Zoran (ZRAN) 10-Q/A 2004 Q1 Quarterly report (amended)

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

Amendment No. 1

to

FORM 10-Q/A

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2004
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934
	For the transition period from                                  to                                  .

Commission File No. 0-27246

ZORAN CORPORATION
(Exact name of registrant as specified in its charter)

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

1390 Kifer Road
Sunnyvale, California 94086

(Address of principal executive offices, including zip code)

(408) 523-6500

(Registrant’s telephone number, including area code)

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 the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes  ý   No  o

As of May 6, 2004, there were outstanding 42,724,654 shares of the registrant’s Common Stock, par value $0.001 per share.

ZORAN CORPORATION AND SUBSIDIARIES

FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2004

We are amending our Form 10-Q for the quarter ended March 31, 2004 primarily to correct two numbers in Management’s Discussion and Analysis, under “Operating Loss,” that were inadvertently transposed.

INDEX

PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited):
		Condensed Consolidated Balance Sheets as of March 31, 2004 and December 31, 2003
		Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2004 and 2003
		Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2004 and 2003
		Notes to Condensed Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings
Item 6.	Exhibits and Reports on Form 8-K
Signatures

ZORAN CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)

	March 31, 2004			December 31, 2003
ASSETS
Current assets:
Cash and cash equivalents	$	65,559		$	47,994
Short-term investments	59,711			78,372
Accounts receivable, net	65,811			65,224
Inventory	17,999			16,805
Prepaid expenses and other current assets	10,618			12,151
Total current assets	219,698			220,546
Property and equipment, net	19,692			20,029
Other assets and investments	81,580			69,311
Goodwill	119,272			119,091
Intangible assets, net	178,128			188,885
	$	618,370		$	617,862
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	33,658		$	29,038
Accrued expenses and other liabilities	45,113			45,182
Total current liabilities	78,771			74,220
Long-term liabilities	8,876			9,363
Stockholders’ equity:
Common stock, $0.001 par value; 105,000,000 shares authorized at March 31, 2004 and December 31, 2003; 42,580,894 shares issued and outstanding as of March 31, 2004; and 42,347,584 shares issued and outstanding as of December 31, 2003	43			42
Additional paid-in capital	705,949			703,812
Deferred stock-based compensation	(10,483		)	(13,014		)
Accumulated other comprehensive income (loss)	2,373			(91		)
Accumulated deficit	(167,159		)	(156,470		)
Total stockholders’ equity	530,723			534,279
	$	618,370		$	617,862

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 March 31,
	2004			2003
Revenues:
Hardware product revenues	$	68,029		$	37,097
Software and other revenues	12,608			736
Total revenues	80,637			37,833
Costs and expenses:
Cost of hardware product revenues	45,328			26,710
Research and development	18,646			4,479
Selling, general and administrative	14,817			6,942
Amortization of intangible assets	10,343			943
Amortization of deferred stock compensation	2,531			10
Total costs and expenses	91,665			39,084
Operating loss	(11,028		)	(1,251		)
Interest income	400			1,593
Other income (loss), net	325			(22		)
Income (loss) before income taxes	(10,303		)	320
Provision for income taxes	386			127
Net income (loss)	$	(10,689	)	$	193
Basic net income (loss) per share	$	(0.25	)	$	0.01
Diluted net income (loss) per share	$	(0.25	)	$	0.01
Shares used to compute basic net income (loss) per share	42,522			27,396
Shares used to compute diluted net income (loss) per share	42,522			28,096

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)

	Three Months Ended March 31,
	2004			2003
Cash flows from operating activities:
Net income (loss)	$	(10,689	)	$	193
Adjustments to reconcile net income (loss) to net cash provided by operations:
Depreciation, amortization and other	2,492			876
Amortization of intangible assets	10,343			1,194
Amortization of deferred stock compensation	2,531			10
Changes in current assets and liabilities:
Accounts receivable	(587		)	(11,613		)
Inventory	(1,194		)	4,983
Prepaid expenses and other current assets and other assets and investments	494			(1,280		)
Accounts payable	4,620			4,333
Accrued expenses and other liabilities and long-term liabilities	(556		)	(1,122		)
Net cash provided by (used in) operating activities	7,454			(2,426		)
Cash flows from investing activities:
Capital expenditures for property and equipment	(1,922		)	(973		)
Purchases of investments	(59,444		)	(31,855		)
Proceeds from sales and maturities of investments	69,339			32,488
Net cash provided by (used in) investing activities	7,973			(340		)
Cash flows from financing activities:
Proceeds from issuance of common stock	2,138			108
Installment payment on purchased core technology	—			(1,500		)
Net cash provided by (used in) financing activities	2,138			(1,392		)
Net increase (decrease) in cash and cash equivalents	17,565			(4,158		)
Cash and cash equivalents at beginning of period	47,994			31,607
Cash and cash equivalents at end of period	$	65,559		$	27,449

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 of Zoran Corporation and subsidiaries (“Zoran” or the “Company”) have been prepared in conformity with accounting principles for interim financial information generally accepted in the United States of America.  However, certain information or footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (the “Commission”).  In the opinion of management, the condensed consolidated financial statements reflect all adjustments considered necessary, consisting only of normally occurring adjustments, for a fair presentation of the consolidated financial position, operating results and cash flows for the periods presented.  The results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for the full fiscal year or in any future period.  This quarterly report on Form 10-Q should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2003, included in the Zoran Corporation 2003 Annual Report on Form 10-K filed with the Commission.

Reclassifications

Certain prior period amounts have been reclassified to conform to the current period presentation.

Recently Issued Accounting Standards

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 March 15, 2004. 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.

In March 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 03-01, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.”  EITF No. 03-01 provides guidance on recording other-than-temporary impairments of cost method investments and requires additional disclosures for those investments.  The recognition and measurement guidance in EITF No. 03-01 should be applied to other-than-temporary impairments evaluations in reporting periods beginning after June 15, 2004.  The disclosure requirements are effective for fiscal years ending after June 15, 2004 and are required only for annual periods.  The Company does not believe that the adoption of this standard will have a material impact on its consolidated balance sheet or statement of operations.

2.     Stock Based Compensation

Zoran applies Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for its stock plans.  Stock options are generally granted with exercise prices equivalent to fair market value of the underlying common stock on the date of grant, and no compensation cost is recognized.  In connection with stock options granted through the acquisition of Nogatech, Inc. during 2000 and Oak Technology, Inc. during 2003, the Company recorded deferred stock-based compensation which is being amortized over the vesting period of the options.  Amortization of deferred stock compensation expense recognized as a result of the amortization of these options during the quarter ended March 31, 2004 and 2003 was approximately $2,531,000 and $10,000, respectively.

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Had compensation cost for the Company’s option and stock purchase plans been determined based on the fair value of the options at the grant date, as prescribed in Statement of Financial Accounting Standards No. 123 “Accounting for Stock Based Compensation” (“SFAS 123”), the Company’s net loss and net loss per share for the three month periods ended March 31, 2004 and 2003 would have been as follows (in thousands, except per share data):

	Three Months Ended March 31,
	2004			2003
Net income (loss) attributable to common stockholders, as reported	$	(10,689	)	$	193
Add:
Employee stock-based compensation expense included in net income (loss), net of tax	2,531			10
Total employee stock-based compensation expense determined under the fair value method, net of tax	(11,844		)	(6,284		)
Pro forma net loss attributable to common stockholders	$	(20,002	)	$	(6,081	)
Pro forma net loss per share attributable to common stockholders:
Basic	$	(0.47	)	$	(0.22	)
Diluted	$	(0.47	)	$	(0.22	)
Net income (loss) per share as reported:
Basic	$	(0.25	)	$	0.01
Diluted	$	(0.25	)	$	0.01

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 option pricing model with the following assumptions used for options and purchase grants during the applicable periods.

