Zoran (ZRAN) 10-Q 2003 Q1 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 March 31, 2003
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 incorporation or organization)	(I.R.S. Employer 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

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

The number of outstanding shares of the registrant’s Common Stock, $.001 par value, as of May 2, 2003 was 27,461,054.

ZORAN CORPORATION

INDEX

PART I.    FINANCIAL INFORMATION
Item 1.   Financial Statements
	Condensed Consolidated Balance Sheets March 31, 2003 and December 31, 2002
	Condensed Consolidated Statements of Operations Three Months Ended March 31, 2003 and 2002
	Condensed Consolidated Statements of Cash Flows Three Months Ended March 31, 2003 and 2002
	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

2

ZORAN CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

(unaudited)

	March 31, 2003			December 31, 2002
ASSETS
Current assets:
Cash and cash equivalents	$	27,449		$	31,607
Short-term investments	109,448			105,468
Accounts receivable, net	46,082			34,652
Inventory	7,703			12,686
Prepaid expenses and other current assets	7,759			6,479
Total current assets	198,441			190,892
Property and equipment, net	5,945			5,848
Other investments	73,860			78,334
Goodwill	59,131			59,131
Intangible assets	7,217			8,411
	$	344,594		$	342,616
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	13,222		$	9,639
Accrued expenses and other liabilities	19,924			21,965
Total current liabilities	33,146			31,604
Stockholders’ equity:
Common Stock, $0.001 par value; 55,000,000 shares authorized; 27,399,578 and 27,395,117 shares issued and outstanding	27			27
Additional paid-in capital	399,160			399,052
Deferred stock-based compensation	(73		)	(83		)
Accumulated other comprehensive income	633			508
Accumulated deficit	(88,299		)	(88,492		)
Total stockholders’ equity	311,448			311,012
	$	344,594		$	342,616

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

3

ZORAN CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

	Three Months Ended March 31,
	2003			2002
Revenues:
Product sales	$	37,097		$	29,105
Software, licensing and development	736			1,985
Total revenues	37,833			31,090
Costs and expenses:
Cost of product sales	26,710			18,832
Research and development	4,479			5,521
Selling, general and administrative	6,942			5,740
Amortization of other intangibles	953			2,445
Total costs and expenses	39,084			32,538
Operating loss	(1,251		)	(1,448		)
Interest income	1,593			2,057
Other income (loss), net	(22		)	(598		)
Income before income taxes	320			11
Provision for income taxes	127			246
Net income (loss)	$	193		$	(235	)
Basic net income (loss) per share	$	0.01		$	(0.01	)
Diluted net income (loss) per share	$	0.01		$	(0.01	)
Shares used to compute basic net income (loss) per share	27,396			26,774
Shares used to compute diluted net income (loss) per share	28,096			26,774

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

4

ZORAN CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Three Months Ended March 31,
	2002			2001
Cash flows from operating activities:
Net income (loss)	$	193		$	(235	)
Adjustments to reconcile net income (loss) to net cash  provided by (used in) operations:
Depreciation, amortization and other	886			630
Allowance for doubtful accounts	315			—
Amortization of intangible assets	1,194			2,445
Realized loss on marketable securities	—			696
Changes in current assets and liabilities:
Accounts receivable	(11,928		)	3,382
Inventory	4,983			2,807
Prepaid expenses and other current assets	(1,280		)	(31		)
Accounts payable	4,333			(2,109		)
Accrued expenses and other liabilities	(1,122		)	(111		)
Net cash provided by (used in) operating activities	(2,426		)	7,474
Cash flows from investing activities:
Capital expenditures for property and equipment	(973		)	(386		)
Purchases of investments	(31,855		)	(18,149		)
Sales of investments	1,005			15,079
Maturities of investments	31,483			1,001
Net cash used in investing activities	(340		)	(2,455		)
Cash flows from financing activities:
Proceeds from issuance of Common Stock, net	108			2,154
Installment payment on purchased core technology	(1,500		)	—
Net cash provided by (used in) financing activities	(1,392		)	2,154
Net increase (decrease) in cash and cash equivalents	(4,158		)	7,173
Cash and cash equivalents at beginning of period	31,607			20,287
Cash and cash equivalents at end of period	$	27,449		$	27,460

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

5

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, 2002.  Results for the interim periods presented are not necessarily indicative of the results to be expected for the full year.

