** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

** **

**FORM 10-K**

** **
| **ý**                                  |   | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                  |
|---------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                        |
| **For the Fiscal Year Ended June 30, 2002** |
|                                        |
| **o**                                       |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**                                                                                                                              |
|                                        |   |                                                                                                                                                                                                                       |
|                                        |   | **For the transition  period  from               to               ** |

** **

**CommissionFile Number: 000-24999**

** **

| **LOTUS PACIFIC, INC.**                                                    |
|----------------------------------------------------------------------------|
| (Exact name of registrant as specified in  its charter)                    |
|                                                                       |
| **Delaware**                                                               |   | **52-1947160** |
| (State or other jurisdiction of  incorporation or organization)            |   | (I.R.S.Employer  Identification Number) |
|                                                                       |
| **2402 Michelson Drive, Suite  220, Irvine, CA 92612**                     |
| (Address of principal executive offices,  Zip code)                        |
|                                                                       |
| Registrant’s telephone number, including  area code: **949-475-1880** |

 

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

Securities registered pursuant to Section 12(g) of the Act: **CommonStock, par value $0.001****per share**

 

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

(1)  Yes  o  No  ý  (2)  Yes  ý  No  o

 

Indicate bycheck mark if disclosure of delinquent filer pursuant to Item 405 of RegistrantS-K is not contained herein, and will not be contained to the best ofRegistrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment tothis Form 10-K. o

 

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

 

The aggregatemarket value of the registrant’s voting Common Stock held by non-affiliates ofthe registrant was approximately $293,633 (computed using the adjusted closingsales price of $0.01 per share of Common Stock on March 31, 2004 as reported bythe Pink Sheets).  Shares of CommonStock held by each officer and director and each person who owns 5% or more ofthe outstanding Common Stock have been excluded in that such persons may bedeemed affiliates.  The determination ofaffiliate status is not necessarily a conclusive determination for otherpurposes.

 

The number of shares of Common Stock outstanding as of March 31, 2004was 50,970,016.

 

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**DOCUMENTSINCORPORATED BY REFERENCE**

#####  

##### None.

 

 

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##### **PART I**

 

**Item 1. Business**

 

***Explanatory Note -Restatement of Prior Financial Information and Delays in Reporting***

 

This Annual Report on Form 10-Kfor Lotus Pacific, Inc. (the “Company” or “Lotus Pacific”) for the fiscal yearended June 30, 2002 is being filed after the required due date as a result ofrestatement of financial information for prior periods as set forth in moredetail throughout this report.

 

As previously reported, on June29, 2001, a majority of the Company’s stockholders, led by T.C.L. IndustriesHoldings (H.K.) Limited (“TCL”), were successful in a hostile consent solicitationto gain control of the Company and to replace prior management of theCompany.  On June 29, 2001, newdirectors and officers were appointed and the then existing directors andofficers were immediately removed from office.

 

Following the replacement ofprior management, the new management began an extensive review of varioustransactions undertaken by and involving old management prior to June 29,2001.  Due to the preliminary results,the Company dismissed its then existing independent accountants and replacedsuch firm with new independent accountants. On March 25, 2002, the new independent accountants were engaged to auditfiscal 2002.  As previously reported,during its preliminary investigation, new management of the Company identifiedvarious transactions involving Regent Electronics Corporation (“Regent”), aformer subsidiary of Lotus Pacific, and other transactions undertaken by priormanagement which impacted reported financial and operating results with respectto its consolidated financial statements for fiscal 2001, 2000 and 1999 andultimately concluded that a reaudit of the financial statements for fiscal2001, 2000 and 1999 was required.  OnJuly 24, 2002, the Company engaged its new independent accountants, to performsuch reaudit and the Company concluded that it must restate these priorperiods. As previously reported, new management concluded such restatementswould include adjustments, among others, to the Company’s previously reportedrevenues, cost of sales, net loss, earnings per share and related partytransactions.