	Stock Option Plans				Employee Stock Purchase Plans
	Three Months Ended March 31, 2004		Three Months Ended March 31, 2003		Three Months Ended March 31, 2004		Three Months Ended March 31, 2003
Expected life (years)	5.0		5.0		0.5		0.5
Expected volatility	85	%	93	%	91	%	93	%
Risk-free interest rate	3.0	%	4.7	%	1.0	%	2.8	%

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 necessarily provide a reliable measure of the fair value of the Company’s stock options.

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3.Comprehensive Income (Loss)

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

	Three Months Ended March 31,
	2004			2003
Net income (loss)	$	(10,698	)	$	193
Change in unrealized gain on investments, net of tax	2,464			125
Total comprehensive income (loss)	$	(8,234	)	$	318

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

4.Inventories

Inventories are stated at the lower of cost (first in, first out) or market and consisted of the following (in thousands):

	March 31, 2004		December 31, 2003
Purchased parts and work in process	$	9,662	$	5,701
Finished goods	8,337		11,104
	$	17,999	$	16,805

5.Goodwill and Other Intangible Assets

The Company adopted Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”, or SFAS 142, as of January 1, 2002. In accordance with SFAS 142, goodwill is not amortized, but is required to be reviewed periodically for impairment on at least an annual basis.  For the year ended December 31, 2003, the Company performed the annual analysis as of September 30, 2003 and concluded that goodwill was not impaired, as the fair value of each reporting unit exceeded its carrying value, including goodwill.

Components of Acquired Intangible Assets (in thousands):

		March 31, 2004							December 31, 2003
	Life (Years)	Gross Carrying Amount		Accumulated Amortization			Net Balance		Gross Carrying Amount		Accumulated Amortization			Net Balance
Amortized intangible assets:
Purchased technology	2-3	$	176,720	$	(40,147	)	$	136,573	$	176,720	$	(31,792	)	$	144,928
Patents	3-5	27,900		(4,346		)	23,554		27,900		(2,996		)	24,904
Customer base	3-5	13,010		(3,023		)	9,987		13,010		(2,450		)	10,560
Tradename and others	3-5	2,100		(965		)	1,135		2,100		(900		)	1,200
Purchased core technology *	4-5	8,799		(1,920		)	6,879		8,799		(1,506		)	7,293
Total		$	228,529	$	(50,401	)	$	178,128	$	228,529	$	(39,644	)	$	188,885

(*) The Company records the amortization of purchased core technology as cost of hardware product revenues.

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Estimated future intangible amortization expense, based on current balances, as of March 31, 2004 is as follows (in thousands):

	Amount
Remaining nine months of 2004	$	32,419
Year ending December 31, 2005	43,401
Year ending December 31, 2006	42,130
Year ending December 31, 2007	38,623
Year ending December 31, 2008	21,555
Total	$	178,128

Changes in the carrying amount of goodwill for the three months ended March 31, 2004 were as follows (in thousands):

	Amount
Balance at December 31, 2003	$	119,091
Adjustment to goodwill related to acquisition of Oak	181
Balance at March 31, 2004	$	119,272

Goodwill by reporting unit at March 31, 2004 and December 31, 2003 was as follows:

	March 31, 2004		December 31, 2003
DVD	$	63,855	$	63,855
Imaging	6,177		5,996
DC	31,252		31,252
DTV	17,988		17,988
	$	119,272	$	119,091

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.Segment Reporting

SFAS No. 131 establishes standards for the reporting by public business enterprises of information about operating segments, products and services, geographic areas, and major customers. The method for determining what information to report is based on the way that management organizes the operating segments within the Company for making operational decisions and assessments of financial performance. The Company’s chief operating decision-maker is considered to be the Chief Executive Officer (“CEO”).

Subsequent to the acquisition of Oak Technology, Inc. in 2003, the Company determined it has four reportable segments: Digital Versatile Disc (DVD), Imaging, Digital Camera (DC) and Digital Television (DTV). The DVD group provides video and audio compression and decompression products based on MPEG, Dolby Digital and DTS standards for use in DVD players and DVD recorders. The Imaging group provides imaging systems, including products used in digital laser copiers and printers as well as multifunction peripherals. The DC group focuses on video compression and decompression products based on JPEG technology and

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CMOS sensors. The DTV group provides highly integrated application-specific integrated circuits, or ASICs, and system-on-a-chip, or SOC, solutions for standard and high definition digital television products including televisions, set top boxes, personal video recorders, digital video recorders, and recordable DVD as well as platforms, drivers and software stacks for a variety of operating systems required for these digital television products.

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

Information about reported segment income or loss is as follows for the three months ended March 31, 2004 and 2003 (in thousands):

	Three Months Ended March 31,
	2004			2003
Net revenues:
DVD	$	47,223		$	31,211
Imaging	18,188			—
DC	7,855			6,622
DTV	7,371			—
	$	80,637		$	37,833
Operating expenses:
DVD	$	48,062		$	31,244
Imaging	10,508			—
DC	7,900			6,887
DTV	12,321			—
	$	78,791		$	38,131
Contribution margin:
DVD	$	(839	)	$	(33	)
Imaging	7,680			—
DC	(45		)	(265		)
DTV	(4,950		)	—
	$	1,846		$	(298	)

A reconciliation of the totals reported for the operating segments to the applicable line items in the consolidated financial statements for the three months ended March 31, 2004 and 2003 is as follows (in thousands):

	Three Months Ended March 31,
	2004			2003
Contribution margin from operating segments	$	1,846		$	(298	)
Amortization of intangibles	10,343			943
Amortization of deferred stock compensation	2,531			10
Total operating loss	$	(11,028	)	$	(1,251	)

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

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The distribution of total revenues for the three months ended March 31, 2004 and 2003 was as follows (in thousands):

	Three Months Ended March 31,
	2004		2003
Revenue from unaffiliated customers originating from:
China	$	28,807	$	15,267
Japan	23,837		5,379
Korea	10,438		10,434
Taiwan	4,786		4,052
North America	8,824		911
Other	3,945		1,790
	$	80,637	$	37,833

For the three months ended March 31, 2004, two customers each accounted for 11% of total revenues. For the same period of 2003, three customers accounted for 26%, 14% and 10% of total revenues, respectively.

As of March 31, 2004, one customer accounted for 11% of total net accounts receivable and as of December 31, 2003, two customers accounted for 14% and 10% of total net accounts receivable, respectively.

8.Acquisition

On August 11, 2003, pursuant to an Agreement and Plan of Reorganization dated as of May 4, 2003 (the “Merger Agreement”) among Zoran, a wholly-owned subsidiary of Zoran (“Merger Sub”), and Oak Technology, Inc., Oak was merged with and into Merger Sub.

