Zoran (ZRAN) 10-Q 2002 Q3 Quarterly report

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended September 30, 2002
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from                        to

Commission File Number:  0-27246

ZORAN CORPORATION

(Exact name of registrant as specified in its charter)

Delaware	94-2794449
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
3112 Scott Boulevard, Santa Clara, California 95054
(Address of principal executive offices)              (Zip Code)
Registrant’s telephone number, including area code:     (408) 919-4111

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  ý                  No  o

The number of outstanding shares of the registrant’s Common Stock, $.001 par value, as of October 31, 2002 was 27,191,727.

ZORAN CORPORATION

INDEX

PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets September 30, 2002 and December 31, 2001
	Condensed Consolidated Statements of Operations Three and Nine Months Ended September 30, 2002 and 2001
	Condensed Consolidated Statements of Cash Flows Nine Months Ended September 30, 2002 and 2001
	Notes to Condensed Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
PART II. OTHER INFORMATION
Item 6.	Exhibits and Reports on Form 8-K
SIGNATURES

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ZORAN CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

(unaudited)

	September 30, 2002			December 31, 2001
ASSETS
Current assets:
Cash and cash equivalents	$	20,678		$	20,287
Short-term investments	97,855			89,818
Accounts receivable, net	34,449			33,367
Inventory	21,695			15,681
Prepaid expenses and other current assets	5,271			5,130
Total current assets	179,948			164,283
Property and equipment, net	6,670			7,159
Other investments	87,975			89,727
Goodwill	59,131			59,131
Intangible assets	4,116			11,044
	$	337,840		$	331,344
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	13,040		$	16,705
Accrued expenses and other liabilities	19,620			16,801
Total current liabilities	32,660			33,506
Stockholders’ equity:
Common Stock, $0.001 par value; 55,000,000 shares authorized; 27,156,498 and 26,702,781 shares issued and outstanding	27			27
Additional paid-in capital	396,563			391,665
Warrants	—			717
Deferred stock-based compensation	(93		)	(375		)
Accumulated other comprehensive loss	(2,629		)	(6		)
Accumulated deficit	(88,688		)	(94,190		)
Total stockholders’ equity	305,180			297,838
	$	337,840		$	331,344

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

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ZORAN CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

	Three Months Ended September 30,					Nine Months Ended September 30,
	2002		2001			2002		2001
Revenues:
Product sales	$	43,814	$	28,976		$	105,118	$	66,913
Software, licensing and development	243		1,448			4,023		5,028
Total revenues	44,057		30,424			109,141		71,941
Costs and expenses:
Cost of product sales	25,349		18,971			64,740		43,075
Research and development	5,880		5,210			16,922		17,100
Selling, general and administrative	6,697		5,416			18,342		15,819
Amortization of goodwill and other intangibles	2,319		10,808			7,209		32,425
Total costs and expenses	40,245		40,405			107,213		108,419
Operating income (loss)	3,812		(9,981		)	1,928		(36,478		)
Interest and other income, net	1,676		2,412			4,987		7,763
Income (loss) before income taxes	5,488		(7,569		)	6,915		(28,715		)
Provision for income taxes	781		486			1,413		557
Net income (loss)	$	4,707	$	(8,055	)	$	5,502	$	(29,272	)
Basic net income (loss) per share	$	0.17	$	(0.31	)	$	0.20	$	(1.12	)
Diluted net income (loss) per share	$	0.17	$	(0.31	)	$	0.19	$	(1.12	)
Shares used to compute basic net income (loss) per share	27,150		26,253			27,018		26,060
Shares used to compute diluted net income (loss) per share	28,089		26,253			28,687		26,060

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

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ZORAN CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Nine Months Ended September 30,
	2002			2001
Cash flows from operating activities:
Net income (loss)	$	5,502		$	(29,272	)
Adjustments to reconcile net income (loss) to net cash provided by operations:
Depreciation, amortization and other	1,804			3,022
Amortization of goodwill and other intangibles	7,209			32,017
Realized loss on exchange of marketable securities	696			—
Changes in current assets and liabilities:
Accounts receivable	(970		)	(3,618		)
Inventory	(6,014		)	(1,596		)
Prepaid expenses and other current assets	(141		)	1,309
Accounts payable	(3,665		)	2,631
Accrued expenses and other liabilities	2,998			(1,014		)
Net cash provided by operating activities	7,419			3,479
Cash flows from investing activities:
Capital expenditures for property and equipment	(1,308		)	(3,120		)
Purchases of investments	(129,488		)	(160,558		)
Sales of investments	37,686			14,404
Maturities of investments	81,901			143,093
Purchases of long-term equity investments	—			(1,171		)
Net cash used in investing activities	(11,209		)	(7,352		)
Cash flows from financing activities:
Proceeds from issuance of Common Stock, net	4,181			4,753
Repurchases of Common Stock	—			(3,867		)
Net cash provided by financing activities	4,181			886
Net increase (decrease) in cash and cash equivalents	391			(2,987		)
Cash and cash equivalents at beginning of period	20,287			16,099
Cash and cash equivalents at end of period	$	20,678		$	13,112

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

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ZORAN CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1.             Basis of Presentation

The accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) which, in the opinion of management, are necessary to present fairly the financial information included therein.  While the Company believes that the disclosures are adequate to make the information not misleading, it is suggested that these financial statements be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2001.  Results for the interim periods presented are not necessarily indicative of the results to be expected for the full year.

2.             Comprehensive Income

The Company applies Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income.

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2002			2001			2002			2001
Net income (loss)	$	4,707		$	(8,055	)	$	5,502		$	(29,272	)
Unrealized gain (loss) on marketable investments	(953		)	1,170			(2,623		)	(623		)
Comprehensive income (loss)	$	3,754		$	(6,885	)	$	2,879		$	(29,895	)

The components of accumulated other comprehensive income (loss) are unrealized gain (loss) on short-term and long-term marketable securities.

3.             Balance Sheet Components (in thousands):

	September 30, 2002		December 31, 2001
Inventory:
Work-in-process	$	6,172	$	3,119
Finished goods	15,523		12,562
	$	21,695	$	15,681

4.             Goodwill and Other Intangible Assets

The Company adopted Financial Accounting Standards Board (“FASB”) Statement No. 142 “Goodwill and Other Intangible Assets” (“SFAS 142”) as of January 1, 2002. SFAS 142 changed the accounting for goodwill from an amortization method to an impairment only approach. Under SFAS 142, goodwill will be tested annually and whenever events or circumstances occur indicating that goodwill might be impaired. In connection with the adoption of SFAS 142, the Company has performed a transitional goodwill impairment assessment based on its structure as one reporting unit and determined that no impairment existed at January 1, 2002. The Company is in the process of conducting its annual impairment assessment. The Company does not anticipate that the completion of this assessment will have a material impact on its financial position, results of operations, or cash flows.

