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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x                  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2008

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

(Exact name of registrant as specified in its charter)

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 x   No o

Indicate by check mark whether registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

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

As of November 5, 2008, there were outstanding 51,167,158 shares of the registrant’s Common Stock, par value $0.001 per share.

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ZORAN CORPORATION AND SUBSIDIARIES

FORM 10-Q

INDEX

For the Quarter Ended September 30, 2008

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PART I. FINANCIAL INFORMATION

Item 1.  Financial Statements

ZORAN CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

(unaudited)

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

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ZORAN CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

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

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ZORAN CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

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

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ZORAN CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

The accompanying unaudited condensed consolidated financial statements of Zoran Corporation and its subsidiaries (“Zoran” or “Company”) have been prepared in conformity with accounting principles 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 (“SEC”).  In the opinion of management, the condensed consolidated financial statements reflect all necessary adjustments, consisting only of normal recurring adjustments, for a fair statement 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, 2007, included in the Company’s 2007 Annual Report on Form 10-K filed with the SEC.

On January 25, 2006, the Company entered into an agreement with MediaTek to settle patent litigation between the companies. In consideration for licenses granted by Zoran, MediaTek agreed to pay Zoran $55.0 million, of which $44.0 million was paid in February 2006 and $11.0 million was paid in April 2006.  These two payments, net of amounts attributable to a holder of rights under patents involved in the litigation, and amounts payable as legal fees, were recognized as license revenues related to litigation settlement. MediaTek was required to pay quarterly royalties totaling $30.0 million over a 30-month period that commenced on the date of the agreement based on future sales of covered MediaTek products.  These royalty payments, net of amounts payable by Zoran to a holder of rights under patents involved in the litigation, and amounts payable as legal fees, are recognized as software and other revenues as they are received.

2.              Stock-based Compensation

As of September 30, 2008, the Company had outstanding options for the purchase of 8,816,109 shares of common stock held by employees and directors under the Company’s 2005 Equity Incentive Plan (the “2005 Plan”), 2005 Outside Directors Equity Plan, 2000 Nonstatutory Stock Option Plan, 1995 Outside Directors Stock Option Plan, 1993 Stock Option Plan and other various plans the Company assumed as a result of acquisitions.  As of September 30, 2008, an aggregate of 3,697,701 shares remained available for future grants and awards.  Options and stock appreciation rights granted under the 2005 Plan must have exercise prices per share not less than the fair market value of Zoran common stock on the date of grant and may not be repriced without stockholder approval.  Such awards will vest and become exercisable upon conditions established by the Compensation Committee and may not have a term exceeding 10 years.

The following table summarizes stock-based compensation expense related to employee stock options, employee stock purchases and restricted stock unit grants for the three and nine month periods ended September 30, 2008 and 2007 as recorded in accordance with SFAS 123(R) (revised 2004), Share-Based Payment (“SFAS 123(R)”) (in thousands):

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The income tax benefit for share-based compensation expense was $335,000 and $1,164,000 for the three and nine month periods ended September 30, 2008.  The Company recognized no tax benefit during the three and nine month periods ended September 30, 2007 due to the Company’s full valuation on its deferred tax assets, which was released in December 2007.

The Company estimates the fair value of stock options using the Black-Scholes valuation model with the following assumptions:

Expected Term:  The expected term represents the period that the Company’s stock-based awards are expected to be outstanding and was determined based on the Company’s historical experience with similar awards, giving consideration to the contractual terms of the stock-based awards and vesting schedules.

Expected Volatility:  The Company uses historical volatility in deriving its volatility assumption.  Management believes that historical volatility appropriately reflects the market’s expectations of future volatility.

Risk-Free Interest Rate:  Management bases its assumptions regarding the risk-free interest rate on U.S. Treasury zero-coupon issues with an equivalent remaining term.

Expected Dividend: The Company has not paid and does not anticipate paying any dividends in the near future.

Stock Option Activity

The following is a summary of stock option activities:

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Significant option groups outstanding as of September 30, 2008 and the related weighted average exercise price and contractual life information, are as follows:

Of the 8,816,109 stock options outstanding as of September 30, 2008, the Company estimates that 8,517,000 will fully vest over the remaining contractual term.  As of September 30, 2008, these options had a weighted average remaining contractual life of 6.07 years, a weighted average exercise price of $17.45 and aggregate intrinsic value of $420,000.

The weighted average grant date fair value of options, as determined under SFAS No. 123(R), granted during the three and nine month periods ended September 30, 2008 was $4.22 and $7.23 per share, respectively.  The weighted average grant date fair value of options, as determined under SFAS No. 123(R), granted during the three and nine month periods ended September 30, 2007 was $12.20 and $11.54 per share, respectively.