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

Zoran’s primary objective in acquiring Oak was based on the Company’s belief that the combined company would benefit from the following:

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

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

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

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

•Oak’s existing market position as a leading supplier of HDTV integrated circuits, providing the combined company with access to this high-growth market segment.

The purchase price exceeded the net assets acquired resulting in the recognition of goodwill and other intangible assets.

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

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

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

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

Acquisition costs include $3.3 million of investment banker fees, $1.7 million of insurance costs, $1.1 million of legal and accounting fees and $0.7 million in other acquisition related expenses.

The purchase price allocation was as follows (in thousands):

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

The following table summarizes the estimated fair value of the tangible assets acquired and liabilities assumed at the date of acquisition (in thousands):

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

Tangible assets were valued at estimates of their current fair values. The valuation of the acquired intangible assets which was based on management’s estimates and considered various factors including appraisals, resulted in a value of purchased technology of approximately $157.9 million, patents of $27.0 million, customer base of $11.5 million and trademarks and tradenames of approximately $1.3 million. Purchased technology is being amortized over a weighted average estimated life of 4.8 years and patents, customer base, trademarks and tradenames are being amortized over their estimated useful lives of five years with no residual values.

During the period August 11, 2003 through March 31, 2004, we revised estimates related to certain assets and liabilities, and as a result, we decreased the purchase price and goodwill by $3.4 million.

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

Approximately $50.1 million of the purchase price was allocated to in-process research and development which had not yet reached technological feasibility and had no alternative future use. Accordingly, this amount was immediately expensed upon the acquisition date. This amount was determined using management’s estimates including consultation with an independent appraiser. The value of the in-process research and development was determined using a discounted cash flow method and factors including projected financial results, relative risk of successful development, time-value of money and level of completion.

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The Company expects that the in-process technologies will be successfully completed by the second quarter of calendar 2005 with approximately $30.0 million in remaining costs. At the time of acquisition, Oak had five material development projects in process as follows:

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

•Fire 3—a programmable SOC solution that will complement the OTI-4110 and ZR-4100 in the inkjet market. Fire 3 will provide a fully scalable solution platform to cover much of the performance and feature range of an OEM’s inkjet offerings.

•Integrated Print System—The Integrated Print System (“IPS”) is a dynamic embedded scalable architecture providing peripheral manufacturers with highly integrated modular controller and connectivity software for powering single and multifunctional devices.

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

•A new lower cost highly integrated HDTV decoder—the first in a family of highly integrated HDTV decoders specifically designed for the FCC mandated digital television chassis market. This device includes all the required interfacing to support digital cable applications and is applicable to existing CRT and flat panel display devices.

The value of in-process research and development was determined using the multi-period excess earnings method by estimating the expected net cash flows from the projects once commercially viable and discounting the net cash flows back to their present value using a discount rate of 22%. This rate was based on the industry segment for the technology, nature of the products to be developed, length of time to complete the project and overall maturity and history of the development team. The net cash flows from the identified projects were based on estimates of revenue, cost of revenue, research and development expenses, selling general and administrative expenses, and applicable income taxes. These estimates did not take into account any potential synergies that could be realized as a result of the acquisition. Revenues for the incremental core technologies developed are expected to commence in the fourth quarter of 2005 and extend through 2011. Revenue projections were based on estimates of market size and growth, expected trends in technology and the expected timing of new product introductions.  As of March 31, 2004, there have been no material variations from the underlying assumptions that were used in the original computation of the value of the acquired in-process research and development.

The following unaudited pro forma financial information presents the combined results of operations of Zoran and Oak as if the acquisition had occurred as of the beginning of fiscal 2003 and 2002, after giving effect to certain adjustments, including amortization of intangibles. The in-process research and development charge of $50.1 million is not reflected in the unaudited pro forma combined condensed statement of operations. The unaudited pro forma financial information does not necessarily reflect the results of operations that would have occurred had the combined companies constituted a single entity during such periods, and is not necessarily indicative of results which may be obtained in the future.

	Year Ended December 31,
	2003			2002
In thousands except for per share data:
Pro forma revenues	$	275,658		$	284,770
Pro forma net loss	$	(73,247	)	$	(83,628	)
Pro forma net loss per share:
Basic	$	(1.77	)	$	(2.08	)
Diluted	$	(1.77	)	$	(2.08	)

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9.Net Income (Loss) Per Share

Basic and diluted net income (loss) per share have been computed using the weighted average number of shares of common stock and dilutive common equivalent shares from stock options and warrants outstanding during the period in accordance with Statement of Financial Accounting Standards (SFAS) No. 128, “Earnings per Share.”  The following table provides a reconciliation of the components of the basic and diluted net income (loss) per share computations (in thousands, except per share data):

	Three Months Ended March 31,
	2004			2003
Net income (loss) from continuing operations	$	(10,689	)	$	193
Basic common shares	42,522			27,396
Effect of dilutive securities:
Common stock options	—			700
Dilutive weighted average shares	42,522			28,096
Net income (loss) per share:
Basic	$	(0.25	)	$	0.01
Diluted	$	(0.25	)	$	0.01

Stock options to purchase 13,426,000 shares of common stock were outstanding during the three months ended March 31, 2004, but were not included in the computation of diluted net loss per share as the Company had a net loss for the three months ended March 31, 2004.  Stock options to purchase 3,108,000 shares of common stock were outstanding during the three months ended March 31, 2003 but were not included in the computation of diluted net loss per share as they would have had an anti-dilutive effect.

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

This report includes a number of forward-looking statements which reflect the Company’s current views with respect to future events and financial performance. These forward-looking statements are subject to certain risks and uncertainties, including those discussed below under the heading “Future Performance and Risk Factors” and in “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Future Performance and Risk Factors” included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. In this report, the words “anticipates,” “believes,” “expects,” “intends,” “future” and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof.

Overview

Prior to the acquisition of Oak Technology, Inc. on August 11, 2003, our products consisted of integrated circuits and related products used in digital versatile disc players, or DVDs, movie and home theater systems, digital cameras and video editing systems.  As a result of the acquisition of Oak, we now also provide integrated circuits, software and platforms for digital television applications that enable the delivery and display of digital video content through a set-top box or television as well as digital imaging products consisting of semiconductor hardware and software that enable users to print, scan, process and transmit documents to computer peripherals that perform printing functions.

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 periodically 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 hardware product revenues 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 hardware product revenues to offset anticipated decreases in average selling prices, our product gross margins will decrease. Our hardware product gross margin is also dependent on product mix and on the proportion of products sold directly to our OEM customers versus indirectly through our marketing partners. These marketing partners 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. As a result, lower gross margins on sales to these resellers are partially offset by reduced selling and marketing expenses related to such sales.  Hardware product sales in Japan are primarily made through distributors including Fujifilm, our strategic partner and reseller in Japan primarily for the DVD segment.  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. Quarterly licensing revenue can be significantly affected by the timing of a small number of licensing transactions. Accordingly, licensing revenues have fluctuated, and will continue to fluctuate, on a quarterly basis. In addition, we have historically generated a portion 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 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 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.

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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 a material amount 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 2004 and 2020, and the benefits from our subsidiary’s Approved Enterprise status expire at various times beginning in 2004.

