR35100)                                                      |         | February 2004  |                                   | DVD recorders                                |
|               |       | Vaddis® 7 integrated DVD decoder (ZR36776)                                                     |         | March 2004     |                                   | DVD players                                  |
|               |       | HDXtreme® (ZR36721)                                                                            |         | March 2004     |                                   | DVD players and recorders                    |
|               |       | Vaddis® 8 integrated DVD decoder (ZR36868)                                                     |         | August 2004    |                                   | DVD players                                  |
|               |       | Vaddis® 9 integrated DVD processor (ZR36966)                                                   |         | December 2005  |                                   | DVD players                                  |
|               |       | Activa® 200—DVD Recorder SoC (ZR35220)                                                    |         | December 2006  |                                   | DVD recorders                                |
| DTV                |       | Generation 9® integrated HD decoder with 64 Bit CPU and  Audio DSP Core (TL 955)          |         | June 2002      |                                   | HDTV and HD  set-top boxes                   |
|               |       | Generation 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                    |
|               |       | Generation 9® Elite integrated HD decoder with dual 32 bit  CPU and audio DSP core (ZR 391055) |         | October 2004   |                                   | HDTV and HD set-top boxes                    |
|               |       | Cascade Demodulator (CAS-220)                                                                            |         | June 2005      |                                   | ATSC Demodulator for HDTV and set-top  boxes |
|               |       | SupraHD® integrated decoder (ZR39660)                                                          |         | August 2005    |                                   | HDTV and SoC                                 |
|               |       | SupraHD® integrated decoder (ZR39640)                                                          |         | August 2005    |                                   | ATSC decoder for CRT and set-top boxes       |
|               |       | Supra TV® 160 integrated processors (ZR39160)                                                  |         | May 2006       |                                   | ATSC decoder for CRT and set-top boxes       |
|               |       | SupraHD® 740 Integrated processor (ZR39740)                                                    |         | December 2006  |                                   | SDTV and SD set-top boxes                    |
| Mobile             |       | Digital  camera processor—COACH 5 (ZR36430)                                                         |         | June 2002      |                                   | Digital  cameras, security                   |
|               |       | Digital camera processor—COACH 6  (ZR36440)                                                         |         | October 2003   |                                   | Digital cameras, security                    |
|               |       | Digital camera processor—COACH 7  (ZR36450)                                                         |         | July 2004      |                                   | Digital cameras, security                    |
|               |       | Approach® multimedia application coprocessor- (ER4521)                                         |         | July 2004      |                                   | Cellular and multi-media applications        |

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|             |   | Approach® multimedia application accelerator- (ER4525  and ER 4527)                                                                        |   | July 2004      |   | Cellular and multi-media applications                   |
|------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|--------|---------------------------------------------------------|
|             |   | Digital camera processor—COACH 8  (ZR36460)                                                                                                     |   | May 2005       |   | Digital cameras, security                               |
|             |   | Digital camera processor—COACH 9  (ZR36470)                                                                                                     |   | October 2006   |   | Digital cameras, security                               |
| Digital  Imaging |   | Quatro® 4110 Inkjet and laser high performance mid  range print head controller platform                                                   |   | March 2003     |   | Mid range  inkjet MFPs and laser printers               |
|             |   | Quatro® 4100 Inkjet high performance low cost print  head controller platform                                                              |   | October 2003   |   | Low cost inkjet MFPs                                    |
|             |   | Integrated Print System (IPS) 6.0  Embedded Software                                                                                                 |   | April 2003     |   | Print devices connected to a network                    |
|             |   | IPS Conductor (IPS/DDK)                                                                                                                              |   | September 2004 |   | Print devices connected to Microsoft  operating systems |
|             |   | Quatro® 4200 Full feature, highly integrated SOC  with high quality scanner analog front-end, USB high speed host and color LCD  interface |   | April 2005     |   | Print devices connected directly or to a  network       |
|             |   | Quatro® 4050 Ultra-low-cost SOC for all-in-one  printers and direct-connect photo printers.                                                |   | May 2005       |   | Print devices connected directly or to a  network       |
|             |   | Quatro® 4230 Full feature, highly integrated SOC for  printer manufacturers                                                                |   | September 2006 |   | Print devices connected directly or to a  network       |

 

Zoran, theZoran logo, Activa, APPROACH, Generation 9, HDXtreme, IPS, Quatro, SupraHD,SupraTV and Vaddis are trademarks or registered trademarks of Zoran Corporationand its subsidiaries in the United States and/or other countries. All othernames and brands may be claimed as property of others.

*DVD.** *Our Vaddis® processors perform all the audio and videodecoding and display requirements of the DVD specification, including MPEG 2audio and video decoding, Dolby Digital, DivX and MLP audio decoding, on-screendisplay, decryption required for copyright protection and presentation ofgraphic information. The Vaddis® processor hasadditional computational power that can be utilized for customerdifferentiation features. For example, it can incorporate virtual surroundsound algorithms without the addition of hardware. This allows the user toenjoy the theater-like sound obtained from six speakers using a system thatincludes only two speakers. The Vaddis® 7 processorincorporates all the functions of previous generations with the addition ofMPEG 4 decoding and an interface that can support high definition television. TheVaddis® 8 adds Super Audio CD, or SACD, upscaler andHDMI transmitter functionality. In 2004, we introduced HDXtreme® technology that allows DVD play back and the viewing ofJPEG pictures on an HDTV with an HDMI interface. The Activa® 200 product, announced in December 2005,delivers the entire DVD recorder capability on a single system-on-a-chip,integrating the front-end and back-end functions to greatly reduce system costsand chip count in DVD recorders. We also provide DVD player and DVD recorderreference designs based on our Vaddis® and Activa® product families that help our customers accelerate thetime to market for their products.

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*DTV.** *Our DTV Division offers integratedcircuit products for both high definition and standard definition formats fordigital televisions, set top boxes and related applications, including personalvideo recorders. In 2004, we introduced the Generation 9® Elite system-on-a-chip which utilizes dual CPUs resultingin higher performance with lower power consumption compared to its forerunner,the Generation 9® product family. During 2005, we began shippingour highly integrated SurpaHD® product line that addresses themainstream market segment as well as high-end and entry-level segments of theflat panel display and analog-to-digital broadcast transition markets. We alsoshipped production volumes of our SupraTV® 150 ICs for use in the worldwide standarddefinition digital terrestrial, satellite and cable broadcast markets. As a result of the Oren acquisition in June 2005,we offer the Cascade 2 TV demodulator with our SupraHD® and Generation 9® back-end decoder and end-to-endsolution for the US Advanced Television Systems Committee market. The Cascade 2product is also sold to TV tuner suppliers as an integrated tuner anddemodulator solution.

*Mobile.** *Our COACH processors are integratedsystem-on-a-chip solutions that include most of the electronics of a digitalcamera, which can be connected directly to a high-resolution CCD or CMOSsensor. The COACH IC processes the video information in real time, compressesthe captured image in real time, while interfacing to an LCD or micro displayand to all types of flash memory. Among the unique capabilities of the COACHproduct 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 products alsoallow for direct connection to a printer, including color correction andspecial effects, for the non-PC consumer environment. The COACH product issupplemented by digital camera reference designs, “CamON” and “CamMini,”products shorten the time to market for Zoran’s customers. The newest COACHprocessors utilize MPEG-4 Codecs to incorporate basic digital camcordercapabilities for displaying video clips on a PC or TV. As a result of ouracquisition of Emblaze Semiconductor in July 2004, our Mobile ProductsDivision also offers mobile multimedia telephone products.

*Digital Imaging.** *Our Quatro® product addresses the consumer market for personal printersand the increasing demand for PC - independent printing appliances. The Quatro® product is a programmable SOC solution forconsumer oriented imaging and printing appliances, including multifunctioncolor inkjet and laser devices that feature print, copy, scan and faxcapabilities and that allow image-rich content such as web pages, digitalphotos and scanned documents to be printed without the use of a PC. Quatro® ASICs are designed for mid-range and entry level inkjetprinters, color photo printers, laser printers and the new generation of dyesublimation printers. The Integrated Print System, or IPS 7.0, is a modular,scalable embedded software product that provides processing and controlfunctions for document imaging peripheral devices. IPS was developed based on along standing expertise in page description language interpreters such asPCL and Postscript. The IPS product line gives the OEM the ability to buildhigh performance, network enabled devices quickly and cost effectively.

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**Customers**

The following table lists representative customers, as wellas other OEMs who purchase our products through us or from our resellers. Eachof these customers and OEMs purchased, directly or indirectly, at least$500,000 of Zoran products during 2006:

| **Product Family** | ** ** | **Direct Customers and  resellers**                                                                                                                                                                                                                                    | ** ** | **Other OEMs**                                                                                                                                                                                                                                             |
|--------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| DVD                |       | Alco Electronics Ltd.

Anam Electronics Co. Ltd.

Eastech Electronics (hui Yang) Co. Ltd.

Everbest Industrial (HK) Ltd.

Fly Ring Digital Technology Ltd.

LG Electronic Inc.

Qisheng International Ltd.

Samsung Electronics

Sea Star Technology (Hong kong)       |       | Shenzhen Kaixinda Multi-Media Co. Ltd.

Sky Wise Holdings Ltd.

Sony TCL Electronics (HK) Ltd.

Tecobest Digital Ltd.

Thomson Hong Kong Holdings Ltd.

Tomei Shoji Ltd.

Universal Pacific Co. Ltd.

Zhongshan Dingcai AV Technology                      |   | Orion

Sanyo

Sharp

Toshiba |
| DTV                |       | 3S Digital  ATM Electronic Corporation  Dae Jin Semiconductor Co. Ltd.  Daewoo Electronics Co. Ltd.  Digital Stream Technology  DVN Technology Ltd.  Ever Best Industrial (HK) Ltd.  Homecast Co. Ltd.  Hongtech Electronics  Kanematsu Corporation                    |       | Lacewood  International Corp.  Marubun Corporation  Mico Electric (HK) Ltd.  Rockwell Collins Inc.  Samsung Electronics  Shenzhen MTC Multi-Media Co. Ltd.  TPV Technology Group  Trident Microsystems Inc.  TTE Technology Inc.  Zhongshan E-Tek Co. Ltd. |   | Funai  JVC  Mitsubishi  Mitsumi  Panasonic  Sanyo Sony |
| Mobile             |       | ASD  Technology Ltd.  Asia Optical International Ltd.  Chicony Electronics Co. Ltd.  Flextronics  Grandtech Industrial Ltd.  Jurong Hi-Tech (Suzhou) Co. Ltd.  Kyoshin Technosonic (Asia) Ltd.  Maxtek Technology Co. Ltd.  Newell Hong long Ltd.  Newgen Telecom Inc. |       | Ningbo  Guangbo Digital  Technology  Pentax Corporation  Primary Technologies  Pure Digital Technologies  Samsung Electronics  Shenzhen Xinlikang Industrial Co.  Tekom Technologies Inc.  Zenitron Corporation                                            |   | Funai |
| Digital  Imaging   |       | Avision  Enterprise (BVI) Inc.  Canon Inc.  Foxlink Image Technology Co. Ltd.  Seiko Epson Corporation  Hewlett Packard  Kanematsu Corporation  Lite-On Technology Co                                                                                                  |       | Mag-Tek Inc.  OkiData Corporation  Ricoh Company Ltd.  Samsung Electronics Co., Ltd.  Sharp Electronics Corporation  Toshiba Corporation  Xerox                                                                                                            |   | Funai  Panasonic  Kyocera  Mita Kodak |

 

In2006, one customer accounted for 14% of our total revenues, and sales to ourfour largest customers accounted for 36% of our total revenues. In 2005, nosingle customer accounted for more than 10% of our total revenues, and sales toour four largest customers accounted for 29% of our total revenues.

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**Research andDevelopment**

Webelieve that our future success depends on our ability to continue to enhanceour existing products and to develop new products that maintain technologicalcompetitiveness and compliance with new standards in rapidly evolving consumer-orienteddigital 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 significantportion of our resources to maintaining and upgrading our products to reduceintegrated circuit cost, feature size, power consumption and the number ofintegrated circuits required to perform compression and other functionsnecessary for the evolving digital audio, video and imaging applicationmarkets. In addition, we seek to design integrated circuits and cores, as wellas near production ready reference designs which reduce the time needed bymanufacturers to integrate our ICs into their own products.

Wehave historically generated a portion of our revenues from developmentcontracts with our strategic partners. These development contracts provide thatwe will receive payments upon reaching certain development milestones and thatwe will retain ownership of the intellectual property developed. Developmentcontracts have enabled us to fund portions of our product development efforts,to respond to the feature requirements of our customers, to accelerate theincorporation of our products into our customers’ products and to acceleratethe time-to-market of our customers’ products. We anticipate, however, that inthe future development contracts with strategic partners will fund a smallerportion of our development efforts than in the past.

Weare a party to research and development agreements with the Chief Scientist inIsrael’s Ministry of Industry and Trade and the Israel-United StatesBi-national Industrial Research and Development Foundation. These organizationsfund up to 50% of incurred costs for approved projects up to contract maximums.The agreements require us to use our best efforts to achieve specified resultsand to pay royalties at rates of 3% to 5% of resulting product sales and up to30% of resulting license revenues, up to a maximum of 100% to 150% of the totalfunding received. Reported research and development expenses are net of thesegrants, which fluctuate from period to period. In 2004, we earned grantstotaling $1.5 million. There were no grant receipts in 2005 and 2006. Theterms of Israeli Government participation include restrictions on the locationof research and development activities, and the terms of the grants from theChief Scientist prohibit the transfer of technology developed pursuant to thesegrants to any person without the prior written consent of the Chief Scientist.

Research and development expenses that qualify for thegrants and the related grants are as follows (in thousands):

| ** **                        | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------|------------|--------------------------------------------|------------|
| ** **                        | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                        | ** ** | ** **                                 | ** ** | **(restated)** | ** ** | **(restated)** | ** ** |
| Research and development expenses |       | $                                          | 60,147     |   |   | $ | 48,377 |   |   |   | $ | 38,461 |   |   |
| Less: grants earned               |       | —                                     |       |   | — |   |   |   | (1,460 | ) |   |
|                              |       | $                                          | 60,147     |   |   | $ | 48,377 |   |   |   | $ | 37,001 |   |   |

 

Asof December 31, 2006, we had 645 research and development personnel, ofwhich 523 were employed full-time, and 122 were part-time or contractemployees.

**Sales and Marketing**

Our sales andmarketing strategy is to focus on providing solutions to manufacturers seekingto design audio, video and imaging products for existing and emerging highvolume consumer applications. In 

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cooperationwith leading manufacturers of audio, video and imaging equipment in thecommercial and consumer markets, we attempt to identify market segments whichhave the potential for substantial growth. To implement our strategy, we haveestablished a worldwide direct sales force in offices located near our keycustomers and strategic partners, and a worldwide network of independent salesrepresentatives and resellers. In some cases, our strategic partners alsoprovide sales and marketing support.

Our sales aregenerally made pursuant to purchase orders received between one and six monthsprior to the scheduled delivery date. We sell our products primarily throughour 138-person direct sales staff, of whom 11 are located in the UnitedStates and 127 are located internationally. Our United States sales staff isprimarily responsible for sales in North America, Europe and South America. Salesmanagement and sales operations staff also reside in the United States. Ourmarketing staff in China, Japan, Korea and Taiwan are responsible for marketingin their respective regions. In addition, we sell our products indirectlyprimarily through selected resellers. We typically warrant our products for a 12-monthperiod. To date, we have not experienced material product returns or warrantyexpense.

We have openedoffices in other parts of the world in order to better address specific markets.We opened an office in Shenzhen, China as part of our effort to capture a leadershipposition in the Chinese digital audio and video markets and an office inTaipei, Taiwan in an effort to better address the digital camera market. As of December 31,2006, we had a staff of 305 employees and 19 contractors in our China officeand 66 employees in our Taiwan office, including sales support, applicationsand customer support employees. In addition, we opened offices in Hong Kong andKorea, which had staff of 4 employees and 25 employees, respectively, as of December 31,2006. These offices also provide sales, applications and customer support.

We distributeour products in Japan primarily through resellers. We also operate an office inTokyo to help promote our products in Japan, assist with the marketing ofproducts not sold through resellers, such as integrated circuit cores andcertain digital camera, digital video, digital television, imaging and JPEGproducts, and provide applications support for some of our customers. At December 31,2006, we had 38 employees and 19 contractors in our Tokyo office.

We sell ourDolby technology enabled products under a perpetual, non-exclusive license fromDolby to sell products that incorporate the Dolby Digital algorithm. We are notrequired to pay license fees or royalties to Dolby under this agreement. Ourcustomers enter into license agreements directly with Dolby, pursuant to whichthey pay royalties to Dolby. Under our agreement with Dolby, we may sell ourDolby Digital-based products only to customers who are licensees of Dolby.To date, most potential customers for our Dolby Digital-based productsare licensees of Dolby. However, the failure or refusal of potential customersto enter into license agreements with Dolby in the future could harm our sales.

Wesell our DivX and DTS Technology-based products under a non-exclusivelicense from DivX Inc. and DTS Technology LLC to sell products that incorporatetheir algorithm. We are not required to pay royalties under this agreement. Ourcustomers enter into license agreements directly with DivX and DTS, pursuant towhich they pay royalties. Under our agreement, we may sell our DivX orDTS-based products only to customers who are licensees of DivX or DTS. Thefailure or refusal of potential customers to enter into license agreements withDivX or DTS in the future could harm our sales.

**Backlog**

Salesof our products are made pursuant to firm purchase orders. However, sometimeswe allow customers to cancel or reschedule deliveries. In addition, purchaseorders are subject to price renegotiations and to 

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changesin quantities of products ordered as a result of changes in customers’requirements and manufacturing availability. Our ability to order products cancarry lead times of between four and sixteen weeks; however, most of ourbusiness is characterized by short lead times and quick delivery schedules. Asa result of these factors, we do not believe that backlog at any given time isa meaningful indicator of future sales.

**Manufacturing**

We contractour wafer fabrication, assembly and testing to independent foundries andcontractors, which enables us to focus on our design strengths, minimize fixedcosts and capital expenditures and gain access to advanced manufacturingfacilities. Our engineers work closely with our foundry partners andsubcontractors to increase yields, lower manufacturing costs and assurequality.

Our primaryfoundry is Taiwan Semiconductor Manufacturing Company, or TSMC, which hasmanufactured integrated circuits for us since 1987. TSMC, Philips and TowerSemiconductor Ltd. are currently manufacturing our DVD, JPEG, DTV imaging andsome of our mobile products. Fujitsu manufactures our USB multimedia controllerchips. Our independent foundries fabricate products for other companies and mayalso produce products of their own design.

Most of ourdevices are currently fabricated using standard complementary metal oxidesemiconductor process technology with 0.13 micron to 0.18 micron feature sizes.Most of our semiconductor products are currently being assembled by one of fourindependent contractors and tested by those contractors or other independentcontractors.

Wecurrently purchase products from all of our foundries under individuallynegotiated purchase orders. We do not currently have a long-term supplycontract with TSMC, and therefore TSMC is not obligated to manufacture productsfor us for any specific period, in any specific quantity or at any specifiedprice, except as may be provided in a particular purchase order.

**Competition**

Our existingand potential competitors include many large domestic and internationalcompanies that have substantially greater finance, manufacturing, technology,marketing and distribution resources than we have.

Some of thesecompetitors also have broader product lines and longer standing relationshipswith customers than we do. Some of our principal competitors maintain their ownsemiconductor foundries and may therefore benefit from capacity, cost andtechnical advantages. Our principal competitors in the integrated audio andvideo devices for DVD applications include Cheertek, ESS, LSI Logic, MagnumSemiconductor, Matsushita, MediaTek, Renesas Technology, Samsung and Sunplus.In the markets for JPEG-based products for use in digital cameras, ourprincipal competitors are in-house solutions developed and used by majorJapanese OEMs, as well as products sold by Sunplus and Texas Instruments. Inthe market for JPEG-based products for desktop video editing applications, ourprincipal competitor is Sunplus. Cirrus Logic (Crystal Semiconductor), Fujitsu,Freescale Semiconductor, STMicroelectronics and Yamaha are currently shippingDolby Digital-based audio compression products. Our principal competitorsfor digital semiconductor devices in the digital television market include AdvancedMicro Devices, Broadcom, Renesas Technology, M-Star, Mediatek and STMicroelectronics. Others who also participate in this market are ALiCorporation, Cheertek, Fujitsu, Genesis Microchip, NEC, Pixelworks and TridentMicrosystems. Competitors in the Printer and Multifunction peripheral spaceinclude Sigmatel 

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Inc, Marvellsemiconductor, TAK Imaging, Peerless Systems, Global Graphics and in-housecaptive suppliers.

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 featuresof our products;

·       the timing and success of new productintroductions by itself, our customers and our competitors;

·       the emergence of new industry standards;

·       its ability to obtain adequate foundrycapacity;

·       the number and nature of our competitorsin a given market; and

·       general market and economic conditions.

The markets inwhich we compete are intensely competitive and are characterized by rapidtechnological change, declining average unit selling prices and rapid productobsolescence. We expect competition to increase in the future from existingcompetitors and from other companies that may enter our existing or futuremarkets with solutions which may be less costly or provide higher performanceor more desirable features than our products.

We believe that growth of the DVD player market will be modest in theforeseeable future, and that continued strong competition will lead to furtherprice reductions, and reduced profit margins. We believe that the DVD recordermarket will continue to grow and that as technology barriers become higher,fewer competitors will enter this market.

Historically,average unit selling prices in the semiconductor industry in general, and forour products in particular, have decreased over the life of a particularproduct. We expect that the average unit selling prices of our products willcontinue to be subject to significant pricing pressures. In order to offsetexpected declines in the average unit selling prices of our products, we willneed to continually reduce the cost of our products and continue to integrateadditional functions into our ICs. We intend to accomplish this by implementingdesign changes that integrate additional functionality, lower the cost ofmanufacturing, assembly and testing, by negotiating reduced charges by ourfoundries as and if volumes increase, and by successfully managing ourmanufacturing and subcontracting relationships. Since we do not operate our ownmanufacturing, assembly or testing facilities, we may not be able to reduce ourcosts as rapidly as companies that operate their own facilities. If we fail tointroduce lower cost versions of our products in a timely manner or tosuccessfully manage our manufacturing, assembly and testing relationships, ourbusiness would be harmed.

**Proprietary Rights and Licenses**

Our ability tocompete successfully is dependent in part upon our ability to protect ourproprietary technology and information. Although we rely on a combination ofpatents, copyrights, trademarks, trade secret laws and licensing arrangementsto protect some of our intellectual property, we believe that factors such asthe technological and creative skills of our personnel and the success of ourongoing product development efforts are more important in maintaining ourcompetitive position. We generally enter into confidentiality or licenseagreements with our employees, resellers, customers and potential customers andlimit access to our proprietary information. We currently hold approximately300 issued patents worldwide, and have additional patent applications pending. Ourintellectual property rights, if challenged, may not be upheld as valid, maynot be adequate to prevent misappropriation of our technology or may notprevent 

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thedevelopment of competitive products. Additionally, we may not be able to obtainpatents or other intellectual property protection in the future. In particular,the existence of several consortiums that license patents relating to the MPEGstandard has created uncertainty with respect to the use and enforceability ofpatents implementing that standard. Furthermore, the laws of certain foreigncountries in which our products are or may be developed, manufactured or sold,including various countries in Asia, may not protect our products orintellectual property rights to the same extent as do the laws of the UnitedStates and thus make the possibility of piracy of our technology and products morelikely in these countries.

We sell ourDolby Digital-based products under a perpetual non-exclusive license fromDolby which permits us to incorporate the Dolby Digital algorithm into ourproducts. Our customers enter into license agreements with Dolby pursuant towhich they pay royalties directly to Dolby. Under our agreement with Dolby, wemay sell our Dolby Digital-based products only to customers who arelicensees of Dolby. To date, most potential customers for our Dolby Digital-based products are licensees of Dolby. However, the failure or refusal ofpotential customers to enter into license agreements with Dolby in the futurecould harm our business. We sell our DTS Technology-based products undera non-exclusive license from DTS Technology LLC to sell products thatincorporate the DTS algorithm. We are not required to pay royalties to DTSunder this agreement. Our customers enter into license agreements directly withDTS, pursuant to which they pay royalties to DTS. Under our agreement with DTS,we may sell our DTS-based products only to customers who are licensees of DTS. Thefailure or refusal of potential customers to enter into license agreements withDolby in the future could harm our sales.

Thesemiconductor industry is characterized by vigorous protection and pursuit ofintellectual property rights, which have resulted in significant and oftenprotracted and expensive litigation. We or our foundries from time to time arenotified of claims that we may be infringing patents or other intellectualproperty rights owned by third parties. We have been subject to intellectualproperty claims and litigation in the past. See Item 3—Legal Proceedings. Wemay be subject to additional claims and litigation in the future. Inparticular, given the uncertainty discussed above regarding patents relating tothe MPEG standard, it is difficult for us to assess the possibility that ouractivities in the MPEG field may give rise to future patent infringement claims.Litigation by or against us relating to patent infringement or otherintellectual property matters could result in significant expense to us anddivert the efforts of our technical and management personnel, whether or notsuch litigation results in a determination favorable 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. Licensesmay not be offered or the terms of any offered licenses may not be acceptableto us. If we fail to obtain a license from a third party for technology that ituses, we could incur substantial liabilities and be forced to suspend themanufacture of products, or the use by our foundries of certain processes.

**Employees**

As of December 31,2006, we had 1,191 full-time and 160 part-time and contract employees,including 645 full-time, part-time and contract employees primarily involved inresearch and development activities, 528 in marketing and sales, 128 infinance, human resources, information systems, legal and administration, and 50in manufacturing control and quality assurance. We have 377 full-time employeesand 84 part-time and contract employees based in Israel, of which 371employees, including both full time and contract employees, are involved inengineering and research and development. We have 198 full-time employees and29 part-time and contract employees at our facilities in Sunnyvale, California,143 full-time employees and 6 part-time and contract employees at our facilityin Woburn, Massachusetts, and 305 full-time employees and 19 part-time contractemployees at our facilities in Shenzhen, China. The remaining 

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employees arelocated in our international offices in Canada, England, Germany, Hong Kong,India, Japan, Korea and Taiwan. We believe that our future success will dependin large part on our ability to attract and retain highly-skilled,engineering, managerial, sales and marketing personnel. Competition for suchpersonnel is intense. Our employees are not represented by any collectivebargaining unit, and we have never experienced a work stoppage. We believe thatour employee relations are good.

**Executive Officers**

The names of our executive officers and their ages as ofDecember 31, 2006 are as follows:

| **NAME**              | ** ** | ** ** | ** ** | **AGE** | ** ** | ** **                                                  | **POSITION** | ** ** | ** ** |
|-----------------------|------------|------------|------------|---------|------------|-------------------------------------------------------------|--------------|------------|------------|
| Levy Gerzberg, Ph.D   |       |       | 61         |    |       | President, Chief Executive Officer and Director             |         |
| Karl Schneider        |       |       | 52         |    |       | Senior Vice President, Finance and Chief Financial  Officer |         |
| Isaac  Shenberg, Ph.D |       |       | 56         |    |       | Senior  Vice President, Business and Strategic Development  |         |

 

*Levy Gerzberg* was a co-founder of Zoran in 1981 and has served as ourPresident and Chief Executive Officer since 1988 and as a director since 1981.Dr. Gerzberg also served as our President from 1981 to 1984 and as ourExecutive Vice President and Chief Technical Officer from 1985 to 1988. Priorto co-founding Zoran, Dr. Gerzberg was Associate Director of StanfordUniversity’s Electronics Laboratory. Dr. Gerzberg holds a Ph.D inElectrical Engineering from Stanford University and an M.S. in MedicalElectronics and a B.S. in Electrical Engineering from the Technion-IsraelInstitute of Technology in Haifa, Israel.

*Karl Schneider* joined Zoran as Corporate Controller in 1998 and waselected Vice President, Finance and Chief Financial Officer in 1998 and SeniorVice President, Finance and Chief Financial Officer in July 2003. From1996 through 1997, Mr. Schneider served as Controller for the FilmMeasurement and Robotics and Integrated Technologies divisions of KLA-Tencor, asemiconductor equipment company. Mr. Schneider served as the CorporateController for SCM Microsystems, Inc. from 1995 to 1996, Controller forReply Corporation from 1994 to 1995, Director of Finance for Digital F/X from1992 to 1994 and Controller for Flextronics from 1987 through 1991.Mr. Schneider holds a B.S. in Business Administration from San Diego StateUniversity.

*Isaac Shenberg* has served as Senior Vice President, Business andStrategic Development since 1998 and previously as Vice President, Sales andMarketing from 1995 through 1998. From 1990 to 1995, Dr. Shenberg servedas our Product Line Business Manager. Prior to joining Zoran, Dr. Shenbergwas Images Processing Group manager and Electro Optics Department manager atRafael, a leading aerospace provider in Israel. Dr. Shenberg holds a Ph.Din Electrical Engineering from Stanford University and a B.S. and M.S. inElectrical Engineering from the Technion-Israel Institute of Technologyin Haifa, Israel.

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**Item 1A—Risk Factors**

Ourfuture business, operating results and financial condition are subject tovarious risks and uncertainties, including those described below.

**The discoverythat the appropriate measurement dates for financial accounting purposes of certainstock option grants differed from the recorded grant dates of those awards hashad, and may continue to have, a material adverse effect on our financialresults.**

Wecannot predict the outcome of the pending government inquiries or stockholderlawsuits, and we may face additional government actions, stockholder lawsuitsand other legal proceedings related to our historical stock option practicesand the remedial actions we have taken. All of these events have required us,and will continue to require us, to expend significant management time andincur significant accounting, legal, and other expenses. This could divertattention and resources from the operation of our business and adversely affectour financial condition and results of operations in a manner that couldpotentially be material.

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

Theindependent investigation of our historical stock option practices andresulting restatement activities have required us to expend significantmanagement time and incur significant accounting, legal and other expensestotaling $5.8 million in 2006 and we expect to incur additional costs inthe future periods. The resulting restatements have had a material adverseeffect on our results of operations. We have recorded additional stock-basedcompensation expense of $13.0 million for stock option grants, recognizedover the periods from 1997 to 2005. There was no tax impact of these additionalstock-based compensation expenses due to the full valuation allowance on ourtax assets. In addition, we have recorded other adjustments previouslyconsidered to be immaterial totaling $1.3 million (net of tax of $0.2 million).As a result, our restated consolidated financial statements reflect a decreasein net income of $13.0 million for the period of 1997 to 2005. The effectof the restatement adjustments on our consolidated balance sheet at December 31,2005 resulted in a $2.4 million decrease in stockholders’ equity.

**Ongoing governmentinquiries relating to our historical stock option practices are time consumingand expensive and could result in injunctions, fines and penalties that mayhave a material adverse effect on our financial condition and results ofoperations.**

Theinquiries by the United States Attorney’s Office for the Northern District ofCalifornia (“USAO”) and the United States Securities and Exchange Commission (“SEC”)into our historical stock option practices are ongoing. We have cooperated withthe USAO and the SEC and intend to continue to do so. The period of timenecessary to resolve these inquiries is uncertain, and we cannot predict theoutcome of these inquiries or whether we will face additional governmentinquiries, investigations or other actions related to our historical stockoption practices. These inquiries will likely require us to continue to expendsignificant management time and incur significant legal and other expenses, andcould result in civil and criminal actions seeking, among other things, injunctionsagainst the Company and the payment of significant fines and penalties by theCompany, which may have a material adverse effect on our financial condition,results of operations and cash flow.

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**We have not been in compliance with SEC reporting requirements andNasdaq listing requirements and may continue to face compliance issues withboth. If we are unable to remain in compliance with SEC reporting requirementsand Nasdaq listing requirements, there may be a material adverse effect on usand our stockholders.**

Due to theindependent investigation and resulting restatements, in recent periods we wereunable to file our periodic reports with the SEC on time and faced thepossibility of delisting of our stock from the Nasdaq Global Select Market. Asa result of our delay in filing periodic reports on a timely basis, we will notbe eligible to use a registration statement on Form S-3 to register offersand sales our securities until all periodic reports have been timely filed forat least 12 months. If the Nasdaq Listing and Hearing Review Council concludesthat we are not in compliance with applicable listing requirements, then we maybe unable to maintain an effective listing of our stock on a nationalsecurities exchange. If this happens, the price of our stock and the ability ofour stockholders to trade in our stock could be adversely affected. Inaddition, we would be subject to a number of restrictions regarding theregistration of our stock under federal securities laws, and we would not beable to issue stock options or other equity awards to our employees ornon-employees or allow them to exercise their outstanding options, which couldadversely affect our business and results of operations.

**We have beennamed as a party to stockholder derivative and class action lawsuits relatingto our historical stock option practices, and we may be named in additionallawsuits in the future. This litigation could become time consuming and expensiveand could result in the payment of significant judgments and settlements, whichcould have a material adverse effect on our financial condition and results ofoperations.**

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

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

**We are subjectto the risks of additional lawsuits from former officers and employees inconnection with our historical stock option practices, the resulting restatements,and the remedial measures we have taken.**

Inaddition to the possibilities that there may be additional governmental actionsand shareholder lawsuits against us, we may be sued or taken to arbitration byformer officers and employees in connection with their stock options and othermatters. These lawsuits may be time consuming and expensive, and cause 

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furtherdistraction from the operation of our business. The adverse resolution of anyspecific lawsuit could have a material adverse effect on our business,financial condition and results of operations.

**Failure tomaintain effective internal controls may cause us to delay filing our periodicreports with the SEC, affect our Nasdaq listing, and adversely affect our stockprice.**

Weare required to include a report of management on internal control overfinancial reporting in our Annual Report on Form 10-K that containsan assessment by management of the effectiveness of our internal control overfinancial reporting. In addition, our independent registered public accountingfirm must attest to and report on management’s assessment of the effectivenessof the internal control over financial reporting. The restatement of financialstatements in prior filings with the SEC is a strong indicator of the existenceof a “material weakness” in the design or operation of internal control overfinancial reporting. However, we have concluded that the control deficienciesthat resulted in the restatement of the previously issued consolidatedfinancial statements did not constitute a material weakness as of December 31,2006 because management determined that as of December 31, 2006 there wereeffective controls designed and in place to prevent or detect a materialmisstatement and therefore the likelihood of stock-based compensation, deferredcompensation and deferred tax assets being materially misstated is not morethan remote.

TheSEC may disagree with the manner in which we have accounted for and reported,or not reported, the financial impact of past option grant measurement dateerrors, and there is a risk that its inquiry could lead to circumstances inwhich we may have to further restate our prior financial statements, amendprior filings with the SEC, or otherwise take other actions not currentlycontemplated. In addition, the SEC may issue guidance or disclosurerequirements related to the financial impact of past option grant measurementdate errors that may require us to amend this filing or prior filings with theSEC to provide additional disclosures pursuant to this guidance. Any suchcircumstance could also lead to future delays in filing our subsequent SECreports and delisting of our common stock from the NASDAQ Global Select Market.

**It may bedifficult or costly to obtain director and officer liability insurance coverageas a result of our stock options problems.**

Weexpect that the issues arising from our historical stock option grant practicesand the related accounting will make it more difficult to obtain director andofficer insurance coverage in the future. If we are able to obtain thiscoverage, it could be significantly more costly than in the past, which wouldhave an adverse effect on our financial results and cash flow. As a result ofthis and related factors, our directors and officers could face increased risksof personal liability in connection with the performance of their duties. As aresult, we may have difficultly attracting and retaining qualified directorsand officers, which could adversely affect our business.

**Our annualrevenues and operating results fluctuate due to a variety of factors, which mayresult in volatility or a decline in the prices of our common stock.**

Our historical operating results have varied significantlyfrom period to period due to a number of factors, including:

·       fluctuation in demand for our products;

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

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

·       the timing or cancellation of largecustomer orders;

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

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

·       the cyclical nature of the semiconductorindustry;

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

·       changes in the mix of products sold;

·       seasonality in demand for our products;

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

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

We expect that our operating results will continue tofluctuate in the future as a result of these factors and a variety of otherfactors, including:

·       the cost and availability of adequatefoundry capacity;

·       fluctuations in manufacturing yields;

·       changes in or the emergence of newindustry standards;

·       failure to anticipate changing customerproduct requirements;

·       the loss or gain of important customers;

·       product obsolescence; and

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

Our operating results could also be harmed by:

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

·       terrorism and international conflicts orother crises;

·       other conditions affecting the timing ofcustomer orders;

·       changes in governmental regulations thatcould affect our products;

·       a downturn in the markets for ourcustomers’ products, particularly the consumer electronics market;

·       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. employeesin such facilities; or

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

Thesefactors are difficult or impossible to forecast. 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. Thislimits our ability to react to fluctuations in demand for their products. If 

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anticipatedshipments in any quarter are canceled or do not occur as quickly as expected,or if we fail to foresee a technology change that could render a productobsolete, expense and inventory levels could be disproportionately high. Ifanticipated license revenues in any quarter are canceled or do not occur, grossmargins may be reduced.

Asignificant portion of our expenses are relatively fixed, and the timing ofincreases in expenses is based in large part on our forecast of future revenues.As a result, if revenues do not meet our expectations, we may be unable toquickly adjust expenses to levels appropriate to actual revenues, which couldharm our operating results.

**Our customersexperience fluctuating product cycles and seasonality, which causes their salesto fluctuate.**

Becausethe markets that our customers serve are characterized by numerous new productintroductions and rapid product enhancements, our operating results may varysignificantly from quarter to quarter. During the final production of a matureproduct, our customers typically exhaust their existing inventories of ourproducts. Consequently, orders for our products may decline in thosecircumstances, even if the products are incorporated into both mature productsand replacement products. A delay in a customer’s transition to commercialproduction of a replacement product would delay our ability to recover the lostsales from the discontinuation of the related mature product. Our customersalso experience significant seasonality in the sales of their consumerproducts, which affects their orders of 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 expectthese seasonal sales fluctuations to continue for the foreseeable future.

Ourability to match production mix with the product mix needed to fill currentorders and orders to be delivered in the given quarter may affect our abilityto meet that quarter’s revenue forecast. In addition, when responding tocustomers’ requests for shorter shipment lead times, we manufacture productsbased on forecasts of customers’ demands. These forecasts are based on multipleassumptions. If we inaccurately forecast customer demand, we may holdinadequate, excess or obsolete inventory that would reduce our profit marginsand adversely affect our results of operations and financial condition.

**Our productsare characterized by average selling prices that decline over relatively shorttime periods; if we are unable to reduce our costs or introduce new productswith higher average selling prices, our financial results will suffer.**

Averageselling prices for our products decline over relatively short time periods,while many of our manufacturing costs are fixed. When our average selling pricesdecline, our revenues decline unless we are able to sell more units, and ourgross margins decline unless we are able to reduce our manufacturing costs by acommensurate amount. Our operating results suffer when gross margins decline. Wehave experienced these problems, and we expect to continue to experience themin the future, although we cannot predict when they may occur or how severethey will be.

**Product supplyand demand in the semiconductor industry is subject to cyclical variations.**

Thesemiconductor industry is subject to cyclical variations in product supply anddemand. Downturns in the industry often occur in connection with, oranticipation of, maturing product cycles for both semiconductor companies andtheir customers and declines in general economic conditions. These downturnshave been characterized by abrupt fluctuations in product demand, productionover-capacity and accelerated decline of average selling prices. In some cases,these downturns have lasted more than one year. We cannot predict whether wewill achieve timely, cost-effective access to that capacity when 

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needed,or when there will be a capacity shortage again in the future. A downturn inthe semiconductor industry could harm our sales and revenues if demand drops,or our gross margins if average selling prices decline.

**Our successfor the foreseeable future will depend on demand for integrated circuits for alimited number of applications.**

Inrecent years, we have derived a substantial majority of our product revenuesfrom the sale of integrated circuits for DVD and digital camera applications. Weexpect that sales of our products for these applications will continue toaccount for a significant portion of our revenues for the foreseeable future.Our future financial performance will also depend on our ability tosuccessfully develop and market new products in the digital television, HDTVand digital imaging markets. If the markets for these products and applicationsdecline or fail to develop as expected, or we are not successful in our effortsto market and sell our products to manufacturers who incorporate integratedcircuits into these products, our financial results will be harmed.

**Our financialperformance is highly dependent on the timely and successful introduction ofnew and enhanced products.**

Ourfinancial performance depends in large part on our ability to successfullydevelop and market next-generation and new products in a rapidly changingtechnological environment. If we fail to successfully identify new product opportunitiesand timely develop and introduce new products that achieve market acceptance,we may lose our market share and our future revenues and earnings may suffer.

Inthe consumer electronic market, our performance has been dependent on oursuccessful development and timely introduction of integrated circuits for DVDplayers, DVD recorders, digital cameras, broadband digital television and HDTV.These markets are characterized by the incorporation of a steadily increasinglevel of integration and numbers of features on a chip at the same or lowersystem cost, enabling original equipment manufacturers, or OEMs, to continuallyimprove the features or reduce the prices of the systems they sell. If we areunable to continually develop and introduce integrated circuits with increasinglevels of integration and new features at competitive prices, our operatingresults will suffer.

Inthe Imaging market, our performance has been dependent on our successfuldevelopment and timely introduction of integrated circuits for printers andmulti-function peripherals. These markets are characterized by theincorporation of a steadily increasing level of integration and higher speedson a chip at the same or lower system cost, enabling original equipmentmanufacturers, or OEMs, to continually improve the performance and features orreduce the prices of the systems they sell. If we are unable to develop andintroduce integrated circuits with increasing levels of integration,performance and new features at competitive prices, our operating results willsuffer. The performance of our software licensing business is dependent on ourability to develop and introduce new releases of our software, whichincorporate new or enhanced printing standards, as well as performanceenhancements required by our OEM customers. If we are unable to develop andrelease versions of our software supporting required standards and offeringenhanced performance, our operating results will suffer.