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Components of Acquired Intangible Assets (in thousands):

		September 30, 2002				December 31, 2001
	Weighted Avg. Life (Years)	Gross carrying Amount		Accumulated Amortization		Gross carrying Amount		Accumulated Amortization
Amortized intangible assets
Covenant not to compete	3	$	800	$	600	$	800	$	400
Patents	3	900		675		900		450
Core technology	3	8,060		5,203		8,060		3,187
Completed technology	2	10,760		10,479		10,760		6,382
Customer base	3	1,560		1,007		1,560		617
Total		$	22,080	$	17,964	$	22,080	$	11,036

During the quarter ended September 30, 2002, the Company incurred $2.3 million in charges related to the amortization of acquired intangible assets associated with the acquisitions of PixelCam Inc. and Nogatech Inc. in June and October 2000, respectively. The Company will incur charges of $1.2 million for the balance of 2002 and $2.9 million for 2003 related to the amortization of these acquired intangible assets.

Reconciliation of Net Income (Loss) Excluding Goodwill Amortization (in thousands except per share data):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2002		2001			2002		2001
Net income (loss):
Net income (loss), as reported	$	4,707	$	(8,055	)	$	5,502	$	(29,272	)
Add back goodwill amortization	—		8,383			—		25,149
Adjusted net income (loss)	$	4,707	$	328		$	5,502	$	(4,123	)
Basic net income (loss) per share:
Net income (loss), as reported	$	0.17	$	(0.31	)	$	0.20	$	(1.12	)
Add back goodwill amortization	—		0.32			—		0.97
Adjusted net income (loss)	$	0.17	$	0.01		$	0.20	$	(0.15	)
Diluted net income (loss) per share:
Net income (loss), as reported	$	0.17	$	(0.31	)	$	0.19	$	(1.12	)
Add back goodwill amortization	—		0.32			—		0.97
Adjusted net income (loss)	$	0.17	$	0.01		$	0.19	$	(0.15	)

5.             Interest and Other Income, Net

On February 1, 2002, Roxio Inc. (“Roxio”) acquired MGI Software Inc (“MGI”). As of the date of acquisition, the Company held approximately 373,000 shares of MGI common stock. Upon consummation of the acquisition, the Company’s MGI common stock was exchanged for 18,843 shares of Roxio common stock. In connection with the exchange, the Company recorded a realized loss of $696,000 and established a new cost basis of its Roxio common stock. The cost basis for the Company’s Roxio common stock is the fair value of the stock on the date of the exchange.

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6.             Income Taxes

The provision for income taxes reflects the estimated annualized effective tax rate applied to earnings excluding charges for amortization of goodwill and other intangibles for the interim periods.  The effective tax rate differs from the U.S. statutory rate due to utilization of net operating losses, adjustments for the nondeductible amortization of goodwill and other intangibles and income tax rate differences on foreign earnings.  The Company has provided for tax on income in excess of net operating loss carryforwards for U.S. Federal and State earnings.  The Company has also provided for tax on its foreign earnings.

7.             Earnings Per Share

Computation of basic and diluted earnings per share is as follows:

	Three Months Ended September 30,
	2002					2001
	Income (Numerator)		Shares (Denominator)	Per Share Amount		(Loss) (Numerator)			Shares (Denominator)	Per Share Amount
Basic and Diluted EPS:
Net income (loss) available to common stockholders	$	4,707	27,150	­$	­0.17	$	(8,055	)	26,253	$	(0.31	)
Effects of Dilutive Securities:
Stock Options	—		939			—			—
Diluted EPS:
Income (loss) available to common stockholders	$	4,707	28,089	$	0.17	$	(8,055	)	26,253	$	(0.31	)

	Nine Months Ended September 30,
	2002					2001
	Income (Numerator)		Shares (Denominator)	Per Share Amount		(Loss) (Numerator)			Shares (Denominator)	Per Share Amount
Basic and Diluted EPS:
Net Income (loss) available to common stockholders	$	5,502	27,018	$	0.20	$	(29,272	)	26,060	$	(1.12	)
Effects of Dilutive Securities:
Stock Options	—		1,646			—			—
Warrants	—		23			—			—
Diluted EPS:
Income (loss) available to common stockholders	$	5,502	28,687	$	0.19	$	(29,272	)	26,060	$	(1.12	)

8.             Repurchase of Common Stock

During the nine months ended September 30, 2001, the Company repurchased 382,500 shares of its common stock for $3.9 million.

9.             Stock Split

On April 21, 2002, the Company’s Board of Directors approved a three-for-two split of our common stock which was effected in the form of a 50 percent stock dividend, paid on May 22, 2002 to stockholders of record on May 7, 2002. All share and per share information for all periods presented in this report are on a post-split basis.

10.          Recently Issued Accounting Standard

In August 2001, the FASB issued SFAS No. 143 (“SFAS 143”), “Accounting for Asset Retirement Obligations”. SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS 143 applies to all entities. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or the normal operation of a long-lived asset, except for certain obligations of lessees. SFAS 143 is effective for financial statements issued for fiscal years beginning after

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June 25, 2002. The Company expects that the initial application of SFAS 143 will not have a material impact on its financial statements.

In April 2002, the FASB issued SFAS No. 145 (“SFAS 145”), “Rescission of SFAS Nos. 4, 44 and 64, Amendment of SFAS 13, and Technical Corrections.” SFAS 145 rescinds SFAS No. 4, “Reporting Gains and Losses from Extinguishment of Debt,” and an amendment of that statement, SFAS No. 64, “Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements,” as well as SFAS No. 44, “Accounting for Intangible Assets of Motor Carriers.” SFAS 145 amends SFAS No. 13, “Accounting for Leases,” to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The provisions of SFAS 145 will be adopted during fiscal 2003. The Company does not expect that the adoption of SFAS 145 will have a material impact on its financial position, results of operations, or cash flows.

In June 2002, the FASB issued SFAS No. 146, (“SFAS 146”), “Accounting for Exit or Disposal Activities.” SFAS 146 addresses significant issues regarding the recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities that are currently accounted for under EITF No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring).” The scope of SFAS 146 also includes costs related to terminating a contract that is not a capital lease and termination benefits that employees who are involuntarily terminated receive under the terms of a one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred-compensation contract. SFAS 146 will be effective for exit or disposal activities that are initiated after December 31, 2002 and early application is encouraged. The Company will adopt SFAS 146 for its fiscal year beginning January 1, 2003 and does not expect that the adoption will have a material impact on its financial position, results of operations, or cash flows.