Statement Regarding Use of Non-GAAP Financial Measures

To supplement the consolidated financial results prepared under generally accepted accounting principles (“GAAP”) we include non-GAAP financial measures in our Management’s Discussion and Analysis, our quarterly press releases regarding operating results and our presentations to investors.  These non-GAAP financial measures consist of GAAP financial measures adjusted to include or exclude certain revenues, costs, expenses and gains.  The purpose of such adjustment is to give an indication of our baseline performance before gains, losses or other charges that are considered by management to be outside of our core operating results.  In some instances, we use financial measures that exclude the effects of the Oak acquisition to provide a meaningful comparison of results in periods occurring before and after that acquisition.  Management uses these non-GAAP measures as a basis for planning and forecasting future periods.  These non-GAAP measures may differ materially from the non-GAAP measures used by other companies and should not be regarded as a replacement for corresponding GAAP measures.

Oak Acquisition

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

Following the completion of the acquisition, the results of operations of Oak have been included in our consolidated financial statements.  Accordingly, our results of operations for the three month periods ended March 31, 2004 and December 31, 2003 each reflect a full quarter of Oak’s operations, while our results of operations for the first quarter of 2003 reflect only Zoran’s historical operations.

Subsequent to the acquisition of Oak, we determined that Zoran has four operating segments: Digital Versatile Disc (DVD), Imaging, Digital Camera (DC) and Digital Television (DTV). The DVD group provides video and audio compression and decompression products based on MPEG, Dolby Digital and DTS standards for use in DVD players and DVD recorders. The Imaging group provides imaging systems, including products used in digital laser copiers and printers as well as multifunction peripherals. The DC group focuses on video compression and decompression products based on JPEG technology and CMOS sensors. The DTV group provides highly integrated application-specific integrated circuits, or ASICs, and system-on-a-chip, or SOC, solutions for standard and high definition digital television products including televisions, set top boxes, personal video recorders, digital video recorders, and recordable DVD as well as platforms, drivers and software for a variety of operating systems required for these digital television products.

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Results of Operations

The following table sets forth certain consolidated statement of operations data as a percentage of total revenues for the periods indicated and percentage changes from period to period:

	Three Months Ended						Percentage Change Between Three Months Ended March 31, 2004 and Three Months Ended
	March 31, 2004		March 31, 2003		December 31, 2003		March 31, 2003		December 31, 2003
Revenues:
DVD hardware products	56.3	%	80.5	%	55.6	%	49.0	%	22.7	%
DTV hardware products	8.7	%	—		10.6	%	—		(0.5	)%
DC hardware products	9.7	%	17.5	%	10.8	%	18.6	%	9.7	%
Imaging hardware products	9.7	%	—		8.7	%	—		34.2	%
Total hardware product revenues	84.4	%	98.0	%	85.7	%	83.4	%	19.4	%
Imaging software	12.9	%	—		8.0	%	—		94.0	%
IP licensing	2.2	%	0.6	%	5.6	%	734.8	%	(50.9	)%
Development and other	0.5	%	1.4	%	0.7	%	(28.2	)%	(18.0	)%
Total software and other revenues	15.6	%	2.0	%	14.3	%	1,613.0	%	31.8
Total revenues	100.0	%	100.0	%	100.0	%	113.1	%	21.2	%
Costs and expenses:
Cost of hardware product revenues	56.2	%	70.6	%	56.7	%	69.7	%	20.2	%
Research and development	23.1	%	11.8	%	26.2	%	316.3	%	6.5	%
Selling and administrative	18.4	%	18.3	%	21.6	%	113.4	%	3.3	%
Amortization of intangible assets	12.9	%	2.6	%	15.8	%		*	(1.9	)%
Amortization of deferred stock compensation	3.1	%	—		5.8	%		*	(34.0	)%
Acquisition related expense	—		—		2.1	%	—			*
Total costs and expenses	113.7	%	103.3	%	128.2	%	134.5	%	7.4	%
Operating loss	(13.7	)%	(3.3	)%	(28.2	)%		*		*
Interest and other income	0.9	%	4.1	%	1.5	%	(53.9	)%	(29.1	)%
Income (loss) before income taxes	(12.8	)%	0.8	%	(26.7	)%		*		*
Provision for income taxes	0.5	%	0.3	%	0.2	%		*		*
Net income (loss)	(13.3	)%	0.5	%	(26.9	)%		*		*
Supplemental information:
Hardware product gross margin	33.4	%	28.0	%	33.8	%	118.5	%	17.9	%
Regional revenue:
China	35.7	%	40.4	%	36.1	%	88.7	%	20.0	%
Japan	29.6	%	14.2	%	21.1	%	343.1	%	70.1	%
Korea	12.9	%	27.6	%	18.3	%	0.0	%	(14.4	)%
Taiwan	5.9	%	10.7	%	9.2	%	18.1	%	(22.1	)
North America	10.9	%	2.4	%	10.3	%	868.6	%	28.2	%
Other	4.9	%	4.7	%	5.0	%	120.4	%	19.7	%
	100.0	%	100.0	%	100.0	%	113.1	%	21.2	%

(*) Not meaningful

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Revenues

Total revenues increased 113% to $80.6 million for the three months ended March 31, 2004 compared to $37.8 million for the three months ended March 31, 2003.  Approximately $18.2 million of the increase was from the Imaging segment and $6.4 million was from the DTV segment which were acquired as a result of the Oak acquisition in August 2003 and which were not included in our revenues for the three months ended March 31, 2003.  Total revenues for the three months ended March 31, 2004 increased by $14.1 million, or 21.2%, from the $66.5 reported for the three months ended December 31, 2003. Approximately 60% of this growth was driven by increased DVD product revenues.  We believe that the overall market for DVD players continued to grow at a substantial rate during the three months ended March 31, 2004.  In addition, we believe that we are continuing to gain market share in certain geographic regions, including China.  Approximately 26% of the sequential increase was from the inclusion of Imaging revenue streams acquired from Oak that were previously excluded due to purchase accounting requirements. The balance of the sequential increase, 14%, was largely attributable to growth in the Imaging and Digital Camera segments. 

Hardware product revenues for the three months ended March 31, 2004 were $68.0 million compared to the $37.1 million recorded in the comparable period of the prior year.  Excluding the impact of the Oak acquisition, hardware product revenues increased by $17.1 million, or 46%, driven by $15 million in increased revenue  in our DVD segment and approximately $1 million each in the Digital Camera and DTV segments.  DVD hardware product revenues comprised 56.3% of total revenues in the three months ended March 31, 2004 compared to 80.5% of total revenues in the same period one year ago. The product line diversification achieved through the acquisition of Oak reduced the concentration of revenues from DVD products to 56.3% in the first quarter of 2004, from what would have been 83.7%, based on Zoran’s historical operations.

Hardware product revenues increased $11.1 million, or 19.4%, sequentially from $57.0 million for the fourth quarter of 2003 to $68.0 million for the first quarter of 2004.  Approximately $8.4 million of this increase resulted from increased sales of DVD products.  Approximately $1.3 million was due to discounts recorded in the fourth quarter of 2003 that related to prior periods. Approximately $2.0 million was attributable to increased Imaging hardware product revenues as a result of the continued ramp of our new Quatro-based imaging products. The remaining $700,000 of sequential growth came from the Digital Camera segment. DVD hardware products accounted for the majority of our total hardware product sales, representing 56.3% of total revenues for the first quarter of 2004 compared to 55.6% in the fourth quarter of 2003. We expect DVD sales to continue to comprise a majority of our revenues for the balance of 2004.