2.             Fair Value Disclosures

In December 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Account Standards No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure an Amendment of FASB Statement No. 123” (SFAS No. 148). SFAS No. 148 provides alternative methods of transition for companies making a voluntary change to fair value based accounting for stock-based employee compensation. The Company continues to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees” and related interpretations. Under APB 25, compensation expense is recognized based on the difference, if any, on the date of grant between the fair value of the Company’s stock and the amount an employee must pay to acquire the stock.  The compensation expense is recognized over the periods the employee performs the related services, generally the vesting period of four years, consistent with the multiple option method described in FASB Interpretation No. 28 (“FIN 28”). Except for options assumed in connection with the Company’s acquisition of Nogatech, Inc. in 2000, no stock-based employee compensation cost is reflected in net income as all other options granted under the Company’s plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Effective for interim periods beginning after December 15, 2002, SFAS No. 148 also requires disclosure of pro-forma results on a quarterly basis as if the Company had applied the fair value recognition provisions of SFAS No. 123.

6

Had compensation cost for the Company’s option and stock purchase plans been determined based on the fair value at the grant dates, as prescribed in SFAS 123, the Company’s net income (loss) and net income (loss) per share for each of the quarters ended March 31, 2003 and 2002, would have been as follows (in thousands, except per share data):

	Three Months Ended March 31,
	2003			2002
Net income (loss) as reported	$	193		$	(235	)
Add: Stock-based employee compensation expense included in reported net income net of related tax effects		10			136
Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards net of related tax effects		(6,284	)		(5,568	)
Pro forma loss	$	(6,081	)	$	(5,667	)
Net income (loss) per share:
As reported
Basic	$	0.01		$	(0.01	)
Diluted	$	0.01		$	(0.01	)
Pro forma
Basic	$	(0.22	)	$	(0.21	)
Diluted	$	(0.22	)	$	(0.21	)

For purposes of the disclosure required under SFAS 123 the fair value of each option grant is estimated on the date of grant using the Black-Scholes model with the following assumptions used for options and purchase grants during the applicable period.

	Three Months Ended March 31,
	2003		2002
Dividend rate	0.0	%	0.0	%
Risk-free interest rates	2.8 to 4.7	%	2.9 to 4.7	%
Volatility	93.0	%	92.0	%
Expected life
Option plans	5 years		5 years
Purchase plan	0.5 years		0.5 years

The Black-Scholes option pricing model was developed for use in estimating the value of traded options that have no vesting restrictions and are fully transferable.  In addition, option pricing models require the input of highly subjective assumptions including the expected stock price volatility.  The Company uses projected data for expected volatility and expected life of its stock options based upon historical and other economic data trended into future years.  Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the estimate, in management’s opinion, existing valuation models, including the Black-Scholes model, do not provide a reliable measure of the fair value of the Company’s stock options.

7

3.             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 March 31,
	2003		2002
Net income (loss)	$	193	$	(235	)
Unrealized gain (loss) on short-term investment	125		(487		)
Comprehensive income (loss)	$	318	$	(722	)

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

8

4.             Balance Sheet Components (in thousands):

	March 31, 2002		December 31, 2002
Inventory:
Work-in-process	$	3,614	$	6,365
Finished goods	4,089		6,321
	$	7,703	$	12,686

5.             Goodwill and Intangible Assets

The Company adopted SFAS 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 is required to 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 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 also conducted its annual impairment assessment in 2002, and again determined that no impairment existed. The Company has not yet conducted its annual assessment for 2003 but does not currently anticipate that the completion of the assessment will have a material impact on its financial position, results of operations or cash flows.

Components of Acquired Intangible Assets (in thousands):

		March 31, 2003				December 31, 2002
	Weighted Avg Life (Years)	Gross carrying Amount		Accumulated Amortization		Gross carrying Amount		Accumulated Amortization
Amortized intangible assets
Covenant not to compete	3	$	800	$	733	$	800	$	667
Patents	3	900		825		900		750
Core technology	3	8,060		6,546		8,060		5,874
Completed technology	2	10,760		10,760		10,760		10,760
Customer base	3	1,560		1,267		1,560		1,137
Purchased core technology	4	5,582		314		5,582		63
Total		$	27,662	$	20,445	$	27,662	$	19,251

During the quarters ended March 31, 2003 and March 31, 2002, the Company incurred $1.2 million and $2.4 million, respectively, in charges related to the amortization of acquired intangible assets associated with the acquisitions of PixelCam Inc. and Nogatech Inc. and purchased core technologies. Amortization of purchased core technologies is included in cost of product sales. The Company will incur additional amortization charges of approximately $4.2 million for the balance of 2003.