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

The following discussion includes forward-looking statements with respect to the Company’s future financial performance.  Actual results may differ materially from those currently anticipated depending upon a variety of factors, including those described below under the sub-heading, “Future Performance and Risk Factors” and discussed more fully in the Company’s Annual Report on Form 10-K for the year ended December 31, 2001.

Overview

From our inception in 1981 through 1991, we derived the substantial majority of our revenue from digital filter processors and vector signal processors used principally in military, industrial and medical applications. In 1989, we repositioned our business to develop and market data compression products for the evolving multimedia markets and discontinued development of digital filter processor and vector signal processor products. In 1994, we discontinued production of these products. Our current lines of digital audio and video products include integrated circuits and related products used in digital versatile disc players, or DVDs, movie and home theater systems, filmless digital cameras and video editing systems.

We derive most of our revenues from the sale of our integrated circuit products. Historically, average selling prices in the semiconductor industry in general, and for our products in particular, have decreased over the life of a particular product. Average selling prices for our hardware products have fluctuated substantially from period to period, primarily as a result of changes in our customer mix of original equipment manufacturer, or OEM, sales versus sales to distributors and the transition from low-volume to high-volume production. In the past, we have reduced the prices of some of our products in order to better penetrate the consumer market. We believe that, as our product lines continue to mature and competitive markets evolve, we are likely to experience further declines in the average selling prices of our products, although we cannot predict the timing and amount of such future changes with any certainty.

Our cost of product sales consists primarily of fabrication costs, assembly and test costs, and the cost of materials and overhead from operations. If we are unable to reduce our cost of product sales to offset anticipated decreases in average selling prices, our product gross margins will decrease. Our product gross margin is also dependent on product mix and on the percentage of products sold directly to our OEM customers versus indirectly through our marketing partners who purchase our products at lower prices but absorb most of the associated marketing and sales support expenses, maintain inventories and provide customer support and training. Lower gross margins on sales to distributors are partially offset by reduced selling and marketing expenses related to such sales. Product sales in Japan are primarily made through Fujifilm, our strategic partner and distributor in Japan. Fujifilm provides more sales and marketing support than our other distributors. We expect both product and customer mix to continue to fluctuate in future periods, causing further fluctuations in margins.

We also derive revenue from licensing our software and other intellectual property. Licensing revenue includes one-time license fees and royalties based on the number of units distributed by the licensee. In addition, we have historically generated a significant percentage of our total revenues from development contracts, primarily with key customers, although development revenue has declined as a percentage of total revenues over the past several years. These development contracts have provided us with partial funding for the development of some of our products. These development contracts provide for license and milestone payments which are recorded as development revenue. We classify all development costs, including costs related to these development contracts, as research and development expenses. We retain ownership of the intellectual property developed by us under these development contracts. While we intend to continue to enter into development contracts with certain strategic partners, we expect development revenue to continue to decline as a percentage of total revenues.

Our research and development expenses consist of salaries and related costs of employees engaged in ongoing research, design and development activities and costs of engineering materials and supplies. We are a party to research and development agreements with the Chief Scientist in Israel’s Ministry of Industry and Trade and the Israel-United States Binational Industrial Research and Development Foundation, which fund up to 50% of incurred project costs for approved products up to specified contract maximums. These agreements require us to use our best efforts to achieve specified results and require us to pay royalties at rates of 3% to 5% of resulting product sales, and up to 30% of resulting license revenues, up to a maximum

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of 100% to 150% of total funding received. Reported research and development expenses are net of these grants, which fluctuate from period to period. We believe that significant investments in research and development are required for us to remain competitive and we expect to continue to devote significant resources to product development, although such expenses as a percentage of total revenues may fluctuate.

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

We conduct most of our research and development and certain sales and marketing and administrative operations in Israel through our wholly-owned Israeli subsidiary. As a result, some of our expenses are incurred in New Israeli Shekels. To date, substantially all of our product sales and our development and licensing revenue have been denominated in U.S. dollars and most costs of product sales have been incurred in U.S. dollars. We expect that most of our sales and costs of sales will continue to be denominated and incurred in U.S. dollars for the foreseeable future. We have not experienced material losses or gains as a result of currency exchange rate fluctuations and have not engaged in hedging transactions to reduce our exposure to such fluctuations. We may in the future elect to take action to reduce our foreign exchange risk.

Our effective income tax rate has benefited from the availability of net operating losses which we have utilized to reduce taxable income for U.S. federal income tax purposes and by our Israeli subsidiary’s status as an “Approved Enterprise” under Israeli law, which provides a ten-year tax holiday for income attributable to a portion of our operations in Israel. Our U.S. federal net operating losses expire at various times between 2002 and 2020, and the benefits from our subsidiary’s Approved Enterprise status expire at various times beginning in 2003.

In June 2000, we acquired PixelCam, Inc., a manufacturer of megapixel CMOS image sensors, in exchange for 556,248 shares of our common stock and options to purchase 6,252 shares of our common stock with an aggregate value of $24.6 million. The acquisition was accounted for under the purchase method of accounting. Additional information regarding this acquisition is contained in our Annual Report on Form 10-K for the year ended December 31, 2001.

On October 26, 2000, we acquired Nogatech Inc., a provider of chips that compress digital video images and establish connections, or video connectivity, between video devices and computers, as well as between video devices across a variety of networks, in exchange for 3,801,898 shares of our common stock and options to purchase 252,708 shares of our common stock with an aggregate value of $163.6 million. The acquisition was accounted for under the purchase method of accounting. Additional information regarding this acquisition is contained in our Annual Report on Form 10-K for the year ended December 31, 2001.

On April 21, 2002, our Board of Directors approved a three-for-two split of our common stock which was effected in the form of a 50 percent stock dividend, paid on May 22, 2002 to stockholders of record on May 7, 2002. All share and per share information for all periods presented in this report are on a post-split basis.