Software and other revenues were $12.6 million and $736,000 for the three months ended March 31, 2004 and 2003, respectively.  The increase includes additional revenues of $10.4 million attributable to the Imaging segment acquired in  the Oak acquisition, $1.1 million attributable to the DVD segment primarily as a result of  increased IP licensing, and $400,000 of development revenue attributable to the DTV segment.

Software and other revenues  increased $3.0 million on a sequential basis from $9.6 million for the fourth quarter of 2003 to $12.6 million for the first quarter of 2004.  The principal reason for this increase was the inclusion of approximately $3.6 million in Imaging software royalty streams acquired from Oak that were excluded in the fourth quarter of 2003 due to the requirements of purchase accounting. Absent the inclusion of this royalty revenue, Imaging revenues grew approximately $1.4 million or 16% over the fourth quarter of 2003.  This growth was offset  in part by a relative decline in DVD related IP license revenues.  As a percentage of total revenues, software and other revenues increased from 14.4% for the fourth quarter of 2003 to 15.6% for the first quarter of 2004.

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Regional Revenue

During the first three months of 2004, approximately 36% of our total revenues, or $28.8 million, was derived from sales to customers in China, compared to 40%, or $15.3 million, for the comparable period in 2003.  The increase of $13.5 million, or 88.7%, was due primarily to increased sales of DVD products.  Sequentially, sales to customers in China grew by 20.0% in the first quarter of 2004 compared to the immediately preceding quarter.

Revenues from sales to customers in Japan accounted for 30% of our total  revenues for the three months ended March 31, 2004, compared to 14% in the comparable period in 2003.  This increase was attributable to the inclusion of revenues from the former Oak Imaging business.  Sequentially, revenue in Japan driven by DVD grew by 70.1%, or $9.8 million, in the first quarter of 2004 to approximately 30% of total revenues, compared to 21% in the immediately preceding quarter.

Revenues from sales to customers in Korea and Taiwan were 18.8% of total revenues for the first quarter of 2004 compared to 38.3% of total revenues in the same quarter one year ago.  This reduced concentration was due to growth in total revenues as a result of the acquisition of Oak. On an absolute basis, revenues from Korea were flat and revenues in Taiwan grew by 18.1% compared to the same quarter one year ago. The growth in Taiwan was the result of new product introductions and design wins ramping into production in the Digital Camera segment. Sequentially, revenues from these regions decreased to 18.8% of total revenues for the first quarter of 2004 compared to 27.5% of total revenues during the fourth quarter of 2003 due to other seasonal factors and greater relative growth of sales to customers in other regions.

North American revenues increased to 10.9% of our total revenues from 2.4% in the same period of the prior year, due to the inclusion of revenues from the former Oak HDTV and Imaging businesses. North American revenues increased sequentially by $1.9 million or 28.2% compared to the immediately preceding quarter. Approximately $1.2 million of this increase was driven primarily by growth in revenues in Imaging software royalties.

Cost of Hardware Product Revenues

Cost of hardware product revenues was $45.3 million for the quarter ending March 31, 2004 compared to $26.7 million for the same period in 2003.  The increase in costs was related to the corresponding increase in revenues during the period.  As a percentage of hardware product revenues, cost of hardware product revenues decreased from 72.0% for the three months ended March 31, 2003 to 66.6% for the three months ended March 31, 2004.  This relative decrease in costs (and corresponding increase in gross profit) was due primarily to the impact of the relatively higher Imaging hardware products acquired from Oak in August 2003, and accordingly, are not reflected in our revenues for the first quarter of 2003.  These products command a higher margin than our more mature products, which in turn improves our gross margin. Absent the acquisition of Oak, the Zoran cost of hardware products decreased in both DVD and Digital Camera by approximately 1% on a blended basis.

Cost of hardware product revenues for the three months ended March 31, 2004 also increased from the $37.7 million recorded during the three months ended December 31, 2003, again due to the corresponding increase in revenues.  As a percentage of hardware product revenues, cost of hardware product revenues were relatively unchanged at 66.6% for the three months ended March 31, 2004 compared to 66.2% for the fourth quarter of 2003.  Revenue during the current quarter included a greater proportion of sales of our new Quatro-based imaging products, consistent with our expectations.  Unlike our other imaging hardware products, these devices are sold into consumer markets, which command lower average selling prices.   The impact of these new imaging products was largely offset by an increase in volumes of a number of newer DVD products, which command higher selling prices and have lower manufacturing costs.

Research and Development

Research and development (“R&D”) expenses were $18.6 million for the three months ended March 31, 2004, compared to $4.5 million for the same period of 2003. This increase was primarily a result of the inclusion of the former Oak operations as well as continued investments in research and development across all of our segments.  In addition, in the first quarter of 2003, we recorded approximately $1.5 million in grants from the Chief Scientist in Israel’s Ministry of Industry and Trade as an offset to R&D expense.  R&D expenses were 23% of total revenues for the three month period ended March 31, 2004, compared to 12% for the same period of 2003.

R&D expenses for the three months ended March 31, 2004 increased by approximately 6.5%, or $1.1 million, compared to the fourth quarter of 2003 as the Company continued to invest in the development of new products and additional DVD recording development.

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Selling, General and Administrative

Selling, general and administrative (“SG&A”) expenses were $14.8 million for the three months ended March 31, 2004 compared to $6.9 million for the same period of 2003.  This increase was primarily a result of the inclusion of the former Oak operations as well as the continued increase in marketing and field application support expenses to support planned revenue growth in our Asia Pacific markets.  SG&A expenses were relatively unchanged at 18.4% of total revenues for the three months ended March 31, 2004 and 18.3% for the three months ended March 31, 2003.

SG&A expenses decreased as a percentage of revenues from 21.6% for the fourth quarter of 2003 to 18.4% for the first quarter of 2004.  In absolute dollars the expenses increased by approximately $500,000.  This increase was driven by increased patent litigation costs, continued investment in sales resources and  costs associated with the implementation of an Oracle information system across the Company.

Amortization of Deferred Stock Compensation

For the three months ended March 31, 2004, we incurred charges of $2.5 million related to the amortization of deferred stock compensation compared to $10,000 during the same period of the prior year.  The increase was due to the stock options granted in connection with the Oak acquisition during 2003 which resulted in a deferred stock compensation balance of $19.2 million which is being amortized over the remaining vesting period.  The amortization of deferred stock compensation decreased by $1.3 million from the $3.8 million recorded during the quarter ended December 31, 2003 due to the accelerated multiple option method.

Amortization of Intangible Assets

During the three months ended March 31, 2004, we incurred charges of $10.3 million related to the amortization of intangible assets compared to $900,000 for the three months ended March 31, 2003. This increase was due to the addition of approximately $198 million of amortizable intangible assets acquired in the Oak acquisition. Amortization declined 1.9% compared to the quarter ended December 31, 2003 due to the final installment of amortization of intangible assets associated with the 2000 Nogatech acquisition being recorded during the three months ended December 31, 2003.