**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.**

Themarkets in which we compete are intensely competitive and are characterized byrapid technological change, declining average unit selling prices and rapidproduct obsolescence. We expect competition to 

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increasein the future from existing competitors and from other companies that may enterour existing or future markets with solutions which may be less costly orprovide higher performance or more desirable features than our products. Competitiontypically occurs at the design stage, when customers evaluate alternativedesign approaches requiring integrated circuits. Because of short product lifecycles, there are frequent design win competitions for next-generation systems.

Ourexisting and potential competitors include many large domestic andinternational companies that have substantially greater financial,manufacturing, technological, market, distribution and other resources. Thesecompetitors may also have broader product lines and longer standingrelationships with customers and suppliers than we have.

Someof our principal competitors maintain their own semiconductor foundries and maytherefore benefit from capacity, cost and technical advantages. Our principalcompetitors in the integrated audio and video devices for DVD applicationsinclude Cheertek, ESS, LSI Logic, Magnum Semiconductor, Matsushita, MediaTek,Renesas Technology, Samsung and Sunplus. In the markets for JPEG-based productsfor use 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 for JPEG-based products for desktop videoediting applications, our principal competitor is Sunplus. Cirrus Logic(Crystal Semiconductor), Fujitsu, Freescale Semiconductor, STMicroelectronicsand Yamaha are currently shipping Dolby Digital-based audio compressionproducts. Our principal competitors for digital semiconductor devices in thedigital television market include Advanced Micro Devices, Broadcom, RenesasTechnology, M-Star, Mediatek and ST Microelectronics. Others who alsoparticipate in this market are ALi Corporation, Cheertek, Fujitsu, GenesisMicrochip, NEC, Pixelworks and Trident Microsystems. Competitors in the Printerand Multifunction peripheral space include Sigmatel Inc., MarvellSemiconductor, TAK Imaging, Peerless Systems, Global Graphics and in-housecaptive suppliers.

We believe that growth of the DVD player marketwill be modest in the foreseeable future, and that continued strong competitionwill lead to further price reductions, and reduced profit margins. Wealso face significant competition in the digital Imaging and digital cameramarkets. The future growth of both markets is highly dependent onOEMs continuing to outsource an increasing portion of their productdevelopment work. Many of our existing competitors, as well as OEM customers thatare expected to compete with us in the future, have substantially greaterfinancial, manufacturing, technical, marketing, distribution and otherresources, broader product lines and longer standing relationships withcustomers than we have. In addition, much of our future success is dependent onthe success of our OEM customers. If we or our OEM customers are unable tocompete successfully against current and future competitors, we couldexperience price reductions, order cancellations and reduced gross margins, anyone of which could harm our business.

**We must keeppace with rapid technological changes and evolving industry standards to remaincompetitive.**

Ourfuture success will depend on our ability to anticipate and adapt to changes intechnology and industry standards and our customers’ 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 to adapt to these changes and to anticipatefuture standards, and the rate of adoption and acceptance of those standards,will be a significant factor in maintaining or improving our competitiveposition and prospects for growth. If new industry standards emerge, ourproducts or the products of our customers could become unmarketable orobsolete, and we could lose market share or be required to incur substantialunanticipated costs to comply with these new standards.

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Oursuccess will also depend on the successful development of new markets and theapplication and acceptance of new technologies and products in those newmarkets. 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 notcontinue to develop to the extent or in the time periods that we currentlyanticipate due to factors outside our control, such as delays in implementationof FCC 02-320 requiring all new televisions to include a digital receiverby February 2009. If new markets do not develop as we anticipate, or ifour products do not gain widespread acceptance in these markets, our business,financial condition and results of operations could be harmed. The emergence ofnew markets 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 notavailable, manufacturers may not be able to sell products incorporating ourproducts, and our sales would suffer.

**We rely on independent foundries and contractors for themanufacture, assembly and testing of our integrated circuits and other hardwareproducts, and the failure of any of these third parties to deliver products orotherwise perform as requested could damage our relationships with ourcustomers and harm our sales and financial results.**

Wedo not operate any manufacturing facilities, and we rely on independentfoundries to manufacture substantially all 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 capacityshortages in the semiconductor industry. We do not have long-term supplycontracts with any of our suppliers, including our principal supplier, TaiwanSemiconductor Manufacturing Company, or TSMC. Therefore, TSMC and our othersuppliers are 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.

Our reliance on independent foundries involves a number ofrisks, including:

·       the inability to obtain adequatemanufacturing capacity;

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

·       lack of control over delivery schedules;

·       lack of control over quality assurance;

·       lack of control over manufacturing yieldsand cost; and

·       potential misappropriation of ourintellectual property.

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

Wealso rely on a limited number of independent contractors for the assembly andtesting of our products. Our reliance on independent assembly and testinghouses limits our control over delivery schedules, 

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qualityassurance and product cost. Disruptions in the services provided by ourassembly or testing houses or other circumstances that would require them toseek alternative sources of assembly or testing could lead to supplyconstraints or delays in the delivery of our products. These constraints ordelays could damage our relationships with current and prospective customersand harm our financial results.

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

If we are not able to obtain additional foundry capacity asrequired, our relationships with our customers would be harmed and our saleswould likely be reduced. In order to secure additional foundry capacity, wehave considered, and may in the future need to consider, various arrangementswith suppliers, which could 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.

Wemay not be able to make any such arrangement in a timely fashion or at all, andsuch arrangements, if any, may not be on terms favorable to us. Moreover, if weare able to secure foundry capacity, we may be obligated to utilize all of thatcapacity or incur penalties. Such penalties may be expensive and could harm ourfinancial results.

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

Thefabrication of silicon wafers is a complex 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 these problems are difficult to detect at anearly stage of the manufacturing process and may be time consuming andexpensive to correct. As a result, foundries often experience problemsachieving acceptable yields, which are represented by the number of goodintegrated circuits as a proportion of the number of total integrated circuitson any particular wafer. Poor yields from our independent foundries wouldreduce our ability to deliver our products to customers, harm our relationshipswith our customers and harm our business.

**We 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.**

During2006, only 7% of our total revenues were derived from North America sales. Weanticipate that international sales will continue to account for a substantialmajority of our total revenues for the foreseeable future. In addition,substantially all of our semiconductor products are manufactured, assembled andtested outside of the United States by independent foundries andsubcontractors.

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We aresubject to a variety of risks inherent in doing business internationally,including:

·       unexpectedchanges in regulatory requirements;

·       fluctuations in exchange rates;

·       political and economic instability;

·       imposition of tariffs and other barriers andrestrictions;

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

·       health risks in a particular region.

Amaterial amount of our research and development personnel and facilities and aportion of our sales and marketing personnel are located in Israel. Political,economic and military conditions in Israel directly affect our operations. Someof our employees in Israel are obligated to perform up to 39 days ofmilitary reserve duty annually. The absence of these employees for significantperiods during the work week may cause us to operate inefficiently during theseperiods.

Ouroperations in China are subject to the economic and political uncertaintiesaffecting that country. For example, the Chinese economy has experiencedsignificant growth in the past decade, but such growth has been uneven acrossgeographic and economic sectors. This growth may decrease and any slowdown mayhave a negative effect on our business. We also maintain offices in Taipei,Taiwan, Hong Kong and Seoul, Korea, and our operations are subject to theeconomic and political uncertainties affecting these countries as well.

Thesignificant concentration of our manufacturing activities with third partyfoundries in Taiwan exposes us to the risk of political instability in Taiwan,including the potential for conflict between Taiwan and China. We have severalsignificant OEM customers in Japan, Korea and other parts of Asia. Adverseeconomic circumstances in Japan and elsewhere in Asia could affect thesecustomers’ willingness or ability to do business with us in the future or theirsuccess in developing and launching devices containing our products.

**The prices ofour products may become less competitive due to foreign exchange fluctuations.**

Foreigncurrency fluctuations may affect the prices of our products. Prices for ourproducts are currently denominated in U.S. dollars for sales to our customersthroughout the world. If there is a significant devaluation of the currency ina specific country, the prices of our products will increase relative to thatcountry’s currency, our products may be less competitive in that country andour revenues may be adversely affected. Also, we cannot be sure that ourinternational customers will continue to be willing to place orders denominatedin U.S. dollars. If they do not, our revenue and operating results will besubject to foreign exchange fluctuations.

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

Weconduct a significant portion of our research and development and engineeringactivities at our design center in Haifa, Israel, a 109,700 square footfacility where we employ approximately 390 people. We also conduct a portion ofour sales and marketing operations at our Haifa facility. We have an additional16,100 square foot facility in Kfar Netter, Israel, where we conduct researchand development activities.

Haifawas a principal target in the recent armed conflict in Northern Israel, and,accordingly, our facility and personnel in Haifa were at significant riskduring that conflict. Although we suffered no damage to our facilities orinjury to our personnel during the recent conflicts, significant damage to ourfacilities in Israel, 

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injuryof our employees working there, or damage to the Israeli business ortransportation infrastructure as a result of future military conflict orterrorist activity could materially affect our operations in Israel and harmour business. In addition, some of our employees in Israel serve in themilitary reserve. Any prolonged absence of a substantial number of theseemployees could materially harm our business.

Inaddition to their impact on our operations in Israel, military conflict in theMiddle East or future terrorist activities there or elsewhere in the worldcould harm our business as a result of a disruption in commercial activityaffecting international commerce or a general economic slowdown and reduceddemand for consumer electronic products.

**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.**

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 bearthe risk that the rate of inflation in Israel or the decline in the value ofUnited States dollar compared to the Israeli shekel will increase our costs asexpressed in United States dollars. To date, we have not engaged in hedgingtransactions. In the future, we may enter into currency hedging transactions todecrease the risk of financial exposure from fluctuations in the exchange rateof the United States dollar against the new Israeli shekel. These measures maynot adequately protect us from the impact of inflation in Israel.

**We derive mostof our revenue from sales to a small number of large customers, and if we arenot able to retain these customers, or they reschedule, reduce or cancel orders,our revenues would be reduced and our financial results would suffer.**

Ourlargest customers have accounted for a substantial percentage of our revenues.In 2006, one customer accounted for 14% of our total revenues, while sales toour four largest customers accounted for 36% of our total revenues. In 2005, nosingle customer accounted for more than 10% of our total revenues, and sales toour four largest customers accounted for 29% of our total revenues. Sales tothese large customers have varied significantly from year to year and willcontinue to fluctuate in the future. These sales also may fluctuatesignificantly from quarter to quarter. We may not be able to retain our keycustomers, or these customers may cancel purchase orders or reschedule or decreasetheir level of purchases from us. Any substantial decrease or delay in sales toone or more of our key customers could harm our sales and financial results. Inaddition, any difficulty in collecting amounts due from one or more keycustomers could harm our financial results. Asof December 31, 2006 four customers accounted for approximately 13%, 12%,10% and 10% of the net accounts receivable balance, respectively.

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

Ourproducts are technologically complex. Prospective customers generally must makea significant commitment of resources to test and evaluate our products and tointegrate 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 ourproducts often last for many months**.**Longer salescycles require us to invest significant resources in attempting to make salesand delay the generation of revenue**.**

Longsales cycles also subject us to other risks, including customers’ budgetaryconstraints, internal acceptance reviews and cancellations. In addition, ordersexpected in one quarter could shift to another because of the timing ofcustomers’ purchase decisions. The time required for our customers toincorporate our products into their own can vary significantly with the needsof our customers and 

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generallyexceeds several months, which further complicates our planning processes andreduces the predictability of our operating results.

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

Wegenerally do not enter into long-term purchase contracts with our customers,and we cannot be certain as to future order levels from our customers. Customersgenerally purchase our products subject to cancelable short-term purchaseorders. We cannot predict whether our current customers will continue to placeorders, whether existing orders will be canceled, or whether customers who haveordered products will pay invoices for delivered products. When we do enterinto a long-term contract, the contract is generally terminable at theconvenience of the customer. Early termination by one of our major customerswould harm our financial results.

**Our productscould contain defects, which could reduce sales of those products or result inclaims against us.**

Wedevelop complex and evolving products. Despite testing by us and our customers,errors may be found in existing or new products. This could result in, amongother things, a delay in recognition or loss of revenues, loss of market shareor failure to achieve market acceptance. These defects may cause us to incursignificant warranty, support and repair costs, divert the attention of ourengineering personnel from our product development efforts and harm ourrelationships with customers. The occurrence of these problems could result in thedelay or loss of market acceptance of our products and would likely harm ourbusiness. Defects, integration issues or other performance problems in ourproducts could result in financial or other damages to customers or coulddamage market acceptance of such products. Our customers could also seekdamages from us for their losses. A product liability claim brought against us,even if unsuccessful, would likely be time consuming and costly to defend.

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

TheFederal Communications Commission, or FCC, has broad jurisdiction over ourtarget markets in the digital television business. Various internationalentities or organizations may also regulate aspects of our business or thebusiness of our customers. Although our products are not directly subject toregulation by any agency, the transmission pipes, as well as much of theequipment into which our products are incorporated, are subject to directgovernment regulation. For example, before they can be sold in the UnitedStates, advanced televisions and emerging interactive displays must be testedand certified by Underwriters Laboratories and meet FCC regulations. Accordingly,the effects of regulation on our customers or the industries in which ourcustomers operate may in turn harm our business. FCC regulatory policiesaffecting the ability of cable operators or telephone companies to offercertain services and other terms on which these companies conduct theirbusiness may impede sales of our products. In addition, our digital televisionbusiness may also be adversely affected by the imposition of tariffs, dutiesand other import restrictions on our suppliers or by the imposition of exportrestrictions on products that we sell internationally. Changes in current lawsor regulations or the imposition of new laws or regulations in the UnitedStates or elsewhere could harm our business. For example, any delays by the FCCin imposing its pending requirement that all new televisions have a digitalreceiver could have an adverse effect on our HDTV business.

**Our ability tocompete could be jeopardized if we are unable to protect our intellectualproperty rights.**

Oursuccess and ability to compete depend in large part upon protection of ourproprietary technology. We rely on a combination of patent, trade secret,copyright and trademark laws, non-disclosure and other contractual agreementsand technical measures to protect our proprietary rights. These agreements and 

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measuresmay not be sufficient to protect our technology from third-party infringement,or to protect us from the claims of others. Monitoring unauthorized use of ourproducts is difficult, and we cannot be certain that the steps we have takenwill prevent unauthorized use of our technology, particularly in foreigncountries where the laws may not protect our proprietary rights as fully as inthe United States. The laws of certain foreign countries in which our productsare or may be developed, manufactured or sold, including various countries inAsia, may not protect our products or intellectual property rights to the sameextent as do the laws of the United States and thus make the possibility ofpiracy of our technology and products more likely in these countries. Ifcompetitors are able to use our technology, our ability to compete effectivelycould be harmed.

Theprotection offered by patents is subject to numerous uncertainties. Forexample, our competitors may be able to effectively design around our patents,or the patents may be challenged, invalidated or circumvented. Thosecompetitors may also independently develop technologies that are substantiallyequivalent or superior to our technology. Moreover, while we hold, or have appliedfor, patents relating to the design of our products, some of our products arebased in part on standards, for which we do not hold patents or otherintellectual property rights.

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

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

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

·       stop selling products that incorporatethe challenged intellectual property;

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

·       pay damages; or

·       redesign those products that use suchtechnology.

Althoughpatent disputes in the semiconductor industry have often been settled throughcross-licensing arrangements, we may not be able in any or every instance tosettle an alleged patent infringement claim through a cross-licensingarrangement. We have a more limited patent portfolio than many of ourcompetitors. If a successful claim is made against us or any of our customersand a license is not made 

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availableto us 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.

**If necessarylicenses of third-party technology are not available to us or are veryexpensive, our products could become obsolete.**

Fromtime to time, we may be required to license technology from third parties todevelop new products or product enhancements. Third party licenses may not beavailable on commercially reasonable terms, if at all. If we are unable to obtainany third-party license required to develop new products and productenhancements, we may have to obtain substitute technology of lower quality orperformance standards or at greater cost, either of which could seriously harmthe competitiveness of our products.

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

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

Ourfuture net income and cash flow will be affected by our ability to apply ournet operating losses, or NOLs, against taxable income in future periods. OurNOLs totaled approximately $185 million for federal and $36 million for statetax reporting purposes as of December 31, 2006. The Internal Revenue Codecontains a number of provisions that limit the use of NOLs under certaincircumstances. During 2006 we reduced the NOL deferred tax asset for amountswhich we believe will expire before they become available for utilization.Changes in tax laws in the United States may further limit our ability toutilize these NOLs. Any further limitation on our ability to utilize theserespective NOLs could harm our financial condition.

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

Unanticipatedchanges in our tax rates could affect our future results of operations. Ourfuture effective tax rates could be unfavorably affected by changes in tax lawsor the interpretation of tax laws, by unanticipated decreases in the amount ofrevenue or earnings in countries with low statutory tax rates, or by changes inthe valuation of our deferred tax assets and liabilities. While we believe ourtax reserves adequately provide for any tax contingencies, the ultimateoutcomes of any future tax audits are uncertain, and we can give no assuranceas to whether an adverse result from one or more of them will have a materialeffect on our operating results and financial position.

**Any additionalacquisitions we make could disrupt our business and severely harm our financialcondition.**

We have made investments in, and acquisitions of othercomplementary companies, products and technologies, and we may acquireadditional businesses, products or technologies in the future. In the event ofany future acquisitions, we could:

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

·       incur debt;

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·       use a significant amount of our cash;

·       assume liabilities;

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

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

Our operation of any other acquired business will alsoinvolve numerous risks, including:

·       problems combining the purchasedoperations, technologies or products;

·       unanticipated costs;

·       diversion of management’s attention fromour core business;

·       adverse effects on existing businessrelationships with customers;

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

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

Wemay not be able to successfully complete the integration of the business,products or technologies or personnel that we might acquire in the future, andany failure to do so could disrupt our business and seriously harm ourfinancial condition.

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

Undergenerally accepted accounting principles, we review our amortizable intangibleassets for impairment when events or changes in circumstances indicate thecarrying value may not be recoverable. Goodwill is required to be tested forimpairment at least annually. Factors that may be considered a change incircumstances indicating that the carrying value of our goodwill or amortizableintangible assets may not be recoverable include a decline in stock price andmarket capitalization, future cash flows, and slower growth rates in ourindustry. We may be required to record a significant charge to earnings in ourfinancial statements during the period in which any impairment of our goodwillor amortizable intangible assets is determined resulting in an impact on ourresults of operations.

**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 capital to financeour future growth, secure additional foundry capacity and fund our ongoingresearch and development activities during 2007 and beyond. Our capitalrequirements will depend on many factors, including:

·       the levels at which we maintain inventoryand accounts receivable;

·       the market acceptance of our products;

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

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

·       volume pricing concessions;

·       capital improvements to new and existingfacilities;

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·       technological advances;

·       the response of competitors to ourproducts; and

·       our relationships with our suppliers andcustomers.

Inaddition, we may require an increase in the level of working capital to accommodateplanned growth, hiring and infrastructure needs. Additional capital may also berequired for additional acquisitions of businesses, products or technologies.

**If we fail tomanage our future growth, if any, our business would be harmed.**

Weanticipate that our future growth, if any, will require us to recruit and hirea substantial number of new engineering, managerial, sales and marketingpersonnel. Our ability to manage growth successfully will also require us toexpand and improve administrative, operational, management and financialsystems and controls. Many of our key operations, including a material portionof our research and development operations and a significant portion of oursales and administrative operations are located in Israel. A majority of oursales and marketing and certain of our research and development andadministrative personnel, including our President and Chief Executive Officerand other officers, are based in the United States. The geographic separationof these operations places additional strain on our resources and our abilityto manage growth effectively. If we are unable to manage growth effectively,our business will be harmed.

**We rely on theservices of our executive officers and other key personnel, whose knowledge ofour business and industry would be extremely difficult to replace.**

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

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

Our certificate of incorporation and bylaws and Delawarelaw contain provisions that could make it more difficult for a third party toacquire us, even if doing so would be beneficial to our stockholders. Theseinclude provisions:

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

·       authorizing the issuance of up to 3,000,000shares of “blank check” preferred stock;

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

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

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

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The market price of our common stock has fluctuatedsignificantly since our initial public offering in 1995. Between January 1,2006 and December 31, 2006, the closing sale price of our common stock, asreported on the Nasdaq Global Select Market, ranged from a low of $13.67 to ahigh of $29.13. The market price of our common stock is subject to significantfluctuations in the future in response to a variety of factors, including:

·       results of regulatory investigations;

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

·       annual and quarterly variations in ouroperating results;

·       changes in analysts’ earnings estimates;

·       announcements of technologicalinnovations;

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

·       loss of key personnel;

·       proprietary rights or other litigation;

·       general conditions in the semiconductorindustry; and

·       developments in the financial markets.

From time totime the stock market experiences extreme price and volume fluctuations thathave particularly affected the market prices for semiconductor companies ortechnology companies generally and which have been unrelated to the operatingperformance of the affected companies. Broad market fluctuations of this typemay reduce the future market price of our common stock.

**Item 1B—Unresolved Staff Comments**

None

**Item 2—Properties**

Our executiveoffices and principal marketing, sales and product development operations arelocated in approximately 89,000 square feet of leased space in Sunnyvale,California, under a lease that expires in September 2016. A significantportion of our research and development and engineering facilities and ouradministration, marketing and sales operations are currently located inapproximately 109,700 square feet of leased space in an industrial park inHaifa, Israel under a lease expiring in November 2016. We also leasefacilities, primarily for sales, product development, and technical support, inWoburn, Massachusetts; Manchester, England; Dortmund, Germany; Tokyo, Japan;Seoul, Korea; Taipei, Taiwan and Shenzhen, Shanghai and Hong Kong, China. Webelieve that our current facilities are adequate for our needs for theforeseeable future and that, should it be needed, suitable additional space ineach of the locations in which we operate will be available to accommodateexpansion of our operations on commercially reasonable terms.

**Item 3—Legal Proceedings**

*U.S.Attorney and SEC Investigations:** *On July 3, 2006, Zoran disclosed ina press release that it received a grand jury subpoena from the office of theU.S. attorney for the Northern District of California requesting documents from1995 through the present referring to, relating to or involving stock options,and also received an informal inquiry from the SEC requesting documents relatedto Zoran’s stock option grants. Zoran intends to cooperate fully in allgovernment investigations. These inquiries likely will require the Company toexpend significant management time and incur significant legal and otherexpenses, and could result in civil and criminal actions seeking, among otherthings, injunctions against the Company and its 

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officersand directors and the payment of significant fines and penalties by the Companyand its officers and directors, which may adversely affect its results ofoperations and cash flow. The Company cannot predict how long it will take toor how much more time and resources it will have to expend to resolve thesegovernment inquiries, nor can it predict the outcome of these inquiries. Also,there can be no assurance that other inquiries, investigations or actions willnot be started by other United States federal or state regulatory agencies orby foreign governmental agencies.

*LateSEC Filings and Nasdaq Delisting Proceedings* Due to the Special Committeeinvestigation and the resulting restatements, the Company did not file on timeits Quarterly Reports on Form 10-Q for the quarters ended June 30,2006 and September 30, 2006, or its Annual Report on Form 10-K forthe year ended December 31, 2006. As a result, the Company received NasdaqStaff Determination letters, dated August 14, 2006, November 15, 2006and March 20, 2007 stating that the Company was not in compliance with thefiling requirements of Marketplace Rule 4310(c)(14) and, therefore, thatthe Company’s stock was subject to delisting from the Nasdaq Global SelectMarket. A hearing before a Nasdaq Listing Qualifications Panel was held on September 27,2006 and a decision to grant the Company’s request for continued listing onNasdaq subject to certain conditions occurred on December 28, 2006. TheCompany has appealed this decision, and the Nasdaq Listing Council hasdetermined to stay the December 28, 2006 Panel decision, and any futurePanel determinations to suspend Zoran’s securities from trading, pendingfurther action from the Listing Council. On March 2, 2007, the Companyprovided the Listing Council with an additional submission for its considerationregarding continued listing. The Listing Council will review the matter on thebasis of the written record.

*ShareholderClass Actions and Derivative Litigation Relating to Historical Stock OptionPractices:*Asdiscussed further below, certainpersons and entities identifying themselves as shareholders of Zoran have filedlitigation purporting to assert claims arising out of the historical accountingfor stock options.

*Zucker v. Zoran Corporation, et al..** *On August 10, 2006, a securitiesclass action complaint was filed against Zoran and certain of its officers anddirectors in the United States District Court, Northern District of California,alleging violations of federal securities laws. The Court selected MiddlesexPension Fund as lead plaintiff and approved lead plaintiff’s selection ofcounsel for the class. Plaintiff filed an amended complaint on February 1,2007 and a second amended complaint on February 20, 2007. On March 8,2007, Defendants filed a motion to dismiss. On March 20, 2007, leadplaintiff filed a notice voluntarily dismissing the action with prejudice as tothe lead plaintiff.

*NCEA-IBEWPension Fund (The Decatur Plan) v. Galil, et al.** *On June 12, 2006, a purportedshareholder derivative action was filed by the Decatur Plan against Zoran as anominal defendant and certain of its officers and directors in the UnitedStates District Court, Northern District of California, alleging, inter alia,violations of federal and state securities laws and breaches of fiduciary duty.On December 4, 2006, Decatur Plan filed a notice of voluntary dismissal.

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

*Gerald del Rosario v. Aharon et al.** *On September 26, 2006, a purportedshareholder derivative action was filed by Gerald del Rosario against Zoran asa nominal defendant and certain of its current and former officers anddirectors in the United States District Court, Northern District of California,alleging, inter alia, violations of federal securities laws and breaches offiduciary duty. On December 8, 2006, the Court issued an orderconsolidating the *Del Rosario* action with the *Pfeiffer* action. The 

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Courtselected del Rosario as lead plaintiff and approved lead plaintiff’s selectionof counsel for the consolidated derivative action. Plaintiffs filed aconsolidated amended complaint on March 14, 2007.

*Baronev. Gerzberg et al.; Durco v. Gerzberg et al.** *On October 23, 2006, two purportedshareholder derivative actions were filed by Moshe Barone and John Durcoagainst Zoran as a nominal defendant and certain of its current and formerofficers and directors in the California Superior Court of Santa Clara County,alleging, inter alia, violations of state securities laws and breaches offiduciary duty. On January 24, 2007 the Court consolidated the *Barone*and *Durco*actions,appointed Messrs. Barone and Durco as co-lead plaintiffs and approvedtheir selection of counsel for the consolidated derivative action. Co-LeadPlaintiffs filed a consolidated amended complaint on March 26, 2007.

*On February 20, 2007, the Company filed acomplaint against ArcSoft Inc. in the California Superior Court for the Countyof Alameda, seeking payment of $4 million in principal, together with accruedinterest then in the amount of approximately $525,000, under four separateconvertible promissory notes.  OnFebruary 28, 2007, the Company filed an application with the Court seeking toattach assets of ArcSoft as security for the payment of its obligations underthe notes.  The notes represent amountsloaned by the Company to ArcSoft in 2004 in connection with a transactioninvolving the transfer to ArcSoft of rights related to a software product thenunder development and related agreements regarding the continued developmentand commercialization of the product.  OnMarch 28, 2007, ArcSoft filed an answer denying liability under the notes andasserting various affirmative defenses. ArcSoft also filed a cross complaint alleging fraud in the inducement ofthe business arrangement, fraudulent and negligent misrepresentation, breach ofcontract and of the implied covenant of good faith and fair dealing, and unjustenrichment and seeking monetary damages of more than $6.9 million.  The hearing on our application for an attachmentis currently scheduled for May 14, 2007.*

*IndemnificationObligations.* Subject to certainlimitations, the Company is obligated to indemnify its current and formerdirectors, officers and employees in connection with the investigation of theCompany’s historical stock option practices and related government inquiriesand litigation. These obligations arise under the terms of the Company’scertificate of incorporation, its bylaws, applicable contracts, and Delawareand California law. The obligation to indemnify generally means that theCompany is required to pay or reimburse the individuals’ reasonable legalexpenses and possibly damages and other liabilities incurred in connection withthese matters. The Company is currently paying or reimbursing legal expensesbeing incurred in connection with these matters by a number of its current andformer directors, officers and employees.

*Other Legal Matters.* The Company is named from time totime as a party to lawsuits in the normal course of its business. Litigation,in general, and intellectual property and securities litigation in particular,can be expensive and disruptive to normal business operations. Moreover, theresults of legal proceedings are difficult to predict.

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

We did notsubmit any matters to a vote of our security holders during the fourth quarterof the year ended December 31, 2006.

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**PART II**

**Item5—Market for Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of Equity Securities**

Our common stock is tradedon the Nasdaq Global Select Market under the symbol “ZRAN.”

Thefollowing table sets forth the high and low closing sales price of our commonstock as reported on The Nasdaq Global Select Market for the periods indicated:

| ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| **2005**       |       |     |       |    |       |
| First Quarter  |       | $        | 11.21      |    | $          | 9.63 |   |
| Second Quarter |       | $        | 13.95      |    | $          | 8.97 |   |
| Third Quarter  |       | $        | 17.19      |    | $          | 13.31 |   |
| Fourth Quarter |       | $        | 17.38      |    | $          | 12.51 |   |
| **2006**       |       |     |       |    |       |
| First Quarter  |       | $        | 22.48      |    | $          | 16.83 |   |
| Second Quarter |       | $        | 29.13      |    | $          | 21.00 |   |
| Third Quarter  |       | $        | 24.31      |    | $          | 14.17 |   |
| Fourth Quarter |       | $        | 16.54      |    | $          | 13.67 |   |

 

As of December 31,2006, there were 287 holders of record of our common stock.

We have never paid cashdividends on our capital stock. It is our present policy to retain earnings tofinance the growth and development of our business and, therefore, we do notanticipate paying any cash dividends in the foreseeable future.

**Purchases of Equity Securities by the Issuer andAffiliated Purchasers**

Neither we nor anyaffiliated purchaser repurchased any of our equity securities in the fourthquarter of 2006.

**Item6—Selected Financial Data**

The consolidated balancesheet as of December 31, 2005, and the consolidated statements ofoperations for the years ended December 31, 2005 and 2004, have beenrestated as set forth in this Annual Report on Form 10-K. The datafor the consolidated balance sheets as of December 31, 2004, 2003 and 2002and the consolidated statements of operations for the fiscal years ended December 31,2003 and 2002, have been restated to reflect the impact of the stock-basedcompensation adjustments, but such restated data have not been audited and isderived from the books and records of the Company. The information set forthbelow is not necessarily indicative of results of future operations, and shouldbe read in conjunction with Item 7, “Management’s Discussion and Analysisof Financial Condition and Results of Operations” and the consolidatedfinancial statements and related notes thereto included in Item 8 of thisAnnual Report on Form 10-K to fully understand factors that mayaffect the comparability of the information presented below. The informationpresented in the following tables has been adjusted to reflect the restatementof the Company’s financial results, which is more fully described in the “ExplanatoryNote” immediately preceding Part I, Item 1 and in Note 2, “Restatement ofConsolidated Financial Statements” in Notes to Consolidated FinancialStatements of this Annual Report on Form 10-K.

The Company has notamended its previously-filed Annual Reports on Form 10-K orQuarterly Reports on Form 10-Q for the periods affected by thisrestatement, other than the Company’s Quarterly Report on Form 10-Qfor the quarter ended March 31, 2006, which is being filed concurrentlywith this Annual 

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Report on Form 10-K. Thefinancial information that has been previously filed or otherwise reported forthese periods is superseded by the information in this Annual Report on Form 10-K,and the financial statements and related financial information contained insuch previously-filed reports should no longer be relied upon.

Thefollowing selected consolidated financial data should be read in conjunctionwith the consolidated financial statements and the notes thereto includedelsewhere herein. 

| ** **                                        | ** ** | **Year Ended December 31,**                         | ** ** |
|---------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                        | ** ** | **2006**                                                           | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                        | ** ** | **(in thousands, except per share data)** | ** ** |
| ** **                                        | ** ** | ** **                                                         | ** ** | **(As  previously  reported)** | ** ** | **(As  previously  reported)** | ** ** | **(As  previously  reported)** | ** ** | **(As  previously  reported)** | ** ** |
| **STATEMENTS OF OPERATIONS DATA:**                |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total revenues                                    |       |                                                               | $          | 495,805 |   |   |   | $ | 395,758 |   |   |   | $ | 378,864 |   |   |   | $ | 216,528 |   |   |   | $ | 149,117 |   |   |
| Gross profit                                      |       |                                                               | 269,545    |   |   |   | 210,209 |   |   |   | 152,629 |   |   |   | 85,477 |   |   |   | 62,213 |   |   |
| Operating income  (loss)                          |       |                                                               | 10,556     |   |   |   | (27,100 | ) |   |   | (46,857 | ) |   |   | (72,004 | ) |   |   | 6,831 |   |   |
| Net income (loss)                                 |       |                                                               | 16,328     |   |   |   | (26,971 | ) |   |   | (47,354 | ) |   |   | (67,978 | ) |   |   | 5,698 |   |   |
| Basic net income  (loss) per share(1)             |       |                                                               | $          | 0.34 |   |   |   | $ | (0.61 | ) |   |   | $ | (1.11 | ) |   |   | $ | (2.05 | ) |   |   | $ | 0.21 |   |   |
| Diluted net  income (loss) per share(1)           |       |                                                               | $          | 0.33 |   |   |   | $ | (0.61 | ) |   |   | $ | (1.11 | ) |   |   | $ | (2.05 | ) |   |   | $ | 0.20 |   |   |
| Shares used in diluted  per share calculations(1) |       |                                                               | 50,099     |   |   |   | 44,267 |   |   |   | 42,788 |   |   |   | 33,231 |   |   |   | 28,629 |   |   |

 

| ** **                                        | ** ** | **Year Ended December 31,**                         | ** ** |
|---------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                        | ** ** | **2006**                                                           | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                        | ** ** | **(in thousands, except per share data)** | ** ** |
| ** **                                        | ** ** | ** **                                                         | ** ** | **(as  restated)** | ** ** | **(as  restated)** | ** ** | **(as  restated)** | ** ** | **(as  restated)** | ** ** |
| **STATEMENTS OF OPERATIONS DATA:**                |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total revenues                                    |       |                                                               | $          | 495,805 |   |   |   | $ | 395,758 |   |   |   | $ | 378,864 |   |   |   | $ | 216,962 |   |   |   | $ | 148,683 |   |   |
| Gross profit                                      |       |                                                               | 269,545    |   |   |   | 209,586 |   |   |   | 152,403 |   |   |   | 85,797 |   |   |   | 61,710 |   |   |
| Operating income  (loss)                          |       |                                                               | 10,556     |   |   |   | (29,879 | ) |   |   | (45,767 | ) |   |   | (75,729 | ) |   |   | 3,187 |   |   |
| Net income (loss)                                 |       |                                                               | 16,328     |   |   |   | (30,272 | ) |   |   | (48,108 | ) |   |   | (71,351 | ) |   |   | 2,093 |   |   |
| Basic net income  (loss) per share(1)             |       |                                                               | $          | 0.34 |   |   |   | $ | (0.68 | ) |   |   | $ | (1.12 | ) |   |   | $ | (2.15 | ) |   |   | $ | 0.08 |   |   |
| Diluted net  income (loss) per share(1)           |       |                                                               | $          | 0.33 |   |   |   | $ | (0.68 | ) |   |   | $ | (1.12 | ) |   |   | $ | (2.15 | ) |   |   | $ | 0.07 |   |   |
| Shares used in  diluted per share calculations(1) |       |                                                               | 50,099     |   |   |   | 44,267 |   |   |   | 42,788 |   |   |   | 33,231 |   |   |   | 28,629 |   |   |

 

| ** **                                         | ** ** | **As of December 31,** | ** ** |
|----------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                         | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                         | ** ** | **(in thousands)**               | ** ** |
| ** **                                         | ** ** | ** **                            | ** ** | **(As  previously  reported)** | ** ** | **(As  previously  reported)** | ** ** | **(As  previously  reported)** | ** ** | **(As  previously  reported)** | ** ** |
| **BALANCE SHEETS DATA:**                           |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Cash, cash  equivalents and short-term investments |       | $                                     | 296,229    |   | $ | 149,346 |   | $ | 70,413 |   | $ | 126,366 |   |   | $ | 137,075 |   |   |
| Working capital                                    |       | 314,790                               |       | 170,946 |   | 109,320 |   | 146,810 |   |   | 159,288 |   |   |
| Total assets                                       |       | 676,630                               |       | 604,223 |   | 599,281 |   | 622,237 |   |   | 342,616 |   |   |
| Accumulated deficit                                |       | (227,510                              | )          | (230,795 | ) | (203,824 | ) | (156,470 | ) |   | (88,492 | ) |   |
| Total stockholders’  equity                   |       | $                                     | 583,997    |   | $ | 499,348 |   | $ | 500,627 |   | $ | 534,279 |   |   | $ | 311,012 |   |   |

 

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| ** **                                         | ** ** | **As of December 31,** | ** ** |
|----------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                         | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                         | ** ** | **(in thousands)**               | ** ** |
| ** **                                         | ** ** | ** **                            | ** ** | **(as  restated)** | ** ** | **(as  restated)** | ** ** | **(as  restated)** | ** ** | **(as  restated)** | ** ** |
| **BALANCE SHEET DATA:**                            |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Cash, cash  equivalents and short-term investments |       | $                                     | 296,229    |   | $ | 149,346 |   | $ | 70,413 |   | $ | 126,366 |   |   | $ | 137,075 |   |   |
| Working capital                                    |       | 314,790                               |       | 170,114 |   | 108,597 |   | 146,528 |   |   | 158,854 |   |   |
| Total assets                                       |       | 676,630                               |       | 602,631 |   | 598,016 |   | 621,847 |   |   | 342,182 |   |   |
| Accumulated  deficit                               |       | (227,510                              | )          | (243,838 | ) | (213,566 | ) | (165,458 | ) |   | (94,107 | ) |   |
| Total stockholders’  equity                   |       | $                                     | 583,997    |   | $ | 496,924 |   | $ | 498,769 |   | $ | 533,607 |   |   | $ | 310,578 |   |   |

 

Effective in fiscal year 2006, we implementedStatement of Financial Accounting Standards (“SFAS”) No. 123(R) “Share-BasedPayment.” It requires us to measure all employee stock-based compensationawards using a fair value method and record such expense in our consolidatedfinancial statements. In addition, to correct our past accounting for somestock options granted primarily from 1997 to 2003, we recorded an aggregate of$11.7 million of additional non-cash, stock-based compensation expense forthe periods 1997 to 2005 under APB No. 25 and $0.4 million for 2006under SFAS No. 123(R). There was no tax impact of these additional stock-basedcompensation expenses due to the full valuation allowance on our tax assets.Net income in fiscal year 2006 includes approximately $17.2 million ofnon-cash, stock-based compensation expense, compared to $4.5 million infiscal year 2005, $2.6 million in fiscal year 2004, $10.2 million infiscal year 2003 and $3.5 million in fiscal year 2002.

In connection with the restatement, the Company isrecording additional non-cash adjustments that were previously considered to beimmaterial relating to the timing of revenue recognition, accrued expenses,amortization of premiums and discounts on investments, additional expenserelated to options granted to a consultant and the calculation of amortizationof stock-based compensation relating to a business combination in 2003. TheCompany is also recording losses under Accounting Principles Board Opinion 18(“APB No. 18”), “The Equity Method of Accounting for Investments in CommonStock,” to record the losses on investment of the prior 17% ownership of OrenSemiconductor, Inc. under the equity method of accounting which was subsequentlyacquired by Zoran in 2005. These additional adjustments resulted in acumulative expense of $1.3 million, including $0.2 million of taxexpense, for the periods 2000 through 2005.

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**Item 7—Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

***This section andother parts of this Annual Report on Form 10-K containforward-looking statements that involve risks and uncertainties.Forward-looking statements can also be identified by words such as “anticipates,”“expects,” “believes,” “plans,” “predicts,” and similar terms. Forward-lookingstatements are not guarantees of future performance and the Company’s actualresults may differ significantly from the results discussed in theforward-looking statements. Factors that might cause such differences include,but are not limited to, those discussed in the subsection entitled “Item 1A—RiskFactors” above. The following discussion should be read in conjunction with theconsolidated financial statements and notes thereto included in Item 8 of thisreport. The Company assumes no obligation to revise or update anyforward-looking statements for any reason, except as required by law.***

**Restatements**

On July 3, 2006, the Company announced that, atthe recommendation of the Audit Committee, the Board of Directors had created aspecial committee of independent directors (“Special Committee”) to conduct areview of our historical stock option practices. As a result of its investigation,the Special Committee found, among other things, that some of the originalmeasurement dates used by the Company for option grants were not adequatelysupported by contemporaneous records, and therefore the measurement dates usedby us for accounting purposes required adjustment. The Special Committeeconcluded that the evidence did not establish that the errors which itidentified resulted from fraud or intentional misconduct by our current seniormanagement.

Based on the Special Committee’s findings and its ownreview of the facts, the Board of Directors concluded that there was no fraudor intentional misconduct by any current member of senior management. The Boardalso concluded that it has confidence in the integrity of the Company’s ChiefExecutive Officer, Dr. Levy Gerzberg, and the Company’s Chief FinancialOfficer, Mr. Karl Schneider.