Results of Operations

Revenues

Total revenues were $44.1 million and $109.1 million for the three and nine month periods ended September 30, 2002, compared to $30.4 million and $71.9 million for the same periods of 2001, representing increases of 44.8% and 51.7% for the respective periods.  For the three and nine month periods ended September 30, 2002, product revenues were $43.8 million and $105.1 million, compared to $29.0 million and $66.9 million for the same periods in 2001, increases of 51.2% and 57.1%, respectively.  The increase in product sales for the quarter was primarily driven by increased sales in our DVD and digital camera product lines of $9.4 million and $3.5 million, respectively. The increased sales for both product lines were due to increased unit shipments. DVD products again accounted for the majority of our total product sales, representing 77% of the total for the quarter. We expect DVD sales to continue to comprise the majority of our product sales for the balance of 2002. Software, licensing and development revenues were $243,000 and $4.0 million, respectively, for the three and nine month periods ended September 30, 2002, compared to $1.4 million and $5.0 million for the same periods of 2001, representing decreases of 83.2% and 20.0% for the respective periods. We did not enter into any new licensing or development agreements during the current quarter. These declines are

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not necessarily indicative of a developing trend as revenue from licensing and development activities tends to fluctuate significantly from quarter to quarter.

Product Gross Margin

Product gross margins were 42.1% and 38.4% of product revenues for the three and nine month periods ended September 30, 2002, compared to 34.5% and 35.6% for the same periods of 2001. The increase in product gross margin for the quarter ended September 30, 2002 was due to margin improvements in our DVD product line resulting from a higher percentage of newer, more cost effective DVD products that are not required to be sold in combination with DVD CPU companion chips which, historically, were sold at low margins. Management currently anticipates that product gross margins for the quarter ending December 31, 2002 will remain at levels comparable to those experienced in the quarter ended September 30, 2002.

Research and Development

Research and development (“R&D”) expenses were $5.9 million and $16.9 million for the three and nine month periods ended September 30, 2002, compared to $5.2 million and $17.1 million for the same periods of 2001. R&D expenses increased quarter-over-quarter as a result of increased tape-out expenses. As a percentage of revenues, R&D expenses decreased to 13.3% and 15.5% for the three and nine month periods ended September 30, 2002, compared to 17.1% and 23.8% for the same periods of 2001 primarily as a result of increased revenues. Management currently expects that gross R&D expenses for the quarter ending December 31, 2002 will be relatively unchanged from the quarter ended September 30, 2002.

Selling, General and Administrative

Selling, general and administrative (“SG&A”) expenses were $6.7 million and $18.3 million for the three and nine month periods ended September 30, 2002, compared to $5.4 million and $15.8 million for the same periods of 2001. The increase quarter over quarter was principally due to $768,000 of increased marketing and application expenses to support planned revenue growth in our Asia Pacific markets and $243,000 of increased product marketing expenses related to the development of our digital camera products. As a percentage of revenues, SG&A expenses were 15.2% and 16.8% for the three and nine month periods ended September 30, 2002, compared to 17.8% and 22.0% for the same periods of 2001. SG&A expenses as a percent of total revenues decreased as a result of increased revenues. Management currently anticipates that for the quarter ending December 31, 2002, SG&A spending will increase compared to the quarter ended September 30, 2002 as we continue to build our presence in Asia Pacific.

Amortization of Goodwill and Other Intangibles

Based on the adoption of Financial Accounting Standards Board (FASB) Statements Nos. 141 and 142, “Business Combinations” and “Goodwill and Other Intangible Assets” (“SFAS 141” and “SFAS 142”), we did not record charges for the amortization of goodwill during the quarter or nine months ended September 30, 2002. For the same periods last year, we recorded charges of $8.4 million and $25.1 million, respectively, in connection with our acquisitions of PixelCam Inc. and Nogatech Inc. SFAS 142 changed the accounting for goodwill from an amortization method to an impairment-only approach. Under SFAS 142, goodwill will be tested annually and whenever events or circumstances occur indicating that goodwill might be impaired. In connection with the adoption of SFAS 142, the Company has performed a transitional goodwill impairment assessment based on its structure as one reporting unit and determined that no impairment existed at January 1, 2002. We are currently in the process of conducting our annual impairment assessment and we do not anticipate that the completion of this assessment will have a material impact on our financial position, results of operations, or cash flows.

During the three and nine months ended September 30, 2002, we incurred charges of $2.3 million and $6.9 million, respectively, related to the amortization of other intangible assets, the same as incurred for the comparable periods last year.

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Interest and Other Income, Net

Net interest and other income for the three and six month periods ended September 30, 2002 was $1.7 million and $5.0 million, respectively, a decrease of 30.5% and 35.8% compared to the same periods in 2001. The decrease was a reflection of the decrease in market interest rates.

On February 1, 2002, Roxio Inc. (“Roxio”) acquired MGI Software Inc (“MGI”). As of the date of acquisition, we held approximately 373,000 shares of MGI common stock. Upon consummation of the acquisition, our MGI common stock was exchanged for 18,843 shares of Roxio common stock. In connection with the exchange, we recorded a realized loss of $696,000 and established a new cost basis of our Roxio common stock. The cost basis for our Roxio common stock is the fair value of the stock on the date of the exchange.

Provision for Income Taxes

Excluding charges related to the amortization of goodwill and other intangibles, our estimated effective tax rate was reduced from 15% for the three and nine months ended September 30, 2001 to 10% for the three and nine months ended September 30, 2002. The Company has booked a tax rate commensurate with the jurisdictional distribution of profits between the U.S. and Israel and the underlying tax positions as a result of the approved enterprise status in Israel. We anticipate utilizing the 10% tax rate for the foreseeable future.

Liquidity and Capital Resources

At September 30, 2002, we had $20.7 million of cash and cash equivalents, $97.9 million of short-term investments and $147.3 million of working capital. In addition, we had $84.3 million of investments in long-term marketable securities at September 30, 2002.

Our operating activities provided cash of $7.4 million during the nine months ended September 30, 2002, primarily due to net income adjusted for the non-cash impact of depreciation and amortization of $14.5 million, and a $3.0 million increase in accrued expenses. Use of cash was associated with a $6.0 million increase in inventory and a $3.7 million decrease in accounts payable. The increase in inventory was the result of increased purchases of our DVD chips that incorporate the functionality of our CPU companion chip. Changes to accrued expenses and accounts payable were due to normal timing differences in our payment patterns.

Cash used in investing activities was $11.2 million during the nine months ended September 30, 2002, principally reflecting the purchases of short-term and long-term marketable investments net of proceeds from sales and maturities of $9.9 million and capital expenditures for property and equipment of $1.3 million.

Cash provided by financing activities was $4.2 million for the nine months ended September 30, 2002, due to the proceeds from the issuance of common stock.

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

•the levels at which we maintain inventory and accounts receivable;

•the market acceptance of our products;

•the levels of promotion and advertising required to launch our new products or to enter markets and attain a competitive position in the marketplace;

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

•volume pricing concessions;

•capital improvements to new and existing facilities;

•technological advances;

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•the response of competitors to our products; and

•our relationships with our suppliers and customers.