 

The financial results presented in this Annual Report reflect theimpact of the adjustments and reclassifications being made in the restatementof the Company’s financial results. Specifically, this Annual Report for fiscal 2002 restates the Company’sconsolidated financial statements for fiscal 2001, 2000 and 1999 to reclassifyor restate certain revenues and expenses, and to restate certain othertransactions and make certain other adjustments, as more fully described in“Management’s Discussion and Analysis of Financial Condition and Results ofOperations,” and “Item 8. Restated Financial Statements and Supplementary DataNote 2 – Restatement of Previously Issued Financial Statements and Delays inReporting.”

 

***Explanatory Note -Events Resulting in Reclassification***

 

In December 2001, under the leadership of new management, the Companysold a major portion of its investment in and cash advances to one of itssubsidiaries, Arescom, Inc (“Arescom”). In addition to the restatement of prior financial information discussedabove, this sale required the reclassification of all periods to presentArescom as discontinued operations. Details of the transaction resulting in thediscontinued operations are provided at “Item 8. Restated Financial Statementsand Supplementary Data Note 2 – Restatement of Previously Issued FinancialStatements and Delays in Reporting” and “***Other Business Developments and Subsidiary Activity During Fiscal 2002***.”

 

***Explanatory Note –Update Subsequent to Fiscal 2002***

 

Because this report relates to fiscal 2002, except as otherwise notedherein, this report speaks as of June 30, 2002. The Company has not updated thedisclosures in this report to speak as of a later date, except as specificallyreferenced in the following sections:

 
| • | Item 1.   Business;                                                                                                                  |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------|
| • | Item 2.   Properties;                                                                                                                |
| • | Item 3.  Legal Proceedings;                                                                                                          |
| • | Item 5.   Market for Registrant’s common equity and related stockholder matters;                                                |
| • | Item 8. Restated Financial Statements and Supplementary Data Note 1 –  Business and Background and Note 21 – Subsequent Events. |

 

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| • | Item 10:   Directors and Executive Officers of the Registrant;             |
|--------|---------------------------------------------------------------------------------|
| • | Item 12.   Security Ownership of Certain Beneficial Owners and Management; |
| • | Item 13.   Certain Relationships and Related Transactions;                 |
| • | Item 14.   Principal Accounting Fees and Services; and                     |
| • | Item  15.  Exhibits                                                        |

 

Accordingly, the disclosure inthis report does not contain complete and updated information regarding theCompany and its operations as of the date of filing this report.  All such information contained in thisreport therefore is subject to updating and supplementing to be provided by theCompany in its reports to be filed with the SEC for periods subsequent tofiscal 2002.  The Company is working tocomplete such reports for subsequent periods and will file them as soon as theyare available.

 

***Explanatory Note –Disclaimer of Audit Opinion***

 

The Company’s independentaccountants were unable to audit the financial statements of Arescom, asignificant subsidiary, during the years ended June 30, 2001, 2000, and 1999,as the subsidiary would not provide the necessary information to allow theindependent accountants to complete the audits.  Due to Arescom’s lack of cooperation, the Company’s independentaccountants were unable to attain satisfaction about Arescom’s account balancesby means of other auditing procedures. As a result, the Company’s independent accountants did not express anopinion on the consolidated financial statements for the years June 30, 2001,2000, and 1999.

 

###### ***Company Overview***

 

Unless otherwise noted,references to “Lotus Pacific,” the “Company,” “we,” “our” or “us” mean LotusPacific, Inc., and its subsidiaries.

 

The Company was incorporated inDelaware on June 25, 1985.  Under priormanagement, the Company was significantly restructured and changed its name toLotus Pacific, Inc. in September 1994. Lotus Pacific is a holding company that conducts its business throughits subsidiaries. The Company develops, manages, and operates emergingcommunications and consumer electronics companies, focusing on developing nextgeneration consumer electronics and communication products. The Company providesits subsidiaries with capital and strategic and infrastructure services.