The aggregate intrinsic value in the table above represents the total pretax intrinsic value, based on the Company’s closing stock price of $8.16 as of September 30, 2008, which would have been received by the option holders had all option holders exercised their options as of that date.  The total number of shares of common stock underlying in-the-money options exercisable as of September 30, 2008 was 207,000.  The total intrinsic value of options exercised during the three and nine month periods ended September 30, 2008 was $137,000 and $569,000 respectively.  There was no excess tax benefit realized by the Company in 2008 and 2007 for option exercises due to the availability of non stock related net operating loss carry forwards which fully offset our taxable income.

As of September 30, 2008, the Company had $20,587,000 of unrecognized stock-based compensation cost related to stock options after estimated forfeitures, which are expected to be recognized over the weighted average remaining term of 2.75 years.  The Company settles employee stock option exercises with newly issued common shares.

Restricted shares and restricted stock units are granted under the 2005 Plan.  As of September 30, 2008, we had $199,000 of unrecognized stock-based compensation cost related to restricted shares and restricted stock units, which are expected to be recognized over the weighted average remaining term of 2.51 years.

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

The Company’s 1995 Employee Stock Purchase Plan (“ESPP”) was adopted by the Company’s Board of Directors in October 1995 and approved by its stockholders in December 1995.  The ESPP enables employees to purchase shares through payroll deductions at approximately 85% of the lesser of the fair value of common stock at the beginning of a 24-month offering period or the end of each six-month segment within such offering period.  The ESPP is intended to qualify as an “employee stock purchase plan” under Section 423 of the U.S. Internal Revenue Code.  There were no purchases during the quarter ended September 30, 2008.  As of September 30, 2008, 1,825,874 shares were reserved and available for issuance under the ESPP.

In March 2008, the Company’s Board of Directors authorized a stock repurchase program under which the Company may repurchase up to $100.0 million of outstanding Zoran common stock.  The Company repurchased 1,163,569 shares for $10.0 million under this program during the three and nine months ended September 30, 2008.  As of September 30, 2008, the authorized amount that remains available under the Company’s stock repurchase program was $90.0 million.

The Company retires all shares repurchased under the stock repurchase program.  The purchase price for the repurchased shares of the Company’s stock repurchased is reflected as a reduction of common stock and additional paid-in capital.

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):

The accumulated other comprehensive income (loss) consists of unrealized gain (loss), net of tax, on marketable securities.

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4.  Marketable Securities

The Company’s portfolio of marketable securities as of September 30, 2008 was as follows (in thousands):

The Company’s portfolio of marketable securities as of December 31, 2007 was as follows (in thousands):

The following table summarizes the maturities of the Company’s fixed income securities as of September 30, 2008 (in thousands):

*Comprised of auction rate securities which have reset dates of 90 days or less but final expiration dates over 5 years.  These securities are included in other assets and long-term investments as of September 30, 2008.  In October 2008, the Company accepted an offer (the “UBS Offer”) from UBS AG (“UBS”), one of its investment providers.  As a UBS client who holds Auction Rate Securities (“ARS”), the Company will receive ARS Rights, which entitle the Company to sell ARS to UBS affiliates during the period from June 30, 2010 to July 2, 2012 for a price equal to par value.  In exchange for the issuance of the ARS Rights, the UBS affiliates have the discretionary right to sell the Company’s eligible ARS on the Company’s behalf, without prior notification, at any time during a two-year period

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beginning June 30, 2010.  The Company also received communications from Wachovia Securities indicating that Wachovia will soon offer to purchase, no later than June 30, 2009, ARS held by the Company at par value. The Company currently holds $37.4 million of ARS with UBS and $20.4 million of ARS with Wachovia.

5.  Fair Value

Effective January 1, 2008, the Company adopted SFAS No. 157, “Fair Value Measurements” (“SFAS 157”).  In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157,” which provides a one year deferral of the effective date of SFAS 157 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually.  Therefore, the Company has adopted the provisions of SFAS 157 with respect to its financial assets and liabilities only.  SFAS 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and enhances disclosures about fair value measurements.  Fair value is defined under SFAS 157 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  Valuation techniques used to measure fair value under SFAS 157 must maximize the use of observable inputs and minimize the use of unobservable inputs.  The standard describes a fair value hierarchy based on three levels of inputs that may be used to measure fair value, of which the first two are considered observable and the last unobservable:

·                  Level 1 - Quoted prices in active markets for identical assets or liabilities.