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

To the extent that our existing resources and cash generated from operations are insufficient to fund our future activities, we may need to raise additional funds through public or private financings or borrowings. If additional funds are raised through the issuance of debt securities, these securities could have rights, preferences and privileges senior to holders of common stock, and the terms of this debt could impose restrictions on our operations. The sale of additional equity or convertible debt securities could result in additional dilution to our stockholders. We cannot be certain that additional financing will be available in amounts or on terms acceptable to us, if at all. If we are unable to obtain this additional financing, we may be required to reduce the scope of our planned product development and sales and marketing efforts, which could harm our business, financial condition and operating results.

Future Performance and Risk Factors

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

Our quarterly revenues and operating results fluctuate due to a variety of factors, which may result in volatility or a decline in the price of our stock.

Our quarterly operating results have varied significantly due to a number of factors, including:

•fluctuation in demand for our products;

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

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

•the timing of large customer orders;

•the length and variability of the sales cycle for our products;

•the cyclical nature of the semiconductor industry;

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

•changes in the mix of products sold;

•seasonality in demand for our products;

•competitive pricing pressures; and

•the evolving and unpredictable nature of the markets for products incorporating our integrated circuits and embedded software.

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

•the cost and availability of adequate foundry capacity;

•fluctuations in manufacturing yields;

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•the emergence of new industry standards;

•product obsolescence; and

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

Our operating results could also be harmed by:

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

•other conditions affecting the timing of customer orders; or

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

These factors are difficult or impossible to forecast. We place orders to purchase our products from independent foundries several months in advance of the scheduled delivery date, often in advance of receiving non-cancelable orders from our customers. If anticipated shipments in any quarter are canceled or do not occur as quickly as expected, expense and inventory levels could be disproportionately high. If anticipated license revenues in any quarter are canceled or do not occur, gross margins may be reduced. A significant portion of our expenses are relatively fixed, and the timing of increases 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 to quickly adjust expenses to levels appropriate to actual revenues, which could harm our operating results.

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

Our success for the foreseeable future will be dependent on growth in demand for integrated circuits for DVD and filmless digital camera applications and, to a lesser extent, digital audio and video editing applications and our ability to market and sell our products to manufacturers who incorporate those types of integrated circuits into their products.

In 2001 and the first nine months of 2002, we derived a substantial majority of our product revenues from the sale of integrated circuits for DVD applications. We expect that sales of our products for DVD applications will continue to account for a significant portion of our revenues for the near future. Our ability to sell our products for filmless digital camera applications and, to a lesser extent, digital audio and video editing applications will also have an impact on our financial performance for the foreseeable future. If the markets for these products and applications decline or fail to develop as expected, or we are not successful in our efforts to market and sell our products to manufacturers who incorporate integrated circuits into these products, our financial results will be harmed.

Our customers experience fluctuating product cycles and seasonality, which causes our sales to fluctuate.

Because the markets our customers serve are characterized by numerous new product introductions and rapid product enhancements, our operating results may vary significantly from quarter to quarter. During the final production of a mature product, our customers typically exhaust their existing inventory of our products. Consequently, orders for our products may decline in those circumstances, even if our products are incorporated into both mature products and replacement products. A delay in the customer’s transition to commercial production of a replacement product would delay our ability to recover the lost sales from the discontinuation of the related mature product. Our customers also experience significant seasonality in the sales of their consumer products, which affects their orders of our products. Typically, the second half of the calendar year represents a disproportionate percentage of sales for our customers due to the holiday period, and therefore a disproportionate percentage of our sales. We expect these sales fluctuations to continue for the foreseeable future.

Product supply and demand in the semiconductor industry is subject to cyclical variations.

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

The development and evolution of markets for our integrated circuits is dependent on factors such as industry standards, over which we have no control; for example, if manufacturers adopt new or competing industry standards with which our products are not compatible, our existing products would become less desirable to the manufacturers and our sales would suffer.

The emergence of markets for our products is affected by a variety of factors beyond our control. In particular, our products are designed to conform to current specific industry standards. Manufacturers may not continue to follow these standards, which would make our products less desirable to manufacturers and reduce our sales. Also, competing standards may emerge that are preferred by manufacturers, which could also reduce our sales and require us to make significant expenditures to develop new products. The emergence of new markets for our products is also dependent in part upon third parties developing and marketing content in a format compatible with commercial and consumer products that incorporate our products. If content compatible with commercial and consumer products that incorporate our products is not available, manufacturers may not be able to sell products incorporating our integrated circuits, and our sales to manufacturers would suffer.

We rely on independent foundries and contractors for the manufacture, assembly and testing of our integrated circuits, and the failure of any of these third parties to deliver products or otherwise perform as requested could damage our relationships with our customers and harm our sales and financial results.

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

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

•the inability to obtain adequate manufacturing capacity;

•the unavailability of or interruption in access to certain process technologies necessary for manufacture of our products;

•lack of control over delivery schedules;

•lack of control over quality assurance;

•lack of control over manufacturing yields and cost; and

•potential misappropriation of our intellectual property.

In addition, TSMC and some of our other foundries are located in areas of the world which are subject to natural disasters such as earthquakes. While the 1999 earthquake in Taiwan did not have a material impact on our independent foundries, a similar event centered near TSMC’s facility could severely reduce TSMC’s ability to manufacture our integrated circuits. The loss of any of our manufacturers as a supplier, our inability to expand the supply of our products in response to increased demand, or our inability to obtain timely and adequate deliveries from our current or future suppliers due to a natural disaster or any other reason could delay or reduce shipments of our products. Any of these circumstances could damage our relationships with current and prospective customers and harm our sales and financial results.

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We also rely on independent contractors for the assembly and testing of our products. At present, all of our semiconductor products are assembled by one of five independent contractors: ASE, Amkor, ASAT, Kyocera, or Vate. Our semiconductor products are tested by these contractors or other independent contractors. Our reliance on independent assembly and testing houses limits our control over delivery schedules, quality assurance and product cost. Disruptions in the services provided by our assembly or testing houses or other circumstances that would require us to seek alternative sources of assembly or testing could lead to supply constraints or delays in the delivery of our products. These constraints or delays could damage our relationships with current and prospective customers and harm our sales and financial results.

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

If we are not able to obtain additional foundry capacity as required, our relationships with our customers would be harmed and our sales would likely be reduced. In order to secure additional foundry capacity, we have considered and will continue to consider various arrangements with suppliers, which could include, among others:

•option payments or other prepayments to a foundry;

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

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

•issuance of our equity securities to a foundry;

•investment in a foundry;

•joint ventures; or

•other partnership relationships with foundries.