 

***BusinessDevelopments and Subsidiary Activity Prior to Fiscal 2002***

 

In April 1997, the Company formed Richtime Far East Ltd. (“Richtime”),a garment import and export business in Hong Kong.  Richtime received customer orders from Europe and North America,and contracted the orders to garment manufacturers mainly in Nanjing, Jiangsu,China.  It then shipped the productsoverseas. In March 1998, the Company set up a new subsidiary LPF International(“LPF”) to expand the apparel business in the United States and transferred allequity interest in Richtime into LPF. On September 30, 1998 the Company sold LPF and Richtime.

 

In April and May 1997, the Company acquired 70% of the common stock ofRegent.  In June 1997, Regent acquiredAmiga-based, multimedia technology related assets and rights from RightimingElectronics Corporation (“Rightiming”). On June 26, 2001, the Company spun-offRegent to Regent’s management.

 

In February 1999, the Company acquired 100% of the outstanding sharesof Professional Market Brokerage, Inc. (“PMB”), a Chicago-based financialtrading firm that provided online trading services, and 100% of the outstandingshares of US Securities & Futures Corp. (“USSF”), a full service brokeragefirm in New York, NY.  In June 1999, theCompany created USS Online, Inc. (“USS Online”), a wholly-owned subsidiary, andtransferred all of its ownership interests in each of USSF and PMB to USSOnline to run those two financial service subsidiaries. In February 2000, theCompany sold 72% of its ownership in USS Online.

 

In March 1999, the Company acquired 95% of the issued and outstandingcommon shares of Correlant Communications, Inc. (formerly TurboNetCommunications, Inc.) (“Correlant”), representing an 81% ownership interest inCorrelant.  Based in San Diego,California, Correlant designed, developed and marketed telecommunicationsproducts to cable operators, network service providers, and communicationsnetwork users in the United States and Asian countries.

 

In March 1999, the Company acquired 77% of the issued and outstandingcommon shares of Arescom.  Based in

 

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Fremont, California, Arescom designed, manufactured and marketed a broadrange of high quality remote access products, such as routers and remotemanaging software, and other inter-networking equipment for Internet ServiceProviders (“ISP”), resellers, and system integrators in the North Americamarket.  In December 2001, the Companysold approximately 92% of its investment in Arescom, representing 65% of theoutstanding securities of Arescom to an unrelated third party.

 

At the time Correlant and Arescom were acquired, Lotus Pacific’sstrategy for growth was to increase its product line and customer base throughthe acquisition of businesses which provided Internet-related products andservices and complemented Lotus Pacific’s existing Internet technology andresources.

 

On April 22, 1999, the Company organized Lotus World, Inc. (“LotusWorld”) to offer Auction Live, an online auction service, to internationalclients.  The wholly-owned subsidiarywas incorporated in Delaware in April 1999, and was a private-label Asianlanguage e-commerce service provider, targeting business-to-business andbusiness-to-customer markets, portals and ISP companies.  Due to the negative response in general toe-commerce, the operations of Lotus World were suspended by prior management in2001.

 

On November 13, 2000, the Company established a wholly-ownedsubsidiary, Acumen Technology, Inc. (“Acumen”), incorporated in Delaware.  In December 2000, the Company transferredall of the capital stock it held in Correlant and Arescom to Acumen. Other thanits holdings of the Correlant and Arescom stock, Acumen had no materialindependent operations.  In December2001, Acumen was merged into Lotus Pacific and all the assets and liabilitiesof Acumen were assumed by the Company.

 

In June 2001, Acumen formed Lotus Pacific Communications Technology(Beijing) Co., Ltd. (“Beijing Lotus”), a wholly-owned subsidiary, to supportbusiness activity in Beijing.  BeijingLotus has no material independent operations.

 

***Significant BusinessDevelopments and Subsidiary Activity During Fiscal 2002***

 

Following the hostile takeover of the Board of Directors of the Companyon June 29, 2001, new management of the Company began a thorough review ofall aspects of the business operations of the Company and its subsidiaries andhas engaged in numerous transactions to restructure the Company’s business.