Operating Loss

The significant operating loss of $11.0 million for the first quarter of 2004 was driven primarily by charges of $10.3 million and $2.5 million  for the amortization of intangible assets and deferred stock compensation, each related primarily to the Oak acquisition.  Excluding these charges, our operating income would have been $1.8 million, or 2.3% of total revenues, for the three months ended March 31, 2004.  On a comparable basis, excluding the amortization of intangible assets of $943,000 and deferred stock compensation of $10,000, we would have recorded an operating loss of $298,000, or (0.8%) of total revenues, for the same period of the prior year.  This $2.1 million improvement in adjusted operating income was primarily due to the net contribution of product  segments acquired in the Oak acquisition.  Zoran’s legacy product segments contributed approximately the same level of operating loss as in the first quarter of the previous year. Continued investment in DVD recording technology and advanced sensor technology adversely affected the profitability of the DVD and Digital Camera segments, respectively.

Sequentially, our operating loss improved by $7.8 million from the fourth quarter ended December 31, 2003. This improvement was the result of higher revenues and slightly lower amortization of intangible assets and deferred stock compensation associated with the Oak acquisition. The fourth quarter of 2003 operating loss was $18.8 million which, when adjusted to exclude:  amortization of intangibles of $10.5 million, amortization of deferred stock compensation of $3.8 million, acquisition related expenses of $1.4 million, discounts recorded in the fourth quarter that relate to previous periods of $1.3 million, and includes additional revenue of $3.6 million in Imaging software royalty streams acquired from Oak excluded under purchase accounting - would have resulted in a level of operating income of $1.9 million or 2.6% of total revenues. This was similar to the 2.3% or $1.8 million level of operating income recorded in the first quarter of 2004 as adjusted on a comparable basis. Research and development expense and selling, general and administrative expense increased sequentially in the first quarter of 2004 in line with the increase in total revenues and aggregate gross margins as compared to the fourth quarter of 2003.

Interest and Other Income

Interest and other income was $700,000 for the three month period ended March 31, 2004, compared to $1.6 million for the same period of 2003. The decrease was primarily due to a decline in interest rates and a decrease in our cash balances due primarily to the use of cash in the Oak acquisition.  Interest and other income was $1.0 million for the three months ended December 31, 2003.

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Provision for Income Taxes

Excluding charges related to the amortization of goodwill and other intangibles, our estimated effective tax rate was 15% for the first quarter of 2004.  We have 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.

At March 31, 2004, we continue to carry a full valuation allowance against our net deferred tax assets as management has determined that it is more likely than not that our deferred tax assets may not be realized.

Liquidity and Capital Resources

At March 31, 2004, we had $65.6 million of cash and cash equivalents, $59.7 million of short-term investments and $140.9 million of working capital. In addition, we had $75.0 million of investments in long-term marketable securities which are included in other assets on our consolidated balance sheet.

Net cash provided by operating activities during the first three months of 2004 was $7.5 million.  While we recorded a net loss of $10.7 million, this loss included non-cash charges of approximately $15.4 million comprised of depreciation of property and equipment of $2.5 million, amortization of intangible asset of $10.3 million and amortization of deferred stock compensation of $2.5 million, resulting in net income adjusted for non-cash charges of approximately $4.7 million for the three months ended March 31, 2004.  Additional cash from operating activities was provided by a $4.6 million increase in accounts payable, partially offset by a $1.2 million increase in inventory.

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

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

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 offset by an increase of $11.6 million in accounts receivable. Partially offsetting the increase in accounts receivable was 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, 2004, 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;

•unanticipated expenses associated with the recently completed acquisition of Oak;

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•We have faced and continue to 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.

•Transaction costs associated with the merger were included as part of the total purchase cost for accounting purposes. In addition, we incurred charges to operations in the quarter in which the merger was completed. We may incur additional charges, in amounts not currently estimable, in future quarters to reflect costs associated with integrating the two companies. These costs could adversely affect our future liquidity and operating results.

•Historically, Oak depended largely on its optical storage business, which during its 2002 fiscal year accounted for approximately 67% of Oak’s revenues. As a result of the sale of certain assets of its optical storage business in April 2003, Oak’s digital imaging and digital television businesses now represent the primary source of revenue from the ongoing Oak operations, and revenues from these emerging businesses are difficult to forecast. As a result, it is not possible to use Oak’s historical financial information to predict its contribution to the future operating results of the combined company.

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

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

•fluctuation in demand for their products;

•the timing of new product introductions or enhancements by Zoran, Oak and their competitors;

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

•the timing or cancellation of large customer orders;

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

•pricing policy changes by Zoran, Oak and their competitors and suppliers;

•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 their products;

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

•the evolving and unpredictable nature of the markets for products incorporating Zoran’s and Oak’s integrated circuits and embedded software.

We expect that the operating results of the combined company 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;

•changes in or the emergence of new industry standards;

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•failure to anticipate changing customer product requirements;

•the loss or gain of important customers;

•product obsolescence; and

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

The operating results of the combined company could also be harmed by:

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

•terrorism and international conflicts or other crisis, such as the recent recurrence of Severe Acute Respiratory Syndrome, or SARS;

•other conditions affecting the timing of customer orders;

•changes in governmental regulations that could affect our products; 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 with independent foundries several months in advance of the scheduled delivery date, often in advance of receiving non-cancelable orders from our customers. This limits our ability to react to fluctuations in demand for their products. If anticipated shipments in any quarter are canceled or do not occur as quickly as expected, or if we fail to foresee a technology change that could render a product obsolete, 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.

Product supply and demand fluctuations common to the semiconductor industry are historically characterized by periods of manufacturing capacity shortages immediately followed by periods of overcapacity, which are caused by the addition of manufacturing capacity in large increments. We cannot predict whether we will achieve timely, cost-effective access to that capacity when needed, or if there will be a capacity shortage again in the future.

As a result of these factors, our operating results may vary significantly from quarter to quarter. These fluctuations may be more pronounced in the future as a result of the challenges we face in integrating the operations of Zoran and Oak. Any shortfall in revenues or net income from levels expected by the investment community could cause a decline in the trading price of our stock.

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

Because the markets that 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 the products are incorporated into both mature products and replacement products. A delay in a 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 shopping period for consumer electronics products, and therefore, a disproportionate percentage of our sales. We expect these seasonal 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.

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Our success for the foreseeable future will be dependent on growth in demand for integrated circuits for a limited number of applications.

In recent years, we have derived a substantial majority of our product revenues from the sale of integrated circuits for DVD and digital camera applications. We expect that sales of our products for these applications will continue to account for a significant portion of our revenues for the foreseeable future. As a result of Oak’s sale of its optical storage business, the future financial performance of the former Oak operations will depend on our ability to successfully develop and market new products in the digital television, HDTV and digital imaging markets. 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 financial performance is highly dependent on the timely and successful introduction of new and enhanced products.

Our financial performance depends in large part on our ability to successfully develop and market next-generation and new products in a rapidly changing technological environment. If we fail to successfully identify new product opportunities and timely develop and introduce new products that achieve market acceptance, we may lose our market share and our future revenues and earnings may suffer. In recent years, our success has been dependent on our successful development and timely introduction of integrated circuits for DVD players, DVD recorders and digital cameras. These markets are characterized by the incorporation of a steadily increasing level of integration and numbers of features on a chip at the same or lower system cost, enabling original equipment manufacturers, or OEMs, to continually improve the features or reduce the prices of the systems they sell. If we are unable to continually develop and introduce integrated circuits with increasing levels of integration and new features at competitive prices, our operating results will suffer.