Based on information obtained from the SpecialCommittee’s review and additional work undertaken by the Company, managementhas concluded, and the Audit Committee has agreed, that the Company shouldrestate certain previously filed financial statements, to reflect additionalstock-based compensation expense with regard to certain past stock optiongrants. The corrections made in the restatements relate to options coveringapproximately 3.6 million shares. These adjustments amounted to anadditional stock-based compensation expense of $0.4 million and $2.6 millionin 2006 and 2005, respectively, and a benefit of $1.5 million in 2004.There was no tax impact of these additional stock-based compensation expensesdue to the full valuation allowance on our tax assets.

In connection with the restatement, the Company isrecording additional non-cash adjustments that were previously considered to beimmaterial relating to the timing of revenue recognition, accrued expenses,amortization of premiums and discounts on investments, additional expenserelated to options granted to a consultant and the calculation of amortizationof stock-based compensation relating to a business combination in 2003. TheCompany is also recording losses under Accounting Principles Board Opinion 18 (“APBNo. 18”), “The Equity Method of Accounting for Investments in CommonStock,” to record the losses on investment of the prior 17% ownership of OrenSemiconductor, Inc. under the equity method of accounting which was subsequentlyacquired by Zoran in 2005. These additional adjustments resulted in acumulative expense of $1.3 million, including $0.2 million of taxexpense, for the periods 2000 through 2005.

Through 2005, we applied Accounting Principles Board(“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” andits related interpretations, and provided the required pro forma disclosuresunder Statement of Financial Accounting Standards (“SFAS”) No. 123,“Accounting for Stock-Based 

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Compensation,” and SFAS No. 148, “Accounting forStock-Based Compensation—Transition and Disclosure.” Under APB OpinionNo. 25 (“APB No. 25”), non-cash, stock-based compensation expense wasrecognized for any option for which the exercise price was below the marketprice on the actual grant date. Because each of the options identified below(other than those which we have determined should be accounted for variably)was deemed to have an exercise price below the market price on the appropriatemeasurement date, we should have recognized a charge for each of those optionsunder APB No. 25, in an amount equal to the number of shares covered bysuch options, multiplied by the difference between the exercise price and themarket price on the appropriate measurement date. That expense should have beenamortized over the vesting periods of the options. Starting in 2006, we adoptedSFAS No. 123(R), “Share-Based Payment.” As a result, for 2006, theadditional stock-based compensation expense required to be recorded for each ofthe options identified below was equal to the incremental fair value of thoseoptions on the appropriate measurement date over the remaining vesting periodsof those options. We did not record such stock-based compensation expensesunder APB No. 25 or SFAS No. 123(R) in our previously issuedfinancial statements, and that is the reason for the restatement in thisreport. To correct our past accounting for stock options, we recordedadditional pre-tax, non-cash, stock-based compensation expense of(a) $11.7 million for the periods 1997 to 2005 under APB No. 25and (b) the remaining $0.4 million for 2006 under SFAS No. 123(R).The fair value of the options is being recorded using the acceleratedamortization method under FIN 28 over the respective vesting periods of theawards.

Consistent with theaccounting literature and recent guidance from the Securities and ExchangeCommission (“SEC”), the Company has organized the grants with respect to whichan accounting adjustment is required into categories based on grant type andprocess by which the grant was finalized. Based on the relevant facts andcircumstances, the Company applied the relevant accounting standards todetermine the measurement date for every grant within each category. TheCompany recorded accounting adjustments as required, resulting in stock-basedcompensation expense and related tax effects. The Company organized the grantswhere adjustments were required as follows:

·       *Company-wide option grants where optionees were added or grant amountswere changed after the option list was complete, or where insufficientcontemporaneous documentation of the grant date exists*. For sevenCompany-wide refresh and retention grants made between 1998 and 2003, theCompany determined that some employees who were omitted from the option grantlist were added to the list after the stated grant date, and that the number ofshares covered by option grants to some employees was not finally determineduntil after the stated grant date. Further, in 2001 and 2002, insufficientcontemporaneous documentation of the stated grant date existed. As a result ofthese issues, the Company restated its historical financial statements toincrease stock-based compensation expense by approximately $6.3 million,recognized over the vesting periods of the relevant options.

·       *Re-priced options.*In August 2002,after consideration of relevant information, the Compensation Committeerescinded its April 2002 grant, and its June 2002 grant, toexecutives and other key employees. The Company thereafter reissued the grantsin August 2002. At the time, in consultation with our external advisors,we determined that these transactions did not require variable accounting. As aresult of the Special Committee review of our historical stock option practices,we have reassessed the circumstances surrounding these transactions with ourexternal advisors and have determined that the grants should have beenaccounted for variably. As a result, the Company restated its historicalfinancial statements to increase stock-based compensation expense by a cumulativenet amount of approximately $3.8 million, recognized over the vestingperiods of these options.

·       *Acquisition-related options*. The Companydetermined a grant given to retain employees hired in connection with anacquisition in October 2000 should have been accounted for variably. As aresult, the Company restated its historical financial statements to increasestock-based 

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compensation expense byapproximately $0.3 million, recognized over the vesting periods of theseoptions.

·       *Improper measurement dates for non-refresh stockoption grants.*The Company revised the measurement dates for**certain grants made to new hires and forpromotional and other miscellaneous non-refresh grants made between 1997 and2003 as a result of approvals that were obtained subsequent to the stated grantdates or as a result of administrative delays or errors and a small number ofstock option grants to non-executives that were determined to have beenestablished retrospectively. As a result, the Company restated its historicalfinancial statements to increase stock-based compensation expense byapproximately $1.3 million, recognized over the vesting periods of theseoptions.

In the aggregate, we have recorded additionalstock-based compensation expense for the periods 1997 through 2005 ofapproximately $11.7 million on stock option grants made from 1997 through2003.

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

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

 

The cumulative effect of all of the restatements throughDecember 31, 2003 increased additional paid-in capital by $10.7 millionfrom $703.8 million to $714.5 million, increased accumulated deficitby $9.0 million from $156.4 million to $165.4 million, anddecreased total stockholders’ equity by $0.7 million from $534.3 millionto $533.6 million. All the restatements of financial statements, financialdata and related disclosures described in this report are collectively referredto in this report as the “restatements.”

In December 2006, the Company amended options topurchase approximately 218,000 shares of common stock held by Dr. Gerzbergand Mr. Schneider to increase the exercise price of those options to thefair market value of the Company’s common stock on the revised measurement dateso that these options are no longer subject to a penalty tax under IRC Section 409A.

We have not amended, and we do not intend to amend,any of our other previously filed Annual Reports on Form 10-K. Wehave amended our Quarterly Report for the period ended March 31, 2006concurrent with the filing of our Annual Report on Form 10-K, and wedo not intend to amend any of our other previously filed Quarterly Reports on Form 10-Qfor the periods affected by the restatements. We present restated quarterlyfinancial information for each of the quarters in 2006 and 2005 in “SelectedQuarterly Financial Information (Unaudited)” included in this report.

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The impact of therestatements on the interim periods of each of the first three quarters of 2006and each of the quarters of 2005 are disclosed in “Selected Quarterly FinancialInformation (Unaudited)” included in this report.

**Internal Controls**

Based on the definition of “material weakness” in thePublic Company Accounting Oversight Board’s Auditing Standard No. 2, *An Audit of Internal Control Over Financial Reporting Performed inConjunction With an Audit of Financial Statements*, the restatementof financial statements in prior filings with the SEC is a strong indicator ofthe existence of a “material weakness” in the design or operation of internalcontrol over financial reporting. However, the Company has concluded that thecontrol deficiencies that resulted in the restatement of the previously issuedconsolidated financial statements did not constitute a material weakness as of December 31,2006 because management determined that as of December 31, 2006 theCompany’s internal controls were effective.

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

As a result of theinvestigation of its historical stock option practices, we analyzed Zoran’sinternal control over financial reporting for periods before January 1, 2003,and determined that the Company did not have sufficient safeguards in place tomonitor its control practices regarding stock option pricing and relatedfinancial reporting and to foster an effective flow of information betweenthose responsible for stock option pricing and those responsible for financialreporting. Inadequate training, communication and coordination in and among theCompany’s human resources, stock administration, legal and finance functionsprevented the Company from assuring that stock options were priced andaccounted for correctly, primarily for the years 1997 through 2002.

From 2003 through 2005,in compliance with the Sarbanes-Oxley Act of 2002 and evolving accountingguidance, the Company implemented improved procedures, processes and systems toprovide additional safeguards and greater internal control over its stockoption granting and administration. These improvements included:

·       Documentingand assessing the design and operation of internal controls;

·       Segregatingresponsibilities, adding reviews and reconciliations, and redefining roles andresponsibilities;

·       Implementinga new equity accounting system and a new stock administration function; and

·       Implementing,prior to the adoption of SFAS No. 123(R), the practice of using the receipt ofthe final Board or Compensation Committee approval as the grant and measurementdate for stock option grants.

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As a result of therecommendations of the Special Committee of our Board of Directors anddeliberations of the Compensation Committee of our Board of Directors, we haveadopted the following policies governing all stock option grants:

·       Alloption grants must be approved by the Compensation Committee or the Board ofDirectors; the authority to approve option grants may not be delegated. 

·       Optiongrants (including officer, vice president, rank and file, promotional and newhire grants) are generally considered at regularly scheduled quarterly meetingsof the Compensation Committee or the Board of Directors, and action may not betaken by unanimous written consent.  

·       Grantsare generally effective as of the later of (i) the second trading day followingthe Company’s public announcement of its financial results for the precedingquarter or (ii) the date of the Board or committee meeting.   

·       Grantsshould be recorded promptly in the Company’s option accounting database, andgrantees should receive prompt written notification of their grants.

·       Theannual focal review process will identify a specific date to complete theprocess of generating recommended grant amounts, after which therecommendations will be submitted to the Compensation Committee or the Board ofDirectors for approval. 

·       Boardor committee minutes are to be drafted and circulated to directors for commentas soon as reasonably possible.

The Special Committeeinvestigation and the Company’s related activities discovered no stock optiongrant after December 31, 2003 that required accounting adjustments.

**Related Proceedings**

*U.S.Attorney and SEC Requests.** *OnJuly 3, 2006, Zoran disclosed in a press release that it received a grandjury subpoena from the office of the U.S. attorney for the Northern District ofCalifornia requesting documents from 1995 through the present referring to,relating to or involving stock options, and also received an informal inquiryfrom the SEC requesting documents related to Zoran’s stock option grants. Zoranintends to cooperate fully in all government inquiries or investigations. Thereis no assurance that we will not be subject to inquiries related to our stockoption grant practices by other federal, state or foreign regulatory agencies.All such inquiries are likely to require us to continue to expend significantmanagement time and incur significant legal and other expenses, and couldresult in civil and criminal actions seeking injunctions, fines or othersanctions that could adversely affect our business and financial results.

*ShareholderClass Actions and Derivative Litigation Relating to Historical StockOption Practices:*** **Asdiscussed under Item 3—Legal Proceedings above, certain persons and entities identifying themselves asshareholders of Zoran have filed class action complaints against the Companyand derivative actions purporting to assert claims on behalf of and in the nameof the Company against various of the Company’s current and former directorsand officers relating to Zoran’s historical accounting for and disclosuresrelated to stock options. There may be additional lawsuits of this nature filedin the future. We cannot predict the outcome of any such litigation, or theamount of time and expenses that will be required to resolve them. If theselawsuits become time consuming and expensive, or if there are unfavorableoutcomes in any of these cases, there could be a material adverse effect on ourbusiness, financial condition and results of operations.

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

*Restatement andImpact on Financial Statements*

The following information has been adjusted to reflectthe restatement of the Company’s financial results, which is more fullydescribed in the “Explanatory Note” immediately preceding Part I, Item 1and in Note 2, “Restatement of Consolidated Financial Statements” in Notesto Consolidated Financial Statements of this Annual Report on Form 10-K.

In connection with the restatement, the Company isrecording additional non-cash adjustments that were previously considered to beimmaterial relating to the timing of revenue recognition, accrued expenses,amortization of premiums and discounts on investments, additional expenserelated to options granted to a consultant and the calculation of amortizationof stock-based compensation relating to a business combination in 2003.

For additional information, refer to “Note 2—Restatementof Consolidated Financial Statements,” in Notes to Consolidated FinancialStatements.

The incomestatement impact of the restatements are as follows (in thousands):

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

 

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

 

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**Overview**

Zoran Corporation is aleading provider of digital solutions in the digital entertainment and digitalimaging market.

Our products consist ofintegrated circuits and related products used in digital versatile disc, orDVD, players, movie and home theater systems, digital cameras and video editingsystems. We also provide integrated circuits, software and platforms fordigital television applications that enable the delivery and display of digitalvideo content through a set-top box or television as well as digital imagingproducts consisting of semiconductor hardware and software that enable users toprint, scan, process and transmit documents to computer peripherals thatperform printing functions. Subsequent to our acquisition of Emblaze SemiconductorLtd. on July 8, 2004, we also provide high performance, low-power applicationprocessors, technology and products for the multimedia mobile telephone market.Through the acquisition of Oren Semiconductor, Inc. on June 10, 2005, Zoranobtained Oren’s demodulator IC technology for the global high definitiontelevision market. We sell our products to original equipment manufacturers, orOEMs, who incorporate them in digital video and audio products for consumer andcommercial applications.

*Revenues*

We derive most of ourrevenues from the sale of our integrated circuit products. Historically,average selling prices in the semiconductor industry in general, and for ourproducts in particular, have decreased over the life of a particular product. Averageselling prices for our hardware products have fluctuated substantially fromperiod to period, primarily as a result of changes in our customer mix oforiginal equipment manufacturer, or OEM, sales versus sales to resellers andthe transition from low-volume to high-volume production. In the past, we haveperiodically reduced the prices of some of our products in order to penetratethe consumer market more broadly. We believe that, as our product linescontinue to mature and competitive markets evolve, we are likely to experiencefurther declines in the average selling prices of our products, although wecannot predict the timing and amount of such changes with any certainty.

We also derive revenuefrom licensing our software and other intellectual property. Licensing revenueincludes one-time license fees and royalties based on the number of unitsdistributed by the licensee. Annual licensing revenue can be significantlyaffected by the timing of a small number of licensing transactions, eachaccounting for substantial revenues. Accordingly, licensing revenues havefluctuated, and will continue to fluctuate, on an annual basis. In addition, wehave historically generated a portion of our total revenues from developmentcontracts, primarily with key customers, although development revenue hasdeclined substantially as a percentage of total revenues over the past severalyears. These development contracts have provided us with partial funding forthe development of some of our products. These development contracts providefor license and milestone payments which are recorded as development revenue. Weclassify all development costs, including costs related to these developmentcontracts, as research and development expenses. We retain ownership of theintellectual property developed by us under these development contracts. Whilewe intend to continue to enter into development contracts with certainstrategic partners, we expect development revenue to continue to decline as apercentage of total revenues.

We recognize softwarelicense revenues in accordance with the provisions of Statement of Position(SOP) No. 97-2, *SoftwareRevenue Recognition,*as amended by SOP No. 98-9, *Modification of*SOP No. 97-2,*Software Revenue Recognition, With Respectto Certain Transactions.* Our software license agreements typicallyinclude obligations to provide maintenance and other support over a fixed termand allow for renewal of maintenance services on an annual basis. We determinethe fair value of our maintenance obligations with reference to substantiverenewal rates within the agreement or objective 

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evidence of fair value asrequired under SOP No. 97-2. Maintenance and support revenue isrecognized ratably over the term of the arrangement. We also receive royaltyrevenues based on per unit shipments of products embedding our software whichwe recognize upon receipt of a royalty report from the customer, typically onequarter in arrears.

*Cost of Hardware Product Revenues*

Our cost of hardwareproduct revenues consists primarily of fabrication costs, assembly and testcosts, and the cost of materials and overhead from operations. If we are unableto reduce our cost of hardware product revenues to offset anticipated decreasesin average selling prices, our product gross margins will decrease. We expectboth product and customer mix to continue to fluctuate in future periods,causing fluctuations in margins.

*Research and Development*

Our research anddevelopment expenses consist of salaries and related costs of employees engagedin ongoing research, design and development activities and costs of engineeringmaterials and supplies. We are a party to research and development agreementswith the Chief Scientist in Israel’s Ministry of Industry and Trade and theIsrael-United States Binational Industrial Research and Development Foundation,which fund up to 50% of incurred project costs for approved products up tospecified contract maximums. These agreements require us to use our bestefforts to achieve specified results and require us to pay royalties at ratesof 3% to 5% of resulting product sales, and up to 30% of resulting licenserevenues, up to a maximum of 100% to 150% of total funding received. Reportedresearch and development expenses are net of these grants, which fluctuate fromperiod to period. From time to time, we enter into non-refundable jointdevelopment projects in which our customers reimburse us for a portion of ourdevelopment costs. We classify such reimbursement of development costs as anoffset to research and development expenses as we retain ownership of theintellectual property developed by us under these development arrangements. During2006, we received approximately $347,000 in such reimbursements. We received$1.2 million in reimbursements in 2005. 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.

*Selling, General and Administrative*

Our selling, general andadministrative expenses consist primarily of employee-related expenses, salescommissions, product promotion and other professional services. We expect thatselling, general and administrative expenses will continue to increase tosupport our anticipated growth.

*Income Taxes*

Our effective income taxrate has benefited from the availability of previously unbenefitted netoperating losses which we have utilized to reduce taxable income for U.S. federalincome tax purposes and by our Israel based subsidiary’s status as an “ApprovedEnterprise” under Israeli law, which provides a ten-year tax holiday for incomeattributable to a portion of our operations in Israel. Our U.S. federal netoperating losses expire at various times between 2017 and 2024, and thebenefits from our subsidiary’s Approved Enterprise status expire at varioustimes beginning in 2008.

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**Acquisitions**

*Oren Semiconductor, Inc.*

On June 10, 2005, wecompleted our acquisition of Oren Semiconductor, Inc. (“Oren”), aprivately-held provider of demodulator ICs for the global high definitiontelevision market. Prior to this acquisition, we had made investments in Orenthat represented a 17% ownership interest. Under the terms of the acquisitionagreement, we acquired the remaining 83% of Oren’s outstanding stock by meansof a merger of Oren with a wholly-owned subsidiary of Zoran, in considerationfor which we paid an aggregate of $28.4 million in cash and issued1,188,061 shares of Zoran common stock valued at $12.9 million, for totalconsideration of $41.3 million, to the other stockholders of Oren and toemployees holding Oren options. The acquisition was accounted for under thepurchase method of accounting.

Following the completionof the acquisition, the results of operations of Oren have been included in ourconsolidated financial statements. In addition, we recordedretroactive losses under Accounting Principles Board Opinion 18 (“APB No. 18”),“The Equity Method of Accounting for Investments in Common Stock,”to record the losses on investment of the prior 17% ownership ofOren Semiconductor, Inc. under the equity basis. Accordingly, ourresults of operations for the year ended December 31, 2006 include Oren’soperations for the full year; our results of operations for the year ended December 31,2005 include Oren’s operations between June 10, 2005 and December 31,2005 and $218,000 representing our portion of the losses incurred by Orenbetween January 1, 2005 and June 10, 2005; and our results of operationsfor the year ended December 31, 2004 do not include Oren’s operations.

*Emblaze Semiconductor Ltd.*

On July 8, 2004, wecompleted our acquisition of Emblaze Semiconductor Ltd. (“Emblaze”), awholly-owned subsidiary of Emblaze Ltd. for $54.2 million in cash. Theacquisition was accounted for under the purchase method of accounting.

Following the completionof the acquisition, the results of operations of Emblaze have been included inour consolidated financial statements. Accordingly, our results of operationsfor the years ended December 31, 2006 and 2005 include Emblaze’soperations for the full years presented while the results of operations for theyear ended December 31, 2004 only reflect Emblaze’s operations between July 8,2004 and December 31, 2004.

**Segments**

During the first quarterof 2006, we reorganized our operating structure to bring together our consumerelectronic product lines under a single operating group, in recognition of theaccelerating convergence of consumer products and our strategy of sharingtechnology among our various product lines. The new Consumer segment combinesthe former Digital Versatile Disc (DVD), Digital Television (DTV) and Mobileproduct groups whose operations were previously reported separately. We willcontinue to report the operations of our Imaging group as a separate operatingsegment.

Prior to July 2004,we had four reportable segments: Digital Versatile Disc (DVD), Imaging, DigitalCamera (DC) and Digital Television (DTV). Subsequent to the Emblaze acquisitionin July 2004, the operations of Emblaze were combined with the DigitalCamera group and the group was renamed the Mobile segment. Each segment’sprimary products are based on highly integrated application-specific integratedcircuits, or ASICs, and system-on-a-chip, or SOC, solutions. The DVD, Imagingand DTV segments also license certain software and other intellectual property.The DVD group provides products for use in DVD players and recordable DVDplayers. The Imaging group provides products used in digital copiers, laser andinkjet printers as well as multifunction peripherals. The Mobile group focuseson 

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solutions for multimediamobile phone products and digital camera products. 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 andanalysis of our financial condition and results of operations are based uponour consolidated financial statements, which have been prepared in accordancewith accounting principles generally accepted in the United States of America. Thepreparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses, and related disclosure of contingent 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 onhistorical experience and on various other assumptions that we believe to bereasonable under the circumstances. The results of these estimates form thebasis for making judgments about the carrying values of assets and liabilitiesthat are not readily apparent from other sources. Actual results may differfrom these estimates under different assumptions or conditions.

Webelieve the following critical accounting policies require our most significantjudgments and estimates used in the preparation of our consolidated financialstatements:

·       Wegenerally recognize product sales to distributors at the time of delivery. However,in some cases we grant rights of return or provide price protectionarrangements. When we are able to estimate the effect of such an arrangement,we establish a reserve for the estimated adjustment and recognize the balanceof the product revenue associated with that arrangement upon shipment. When wecannot reasonably estimate the effect of such an arrangement, we defer allrevenue subject to the arrangement until the return right has lapsed or theprice has become fixed. The deferred revenue balance at the end of eachaccounting period was not material.

·       Revenuefrom development contracts is generally recognized as the services areperformed based on the specific deliverables outlined in each contract. Amountsreceived in advance of performance under contracts are recorded as deferredrevenue and are generally recognized within one year from receipt. Costsassociated with development revenues are included primarily in research anddevelopment expenses.

·       Revenuefrom litigation settlement is recognized in accordance with the terms of theagreement when actual cash payments are received.

·       Inventoriesare recorded at the lower of standard cost, which approximates actual cost on afirst-in-first-out basis, or market value. We write down inventories to netrealizable value based on forecasted demand and market conditions. Actualdemand and market conditions may be different from those projected by ourmanagement. This could have a material effect on our operating results andfinancial position. Inventory write-downs are not reversed and permanentlyreduce the cost basis of the affected inventory until such inventory is sold orscrapped.

·       Wemaintain allowances for doubtful accounts for estimated losses resulting fromthe delays or inability of certain customers to make required payments. Theseallowances are estimated based on both specific identification of facts andcircumstances with respect to each doubtful account. If the financial conditionof our customers were to deteriorate, resulting in an impairment of theirability to make payments, additional allowances may be required.

·       Wehold minority interests in private companies having operations or technology inareas within our strategic focus. At December 31, 2006, these investmentstotaled $4.2 million. The investments are in start up companies engaged indevelopment and are expected to incur losses. We record an 

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investmentimpairment charge when we believe an investment has experienced a decline invalue. We assess the value of this investment principally by using information obtainedfrom the investee, including historical and projected financial performance andrecent funding events. Future adverse changes in market conditions orunexpected operating losses of underlying investments could result in losses oran inability to recover the carrying value of the investments that may not bereflected in an investment’s current carrying value thereby possibly requiringan impairment charge in the future.

·       Weassess the impairment of goodwill annually, or more frequently if events orchanges in circumstances indicate that the carrying value of such assetsexceeds their fair value. We assess the carrying value of our long lived assetsif events or circumstances indicate the carrying value of the assets exceedsthe future undiscounted cash flows attributable to such assets. With respect toboth goodwill and long lived assets, factors which could trigger an impairmentreview include significant negative industry or economic trends, exiting anactivity in conjunction with a restructuring of operations, current, historicalor projected losses that demonstrate continuing losses associated with an assetor a significant decline in our market capitalization for an extended period oftime, relative to net book value. Impairment evaluations involve managementestimates of asset useful lives and future cash flows. These estimates includeassumptions about future conditions such as future revenues, gross margins,operating expenses, the fair values of certain assets based on appraisals, andindustry trends. Actual useful lives and cash flows could be different fromthose estimated by our management. This could have a material effect on ouroperating results and financial position.

·       Priorto January 1, 2006, we applied APB No. 25, “Accounting for StockIssued to Employees,” and its related Interpretations and provided the requiredpro forma disclosures under SFAS No. 123, “Accounting for Stock-BasedCompensation.” In accordance with APB No. 25, a non-cash stock-basedcompensation expense was recognized for any options for which the exerciseprice was below the market price on the actual grant date. The charge for theoptions with an exercise price below the market price on the actual grant datewas equal to the number of options multiplied by the difference between theexercise price and the market price of the option shares on the actual grantdate. That expense was amortized over the vesting period of the option.Beginning January 1, 2006, we have accounted for stock-based compensationusing the fair value of stock options using a Black-Scholes valuation model,consistent with the provisions of SFAS No. 123(R), SEC Staff AccountingBulletin (“SAB”) No. 107. We elected to adopt the modified prospectiveapplication method as provided by SFAS No. 123(R). SFAS No. 123(R) requiresthe use of option pricing models that were not developed for use in valuingemployee stock options. The Black-Scholes option-pricing model was developedfor use in estimating the fair value of short-lived exchange traded optionsthat have no vesting restrictions and are fully transferable. In addition, option-pricingmodels require the input of highly subjective assumptions, including the option’sexpected life and the price volatility of the underlying stock. The expectedstock price volatility assumption was determined using the historicalvolatility of the Company’s common stock. We determined that historicalvolatility is reflective of market conditions and a good indicator of expectedvolatility. Prior to the adoption of SFAS No. 123(R), we also usedhistorical volatility in deriving the expected volatility assumption. In November 2005,the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”)No. 123(R)-3, “Transition Election Related to Accounting for TaxEffects of Share-Based Payment Awards” (“FSP 123R-3”). We haveelected not to adopt the alternative transition method provided in theFSP 123R-3 for calculating the tax effects of stock-basedcompensation pursuant to SFAS No. 123(R). We followed paragraph 81 ofSFAS No. 123(R) to calculate the initial pool of excess tax benefitsand to determine the subsequent impact on the Additional Paid-In-Capital (“APIC”)pool and Consolidated Statements of Cash Flows of the tax effects of employeestock-based compensation awards that are outstanding upon adoption of SFAS No. 123(R).See Notes 3 and 11 to Consolidated Financial Statements for a detaileddescription. Additionally, the Company has restated the pro forma expense underStatement of Financial 

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AccountingStandards (“SFAS”) No. 123 in Note 2 of the Notes to Consolidated FinancialStatements of this Form 10-K to reflect the impact of therestatement adjustments for the years ended December 31, 2005 and 2004.

·       Weare subject to the possibility of losses from various contingencies.Considerable judgment is necessary to estimate the probability and amount ofany loss from such contingencies. An accrual is made when it is probable that aliability has been incurred or an asset has been impaired and the amount ofloss can be reasonably estimated. We accrue a liability and charge operationsfor the estimated costs expected to be incurred over the next twelve months ofadjudication or settlement of asserted and unasserted claims existing as of thebalance sheet date. See Note 9 to Consolidated Financial Statements, “Commitmentsand Contingencies,” for a detailed description.

·       Wefollow 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. Realization of deferredtax assets is based on our ability to generate sufficient future taxableincome. The valuation allowance was determined in accordance with theprovisions of SFAS No. 109 which requires an assessment of both positiveand negative evidence when determining whether it is more likely than not thatdeferred tax assets are recoverable; such assessment is required on ajurisdiction by jurisdiction basis. Historical operating losses and continuingbusiness uncertainty represent sufficient negative evidence which it wasdifficult for positive evidence to overcome under SFAS No. 109 andaccordingly, a full valuation allowance was recorded. If the facts or estimatesof future financial results were to change, increasing the likelihood ofrealizing the deferred tax assets, judgment would have to be applied todetermine the amount of valuation allowance required in any given period. Weintend to maintain a full valuation allowance until sufficient positiveevidence exists to support reversal of the valuation allowance.

·       With respect to mergers andacquisitions, we assess the technological feasibility of in process researchand development projects and determine the number of alternative future usesfor the technology being developed. To the extent there are no alternativefuture uses we allocate a portion of the purchase price to in-process researchand development expense. This expense is generally estimated based upon theprojected fair value of the technology, as determined by a discounted futurecash flow reduced by the cost to complete. This analysis includes certainestimates and assumptions made by management. For larger acquisitions, we havehistorically engaged an external appraiser to assist with the assumptions andmodels used in this analysis.

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**Results of Operations**

Thefollowing table sets forth certain consolidated statement of operations data asa percentage of total revenues for the periods indicated and percentage changesfrom period to period:

| ** **                                                                     | ** ** | **Years ended December 31,** | ** ** | **Percentage change** | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------------------------------|------------|----------------------------|------------|
| ** **                                                                     | ** ** | ** **                                  | ** ** | ** **                 | ** ** | ** ** | ** ** | **2006 to** | ** ** | **2005 to** | ** ** |
| ** **                                                                     | ** ** | **2006**                                    | ** ** | **2005**                   | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                     | ** ** | ** **                                  | ** ** | **(restated)**             | ** ** | **(restated)** | ** ** | **(restated)** | ** ** | **(restated)** | ** ** |
| Revenues:                                                                      |       |                                        |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Hardware product revenues                                                      |       | 81.5                                        | %          |                       | 85.8       | % |   |   | 83.3 | % |   |   | 18.9 | % |   |   | 7.6 | % |   |
| Software and other revenues                                                    |       | 11.3                                        | %          |                       | 14.2       | % |   |   | 16.7 | % |   |   | 0.1 | % |   |   | (11.0 | )% |   |
| License revenues related to litigation settlement                              |       | 7.2                                         | %          |                       | —     |   |   |   | — |   |   |   | * |   |   |   | * |   |   |
| Total revenues                                                                 |       | 100.0                                       | %          |                       | 100.0      | % |   |   | 100.0 | % |   |   | 25.3 | % |   |   | 4.5 | % |   |
| Cost and expenses:                                                             |       |                                        |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of hardware product revenues                                              |       | 45.6                                        | %          |                       | 47.0       | % |   |   | 59.8 | % |   |   | 21.5 | % |   |   | (17.8 | )% |   |
| Research and development                                                       |       | 20.0                                        | %          |                       | 22.7       | % |   |   | 21.6 | % |   |   | 10.3 | % |   |   | 9.8 | % |   |
| Selling, general and administrative                                            |       | 22.1                                        | %          |                       | 24.1       | % |   |   | 17.4 | % |   |   | 15.4 | % |   |   | 43.8 | % |   |
| Amortization of intangible assets                                              |       | 10.1                                        | %          |                       | 12.7       | % |   |   | 12.0 | % |   |   | (0.4 | )% |   |   | 10.8 | % |   |
| Amortization of stock-based compensation resulting  from business combinations |       | —                                      |       |                       | 0.4        | % |   |   | 1.1 | % |   |   | * |   |   |   | (61.8 | )% |   |
| Restructuring expense                                                          |       | —                                      |       |                       | —     |   |   |   | 0.2 | % |   |   | * |   |   |   | * |   |   |
| In-process research and development                                            |       | —                                      |       |                       | 0.7        | % |   |   | — |   |   |   | * |   |   |   | * |   |   |
| Total costs and expenses                                                       |       | 97.8                                        | %          |                       | 107.6      | % |   |   | 112.1 | % |   |   | 14.0 | % |   |   | 0.2 | % |   |
| Operating income  (loss)                                                       |       | 2.2                                         | %          |                       | (7.6       | )% |   |   | (12.1 | )% |   |   | * |   |   |   | (34.7 | )% |   |
| Interest income                                                                |       | 2.2                                         | %          |                       | 0.7        | % |   |   | 0.1 | % |   |   | 326.4 | % |   |   | 885.9 | % |   |
| Other income  (loss), net                                                      |       | 0.1                                         | %          |                       | (0.2       | )% |   |   | (0.3 | )% |   |   | * |   |   |   | * |   |   |
| Income (loss)  before income taxes                                             |       | 4.5                                         | %          |                       | (7.1       | )% |   |   | (12.3 | )% |   |   | * |   |   |   | (40.1 | )% |   |
| Provision for  income taxes                                                    |       | 1.2                                         | %          |                       | 0.6        | % |   |   | 0.4 | % |   |   | 144.6 | % |   |   | 53.0 | % |   |
| Net income (loss)                                                              |       | 3.3                                         | %          |                       | (7.7       | )% |   |   | (12.7 | )% |   |   | * |   |   |   | (37.1 | )% |   |
| Supplemental Operating  Data:                                                  |       |                                        |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Product gross  margin                                                          |       | 44.0                                        | %          |                       | 45.2       | % |   |   | 28.3 | % |   |   | 15.7 | % |   |   | 71.9 | % |   |

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(*)          notmeaningful

*Year Ended December 31, 2006 Compared to YearEnded December 31, 2005*

Total revenues increasedby $100.0 million, or 25.3%, to $495.8 million in 2006 from $395.8 millionin 2005. This increase was a result of a $110.2 million increase inConsumer segment revenues, partially offset by a $10.2 million decrease inthe Imaging segment. Within the Consumer segment, license revenues related tothe litigation settlement accounted for $35.8 million of the increasewhile the remaining increase was primarily a result of increase in hardwareproduct revenues of $73.5 million. The decrease in Imaging segmentrevenues in 2006 was primarily due to a $9.3 million decrease in hardwareproduct revenues due to decrease in unit shipments.

Hardware product revenuesincreased by $64.2 million, or 18.9%, to $403.7 million in 2006 from$339.5 million in 2005. The increase in hardware product revenues wasdriven by growth in Consumer segment product revenues. Within the Consumersegment, hardware product revenues increased primarily due to a $46.9 millionincrease in the Mobile product line and $31.0 million increase in the DTVproduct line, in each case driven by increased unit shipments offset by areduction of $4.5 million in the DVD product line attributable toreductions in unit shipments and average selling prices.

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Software and otherrevenues remained essentially unchanged at $56.3 million and $56.2 millionin 2006 and 2005, respectively.

*Cost of Hardware Product Revenues*

Cost of hardware productrevenues were $226.3 million in 2006 compared to $186.2 million in2005. The increase in costs was primarily a result of the correspondingincrease in hardware product revenues. As a percentage of hardware productrevenues, hardware product costs were 56.0% in 2006 compared to 54.8% in 2005.Hardware product costs for 2005 included adjustments resulting in a $9.4 milliondecrease in inventory. Excluding the benefit of the net reduction in theinventory allowance, hardware product costs as a percentage of hardware productrevenues would have been 57.6 % in 2005 with no significant change in 2006. Thedecrease in hardware product costs as a percentage of hardware product revenuesin 2006 to 56.0% compared to the adjusted costs of 57.6% in 2005 reflected achange in product mix as revenues from the lower margin DVD product linerepresented a smaller proportion of total hardware product revenue with arelative increase in revenue from the higher margin Mobile and DTV productlines.

*Research and Development*

Research and development (“R&D”)expenses increased to $99.1 million in 2006 from $89.8 million in2005, an increase of 10.3%. The increase in 2006 was primarily due tostock-based compensation expenses of $5.5 million recorded in 2006 as aresult of the adoption of SFAS No. 123(R), compared with stock-basedcompensation expense of $0.8 million in 2005 prior to the adoption of SFASNo. 123(R); the inclusion of the operations of Oren which was acquired in June 2005for the full year in 2006 as well as continued investments in research anddevelopment across all of our segments.

*Selling, General and Administrative*

Selling, general andadministrative (“SG&A”) expenses increased to $109.8 million in 2006from $95.2 million in 2005, representing a 15.4% increase. This increasewas primarily due to stock-based compensation expenses of $11.3 millionrecorded in 2006 as a result of the adoption of SFAS No. 123(R), comparedwith stock-based compensation expense of $1.7 million in 2005 prior to theadoption of SFAS No. 123(R); $5.8 million of expenses inconnection with the ongoing stock option review, continued increases in marketingand field application support expenses to support revenue growth in our AsiaPacific markets and the inclusion of the operations of Oren which was acquiredin June 2005 for the full year in 2006. This increase was partially offsetby the reduction of legal fees as a result of the completion of the Mediateklitigation.

*Amortization of Intangible Assets*

Amortizationof intangible assets decreased to $50.1 million in 2006 from $50.3 millionin 2005. At December 31, 2006, we had approximately $69.2 millionin net intangible assets acquired through the Oak, Emblaze and Orenacquisitions which we will continue to amortize on a straight line basis forvarious periods extending through 2010.

*Amortization of Stock-Based Compensation Resultingfrom Business Combinations*

As a result of theadoption of SFAS No. 123(R) during the first quarter of 2006, we nowrecord a charge for all stock-based compensation expenses as described in Note3 to Notes to Consolidated Financial Statements and no longer record a separatecharge for amortization of stock-based compensation resulting from businesscombinations. In 2005, we recorded charges of $1.5 million related to theamortization of amortization of stock-based compensation resulting frombusiness combinations primarily as a result of stock options granted inconnection with the Oak acquisition.

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*In-Process Research and Development*

There were no chargesrecorded for in-process research and development during 2006. In 2005*,*approximately $2.7 million of the purchase price ofOren Semiconductor, Inc. was allocated to in-process research anddevelopment for projects which had not reached technical feasibility and had noalternative future use. Accordingly, this amount was immediately expensed uponthe acquisition date. This amount was determined using management’s estimatesincluding consultation with an independent appraiser. At December 31,2006, there have been no material variations from the underlying assumptionsthat were used in the original computation of the value of the acquiredin-process research and development.

*Interest Income*

Interest income increasedby $8.5 million to $11.1 million in 2006 compared to $2.6 millionin 2005. The increase was a result of higher average cash and short terminvestment balances and the higher interest rates during 2006.

*Provision for Income Taxes*

Our effective tax ratediffers from the U.S. statutory rate primarily due to utilization of previouslyunbenefitted net operating losses (“NOLs”) and State of Israel tax benefits onforeign earnings. The provision is primarily due to domestic income offset bypreviously unbenefitted purchased NOLs which when utilized reduce goodwill andnot tax expense. For the year ended December 31, 2006, the Company reduced itsincome tax reserves by $2.1 million. This was due to an expiring statute of limitations and the settlement ofa domestic income tax audit.

Realization of deferredtax assets is based on our ability to generate sufficient future taxableincome. The valuation allowance was determined in accordance with theprovisions of SFAS No. 109, which requires an assessment of both positiveand negative evidence on a jurisdiction by jurisdiction basis when determiningwhether it is more likely than not that deferred tax assets are recoverable. Historicaloperating losses and continuing business uncertainty represent sufficientnegative evidence which it was difficult for positive evidence to overcomeunder SFAS No. 109 and accordingly, a full valuation allowance wasrecorded. If the facts or estimates of future financial results were to change,increasing the likelihood of realizing the deferred tax assets, judgment wouldhave to be applied to determine the amount of valuation allowance required inany given period. We intend to maintain a full valuation allowance untilsufficient positive evidence exists to support reversal of the valuationallowance.

*Year Ended December 31, 2005 Compared to YearEnded December 31, 2004*

*Revenues*

Totalrevenues increased by $16.9 million, or 4.5%, to $395.8 million in2005 from $378.9 million in 2004. This increase was a result of a$16.2 million increase in Consumer segment revenues and a $0.7 millionincrease in Imaging segment revenues.Within the Consumer segment, the increase in revenues was primarily as a resultof increase in hardware product revenues.

Hardware product revenuesincreased by $23.8 million, or 7.6%, to $339.5 million in 2005 from$315.7 million in 2004. The increase in hardware product revenues wasdriven by growth in Consumer segment product revenues by $20.5 million andImaging segment product revenues by $3.3 million. Within the Consumersegment, hardware product revenues increased primarily due to revenue increasesof $75.8 million in the Mobile product line, $17.5 million in the DTVproduct line, in each case driven by increased unit shipments. These increaseswere partially offset by a decrease of $72.8 million in the DVD productline due to reduced unit shipments. The increase in Imaging segment revenueswas due to increase in unit shipments.

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Software and otherrevenues decreased by $6.9 million, or 11.0%, to $56.2 million in2005 from $63.2 million in 2004. The decrease in software and otherrevenues primarily resulted from decreases of $4.3 million in the Consumersegment and $2.6 million in the Imaging segment revenues. Within theConsumer segment, software and other revenues decreased by $6.3 million inthe DVD product line and $2.3 million in the Mobile product line, partiallyoffset by an increase of $4.3 million in the DTV segment. These changeswere primarily due to the timing of new agreements.

*Cost of Hardware Product Revenues*

Cost of hardware productrevenues was $186.2 million in 2005 compared to $226.5 million in 2004.This decrease in the cost of hardware product revenues was mainly due to lowerunit costs primarily due to changes in product mix. In addition, part of theunit cost reduction was due to charges recorded in 2004 for inventorywrite-downs of $14.7 million coupled with the reduction in our inventoryallowances of $9.4 million in 2005 as a result of the sale or disposal ofinventory that had been fully written down in 2004. Most of the inventorywrite-downs in 2004, as well as the sale of previously written down inventoryin 2005, primarily related to our DVD Vaddis 6 product and a companion chip. Therevenue recorded in 2005 associated with the sale of these previously writtendown products was approximately $18.5 million. Partially offsetting thesereductions in unit costs was an increase associated with increased unitshipments, primarily in the Mobile product line. As a percentage of hardwareproduct revenues, hardware product costs were 54.8% in 2005 compared to 71.7%in 2004. The decrease in hardware product costs as a percentage of hardwareproduct revenues was primarily due to a change in product mix to a lowerpercentage of DVD products which generally have higher product costs as apercentage of hardware product revenues than Mobile and DTV products. Theinventory write down charges in 2004 coupled with the reduction in inventoryallowances also contributed to the reduction in hardware product costs as apercentage of hardware product revenues.