6.             Other Income (Loss), net

During the quarter ended March 31, 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 included as other loss for the quarter ended March 31, 2002, and established a new cost basis of its Roxio common stock equal to the fair value of the stock on the date of the exchange.

9

7.             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.

8.             Earnings Per Share

Computation of basic and diluted earnings per share is as follows (in thousands, except per share data):

	Three Months Ended March 31,
	2003					2002
	Income (Numerator)		Shares (Denominator)	Per Share Amount		(Loss) (Numerator)			Shares (Denominator)	Per Share Amount
Basic EPS:
Net income available to common stockholders	$	193	27,396	$	0.01	$	(235	)	26,774	$	(0.01	)
Effects of dilutive securities:
Stock options	—		700			—			—
Diluted EPS:
Income available to common stockholders	$	193	28,096	$	0.01	$	(235	)	26,774	$	(0.01	)

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 November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company does not expect that this will have a material impact on its financial position, results of operations, or cash flows.

In January 2003, the FASB issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.”  FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. The Company does not expect that the adoption of FIN 46 will have a material impact on its financial position, results of operations, or cash flows.

10

11.          Subsequent Events

On May 4, 2003, the Company entered into an agreement to acquire Oak Technology, Inc. (“Oak”) a publicly-held company that provides integrated circuit solutions for the HDTV and digital imaging markets. Under the agreement, Oak will merge with a wholly-owned subsidiary of the Company, and each outstanding share of Oak’s common stock will be converted into the right to receive 0.2323 of a share of Zoran common stock and $1.78 in cash. As of the date of the agreement, the total merger consideration was valued at $358 million. The transaction is expected to be completed in the third quarter of 2003, and is subject to approval by the stockholders of both companies as well as regulatory approval. If the merger is consummated, it will be accounted for as a purchase and, accordingly, the results of operations of Oak (beginning with the closing date of the acquisition) and the estimated fair value of assets acquired and liabilities assumed will be included in the Company’s consolidated financial statements beginning with the quarter in which the closing takes place.

11

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, 2002.

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, or DVD, players and recorders, 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 resellers 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 resellers 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 reseller in Japan. Fujifilm provides more sales and marketing support than our other resellers. 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 substantially 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

12

are also 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 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 2003 and 2020, and the benefits from our subsidiary’s Approved Enterprise status expire at various times beginning in 2003.

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 fifty 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.

Pending Acquisition

On May 4, 2003, we entered into an agreement to acquire Oak Technology, Inc. (“Oak”) a publicly-held company that provides integrated circuit solutions for the HDTV and digital imaging markets.  Under the agreement, Oak will merge with a wholly-owned subsidiary of Zoran, and each outstanding share of Oak’s common stock will be converted into the right to receive 0.2323 of a share of Zoran common stock and $1.78 in cash.  As of the date of the agreement, the total merger consideration was valued at $358 million.  The transaction is expected to be completed in the third quarter of 2003, and is subject to approval by the stockholders of both companies as well as regulatory approval.  If the merger is consummated, it will be accounted for as a purchase and, accordingly, the results of operations of Oak (beginning with the closing date of the acquisition) and the estimated fair value of assets acquired and liabilities assumed will be included in our consolidated financial statements beginning with the quarter in which the closing takes place.  If the acquisition is consummated, our future results of operations will be substantially influenced by the operations of Oak.  Our management currently expects the acquisition to be accretive to our earnings (before amortization of intangible assets) in the first half of 2004.  However, the operating results of the combined company will be affected by our success in achieving our strategic objectives and realizing potential operating benefits, including cost savings.  We will face a number of significant challenges in integrating the technologies, operations and personnel of the two companies in a timely and efficient manner, and our failure to do so effectively could have a material adverse effect on the business and operating results of the combined company.