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

If our independent foundries do not achieve satisfactory yields, our relationships with our customers may be harmed.

The fabrication of silicon wafers is a complex process. Minute levels of contaminants in the manufacturing environment, defects in photomasks used to print circuits on a wafer, difficulties in the fabrication process or other factors can cause a substantial portion of the integrated circuits on a wafer to be non-functional. Many of these problems are difficult to detect at an early stage of the manufacturing process and may be time consuming and expensive to correct. As a result, foundries often experience problems achieving acceptable yields, which are represented by the number of good integrated circuits as a proportion of the number of total integrated circuits on any particular wafer.  Poor yields from our independent foundries would reduce our ability to deliver our products to customers, harm our relationships with our customers, and harm our business.

To be successful, we must efficiently develop new and enhanced products to meet rapidly changing customer requirements and industry standards.

The markets for our products are characterized by:

•rapidly changing technologies;

•evolving industry standards;

•frequent new product introductions; and

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•short product life cycles.

Over the long run, we expect to increase our product development expenses, and our future success will depend to a substantial degree upon our ability to develop and introduce, on a timely and cost-effective basis, new and enhanced products that meet rapidly changing customer requirements and industry standards. We may not successfully develop, introduce or manage the transition to new products. Delays in the introduction or shipment of new or enhanced products, lack of market acceptance for such products or problems associated with new product transitions could harm our sales and financial results.

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

Competition in the compression technology market has historically been dominated by large companies, such as STMicroelectronics, and companies that develop and use their own integrated circuits, such as Sony. As this market continues to develop, we face competition from other large semiconductor vendors, including:

•ALi Corporation;

•Atmel Corporation;

•Cirrus Logic (Crystal Semiconductor);

•ESS Technology, Inc.;

•Fujitsu;

•LSI Logic;

•MediaTek Inc.

•Motorola;

•Omnivision Technologies, Inc.;

•Sunplus Technology; and

•Texas Instruments.

We also face competition from internally developed solutions developed and used by major Japanese original equipment manufacturers, who may also be our customers.

Many of our existing and potential competitors have substantially greater resources than ours in many areas, including:

•finances;

•manufacturing;

•technology;

•research and development;

•marketing; and

•distribution.

Many of our competitors have broader product lines and longer standing relationships with customers than we do. Moreover, our competitors may foresee the course of market developments more accurately than we

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do and could in the future develop new technologies that compete with our products or even render our products obsolete. In addition, a number of private companies have announced plans for new products to address the same digital multimedia problems that our products address. If we are unable to compete successfully against our current and future competitors, we could experience price reductions, order cancellations and reduced gross margins, any one of which could harm our business.

The DVD market is growing, and additional competitors are expected to enter the market for DVD players and software. Some of these potential competitors may develop captive implementations for use only with their own PC and consumer electronics products. It is also possible that application software vendors, such as Microsoft, may attempt to enter the DVD application market in the future. This increased competition may result in price reductions, reduced profit margins and loss of market share.

Our products are characterized by average selling prices that decline over relatively short time periods; if we are unable to reduce our costs or introduce new products with higher average selling prices, our financial results would suffer.

Average selling prices for our products decline over relatively short time periods. Many of our manufacturing costs are fixed. When our average selling prices decline, our revenues decline unless we sell more units, and our gross margins decline unless we are able to reduce our manufacturing costs by a commensurate amount. Our operating results suffer when gross margins decline. We have experienced these problems and may continue to experience them in the future and cannot predict when they may occur or their severity.

We derive most of our revenue from sales to a small number of large customers, and if we are not able to retain these customers, or they reschedule, reduce or cancel orders, our revenues would be reduced and our financial results would suffer.

Our largest customers account for a substantial percentage of our revenues. In 2001, sales to Fujifilm accounted for 29.2% of our total revenue. Our four largest customers in 2001 accounted for approximately 56.3% of our total revenues.  During 2000, our four largest customers accounted for approximately 45.4% of our revenues with Fujifilm accounting for 25.2%. Sales to these large customers have varied significantly from year to year and will continue to fluctuate in the future.  These sales also may fluctuate significantly from quarter to quarter. We may not be able to retain our key customers or these customers may cancel purchase orders or reschedule or decrease their level of purchases from us. Any substantial decrease or delay in sales to one or more of our key customers could harm our sales and financial results. In addition, any difficulty in collecting amounts due from one or more key customers could harm our financial results.

We are dependent on our relationship with Fujifilm for a significant percentage of our product sales, and if this relationship were terminated, our business would be harmed.

Fujifilm has been our largest customer in four of the last five years. Fujifilm purchases our products primarily as a distributor. Under our arrangement with Fujifilm, Fujifilm acts as the primary distributor in Japan of products developed by us under development contracts with Fujifilm. Fujifilm also sells some of these products in Japan under its own name. We may sell these products directly in Japan only to specified customers and must first buy the products from Fujifilm. Fujifilm provides more sales and marketing support than our other distributors. Fujifilm also has a nonexclusive license to distribute most of our products outside of Japan. Fujifilm has provided wafer manufacturing services on a most-favored terms basis to us since 1993 and has also provided funding to support our development efforts. If our relationship with Fujifilm were terminated, our business would be harmed.

Our products generally have long sales cycles and implementation periods, which increases our costs in obtaining orders and reduces the predictability of our earnings.

Our products are technologically complex. Prospective customers generally must make a significant commitment of resources to test and evaluate our products and to integrate them into larger systems. As a result, our sales process is often subject to delays associated with lengthy approval processes that typically accompany the design and testing of new products. The sales cycles of our products often last for many months or even years. Longer sales cycles require us to invest significant resources in attempting to make sales and delay the generation of revenue.

Long sales cycles also subject us to other risks, including customers’ budgetary constraints, internal acceptance reviews and cancellations. In addition, orders expected in one quarter could shift to another because of the timing of customers’ purchase decisions. The time required for our customers to incorporate

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our products into their own can vary significantly with the needs of our customers and generally exceeds several months, which further complicates our planning processes and reduces the predictability of our operating results.

We are not protected by long-term contracts with our customers.

We generally do not enter into long-term purchase contracts with our customers, and we cannot be certain as to future order levels from our customers. When we do enter into a long-term contract, the contract is generally terminable at the convenience of the customer. In the event of an early termination by one of our major customers, it is unlikely that we will be able to rapidly replace that revenue source, which would harm our financial results.

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

During 2001, 93% of our total revenues were derived from international sales. We anticipate that international sales will continue to represent a substantial majority of our total revenues for the foreseeable future. In addition, substantially all of our semiconductor products are manufactured, assembled and tested outside of the United States by independent foundries and subcontractors.