*Research and Development*

Research and development (“R&D”)expenses increased to $89.8 million in 2005 from $81.8 million in2004, an increase of 9.8%. This increase was driven primarily by theacquisition of Oren Semiconductor, Inc. in June 2005 and inclusion ofEmblaze operations acquired in July 2004 for the full year in 2005.R&D expense included increased stock-based compensation expense of $0.8 millionin 2005, compared with a benefit (credit) of $0.5 million in 2004. ActualR&D expenses in 2004 were offset in part by $1.5 million of researchgrants received from the Chief Scientist in Israel. We did not receive any suchgrants in 2005. These grants are provided by the Israeli government to fundspecific R&D projects. We are not obligated to repay the grants; however,future royalties may be owed to the government if the R&D activities resultin commercial product sales. We remain committed to investing in research anddevelopment to enhance our technology and development capabilities.

*Selling, General and Administrative*

Selling, general andadministrative (“SG&A”) expenses increased to $95.2 million in 2005from $66.2 million in 2004, representing a 43.8% increase. This increasewas primarily due to increase in legal fees by $8.4 million related to ourpatent litigation with Mediatek, Inc., continued increases in marketingand field application support expenses to support revenue growth in our AsiaPacific markets, an increase in the allowance for doubtful accounts receivableby $4.8 million to cover slow paying accounts and potential risk withincreasing business in certain regions of the world and the inclusion of theOren and Emblaze operations in 2005. Selling, general and administrativeexpense included increased stock-based compensation expense of $1.8 millionin 2005, compared with a benefit of $1.0 million in 2004.

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*Amortization of Intangible Assets*

Amortization of intangibleassets increased to $50.3 million in 2005 from $45.4 million in 2004,an increase of 10.8%. This increase was the result of amortization ofapproximately $24.2 million of intangible assets acquired in the Emblazeacquisition in July 2004 for the full year in 2005 and amortization of$9.1 million of intangible assets acquired in the Oren acquisition in June 2005.At December 31, 2005, we had approximately $119.2 million in netintangible assets acquired through the Oak, Emblaze and Oren acquisitions whichwe will continue to amortize on a straight line basis for various periodsextending through 2010.

*Amortization of Stock-Based Compensation Resultingfrom Business Combinations*

Amortization of stock-basedcompensation resulting from business combinations was recorded primarily as aresult of stock options granted in connection with the Oak acquisition. For theyear ended December 31, 2005, these charges were $1.5 millioncompared to $4.1 million during the prior year. The 61.8 % decrease forfiscal 2005 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.

*Restructuring Expense*

Therewere no charges recorded for restructuring expenses during 2005.**During the year ended December 31,2004, we recorded restructuring charges of $746,000 due to the discontinuationof the Sensor product line of the Mobile group. This charge included $523,000related to the reduction in force of 15 employees for severance and othertermination expenses, $173,000 for lease losses on abandoned office space andother miscellaneous legal and consulting fees of approximately $50,000. Theremaining accrual balance at December 31, 2005 of $73,000 relating tofacilities will be paid over the lease term through June 2007.

*In-Process Research and Development*

In 2005*,*approximately $2.7 million of the purchase price ofOren Semiconductor, Inc. was allocated to in-process research anddevelopment for projects which had not reached technical feasibility and had noalternative future use. Accordingly, this amount was immediately expensed uponthe acquisition date. This amount was determined using management’s estimatesincluding consultation with an independent appraiser. The value of in-processresearch and development was determined using the multi-period excessearnings method by estimating the expected net cash flows from the projects oncecommercially viable and discounting the net cash flows back to their presentvalue using a discount rate of 21%. 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 development team.The net cash flows from the identified projects were based on estimates ofrevenue, cost of revenue, research and development expenses, selling generaland administrative expenses, and applicable income taxes. These estimates didnot take into account any potential synergies that could be realized as aresult of the acquisition. At December 31, 2005, there have been nomaterial variations from the underlying assumptions that were used in the originalcomputation of the value of the acquired in-process research and development.There were no charges recorded for in-process research and development during2004.

*Interest Income*

Interest income increasedby $2.3 million to $2.6 million in 2005 compared to $0.3 millionin 2004. The increase was a result of the higher interest rates during 2005.

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*Provision for Income Taxes*

Oureffective tax rate differs from the U.S. statutory rate primarily due toutilization of previously unbenefitted net operating losses and State of Israeltax benefits on foreign earnings. The provision is primarily due to domesticincome offset by previously unbenefitted purchased NOLs which when utilizedreduce goodwill and not tax expense.

**Liquidity and Capital Resources**

At December 31,2006, we had $100.0 million of cash and cash equivalents, $196.2 millionof short-term investments and $314.8 million of working capital.

Our operatingactivities generated cash of $101.5 million during 2006, primarily due tonet income of $16.3 million adjusted for non-cash items such asamortization of $50.1 million, depreciation of $9.4 million and stockbased compensation expense of $17.3 million. Cash provided by operationsalso increased due to a net decrease of $27.6 million in accountsreceivable due to the timing of collections. These increases were partiallyoffset by a $12.4 million increase in inventories to meet the increasingdemand for our products, net decrease in accounts payable, accrued expenses andother liabilities, goodwill and other long term liabilities totaling $4.8 millionand a $2.0 million increase in prepaid expenses and other assets.

Cash used in investing activities was $132.6 million during 2006,principally reflecting the net purchase of investments of $123.6 million.In addition we spent $9.0 million for purchases of property and equipment.

Cash providedby financing activities during 2006 was $52.3 million consisting ofproceeds received from issuances of common stock through exercises of employeestock options and proceeds from the sale of stock under our employee stockpurchase plan.

Our operatingactivities generated cash of $51.2 million during 2005, primarily due tonon-cash items such as amortization of $50.4 million, depreciation of$10.3 million, in process research and development expense of $2.7 millionand stock based compensation of $4.5 million which offset our net loss of$30.3 million. Cash provided by operations also increased due to decreasesof $17.6 million in net inventory primarily associated with our DVDproduct line due to reduction in supply chain inventory, $0.5 million inprepaid expenses and other assets and increases in accounts payable, accruedexpenses and other liabilities, goodwill and other long term liabilitiestotaling $5.4 million which were partially offset by a $9.9 millionincrease in net accounts receivable due to higher revenues recorded in thefourth quarter of 2005 compared to the same period of 2004.

Cash used ininvesting activities was $19.2 million during 2005, principally reflectingthe use of $27.6 million in the acquisition of Oren Semiconductor, Inc,partially offset by $16.8 million of net proceeds from sales andmaturities of investments. In addition we spent $8.5 million for propertyand equipment.

Cashprovided by financing activities was $9.5 million during 2005 andconsisted of proceeds received from issuances of common stock through exercisesof employee stock options and employee stock purchase programs.

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**Off Balance Sheet Arrangements**

AtDecember 31, 2006 and 2005, we did not have any relationships withunconsolidated entities or financial partnerships, such as entities oftenreferred to as structured finance or special purpose entities, established forthe purpose of facilitating off-balance sheet arrangements or othercontractually narrow or limited purposes. Accordingly, we are not exposed tothe type of financing, liquidity, market or credit risk that could arise if wehad engaged in such relationships.

**Contractual Obligations**

The following is a summary of fixed payments related to certaincontractual obligations (in thousands):

| **Contractual Obligation**          | ** ** | ** ** | ** ** | **Total** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Thereafter** | ** ** |
|------------------------------------------|------------|------------|------------|-----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|
| Operating leases and license commitments |       | $          | 39,566     |      | $          | 10,188   |       | $        | 3,819      |     | $          | 3,345    |       | $        | 3,211      |           | $          | 3,108 |   |   | $ | 15,895 |   |   |
| Purchase commitments                     |       | 58,930     |       | 58,930    |       | —   |       | —   |       | —   |       | —   |       |     | —     |           |       |
| Total                                    |       | $          | 98,496     |      | $          | 69,118   |       | $        | 3,819      |     | $          | 3,345    |       | $        | 3,211      |           | $          | 3,108 |   |   | $ | 15,895 |   |   |

 

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

·       the levels at which we maintain inventoryand accounts receivable;

·       the market acceptance of our products;

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

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

·       volume pricing concessions;

·       capital improvements to new and existingfacilities;

·       technological advances;

·       the response of competitors to ourproducts; and

·       our relationships with our suppliers andcustomers.

In addition,we may require an increase in the level of working capital to accommodateplanned growth, hiring and infrastructure needs. Additional capital may also berequired for additional acquisitions of businesses, products or technologies.

To the extentthat our existing resources and cash generated from operations are insufficientto fund our future activities, we may need to raise additional funds throughpublic or private financings or borrowings. If additional funds are raisedthrough the issuance of debt securities, these securities could have rights,preferences and privileges senior to holders of common stock, and the terms ofthis debt could impose restrictions on our operations. The sale of additionalequity or convertible debt securities could result in additional dilution toour stockholders. We cannot be certain that additional financing will beavailable in amounts or on terms acceptable to us, if at all. If we are unableto obtain this additional financing, we may 

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be required toreduce the scope of our planned product development and sales and marketingefforts, which could harm our business, financial condition and operatingresults.

**Item 7A—Quantitative and Qualitative Disclosures about MarketRisks**

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 bearthe risk that the rate of inflation in Israel or the decline in the value ofUnited States dollar compared to the New Israeli Shekel will increase our costsas expressed in United States dollars. We have not engaged in hedgingtransactions to reduce our exposure to fluctuations that may arise from changesin foreign exchange rates. Based on our overall currency rate exposure at December 31,2006, a near-term 10% appreciation or depreciation of the New Israeli Shekelwould have an immaterial affect on our financial condition.

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**Item 8—FinancialStatements and Supplemental Data**

**Index to Consolidated Financial Statements**
| Report of Independent  Registered Public Accounting Firm                                               |   | 61 |   |
|--------------------------------------------------------------------------------------------------------|--------|----|--------|
| Consolidated  Balance Sheets as of December 31, 2006 and 2005                                     |   | 63 |   |
| Consolidated Statements of Operations for each of the  three years ended December 31, 2006        |   | 64 |   |
| Consolidated Statements of Stockholders’ Equity for  the three years ended December 31, 2006 |   | 65 |   |
| Consolidated Statements of Cash Flows for each of the  three years ended December 31, 2006        |   | 66 |   |
| Notes to  Consolidated Financial Statements                                                            |   | 67 |   |

 

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**Reportof Independent Registered Public Accounting Firm**

To the Board of Directors and Stockholders of ZoranCorporation:

We have completed integrated audits of ZoranCorporation’s consolidated financial statements and of its internal controlover financial reporting as of December 31, 2006, in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, arepresented below.

*Consolidated financial statements*

In our opinion, theaccompanying consolidated financial statements listed in the accompanying index present fairly, inall material respects, the financial position of Zoran Corporation and itssubsidiaries at December 31, 2006 and December 31, 2005, and theresults of their operations and their cash flows for each of the three years inthe period ended December 31, 2006 in conformity with accountingprinciples generally accepted in the United States of America. These financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits. We conducted our audits of these statements in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit of financial statements includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, and evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

As discussed in Note 2 to the Consolidated FinancialStatements, the Company has restated its fiscal 2005 and fiscal 2004consolidated financial statements.

As discussed in Note 3 to the Consolidated Financial Statements, theCompany changed the manner in which it accounts for share-based compensation infiscal 2006.

*Internal controlover financial reporting*

Also, in our opinion, management’s assessment,included in Management’s Report on Internal Control Over Financial Reportingappearing under Item 9A, that the Company maintained effective internal controlover financial reporting as of December 31, 2006 based on criteriaestablished in *Internal Control - Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO), is fairly stated, in all material respects, based on those criteria.Furthermore, in our opinion, the Company maintained, in all material respects,effective internal control over financial reporting as of December 31,2006, based on criteria established in *Internal Control -Integrated Framework* issued by the COSO. The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting. Our responsibility is to express opinions on management’s assessmentand on the effectiveness of the Company’s internal control over financialreporting based on our audit. We conducted our audit of internal control overfinancial reporting in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). 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 internal control over financial reportingincludes obtaining an understanding of internal control over financialreporting, evaluating management’s assessment, testing and evaluating the designand operating effectiveness of internal control, and performing such otherprocedures as we consider necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinions.

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A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (i) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (ii) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (iii) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

PricewaterhouseCoopers LLP

San Jose, CaliforniaApril 19, 2007

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**ZORAN CORPORATION**

**CONSOLIDATED BALANCE SHEETS(in thousands, except share data)**
|                                                                                                                                                                                                                                                                         | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                              | ** ** | ** **                  | ** ** | **(restated)(1)**           | ** ** |
| ASSETS                                                                                                                                                                                                                                                                  |       |                        |       |                        |       |   |   |   |   |
| Current assets:                                                                                                                                                                                                                                                         |       |                        |       |                        |       |   |   |   |   |
| Cash and cash equivalents                                                                                                                                                                                                                                               |       |                        | $          | 100,034                     |       |   |   | $ | 78,856 |   |   |
| Short-term investments                                                                                                                                                                                                                                                  |       |                        | 196,195    |                        |       |   | 70,490 |   |   |
| Accounts receivable, net of allowance for doubtful  accounts of $9,265 and $6,180, respectively                                                                                                                                                                         |       |                        | 42,640     |                        |       |   | 70,174 |   |   |
| Inventory                                                                                                                                                                                                                                                               |       |                        | 45,044     |                        |       |   | 32,616 |   |   |
| Prepaid expenses and other current assets                                                                                                                                                                                                                               |       |                        | 10,726     |                        |       |   | 11,746 |   |   |
| Total current assets                                                                                                                                                                                                                                                    |       |                        | 394,639    |                        |       |   | 263,882 |   |   |
| Property and equipment, net                                                                                                                                                                                                                                             |       |                        | 15,673     |                        |       |   | 16,057 |   |   |
| Other assets and investments                                                                                                                                                                                                                                            |       |                        | 22,890     |                        |       |   | 20,799 |   |   |
| Goodwill                                                                                                                                                                                                                                                                |       |                        | 174,259    |                        |       |   | 182,662 |   |   |
| Intangible assets, net                                                                                                                                                                                                                                                  |       |                        | 69,169     |                        |       |   | 119,231 |   |   |
|                                                                                                                                                                                                                                                                    |       |                        | $          | 676,630                     |       |   |   | $ | 602,631 |   |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                              |       |                        |       |                        |       |   |   |   |   |
| Current  liabilities:                                                                                                                                                                                                                                                   |       |                        |       |                        |       |   |   |   |   |
| Accounts payable                                                                                                                                                                                                                                                        |       |                        | $          | 33,767                      |       |   |   | $ | 38,999 |   |   |
| Accrued expenses and other liabilities                                                                                                                                                                                                                                  |       |                        | 46,082     |                        |       |   | 54,769 |   |   |
| Total current liabilities                                                                                                                                                                                                                                               |       |                        | 79,849     |                        |       |   | 93,768 |   |   |
| Other long-term liabilities                                                                                                                                                                                                                                             |       |                        | 12,784     |                        |       |   | 11,939 |   |   |
| Commitments and  contingencies (Note 9)                                                                                                                                                                                                                            |       |                        |       |                        |       |   |   |   |   |
| Stockholders’  equity:                                                                                                                                                                                                                                             |       |                        |       |                        |       |   |   |   |   |
| Common stock, $0.001 par value; 105,000,000 shares  authorized at December 31, 2006 and December 31, 2005; 49,433,780  shares issued and outstanding as of December 31, 2006; and 45,426,912  shares issued and outstanding as of December 31, 2005 |       |                        | 49         |                        |       |   | 45 |   |   |
| Additional paid-in capital                                                                                                                                                                                                                                              |       |                        | 807,220    |                        |       |   | 738,253 |   |   |
| Deferred stock-based compensation                                                                                                                                                                                                                                       |       |                        | —     |                        |       |   | (593 | ) |   |
| Accumulated other comprehensive income                                                                                                                                                                                                                                  |       |                        | 4,238      |                        |       |   | 3,057 |   |   |
| Accumulated deficit                                                                                                                                                                                                                                                     |       |                        | (227,510   | )                           |       |   | (243,838 | ) |   |
| Total stockholders’ equity                                                                                                                                                                                                                                         |       |                        | 583,997    |                        |       |   | 496,924 |   |   |
|                                                                                                                                                                                                                                                                    |       |                        | $          | 676,630                     |       |   |   | $ | 602,631 |   |   |

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(1)          See Note 2, “Restatementof Consolidated Financial Statements” in Notes to Consolidated FinancialStatements.

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

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**ZORANCORPORATION**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS(in thousands, except per share data)**

| ** **                                                                     | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                     | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                     | ** ** | ** **                                 | ** ** | **(restated)(1)** | ** ** | **(restated)(1)** | ** ** |
| Revenues:                                                                      |       |                                       |       |   |   |   |   |   |   |   |   |
| Hardware product revenues                                                      |       | $                                          | 403,744    |   |   | $ | 339,539 |   |   |   | $ | 315,697 |   |   |
| Software and other revenues                                                    |       | 56,269                                     |       |   | 56,219 |   |   |   | 63,167 |   |   |
| License revenues related to litigation  settlement                             |       | 35,792                                     |       |   | — |   |   |   | — |   |   |
| Total revenues                                                                 |       | $                                          | 495,805    |   |   | $ | 395,758 |   |   |   | $ | 378,864 |   |   |
| Costs and expenses:                                                            |       |                                       |       |   |   |   |   |   |   |   |   |
| Cost of hardware product revenues                                              |       | 226,260                                    |       |   | 186,172 |   |   |   | 226,461 |   |   |
| Research and development                                                       |       | 99,102                                     |       |   | 89,809 |   |   |   | 81,820 |   |   |
| Selling, general and administrative                                            |       | 109,825                                    |       |   | 95,206 |   |   |   | 66,195 |   |   |
| Amortization of intangible assets                                              |       | 50,062                                     |       |   | 50,254 |   |   |   | 45,358 |   |   |
| Amortization of stock-based compensation  resulting from business combinations |       | —                                     |       |   | 1,546 |   |   |   | 4,051 |   |   |
| Restructuring expense                                                          |       | —                                     |       |   | — |   |   |   | 746 |   |   |
| In-process research and  development                                           |       | —                                     |       |   | 2,650 |   |   |   | — |   |   |
| Total costs and expenses                                                       |       | 485,249                                    |       |   | 425,637 |   |   |   | 424,631 |   |   |
| Operating income (loss)                                                        |       | 10,556                                     |       |   | (29,879 | ) |   |   | (45,767 | ) |   |
| Interest income                                                                |       | 11,057                                     |       |   | 2,593 |   |   |   | 263 |   |   |
| Other income (loss), net                                                       |       | 477                                        |       |   | (630 | ) |   |   | (1,064 | ) |   |
| Income (loss) before income taxes                                              |       | 22,090                                     |       |   | (27,916 | ) |   |   | (46,568 | ) |   |
| Provision for income taxes                                                     |       | 5,762                                      |       |   | 2,356 |   |   |   | 1,540 |   |   |
| Net income (loss)                                                              |       | $                                          | 16,328     |   |   | $ | (30,272 | ) |   |   | $ | (48,108 | ) |   |
| Basic net income (loss) per share                                              |       | $                                          | 0.34       |   |   | $ | (0.68 | ) |   |   | $ | (1.12 | ) |   |
| Diluted net income (loss) per share                                            |       | $                                          | 0.33       |   |   | $ | (0.68 | ) |   |   | $ | (1.12 | ) |   |
| Shares used to compute basic net income  (loss) per share                      |       | 48,353                                     |       |   | 44,267 |   |   |   | 42,788 |   |   |
| Shares used to compute diluted net income (loss) per share                     |       | 50,099                                     |       |   | 44,267 |   |   |   | 42,788 |   |   |

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(1)          See Note 2, “Restatement of ConsolidatedFinancial Statements” in Notes to Consolidated Financial Statements.

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

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**ZORANCORPORATION**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY(in thousands)**

| ** **                                                                                                                    | ** ** | ** **            | ** ** | **Additional** | ** ** | **Deferred**    | ** ** | **Accumulated  Other  Comprehensive** | ** ** | ** **      | ** ** | ** **  | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|-----------------|------------|---------------------------------------|------------|-----------------|------------|-------------|------------|
| ** **                                                                                                                    | ** ** | **Common Stock** | ** ** | **Paid-In**    | ** ** | **Stock-Based** | ** ** | **Income**                            | ** ** | **Accumulated** | ** ** | ** **  | ** ** |
| ** **                                                                                                                    | ** ** | **Shares**            | ** ** | **Amount**     | ** ** | **Capital**     | ** ** | **Compensation**                      | ** ** | **(Loss)**      | ** ** | **Deficit** | ** ** | **Total** | ** ** |
| **Balance at  December 31, 2003, as reported**                                                                           |       |                  | 42,348     |           |       |            | $          | 42                                    |       |            |       | $           | 703,812    |   |   |   | $ | (13,014 | ) |   |   | $ | (91 | ) |   |   | $ | (156,470 | ) |   | $ | 534,279 |   |
| Cumulative  effect of restatements on prior years                                                                             |       |                  | —     |           |       |            | —     |                                  |       |            | 10,656     |        |       |   | (1,147 | ) |   |   | (1,193 | ) |   |   | (8,988 | ) |   | (672 | ) |
| Balance at  December 31, 2003, as restated (1)                                                                           |       |                  | 42,348     |           |       |            | 42         |                                  |       |            | 714,468    |        |       |   | (14,161 | ) |   |   | (1,284 | ) |   |   | (165,458 | ) |   | 533,607 |   |
| Issuance of  common stock                                                                                                     |       |                  | 847        |           |       |            | 1          |                                  |       |            | 8,021      |        |       |   | — |   |   |   | — |   |   |   | — |   |   | 8,022 |   |
| Amortization  of deferred stock-based compensation, net                                                                       |       |                  | —     |           |       |            | —     |                                  |       |            | (6,172     | )           |       |   | 8,747 |   |   |   | — |   |   |   | — |   |   | 2,575 |   |
| Change in  unrealized gain (loss) on securities available for sale                                                            |       |                  | —     |           |       |            | —     |                                  |       |            | —     |        |       |   | — |   |   |   | 2,673 |   |   |   | — |   |   | 2,673 |   |
| Net loss, as  restated                                                                                                        |       |                  | —     |           |       |            | —     |                                  |       |            | —     |        |       |   | — |   |   |   | — |   |   |   | (48,108 | ) |   | (48,108 | ) |
| **Balance at  December 31, 2004, as restated (1)**                                                                       |       |                  | 43,195     |           |       |            | 43         |                                  |       |            | 716,317    |        |       |   | (5,414 | ) |   |   | 1,389 |   |   |   | (213,566 | ) |   | 498,769 |   |
| Issuance of  common stock                                                                                                     |       |                  | 1,044      |           |       |            | 1          |                                  |       |            | 9,487      |        |       |   | — |   |   |   | — |   |   |   | — |   |   | 9,488 |   |
| Issuance of  common stock in conjunction with the acquisition of Oren  Semiconductor, Inc., net of issuance costs of $89 |       |                  | 1,188      |           |       |            | 1          |                                  |       |            | 12,815     |        |       |   | — |   |   |   | — |   |   |   | — |   |   | 12,816 |   |
| Amortization  of deferred stock-based compensation, net                                                                       |       |                  | —     |           |       |            | —     |                                  |       |            | (366       | )           |       |   | 4,821 |   |   |   | — |   |   |   | — |   |   | 4,455 |   |
| Change in  unrealized gain (loss) on securities available for sale                                                            |       |                  | —     |           |       |            | —     |                                  |       |            | —     |        |       |   | — |   |   |   | 1,668 |   |   |   | — |   |   | 1,668 |   |
| Net loss, as  restated                                                                                                        |       |                  | —     |           |       |            | —     |                                  |       |            | —     |        |       |   | — |   |   |   | — |   |   |   | (30,272 | ) |   | (30,272 | ) |
| **Balance at  December 31, 2005, as restated (1)**                                                                       |       |                  | 45,427     |           |       |            | 45         |                                  |       |            | 738,253    |        |       |   | (593 | ) |   |   | 3,057 |   |   |   | (243,838 | ) |   | 496,924 |   |
| Issuance of  common stock                                                                                                     |       |                  | 4,007      |           |       |            | 4          |                                  |       |            | 52,265     |        |       |   | — |   |   |   | — |   |   |   | — |   |   | 52,270 |   |
| Elimination  of deferred stock-based compensation upon adoption of SFAS No. 123(R)                                       |       |                  | —     |           |       |            | —     |                                  |       |            | (593       | )           |       |   | 593 |   |   |   | — |   |   |   | — |   |   | — |   |
| Stock-based  compensation, net                                                                                                |       |                  | —     |           |       |            | —     |                                  |       |            | 17,294     |        |       |   | — |   |   |   | — |   |   |   | — |   |   | 17,294 |   |
| Change in  unrealized gain (loss) on securities available for sale                                                            |       |                  | —     |           |       |            | —     |                                  |       |            | —     |        |       |   | — |   |   |   | 1,181 |   |   |   | — |   |   | 1,181 |   |
| Net income                                                                                                                    |       |                  | —     |           |       |            | —     |                                  |       |            | —     |        |       |   | — |   |   |   | — |   |   |   | 16,328 |   |   | 16,328 |   |
| **Balance at December 31, 2006**                                                                                         |       |                  | 49,434     |           |       |            | $          | 49                                    |       |            |       | $           | 807,220    |   |   |   | $ | — |   |   |   | $ | 4,238 |   |   |   | $ | (227,510 | ) |   | $ | 583,997 |   |

----

(1)          See Note 2, “Restatement of ConsolidatedFinancial Statements” in Notes to Consolidated Financial Statements.

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

65

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**ZORAN CORPORATION**

**CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands)**

| ** **                                                                               | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                               | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                               | ** ** | ** **                                 | ** ** | **(restated)(1)** | ** ** | **(restated)(1)** | ** ** |
| Cash flows from  operating activities:                                                   |       |                                       |       |   |   |   |   |   |   |   |   |
| Net income (loss)                                                                        |       | $                                          | 16,328     |   |   | $ | (30,272 | ) |   |   | $ | (48,108 | ) |   |
| Adjustments to  reconcile net income(loss) to net cash provided by (used in) operations: |       |                                       |       |   |   |   |   |   |   |   |   |
| Depreciation                                                                             |       | 9,403                                      |       |   | 10,329 |   |   |   | 9,896 |   |   |
| Amortization                                                                             |       | 50,062                                     |       |   | 50,366 |   |   |   | 45,358 |   |   |
| Stock based compensation expense                                                         |       | 17,294                                     |       |   | 4,455 |   |   |   | 2,575 |   |   |
| In-process research and development                                                      |       | —                                     |       |   | 2,650 |   |   |   | — |   |   |
| Provision for doubtful accounts                                                          |       | 3,085                                      |       |   | 4,771 |   |   |   | 175 |   |   |
| Write-down of inventory                                                                  |       | —                                     |       |   | — |   |   |   | 14,680 |   |   |
| Changes in assets  and liabilities, net of effect of acquisitions:                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Accounts receivable                                                                      |       | 24,449                                     |       |   | (14,706 | ) |   |   | 5,188 |   |   |
| Inventory                                                                                |       | (12,428                                    | )          |   | 17,630 |   |   |   | (47,022 | ) |   |
| Prepaid expenses and other current assets and other  assets                              |       | (2,034                                     | )          |   | 464 |   |   |   | (7,048 | ) |   |
| Accounts payable                                                                         |       | (5,233                                     | )          |   | 4,437 |   |   |   | 4,595 |   |   |
| Accrued expenses and other liabilities, goodwill and  other long term liabilities        |       | 562                                        |       |   | 1,029 |   |   |   | 2,391 |   |   |
| Net cash provided by (used in) operating activities                                      |       | 101,488                                    |       |   | 51,153 |   |   |   | (17,320 | ) |   |
| Cash flows from  investing activities:                                                   |       |                                       |       |   |   |   |   |   |   |   |   |
| Purchases of property and equipment                                                      |       | (8,997                                     | )          |   | (8,492 | ) |   |   | (7,165 | ) |   |
| Proceeds from sale of property and equipment                                             |       | —                                     |       |   | — |   |   |   | 978 |   |   |
| Purchases of investments                                                                 |       | (356,339                                   | )          |   | (43,576 | ) |   |   | (116,165 | ) |   |
| Proceeds from sales and maturities of investments                                        |       | 232,756                                    |       |   | 60,415 |   |   |   | 175,252 |   |   |
| Acquisition of Emblaze, net of cash acquired                                             |       | —                                     |       |   | — |   |   |   | (54,161 | ) |   |
| Acquisition of Oren Semiconductor, Inc., net of  cash acquired                      |       | —                                     |       |   | (27,567 | ) |   |   | — |   |   |
| Net cash used in investing activities                                                    |       | (132,580                                   | )          |   | (19,220 | ) |   |   | (1,261 | ) |   |
| Cash flows from  financing activities:                                                   |       |                                       |       |   |   |   |   |   |   |   |   |
| Proceeds from issuance of common stock                                                   |       | 52,270                                     |       |   | 9,488 |   |   |   | 8,022 |   |   |
| Net cash provided by financing activities                                                |       | 52,270                                     |       |   | 9,488 |   |   |   | 8,022 |   |   |
| Net increase  (decrease) in cash and cash equivalents                                    |       | 21,178                                     |       |   | 41,421 |   |   |   | (10,559 | ) |   |
| Cash and cash  equivalents at beginning of period                                        |       | 78,856                                     |       |   | 37,435 |   |   |   | 47,994 |   |   |
| Cash and cash  equivalents at end of period                                              |       | $                                          | 100,034    |   |   | $ | 78,856 |   |   |   | $ | 37,435 |   |   |
| **Supplemental  information:**                                                           |       |                                       |       |   |   |   |   |   |   |   |   |
| Fair value of  stock issued in Oren acquisition, net of issuance costs of $89            |       | $                                          | —     |   |   | $ | 12,816 |   |   |   | $ | — |   |   |

----

(1)          See Note 2, “Restatementof Consolidated Financial Statements” in Notes to Consolidated FinancialStatements.

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

66

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**NOTE 1—THE COMPANY**

ZoranCorporation (“Zoran” or the “Company”) was incorporated in California in December 1981and reincorporated in Delaware in November 1986. Zoran develops andmarkets integrated circuits, integrated circuit cores and embedded software usedby original equipment manufacturers, or OEMs, in digital audio and videoproducts for commercial and consumer markets, digital television applicationsand digital imaging products. Current applications incorporating Zoran’sproducts and IP include digital versatile disc, or DVD, players and recorders,digital cameras, professional and consumer video editing systems, digitalspeakers and audio systems, applications that enable the delivery and displayof digital video content through a set top box or television as well as digitalimaging products consisting of semiconductor hardware and software that enableusers to print, scan, process and transmit documents to computer peripheralsthat perform printing functions. The Company operates in two reportable segments,Consumer group which combines the former Digital Versatile Disc (DVD), DigitalTelevision (DTV) and Mobile product groups and Imaging group.

*Risk and Uncertainties*

Because themarkets that the Company’s customers serve are characterized by numerous newproduct introductions and rapid product enhancements, its operating results mayvary significantly from quarter to quarter. During the final production of amature product, its customers typically exhaust their existing inventories ofthe Company’s products. Consequently, orders for its products may decline inthose circumstances, even if the products are incorporated into both matureproducts and replacement products. A delay in a customer’s transition tocommercial production of a replacement product would delay the Company’sability to recover the lost sales from the discontinuation of the relatedmature product. The Company’s customers also experience significant seasonalityin the sales of their consumer products, which affects their orders of theCompany’s products. Typically, the second half of the calendar year representsa disproportionate percentage of sales for the Company’s customers due to theholiday shopping period for consumer electronics products, and therefore, adisproportionate percentage of the Company’s sales.

Averageselling prices for the Company’s products decline over relatively short timeperiods, while many of its manufacturing costs are fixed. When the Company’saverage selling prices decline, its revenues decline unless the Company is ableto sell more units, and its gross margins decline unless it is able to reduceits manufacturing costs by a commensurate amount. The Company’s operatingresults suffer when gross margins decline. The Company has experienced theseproblems, and the Company expects to continue to experience them in the future.

The Companydoes not operate any manufacturing facilities, and it relies on independentfoundries to manufacture substantially all of its products. These independentfoundries fabricate products for other companies and may also produce productsof their own design. From time to time, there are manufacturing capacityshortages in the semiconductor industry. The Company does not have long-termsupply contracts with any of its suppliers, including its principal supplier,Taiwan Semiconductor Manufacturing Company, or TSMC. Therefore, TSMC and theCompany’s other suppliers are not obligated to manufacture products for theCompany for any specific period, in any specific quantity or at any specifiedprice, except as may be provided in a particular purchase order.

The Company anticipates that international sales will continue toaccount for a substantial majority of its total revenues for the foreseeablefuture. In addition, substantially all of its semiconductor products aremanufactured, assembled and tested outside of the United States by independentfoundries and 

67

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

subcontractors. The Company is subject to a variety of risksinherent in doing business internationally, including:

·       unexpected changes in regulatoryrequirements;

·       fluctuations in exchange rates;

·       political and economic instability;

·       imposition of tariffs and other barriersand restrictions;

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

·       health risks in a particular region.

Economic,political or military events in a country where the Company make significantsales or has significant operations could harm its business.

*Principles of consolidation and basis of presentation*

Theconsolidated financial statements include the accounts of Zoran and all of itssubsidiaries. Intercompany transactions and balances have been eliminated inconsolidation.

**NOTE 2—RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS**

**Independent Investigation**

On July 3,2006, the Company announced that, at the recommendation of the Audit Committee,the Board of Directors had created a special committee of independent directors(“Special Committee”) to conduct a review of our historical stock optionpractices. As a result of its investigation, the Special Committee found, amongother things, that some of the original measurement dates used by the Companyfor option grants were not adequately supported by contemporaneous records, andtherefore the measurement dates used by us for accounting purposes requiredadjustment. The Special Committee concluded that the evidence did not establishthat the errors which it identified resulted from fraud or intentionalmisconduct by our current senior management.

Based on theSpecial Committee’s findings and its own review of the facts, the Board ofDirectors concluded that there was no fraud or intentional misconduct by anycurrent member of senior management. The Board also concluded that it hasconfidence in the integrity of the Company’s Chief Executive Officer, Dr. LevyGerzberg, and the Company’s Chief Financial Officer, Mr. Karl Schneider.

Based oninformation obtained from the Special Committee’s review and additional workundertaken by the Company, management has concluded, and the Audit Committeehas agreed, that the Company should restate certain previously filed financialstatements, to reflect additional stock-based compensation expense with regardto certain past stock option grants. The corrections made in the restatementsrelate to options covering approximately 3.6 million shares. Theseadjustments amounted to an additional stock-based compensation expense of $0.4 millionand $2.6 million in 2006 and 2005, respectively, and a reduction ofexpense of $1.5 million in 2004. There was no tax impact of theseadditional stock-based compensation expenses due to the full valuationallowance on our tax assets.

68

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

In connectionwith the restatement, the Company is recording additional non-cash adjustmentsthat were previously considered to be immaterial relating to the timing ofrevenue recognition, accrued expenses, amortization of premiums and discountson investments, additional expense related to options granted to a consultantand the calculation of amortization of stock-based compensation relating to abusiness combination in 2003. The Company is also recording losses underAccounting Principles Board Opinion 18 (“APB No. 18”), “The Equity Method of Accountingfor Investments in Common Stock,” to record the losses on investment of the prior17% ownership of Oren Semiconductor, Inc. under the equity method ofaccounting which was subsequently acquired by Zoran in 2005. These additionaladjustments resulted in a cumulative expense of $1.3 million, including$0.2 million of tax expense, for the periods 2000 through 2005.

Through 2005,we applied Accounting Principles Board (“APB”) Opinion No. 25, “Accountingfor Stock Issued to Employees,” and its related interpretations, and providedthe required pro forma disclosures under Statement of Financial AccountingStandards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” andSFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.”Under APB No. 25, non-cash, stock-based compensation expense wasrecognized for any option for which the exercise price was below the marketprice on the actual grant date. Because each of the options identified below(other than those which we have determined should be accounted for variably)was deemed to have an exercise price below the market price on the appropriatemeasurement date, we should have recognized a charge for each of those optionsunder APB No. 25, in an amount equal to the number of shares covered bysuch options, multiplied by the difference between the exercise price and themarket price on the appropriate measurement date. That expense should have beenamortized over the vesting periods of the options. Starting in 2006, we adoptedSFAS No. 123(R), “Share-Based Payment.” As a result, for 2006, theadditional stock-based compensation expense required to be recorded for each ofthe options identified below was equal to the incremental fair value of thoseoptions on the appropriate measurement date over the remaining vesting periodsof those options. We did not record such stock-based compensation expensesunder APB No. 25 or SFAS No. 123(R) in our previously issuedfinancial statements, and that is the reason for the restatement in thisreport. To correct our past accounting for stock options, we recordedadditional pre-tax, non-cash, stock-based compensation expense of(a) $11.7 million for the periods 1997 to 2005 under APB No. 25and (b) the remaining $0.4 million for 2006 under SFAS No. 123(R).The fair value of the options is being recorded using the acceleratedamortization method under FIN 28 over the respective vesting periods of theawards.

Consistent with the accounting literature and recent guidance fromthe Securities and Exchange Commission (“SEC”), the Company has organized thegrants with respect to which an accounting adjustment is required intocategories based on grant type and process by which the grant was finalized. Basedon the relevant facts and circumstances, the Company applied the relevant accountingstandards to determine the measurement date for every grant within eachcategory. The Company recorded accounting adjustments as required, resulting instock-based compensation expense and related tax effects. The Company organizedthe grants where adjustments were required as follows:

·       *Company-wide option grants where optionees were added or grant amountswere changed after the option list was complete, or where insufficientcontemporaneous documentation of the grant date exists.*   For seven Company-wide refresh andretention grants made between 1998 and 2003, the Company determined that someemployees who were omitted from the option grant list were added to the listafter the stated grant date, and that the number of shares covered by optiongrants to some employees was not finally determined until after the statedgrant date. Further, in 2001 and 2002, 

69

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

insufficientcontemporaneous documentation of the stated grant date existed. As a result ofthese issues, the Company restated its historical financial statements toincrease stock-based compensation expense by approximately $6.3 million,recognized over the vesting periods of the relevant options.

·       *Re-priced options.  *In August 2002, after considerationof relevant information, the Compensation Committee rescinded its April 2002grant, and its June 2002 grant, to executives and other key employees. TheCompany thereafter reissued the grants in August 2002. At the time, inconsultation with our external advisors, we determined that these transactions didnot require variable accounting. As a result of the Special Committee review ofour historical stock option practices, we have reassessed the circumstancessurrounding these transactions with our external advisors and have determinedthat the grants should have been accounted for variably. As a result, theCompany restated its historical financial statements to increase stock-basedcompensation expense by a cumulative net amount of approximately $3.8 million,recognized over the vesting periods of these options.

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

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

In theaggregate, we have recorded additional stock-based compensation expense for theperiods 1997 through 2005 of approximately $11.7 million on stock optiongrants made from 1997 through 2003.

70

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

The incremental impact from recognizing stock-based compensationexpense resulting from the investigation of past stock option grants is asfollows (dollars in thousands):

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

 

The cumulativeeffect of all of the restatements through December 31, 2003 increasedadditional paid-in capital by $10.7 million from $703.8 million to$714.5 million, increased accumulated deficit by $9.0 million from$156.4 million to $165.4 million, and decreased total stockholders’equity by $0.7 million from $534.3 million to $533.6 million.All the restatements of financial statements, financial data and relateddisclosures described in this report are collectively referred to in thisreport as the “restatements.”

In December 2006,the Company amended options to purchase approximately 218,000 shares ofcommon stock held by Dr. Gerzberg and Mr. Schneider to increase theexercise price of those options to the fair market value of the Company’scommon stock on the revised measurement date so that these options are nolonger subject to a penalty tax under IRC Section 409A.

We have notamended, and we do not intend to amend, any of our previously filed AnnualReports on Form 10-K. We have amended our Quarterly Report for theperiod ended March 31, 2006 concurrent with the filing of our AnnualReport on Form 10-K, and we do not intend to amend any of our other previouslyfiled Quarterly Reports on Form 10-Q for the periods affected by therestatements. We present restated quarterly financial information for each ofthe quarters in 2006 and 2005 in “Selected Quarterly Financial Information(Unaudited)” included in this report.

The impact ofthe restatements on the interim periods of each of the first three quarters of2006 and each of the quarters of 2005 are disclosed in “Selected QuarterlyFinancial Information (Unaudited)” included in this report.

71

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

*Restatement and Impact on Financial Statements*

The income statement impacts of therestatements are as follows (in thousands):

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

 

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

 

In addition,the Company evaluated the impact of the restatements on its global taxprovision. The Company and its subsidiaries file tax returns in multiple taxjurisdictions around the world. In certain jurisdictions, including, but notlimited to, the United States and Israel, the Company is able to claim a taxdeduction relative to stock options. In those jurisdictions, where a taxdeduction is claimed, the Company has recorded deferred tax assets relative tothe book compensation now recorded on the restated options. As with our otherdeferred tax assets, the Company recorded a full valuation allowance on alldeferred tax assets relating to restated options. The Company also believesthat it should not have taken a United States tax deduction of$0.6 million in prior years for stock option related amounts pertaining tocertain executives under Internal Revenue Code (IRC) Section 162(m) whichlimits the deductibility of compensation above certain thresholds. The deferredtax asset and related valuation allowance have been adjusted accordingly. Thecumulative tax effect of all components of the restatements for 1997 to 2005 isan increase in tax expense of $200,000.