In the consumer electronics market, Oak’s performance has been highly dependent upon the successful development and timely introduction of new products and solutions for broadband digital television and HDTV. In the digital office market, Oak’s performance has been dependant on its ability to successfully develop embedded image processing system on a chip, or SOC, solutions for the digital office market, in particular, embedded digital color copier technology and image processing chips for a variety of imaging peripherals, including printers and multi-function peripherals, or MFPs. Among other technological changes, embedded PDF and color capability are rapidly emerging as market requirements for printers and other imaging devices. Some of Oak’s competitors have the capacity to supply these solutions, and some of their solutions have been well received in the marketplace. We face the challenge of continuing Oak’s development of digital television and HDTV solutions as well as developing new imaging products with the capability to handle greater color and image complexity, including web-based documents, and work with higher-performing devices in networked environments. If we are unable to meet these challenges with the development of products that can effectively compete in the OEM software and solutions market, our future operating results could suffer.

We must keep pace with rapid technological changes and evolving industry standards to remain competitive.

Our future success will depend on our ability to anticipate and adapt to changes in technology and industry standards and our customers’ changing demands. The consumer electronics market, in particular, is characterized by rapidly changing technology, evolving industry standards, frequent new product introductions, short product life cycles and increasing demand for higher levels of integration. Our ability to adapt to these changes and to anticipate future standards, and the rate of adoption and acceptance of those standards, will be a significant factor in maintaining or improving our competitive position and prospects for growth. If new industry standards emerge, our products or the products of our customers could become unmarketable or obsolete, and we could lose market share or be required to incur substantial unanticipated costs to comply with these new standards.

Our success will also depend on the successful development of new markets and the application and acceptance of new technologies and products in those new markets. For example, our success will depend on the ability of our customers to develop new products and enhance existing products in the recordable DVD player market and products for the broadband digital television and HDTV markets and to introduce and promote those products successfully. These markets may not continue to develop to the extent or in the time periods that we currently anticipate due to factors outside our control, such as delays in implementation of FCC 02-320 requiring all new televisions to include a digital receiver. If new markets do not develop as we anticipate, or if our products do not gain widespread acceptance in these markets, our business, financial condition and results of operations could be materially and adversely affected. 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 this content is not available, manufacturers may not be able to sell products incorporating our products, and our sales would suffer.

We rely on independent foundries and contractors for the manufacture, assembly and testing of our integrated circuits and other hardware products, 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.

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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 our 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 that 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 their 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 a limited number of independent contractors for the assembly and testing of our products. 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 them 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 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 may in the future need 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.

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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 photo masks 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.

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.

We face intense competition in the markets in which we compete. We expect that the level of competition will increase in the future from existing competitors and from other companies that may enter our existing or future markets with solutions that may be less costly or provide higher performance or additional features.

Competition in Zoran’s core compression technology market has historically been dominated by large companies, such as ST Microelectronics, 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.

The DVD market continues to expand, 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.

We face competition from several large semiconductor companies in the broadband digital television and set-top box markets. We expect competition to continue to increase in these markets as industry standards become well known and as other competitors enter these markets.

We also face significant competition in the digital office market. The future growth of the digital office market is highly dependent on OEMs continuing to outsource an increasing portion of their product development work. While the trend toward outsourcing on the part of our OEM customers in this market has accelerated in recent years, any reversal of this trend, or a change in the way they outsource, could seriously harm our business.

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

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 will suffer.

Average selling prices for our products decline over relatively short time periods, while many of our manufacturing costs are fixed. When our average selling prices decline, our revenues decline unless we are able to 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 we expect to continue to experience them in the future, although we cannot predict when they may occur or how severe they will be.

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.

Zoran’s and Oak’s largest customers have accounted for a substantial percentage of their revenues. In 2003, sales to Fujifilm accounted for approximately 14% of Zoran’s total revenues, and Zoran’s four largest customers accounted for approximately 46% of its total

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revenues. Similarly, during Oak’s fiscal 2002, Oak’s top 10 customers accounted for approximately 69% of its total revenues. 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.

Fujifilm has been our largest customer over the last six 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 also provided funding to support Zoran’s 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 operating results.

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 processes are 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.

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. Customers generally purchase our products subject to cancelable short-term purchase orders. We cannot predict whether our current customers will continue to place orders, whether existing orders will be canceled, or whether customers who have ordered products will pay invoices for delivered products. 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.

Regulation of our customers’ products may slow the process of introducing new products and could impair our ability to compete.

The Federal Communications Commission, or FCC, has broad jurisdiction over our target markets in the digital television business we acquired from Oak. Various international entities or organizations may also regulate aspects of our business or the business of our customers. Although our products are not directly subject to regulation by any agency, the transmission pipes, as well as much of the equipment into which our products are incorporated, are subject to direct government regulation. For example, before they can be sold in the United States, advanced televisions and emerging interactive displays must be tested and certified by Underwriters Laboratories and meet FCC regulations. Accordingly, the effects of regulation on our customers or the industries in which our customers operate may in turn harm our business. FCC regulatory policies affecting the ability of cable operators or telephone companies to offer certain services and other terms on which these companies conduct their business may impede sales of our products. In addition, our digital television business may also be adversely affected by the imposition of tariffs, duties and other import restrictions on our suppliers or by the imposition of export restrictions on products that we sell internationally. Changes in current laws or regulations or the imposition of new laws or regulations in the United States or elsewhere could harm our business. For example, any delays by the FCC in imposing its pending requirement that all new televisions have a digital receiver could have an adverse effect on our HDTV business.

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 2003, 97% of our total revenues and 89% of Oak’s total revenues were derived from international sales. We anticipate that international sales will continue to account for the majority of our total revenues for the foreseeable future. In addition, substantially all

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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;

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

•health risks in a particular region.

A material amount of our research and development personnel and facilities and a portion of our sales and marketing 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. This growth may decrease and any slowdown may have a negative effect on our business. We also maintain offices in Taipei, Taiwan, Hong Kong and Seoul, Korea, and our operations are subject to the economic and political uncertainties affecting these countries as well.

The significant concentration of our manufacturing activities with third party foundries in Taiwan exposes us to the risk of political instability in Taiwan, including the potential for conflict between Taiwan and China. We have several significant OEM customers in Japan, Korea and other parts of Asia. Adverse economic circumstances in Japan and elsewhere in Asia could affect these customers’ willingness or ability to do business with us in the future or their success in developing and launching devices containing our products.

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

•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.

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Our success and ability to compete depend in large part upon protection of 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.

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

Oak has generally limited access to and distribution of the source and object code of its software and other proprietary information. With respect to its page description language software and drivers for the digital office market and in limited circumstances with respect to firmware and platforms for its HDTV products, Oak has granted licenses that give its customers access to and restricted use of the source code of Oak’s software. This access increases the likelihood of misappropriation or misuse of our technology.

We are involved in several lawsuits.

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

We could become subject to claims and litigation regarding intellectual property rights, which could seriously harm its business and require it 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, Zoran and Oak have been subject to claims and litigation regarding alleged infringement of other parties’ intellectual property rights, and both Oak and Zoran are currently parties to a number of patent-related lawsuits. We could become subject to additional 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 or 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 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.