Results of Operations

Revenues

Total revenues increased by 21.7% to $37.8 million for the quarter ended March 31, 2003 from $31.1 million for the same period in 2002.  Product sales increased by 27.5% to $37.1 million from $29.1 million for first quarter of 2002.  The increase in product sales was primarily driven by increased sales in our digital camera and DVD product lines of $5.0 million and $2.5 million, respectively. The increased sales for both product lines were due to increased unit shipments partially offset by reduced average selling prices. DVD products continued to account for the majority of our total product sales, representing approximately 78% of the total for the quarter. We expect DVD sales to continue to comprise the majority of our product sales for the balance of 2003.  Software, licensing and development revenues decreased by 62.9% to $736,000 for the first quarter of 2003, compared to $2.0 million for the first quarter of 2002. The decrease reflected the fact that we did not enter into any new licensing agreements during the quarter ended March 31, 2003. This decline is not necessarily indicative of a developing trend as revenue from licensing activities tends to fluctuate significantly from quarter to quarter.

Product Gross Margin

Product gross margin decreased to 28.0% for the quarter ended March 31, 2003 from 35.3% for the same period in 2002.  The decrease was due to continued erosion of the average selling prices for our older multi-chip DVD solutions. We anticipate that our product gross margin will improve over the balance of 2003 as we have substantially depleted the inventory of these older products and transitioned most of our customer base

13

to our newer DVD products that do not require our DVD CPU companion chips which, historically, were sold at low margins.

Research and Development

Research and development (“R&D”) expenses decreased by 18.9% to $4.5 million for the quarter ended March 31, 2003 from $5.5 million for the same period in 2002. The reduction was due to development grants of $1.5 million related to R&D expenditures in previous periods that were received and recorded as offsets to R&D expense during the quarter ended March 31, 2003. R&D expenses decreased as a percentage of total revenues from 17.8% for the first quarter of 2002 to 11.8% for the first quarter of 2003 with approximately half of the percentage decrease due to increased revenues and the other half resulting from the grant offset.  We expect that R&D expense will increase over the balance of 2003.

Selling, General and Administrative

Selling, general and administrative (“SG&A”) expenses increased by 20.9% to $6.9 million for the quarter ended March 31, 2003 from $5.7 million for the same period in 2002.  The increase was due to increased sales and marketing expenses to support planned revenue growth in the Asia Pacific markets.  SG&A expenses were 18.3% of total revenues for the three months ended March 31, 2003, compared to 18.5% for the same period in 2002. We anticipate that SG&A expenses will continue to increase for the remainder of 2003 as we continue to expand our presence in the Asia Pacific region.

Amortization of Intangibles Assets

During the quarter ended March 31, 2003, we incurred charges of $953,000 related to the amortization of intangible assets compared to $2.4 million for the same period in 2002. The reduction was due to the full amortization of the completed technology acquired as part of the Nogatech Inc. acquisition by the end of 2002.

Interest Income

Interest income decreased by  $464,000 to $1.6 million for the quarter ended March 31, 2003 compared with $2.1 million for the same period in 2002. The reduction was due to a decline in market interest rates.

Other Income (Loss), Net

Other loss decreased by 96.3% to 22,000 for the quarter ended March 31, 2003 compared with $598,000 for the same period in 2002. The reduction was primarily the result of a non-cash loss of $696,000 realized in the first quarter of 2002, upon the exchange of shares of MGI Software Inc. (“MGI”) common stock held by us for shares of Roxio Inc. (“Roxio”) common stock in conjunction with Roxio’s acquisition of MGI.

Provision for Income Taxes

Excluding charges related to the amortization of goodwill and other intangibles our estimated effective tax rate was 10% for the first quarter of 2003, consistent with the effective tax rate for first quarter of 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.

14

Liquidity and Capital Resources

At March 31, 2003, we had $27.4 million of cash and cash equivalents, $109.4 million of short-term investments and $165.3 million of working capital. In addition, we had $72.7 million of long-term investments in marketable securities.

Our operating activities used cash of $2.4 million during the three months ended March 31, 2003, primarily due to our net income of $193,000 adjusted for the cash impact associated with an increase of $11.9 million in accounts receivable. Partially offsetting the increase in accounts receivable was the cash impact of a $5.0 million decrease in inventory and a $4.3 million increase in accounts payable. The decrease in inventory was primarily associated with a reduction in DVD inventory. The increase in accounts payable was due to normal timing differences in our payment patterns.