On February 27,2007, the Company elected to: (i) participate in the Internal RevenueService remediation program 2007-18 and pay to the IRS, on behalf ofaffected and eligible employees (not including executive officers), their IRC409A tax liabilities and penalties; (ii) participate in any similarremediation program that may be offered by any state for applicable state taxliabilities and penalties; (iii) act directly with any state not offering asimilar remediation program to address any applicable tax liabilities andpenalties on behalf of employees; and (iv) pay to such employees a “gross-up”payment to offset the associated federal and state income tax consequences. TheCompany took this action because the vast majority of the holders of stockoptions issued by the Company that are now subject to re-measurement as aresult of the 

72

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

Company’soption investigation were not involved in or aware of the stock option pricingdetermination. Employees who exercised such options in 2006, other thanexecutive officers at the time of option grant or entering into this program,will participate in this program. The Company estimates that the total cashpayments needed to deal with the adverse tax consequences of previouslyexercised discount priced options granted to non-officers will be approximately$0.8 million, which is expected to be recorded in 2007.

In addition,the Company may consider taking action to minimize the adverse tax consequencesthat may be incurred by the holders of unexercised discount options.Discount-priced stock options vesting after December 31, 2004 (“409AAffected Options”) subject U.S. option holders to a penalty tax under IRC Section 409A(and to similar penalty taxes under California and other state tax laws, asapplicable). The Company may consider offering to amend the 409A AffectedOptions held by persons other than directors and executive officers to increasethe exercise prices of those options to the market price of our common stock onthe revised measurement date. The amended options would not be subject totaxation under IRC Section 409A. Under IRS regulations, the amendments fornon-executives cannot be offered until after this Report is filed and do notneed to be completed until December 31, 2007. The Company may alsoconsider approving the payment of bonuses to holders of those amended optionsto compensate them for the resulting increase in their option exercise price.The amount of these bonuses would be effectively repaid to the Company if andwhen the options are exercised and the increased exercise price is paid (butthere is no assurance that the options will be exercised). The Company has notestimated the expense of any such bonus payments.

Therestatement adjustments did not affect the Company’s previously reported cashand cash equivalents and investments balances in prior periods. The following presentsthe effect of the restatement adjustments by financial statement line item forthe Consolidated Balance Sheet as of December 31, 2005, Statements ofOperations for the years ended December 31, 2005 and 2004 and theStatements of Cash Flows for the years ended December 31, 2005 and 2004and the SFAS No. 123 pro forma disclosures.

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**ZORAN CORPORATION**

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

| ** **                                                                                                                                                                                                                                                               | ** ** | **December 31,  2005** | ** ** | **Adjustments(1)** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|--------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                               | ** ** | **(As reported)**      | ** ** | ** **         | ** ** | **(As restated)**      | ** ** |
| ASSETS                                                                                                                                                                                                                                                                   |       |                        |       |               |       |                        |       |   |   |   |   |   |   |
| Current assets:                                                                                                                                                                                                                                                          |       |                        |       |               |       |                        |       |   |   |   |   |   |   |
| Cash and cash equivalents                                                                                                                                                                                                                                                |       |                        | $          | 78,856             |       |                        |       | $ | — |   |   |   | $ | 78,856 |   |   |
| Short-term investments                                                                                                                                                                                                                                                   |       |                        | 70,490     |               |       |                        | —     |   |   |   | 70,490 |   |   |
| Accounts receivable, net of allowance for doubtful  accounts of $6,180 and $1,409, respectively                                                                                                                                                                          |       |                        | 70,174     |               |       |                        | —     |   |   |   | 70,174 |   |   |
| Inventory                                                                                                                                                                                                                                                                |       |                        | 32,616     |               |       |                        | —     |   |   |   | 32,616 |   |   |
| Prepaid expenses and other current assets                                                                                                                                                                                                                                |       |                        | 11,746     |               |       |                        | —     |   |   |   | 11,746 |   |   |
| Total current assets                                                                                                                                                                                                                                                     |       |                        | 263,882    |               |       |                        | —     |   |   |   | 263,882 |   |   |
| Property and equipment, net                                                                                                                                                                                                                                              |       |                        | 16,057     |               |       |                        | —     |   |   |   | 16,057 |   |   |
| Other assets and investments                                                                                                                                                                                                                                             |       |                        | 20,799     |               |       |                        | —     |   |   |   | 20,799 |   |   |
| Goodwill                                                                                                                                                                                                                                                                 |       |                        | 184,254    |               |       |                        | (1,592     | ) |   |   | 182,662 |   |   |
| Intangible assets, net                                                                                                                                                                                                                                                   |       |                        | 119,231    |               |       |                        | —     |   |   |   | 119,231 |   |   |
|                                                                                                                                                                                                                                                                     |       |                        | $          | 604,223            |       |                        |       | $ | (1,592 | ) |   |   | $ | 602,631 |   |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                               |       |                        |       |               |       |                        |       |   |   |   |   |   |   |
| Current  liabilities:                                                                                                                                                                                                                                                    |       |                        |       |               |       |                        |       |   |   |   |   |   |   |
| Accounts payable                                                                                                                                                                                                                                                         |       |                        | $          | 38,999             |       |                        |       | $ | — |   |   |   | $ | 38,999 |   |   |
| Accrued expenses and other liabilities                                                                                                                                                                                                                                   |       |                        | 53,937     |               |       |                        | 832        |   |   |   | 54,769 |   |   |
| Total current liabilities                                                                                                                                                                                                                                                |       |                        | 92,936     |               |       |                        | 832        |   |   |   | 93,768 |   |   |
| Other long-term liabilities                                                                                                                                                                                                                                              |       |                        | 11,939     |               |       |                        | —     |   |   |   | 11,939 |   |   |
| Stockholders’ equity:                                                                                                                                                                                                                                               |       |                        |       |               |       |                        |       |   |   |   |   |   |   |
| Common stock, $0.001 par  value; 105,000,000 shares authorized at December 31, 2005 and  December 31, 2004; 45,426,912 shares issued and outstanding as of  December 31, 2005; and 43,195,432 shares issued and outstanding as of  December 31, 2004 |       |                        | 45         |               |       |                        | —     |   |   |   | 45 |   |   |
| Additional paid-in capital                                                                                                                                                                                                                                               |       |                        | 727,597    |               |       |                        | 10,656     |   |   |   | 738,253 |   |   |
| Deferred stock-based compensation                                                                                                                                                                                                                                        |       |                        | (593       | )                  |       |                        | —     |   |   |   | (593 | ) |   |
| Accumulated other comprehensive income                                                                                                                                                                                                                                   |       |                        | 3,094      |               |       |                        | (37        | ) |   |   | 3,057 |   |   |
| Accumulated deficit                                                                                                                                                                                                                                                      |       |                        | (230,795   | )                  |       |                        | (13,043    | ) |   |   | (243,838 | ) |   |
| Total stockholders’ equity                                                                                                                                                                                                                                          |       |                        | 499,348    |               |       |                        | (2,424     | ) |   |   | 496,924 |   |   |
|                                                                                                                                                                                                                                                                     |       |                        | $          | 604,223            |       |                        |       | $ | (1,592 | ) |   |   | $ | 602,631 |   |   |

----

(1)          The restated consolidated balance sheetfor the fiscal year ended 2005 reflects a $13.0 million increase toaccumulated deficit and a $10.7 million increase to additional paid-incapital primarily due to additional stock-based compensation recorded inconnection with this restatement to correct prior year stock option-relatedaccounting errors as described above and to reflect the cumulative impact of otheradjustments that were previously considered to be immaterial. The $1.6 milliondecrease to goodwill is the impact of recording losses associated with ourinvestment in Oren Semiconductor under the equity method of accounting and $0.8 millionincrease to accrued expenses and other liabilities relates to the accrual ofroyalty obligations that was previously not recorded at December 31, 2005.

74

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**ZORAN CORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data)**

| ** **                                                                     | ** ** | **Year Ended December 31, 2005** | ** ** | **Year Ended December 31, 2004** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                     | ** ** | **As   previously   reported**             | ** ** | **Adjust-  ments  (1)**                              | ** ** | **As   restated** | ** ** | **As   previously   reported** | ** ** | **Adjust-  ments(1)** | ** ** | **As   restated** | ** ** |
| Revenues:                                                                      |       |                                                 |       |                                                 |       |   |   |   |   |   |   |   |   |
| Hardware product revenues                                                      |       | $                                                    | 339,539    |                                                 | $          | — |   | $ | 339,539 |   | $ | 315,697 |   | $ | — |   | $ | 315,697 |   |
| Software and other revenues                                                    |       | 56,219                                               |       | —                                               |       | 56,219 |   | 63,167 |   | — |   | 63,167 |   |
| Total revenues                                                                 |       | 395,758                                              |       | —                                               |       | 395,758 |   | 378,864 |   | — |   | 378,864 |   |
| Costs and  expenses:                                                           |       |                                                 |       |                                                 |       |   |   |   |   |   |   |   |   |
| Cost of hardware product revenues*                                             |       | 185,549                                              |       | 623                                                  |       | 186,172 |   | 226,235 |   | 226 |   | 226,461 |   |
| Research and development*                                                      |       | 89,028                                               |       | 781                                                  |       | 89,809 |   | 82,245 |   | (425 | ) | 81,820 |   |
| Selling, general and administrative*                                           |       | 93,831                                               |       | 1,375                                                |       | 95,206 |   | 67,086 |   | (891 | ) | 66,195 |   |
| Amortization of intangible assets                                              |       | 50,254                                               |       | —                                               |       | 50,254 |   | 45,358 |   | — |   | 45,358 |   |
| Amortization of stock-based compensation  resulting from business combinations |       | 1,546                                                |       | —                                               |       | 1,546 |   | 4,051 |   | — |   | 4,051 |   |
| Restructuring expense                                                          |       | —                                               |       | —                                               |       | — |   | 746 |   | — |   | 746 |   |
| In-process research and development                                            |       | 2,650                                                |       | —                                               |       | 2,650 |   | — |   | — |   | — |   |
| Total costs  and expenses                                                      |       | 422,858                                              |       | 2,779                                                |       | 425,637 |   | 425,721 |   | (1,090 | ) | 424,631 |   |
| Operating  loss                                                                |       | (27,100                                              | )          | (2,779                                               | )          | (29,879 | ) | (46,857 | ) | 1,090 |   | (45,767 | ) |
| Interest  income                                                               |       | 2,705                                                |       | (112                                                 | )          | 2,593 |   | 1,307 |   | (1,044 | ) | 263 |   |
| Other income  (loss), net                                                      |       | (412                                                 | )          | (218                                                 | )          | (630 | ) | (264 | ) | (800 | ) | (1,064 | ) |
| Loss before  income taxes                                                      |       | (24,807                                              | )          | (3,109                                               | )          | (27,916 | ) | (45,814 | ) | (754 | ) | (46,568 | ) |
| Provision for  income taxes                                                    |       | 2,164                                                |       | 192                                                  |       | 2,356 |   | 1,540 |   | — |   | 1,540 |   |
| Net loss                                                                       |       | $                                                    | (26,971    | )                                                    | $          | (3,301 | ) | $ | (30,272 | ) | $ | (47,354 | ) | $ | (754 | ) | $ | (48,108 | ) |
| Basic net  loss per share                                                      |       | $                                                    | (0.61      | )                                                    | $          | (0.07 | ) | $ | (0.68 | ) | $ | (1.11 | ) | $ | (0.01 | ) | $ | (1.12 | ) |
| Diluted net  loss per share                                                    |       | $                                                    | (0.61      | )                                                    | $          | (0.07 | ) | $ | (0.68 | ) | $ | (1.11 | ) | $ | (0.01 | ) | $ | (1.12 | ) |
| Shares used  to compute basic net loss per share                               |       | 44,267                                               |       |                                                 |       | 44,267 |   | 42,788 |   |   |   | 42,788 |   |
| Shares used to compute diluted loss per share                                  |       | 44,267                                               |       |                                                 |       | 44,267 |   | 42,788 |   |   |   | 42,788 |   |

----

*                     includes thefollowing amounts related to employee equity awards

| Cost of  hardware product revenues  |   | $ | — |   | $ | 57    |   | $ | 57    |   | $ | — |   | $ | (32  | ) | $ | (32  | ) |
|-------------------------------------|--------|---|--------|--------|---|-------|--------|---|-------|--------|---|--------|--------|---|------|---|---|------|---|
| Research and  development           |   | $ | — |   | $ | 815   |   | $ | 815   |   | $ | — |   | $ | (459 | ) | $ | (459 | ) |
| Selling, general and administrative |   | $ | 286    |   | $ | 1,751 |   | $ | 2,037 |   | $ | — |   | $ | (985 | ) | $ | (985 | ) |

 

(1)           In addition torestating the consolidated financial statements in response to the SpecialCommittee’s findings, the Company has recorded additional non-cash adjustmentsthat were considered to be immaterial to our previously filed consolidatedfinancial statements relating to the timing of revenue recognition, accruedexpenses, amortization of premiums and discounts on investments, additionalexpense related to options granted to a consultant and the amortization of stock-basedcompensation relating to a business combination in 2003. In addition, theCompany is also recording losses under Accounting Principles Board Opinion 18 (“APBNo. 18”), “The Equity Method of Accounting for Investments in CommonStock,” to record the losses on investment of the prior 17% ownership of OrenSemiconductor, Inc. under the equity method of accounting which was subsequentlyacquired by Zoran in 2005.

75

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**ZORAN CORPORATION**

**CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands)**

| ** **                                                                        | ** ** | **Year Ended December 31, 2005** | ** ** | **Year Ended December 31, 2004** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                        | ** ** | **As  previously   reported**                   | ** ** | **Adjust-  ments**                                   | ** ** | **As  restated** | ** ** | **As  previously  reported** | ** ** | **Adjust-  ments** | ** ** | **As  restated** | ** ** |
| Cash flows from operating  activities:                                            | ** ** |                                                 | ** ** | ** **                                           |       |   | ** ** |   |   |   |   |   |   | ** ** |   |   | ** ** |   |   |   |   |
| Net loss                                                                          |       |                                                 | $          | (26,971                                              | )          |   |   | $ | (3,301 | ) |   | $ | (30,272 | ) |   | $ | (47,354 | ) |   |   | $ | (754 | ) |   | $ | (48,108 | ) |
| Adjustments  to reconcile net loss to net cash provided by (used in) operations:  | ** ** |                                                 | ** ** |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Depreciation                                                                      |       |                                                 | 10,329     |                                                 |       |   | — |   |   | 10,329 |   |   | 9,896 |   |   |   | — |   |   | 9,896 |   |
| Amortization                                                                      |       |                                                 | 50,254     |                                                 |       |   | 112 |   |   | 50,366 |   |   | 45,358 |   |   |   | 1,044 |   |   | 46,402 |   |
| Stock based compensation expense                                                  |       |                                                 | 1,832      |                                                 |       |   | 2,623 |   |   | 4,455 |   |   | 4,051 |   |   |   | (1,476 | ) |   | 2,575 |   |
| In-process research and development                                               |       |                                                 | 2,650      |                                                 |       |   | — |   |   | 2,650 |   |   | — |   |   |   | — |   |   |   |   |
| Allowance for doubtful accounts                                                   |       |                                                 | 4,771      |                                                 |       |   | — |   |   | 4,771 |   |   | 175 |   |   |   | — |   |   | 175 |   |
| Write-down of inventory.                                                          |       |                                                 | —     |                                                 |       |   | — |   |   | — |   |   | 14,680 |   |   |   | — |   |   | 14,680 |   |
| Changes  in assets and liabilities, net of effect of acquisitions:                | ** ** |                                                 | ** ** |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Accounts receivable                                                               |       |                                                 | (14,706    | )                                                    |       |   | — |   |   | (14,706 | ) |   | 5,188 |   |   |   | — |   |   | 5,188 |   |
| Inventory                                                                         |       |                                                 | 17,630     |                                                 |       |   | — |   |   | 17,630 |   |   | (47,022 | ) |   |   | — |   |   | (47,022 | ) |
| Prepaid expenses and other current assets and other  assets                       |       |                                                 | 1,784      |                                                 |       |   | (1,320 | ) |   | 464 |   |   | (7,978 | ) |   |   | 930 |   |   | (7,048 | ) |
| Accounts payable                                                                  |       |                                                 | 4,437      |                                                 |       |   | — |   |   | 4,437 |   |   | 4,595 |   |   |   | — |   |   | 4,595 |   |
| Accrued expenses and other liabilities, goodwill and  other long term liabilities |       |                                                 | (857       | )                                                    |       |   | 1,886 |   |   | 1,029 |   |   | 2,135 |   |   |   | 256 |   |   | 2,391 |   |
| Net cash provided  by (used in) operating activities                              |       |                                                 | 51,153     |                                                 |       |   | — |   |   | 51,153 |   |   | (16,276 | ) |   |   | — |   |   | (16,276 | ) |
| Cash  flows from investing activities:                                            | ** ** |                                                 | ** ** |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Purchases of property and equipment                                               |       |                                                 | (8,492     | )                                                    |       |   | — |   |   | (8,492 | ) |   | (7,165 | ) |   |   | — |   |   | (7,165 | ) |
| Proceeds from sale of property and equipment                                      |       |                                                 | —     |                                                 |       |   | — |   |   | — |   |   | 978 |   |   |   | — |   |   | 978 |   |
| Purchases of investments                                                          |       |                                                 | (43,576    | )                                                    |       |   | — |   |   | (43,576 | ) |   | (117,209 | ) |   |   | — |   |   | (117,209 | ) |
| Proceeds from sales and maturities of investments                                 |       |                                                 | 60,415     |                                                 |       |   | — |   |   | 60,415 |   |   | 175,252 |   |   |   | — |   |   | 175,252 |   |
| Acquisition of Emblaze, net of cash acquired                                      |       |                                                 | —     |                                                 |       |   | — |   |   | — |   |   | (54,161 | ) |   |   | — |   |   | (54,161 | ) |
| Acquisition of Oren Semiconductor, Inc., net of cash  acquired                    |       |                                                 | (27,567    | )                                                    |       |   | — |   |   | (27,567 | ) |   | — |   |   |   | — |   |   | — |   |
| Net cash used in investing activities                                             |       |                                                 | (19,220    | )                                                    |       |   | — |   |   | (19,220 | ) |   | (2,305 | ) |   |   | — |   |   | (2,305 | ) |
| Cash flows from financing  activities:                                            | ** ** |                                                 | ** ** |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Proceeds from issuance of common stock                                            |       |                                                 | 9,488      |                                                 |       |   | — |   |   | 9,488 |   |   | 8,022 |   |   |   | — |   |   | 8,022 |   |
| Net cash provided by financing activities                                         |       |                                                 | 9,488      |                                                 |       |   | — |   |   | 9,488 |   |   | 8,022 |   |   |   | — |   |   | 8,022 |   |
| Net increase (decrease) in cash and cash equivalents                              |       |                                                 | 41,421     |                                                 |       |   | — |   |   | 41,421 |   |   | (10,559 | ) |   |   | — |   |   | (10,559 | ) |
| Cash and cash equivalents at beginning of period                                  |       |                                                 | 37,435     |                                                 |       |   | — |   |   | 37,435 |   |   | 47,994 |   |   |   | — |   |   | 47,994 |   |
| Cash and cash equivalents at end of period                                        |       |                                                 | $          | 78,856                                               |       |   |   | $ | — |   |   | $ | 78,856 |   |   | $ | 37,435 |   |   |   | $ | — |   |   | $ | 37,435 |   |
| **Supplemental  information:**                                                    | ** ** |                                                 | ** ** |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Fair value of  stock issued in Oren acquisition, net of issuance costs of $89     |       |                                                 | $          | 12,816                                               |       |   |   | $ | — |   |   | $ | 12,816 |   |   | $ | — |   |   |   | $ | — |   |   | $ | — |   |

 

76

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

**SFASNO. 123 PRO FORMA DISCLOSURE(in thousands)**

| ** **                                                                        | ** ** | **Year Ended December 31, 2005** | ** ** | **Year Ended December 31, 2004** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                        | ** ** | **As  previously  reported**                         | ** ** | **Adjustments**                                      | ** ** | **As  restated** | ** ** | **As  previously  reported** | ** ** | **Adjustments** | ** ** | **As  restated** | ** ** |
| Net loss                                                                          |       | $                                                    | (26,971    | )                                                    |       | $ | (3,301 | ) |   | $ | (30,272 | ) | $ | (47,354 | ) |   | $ | (754 | ) |   | $ | (48,108 | ) |
| Adjustments:                                                                      | ** ** |                                                 |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Stock-based employee compensation  expense (benefit) included in net loss         |       | 1,832                                                |       |                                                 | 2,623      |   |   | 4,455 |   | 4,051 |   |   | (1,476 | ) |   | 2,575 |   |
| Stock-based employee compensation  expense determined under the fair value method |       | (26,831                                              | )          |                                                 | (1,431     | ) |   | (28,262 | ) | (39,693 | ) |   | (3,119 | ) |   | (42,812 | ) |
| Pro forma net loss                                                                |       | $                                                    | (51,970    | )                                                    |       | $ | (2,109 | ) |   | $ | (54,079 | ) | $ | (82,996 | ) |   | $ | (5,349 | ) |   | $ | (88,345 | ) |
| Pro forma  net loss per share:                                                    | ** ** |                                                 |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                             |       | $                                                    | (1.18      | )                                                    |       | $ | (0.05 | ) |   | $ | (1.22 | ) | $ | (1.94 | ) |   | $ | (0.13 | ) |   | $ | (2.07 | ) |
| Diluted                                                                           |       | $                                                    | (1.18      | )                                                    |       | $ | (0.05 | ) |   | $ | (1.22 | ) | $ | (1.94 | ) |   | $ | (0.13 | ) |   | $ | (2.07 | ) |
| Net loss per  share:                                                              |       |                                                 |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                             |       | $                                                    | (0.61      | )                                                    |       | $ | (0.07 | ) |   | $ | (0.68 | ) | $ | (1.11 | ) |   | $ | (0.01 | ) |   | $ | (1.12 | ) |
| Diluted                                                                           |       | $                                                    | (0.61      | )                                                    |       | $ | (0.07 | ) |   | $ | (0.68 | ) | $ | (1.11 | ) |   | $ | (0.01 | ) |   | $ | (1.12 | ) |

 

**NOTE 3—SIGNIFICANT ACCOUNTING POLICIES**

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

*Use of estimates*

Thepreparation of these financial statements in conformity with generally acceptedaccounting principles in the Unites States of America requires management tomake estimates and assumptions that affect the amounts reported in thefinancial statements and accompanying notes. 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 not experienced material losses or gains as aresult of currency exchange rate fluctuations and has not engaged in hedgingtransactions to reduce its exposure to such fluctuations. The Company may takeaction in the future to reduce its foreign exchange risk. Monetary assets andliabilities of the Company’s foreign subsidiaries are remeasured into U.S.dollars from the local currency at rates in effect at period-end andnon-monetary assets and liabilities are remeasured at historical rates. Revenuesand expenses are remeasured at average rates during the period. In accordancewith Statement of Financial Accounting Standards No. 52, gains and lossesarising from the remeasurement of local currency financial statements areincluded in other income (loss), net and have not been significant for any ofthe periods presented.

77

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

*Revenuerecognition*

TheCompany’s policy is to recognize revenue from product sales upon shipment,provided that persuasive evidence of an arrangement exists, the price is fixedand determinable, collectibility is reasonably assured and legal title and riskof ownership has transferred. A provision for estimated future returns andpotential warranty liability is recorded at the time revenue is recognized. Warrantyexpenses in 2006, 2005 and 2004, were immaterial. Development revenue underdevelopment contracts is recognized as the services are performed based on thespecific deliverables outlined in each contract. Amounts received in advance ofperformance under contracts are recorded as deferred revenue and are recognizedwhen our obligations have been met. Costs associated with development revenuesare included primarily in research and development 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 and maintenance fees which provide customersaccess to technical support and minor enhancements to licensed releases arerecognized ratably over the service or maintenance period. Royalty revenue isrecognized in the period licensed sales are reported to the Company whichtypically ranges between one month to one quarter in arrears. Revenue fromlitigation settlement is recognized in accordance with the terms of theagreement when actual cash payments are received.

*Research anddevelopment costs*

Researchand development expenses are charged to operations as incurred.

*Cashequivalents and investments*

Allhighly liquid investments purchased with an original maturity of 90 daysor less are considered to be cash equivalents.

Allof the Company’s investments in marketable securities are classified asavailable-for-sale and, therefore, are reported at fair value with unrealizedgains and losses, net of related tax, if any, included as accumulated othercomprehensive income (loss), a component of stockholders’ equity. Gains andlosses realized upon sales of all such securities are reported in interestincome. See Note 3.

Whenthe fair value of an investment declines below its amortized cost, the Companyconsiders all available evidence to evaluate whether an other-than-temporarydecline in value has occurred. Among other things, the Company considers theduration and extent to which the market value has declined relative to our costbasis, the economic factors influencing the markets, the relative performanceof the investee and its near-term prospects.

AtDecember 31, 2006 and 2005, the Company’s marketable securities includedcorporate debt, US government securities, auction rate securities, foreignbonds, municipal bonds and marketable equity securities. See Note 4.

A significantportion of the Company’s portfolio is comprised of auction rate securities withstated maturity dates that may be one year or more beyond the balance sheetdates. Based on historical experience in the financial markets, the Companybelieves there is a reasonable expectation of completing a successful auctionwithin a 12-month period.

Other assetsand investments also include investments in non-marketable securities which areaccounted for on the cost basis and amounted to $4.2 million and $5.2million at December 31, 2006 and 2005, respectively. The Company recordsan investment impairment charge when the fair value of an investment 

78

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

declines belowits cost basis. In making this determination the Company considers allavailable evidence including the historical and projected financial performanceand recent funding events which are ascertained from an investee. The Companyrecorded an investment impairment charge of $0.9 million in 2006. There were nosuch charges in 2005.

*Concentration of credit risk of financial instruments*

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 cash in banks and cash equivalents consistprimarily of certificates of deposit and commercial paper. The Company, bypolicy, limits the amount of its credit exposure through diversification andrestricting its investments to highly rated securities. Individual securitiesare limited to comprising no more than 10% of the portfolio value at the timeof purchase. Highly rated securities are defined as having a minimum Moody orStandard & Poor’s rating of A2 or A respectively. The average maturityof the portfolio shall not exceed 24 months. The Company has not experiencedany significant losses on its cash equivalents or short-term investments.

The Companymarkets integrated circuits and technology to manufacturers and distributors ofelectronic equipment primarily in North America, Europe and the Pacific Rim. TheCompany performs ongoing credit evaluations of its customers’ financial conditionand limits the amount of credit extended when deemed necessary, but generallydoes not require collateral. Management believes that any risk of loss issignificantly reduced due to the diversity of its customers and geographicsales areas. As of December 31, 2006 four customers accounted forapproximately 13%, 12%, 10% and 10% of the net accounts receivable balance,respectively. As of December 31, 2005 one customer accounted forapproximately 14% of the net accounts receivable balance.

*Inventory*

Inventoriesare stated at the lower of standard cost (which approximates actual cost on afirst-in, first-out basis) or market. Market is based on estimated netrealizable value. The Company writes down inventories to net realizable valuebased on forecasted demand and market conditions. Inventory write-downs are notreversed and permanently reduce the cost basis of the affected inventory untilsuch inventory is sold or scrapped.

*Property and equipment*

Property andequipment are recorded at cost. Depreciation is computed using thestraight-line method over the estimated useful lives of three 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*

In accordancewith Financial Accounting Standards Board (“FASB”) Statement No. 142 “Goodwilland Other Intangible Assets” (“SFAS No. 142”) goodwill is not amortized. TheCompany monitors the recoverability of goodwill recorded in connection withacquisitions, by reporting unit, annually, or sooner if events or changes incircumstances indicate that the carrying amount may not be recoverable. Foreach of the years ended December 31, 2006, 2005 and 2004, the Companyperformed the annual analysis and concluded that goodwill was not impaired, asthe fair value of each reporting unit exceeded its carrying value, includinggoodwill.

79

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

*Other Intangibles*

Otherintangible assets were recorded in connection with the acquisitions of OakTechnology, Inc., Emblaze Semiconductor, Ltd and Oren Semiconductor, Inc.and are amortized on a straight-line basis over the estimated periods ofbenefit, which range between three and five years.

*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. The Company evaluates these assets by comparingexpected undiscounted cash flows to the carrying 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 not recorded any impairment chargesagainst 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 carryingamounts for cash and cash equivalents, short-term investments, accountsreceivable, accounts payable and accrued liabilities approximate theirrespective fair values because of the short-term maturity of these items.

*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.

The Company’seffective income tax rate has benefited from the availability of previouslyunbenefitted net operating losses which the Company has utilized for U.S. federalincome tax purposes and by our Israel based subsidiary’s status as an “ApprovedEnterprise” under Israeli law, which provides a ten-year tax holiday for incomeattributable to a portion of our operations in Israel. Our U.S. federal netoperating losses expire at various times between 2017 and 2024, and thebenefits from our subsidiary’s Approved Enterprise status expire at varioustimes beginning in 2008.

Realization ofdeferred tax assets is based on our ability to generate sufficient futuretaxable income. The valuation allowance was determined in accordance with theprovisions of SFAS No. 109 which requires an assessment of both positiveand negative evidence when determining whether it is more likely than not thatdeferred tax assets are recoverable; such assessment is required on ajurisdiction by jurisdiction basis. Historical operating losses and continuingbusiness uncertainty represent sufficient negative evidence which it wasdifficult for positive evidence to overcome under SFAS No. 109 andaccordingly, a full valuation allowance was recorded. If the facts or estimatesof future financial results were to change, increasing the likelihood ofrealizing the deferred tax assets, judgment would have to be applied todetermine the amount of valuation allowance required in any given period. Weintend to maintain a full valuation allowance until sufficient positiveevidence exists to support reversal of the valuation allowance.

*Earnings per share*

In accordancewith Statement of Financial Accounting Standards No. 128, Zoran reportsEarnings per Share (“EPS”), both basic and diluted, on the consolidated statementof operations. Basic EPS is based 

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

upon theweighted average number of common shares outstanding. Diluted EPS is computedusing the weighted average common shares outstanding plus any potential commonstock, except when their effect is anti-dilutive. Potential common stockincludes common stock issuable upon the exercise of stock options andrestricted stock units. See Note 13.

*Stock-based compensation*

Effective January 1,2006, Zoran adopted SFAS No. 123(R), using the modified prospective applicationtransition method, which establishes accounting for stock-based awardsexchanged for employee services. Accordingly, stock-based compensation cost ismeasured at grant date, based on the fair value of the award, over therequisite service period. The Company previously applied Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”), and related interpretations andprovided the pro forma disclosures required by SFAS No. 123, “Accountingfor Stock-Based Compensation” (“SFAS No. 123”).

***Periods Priorto the Adoption of SFAS 123(R) ***

Prior to theadoption of SFAS No. 123(R), the Company provided the disclosures required underSFAS No. 123, asamended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transitionand Disclosures.”

Had compensation cost for the Company’s option and stock purchaseplans been determined based on the fair value at the grant dates, as prescribedin SFAS No. 123, the Company’s net loss and net loss per share foreach of the year ended December 31, 2005 and 2004, would have been asfollows (in thousands, except per share data):

| ** **                                                               | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                               | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| ** **                                                               | ** ** | **(restated)**                             | ** ** | **(restated)** | ** ** |
| Net loss as restated                                                     |       | $                                          | (30,272    | ) | $ | (48,108 | ) |
| Adjustments:                                                             |       |                                       |       |   |   |
| Stock-based compensation expense  included in net loss                   |       | 4,455                                      |       | 2,575 |   |
| Stock-based compensation expense  determined under the fair value method |       | (28,262                                    | )          | (42,812 | ) |
| Pro forma net loss as restated                                           |       | $                                          | (54,079    | ) | $ | (88,345 | ) |
| Pro forma  net loss per share as restated:                               |       |                                       |       |   |   |
| Basic                                                                    |       | $                                          | (1.22      | ) | $ | (2.07 | ) |
| Diluted                                                                  |       | $                                          | (1.22      | ) | $ | (2.07 | ) |
| Net loss per  share as restated:                                         |       |                                       |       |   |   |
| Basic                                                                    |       | $                                          | (0.68      | ) | $ | (1.12 | ) |
| Diluted                                                                  |       | $                                          | (0.68      | ) | $ | (1.12 | ) |

 

For purposesof this pro forma disclosure, the value of the options was estimated using theaccelerated amortization method under FIN 28 over the respective vestingperiods of the awards. Due to the valuation allowance provided on our deferredtax assets, the Company has not recorded any tax benefits attributable to proforma stock-based compensation.

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

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

***Impact of Adoption of SFAS No. 123(R) ***

Duringthe year ended December 31 2006, the Company recorded stock-basedcompensation expense for awards granted prior to but not yet vested as of January 1,2006 as if the fair value method required for pro forma disclosure under SFAS No. 123 were in effect for expenserecognition purposes adjusted for estimated forfeitures. For these awards, theCompany has continued to recognize compensation expense using the acceleratedamortization method. For stock-based awards granted after January 1, 2006,the Company recognized compensation expense based on the grant date fair valuerequired under SFAS No. 123(R). For these awards, the Company recognizedcompensation expense using a straight-line amortization method. As SFAS No. 123(R) requires that stock-basedcompensation expense be based on awards that are ultimately expected to vest,estimated stock-based compensation for the year ended December 31, 2006has been reduced for estimated forfeitures. The adoption of SFAS No. 123(R) resulted in a one-timebenefit of $314,000 related to unvested awards for which compensation expensehad already been recorded.

The following table summarizes stock-based compensationexpense related to employee stock options, employee stock purchases andrestricted stock unit grants for the year ended December 31, 2006 asrecorded in accordance with SFAS No. 123(R) (including the effect of the restatements) (inthousands):

| ** **                          | ** ** | **Year Ended  December 31, 2006** | ** ** |
|-------------------------------------|------------|--------------------------------------------------|------------|
| Cost of hardware product revenues.  |       |                                             | $          | 526 |   |   |
| Research and development            |       |                                             | 5,509      |   |   |
| Selling, general and administrative |       |                                             | 11,259     |   |   |
| Total costs and expenses            |       |                                             | $          | 17,294 |   |   |

 

Theeffect of recording additional stock-based compensation expense on basic anddiluted net income per share was $0.36 and $0.35 per share respectively for theyear ended December 31, 2006.

*Segmentreporting*

SFASNo. 131 establishes standards for the reporting by public businessenterprises of information about operating segments, products and services,geographic areas, and major customers. The method for determining whatinformation to report is based on the manner in which management organizes theoperating segments within the Company for making operational decisions andassessments of financial performance. The Company’s chief operatingdecision-maker is considered to be the Chief Executive Officer.

TheCompany’s products are based on highly integrated application-specificintegrated circuits, or ASICs, and system-on-a-chip, or SOC, solutions. TheCompany also licenses certain software and other intellectual property. Duringthe first quarter of 2006, the Company reorganized its operating structure to bringtogether its consumer electronic product lines under a single operating group,in recognition of the accelerating convergence of consumer products and theCompany’s strategy of sharing technology among its various product lines. Thenew Consumer group combines the former Digital Versatile Disc (DVD), DigitalTelevision (DTV) and Mobile product groups whose operations were previouslyreported separately. The Company will continue to report the operations of itsImaging group as a separate operating segment.

TheConsumer group provides products for use in DVD players, recordable DVDplayers, standard and high definition digital television products, digitalcamera products and multimedia mobile phone products. 

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

TheImaging group provides products used in digital copiers, laser and inkjetprinters as well as multifunction peripherals.

*Comprehensive Income (loss)*

Comprehensive Income (loss) is defined as the change inequity of a business enterprise during a period from transactions and otherevents and circumstances from non-owner sources. Comprehensive loss includesunrealized gains and losses on available-for-sale securities.

Thefollowing are the components of comprehensive income (loss) (in thousands):

| ** **                                            | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                            | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                            | ** ** | ** **                                 | ** ** | **(restated)** | ** ** | **(restated)** | ** ** |
| Net  income (loss)                                    |       | $                                          | 16,328     |   | $ | (30,272 | ) | $ | (48,108 | ) |
| Change  in unrealized gain (loss) on investments, net |       | 1,181                                      |       | 1,668 |   | 2,673 |   |
| Total comprehensive income (loss)                     |       | $                                          | 17,509     |   | $ | (28,604 | ) | $ | (45,435 | ) |

 

The components of accumulated other comprehensive income(loss) as of December 31, 2006, 2005 and 2004 consisted of the unrealizedgain (loss) on marketable securities, net of related taxes.

*Recentaccounting pronouncements*

In February 2007, the Financial Accounting StandardsBoard (“FASB”) issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” Thisstatement expands the standards under SFAS No. 157, “Fair Value Measurement,” to provide entities the one-timeelection (Fair Value Option or FVO) to measure financial instruments andcertain other items at fair value. Most of the provisions of this statementapply only to entities that elect the fair value option. The provisions of SFASNo. 159 are effective for the Company for fiscal years beginning January 1,2008. The Company is evaluating the impact of the provisions of this statementon its consolidated financial position, results of operations and cash flows.

In September 2006,the SEC staff issued Staff Accounting Bulletin (“SAB”) No. 108, “Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements.” SAB No. 108 was issued in orderto eliminate the diversity of practice surrounding how public companiesquantify financial statement misstatements. SAB No. 108 requiresregistrants to quantify the impact of correcting all misstatements using boththe “rollover” method, which focuses primarily on the impact of a misstatementon the income statement and is the method currently used by the Company, andthe “iron curtain” method, which focuses primarily on the effect of correctingthe period-end balance sheet. The use of both of these methods is referred toas the “dual approach” and should be combined with the evaluation ofqualitative elements surrounding the errors in accordance with SAB No. 99,“Materiality.” The provisions of SAB No. 108 are effective for theCompany for the fiscal year ended December 31, 2006. The adoption ofSAB No. 108 did not have a material impact on the Company’s consolidatedfinancial position, results of operations or cash flows.

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements” (“SFAS No. 157”), which defines fair value,establishes a framework for measuring fair value in accordance with generallyaccepted accounting principles, and expands disclosures about fair valuemeasurements. The provisions of SFAS No. 157 are effective for the Companyfor fiscal years beginning after December 31, 2007. The Company isevaluating the impact of the provisions of this statement on its consolidatedfinancial position, results of operations and cash flows.

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

InSeptember 2006, the FASB issued SFAS No. 158, “Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans.”SFAS No. 158 requires employers to fully recognize the obligationsassociated with single-employer defined benefit pension, retiree healthcare andother post-retirement plans in their financial statements. The provisions ofSFAS No. 158 are effective for the Company as of the end of thefiscal year ending December 31, 2006. The adoption of SFAS No. 158did not have a material effect on the Company’s consolidated financialposition, results of operations or cash flows.

InJune 2006, the FASB published FIN 48, “Accounting for Uncertainty inIncome Taxes—an interpretation of FASB Statement No. 109” which clarifiesthe accounting for uncertainty in income taxes recognized in an enterprise’sfinancial statements in accordance with SFAS No. 109, Accounting for IncomeTaxes. This Interpretation prescribes a recognition threshold and measurementattribute for the financial statement recognition and measurement of a taxposition taken or expected to be taken in a tax return. This Interpretationalso provides guidance on derecognition, classification, interest andpenalties, accounting in interim periods, disclosure, and transition. ThisInterpretation is effective for the Company in fiscal years beginning January 1,2007. The impact of the provisions of this Interpretation on the Company’sretained earnings is expected to be less than $5 million.

InFebruary 2006, the FASB issued SFAS No. 155, “Accounting for CertainHybrid Financial Instruments,” an amendment of SFAS No. 133, “Accountingfor Derivative Instruments and Hedging Activities,” and SFAS No. 140, “Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities.” This Statement permits fair value remeasurement for any hybridfinancial instrument that contains an embedded derivative that otherwise wouldrequire bifurcation. This Statement is effective for the Company for allfinancial instruments acquired or issued after July 1, 2007. The adoptionof SFAS No. 155 is not expected to have a material effect on the Company’sconsolidated financial position, results of operations or cash flows.

InJune 2005, the FASB issued SFAS No. 154, “Accounting Changes andError Corrections,” a replacement of APB No. 20, “Accounting Changes,” andSFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements.”SFAS No. 154 changes the requirements for the accounting for and reportingof a change in accounting principle. Previously, most voluntary changes inaccounting principles required recognition via a cumulative effect adjustmentwithin net income of the period of the change. SFAS No. 154 requiresretrospective application to prior periods’ financial statements, unless it isimpracticable to determine either the period-specific effects or the cumulativeeffect of the change. SFAS No. 154 is effective for the Company foraccounting changes made in fiscal years beginning January 1, 2006;however, the Statement does not change the transition provisions of anyexisting accounting pronouncements. The adoption of SFAS No. 154 did nothave a material effect on the Company’s consolidated financial position,results of operations or cash flows.

In March 2005,the FASB published FIN 47, “Accounting for Conditional Asset RetirementObligations,” which clarifies that the term, conditional asset retirementobligation, as used in SFAS No. 143, “Accounting for Asset RetirementObligations,” refers to a legal obligation to perform an asset retirement activityin which the timing and (or) method of settlement are conditional on a futureevent that may or may not be within the control of the entity. The uncertaintyabout the timing and (or) method of settlement of a conditional assetretirement obligation should be factored into the measurement of the liabilitywhen sufficient information exists. The Interpretation also clarifies when anentity would have sufficient information to reasonably estimate the fair valueof an asset retirement obligation. The adoption of this Interpretation did nothave a material effect on the Company’s consolidated financial position,results of operations or cash flows.