Although patent disputes in the semiconductor industry have often been settled through cross-licensing arrangements, we may not be able in any or every instance to settle an alleged patent infringement claim through a cross-licensing arrangement. We have a more limited patent portfolio than many of our competitors. If a successful claim is made against us or any of our customers and a license is not made available to us on commercially reasonable terms or we are required to pay substantial damages or awards, our business, financial condition and results of operations would be materially adversely affected.

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

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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 on commercially reasonable terms, if 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.

Certain technology used in our products is licensed from third parties, and in connection with these licenses, we are required to fulfill confidentiality obligations and, in some cases, pay royalties. Some of our products require various types of copy protection software that we must license from third parties. If we are unable to obtain or maintain our right to use the necessary copy protection software, we would be unable to sell and market these 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, or NOLs, against taxable income in future periods. Our NOLs totaled approximately $261 million for federal and $83 million for state tax reporting purposes as of December 31, 2003. As a result of the change of control resulting from our initial public offering in 1995, the amount of NOLs that we can use to reduce future taxable income for federal tax purposes is limited to approximately $3.0 million per year. The Internal Revenue Code contains a number of provisions that could limit the use of NOLs against income of the combined company as a result of the merger or as a result of the combination of these transactions. Our utilization of Oak’s NOLs may be further limited due to prior Oak transactions. No opinion or IRS ruling has been sought regarding the potential application of any of these provisions. Changes in tax laws in the United States may further limit our ability to utilize these NOLs. Any further limitation on our ability to utilize these respective NOLs could harm our financial condition.

Any additional acquisitions we make could disrupt our business and severely harm our financial condition.

We have made investments in, and acquisitions of, other complementary companies, products and technologies. We have recently completed the acquisition of Oak, and we may acquire additional businesses, products or technologies in the future. In the event of any future acquisitions, we could:

•issue stock that would dilute its 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 other 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 complete the integration of the business, 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

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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 investment.

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

We develop complex and evolving products. Despite testing by us and our customers, errors may be found in existing or new products. This could result in, among other things, 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 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 customers or could damage market acceptance of such 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 current development contracts or are unable to enter into new development contracts, our business could be harmed.

We historically have generated a portion of our total revenues 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 if 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 2004. 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;

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

•any additional acquisitions that we may make.

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 growth successfully will also require us to expand and improve administrative, operational, management and financial systems and controls. Many of our key operations, including a material 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 manage growth effectively. If we are unable to manage growth effectively, our business will 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. Management and other employees may voluntarily terminate their employment with us at any time upon short notice. The loss of key personnel could delay product development cycles or otherwise harm our business. 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, located in the United States, Israel and China. 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 United States 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 United States dollar, which will increase our costs as expressed in United States 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 United States dollar against the new Israeli shekel. These measures may not adequately protect us from the impact of inflation in Israel.

The government programs in which we participate 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 earn such proceeds in 2003 and 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.

Provisions in our charter documents and Delaware law could prevent or delay a change in control of Zoran.

Our certificate of incorporation and 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 prohibitions:

•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, 2003 and March 31, 2004, the closing sale price of our common stock, as reported on The Nasdaq National Market, ranged from a low of $10.85 to a high of $27.28. 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;

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•changes in analysts’ earnings estimates;

•announcements of technological innovations;

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

•loss of key personnel;

•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, 2004, 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

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

Internal Controls Over Financial Reporting.  In connection with our year-end closing process and the audit of our financial statements for the year ended December 31, 2003, we reviewed the nature, timing and accounting treatment of obligations to certain customers. As a result of the review, we determined that a substantial portion of these obligations were related to transactions prior to the fourth quarter. However, since the impact on any given period would have been immaterial, we recorded a charge of $1.3 million against revenues in the fourth quarter to reflect these obligations.

In connection with its audit, our independent auditors, PricewaterhouseCoopers LLP, advised management and our Audit Committee that they considered our lack of formal policies and internal communications surrounding the administration and documentation of certain contractual arrangements with customers, including the contractual arrangements to which the obligations discussed in the prior paragraph relate, to constitute material weaknesses in our internal control over financial reporting.  During the quarter ended March 31, 2004, both management and our Audit Committee conducted a review of these matters. As a result of these reviews, we have implemented additional controls and procedures to improve the administration and documentation of certain contractual arrangement with our customers. We believe that these additional controls and procedures address the weaknesses noted and that our current internal controls are sufficient to provide reasonable assurance that our financial statements are fairly presented in conformity with generally accepted accounting principles.

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PART II. OTHER INFORMATION

Item 1.Legal Proceedings

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

On March 11, 2004, Zoran and Oak filed a complaint with the United States International Trade Commission alleging that certain MediaTek DVD player and optical disk controller chips and chipsets, and products in which they are used, infringe Zoran's and Oak's patents. In addition to MediaTek, the complaint named 10 other proposed defendants that sell products, including DVD players and PC optical storage devices that use MediaTek's chips and chipsets. The other proposed defendants are ASUSTek Computer, Inc., Creative Labs, Inc., Creative Technology, Ltd., Jiangsu Shinco Electronic Group Co., Ltd., LITE-ON Information Technology Corporation, Mintek Digital, Shinco International AV Co., Ltd., TEAC Corporation, TEAC America, Inc., and Terapin Technology Corporation. The complaint requested that the ITC institute an immediate investigation of the accused products and issue exclusion and cease and desist orders prohibiting the importation into the United States of the infringing MediaTek devices and products that contain them.  On April 8, 2004, the ITC instituted an investigation based on Zoran's complaint.  The respondents served their initial response to the complaint on May 4, 2004.  Discovery is currently underway.  The ITC has not yet set a schedule for the completion of the investigation.  On April 28, 2004, Zoran and Oak reached a settlement with respondents Creative Technology, Ltd. and Creative Labs, Inc., and on May 6, 2004, these parties filed a joint motion with the ITC to dismiss the Creative respondents from the investigation pursuant to the terms of the settlement agreement and a consent order. On April 28, 2004, Zoran and Oak reached a settlement with respondents Creative Technology, Ltd. and Creative Labs, Inc., and on May 6, 2004, these parties filed a joint motion with the ITC to dismiss the Creative respondents from the investigation pursuant to the terms of the settlement agreement and a consent order.

On March 15, 2004, Zoran and Oak filed a complaint against MediaTek and Mintek Digital in the United States District Court, Central District of California alleging similar facts regarding infringement by MediaTek’s chips and chipsets and products in which they are used. The lawsuit seeks both monetary damages and an injunction to stop the importation and sale of infringing products. MediaTek and Mintek are due to respond to the complaint on May 24, 2004.

Item 6.Exhibits and Reports on Form 8-K

(a)	Exhibits:
31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a).
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a).
32.1	Certification of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350.
32.2	Certification of Chief Financial Officer, pursuant to 18 U.S.C. Section 1350.

(b)           On February 23, 2004, we filed a Report on Form 8-K, pursuant to Item 12 thereof, relating to financial information for the quarter and year ended December 31, 2003 and the outlook for the first quarter of 2004, as presented in a press release dated February 23, 2004.

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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:  May 14, 2004	/s/  Karl Schneider
	Karl Schneider
	Senior Vice President, Finance
	and Chief Financial Officer
	(Principal Financial and Accounting Officer)

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