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

•unexpected changes in regulatory requirements;

•fluctuations in exchange rates;

•political and economic instability;

•imposition of tariffs and other barriers and restrictions; and

•the burdens of complying with a variety of foreign laws.

The majority of our research and development personnel and facilities and a significant portion of our sales personnel are located in Israel. Political, economic and military conditions in Israel directly affect our operations. Some of our officers and employees in Israel are obligated to perform up to 39 days of military reserve duty annually. The absence of these employees for significant periods during the work week may cause us to operate inefficiently during these periods.

Our operations in China are subject to the economic and political uncertainties affecting that country. For example, the Chinese economy has experienced significant growth in the past decade, but such growth has been uneven across geographic and economic sectors and has recently been slowing. This growth may continue to decrease and any slowdown may have a negative effect on our business. During 2000 and 2001, we also opened offices in Taipei, Taiwan, Hong Kong and Seoul, Korea. Our operations are subject to the economic and political uncertainties affecting these countries as well.

Our business and future operating results could be harmed by terrorist activity or armed conflict.

Our business and operating results are subject to uncertainties arising out of possible terrorist attacks on the United States and other regions of the world including locations where we maintain operations and by the potential expansion of armed conflict and potential instability associated with terrorism. Our operations could be harmed due to:

•disruption in commercial activities associated with heightened security concerns affecting international travel and commerce;

•reduced demand for consumer electronic products due to a potential extension of the global economic slowdown;

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

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

The prices of our products may become less competitive due to foreign exchange fluctuations.

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

Our ability to compete could be jeopardized if we are unable to protect our intellectual property rights from challenges by third parties.

Our success and ability to compete depend in large part upon protecting our proprietary technology. We rely on a combination of patent, trade secret, copyright and trademark laws, non-disclosure and other contractual agreements and technical measures to protect our proprietary rights. These agreements and measures may not be sufficient to protect our technology from third-party infringement, or to protect us from the claims of others. Monitoring unauthorized use of our products is difficult and we cannot be certain that the steps we have taken will prevent unauthorized use of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. The laws of certain foreign countries in which our products are or may be developed, manufactured or sold, including various countries in Asia, may not protect our products or intellectual property rights to the same extent as do the laws of the United States and thus make the possibility of piracy of our technology and products more likely in these countries. If competitors are able to use our technology, our ability to compete effectively could be harmed.

We could become subject to claims and litigation regarding intellectual property rights, which could seriously harm our business and require us to incur significant costs.

In recent years, there has been significant litigation in the United States involving patents and other intellectual property rights. In the past, we have been subject to claims and litigation regarding alleged infringement of other parties’ intellectual property rights. We could become subject to litigation in the future either to protect our intellectual property or as a result of allegations that we infringe others’ intellectual property rights. Claims that our products infringe proprietary rights would force us to defend ourselves and possibly our customers or manufacturers against the alleged infringement. These claims and any resulting lawsuit, if successful, could subject us to significant liability for damages and invalidation of our proprietary rights. These lawsuits, regardless of their success, would likely be time-consuming and expensive to resolve and would divert management time and attention. Any potential intellectual property litigation could force us to do one or more of the following:

•stop selling our products that incorporate the challenged intellectual property;

•obtain from the owner of the infringed intellectual 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 such technology.

If we are forced to take any of the foregoing actions, our business could be severely harmed.

If necessary licenses of third-party technology are not available to us or are very expensive, our products could become obsolete.

From time to time we may be required to license technology from third parties to develop new products or product enhancements. Third party licenses may not be available to us on commercially reasonable terms, if

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at all. If we are unable to obtain any third-party license required to develop new products and product enhancements, we may have to obtain substitute technology of lower quality or performance standards or at greater cost, either of which could seriously harm the competitiveness of our products.

If we are not able to apply our net operating losses against taxable income in future periods, our financial results will be harmed.

Our future net income and cash flow will be affected by our ability to apply our net operating losses, which totaled approximately $48.0 million for federal tax reporting purposes as of December 31, 2001, against taxable income in future periods. Our net operating losses incurred prior to the consummation of our initial public offering in 1995 that we can use to reduce future taxable income for federal tax purposes are limited to approximately $3.0 million per year. Changes in tax laws in the United States may further limit our ability to utilize our net operating losses. Any further limitation on our ability to utilize our net operating losses could harm our financial condition.

Any acquisitions or strategic investments we make could disrupt our business and severely harm our financial condition.

We have made investments in, and acquisitions of, complementary companies, products and technologies. During 2000, we acquired PixelCam and Nogatech, and we may acquire additional businesses, products, or technologies in the future. In the event of any future acquisitions, we could:

•issue stock that would dilute our current stockholders’ percentage ownership;

•incur debt;

•assume liabilities;

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

•incur other large write-offs immediately or in the future.

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

•problems combining the purchased operations, technologies or products;

•unanticipated costs;

•diversion of management’s attention from our core business;

•adverse effects on existing business relationships with customers;

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

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

We may not be able to successfully integrate any businesses, products or technologies or personnel that we might acquire in the future and any failure to do so could disrupt our business and seriously harm our financial condition.

In addition, we have made minority equity investments in early-stage companies, and we expect to continue to review opportunities to make additional investments in such companies where we believe such investments will provide us with opportunities to gain access to important technologies or otherwise enhance important commercial relationships. We have little or no influence over the early-stage companies in which we have made or may make strategic, minority equity investments. Each of these investments involves a high degree of risk. We may not be successful in achieving the technological or commercial advantage upon which any given investment is premised, and failure by the early-stage company to achieve its own business objectives could result in a loss of all or part of our invested capital.

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

We develop complex and evolving products. Despite testing by us and our customers, errors may be found in existing or new products. This could result in, among other things, a delay in recognition or loss of revenues, loss of market share or failure to achieve market acceptance. These defects may cause us to incur significant warranty, support and repair costs, divert the attention of our engineering personnel from our product development efforts and harm our relationships with our customers. The occurrence of these problems could result in the delay or loss of market acceptance of our products and would likely harm our business. Defects, integration issues or other performance problems in our products could result in financial or other damages to our customers or could damage market acceptance of our products. Our customers could also seek damages from us for their losses. A product liability claim brought against us, even if unsuccessful, would likely be time consuming and costly to defend.

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

We historically have generated a significant percentage of our total revenues from development contracts, primarily with key customers. These development contracts have provided us with partial funding for the development of some of our products. Under these contracts, we receive payments upon reaching certain development milestones. If we fail to achieve the milestones specified in our existing development contracts, if our existing contracts are terminated or we are unable to secure future development contracts, our ability to cost-effectively develop new products would be reduced and our business would be harmed.