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

**NOTE**           4—MARKETABLE SECURITIES

The Company’s portfolio of marketable securities at December 31,2006 was as follows (in thousands):

| ** **                        | ** ** | **Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|-----------------------------------|------------|----------|------------|-----------------------|------------|------------------------|------------|----------------------------|------------|
| Corporate debt                    |       | $        | 97,175     |                  |       | $                      | 10         |                       |       |   | $ | (245 | ) |   | $ | 96,940 |   |
| U.S. government securities        |       | 42,822   |       |                  | 7          |                   |       |                       | (141       | ) |   | 42,688 |   |
| Auction rate securities           |       | 37,550   |       |                  | —     |                   |       |                       | —     |   |   | 37,550 |   |
| Foreign bonds                     |       | 11,427   |       |                  | 1          |                   |       |                       | (12        | ) |   | 11,416 |   |
| Municipal bonds                   |       | 1,500    |       |                  | —     |                   |       |                       | (1         | ) |   | 1,499 |   |
| Total fixed income securities     |       | 190,474  |       |                  | 18         |                   |       |                       | (399       | ) |   | 190,093 |   |
| Publicly traded equity securities |       | 1,483    |       |                  | 4,619      |                   |       |                       | —     |   |   | 6,102 |   |
| Total                             |       | $        | 191,957    |                  |       | $                      | 4,637      |                       |       |   | $ | (399 | ) |   | $ | 196,195 |   |

 

The Company’s portfolio of marketable securities at December 31,2005 was as follows (in thousands):

| ** **                        | ** ** | **Cost** | ** ** | **Unrealized  Gains** | ** ** | **Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|-----------------------------------|------------|----------|------------|-----------------------|------------|------------------------|------------|----------------------------|------------|
| Corporate debt                    |       | $        | 26,211     |                  |       | $                      | —     |                       |       |   | $ | (151 | ) |   |   | $ | 26,060 |   |   |
| U.S. government securities        |       | 20,000   |       |                  | —     |                   |       |                       | (151       | ) |   |   | 19,849 |   |   |
| Auction rate securities           |       | 15,125   |       |                  | —     |                   |       |                       | —     |   |   |   | 15,125 |   |   |
| Foreign bonds                     |       | 4,474    |       |                  | —     |                   |       |                       | (6         | ) |   |   | 4,468 |   |   |
| Total fixed income securities     |       | 65,810   |       |                  | —     |                   |       |                       | (308       | ) |   |   | 65,502 |   |   |
| Publicly traded equity securities |       | 1,623    |       |                  | 3,365      |                   |       |                       | —     |   |   |   | 4,988 |   |   |
| Total                             |       | $        | 67,433     |                  |       | $                      | 3,365      |                       |       |   | $ | (308 | ) |   |   | $ | 70,490 |   |   |

 

The following table summarizes the contractual maturities of theCompany’s fixed income securities at December 31, 2006 (in thousands):

| ** **                    | ** ** | **Cost** | ** ** | **Estimated  Fair  Value** | ** ** |
|-------------------------------|------------|----------|------------|----------------------------|------------|
| Less than 1 year              |       | $        | 90,417     |                       | $90,310    |   |
| Due in 1 to 2 years           |       | 46,389   |       | 46,178                     |       |
| Due in 2 to 5 years           |       | 16,118   |       | 16,055                     |       |
| Greater than 5 years*    |       | 37,550   |       | 37,550                     |       |
| Total fixed income securities |       | $        | 190,474    |                       | $          | 190,093 |   |
|                               |            |          |            |                            |            |  |  |

----

*                    Comprised of auction rate securitieswhich have reset dates of 90 days or less but final expiration dates over 5 years.

Gross realizedgains on sales of marketable securities were $2,398,000; $143,000 and $94,000in 2006, 2005 and 2004, respectively. There were no gross realized losses onsales of marketable securities in 2006. Gross realized losses on sales ofmarketable securities were $287,000 and $104,000 in 2005 and 2004,respectively.

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

Interestincome on cash and marketable securities was $11,057,000, $2,593,000 and$263,000 for the years ended December 31, 2006, 2005 and 2004,respectively.

**NOTE 5—BALANCESHEET COMPONENTS (in thousands)**

| ** **                            | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|-----------------------|------------|
| **Accounts receivable:**         | ** ** | ** **            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Trade                                 |       | $                     | 51,905     |   | $ | 76,354 |   |
| Less: allowance for doubtful accounts |       | (9,265                | )          | (6,180 | ) |
|                                  |       | $                     | 42,640     |   | $ | 70,174 |   |
|                                       |            |                       |            |  |  |  |  |  |  |

 

| ** **                          | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|-----------------------|------------|
| **Inventory:**                      | ** ** | ** **            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Purchased parts and work in process |       | $                     | 18,748     |   | $ | 14,904 |   |
| Finished goods                      |       | 26,296                |       | 17,712 |   |
|                                |       | $                     | 45,044     |   | $ | 32,616 |   |
|                                     |            |                       |            |  |  |  |  |  |  |

 

| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| **Property and equipment:**           | ** ** | ** **            | ** ** | **2006** | ** ** | **2005** | ** ** |
| Computer equipment                              |       | $                     | 13,992     |   | $ | 15,749 |   |
| Office equipment and furniture                  |       | 4,079                 |       | 2,512 |   |
| Machinery and equipment                         |       | 12,910                |       | 5,762 |   |
| Software                                        |       | 29,397                |       | 24,196 |   |
| Building and leasehold improvements             |       | 6,157                 |       | 4,465 |   |
|                                            |       | 66,535                |       | 52,684 |   |
| Less: accumulated depreciation and amortization |       | (50,862               | )          | (36,627 | ) |
|                                            |       | $                     | 15,673     |   | $ | 16,057 |   |
|                                                 |            |                       |            |  |  |  |  |  |  |

 

| ** **                                                      | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------|------------|
| **Accrued expenses and other liabilities:** | ** ** | ** **            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                      | ** ** | ** **            | ** ** | **(restated)** | ** ** |
| Accrued payroll and related expenses                            |       | $                     | 19,873     |   | $ | 18,981 |   |
| Accrued royalties                                               |       | 3,134                 |       | 6,179 |   |
| Taxes payable                                                   |       | 7,579                 |       | 12,188 |   |
| Deferred revenue                                                |       | 4,360                 |       | 5,590 |   |
| Other accrued liabilities                                       |       | 11,136                |       | 11,831 |   |
|                                                            |       | $                     | 46,082     |   | $ | 54,769 |   |
|                                                                 |            |                       |            |  |  |  |  |  |  |

 

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

In accordance with SFAS No. 142, goodwill is not amortized.The Company monitors the recoverability of goodwill recorded in connection withacquisitions, by reporting unit, annually, or sooner if events or changes incircumstances indicate that the carrying amount may not be recoverable. For each of the years ended December 31,2006, 2005 and 2004, the Company performed the annual analysis and concludedthat goodwill was not impaired, as the fair value of each reporting unitexceeded its carrying value, including goodwill.

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

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

| ** **                    | ** ** | ** **        | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|-------------------------------|------------|-------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                    | ** ** | **Life  (Years)** | ** ** | **Gross  Carrying  Amount**     | ** ** | **Accumulated  Amortization**   | ** ** | **Net  Balance** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Balance** | ** ** |
| Amortized  intangible assets: |       |              |       |                            |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Purchased technology          |       |              | 2-3        |                            |       | $                               | 195,505    |   |   | $ | (142,658 | ) |   | $ | 52,847 |   | $ | 195,505 |   |   | $ | (105,088 | ) |   | $ | 90,417 |   |
| Patents                       |       |              | 3-5        |                            |       | 40,265                          |       |   | (29,500 | ) |   | 10,765 |   | 40,265 |   |   | (19,978 | ) |   | 20,287 |   |
| Customer base                 |       |              | 3-5        |                            |       | 13,860                          |       |   | (9,583 | ) |   | 4,277 |   | 13,860 |   |   | (7,123 | ) |   | 6,737 |   |
| Tradename and others          |       |              | 3-5        |                            |       | 3,350                           |       |   | (2,070 | ) |   | 1,280 |   | 3,350 |   |   | (1,560 | ) |   | 1,790 |   |
| Total                         |       |              |       |                            |       | $                               | 252,980    |   |   | $ | (183,811 | ) |   | $ | 69,169 |   | $ | 252,980 |   |   | $ | (133,749 | ) |   | $ | 119,231 |   |

 

Estimated future intangible amortization expense, based on currentbalances, as of December 31, 2006 is as follows (in thousands):

| **Year ending December 31,** | ** ** | ** ** | ** ** | **Amount** | ** ** |
|---------------------------------------------|------------|------------|------------|------------|------------|
| 2007                                        |       | $          | 43,224     |       |
| 2008                                        |       | 23,315     |       |
| 2009                                        |       | 1,820      |       |
| 2010                                        |       | 810        |       |
| Total                                       |       | $          | 69,169     |       |

 

Changes in the carrying amount of goodwill for the year ended December 31,2006 are as follows (including the effect of the restatements related toacquisition of Oren Semiconductor, Inc.) in thousands:

| ** **                                           | ** ** | **Amount** | ** ** |
|------------------------------------------------------|------------|------------|------------|
| Balance at December 31, 2004                    |       | $          | 150,151    |   |
| Acquisition of Oren Semiconductor, Inc.         |       | 33,897     |       |
| Adjustment to goodwill related to acquisition of Oak |       | (1,386     | )          |
| Balance at December 31, 2005                    |       | 182,662    |       |
| Adjustment to goodwill related to acquisition of Oak |       | (8,403     | )          |
| Balance at December 31, 2006.                   |       | $          | 174,259    |   |

 

The adjustmentto goodwill in 2006 and 2005 is related to the realization of certainpre-acquisition tax net operating losses. Realization of these net operatinglosses is reported as an adjustment to goodwill in accordance with FAS No. 109.

Goodwill by operating segment at December 31, 2006 and 2005were as follows (in thousands):

| ** ** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|------------|------------|-----------------------|------------|-----------------------|------------|
| ** ** | ** ** | **2006**              | ** ** | **2005**              | ** ** |
| ** ** | ** ** | ** **            | ** ** | **(restated)**        | ** ** |
| Consumer   |       |                  | $          | 169,060               |       |   |   | $ | 176,623 |   |   |
| Imaging    |       |                  | 5,199      |                  |       |   | 6,039 |   |   |
|       |       |                  | $          | 174,259               |       |   |   | $ | 182,662 |   |   |

 

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

**NOTE 7—RESEARCH AND DEVELOPMENT ARRANGEMENTS**

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 andDevelopment Foundation (“BIRDF”), which fund up to 50% of incurred projectcosts for approved products up to specified contract maximums. The Company isnot obligated to repay funding regardless of the outcome of its developmentefforts; however, these agreements require the Company to use its best effortsto achieve specified results and require the Company to pay royalties at ratesof 3% to 5% of resulting products sales, and up to 30% of resulting licenserevenues, up to a maximum of 100% to 150% of the total funding received. Reportedresearch and development expenses incurred in Israel are net of these grants,which fluctuate from period to period.

Research and development expenses that qualify for the grants and therelated grants are as follows (in thousands):

| ** **                        | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------|------------|--------------------------------------------|------------|
| ** **                        | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                        | ** ** | ** **                                 | ** ** | **(restated)** | ** ** |
| Research and development expenses |       | $                                          | 60,147     |   | $ | 48,377 |   | $ | 38,461 |   |
| Less: grants earned               |       | —                                     |       | — |   | (1,460 | ) |
|                              |       | $                                          | 60,147     |   | $ | 48,377 |   | $ | 37,001 |   |

 

There were nogrant receipts or royalty expense in 2006 and 2005. Royalty expenses related tothese grants were $654,000 in 2004.

**NOTE 8—DEVELOPMENT CONTRACTS**

The Companyhas generated a portion of its total revenues from development contracts,primarily with key customers. The Company classifies costs related to thesedevelopment contracts as research and development 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 ownershipof the intellectual property developed under the contracts; however, somecontracts limit the product markets in which the Company may directly sell thedeveloped product. Revenues generated under these contracts were $2.7 millionin 2006; $3.2 million in 2005 and $1.6 million in 2004. In addition,from time to time, we enter into non-refundable joint development projects inwhich our customers reimburse us for a portion of our development costs. Weclassify such reimbursement of development costs as an offset to research anddevelopment expenses as we retain ownership of the intellectual propertydeveloped by us under these development arrangements. During 2006 and 2005, wereceived approximately $370,000 and $1.2 million in such reimbursements. Wedid not receive any reimbursements in 2004.

**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 contingentliabilities when it is probable that future expenditures will be made and suchexpenditures can be reasonably estimated.

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

*Lease and license commitments*

The Company rents facilities under various lease agreementsexpiring through 2016. Rent expense for 2006, 2005 and 2004 totaledapproximately $5.4 million; $5.6 million and $4.4 million,respectively. The Company also entered into a time based license agreement forthe right to use certain intellectual property. Future minimum lease andlicense payments required under non-cancelable agreements at December 31,2006 are as follows: (in thousands)

| **Year ending December 31,** | ** ** | ** ** | ** ** | **Amount** | ** ** |
|---------------------------------------------|------------|------------|------------|------------|------------|
| 2007                                        |       | $          | 10,188     |       |
| 2008                                        |       | 3,819      |       |
| 2009                                        |       | 3,345      |       |
| 2010                                        |       | 3,211      |       |
| 2011                                        |       | 3,108      |       |
| Thereafter                                  |       | 15,895     |       |
| Total                                       |       | $          | 39,566     |       |

 

*Legal proceedings*

*U.S.Attorney and SEC Investigations:** *On July 3, 2006, Zoran disclosed in a press releasethat it received a grand jury subpoena from the office of the U.S. attorney forthe Northern District of California requesting documents from 1995 through thepresent referring to, relating to or involving stock options, and also receivedan informal inquiry from the SEC requesting documents related to Zoran’s stockoption grants. Zoran intends to cooperate fully in all governmentinvestigations. These inquiries likely will require the Company to expendsignificant management time and incur significant legal and other expenses, andcould result in civil and criminal actions seeking, among other things,injunctions against the Company and its officers and directors and the paymentof significant fines and penalties by the Company and its officers anddirectors, which may adversely affect its results of operations and cash flow. TheCompany cannot predict how long it will take to or how much more time andresources it will have to expend to resolve these government inquiries, nor canit predict the outcome of these inquiries. Also, there can be no assurance thatother inquiries, investigations or actions will not be started by other UnitedStates federal or state regulatory agencies or by foreign governmentalagencies.

*LateSEC Filings and Nasdaq Delisting Proceedings* Due to the Special Committeeinvestigation and the resulting restatements, the Company did not file on timeits Quarterly Report on Form 10-Q for the quarters ended June 30,2006 and September 30, 2006, or its Annual Report on Form 10-K forthe year ended December 31, 2006. As a result, the Company received NasdaqStaff Determination letters, dated August 14, 2006, November 15, 2006and March 20, 2007 stating that the Company was not in compliance with thefiling requirements of Marketplace Rule 4310(c)(14) and, therefore, thatthe Company’s stock was subject to delisting from the Nasdaq Global SelectMarket. A hearing before a Nasdaq Listing Qualifications Panel was held on September 27,2006 and a decision to grant the Company’s request for continued listing onNasdaq subject to certain conditions occurred on December 28, 2006. TheCompany has appealed this decision, and the Nasdaq Listing Council hasdetermined to stay the December 28, 2006 Panel decision, and any futurePanel determinations to suspend Zoran’s securities from trading, pendingfurther action from the Listing Council. On March 2, 2007, the Companyprovided the Listing Council with an additional submission for itsconsideration regarding continued listing. The Listing Council will review thematter on the basis of the written record.

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

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

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

*NCEA-IBEWPension Fund (The Decatur Plan) v. Galil, et al.** *On June 12, 2006, a purported shareholderderivative action was filed by the Decatur Plan against Zoran as a nominaldefendant and certain of its officers and directors in the United StatesDistrict Court, Northern District of California, alleging, inter alia,violations of federal and state securities laws and breaches of fiduciary duty.On December 4, 2006, Decatur Plan filed a notice of voluntary dismissal.

*Pfeiffer v.Zoran Corporation et al.** *On September 7, 2006, a purported shareholder derivativeaction was filed by Milton Pfeiffer against Zoran as a nominal defendant andcertain of its officers and directors in the United States District Court,Northern District of California, alleging, inter alia, violations of federalsecurities laws and breaches of fiduciary duties.

*Gerald delRosario v. Aharon et al.** *On September 26, 2006, a purported shareholder derivativeaction was filed by Gerald del Rosario against Zoran as a nominal defendant andcertain of its current and former officers and directors in the United StatesDistrict Court, Northern District of California, alleging, inter alia,violations of federal securities laws and breaches of fiduciary duty. On December8, 2006, the Court issued an order consolidating the *Del Rosario*action with the *Pfeiffer* action. The Courtselected del Rosario as lead plaintiff and approved lead plaintiff’s selectionof counsel for the consolidated derivative action. Plaintiffs filed aconsolidated amended complaint on March 14, 2007.

*Barone v.Gerzberg et al.; Durco v. Gerzberg et al.** *On October 23, 2006, two purportedshareholder derivative actions were filed by Moshe Barone and John Durcoagainst Zoran as a nominal defendant and certain of its current and formerofficers and directors in the California Superior Court of Santa Clara County,alleging, inter alia, violations of state securities laws and breaches offiduciary duty. On January 24, 2007 the Court consolidated the *Barone*and *Durco*actions,appointed Messrs. Barone and Durco as co-lead plaintiffs and approvedtheir selection of counsel for the consolidated derivative action. Co-LeadPlaintiffs filed a consolidated amended complaint on March 26, 2007.

*On February 20, 2007, the Company filed a complaint againstArcSoft Inc. in the California Superior Court for the County of Alameda,seeking payment of $4 million in principal, together with accrued interest thenin the amount of approximately $525,000, under four separate convertiblepromissory notes.  On February 28, 2007,the Company filed an application with the Court seeking to attach assets ofArcSoft as security for the payment of its obligations under the notes.  The notes represent amounts loaned by theCompany to ArcSoft in 2004 in connection with a transaction involving thetransfer to ArcSoft of rights related to a software product then underdevelopment and related agreements regarding the continued development andcommercialization of the product.  OnMarch 28, 2007, ArcSoft filed an answer denying liability under the notes andasserting various affirmative defenses. ArcSoft also filed a cross complaint alleging fraud in the inducement ofthe business arrangement, fraudulent and negligent misrepresentation, breach ofcontract and of the implied covenant of good faith and fair dealing, and unjustenrichment and*

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

*seeking monetary damages of more than $6.9 million.  The hearing on our application for anattachment is currently scheduled for May 14, 2007.*

*IndemnificationObligations.* Subject to certainlimitations, the Company is obligated to indemnify its current and formerdirectors, officers and employees in connection with the investigation of theCompany’s historical stock option practices and related government inquiriesand litigation. These obligations arise under the terms of the Company’scertificate of incorporation, its bylaws, applicable contracts, and Delawareand California law. The obligation to indemnify generally means that theCompany is required to pay or reimburse the individuals’ reasonable legalexpenses and possibly damages and other liabilities incurred in connection withthese matters. The Company is currently paying or reimbursing legal expensesbeing incurred in connection with these matters by a number of its current andformer directors, officers and employees. Although the maximum potential amountof future payments the Company could be required to make under these agreementsis theoretically unlimited, the Company believes the fair value of thisliability is adequately covered within the reserves it has established forcurrently pending legal proceedings.

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

**NOTE 10**—RESTRUCTURING

During the year ended December 31, 2004, theCompany recorded restructuring charges of $746,000 due to the discontinuationof the Sensor product line of the Consumer operating segment. These chargesincluded $523,000 related to the reduction in force of 15 employees forseverance and other termination expenses, $173,000 for lease losses onabandoned office space and other miscellaneous legal and consulting fees of approximately$50,000. The remaining balance at December 31, 2006 of approximately$52,000 related to facilities will be paid over the lease term throughJune 2007.

**NOTE 11—STOCKHOLDERS’ EQUITY**

*1993 Stock Option Plan*

The Company’s 1993 Stock Option Plan (the “1993 OptionPlan”) was adopted 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 ofcommon stock were reserved for issuance under the 1993 Option Plan. The 1993Option Plan provided for grants of options to employees, non-employee directorsand consultants. The 1993 Stock Option Plan expired during 2003 and no futureshares will be granted under this plan. The option price for shares grantedunder the 1993 Option Plan was typically equal to the fair market value of thecommon stock at the date of grant.

Generally, options granted under the 1993 Option Planare fully exercisable on and after the date of grant, subject to the Company’sright to repurchase from an optionee, at the optionee’s original per shareexercise price, any unvested shares which the optionee has purchased and holdsin the event of the termination of the optionee’s employment, with or withoutcause. The Company’s right lapses as shares subject to the option becomevested. 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 of grant and an option shall generallyterminate three months after termination of employment.

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

*2000 NonstatutoryStock Option Plan*

The Company’s 2000 Nonstatutory Stock Option Plan (the“2000 Option Plan”) was adopted by the Board of Directors of the Company in October 2000.A total of 450,000 shares of preferred stock were initially reserved for issuanceunder the 2000 Option Plan. The options to purchase preferred stockautomatically converted to options to purchase common stock upon the amendmentof the Company’s certificate of incorporation to affect an increase in thenumber of authorized shares of common stock to 55,000,000 in October 2000.A total of 13,325,000 shares of common stock were reserved for issuance underthe 2000 Option Plan. The 2000 Option Plan provided for grants of options toemployees or consultants. The 2000 Option Plan was modified in 2001 to allowfor exercisability of stock options ahead of vesting subject to the Company’sright to repurchase the associated stock at the option exercise price throughthe original vesting schedule. The option price for shares granted under the2000 Option Plan was typically equal to the fair market value of the commonstock at the date of grant. Options expire ten years from the date of grant andan option generally terminates three months after termination of employment. The2000 Stock Option Plan was terminated in 2005 and was replaced by the 2005Equity Incentive Plan.

*1995 OutsideDirectors Stock Option Plan*

The Company’s Outside Directors Stock Option Plan (the“1995 Directors Plan”) was adopted by the Company’s Board of Directors in October 1995,and was approved by its stockholders in December 1995. A total of 525,000shares of Common Stock were reserved for issuance under the 1995 Directors Plan.The 1995 Directors Plan provided for the grant of nonstatutory stock options tononemployee directors of the Company. The 1995 Directors Plan provided thateach new nonemployee director would automatically be granted an option topurchase 30,000 shares on the date the optionee first became a nonemployeedirector (the “Initial Grant”). Thereafter, on the date immediately followingeach annual stockholders’ meeting, each nonemployee director who was reelectedat the meeting to an additional term was granted an additional option topurchase 15,000 shares of Common Stock if, on such date, he or she had servedon the Company’s Board of Directors for at least six months (the “Annual Grant”).Initial Grants were exercisable in four equal annual installments, and eachAnnual Grant became exercisable in full one year after the date of grant,subject to the director’s continuous service. The exercise price of all stockoptions granted under the 1995 Directors Plan was equal to the fair marketvalue of the Company’s Common Stock on the date of grant. Options granted underthe 1995 Directors Plan have a term of ten years. This plan was terminated in July 2005and was replaced by the 2005 OutsideDirectors Equity Plan.

*2005 EquityIncentive Plan*

The 2005 Equity Incentive Plan (the “2005 Plan”) wasadopted by the Board of Directors in May 2005 and replaced the 1993 StockOption Plan, which expired in 2003, and the 2000 Nonstatutory Stock OptionPlan, which was terminated by the Board of Directors upon stockholder approvalof the 2005 Plan in July 2005. A total of 4,556,663 shares of the Company’scommon stock is authorized for issuance pursuant to awards granted under the2005 Plan. Such awards may include stock options, stock appreciation rights,restricted stock, restricted stock units, performance shares, performanceunits, deferred stock units and other stock-based or cash-based awards. The2005 Plan is generally administered by the Compensation Committee of the Boardof Directors and has a term of 10 years. Participation in the 2005 Plan islimited to employees and consultants of Zoran and its subsidiaries and otheraffiliates.

Options and stock appreciation rights granted underthe 2005 Plan must have exercise prices per share not less than the fair marketvalue of Zoran common stock on the date of grant and may not be repriced 

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

without stockholder approval. Such awards will vestand become exercisable upon conditions established by the CompensationCommittee and may not have a term exceeding 10 years.

Except with respect to 5% of the number of sharesauthorized under the 2005 Plan, awards of restricted stock, restricted stockunits, performance shares, performance units and other full value awardsgranted under the 2005 Plan generally must have service-based vesting schedulesof at least three years or a performance period of at least 12 months. However,restricted stock or restricted stock units issued pursuant to astockholder-approved option exchange program which vest based on service musthave a vesting schedule of at least two years. Performance share andperformance unit awards vest to the extent that pre-established performancegoals based on one or more measures of business and financial performanceauthorized by the 2005 Plan are attained during a performance periodestablished by the Compensation Committee. The grant or vesting of other typesof awards under the 2005 Plan may similarly be based on the attainment of oneor more such performance goals. The 2005 Plan provides that the number ofshares remaining available for issuance will be reduced by 1.3 shares for eachone share of Zoran common stock subject to a full value award granted under the2005 Plan.

At December 31, 2006, 3,555,449 shares of theCompany’s common stock were available for the grant of the options and otherawards under the 2005 Plan, subject to the provisions described above thatreduce the number of shares available for full value awards.

*2005 OutsideDirectors Equity Plan*

The 2005 Outside Directors Equity Plan (the “2005Directors Plan”) was adopted by the Board of Directors in May 2005 andreplaced the 1995 Outside Directors Stock Option Plan, which was terminated bythe Board of Directors upon stockholder approval of the Directors Plan in July 2005.A total of 600,000 shares of the Company’s common stock is authorized forissuance pursuant to awards granted under the 2005 Directors Plan. Such awardsmay include stock options, stock appreciation rights, restricted stock unitsand deferred stock units. The 2005 Directors Plan is generally administered bythe Board of Directors and has a term of 10 years. Participation in theDirectors Plan is limited to non-employee members of the Zoran Board ofDirectors (“outside directors”). The 2005 Directors Plan provides that thenumber of shares remaining available for issuance will be reduced by 1.3 sharesfor each one share of Zoran common stock subject to a full value award grantedunder the 2005 Directors Plan.

Awards under the 2005 Directors Plan are granted bythe Board of Directors to all outside directors on a periodic,nondiscriminatory basis within limits prescribed by the 2005 Directors Plan. Subjectto appropriate adjustment for any change in the Company’s capital structure,awards granted to any outside director in any fiscal year may not exceed 20,000shares, increased by one or more of the following: 40,000 shares upon anoutside director’s initial election, 10,000 shares for service as Chairman ofthe Board or Lead Director, 5,000 shares for service on a Board committee aschairman and 2,500 shares for service on a Board committee other than aschairman. Stock options, stock appreciation rights, restricted stock units anddeferred stock units granted under the Directors Plan are generally subject toterms substantially similar to those applicable to the same type of awardgranted under the 2005 Plan.

At December 31, 2006, 405,000 shares of theCompany’s common stock were available for the grant of the options and otherawards under the 2005 Directors Plan, subject to the provisions described abovethat reduce the number of shares available for full value awards.

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

The following tablesummarizes the Company’s stock option activity for the years ended December 31,2006, 2005 and 2004. The weighted average exercise price for each categorypresented is also shown in the table below:

| ** **                        | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|-----------------------------------|------------|--------------------------|------------|----------------------------------------|------------|
| 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 |   |   |
| Granted                           |       | 2,296,315                |       |                                   | $          | 11.63 |   |   |
| Exercised                         |       | (555,106                 | )          |                                   | $          | 9.26 |   |   |
| Canceled                          |       | (1,631,381               | )          |                                   | $          | 17.95 |   |   |
| Balances,  December 31, 2005 |       | 12,955,585               |       |                                   | $          | 16.32 |   |   |
| Granted                           |       | 363,065                  |       |                                   | $          | 21.13 |   |   |
| Exercised                         |       | (3,683,846               | )          |                                   | $          | 13.53 |   |   |
| Canceled*                         |       | (1,538,460               | )          |                                   | $          | 23.09 |   |   |
| Balances,  December 31, 2006 |       | 8,096,344                |       |                                   | $          | 16.52 |   |   |

----

*                    Includes1,060,536 underwater options exchanged for restricted shares and restrictedstock units. See “Restricted Sharesand Restricted Stock Units” below.

Significant option groups outstanding as of December 31,2006 and the related weighted average exercise price and contractual lifeinformation, are as follows:

| ** **               | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                                     | ** ** |
|--------------------------|------------|------------------------------|------------|------------------------------------------------------------------|------------|
| **Exercise Prices** | ** ** | ** **                   | ** ** | **Shares  Underlying  Options at  December 31,  2006** | ** ** | **Weighted  Average  Remaining  Contractual  Life  (Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Aggregate  intrinsic  value  (‘000)** | ** ** | **Shares  Underlying  Options at  December 31,  2006** | ** ** | **Weighted  Average  Remaining  Contractual  Life  (Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Aggregate  intrinsic  value  (‘000)** | ** ** |
| $0.00 to $9.99           |       |                         | 577,841    |                                                             |       |   | 5.11 |   |   |   | $ | 6.27 |   |   |   | $ | 4,800 |   |   |   | 539,359 |   |   |   | 4.95 |   |   |   | $ | 6.12 |   |   |   | $ | 4,564 |   |   |
| $10.00 to $11.99         |       |                         | 1,354,392  |                                                             |       |   | 7.39 |   |   |   | $ | 10.56 |   |   |   | 5,442 |   |   |   | 1,354,392 |   |   |   | 7.39 |   |   |   | $ | 10.56 |   |   |   | 5,442 |   |   |
| $12.00 to $14.99         |       |                         | 1,632,033  |                                                             |       |   | 6.32 |   |   |   | $ | 13.00 |   |   |   | 2,581 |   |   |   | 1,389,337 |   |   |   | 5.92 |   |   |   | $ | 12.86 |   |   |   | 2,364 |   |   |
| $15.00 to $19.99         |       |                         | 2,333,485  |                                                             |       |   | 7.07 |   |   |   | $ | 17.11 |   |   |   | — |   |   |   | 1,970,133 |   |   |   | 6.92 |   |   |   | $ | 17.11 |   |   |   | — |   |   |
| $20.00 to $25.99         |       |                         | 1,803,997  |                                                             |       |   | 6.66 |   |   |   | $ | 24.04 |   |   |   | — |   |   |   | 1,566,024 |   |   |   | 6.26 |   |   |   | $ | 24.21 |   |   |   | — |   |   |
| $26.00 to $46.53         |       |                         | 394,596    |                                                             |       |   | 3.79 |   |   |   | $ | 28.59 |   |   |   | — |   |   |   | 385,631 |   |   |   | 3.66 |   |   |   | $ | 28.61 |   |   |   | — |   |   |
| Total                    |       |                         | 8,096,344  |                                                             |       |   | 6.58 |   |   |   | $ | 16.52 |   |   |   | $ | 12,823 |   |   |   | 7,204,876 |   |   |   | 6.35 |   |   |   | $ | 16.40 |   |   |   | $ | 12,370 |   |   |
|                          |            |                              |            |                                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The weighted average grant date fair value of options,as determined under SFAS No. 123(R), granted during the year ended December 31,2006 was $11.46 per share. The weightedaverage grant date fair value of options granted during the year ended December 31,2005 and 2004 as defined by SFAS No. 123, was $6.62 and $11.08 per share, respectively.

The aggregate intrinsic value in the table aboverepresents the total pretax intrinsic value, based on the Company’s closingstock price of $14.58 as of December 31, 2006, which would have beenreceived by the option holders had all option holders exercised their optionsas of that date. The total number of shares of common stock underlyingin-the-money options exercisable as of December 31, 2006 was 3.3 million.

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

The total intrinsic value of options exercised duringthe year ended December 31, 2006 was $40.8 million. The total cashreceived from employees as a result of employee stock option exercises duringthe year ended December 31, 2006 was approximately $49.8 million. Inconnection with these exercises, there was no tax benefit realized by theCompany due to the Company’s current loss position.

As of December 31, 2006, the total unrecognizedcompensation cost related to stock options was $8.4 million afterestimated forfeitures which are expected to be recognized over an estimatedamortization period of up to four years.

The Company settles employee stock option exerciseswith newly issued common shares.

For purposes of the disclosure requirements of SFAS No. 123and the requirements of SFAS No. 123(R), the Company estimates the fairvalue of stock options using the Black-Scholes option pricing model using thefollowing weighted-average assumptions:

| ** **                     | ** ** | **Stock Option Plans** | ** ** | **Stock Purchase Plan** | ** ** |
|--------------------------------|------------|----------------------------------|------------|-----------------------------------|------------|
| ** **                     | ** ** | **2006**                         | ** ** | **2005**                          | ** ** | **2004** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Average expected  term (years) |       | 5.7                              |       | 3.9                               |       | 5.1 |   | 1.25 |   | 1.25 |   | 1.25 |   |
| Expected  volatility           |       | 70                               | %          | 68                                | %          | 75 | % | 57 | % | 46 | % | 59 | % |
| Risk-free  interest rate       |       | 4.6% to 5.0                      | %          | 3.8% to 4.4                       | %          | 3.0% to 3.7 | % | 2.3 | % | 2.9% to 4.3 | % | 1.0% to 2.3 | % |
| Dividend yield                 |       | 0                                | %          | 0                                 | %          | 0 | % | 0 | % | 0 | % | 0 | % |

* *

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

*ExpectedVolatility:* The Company used historicalvolatility in deriving its volatility assumption. Management believes thathistorical volatility appropriately reflects the market’s expectations offuture volatility.

*Risk-FreeInterest Rate:* Management bases its assumptionsregarding the risk-free interest rate on U.S. Treasury zero-coupon issues withan equivalent remaining term.

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

*EstimatedPre-vesting Forfeitures:** *When estimating forfeitures, the Company considersvoluntary termination behavior based on actual historical information.

***RestrictedShares and Restricted Stock Units***

Restricted shares and restricted stock units aregranted under the 2005 Plan. On January 6, 2006, the Company filed aTender Offer Statement with the Securities and Exchange Commission andcommenced an offer to current employees to exchange outstanding options withexercise prices per share that were 

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

more than the greater of $20.00 and the closing saleprice of Zoran common stock on the offer expiration date of February 6,2006. The exchange offer was approved by Zoran’s stockholders at their 2005annual meeting. On February 6, 2006, the Company accepted for exchangeoptions to purchase an aggregate of 1,060,536 shares of Zoran common stockhaving an exercise price greater than $22.48. Subject to the terms andconditions of the exchange, the Company granted 197,433 restricted shares ofcommon stock or restricted stock units in exchange for the tendered options. Theshares of restricted stock and restricted stock units granted as part of thisexchange vest over a period of two years. None of the directors or executiveofficers was eligible for participation in the exchange offer. This exchangewas accounted as a modification under FAS No. 123(R). As of December 31,2006, there was $0.3 million of total unrecognized stock-basedcompensation expense related to restricted shares and restricted stock units.This cost is expected to be recognized over the vesting period of two to fouryears.

The following is a summary of restricted shares andrestricted stock units activities:

| ** **                        | ** ** | **Outstanding  restricted shares  and stock units** | ** ** | **Weighted  average grant-  date fair value** | ** ** |
|-----------------------------------|------------|--------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| Balances,  December 31, 2005 |       |                                                               | 65,333     |                                                         |       |   | $ | 13.59 |   |   |
| Granted                           |       |                                                               | 197,433    |                                                         |       |   | $ | 21.56 |   |   |
| Released                          |       |                                                               | (64,986    | )                                                            |       |   | $ | 19.56 |   |   |
| Forfeited                         |       |                                                               | (8,064     | )                                                            |       |   | $ | 21.56 |   |   |
| Balances,  December 31, 2006 |       |                                                               | 189,716    |                                                         |       |   | $ | 19.50 |   |   |

 

*Employee StockPurchase Plan*

The Company’s 1995Employee Stock Purchase Plan (“ESPP”) was adopted by the Company’s Board ofDirectors in October 1995, and approved by its stockholders inDecember 1995. The ESPP enables employees to purchase shares throughpayroll deductions at approximately 85% of the lesser of the fair value ofcommon stock at the beginning of a 24-month offering period or the end ofeach six-month segment within such offering period. The ESPP is intended toqualify as an “employee stock purchase plan” under Section 423 of the U.S.Internal Revenue Code. During the yearsended December 31, 2006 and 2005, 263,349 and 488,313 shares werepurchased by employees under the terms of the plan agreements at a weightedaverage price of $9.16 and $8.90 per share, respectively. As ofDecember 31, 2006, 2,311,447 shares were reserved and available forissuance under this plan. Due to the delay in the filing of its periodicreports during 2006, the Company was unable to issue shares under the ESPP forthe six-month segment ended October 31, 2006.

**NOTE 12—RETIREMENTAND EMPLOYEE BENEFIT PLANS**

We maintain a 401(k) Plan that coverssubstantially all of the Company’s US 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 theability to make a discretionary matching contribution to the 401(k) Planbased on a uniform percentage of the employee’s eligible contribution up to amaximum employer match of $2,000 per year per employee. Approximately $525,000,$235,000 and $384,000 in matching contributions were recorded during 2006, 2005and 2004, respectively.

96

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

Under Israeli law, the Company is required to makeseverance payments to its retired or dismissed Israeli employees and Israeliemployees leaving its employment in certain other circumstances. The Company’sseverance pay liability to its Israeli employees, which is calculated based onthe salary of each employee multiplied by the years of such employee’semployment, is reflected in the Company’s balance sheet in other long-termliabilities on an accrual basis, and is partially funded by the purchase ofinsurance policies in the name of the employees. The surrender value of theinsurance policies is recorded in other non-current assets. The severance payexpenses for the years ended December 31, 2006, 2005 and 2004 were$979,000, $645,000 and $412,000 respectively. The severance pay detail is asfollows (in thousands):

| ** **                                   | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                   | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Accrued severance                            |       | $                                          | 11,052     |   | $ | 7,690 |   | $ | 6,212 |   |
| Less : amount  funded                        |       | (9,702                                     | )          | (6,404 | ) | (5,492 | ) |
| Unfunded portion, net  accrued severance pay |       | $                                          | 1,350      |   | $ | 1,286 |   | $ | 720 |   |

 

**NOTE 13—EARNINGSPER SHARE**

The following is a reconciliation of the numeratorsand denominators of the basic and diluted net income (loss) per sharecomputations for the periods presented (in thousands except per share amounts):

| ** **                                                    | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                    | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                    | ** ** | ** **                                 | ** ** | **(restated)** | ** ** | **(restated)** | ** ** |
| Net income (loss)                                             |       | $                                          | 16,328     |   | $ | (30,272 | ) | $ | (48,108 | ) |
| Shares:                                                       |       |                                       |       |   |   |   |   |
| Weighted average shares outstanding                           |       | 48,353                                     |       | 44,267 |   | 42,788 |   |
| Effect of dilutive  options, ESPP and restricted stock units. |       | 1,746                                      |       | — |   | — |   |
| Dilutive weighted average shares                              |       | 50,099                                     |       | 44,267 |   | 42,788 |   |
| Net income (loss) per  share:                                 |       |                                       |       |   |   |   |   |
| Basic                                                         |       | $                                          | 0.34       |   | $ | (0.68 | ) | $ | (1.12 | ) |
| Diluted                                                       |       | $                                          | 0.33       |   | $ | (0.68 | ) | $ | (1.12 | ) |

 

For the years ended December 31,2006, 2005 and 2004 outstanding options and restricted stock units totaling 3.1million, 13.0 million and, 12.8 million shares, respectively, were excludedfrom the calculation of diluted net income (loss) per share as the inclusion ofsuch shares would have had an anti-dilutive effect.