Cash used in investing activities was $340,000 during the three months ended March 31, 2003, principally reflecting capital expenditures for property and equipment.

Cash used by financing activities was $1.4 million for the three months ended March 31, 2003, and principally reflected installment payments on core technology.

At March 31, 2003 and 2002, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Accordingly, we are not exposed to the type of financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

We believe that our current balances of cash, cash equivalents 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;

•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 consummation of any 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

15

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;

•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

16

•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.

We are subject to a number of special risks as a result of our planned acquisition of Oak Technology, Inc.

On May 4, 2003, we entered into an agreement to acquire Oak Technology, Inc. (“Oak”), a publicly-held company that provides integrated circuit solutions for the HDTV and digital imaging markets.  As a result of our entering into the agreement, we are subject to a number of risks and uncertainties, including the following:

•Immediately following the completion of the merger, former Oak securityholders will own approximately 33.4% of the capital stock of Zoran.  The issuance of these shares in connection with the merger will cause a significant reduction in the relative percentage interests of current Zoran stockholders.

•We will face a number of significant challenges in integrating the technologies, operations and personnel of Zoran and Oak in a timely and efficient manner, and our failure to do so effectively could have a material adverse effect on the business and operating results of the combined company.

•We may not achieve the strategic objectives, cost savings and other anticipated potential benefits of the merger, and our failure to achieve these strategic objectives could have a material adverse effect on our revenues, expenses and operating results.

•Transactions costs associated with the merger will be included as part of the total purchase cost for accounting purposes.  In addition, the combined company may incur charges to operations, which amounts are not currently estimable, in the quarter in which the merger is completed or following quarters, to reflect costs associated with integrating the two companies.  These costs could adversely affect our future liquidity and operating results.

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

In 2002 and the first quarter of 2003, 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 majority of our revenues for the near future. Our ability to sell our products for filmless digital camera 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.

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.

17

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.

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 seven independent contractors: ASE, Amkor, ASAT, Kingpak, Kyocera, STATS 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.

18

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

•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.

19

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 and Matsushita. 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 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.

20

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 2002, sales to Fujifilm accounted for 36.6% of our total revenue. Our four largest customers in 2002 accounted for approximately 58.6% of our total revenues.  During 2001, our four largest customers accounted for approximately 56.3% of our revenues with Fujifilm accounting for 29.2%. 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 could be harmed.

Fujifilm has been our largest customer over each of the last five years. Fujifilm purchases our products primarily as a reseller. Fujifilm acts as the primary reseller in Japan of products developed by us under development contracts with Fujifilm. We may sell these products directly in Japan only to specified customers with Fujifilm’s consent. Fujifilm provides more sales and marketing support than our other resellers. 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 could 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 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.

21

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 2002, 97% 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 armed conflict in the Middle East and related economic instability. 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;

•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

22

•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 at all. If we are unable to obtain any third-party license required to develop new products and product

23

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 $34.0 million for federal and $4.0 million for state tax reporting purposes as of December 31, 2002, 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 in May 2003, we entered into an agreement to acquire Oak.  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 (including our potential operation of Oak) 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 and require us to write-off all or a portion of such investments.

24

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 2003. 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.

25

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.

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, in the United States, Israel and the Asia Pacific region. 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.

Historically, we have financed a portion of our research and development activities with grants for research and development from the Chief Scientist in Israel’s Ministry of Industry and Trade. Although we did not receive proceeds from such grants in 2001 or 2002, we did receive such proceeds in the first quarter of 2003, and we plan to continue 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.

26

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, 2002 and December 31, 2002, the closing sale price of our common stock, as reported on the Nasdaq National Market, ranged from a low of $9.11 to a high of $31.81.  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 March 31, 2003, 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 and 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.

27

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 three months ended March 31, 2003.

28

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:  May 15, 2003	/s/  Karl Schneider
	Karl Schneider
	Vice President Finance
	And Chief Financial Officer
	(Principal Financial and Accounting Officer)

29

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:  May 15, 2003

30

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:  May 15, 2003

31