·                  Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

·                  Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The adoption of this statement did not have a material impact on the Company’s consolidated results of operations and financial condition.  In October 2008 the FASB Issued FASB Staff Position No. FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for that Asset is Not Active” (“FSP 157-3”), to clarify the application of the provisions of SFAS 157 in an inactive market and how an entity would determine fair value in an inactive market.  FSP 157-3 is effective immediately and applies to the Company’s current quarter financial statements.  The application of the provision of FSP 157-3 did not impact the Company’s results of operations or financial condition as of and for the periods ended September 30, 2008.

Effective January 1, 2008, the Company adopted SFAS No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”).  SFAS 159 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for specified financial assets and liabilities on a contract-by-contract basis.  The Company did not elect to adopt the fair value option under this Statement.

In accordance with SFAS 157, the following table represents the Company’s fair value hierarchy for its financial assets (cash equivalents and investments) measured at fair value on a recurring basis as of September 30, 2008 (in thousands):

The Company’s Level 3 investments as of September 30, 2008 include high-grade auction rate securities primarily consisting of government guaranteed student loans.  Auction rate securities are securities that are structured with short-term interest rates which periodically reset through auctions, typically within every 90 days.  At the end of each reset period, investors can sell or continue to

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hold the securities at par. During the current year, some of the auction rate securities were sold and others failed to auction successfully due to market supply exceeding market demand.  In the event of a failed auction, the notes continue to bear interest at a predetermined maximum rate based on the credit rating of notes as determined by one or more nationally recognized statistical rating organizations.  The funds associated with failed auctions will not be accessible until a successful auction occurs, a buyer is found outside of the auction process, the issuers redeem the securities or the underlying securities have matured.  As a result, the Company has classified all auction rate securities as long-term assets at cost in the condensed consolidated balance sheets.  In October 2008, the Company accepted an offer (the “UBS Offer”) from UBS AG (“UBS”), one of its investment providers.  As a UBS client who holds Auction Rate Securities (“ARS”), the Company will receive ARS Rights, which entitle the Company to sell ARS to UBS affiliates during the period from June 30, 2010 to July 2, 2012 for a price equal to par value.  In exchange for the issuance of the ARS Rights, the UBS affiliates have the discretionary right to sell the Company’s eligible ARS on the Company’s behalf, without prior notification, at any time during a two-year period beginning June 30, 2010.  The Company also received communications from Wachovia Securities indicating that Wachovia will soon offer to purchase, no later than June 30, 2009, ARS held by the Company at par value. The Company currently holds $37.4 million of ARS with UBS and $20.4 million of ARS with Wachovia.

Due to the current economic environment in which there is a lack of market activity for auction rate securities, the Company has been unable to obtain quoted prices or market prices for identical assets as of the measurement date resulting in significant unobservable inputs used in determining the fair value.  The Company estimated the fair value of these auction rate securities using the income approach based on the following: (i) the underlying structure and contractual provisions of each security; (ii) the present value of future principal and interest payments discounted at rates considered to reflect current market conditions; and (iii) consideration of the probabilities of default, auction failure, or repurchase at par for each period.  These estimated fair values could change significantly based on future market conditions, which could result in recognizing an other-than-temporary impairment loss.

The fair value indicated by this approach yielded a value that approximated the par value of the respective securities.

The reconciliation of beginning and ending balances for auction rate securities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the period was as follows (in thousands):

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

The Company conducted its annual impairment test of goodwill as of September 30, 2008 in accordance with Statement of Financial Accounting Standard 142 (“SFAS 142”), “Goodwill and Other Intangible Assets” and SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”  Impairment is tested at the reporting unit level which is one level below the reportable segments.  Potential goodwill impairment is measured based upon a two-step process.  In the first step, the Company compares the fair value of a reporting unit with its carrying amount including goodwill.  If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired, thus the second step of the impairment test is unnecessary.  If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of an impairment loss.

As a result of this test, the Company determined that the carrying amounts of its Consumer segment reporting units exceeded their fair values and recorded a goodwill impairment charge of approximately $164.5 million and an impairment charge for other intangibles of $3.1 million in the current quarter.  The impairment charge was primarily due to a decrease in valuation based on a decline in the Company’s business forecasts as a result of the current economic downturn as well as a decline in the Company’s stock value over the last several months due to the current global financial crisis.  The fair values of reporting units were estimated using the expected present value of future cash flows.  The total of all reporting fair values was also compared to the Company’s market capitalization plus a control premium for reasonableness.

Components of Acquired Intangible Assets (in thousands):