**NOTE 14—INCOMETAXES**

The components of income (loss) before income taxesare as follows (in thousands):

| ** ** | ** ** | **December 31,** | ** ** |
|------------|------------|-----------------------|------------|
| ** ** | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** ** | ** ** | ** **            | ** ** | **(restated)** | ** ** | **(restated)** | ** ** |
| Current:   |       |                  |       |   |   |   |   |
| Federal    |       | $                     | (754       | ) | $ | (49,313 | ) | $ | (35,593 | ) |
| Foreign    |       | 22,844                |       | 21,397 |   | (10,975 | ) |
|       |       | $                     | 22,090     |   | $ | (27,916 | ) | $ | (46,568 | ) |

 

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

The components of the provision for income taxes areas follows:

| ** **               | ** ** | **December 31,** | ** ** |
|--------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **               | ** ** | ** **            | ** ** | **(restated)** | ** ** | **(restated)** | ** ** |
| Current:                 |       |                  |       |   |   |   |   |   |   |   |   |
| Federal                  |       | $                     | 4,463      |   |   | $ | 896 |   |   |   | $ | (694 | ) |   |
| State                    |       | (623                  | )          |   | (183 | ) |   |   | — |   |   |
| Foreign                  |       | 1,922                 |       |   | 1643 |   |   |   | 2,234 |   |   |
|                     |       | 5,762                 |       |   | 2,356 |   |   |   | 1,540 |   |   |
| Deferred                 |       | —                |       |   | — |   |   |   | — |   |   |
| Total income tax expense |       | $                     | 5,762      |   |   | $ | 2,356 |   |   |   | $ | 1,540 |   |   |

 

The tax provisiondiffers from the amounts obtained by applying the statutory U.S. Federal IncomeTax Rate to income taxes as shown below.

| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                      | ** ** | ** **            | ** ** | **(restated)** | ** ** | **(restated)** | ** ** |
| Tax provision  (benefit) at U.S. statutory rate |       | $                     | 7,511      |   |   | $ | (9,491 | ) |   | $ | (15,834 | ) |
| Foreign earnings                                |       | (6,016                | )          |   | (5,632 | ) |   | 3,331 |   |
| State taxes net  of federal benefit             |       | 259                   |       |   | 98 |   |   | — |   |
| Other differences  not benefited                |       | 5,234                 |       |   | 16,145 |   |   | 15,387 |   |
| Permanent  differences                          |       | (1,597                | )          |   | 1,214 |   |   | 36 |   |
| Alternative  Minimum tax                        |       | 371                   |       |   | 22 |   |   | — |   |
| Research and  development credits               |       | —                |       |   | — |   |   | (1,380 | ) |
| Total income tax expense                        |       | $                     | 5,762      |   |   | $ | 2,356 |   |   | $ | 1,540 |   |

 

Deferred income tax assets comprise the following:

| ** **                                         | ** ** | **December 31,** | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                         | ** ** | ** **            | ** ** | **(restated)** | ** ** | **(restated)** | ** ** |
| Deferred tax assets:                               |       |                  |       |   |   |   |   |
| Federal and state net operating loss carryforwards |       | $                     | 66,218     |   | $ | 101,820 |   | $ | 103,903 |   |
| Tax credits                                        |       | 43,102                |       | 30,859 |   | 33,540 |   |
| Nondeductible reserves and accruals                |       | 8,782                 |       | 9,923 |   | 10,475 |   |
| Total deferred  tax assets                         |       | 118,102               |       | 142,602 |   | 147,918 |   |
| Deferred tax  liabilities:                         |       |                  |       |   |   |   |   |
| Intangible assets                                  |       | (17,964               | )          | (34,964 | ) | (46,904 | ) |
| Deferred tax  assets                               |       | 100,138               |       | 107,638 |   | 101,014 |   |
| Valuation  allowance                               |       | (100,138              | )          | (107,638 | ) | (101,014 | ) |
| Net deferred tax assets                            |       | $                     | —     |   | $ | — |   | $ | — |   |

 

A significant portion of the deferred tax asset aboverelates to pre-acquisition loss carryforwards and other attributes or stockoption benefits that will result in an adjustment to goodwill or paid incapital respectively, when realized. During 2006, the Company realized $7.1million related to certain pre-acquisition tax net operating losses. Realizationof these net operating losses is reported as an adjustment to goodwill inaccordance with SFAS No. 109. During 2006 we reduced the NOL deferred taxasset for 

98

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

amounts which we believe will expire before they becomeavailable for utilization. As of December 31, 2006, the Company had NOLsof approximately $185 million for federal and $36 million for state taxreporting purposes. The federal NOLs expire on various dates between 2017 and2024. The state NOLs expire between 2012 and 2014. Approximately $45 million ofthe valuation allowance relates to tax benefits for stock option deductions,for which a full valuation allowance has been recorded. As of December 31,2006, the Company had tax credits of approximately $23 million for federal and$19 million for state tax purposes, which will expire beginning in 2007.

Realization of deferred tax assets is based on ourability to generate sufficient future taxable income. The valuation allowancewas determined in accordance with the provisions of SFAS No. 109 whichrequires an assessment of both positive and negative evidence when determiningwhether it is more likely than not that deferred tax assets are recoverable;such assessment is required on a jurisdiction by jurisdiction basis. Historicaloperating results and continuing business uncertainty represent sufficientnegative evidence which it was difficult for positive evidence to overcomeunder SFAS No. 109 and accordingly, a full valuation allowance wasrecorded. The amount of the deferred tax asset valuation allowance, however,could be reduced in the near term if estimates of future taxable income arerealized. The calculation of the Company’stax liabilities involves dealing with uncertainties in the application ofcomplex tax regulations. The Company records liabilities for anticipated taxaudit issues based on its estimate of whether, and the extent to which,additional taxes may be due. Actual tax liabilities may be different than therecorded estimates and could result in an additional charge or benefit to thetax provision in the period when the ultimate tax assessment is determined.

The Company has not provided for federal income tax onapproximately $55.6 million of undistributed earnings of its foreign subsidiariessince the Company intends to reinvest this amount outside the U.S. indefinitely.If the Company did not intend to permanently reinvest this amount outside the U.S.,it would calculate a deferred tax liability of approximately $19.5 millionrelated to the U.S. taxes that would be due upon repatriation.

The Company’s Israelisubsidiary has been granted the status of an Approved Enterprise pursuant tothe Israeli law for the Encouragement of Capital Investments, 1959, as amended.The Company has eight approved programs pursuant to this law; the first wasapproved in 1984 and the most recent was approved in 2004. Income subject tothis program is exempt from tax for two/four years from the first year in whichthe Company has taxable income, net of NOLs, and is taxed at a rate of 10% foreight/six years thereafter. Benefits under the programs are granted for aperiod of ten years limited to the earlier of fourteen years from applicationor twelve years from commencement of production. Benefits for the eighthprogram will expire on 2014. The benefit of these Approved Enterprise programsto the Company’s net income in 2006 was $7.8 million and resulted in a benefitof $5.7 million to the net loss in 2005. These tax holidays had no impact tothe Company’s net loss in 2004.

**NOTE 15—SEGMENTREPORTING**

SFAS No. 131 establishes standards for thereporting by public business enterprises of information about operatingsegments, products and services, geographic areas, and major customers. Themethod for determining what information to report is based on the way thatmanagement organizes the operating segments within the Company for makingoperational decisions and assessments of financial performance. The Company’schief operating decision-maker is considered to be the Chief Executive Officer.

99

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

Subsequent to the acquisition of Oak Technology, Inc.in 2003, the Company determined it had four reportable segments: Digital VersatileDisc (DVD), Imaging, Digital Camera (DC) and Digital Television (DTV). Subsequentto the Emblaze acquisition in July 2004, the Digital Camera segment wascombined with the Emblaze Mobile business unit and was renamed the Mobilesegment. Each segment’s primary products are based on highly integratedapplication-specific integrated circuits, or ASICs, and system-on-a-chip, orSOC, solutions. The DVD, DTV, Mobile and Imaging segments also license certainsoftware and other intellectual property. The DVD group provides products foruse in DVD players and recordable DVD players. The DTV group provides productsfor standard and high definition digital television products includingtelevisions, set top boxes and personal video recorders. The Mobile groupfocuses on solutions for multimedia mobile phone products and digital cameraproducts. The Imaging group provides products used in digital copiers, laserand inkjet printers as well as multifunction peripherals.

During the first quarter of 2006, we reorganized ouroperating structure to bring together our consumer electronic product linesunder a single operating group, in recognition of the accelerating convergenceof consumer products and our strategy of sharing technology among our variousproduct lines. The new Consumer group combines the former DVD, DTV and Mobileproduct groups whose operations were previously reported separately. We willcontinue to report the operations of our Imaging group as a separate operatingsegment.

The Company evaluates operating segment performancebased on net revenues and operating expenses of these segments. The accountingpolicies of the operating segments are the same as those described in thesummary of accounting policies. No reportable segments have been aggregated.

Information about reported segment income or loss isas follows for the years ended December 31, 2006, 2005 and 2004 (in thousands):

| ** **           | ** ** | **2006**   | ** ** | **2005**       | ** ** | **2004**       | ** ** |
|----------------------|------------|------------|------------|----------------|------------|----------------|------------|
| ** **           | ** ** | ** ** | ** ** | **(restated)** | ** ** | **(restated)** | ** ** |
| Net revenues:        |       |       |       |           |       |           |       |
| Consumer             |       | $          | 420,990    |           | $          | 310,695        |       | $ | 294,496 |   |
| Imaging              |       | 74,815     |       | 85,063         |       | 84,368         |       |
|                 |       | $          | 495,805    |           | $          | 395,758        |       | $ | 378,864 |   |
| Operating expenses:  |       |       |       |           |       |           |       |
| Consumer             |       | $          | 374,435    |           | $          | 312,488        |       | $ | 323,637 |   |
| Imaging              |       | 60,752     |       | 58,699         |       | 50,839         |       |
|                 |       | $          | 435,187    |           | $          | 371,187        |       | $ | 374,476 |   |
| Contribution Margin: |       |       |       |           |       |           |       |
| Consumer             |       | $          | 46,555     |           | $          | (1,793         | )          | $ | (29,141 | ) |
| Imaging              |       | 14,063     |       | 26,364         |       | 33,529         |       |
|                 |       | $          | 60,618     |           | $          | 24,571         |       | $ | 4,388 |   |

 

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

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, 2006, 2005 and 2004 (inthousands):

| ** **                                                                     | ** ** | **2006**   | ** ** | **2005**       | ** ** | **2004**       | ** ** |
|--------------------------------------------------------------------------------|------------|------------|------------|----------------|------------|----------------|------------|
| ** **                                                                     | ** ** | ** ** | ** ** | **(restated)** | ** ** | **(restated)** | ** ** |
| Contribution margin from operating segments                                    |       | $          | 60,618     |           | $          | 24,571         |       | $ | 4,388 |   |
| Amortization of intangibles                                                    |       | (50,062    | )          | (50,254        | )          | (45,358        | )          |
| Amortization of stock-based compensation resulting from business  combinations |       | —     |       | (1,546         | )          | (4,051         | )          |
| Restructuring expense                                                          |       | —     |       | —         |       | (746           | )          |
| Acquired in-process research and development                                   |       | —     |       | (2,650         | )          | —         |       |
| Total  operating income (loss)                                                 |       | $          | 10,556     |           | $          | (29,879        | )          | $ | (45,767 | ) |

 

Zoranmaintains operations in the Canada, China, Germany, Israel, India, Japan,Korea, Taiwan, the United Kingdom and United States. Activities in Israel andUnited States consist of corporate administration, product development,logistics and worldwide sales management. Other foreign operations consist ofsales, product development and technical support.

The distribution of net revenues for the years ended December 31,2006, 2005 and 2004 was as follows (in thousands):

| ** **                                                | ** ** | **Year ended December 31,** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Revenue from unaffiliated customers originating from:** |       |                                       |       |   |   |   |   |
| China                                                     |       | $                                          | 165,611    |   | $ | 156,737 |   | $ | 150,562 |   |
| Japan                                                     |       | 109,066                                    |       | 111,370 |   | 101,792 |   |
| Korea                                                     |       | 28,544                                     |       | 24,865 |   | 28,353 |   |
| Taiwan                                                    |       | 127,311                                    |       | 51,900 |   | 36,631 |   |
| United States                                             |       | 35,949                                     |       | 24,201 |   | 34,403 |   |
| North America (excluding United States)                   |       | 65                                         |       | 1,206 |   | — |   |
| Other                                                     |       | 29,259                                     |       | 25,479 |   | 27,123 |   |
|                                                      |       | $                                          | 495,805    |   | $ | 395,758 |   | $ | 378,864 |   |

 

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

The distribution of identifiable assets by geographic areas andproperty and equipment as of December 31, 2006 and 2005 was as follows (inthousands):

| ** **                       | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **2006**              | ** ** | **2005** | ** ** |
| ** **                       | ** ** | ** **            | ** ** | **(restated)** | ** ** |
| **Identifiable assets:**         |       |                  |       |   |   |
| U.S.                             |       | $                     | 506,885    |   | $ | 476,664 |   |
| Israel                           |       | 162,473               |       | 117,736 |   |
| China                            |       | 2,744                 |       | 2,399 |   |
| Japan                            |       | 1,867                 |       | 2,722 |   |
| United Kingdom                   |       | 831                   |       | 689 |   |
| Korea                            |       | 578                   |       | 186 |   |
| Canada                           |       | 274                   |       | 266 |   |
| Taiwan                           |       | 271                   |       | 318 |   |
| Other                            |       | 707                   |       | 1,651 |   |
|                             |       | $                     | 676,630    |   | $ | 602,631 |   |
| **Property and equipment, net:** |       |                  |       |   |   |
| U.S.                             |       | $                     | 6,080      |   | $ | 7,569 |   |
| Israel                           |       | 6,219                 |       | 4,940 |   |
| China                            |       | 1,367                 |       | 1,388 |   |
| Japan                            |       | 548                   |       | 685 |   |
| United Kingdom                   |       | 261                   |       | 318 |   |
| Taiwan                           |       | 611                   |       | 229 |   |
| Canada                           |       | 197                   |       | 158 |   |
| Korea                            |       | 132                   |       | 73 |   |
| Other                            |       | 258                   |       | 697 |   |
|                             |       | $                     | 15,673     |   | $ | 16,057 |   |

 

The following table summarizes the percentage contribution to netrevenues by customers when sales to such customers exceeded 10% of netrevenues:

| ** **                      | ** ** | **Year ended**   | ** ** |
|---------------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **December 31,** | ** ** |
| ** **                      | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Percentage of net revenues:** |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| A                               |       |                  | 14         | % |   |   | — |   |   |   | 11 | % |   |

 

Theabove customer had accounts receivable balance greater than 10% as of the endof 2006.

**NOTE 16—ACQUISITIONS**

**Oren Semiconductor, Inc.**

On June 10,2005, Zoran completed the acquisition of Oren Semiconductor, Inc. (“Oren”),a privately-held provider of demodulator ICs for the global high definitiontelevision market. Prior to this acquisition, Zoran had made investments inOren that represented a 17% ownership interest with a net book value of $3.4million at the time of the acquisition. Under the terms of the acquisitionagreement, Zoran acquired 

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

the remaining83% of Oren’s outstanding stock by means of a merger of Oren with awholly-owned subsidiary of Zoran, in consideration for which Zoran paid anaggregate of $28.4 million in cash and issued 1,188,061 shares of Zorancommon stock valued at $12.9 million, for total consideration of $41.3 million,to the other stockholders of Oren and to employees holding Oren options. As aresult of the restatement, the Company considered the requirements under AccountingPrinciples Board Opinion 18 (“APB No. 18”), “The Equity Method of Accounting for Investments inCommon Stock,” to record the gains or losses on investment of the prior 17%ownership under the equity method of accounting. Based on the Company’sanalysis, the prior financial results of the Company were restated to record theloss on investment.

The primarypurpose of the acquisition was to obtain Oren’s demodulator IC technology forthe global high definition television market. This technology was combined withZoran’s digital television technology to deliver a complete and cost-effectivesystem solution for digital television makers. As of December 31, 2006, therehave been no material variations from the underlying assumptions that were usedin the original computation of the value of the acquired entity.

Thetransaction was accounted for under SFAS No. 141, “Business Combinations,”using the purchase method of accounting. The Company incurred approximately$375,000 for acquisition-related expenses consisting of financial advisory,legal and other consulting services. The Company completed a valuation analysisand purchase price allocation. The results of operations of Oren have beenincluded in the consolidated financial statements from the date of acquisition.The acquisition resulted in goodwill of approximately $33.9 million. In accordance with SFAS No. 142, “Goodwill andOther Intangible Assets,” goodwill will not be amortized and will be tested forimpairment at least annually. The Company does not expect goodwill to bedeductible for tax purposes.

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

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

 

Tangible assets were valued at estimates of their current fair values. Thepurchase price exceeded the net assets acquired resulting in the recognition ofgoodwill and other intangible assets. The amounts allocated to intangibleassets include purchased technology totaling $7.0 million, trade name andother intangible assets totaling $1.25 million and customer base totaling$850,000 which are being amortized over their estimated useful lives of fiveyears.

Approximately$2.7 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 uponthe acquisition date. This amount was determined using management’s estimatesincluding consultation with an independent appraiser. The value of thein-process research and development was determined using a discounted cash flowmethod and factors including projected financial results, relative risk ofsuccessful development, time-value of money and level of completion.

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

**Emblaze Semiconductor Ltd.**

On July 8,2004, Zoran acquired Emblaze Semiconductor Ltd. (“Emblaze”), a subsidiary ofEmblaze Ltd. and a provider of semiconductor-based solutions for high volumemanufacturers of multimedia mobile telephones. Under the terms of theagreement, Zoran’s wholly-owned Israel based subsidiary, Zoran MicroelectronicsLtd., acquired all of the outstanding common shares of Emblaze forapproximately $54.2 million in cash.

The primarypurpose of the acquisition was to gain high performance, low-power applicationprocessors, technology and products for the fast growing multimedia mobilephone market. This technology was combined with Zoran’s image processingtechnology to deliver reliable, cost-effective system solutions for mobilephone makers. As of December 31, 2006, there have been no material variationsfrom the underlying assumptions that were used in the original computation ofthe value of the acquired entity.

Thetransaction was accounted for under SFAS No. 141, “Business Combinations,”using the purchase method of accounting. The Company incurred approximately$180,000 for acquisition-related expenses consisting of financial advisory,legal and other consulting services. The Company completed a valuation analysisand purchase price allocation with the assistance of a third party appraiser. Theresults of operations of Emblaze have been included in the consolidatedfinancial statements from the date of acquisition. The acquisition resulted ingoodwill of approximately $30.9 million. Inaccordance with SFAS No. 142, “Goodwill and Other IntangibleAssets,” goodwill will not be amortized and will be tested for impairment atleast annually. The Company does not expect goodwill to be deductible for taxpurposes.

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

 

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

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**ZORAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)**

**Pro Forma Financial Information**

Thefollowing unaudited pro forma financial information presents the combinedresults of operations of Zoran, Emblaze and Oren as if the acquisitions hadoccurred as of the beginning of each period presented, after giving effect tocertain adjustments, including amortization of intangibles. The in-processresearch and development charge of $2.7 million related to the Orenacquisition is not reflected in the unaudited pro forma combined condensedstatement of operations. The unaudited pro forma financial information does notnecessarily reflect the results of operations that would have occurred had thecombined companies constituted a single entity during such periods, and is notnecessarily indicative of results which may be obtained in the future.

| ** **                                  | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                  | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| ** **                                  | ** ** | **(restated)**                             | ** ** | **(restated)** | ** ** |
| **In thousands except for per share data:** |       |                                       |       |   |   |
| Pro forma revenues                          |       | $                                          | 396,737    |   | $ | 383,131 |   |
| Pro forma net loss                          |       | $                                          | (33,024    | ) | $ | (63,207 | ) |
| Pro forma net loss per share:               |       |                                       |       |   |   |
| Basic                                       |       | $                                          | (0.75      | ) | $ | (1.48 | ) |
| Diluted                                     |       | $                                          | (0.75      | ) | $ | (1.48 | ) |

 

**NOTE 17—SUBSEQUENT EVENTS**

On February 27,2007, the Company elected to (i) participate in the Internal RevenueService remediation program 2007-18 and pay to the IRS, on behalf ofaffected and eligible employees (not including executive officers), their IRC409A tax liabilities and penalties; (ii) participate in any similarremediation program that may be offered by any state for applicable state taxliabilities and penalties; (iii), act directly with any state not offering asimilar remediation program to address any applicable tax liabilities andpenalties on behalf of employees; and (iv) pay to such employees a “gross-up”payment to offset the associated federal and state income tax consequences. TheCompany took this action because the vast majority of the holders of stockoptions issued by the Company that are now subject to re-measurement as aresult of the Company’s option investigation were not involved in or aware ofthe stock option pricing determination. Employees who exercised such options in2006, other than executive officers at the time of option grant or enteringinto this program, will participate in this program. The Company estimates thatthe total cash payments needed to deal with the adverse tax consequences of previouslyexercised discount priced options granted to non-officers will be approximately$0.8 million, which is expected to be recorded in 2007.

In addition,the Company may consider taking action to minimize the adverse tax consequencesthat may be incurred by the holders of unexercised discount options.Discount-priced stock options vesting after December 31, 2004 (“409AAffected Options”) subject U.S. option holders to a penalty tax under IRC Section 409A(and to similar penalty taxes under California and other state tax laws, asapplicable). The Company may consider offering to amend the 409A AffectedOptions held by persons other than directors and executive officers to increasethe exercise prices of those options to the market price of our common stock onthe revised measurement date. The amended options would not be subject totaxation under IRC Section 409A. Under IRS regulations, the amendments fornon-executives cannot be offered until after this Report is filed and do notneed to be completed until December 31, 2007. The Company may alsoconsider approving the payment of bonuses to holders of those amended optionsto compensate them for the resulting increase in their option exercise price.The amount of these bonuses would be effectively repaid to the Company if andwhen the options are exercised and the increased exercise price is paid (butthere is no assurance that the options will be exercised). The Company has notestimated the expense of any such bonus payments.

105

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**The following tables containselected unaudited quarterly financial data for the eight fiscal quarters inthe period ended December 31, 2006. In management’s opinion, the unaudited datahas been prepared on the same basis as the audited information and includes alladjustments (consisting only of normal recurring adjustments) necessary for afair presentation of the data for the periods presented. Our results ofoperations have varied and may continue to fluctuate significantly from quarterto quarter. The results of operations in any period should not be consideredindicative of the results to be expected from any future period.**

**The selected quarterly informationhas been restated for all quarters of fiscal 2005 and the first quarter offiscal 2006 from previously reported information filed on Form 10-Q and Form10-K, as a result of the restatement of our financial results discussed in thisAnnual Report on Form 10-K.**

**ZORAN CORPORATIONSELECTED QUARTERLY FINANCIAL INFORMATION(Unaudited)(restated)**
|                                                   | ** ** | **Three Months Ended**                                   | ** ** |
|---------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                        | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | **Mar. 31,** | ** ** | **Dec. 31,** | ** ** | **Sep 30,** | ** ** | **Jun. 30,** | ** ** | **Mar. 31,** | ** ** |
| ** **                                        | ** ** | **Dec. 31,**                                                  | ** ** | **Sep 30,** | ** ** | **Jun. 30,** | ** ** | **2006** | ** ** | **2005** | ** ** | **2005** | ** ** | **2005** | ** ** | **2005** | ** ** |
| ** **                                        | ** ** | **2006**                                                           | ** ** | **2006** | ** ** | **2006** | ** ** | **(restated)** | ** ** | **(restated)** | ** ** | **(restated)** | ** ** | **(restated)** | ** ** | **(restated)** | ** ** |
| ** **                                        | ** ** | **(In thousands, except per share data)** | ** ** |
| Total revenues                                    |       | $                                                                  | 96,251     |   | $ | 129,379 |   | $ | 127,929 |   | $ | 142,246 |   | $ | 109,311 |   | $ | 117,484 |   | $ | 95,079 |   | $ | 73,884 |   |
| Gross profit                                      |       | $                                                                  | 50,806     |   | $ | 62,569 |   | $ | 67,574 |   | $ | 88,596 |   | $ | 59,359 |   | $ | 63,575 |   | $ | 49,703 |   | $ | 36,949 |   |
| Operating income  (loss)                     |       | $                                                                  | (14,644    | ) | $ | (1,016 | ) | $ | (496 | ) | $ | 26,712 |   | $ | (3,459 | ) | $ | 4,517 |   | $ | (12,111 | ) | $ | (18,826 | ) |
| Net income (loss)                                 |       | $                                                                  | (10,986    | ) | $ | 1,852 |   | $ | 4,779 |   | $ | 20,683 |   | $ | (3,769 | ) | $ | 3,995 |   | $ | (11,775 | ) | $ | (18,723 | ) |
| Basic net income  (loss) per  share(1)            |       | $                                                                  | (0.22      | ) | $ | 0.04 |   | $ | 0.10 |   | $ | 0.45 |   | $ | (0.08 | ) | $ | 0.09 |   | $ | (0.27 | ) | $ | (0.43 | ) |
| Diluted net  income (loss) per  share(1)          |       | $                                                                  | (0.22      | ) | $ | 0.04 |   | $ | 0.09 |   | $ | 0.43 |   | $ | (0.08 | ) | $ | 0.09 |   | $ | (0.27 | ) | $ | (0.43 | ) |
| Shares used in  basic per share calculations(1)   |       | 49,426                                                             |       | 49,333 |   | 48,461 |   | 46,207 |   | 45,249 |   | 44,877 |   | 43,707 |   | 43,213 |   |
| Shares used in diluted  per share calculations(1) |       | 49,426                                                             |       | 50,712 |   | 51,311 |   | 48,487 |   | 45,249 |   | 46,622 |   | 43,707 |   | 43,213 |   |

----

(1)          Computedon the basis described in Note 3 of Notes to Consolidated FinancialStatements.

106

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The following tables present the impact of thefinancial statement adjustments on our previously reported CondensedConsolidated Statements of Operations for the three month period ended March31, 2006 (inthousands, except per share data):

| ** **                                          | ** ** | **Three Months Ended**March 31, 2006 | ** ** |
|-----------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                          | ** ** | **As previously reported**                     | ** ** | **Adjustments(1)** | ** ** | **As restated(1)** | ** ** |
| Revenues:                                           |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Hardware product  revenues                          |       |                                                     | $          | 99,169 |   |   |   | $ | — |   |   |   | $ | 99,169 |   |   |
| Software and other  revenues                        |       |                                                     | 12,909     |   |   |   | — |   |   |   | 12,909 |   |   |
| License revenues related  to litigation settlement. |       |                                                     | 30,168     |   |   |   | — |   |   |   | 30,168 |   |   |
| Total revenues                                      |       |                                                     | 142,246    |   |   |   | — |   |   |   | 142,246 |   |   |
| Costs and expenses:                                 |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Cost of hardware product  revenues                  |       |                                                     | 54,466     |   |   |   | (816 | ) |   |   | 53,650 |   |   |
| Research and development                            |       |                                                     | 24,151     |   |   |   | 97 |   |   |   | 24,248 |   |   |
| Selling, general and  administrative                |       |                                                     | 24,755     |   |   |   | 146 |   |   |   | 24,901 |   |   |
| Amortization of  intangible assets                  |       |                                                     | 12,735     |   |   |   | — |   |   |   | 12,735 |   |   |
| Total costs and expenses                            |       |                                                     | 116,107    |   |   |   | (573 | ) |   |   | 115,534 |   |   |
| Operating income                                    |       |                                                     | 26,139     |   |   |   | 573 |   |   |   | 26,712 |   |   |
| Interest income                                     |       |                                                     | 1,630      |   |   |   | (37 | ) |   |   | 1,593 |   |   |
| Other income (loss), net                            |       |                                                     | 1,193      |   |   |   | — |   |   |   | 1,193 |   |   |
| Income before income  taxes                         |       |                                                     | 28,962     |   |   |   | 536 |   |   |   | 29,498 |   |   |
| Provision for income  taxes                         |       |                                                     | 8,202      |   |   |   | 613 |   |   |   | 8,815 |   |   |
| Net income                                          |       |                                                     | $          | 20,760 |   |   |   | $ | (77 | ) |   |   | $ | 20,683 |   |   |
| Basic net income per  share                         |       |                                                     | $          | 0.45 |   |   |   | $ | — |   |   |   | $ | 0.45 |   |   |
| Diluted net income per  share                       |       |                                                     | $          | 0.43 |   |   |   | $ | — |   |   |   | $ | 0.43 |   |   |
| Shares used to compute  basic net income per share  |       |                                                     | 46,207     |   |   |   |   |   |   |   | 46,207 |   |   |
| Shares used to compute  diluted income per share    |       |                                                     | 48,487     |   |   |   |   |   |   |   | 48,487 |   |   |

----

(1)    Inaddition to restating the consolidated financial statements in response to theSpecial Committee’s findings, the Company has recorded additional non-cashadjustments that were considered to be immaterial to our previously filedconsolidated financial statements relating to the timing of revenuerecognition, accrued expenses, amortization of premiums and discountson investments, additional expense related to options granted to a consultant andthe calculation of amortization of stock-based compensation relating to abusiness combination in 2003.  In addition, the Company isalso recording losses under Accounting Principles Board Opinion No. 18,“The Equity Method of Accounting for Investments in Common Stock,”to record the losses on investment of the prior 17% ownership ofOren Semiconductor, Inc. under the equity method of accounting whichwas acquired by Zoran in 2005. 

107

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The following tables present the impact of thefinancial statement adjustments on our previously reported CondensedConsolidated Statements of Operations for the three month periods ended December31, 2005 and September 30, 2005 (in thousands, except per share data):

**CONSOLIDATED STATEMENTS OF OPERATIONS**

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

| ** **                                                                     | ** ** | **Three Months Ended  December 31, 2005** | ** ** | **Three Months Ended**September 30, 2005 | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                                                     | ** ** | **As previously  reported**                              | ** ** | **Adjustments(1)**                                           | ** ** | **As restated** | ** ** | **As previously  reported** | ** ** | **Adjustments(1)** | ** ** | **As restated** | ** ** |
| Revenues:                                                                      |       |                                                          |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Hardware product revenues                                                      |       |                                                          | $          | 95,432                                                       |       |   |   | $ | — |   |   |   | $ | 95,432 |   |   |   | $ | 104,208 |   |   |   | $ | — |   |   |   | $ | 104,208 |   |   |
| Software and other revenues                                                    |       |                                                          | 13,879     |                                                         |       |   | — |   |   |   | 13,879 |   |   |   | 13,276 |   |   |   | — |   |   |   | 13,276 |   |   |
| Total revenues                                                                 |       |                                                          | 109,311    |                                                         |       |   | — |   |   |   | 109,311 |   |   |   | 117,484 |   |   |   | — |   |   |   | 117,484 |   |   |
| Costs and expenses:                                                            |       |                                                          |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of hardware product revenues                                              |       |                                                          | 49,689     |                                                         |       |   | 263 |   |   |   | 49,952 |   |   |   | 53,660 |   |   |   | 249 |   |   |   | 53,909 |   |   |
| Research and development                                                       |       |                                                          | 24,138     |                                                         |       |   | 379 |   |   |   | 24,517 |   |   |   | 23,469 |   |   |   | 213 |   |   |   | 23,682 |   |   |
| Selling, general and administrative                                            |       |                                                          | 24,522     |                                                         |       |   | 815 |   |   |   | 25,337 |   |   |   | 21,817 |   |   |   | 458 |   |   |   | 22,275 |   |   |
| Amortization of intangible assets                                              |       |                                                          | 12,736     |                                                         |       |   | — |   |   |   | 12,736 |   |   |   | 12,757 |   |   |   | — |   |   |   | 12,757 |   |   |
| Amortization of stock-based compensation resulting  from business combinations |       |                                                          | 228        |                                                         |       |   | — |   |   |   | 228 |   |   |   | 344 |   |   |   | — |   |   |   | 344 |   |   |
| Total costs and expenses                                                       |       |                                                          | 111,313    |                                                         |       |   | 1,457 |   |   |   | 112,770 |   |   |   | 112,047 |   |   |   | 920 |   |   |   | 112,967 |   |   |
| Operating income (loss)                                                        |       |                                                          | (2,002     | )                                                            |       |   | (1,457 | ) |   |   | (3,459 | ) |   |   | 5,437 |   |   |   | (920 | ) |   |   | 4,517 |   |   |
| Interest income                                                                |       |                                                          | 909        |                                                         |       |   | (42 | ) |   |   | 867 |   |   |   | 689 |   |   |   | (43 | ) |   |   | 646 |   |   |
| Other income (loss), net                                                       |       |                                                          | (21        | )                                                            |       |   | — |   |   |   | (21 | ) |   |   | 32 |   |   |   | — |   |   |   | 32 |   |   |
| Income (loss) before income taxes                                              |       |                                                          | (1,114     | )                                                            |       |   | (1,499 | ) |   |   | (2,613 | ) |   |   | 6,158 |   |   |   | (963 | ) |   |   | 5,195 |   |   |
| Provision for income taxes                                                     |       |                                                          | 964        |                                                         |       |   | 192 |   |   |   | 1,156 |   |   |   | 1,200 |   |   |   | — |   |   |   | 1,200 |   |   |
| Net income (loss)                                                              |       |                                                          | $          | (2,078                                                       | )          |   |   | $ | (1,691 | ) |   |   | $ | (3,769 | ) |   |   | $ | 4,958 |   |   |   | $ | (963 | ) |   |   | $ | 3,995 |   |   |
| Basic net loss per share                                                       |       |                                                          | $          | (0.05                                                        | )          |   |   | $ | (0.03 | ) |   |   | $ | (0.08 | ) |   |   | $ | 0.11 |   |   |   | $ | (0.02 | ) |   |   | $ | 0.09 |   |   |
| Diluted net loss per share                                                     |       |                                                          | $          | (0.05                                                        | )          |   |   | $ | (0.03 | ) |   |   | $ | (0.08 | ) |   |   | $ | 0.11 |   |   |   | $ | (0.02 | ) |   |   | $ | 0.09 |   |   |
| Shares used to compute basic net loss per share                                |       |                                                          | 45,249     |                                                         |       |   |   |   |   |   | 45,249 |   |   |   | 44,877 |   |   |   |   |   |   |   | 44,877 |   |   |
| Shares used to  compute diluted loss per share                                 |       |                                                          | 45,249     |                                                         |       |   |   |   |   |   | 45,349 |   |   |   | 46,622 |   |   |   |   |   |   |   | 46,622 |   |   |

----

(1)    Inaddition to restating the consolidated financial statements in response to theSpecial Committee’s findings, the Company has recorded additional non-cashadjustments that were considered to be immaterial to our previously filedconsolidated financial statements relating to the timing of revenue recognition,accrued expenses, amortization of premiums and discounts oninvestments, additional expense related to options granted to a consultant andthe calculation of amortization of stock-based compensation relating to abusiness combination in 2003.  In addition, the Company isalso recording losses under Accounting Principles Board Opinion No. 18,“The Equity Method of Accounting for Investments in Common Stock,”to record the losses on investment of the prior 17% ownership ofOren Semiconductor, Inc. under the equity method of accounting whichwas acquired by Zoran in 2005.

108

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The following tables present the impact of thefinancial statement adjustments on our previously reported CondensedConsolidated Statements of Operations for the three month periods endedJune 30, 2005 and March 31, 2005 (in thousands, except per share data):

**CONSOLIDATED STATEMENTS OF OPERATIONS**

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

| ** **                                                                     | ** ** | **Three Months Ended**June 30, 2005 | ** ** | **Three Months Ended  March 31, 2005** | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                                                     | ** ** | **As previously  reported**                        | ** ** | **Adjustments(1)**                                         | ** ** | **As restated** | ** ** | **As previously  reported** | ** ** | **Adjustments(1)** | ** ** | **As restated** | ** ** |
| Revenues:                                                                      |       |                                                    |       |                                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Hardware product revenues                                                      |       |                                                    | $          | 80,897                                                     |       |   |   | $ | — |   |   |   | $ | 80,897 |   |   |   | $ | 59,002 |   |   |   | $ | — |   |   |   | $ | 59,002 |   |   |
| Software and other revenues                                                    |       |                                                    | 14,182     |                                                       |       |   | — |   |   |   | 14,182 |   |   |   | 14,882 |   |   |   | — |   |   |   | 14,882 |   |   |
| Total revenues                                                                 |       |                                                    | 95,079     |                                                       |       |   | — |   |   |   | 95,079 |   |   |   | 73,884 |   |   |   | — |   |   |   | 73,884 |   |   |
| Costs and  expenses:                                                           |       |                                                    |       |                                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of hardware product revenues                                              |       |                                                    | 45,236     |                                                       |       |   | 140 |   |   |   | 45,376 |   |   |   | 36,964 |   |   |   | (29 | ) |   |   | 36,935 |   |   |
| Research and development                                                       |       |                                                    | 21,321     |                                                       |       |   | 202 |   |   |   | 21,523 |   |   |   | 20,100 |   |   |   | (13 | ) |   |   | 20,087 |   |   |
| Selling, general and administrative                                            |       |                                                    | 24,318     |                                                       |       |   | 435 |   |   |   | 24,753 |   |   |   | 23,174 |   |   |   | (333 | ) |   |   | 22,841 |   |   |
| Amortization of intangible assets                                              |       |                                                    | 12,431     |                                                       |       |   | — |   |   |   | 12,431 |   |   |   | 12,330 |   |   |   | — |   |   |   | 12,330 |   |   |
| Amortization of stock-based compensation resulting  from business combinations |       |                                                    | 457        |                                                       |       |   | — |   |   |   | 457 |   |   |   | 517 |   |   |   | — |   |   |   | 517 |   |   |
| In-process research and development                                            |       |                                                    | 2,650      |                                                       |       |   | — |   |   |   | 2,650 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Total costs and expenses                                                       |       |                                                    | 106,413    |                                                       |       |   | 777 |   |   |   | 107,190 |   |   |   | 93,085 |   |   |   | (375 | ) |   |   | 92,710 |   |   |
| Operating loss                                                                 |       |                                                    | (11,334    | )                                                          |       |   | (777 | ) |   |   | (12,111 | ) |   |   | (19,201 | ) |   |   | 375 |   |   |   | (18,826 | ) |   |
| Interest income                                                                |       |                                                    | 572        |                                                       |       |   | (19 | ) |   |   | 553 |   |   |   | 535 |   |   |   | (8 | ) |   |   | 527 |   |   |
| Other income (loss), net                                                       |       |                                                    | (293       | )                                                          |       |   | 76 |   |   |   | (217 | ) |   |   | (130 | ) |   |   | (294 | ) |   |   | (424 | ) |   |
| Loss before income taxes                                                       |       |                                                    | (11,055    | )                                                          |       |   | (720 | ) |   |   | (11,775 | ) |   |   | (18,796 | ) |   |   | 73 |   |   |   | (18,723 | ) |   |
| Provision for income taxes                                                     |       |                                                    | —     |                                                       |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Net loss                                                                       |       |                                                    | $          | (11,055                                                    | )          |   |   | $ | (720 | ) |   |   | $ | (11,775 | ) |   |   | $ | (18,796 | ) |   |   | $ | 73 |   |   |   | $ | (18,723 | ) |   |
| Basic net loss per share                                                       |       |                                                    | $          | (0.25                                                      | )          |   |   | $ | (0.02 | ) |   |   | $ | (0.27 | ) |   |   | $ | (0.43 | ) |   |   | $ | — |   |   |   | $ | (0.43 | ) |   |
| Diluted net loss per share                                                     |       |                                                    | $          | (0.25                                                      | )          |   |   | $ | (0.02 | ) |   |   | $ | (0.27 | ) |   |   | $ | (0.43 | ) |   |   | $ | — |   |   |   | $ | (0.43 | ) |   |
| Shares used to compute basic net loss per share                                |       |                                                    | 43,707     |                                                       |       |   |   |   |   |   | 43,707 |   |   |   | 43,213 |   |   |   |   |   |   |   | 43,213 |   |   |
| Shares used to  compute diluted loss per share                                 |       |                                                    | 43,707     |                                                       |       |   |   |   |   |   | 43,707 |   |   |   | 43,213 |   |   |   |   |   |   |   | 43,213 |   |   |

----

(1)          Inaddition to restating the consolidated financial statements in response to theSpecial Committee’s findings, the Company has recorded additional non-cashadjustments that were considered to be immaterial to our previously filedconsolidated financial statements relating to the timing of revenuerecognition, accrued expenses, amortization of premiums and discountson investments, additional expense related to options granted to a consultantand the calculation of amortization of stock-based compensation relating to abusiness combination in 2003. In addition, the Company isalso recording losses under Accounting Principles Board Opinion No. 18,“The Equity Method of Accounting for Investments in Common Stock,” to recordthe losses on investment of the prior 17% ownership of OrenSemiconductor, Inc. under the equity method of accounting whichwas acquired by Zoran in 2005.

109

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The following tables present the impact of thefinancial statement adjustments on our previously reported CondensedConsolidated Balance Sheets as of March 31, 2006:

**CONDENSED CONSOLIDATED BALANCE SHEETS**

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

| ** **                                                                                                                                                 | ** ** | **March 31, 2006** | ** ** | **Adjustment(1)** | ** ** | **March 31, 2006** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-------------------|------------|------------------------------|------------|
| ** **                                                                                                                                                 | ** ** | **(As reported)**       | ** ** | ** **        | ** ** | **(As restated)**       | ** ** |
| ASSETS                                                                                                                                                     |       |                         |       |              |       |                         |       |   |   |   |   |   |   |
| Current assets:                                                                                                                                            |       |                         |       |              |       |                         |       |   |   |   |   |   |   |
| Cash and cash equivalents                                                                                                                                  |       |                         | $          | 113,752           |       |                         |       | $ | — |   |   |   | $ | 113,752 |   |   |
| Short-term investments                                                                                                                                     |       |                         | 104,124    |              |       |                         | —     |   |   |   | 104,124 |   |   |
| Accounts receivable, net                                                                                                                                   |       |                         | 62,431     |              |       |                         | —     |   |   |   | 62,431 |   |   |
| Inventories                                                                                                                                                |       |                         | 38,663     |              |       |                         | —     |   |   |   | 38,663 |   |   |
| Prepaid expenses and other current assets                                                                                                                  |       |                         | 9,800      |              |       |                         | —     |   |   |   | 9,800 |   |   |
| Total current assets                                                                                                                                       |       |                         | 328,770    |              |       |                         | —     |   |   |   | 328,770 |   |   |
| Property and equipment, net                                                                                                                                |       |                         | 14,905     |              |       |                         | —     |   |   |   | 14,905 |   |   |
| Other assets and investments                                                                                                                               |       |                         | 21,627     |              |       |                         | —     |   |   |   | 21,627 |   |   |
| Goodwill                                                                                                                                                   |       |                         | 180,254    |              |       |                         | (1,592     | ) |   |   | 178,662 |   |   |
| Intangible assets, net                                                                                                                                     |       |                         | 106,496    |              |       |                         | —     |   |   |   | 106,496 |   |   |
|                                                                                                                                                       |       |                         | $          | 652,052           |       |                         |       | $ | (1,592 | ) |   |   | $ | 650,460 |   |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                  |       |                         |       |              |       |                         |       |   |   |   |   |   |   |
| Current liabilities:                                                                                                                                       |       |                         |       |              |       |                         |       |   |   |   |   |   |   |
| Accounts payable                                                                                                                                           |       |                         | $          | 44,737            |       |                         |       | $ | — |   |   |   | $ | 44,737 |   |   |
| Accrued expenses and other liabilities                                                                                                                     |       |                         | 53,562     |              |       |                         | 621        |   |   |   | 54,183 |   |   |
| Total current liabilities                                                                                                                                  |       |                         | 98,299     |              |       |                         | 621        |   |   |   | 98,920 |   |   |
| Other long-term liabilities                                                                                                                                |       |                         | 12,770     |              |       |                         | —     |   |   |   | 12,770 |   |   |
| Stockholders’ equity:                                                                                                                                 |       |                         |       |              |       |                         |       |   |   |   |   |   |   |
| Common stock, $0.001 par value; 105,000,000 shares  authorized at March 31, 2006; 46,716,431 shares issued and outstanding  as of March 31, 2006 |       |                         | 47         |              |       |                         | —     |   |   |   | 47 |   |   |
| Additional paid-in capital                                                                                                                                 |       |                         | 748,792    |              |       |                         | 10,907     |   |   |   | 759,699 |   |   |
| Accumulated other comprehensive income                                                                                                                     |       |                         | 2,179      |              |       |                         | —     |   |   |   | 2,179 |   |   |
| Accumulated deficit                                                                                                                                        |       |                         | (210,035   | )                 |       |                         | (13,120    | ) |   |   | (223,155 | ) |   |
| Total stockholders’ equity                                                                                                                            |       |                         | 540,983    |              |       |                         | (2,213     | ) |   |   | 538,770 |   |   |
|                                                                                                                                                       |       |                         | $          | 652,052           |       |                         |       | $ | (1,592 | ) |   |   | $ | 650,460 |   |   |

----

(1)          The restated consolidated balancesheet as of March 31, 2006 reflects a $13.1 million increase to accumulateddeficit and a $10.9 million increase to additional paid-in capital primarilydue to additional stock-based compensation recorded in connection with thisrestatement to correct prior year stock option-related accounting errors asdescribed above and to reflect the cumulative impact of other adjustments thatwere previously considered to be immaterial. The $1.6 million decrease togoodwill is the impact of recording losses associated with our investment inOren Semiconductor and $0.6 million increase to accrued expenses and otherliabilities relates to the tax adjustments associated with other adjustments atMarch 31, 2006. 