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

We may require substantial additional capital to finance our future growth, secure additional foundry capacity and fund our ongoing research and development activities beyond 2002. Our capital requirements will depend on many factors, including:

•acceptance of and demand for our products;

•the types of arrangements that we may enter into with our independent foundries; and

•the extent to which we invest in new technology and research and development projects.

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

If we fail to manage our future growth, if any, our business would be harmed.

We anticipate that our future growth, if any, will require us to recruit and hire a substantial number of new engineering, managerial, sales and marketing personnel. Our ability to manage our growth successfully will also require us to expand and improve our administrative, operational, management and financial systems and controls. Many of our key operations, including the major portion of our research and development operations and a significant portion of our sales and administrative operations, are located in Israel. A majority of our sales and marketing and certain of our research and development and administrative personnel, including our President and Chief Executive Officer and other officers, are based in the United States. The geographic separation of these operations places additional strain on our resources and our ability to effectively manage our growth. If we are unable to manage growth effectively, our business would be harmed.

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

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Our success depends to a significant degree upon the continuing contributions of our senior management. The loss of key management personnel could delay product development cycles or otherwise harm our business. We may not be able to retain the services of any of our key employees. We believe that our future success will also depend in large part on our ability to attract, integrate and retain highly-skilled engineering, managerial, sales and marketing personnel, both in the United States and in Israel. Competition for such personnel is intense, and we may not be successful in attracting, integrating and retaining such personnel. Failure to attract, integrate and retain key personnel could harm our ability to carry out our business strategy and compete with other companies.

The Israeli rate of inflation may negatively impact our costs if it exceeds the rate of devaluation of the New Israeli Shekel against the U.S. dollar.

A portion of the cost of our operations, relating mainly to our personnel and facilities in Israel, is incurred in New Israeli Shekels. As a result, we bear the risk that the rate of inflation in Israel will exceed the rate of devaluation of the New Israeli Shekel in relation to the dollar, which will increase our costs as expressed in dollars. To date, we have not engaged in hedging transactions. In the future, we may enter into currency hedging transactions to decrease the risk of financial exposure from fluctuations in the exchange rate of the U.S. dollar against the New Israeli Shekel. These measures may not adequately protect us from the impact of inflation in Israel.

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

In 2001, we did not receive proceeds from grants for research and development from the Chief Scientist in Israel’s Ministry of Industry and Trade. However, we did receive an aggregate of $333,000 in such grants during 2000. We plan to seek additional grants from the Chief Scientist in the future. To be eligible for these grants, our development projects must be approved by the Chief Scientist on a case-by-case basis.  If our development projects are not approved by the Chief Scientist, we will not receive grants to fund these projects, which would increase our research and development costs. We also receive tax benefits, in particular exemptions and reductions as a result of the “Approved Enterprise” status of our existing operations in Israel. To be eligible for these tax benefits, we must maintain our Approved Enterprise status by meeting conditions, including making specified investments in fixed assets located in Israel and investing additional equity in our Israeli subsidiary. If we fail to meet these conditions in the future, the tax benefits would be canceled and we could be required to refund the tax benefits already received. These tax benefits may not be continued in the future at their current levels or at any level. Israeli governmental authorities have indicated that the government may reduce or eliminate these benefits in the future, which would harm our business.

We have anti-takeover provisions in our charter documents and there are provisions of Delaware law that could prevent or delay a change in control of our company.

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

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

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

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

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

Our stock price has fluctuated and may continue to fluctuate widely.

The market price of our common stock has fluctuated significantly since our initial public offering in 1995. Between January 1, 2001 and December 31, 2001, the closing sale price of our common stock, as reported

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on the Nasdaq National Market, ranged from a low of $8.67 to a high of $27.03.  The market price of our common stock is subject to significant fluctuations in the future in response to a variety of factors, including:

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

•quarterly variations in operating results;

•changes in analysts’ earnings estimates;

•announcements of technological innovations;

•the introduction of new products or changes in product pricing policies by us or our competitors;

•proprietary rights or other litigation;

•general conditions in the semiconductor industry; and

•developments in the financial markets.

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

Item 3.   Quantitative and Qualitative Disclosures About Market Risk

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

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

A majority of our revenue and capital spending is transacted in U.S. dollars, although a portion of the cost of our operations, relating mainly to our personnel and facilities in Israel, is incurred in New Israeli Shekels. We have not engaged in hedging transactions to reduce our exposure to fluctuations that may arise from changes in foreign exchange rates. Based on our overall currency rate exposure at September 30, 2002, a near-term 10% appreciation or depreciation of the New Israeli Shekel would have an immaterial affect on our financial condition.

Item 4.   Controls and Procedures

Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934, as amended) within 90 days prior to the filing date of this report. Based on their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective.

There have been no significant changes (including corrective actions with regard to significant deficiencies or material weaknesses) in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referred to above.

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PART II. OTHER INFORMATION

Item 6.  Exhibits and Reports on Form 8-K
(a)	Exhibits:
	99.1      Certification of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350.
	99.2      Certification of Chief Financial Officer, pursuant to 18 U.S.C. Section 1350.
(b)	Reports on Form 8-K:
	No reports on Form 8-K were filed during the quarter ended September 30, 2002.

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SIGNATURES

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

	ZORAN CORPORATION
Date:  November 14, 2002	/s/  Karl Schneider
	Karl Schneider
	Vice President, Finance and Chief Financial Officer
	(Principal Financial and Accounting Officer)

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CERTIFICATION OF

CHIEF EXECUTIVE  OFFICER

I, Levy Gerzberg, certify that:

1.             I have reviewed this quarterly report on Form 10-Q of Zoran Corporation;

2.             Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with a respect to the period covered by this quarterly report;

3.             Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.             The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

(a)designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

(b)evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

(c)presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.             The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors:

(a)all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

(b)any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.             The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

	/s/ Levy Gerzberg
	Levy Gerzberg
	President and
	Chief Executive Officer
Dated:  November 14, 2002

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CERTIFICATION OF

CHIEF FINANCIAL OFFICER

I, Karl Schneider, certify that:

1.             I have reviewed this quarterly report on Form 10-Q of Zoran Corporation;

2.             Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with a respect to the period covered by this quarterly report;

3.             Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.             The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

(a)designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

(b)evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

(c)presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.             The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors:

(a)all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

(b)any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.             The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

	/s/ Karl Schneider
	Karl Schneider
	Vice President, Finance and
	Chief Financial Officer
Dated:  November 14, 2002

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