 

110

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The following tables present the impact of thefinancial statement adjustments on our previously reported CondensedConsolidated Balance Sheets as of December 31, 2005:

**CONSOLIDATED BALANCE SHEETS**

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

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

----

(1)          The restated consolidated balance sheet for the fiscal year ended2005 reflects a $13.0 million increase to accumulated deficit and a $10.7million increase to additional paid-in capital primarily due to additionalstock-based compensation recorded in connection with this restatement tocorrect prior year stock option-related accounting errors as described aboveand to reflect the cumulative impact of other adjustments that were previouslyconsidered to be immaterial. The $1.6 million decrease to goodwill is theimpact of recording losses associated with our investment in Oren Semiconductorunder the equity method of accounting and $0.8 million increase to accruedexpenses and other liabilities relates to the accrual of royalty obligationsthat was previously not recorded at December 31, 2005. 

 

 

111

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The following tables present the impact of thefinancial statement adjustments on our previously reported CondensedConsolidated Balance Sheets as of September 30, 2005:

**CONDENSEDCONSOLIDATED BALANCE SHEETS(in thousands, except share data)**
|                                                                                                                                                                    | ** ** | **September **30,  2005 | ** ** | **Adjustments(1)** | ** ** | **September 30,  2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|--------------------|------------|------------------------------|------------|
| ** **                                                                                                                                                         | ** ** | **(As reported)**       | ** ** | ** **         | ** ** | **(As restated)**       | ** ** |
| ASSETS                                                                                                                                                             |       |                         |       |               |       |                         |       |   |   |   |   |   |   |
| Current assets:                                                                                                                                                    |       |                         |       |               |       |                         |       |   |   |   |   |   |   |
| Cash and cash equivalents                                                                                                                                          |       |                         | $          | 64,782             |       |                         |       | $ | — |   |   |   | $ | 64,782 |   |   |
| Short-term investments                                                                                                                                             |       |                         | 65,412     |               |       |                         | —     |   |   |   | 65,412 |   |   |
| Accounts receivable, net                                                                                                                                           |       |                         | 80,735     |               |       |                         | —     |   |   |   | 80,735 |   |   |
| Inventories                                                                                                                                                        |       |                         | 27,331     |               |       |                         | —     |   |   |   | 27,331 |   |   |
| Prepaid expenses and other current assets                                                                                                                          |       |                         | 13,151     |               |       |                         | —     |   |   |   | 13,151 |   |   |
| Total current assets                                                                                                                                               |       |                         | 251,411    |               |       |                         | —     |   |   |   | 251,411 |   |   |
| Property and equipment, net                                                                                                                                        |       |                         | 16,627     |               |       |                         | —     |   |   |   | 16,627 |   |   |
| Other assets and investments                                                                                                                                       |       |                         | 20,488     |               |       |                         | —     |   |   |   | 20,488 |   |   |
| Goodwill                                                                                                                                                           |       |                         | 185,456    |               |       |                         | (1,408     | ) |   |   | 184,048 |   |   |
| Intangible assets, net                                                                                                                                             |       |                         | 131,966    |               |       |                         | —     |   |   |   | 131,966 |   |   |
|                                                                                                                                                               |       |                         | $          | 605,948            |       |                         |       | $ | (1,408 | ) |   |   | $ | 604,540 |   |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                         |       |                         |       |               |       |                         |       |   |   |   |   |   |   |
| Current  liabilities:                                                                                                                                              |       |                         |       |               |       |                         |       |   |   |   |   |   |   |
| Accounts payable                                                                                                                                                   |       |                         | $          | 37,800             |       |                         |       | $ | — |   |   |   | $ | 37,800 |   |   |
| Accrued expenses and other liabilities                                                                                                                             |       |                         | 59,306     |               |       |                         | 586        |   |   |   | 59,892 |   |   |
| Total current liabilities                                                                                                                                          |       |                         | 97,106     |               |       |                         | 586        |   |   |   | 97,692 |   |   |
| Other long-term liabilities                                                                                                                                        |       |                         | 11,538     |               |       |                         | —     |   |   |   | 11,538 |   |   |
| Stockholders’  equity:                                                                                                                                        |       |                         |       |               |       |                         |       |   |   |   |   |   |   |
| Common stock, $0.001 par value; 105,000,000 shares  authorized at September 30, 2005; 45,011,293 shares issued and  outstanding as of September 30, 2005 |       |                         | 45         |               |       |                         | —     |   |   |   | 45 |   |   |
| Additional paid-in capital                                                                                                                                         |       |                         | 723,671    |               |       |                         | 10,656     |   |   |   | 734,327 |   |   |
| Deferred stock-based compensation                                                                                                                                  |       |                         | (957       | )                  |       |                         | (1,219     | ) |   |   | (2,176 | ) |   |
| Accumulated other comprehensive income                                                                                                                             |       |                         | 3,262      |               |       |                         | (79        | ) |   |   | 3,183 |   |   |
| Accumulated deficit                                                                                                                                                |       |                         | (228,717   | )                  |       |                         | (11,352    | ) |   |   | (240,069 | ) |   |
| Total stockholders’ equity                                                                                                                                    |       |                         | 497,304    |               |       |                         | (1,994     | ) |   |   | 495,310 |   |   |
|                                                                                                                                                               |       |                         | $          | 605,948            |       |                         |       | $ | (1,408 | ) |   |   | $ | 604,540 |   |   |

----

(1)          The restated consolidated balance sheet as of September 30,2005 reflects a $11.4 million increase to accumulated deficit and a $10.7million increase to additional paid-in capital primarily due to additionalstock-based compensation recorded in connection with this restatement tocorrect prior year stock option-related accounting errors as described aboveand to reflect the cumulative impact of other adjustments that were previouslyconsidered to be immaterial. The $1.4 million decrease to goodwill is theimpact of recording losses associated with our investment in Oren Semiconductorunder the equity method of accounting and $0.6 million increase to accruedexpenses and other liabilities relates to the accrual of royalty obligationsthat were previously not recorded at September 30, 2005.

112

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The following tables present the impact of thefinancial statement adjustments on our previously reported CondensedConsolidated Balance Sheets as of June 30, 2005:

**CONDENSEDCONSOLIDATED BALANCE SHEETS(in thousands, except share data)**
|                                                                                                                                                          | ** ** | **June 30,  2005** | ** ** | **Adjustments(1)** | ** ** | **June 30,  2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|--------------------|------------|-------------------------|------------|
| ** **                                                                                                                                               | ** ** | **(As reported)**  | ** ** | ** **         | ** ** | **(As restated)**  | ** ** |
| ASSETS                                                                                                                                                   |       |                    |       |               |       |                    |       |   |   |   |   |   |   |
| Current assets:                                                                                                                                          |       |                    |       |               |       |                    |       |   |   |   |   |   |   |
| Cash and cash equivalents                                                                                                                                |       |                    | $          | 53,425             |       |                    |       | $ | — |   |   |   | $ | 53,425 |   |   |
| Short-term investments                                                                                                                                   |       |                    | 62,618     |               |       |                    | —     |   |   |   | 62,618 |   |   |
| Accounts receivable, net                                                                                                                                 |       |                    | 68,454     |               |       |                    | —     |   |   |   | 68,454 |   |   |
| Inventories                                                                                                                                              |       |                    | 25,353     |               |       |                    | —     |   |   |   | 25,353 |   |   |
| Prepaid expenses and other current assets                                                                                                                |       |                    | 14,903     |               |       |                    | —     |   |   |   | 14,903 |   |   |
| Total current assets                                                                                                                                     |       |                    | 224,753    |               |       |                    | —     |   |   |   | 224,753 |   |   |
| Property and equipment, net                                                                                                                              |       |                    | 17,233     |               |       |                    | —     |   |   |   | 17,233 |   |   |
| Other assets and investments                                                                                                                             |       |                    | 24,435     |               |       |                    | —     |   |   |   | 24,435 |   |   |
| Goodwill                                                                                                                                                 |       |                    | 185,456    |               |       |                    | (1,408     | ) |   |   | 184,048 |   |   |
| Intangible assets, net                                                                                                                                   |       |                    | 144,724    |               |       |                    | —     |   |   |   | 144,724 |   |   |
|                                                                                                                                                     |       |                    | $          | 596,601            |       |                    |       | $ | (1,408 | ) |   |   | $ | 595,193 |   |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                               |       |                    |       |               |       |                    |       |   |   |   |   |   |   |
| Current  liabilities:                                                                                                                                    |       |                    |       |               |       |                    |       |   |   |   |   |   |   |
| Accounts payable                                                                                                                                         |       |                    | $          | 38,837             |       |                    |       | $ | — |   |   |   | $ | 38,837 |   |   |
| Accrued expenses and other liabilities                                                                                                                   |       |                    | 56,330     |               |       |                    | 353        |   |   |   | 56,683 |   |   |
| Total current liabilities                                                                                                                                |       |                    | 95,167     |               |       |                    | 353        |   |   |   | 95,520 |   |   |
| Other long-term liabilities                                                                                                                              |       |                    | 12,250     |               |       |                    | —     |   |   |   | 12,250 |   |   |
| Stockholders’  equity:                                                                                                                              |       |                    |       |               |       |                    |       |   |   |   |   |   |   |
| Common stock, $0.001 par value; 105,000,000 shares  authorized at June 30, 2005; 44,759,422 shares issued and outstanding as  of June 30, 2005 |       |                    | 45         |               |       |                    | —     |   |   |   | 45 |   |   |
| Additional paid-in capital                                                                                                                               |       |                    | 721,143    |               |       |                    | 10,656     |   |   |   | 731,799 |   |   |
| Deferred stock-based compensation                                                                                                                        |       |                    | (1,417     | )                  |       |                    | (1,906     | ) |   |   | (3,323 | ) |   |
| Accumulated other comprehensive income                                                                                                                   |       |                    | 3,088      |               |       |                    | (122       | ) |   |   | 2,966 |   |   |
| Accumulated deficit                                                                                                                                      |       |                    | (233,675   | )                  |       |                    | (10,389    | ) |   |   | (244,064 | ) |   |
| Total stockholders’ equity                                                                                                                          |       |                    | 489,184    |               |       |                    | (1,761     | ) |   |   | 487,423 |   |   |
|                                                                                                                                                     |       |                    | $          | 596,601            |       |                    |       | $ | (1,408 | ) |   |   | $ | 595,193 |   |   |

----

(1)          The restated consolidated balance sheet as of June 30, 2005reflects a $10.4 million increase to accumulated deficit and a $10.7 millionincrease to additional paid-in capital primarily due to additional stock-basedcompensation recorded in connection with this restatement to correct prior yearstock option-related accounting errors as described above and to reflect thecumulative impact of other adjustments that were previously considered to beimmaterial. The $1.4 million decrease to goodwill is the impact of recordinglosses associated with our investment in Oren Semiconductor under the equitymethod of accounting and $0.4 million increase to accrued expenses and otherliabilities relates to the accrual of royalty obligations that were previouslynot recorded at June 30, 2005.

113

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The following tables present the impact of thefinancial statement adjustments on our previously reported CondensedConsolidated Balance Sheets as of March 31, 2005:

**CONDENSEDCONSOLIDATED BALANCE SHEETS(in thousands, except share data)**
|                                                                                                                                                            | ** ** | **March 31,  2005** | ** ** | **Adjustments**(1) | ** ** | **March 31,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|--------------------|------------|--------------------------|------------|
| ** **                                                                                                                                                 | ** ** | **(As reported)**   | ** ** | ** **         | ** ** | **(As restated)**   | ** ** |
| ASSETS                                                                                                                                                     |       |                     |       |               |       |                     |       |   |   |   |   |   |   |
| Current assets:                                                                                                                                            |       |                     |       |               |       |                     |       |   |   |   |   |   |   |
| Cash and cash equivalents                                                                                                                                  |       |                     | $          | 31,025             |       |                     |       | $ | — |   |   |   | $ | 31,025 |   |   |
| Short-term investments                                                                                                                                     |       |                     | 50,311     |               |       |                     | —     |   |   |   | 50,311 |   |   |
| Accounts receivable, net                                                                                                                                   |       |                     | 68,023     |               |       |                     | —     |   |   |   | 68,023 |   |   |
| Inventories                                                                                                                                                |       |                     | 34,207     |               |       |                     | —     |   |   |   | 34,207 |   |   |
| Prepaid expenses and other current assets                                                                                                                  |       |                     | 17,995     |               |       |                     | —     |   |   |   | 17,995 |   |   |
| Total current assets                                                                                                                                       |       |                     | 201,561    |               |       |                     | —     |   |   |   | 201,561 |   |   |
| Property and equipment, net                                                                                                                                |       |                     | 16,270     |               |       |                     | —     |   |   |   | 16,270 |   |   |
| Other assets and investments                                                                                                                               |       |                     | 62,470     |               |       |                     | (1,484     | ) |   |   | 60,986 |   |   |
| Goodwill                                                                                                                                                   |       |                     | 150,151    |               |       |                     | —     |   |   |   | 150,151 |   |   |
| Intangible assets, net                                                                                                                                     |       |                     | 148,054    |               |       |                     | —     |   |   |   | 148,054 |   |   |
|                                                                                                                                                       |       |                     | $          | 578,506            |       |                     |       | $ | (1,484 | ) |   |   | $ | 577,022 |   |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                 |       |                     |       |               |       |                     |       |   |   |   |   |   |   |
| Current  liabilities:                                                                                                                                      |       |                     |       |               |       |                     |       |   |   |   |   |   |   |
| Accounts payable                                                                                                                                           |       |                     | $          | 27,955             |       |                     |       | $ | — |   |   |   | $ | 27,955 |   |   |
| Accrued expenses and other liabilities                                                                                                                     |       |                     | 53,797     |               |       |                     | 227        |   |   |   | 54,024 |   |   |
| Total current liabilities                                                                                                                                  |       |                     | 81,752     |               |       |                     | 227        |   |   |   | 81,979 |   |   |
| Other long-term liabilities                                                                                                                                |       |                     | 13,064     |               |       |                     | —     |   |   |   | 13,064 |   |   |
| Stockholders’  equity:                                                                                                                                |       |                     |       |               |       |                     |       |   |   |   |   |   |   |
| Common stock, $0.001 par value; 105,000,000 shares  authorized at March 31, 2005; 45,252,892 shares issued and outstanding  as of March 31, 2005 |       |                     | 43         |               |       |                     | —     |   |   |   | 43 |   |   |
| Additional paid-in capital                                                                                                                                 |       |                     | 705,761    |               |       |                     | 10,656     |   |   |   | 716,417 |   |   |
| Deferred stock-based compensation                                                                                                                          |       |                     | (1,999     | )                  |       |                     | (2,557     | ) |   |   | (4,556 | ) |   |
| Accumulated other comprehensive income                                                                                                                     |       |                     | 2,505      |               |       |                     | (141       | ) |   |   | 2,364 |   |   |
| Accumulated deficit                                                                                                                                        |       |                     | (222,620   | )                  |       |                     | (9,669     | ) |   |   | (232,289 | ) |   |
| Total stockholders’ equity                                                                                                                            |       |                     | 483,690    |               |       |                     | (1,711     | ) |   |   | 481,979 |   |   |
|                                                                                                                                                       |       |                     | $          | 578,506            |       |                     |       | $ | (1,484 | ) |   |   | $ | 577,022 |   |   |

----

(1)          The restated consolidated balance sheet as of March 31, 2005reflects a $9.7 million increase to accumulated deficit and a $10.7 millionincrease to additional paid-in capital primarily due to additional stock-basedcompensation recorded in connection with this restatement to correct prior yearstock option-related accounting errors as described above and to reflect thecumulative impact of other adjustments that were previously considered to beimmaterial. The $1.5 million decrease to goodwill is the impact of recordinglosses associated with our investment in Oren Semiconductor under the equity methodof accounting and $0.2 million increase to accrued expenses and otherliabilities relates to the accrual of royalty obligations that were previouslynot recorded at March 31, 2005.

114

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**Item 9—Changes inand Disagreements with Accountants on Accounting and Financial Disclosure**

Not applicable.

**Item 9A—Controlsand Procedures**

*Disclosure Controlsand Procedures*

Under the supervision and with the participation ofthe Company’s management, including the Company’s Chief Executive Officer andChief Financial Officer, the Company conducted an evaluation of its disclosurecontrols and procedures as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934, as amended (“Exchange Act”). Based on thisevaluation, our Chief Executive Officer and Chief Financial Officer concludedthat the Company’s disclosure controls and procedures were effective as ofDecember 31, 2006. The Company’s disclosure controls and procedures are designedto ensure that information required to be disclosed by us in the reports wefile under the Exchange Act is recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and forms and that suchinformation is accumulated and communicated to management, including the ChiefExecutive Officer and Chief Financial Officer, to allow timely discussionsregarding required disclosures.

*Management’s Reporton Internal Control Over Financial Reporting.*

Our management isresponsible for establishing and maintaining adequate internal control overfinancial reporting. Internal control over financial reporting is a processdesigned by, or under the supervision of, our Chief Executive Officer and ChiefFinancial Officer, and effected by our board of directors, management and otherpersonnel, to provide reasonable assurance regarding the reliability offinancial 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 themaintenance of records that in reasonable detail accurately and fairly reflectthe transactions and dispositions of the assets of the Company;

2.                provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with GAAP, and that our receipts andexpenditures are being made only in accordance with authorizations of ourmanagement and directors; and

3.                provide reasonableassurance regarding prevention or timely detection of unauthorized acquisition,use or disposition of our assets that could have a material effect on ourfinancial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent 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.

Under the supervision and with the participation ofour management, including our Chief Executive Officer and Chief FinancialOfficer, we conducted an evaluation of the effectiveness of our internalcontrol over financial reporting based on criteria established in *Internal Control—Integrated Framework* issued by theCommittee of Sponsoring Organizations of the Treadway Commission. Based on ourevaluation using criteria established in *Internal Control—IntegratedFramework*, our management concluded that our internal control overfinancial reporting was effective as of December 31, 2006.

Our management’s assessment of the effectiveness ofour internal control over financial reporting as of December 31, 2006 has beenaudited by PricewaterhouseCoopers LLP, an independent registered publicaccounting firm, as stated in their report which appears herein.

115

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*Management’s Consideration of the Restatement*

As disclosed in Note 2, “Restatement of ConsolidatedFinancial Statements,” to our consolidated financial statements included inItem 8 of this Annual Report on Form 10-K, we restated previously issuedfinancial statements to record incremental non-cash stock based compensationcharges under APB No. 25 in the amount of $11.7 million between 1997 and 2005and an additional $0.4 million in 2006 under SFAS No. 123(R). Theseaccounting errors arose from the use of incorrect stock option grantmeasurement dates for grants made during the period 1997 to 2003. 

In coming to the conclusion that our disclosurecontrols and procedures and our internal control over financial reporting wereeffective as of December 31, 2006, management considered control deficienciesrelated to the stock option granting process that resulted in the need torestate our previously issued financial statements.

During fiscal year2004 in compliance with the Sarbanes-Oxley Act of 2002, the Company implementedimproved procedures, processes and systems to provide additional safeguards andgreater internal control over its stock option granting and administration.These improvements included:

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

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

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

The Company believes that these changes remediated thehistorical control deficiency. Consequently, the stock option grant process didnot constitute a control deficiency as of December 31, 2006.

*Changes to InternalControl Over Financial Reporting*

There were no changes in the Company’s internalcontrol over financial reporting during the fourth quarter of fiscal 2006 thathave materially affected, or are reasonably likely to materially affect, theCompany’s internal control over financial reporting.

**Item 9B—OtherInformation**

Not applicable.

116

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**PART III**

Certain informationrequired by Part III is omitted from this report in that the Companyintends to file its definitive proxy statement pursuant to Regulation 14A(the “Proxy Statement”) not later than 120 days after the end of thefiscal year covered by this report and certain information therein isincorporated herein by reference.

**Item10—Directors, Executive Officers and Corporate Governance**

The information concerningour directors required by this Item is incorporated by reference to the sectionin our Proxy Statement entitled “Proposal No. 1—Election of Directors.”

The information concerningour executive officers required by this Item is incorporated by reference tothe section in our Proxy Statement entitled “Executive Officers.”

The information concerningcompliance with Section 16(a) of the Securities Exchange Act of 1934required by this Item is incorporated by reference to the section in our ProxyStatement entitled “Section 16(a) Beneficial Ownership Reporting Compliance.”

The information concerningwhether we have adopted a code of ethics that applies to our principalexecutive officer, principal financial officer, principal accounting officer orcontroller, or persons performing similar functions, is incorporated byreference to the section in our Proxy Statement entitled “Committee Chartersand Other Corporate Governance Materials.”

The information concerningmaterial changes to the procedures by which stockholders may recommend nomineesto the Board of Directors required by this Item is incorporated by reference tothe section in our Proxy Statement entitled “Director Nominations.”

The information concerningthe audit committee of the Board of Directors required by this Item isincorporated by reference to the section in our Proxy Statement entitled “BoardMeetings and Committees.”

**Item11—Executive Compensation**

The information requiredby this Item is incorporated by reference to the section of our Proxy Statemententitled “Executive Compensation and Other Matters”.

**Item12—Security Ownership of Certain Beneficial Owners and Management and RelatedStockholder Matters**

The information requiredby this Item is incorporated by reference to the section of our Proxy Statemententitled “Principal Stockholders and Stock Ownership by Management” and “EquityCompensation Plan Information.”

**Item13—Certain Relationships and Related Transactions, and Director Independence**

The information requiredby this Item with respect to certain relationships and related transactions isincorporated by reference to the section of our Proxy Statement entitled“Certain Relationships and Related Transactions.”

The information requiredby this Item with respect to director independence is incorporated by referenceto the section of our Proxy Statement entitled “Directors” “Independence of theBoard of Directors and its Committees.”

**Item14—Principal Accounting Fees and Services**

The information requiredby this Item is incorporated by reference to the section of our Proxy Statemententitled “Principal Auditor Fees and Services.”

117

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**PART IV**

**Item15—Exhibits and Financial Statement Schedules**

Thefollowing documents are filed as a part of this report:

(1)   Financial Statements:

See Index to ConsolidatedFinancial Statements at page 62 of this report.

(2)   Financial Statement Schedules:

Allfinancial statement schedules are omitted because they are not applicable ornot required, or because the required information is included in theConsolidated Financial Statements and Notes thereto which are included herein.

(3)   Exhibits:

**EXHIBITLIST**

|             | ** ** | ** **                                                                                                                                                                                                                            | ** ** | **Incorporated by Reference** |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                                            | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Filed** |
| **Number**  | ** ** | **Exhibit Title**                                                                                                                                                                                                                | ** ** | **Form**                      | ** ** | **File No.** | ** ** | **Exhibit** | ** ** | **Filing Date** | ** ** | **Herewith** |
| 3.1         |       | Restated Certificate of Incorporation of the  Registrant                                                                                                                                                                              |       |                          |   |   |   |   |   |   |   | X |
| 3.2         |       | Amended Bylaws of the Registrant                                                                                                                                                                                                      |       |                          |   |   |   |   |   |   |   | X |
| 4.1         |       | Form of Stock Certificate                                                                                                                                                                                                        |       |                          |   |   |   |   |   |   |   | X |
| *10.1       |       | Form of Indemnity Agreement for officers and  directors                                                                                                                                                                          |       | SB-2                          |   | 33-98630 |   | 10.4 |   | 12/14/1995 |   |   |
| *10.2       |       | 2000 Nonstatutory Stock Option Plan                                                                                                                                                                                                   |       | 10-K                          |   | 000-27246 |   | 10.39 |   | 03/31/2003 |   |   |
| *10.3       |       | Executive Retention and Severance Plan, as amended                                                                                                                                                                                    |       | 8-K                           |   | 000-27246 |   | 99.1 |   | 10/31/05 |   |   |
| 10.4        |       | Oak Technology, Inc. 1994 Stock Option Plan (as  amended and restated)                                                                                                                                                           |       | S-8                           |   | 333-104498 |   | 99.1 |   | 04/14/2003 |   |   |
| 10.5        |       | Oak Technology, Inc. 1994 Outside Directors’  Stock Option Plan (as Amended and Restated November 21, 2002)                                                                                                            |       | 10-Q/A                        |   | 000-25298 |   | 10.1 |   | 06/27/2003 |   |   |
| *10.6       |       | 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-Q                          |   | 000-27246 |   | 10.46 |   | 11/14/2003 |   |   |
| 10.7        |       | Asset Purchase Agreement between Oak  Technology, Inc., and Sunplus Technology, Co. LTD. dated  February 5, 2003                                                                                                            |       | 8-K                           |   | 000-25298 |   | 2.1 |   | 02/20/2003 |   |   |
| 10.8        |       | First Amendment to Asset Purchase Agreement between  Oak Technology, Inc., and Sunplus Technology, Co. LTD. dated  April 3, 2003                                                                                            |       | 8-K                           |   | 000-25298 |   | 2.2 |   | 04/18/2003 |   |   |
| *10. 9      |       | Summary of Compensation Arrangements with Named  Executive Officers and Nonemployee Directors                                                                                                                                         |       | 8-K                           |   | 000-27246 |   | 99.1 |   | 03/31/2006 |   |   |
| *10.10      |       | Offer Letter to Karl Schneider dated  December 15, 1997, as amended July 15, 1998                                                                                                                                           |       | 10-K/A                        |   | 000-27246 |   | 10.49 |   | 05/02/2005 |   |   |

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| 10.11  |   | Lease Agreement dated February 2005 between ZML  and Matam                                                                                                                                      |   | POS-AM |   | 333-125948 |   | 10.11  |   | 07/29/05   |   |   |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|------------|--------|--------|--------|------------|--------|--------|
| 10.12  |   | Form of Employee Proprietary Information and  Invention Agreement                                                                                                                               |   | 10-K/A |   | 000-27246  |   | 10.51  |   | 05/02/2005 |   |   |
| *10.13 |   | Zoran Corporation 2005 Equity Incentive Plan                                                                                                                                                         |   | 8-K    |   | 000-27246  |   | 99.1   |   | 07/13/2006 |   |   |
| 10.14  |   | Zoran Corporation 2005 Outside Directors Equity Plan                                                                                                                                                 |   | 8-K    |   | 000-27246  |   | 99.2   |   | 08/03/2005 |   |   |
| 10.15  |   | PC Optical Storage Technology Patent License  Agreement dated as of January 25, 2006 among Zoran, Zoran’s subsidiary  Oak Technology, Inc., and MediaTek, Inc                         |   | 10-Q   |   | 000-27246  |   | 10.54  |   | 05/10/2006 |   |   |
| 10.16  |   | PC Optical Storage Patent Cross License Agreement  dated as of January 25, 2006 among Zoran, Zoran’s subsidiary Oak  Technology, Inc. and MediaTek, Inc.                         |   | 10-Q   |   | 000-27246  |   | 10.55  |   | 05/10/2006 |   |   |
| *10.17 |   | 1993 Stock Option Plan, as amended                                                                                                                                                                   |   |   |   |       |   |   |   |       |   | X      |
| *10.18 |   | 1995 Outside Directors Stock Option Plan                                                                                                                                                             |   |   |   |       |   |   |   |       |   | X      |
| *10.19 |   | Form of Amendment of Nonstatutory Stock Option  Agreement for Outside Directors                                                                                                                 |   |   |   |       |   |   |   |       |   | X      |
| 10.20  |   | Lease Agreement dated as of February 8, 2007 by  and between Arturo J. Gutierrez and John A. Cataldo, Trustees of  Auburn-Oxford Trust, u/d/t dated October 19, 1983 and Zoran Corporation |   |   |   |       |   |   |   |       |   | X      |
| 10.21  |   | Lease Agreement dated as of May 19, 2006 by and  between WTA Kifer LLC and Zoran Corporation, as amended on May 19, 2006                                                                   |   |   |   |       |   |   |   |       |   | X      |
| *10.22 |   | Amended Summary of Compensation Arrangements with  Named Executive Officers and Non Employee Directors                                                                                               |   | 8-K    |   | 000-27246  |   | 99.1   |   | 03/31/2006 |   |   |
| 21.1   |   | List of Subsidiaries of the Registrant                                                                                                                                                               |   |   |   |       |   |   |   |       |   | X      |
| 23.1   |   | Consent of PricewaterhouseCoopers LLP                                                                                                                                                                |   |   |   |       |   |   |   |       |   | X      |
| 31.1   |   | Certification of Chief Executive Officer, pursuant  to Rule 13a-14(a) or 15d-14(a)                                                                                                         |   |   |   |       |   |   |   |       |   | X      |
| 31.2   |   | Certification of Chief Financial Officer, pursuant  to Rule 13a-14(a) or 15d-14(a)                                                                                                         |   |   |   |       |   |   |   |       |   | X      |
| 32.1   |   | Certification of Chief Executive Officer, pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                            |   |   |   |       |   |   |   |       |   | X      |
| 32.2   |   | Certification of Chief Financial Officer, pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                            |   |   |   |       |   |   |   |       |   | X      |

----

*                    Constitutes amanagement contract or compensatory plan, contract or arrangement.

119

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**SIGNATURES**

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.
| Dated:  April 19, 2007 |   | ZORAN CORPORATION |
|-----------------------------|--------|-------------------|
|                        |   | By:               |   | /s/   LEVY GERZBERG |
|                        |   |              |   | **Levy  Gerzberg,   President and Chief Executive Officer** |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.
|                                     | **Signature** | ** **                                                              | ** ** | ** **          | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|-------------------------------------|---------------|-------------------------------------------------------------------------|------------|---------------------|-----------|------------|------------|------------|----------|------------|
| /s/   LEVY  GERZBERG      |          | President, Chief  Executive Officer and Director                        |       | April 19, 2007 |
| **Levy Gerzberg**                   |          | (Principal Executive Officer)                                           |       |                |
| /s/   KARL  SCHNEIDER     |          | Senior Vice President, Finance and Chief Financial                      |       | April 19, 2007 |
| **Karl Schneider**                  |          | Officer  (Principal Financial Officer and Principal Accounting Officer) |       |                |
| /s/   UZIA  GALIL         |          | Chairman of the  Board of Directors                                     |       | April 19, 2007 |
| **Uzia Galil**                      |          |                                                                    |       |                |
| /s/   RAYMOND  A. BURGESS |          | Director                                                                |       | April 19, 2007 |
| **Raymond A. Burgess**              |          |                                                                    |       |                |
| /s/   JAMES  D. MEINDL    |          | Director                                                                |       | April 19, 2007 |
| **James D. Meindl**                 |          |                                                                    |       |                |
| /s/   JAMES  B. OWENS     |          | Director                                                                |       | April 19, 2007 |
| **James B. Owens, Jr.**        |          |                                                                    |       |                |
| /s/   DAVID  RYNNE        |          | Director                                                                |       | April 19, 2007 |
| **David Rynne**                     |          |                                                                    |       |                |
| /s/   ARTHUR  B. STABENOW |          | Director                                                                |       | April 19, 2007 |
| **Arthur B. Stabenow**              |          |                                                                    |       |                |
| /s/   PHILIP  M. YOUNG    |          | Director                                                                |       | April 19, 2007 |
| **Philip  M. Young**                |          |                                                                    |       |                |

 

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**EXHIBIT LIST**

|                     | ** ** | ** **             | ** ** | **Incorporated by Reference**                                                                                                                                                                                               | ** ** |
|---------------------|------------|------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Exhibit  Number** | ** ** | **Exhibit Title** | ** ** | ** **                                                                                                                                                                                                                            | ** ** | **Form** | ** ** | **File No.** | ** ** | **Exhibit** | ** ** | **Filing Date** | ** ** | **Filed  Herewith** | ** ** |
|                | 3.1        |                   |       | Restated  Certificate of Incorporation of the Registrant                                                                                                                                                                              |       |   |   |   |   |   |   |   |   |   |   |   | X |   |   |
|                | 3.2        |                   |       | Amended Bylaws of  the Registrant                                                                                                                                                                                                     |       |   |   |   |   |   |   |   |   |   |   |   | X |   |   |
|                | 4.1        |                   |       | Form of  Stock Certificate                                                                                                                                                                                                       |       |   |   |   |   |   |   |   |   |   |   |   | X |   |   |
|                | *10.1      |                   |       | Form of  Indemnity Agreement for officers and directors                                                                                                                                                                          |       | SB-2 |   | 33-98630 |   |   | 10.4 |   |   | 12/14/1995 |   |   |   |   |   |
|                | *10.2      |                   |       | 2000 Nonstatutory  Stock Option Plan                                                                                                                                                                                                  |       | 10-K |   | 000-27246 |   |   | 10.39 |   |   | 03/31/2003 |   |   |   |   |   |
|                | *10.3      |                   |       | Executive  Retention and Severance Plan, as amended                                                                                                                                                                                   |       | 8-K |   | 000-27246 |   |   | 99.1 |   |   | 10/31/05 |   |   |   |   |   |
|                | 10.4       |                   |       | Oak  Technology, Inc. 1994 Stock Option Plan (as amended and restated)                                                                                                                                                           |       | S-8 |   | 333-104498 |   |   | 99.1 |   |   | 04/14/2003 |   |   |   |   |   |
|                | 10.5       |                   |       | Oak  Technology, Inc. 1994 Outside Directors’ Stock Option Plan (as Amended  and Restated November 21, 2002)                                                                                                           |       | 10-Q/A |   | 000-25298 |   |   | 10.1 |   |   | 06/27/2003 |   |   |   |   |   |
|                | *10.6      |                   |       | 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-Q |   | 000-27246 |   |   | 10.46 |   |   | 11/14/2003 |   |   |   |   |   |
|                | 10.7       |                   |       | Asset Purchase  Agreement between Oak Technology, Inc., and Sunplus Technology, Co. LTD.  dated February 5, 2003                                                                                                            |       | 8-K |   | 000-25298 |   |   | 2.1 |   |   | 02/20/2003 |   |   |   |   |   |
|                | 10.8       |                   |       | First Amendment  to Asset Purchase Agreement between Oak Technology, Inc., and Sunplus  Technology, Co. LTD. dated April 3, 2003                                                                                            |       | 8-K |   | 000-25298 |   |   | 2.2 |   |   | 04/18/2003 |   |   |   |   |   |
|                | *10.9      |                   |       | Summary of  Compensation Arrangements with Named Executive Officers and Nonemployee  Directors                                                                                                                                        |       | 8-K |   | 000-27246 |   |   | 99.1 |   |   | 03/31/2006 |   |   |   |   |   |
|                | *10.10     |                   |       | Offer Letter to  Karl Schneider dated December 15, 1997, as amended July 15, 1998                                                                                                                                           |       | 10-K/A |   | 000-27246 |   |   | 10.49 |   |   | 05/02/2005 |   |   |   |   |   |
|                | 10.11      |                   |       | Lease Agreement  dated February 2005 between ZML and Matam                                                                                                                                                                       |       | POS-AM |   | 333-125948 |   |   | 10.11 |   |   | 07/29/05 |   |   |   |   |   |
|                | 10.12      |                   |       | Form of  Employee Proprietary Information and Invention Agreement                                                                                                                                                                |       | 10-K/A |   | 000-27246 |   |   | 10.51 |   |   | 05/02/2005 |   |   |   |   |   |
|                | *10.13     |                   |       | Zoran Corporation  2005 Equity Incentive Plan                                                                                                                                                                                         |       | 8-K |   | 000-27246 |   |   | 99.1 |   |   | 07/13/2006 |   |   |   |   |   |
|                     |            |                        |            |                                                                                                                                                                                                                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

121

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|                     | ** ** | ** **             | ** ** | **Incorporated by Reference**                                                                                                                                                               | ** ** |
|---------------------|------------|------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Exhibit  Number** | ** ** | **Exhibit Title** | ** ** | ** **                                                                                                                                                                                            | ** ** | **Form** | ** ** | **File No.** | ** ** | **Exhibit** | ** ** | **Filing Date** | ** ** | **Filed  Herewith** | ** ** |
|                | 10.14      |                   |       | Zoran Corporation  2005 Outside Directors Equity Plan                                                                                                                                                 |       | 8-K |   | 000-27246 |   |   | 99.2 |   |   | 08/03/2005 |   |   |   |   |   |
|                | 10.15      |                   |       | PC Optical  Storage Technology Patent License Agreement dated as of January 25, 2006  among Zoran, Zoran’s subsidiary Oak Technology, Inc., and MediaTek, Inc                          |       | 10-Q |   | 000-27246 |   |   | 10.54 |   |   | 05/10/2006 |   |   |   |   |   |
|                | 10.16      |                   |       | PC Optical  Storage Patent Cross License Agreement dated as of January 25, 2006  among Zoran, Zoran’s subsidiary Oak Technology, Inc. and  MediaTek, Inc.                         |       | 10-Q |   | 000-27246 |   |   | 10.55 |   |   | 05/10/2006 |   |   |   |   |   |
|                | *10.17     |                   |       | 1993 Stock Option  Plan, as amended                                                                                                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   | X |   |   |
|                | *10.18     |                   |       | 1995 Outside  Directors Stock Option Plan                                                                                                                                                             |       |   |   |   |   |   |   |   |   |   |   |   | X |   |   |
|                | *10.19     |                   |       | Form of  Amendment of Nonstatutory Stock Option Agreement for Outside Directors                                                                                                                  |       |   |   |   |   |   |   |   |   |   |   |   | X |   |   |
|                | 10.20      |                   |       | Lease Agreement  dated as of February 8, 2007 by and between Arturo J. Gutierrez and John  A. Cataldo, Trustees of Auburn-Oxford Trust, u/d/t dated October 19,  1983 and Zoran Corporation |       |   |   |   |   |   |   |   |   |   |   |   | X |   |   |
|                | 10.21      |                   |       | Lease Agreement  dated as of May 19, 2006 by and between WTA Kifer LLC and Zoran Corporation,  as amended on May 19, 2006                                                                   |       |   |   |   |   |   |   |   |   |   |   |   | X |   |   |
|                | *10.22     |                   |       | Amended Summary  of Compensation Arrangements with Named Executive Officers and Non Employee  Directors                                                                                               |       | 8-K |   | 000-27246 |   |   | 99.1 |   |   | 03/31/2006 |   |   |   |   |   |
|                | 21.1       |                   |       | List of  Subsidiaries of the Registrant                                                                                                                                                               |       |   |   |   |   |   |   |   |   |   |   |   | X |   |   |
|                | 23.1       |                   |       | Consent of  PricewaterhouseCoopers LLP                                                                                                                                                                |       |   |   |   |   |   |   |   |   |   |   |   | X |   |   |
|                | 31.1       |                   |       | Certification of  Chief Executive Officer, pursuant to Rule 13a-14(a) or 15d-14(a)                                                                                                               |       |   |   |   |   |   |   |   |   |   |   |   | X |   |   |
|                | 31.2       |                   |       | Certification of  Chief Financial Officer, pursuant to Rule 13a-14(a) or 15d-14(a)                                                                                                               |       |   |   |   |   |   |   |   |   |   |   |   | X |   |   |
|                | 32.1       |                   |       | Certification of  Chief Executive Officer pursuant to 18 U.S.C. Section 1350                                                                                                                     |       |   |   |   |   |   |   |   |   |   |   |   | X |   |   |
|                | 32.2       |                   |       | Certification of Chief  Financial Officer pursuant to 18 U.S.C. Section 1350                                                                                                                     |       |   |   |   |   |   |   |   |   |   |   |   | X |   |   |
|                     |            |                        |            |                                                                                                                                                                                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

*                    Constitutes amanagement contract or compensatory plan, contract or arrangement.

122

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