 

Under new management, the Company’s primary strategy for businessoperations has been to restructure or shut down its unprofitable businesses,acquire undervalued or underutilized companies and focus on profitablegrowth.  The Company has movedaggressively to sell, restructure or shutdown its businesses which were notoperating profitably and/or which may or would have required significant cashinvestments. The Company seeks to identify market opportunities that willcreate and accelerate the growth and success of its subsidiary companies and toimplement new business plans to improve the returns on these businesses.

 

As of June 30, 2002, Lotus Pacific had one operating subsidiary,Correlant. Until December 23, 2003, Correlant was a developer of cable modemsand cable modem termination systems (“CMTS”). See “***Significant BusinessDevelopments and Subsidiary Activity Subsequent to Fiscal 2002.***”

 

Correlant is a significant subsidiary of Lotus Pacific and representedessentially 100% of the Company’s consolidated revenues, cost of revenues andresearch and development expense during fiscal 2002, 2001, 2000 and 1999,included in continuing operations. Correlant was incorporated in California onFebruary 13, 1996 under the name TurboNet Communications, Inc. andreincorporated in Delaware on October 4, 2000 as Correlant Communications, Inc.

 

From inception through March 1999, Correlant was a development stagecompany whose operating activities related primarily to establishing a researchand development organization, testing prototype designs, developing a MediaAccess Control (“MAC”) chip, developing production-ready cable modems includingthe complete software application, developing CMTS infrastructure equipment,commencing the staffing of general and administrative, marketing and technicalsupport organizations and establishing manufacturing relationships.

 

From 1996 through March 1999, the major domestic cable operatorscollaborated through the Multimedia Cable Network Systems consortium, of whichCorrelant was a contributing member, to develop the Data-Over-Cable SystemInterface Specification (“DOCSIS”) standard. Correlant was able to begincommercial distribution of its products in the United States as a result ofbeing awarded the DOCSIS certification for its cable modem technology in March1999. Correlant continued to design, develop, and market DOCSIS certified,high-speed

 

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data over cable technology, including cable modems and CMTS units forresale to corporate telecommuters, small office/home office, and residentialusers domestically and internationally through December 23, 2003.

 

Prior to February 2002, Correlant sold DOCSIS certified cable modemsand in certain instances, the MAC bundled with Correlant’s cable modem software(“MAC+software”), which are both components of the competed cable modem.  Correlant developed and owns the proprietarysoftware used in the cable modem. Effective February 2002, Correlant changed its business model whereby itprimarily sold the MAC + software and only sold the completed cable modem inspecific circumstances.  Instead offocusing on selling the completed cable modem, Correlant then concentratedefforts toward selling only the MAC+software. The new business model was aresult of Correlant’s attempt to increase gross profit percentage, streamlinebusiness operations and reduce operating expenses. However, this business modelultimately proved unsuccessful, as gross margins continued to decrease as aresult of increased competition in the cable modem market and more broadly, thehigh-speed Internet market.  Inaddition, many of Correlant’s major customers chose to design and manufacturetheir own DOCSIS cable modems or chose to utilize either platforms ofcompetitors or platforms incompatible with Correlant’s products.

 

During this period, Correlant faced competition from other technologiesthat enabled high-speed Internet access services such as  technologies to increase the efficiency ofdigital transmission over telephone companies’ existing copper infrastructure,high-speed Internet access service deployed over a number of other media,including fiber optic cable, digital subscriber lines (“DSL”), direct broadcastsatellite (“DBS”) and other wireless technologies. As high-speed Internetaccess services based on competing technologies became more readilyavailable,  the market for cablemodem-based services was materially and adversely affected.

 

#### ***Products***

 

Correlant’s products were divided into two categories:

 

•                  Cablemodems.  Cable modems, installed at theend user’s premises, allowed access to data-over-cable services; and

•                  Infrastructureequipment.  Correlant’s CMTS wasinfrastructure equipment installed at the service provider’s premises, which enabledservice providers to provide high-speed two-way data services to theircustomers.

 

Cable Modems.  Correlant’s cablemodems received both the *DOCSIS 1.0* and *1.1* certifications.  The cable modems connect to the end user’scomputer via a standard Ethernet or Universal Serial Bus (“USB”) connector, andto the cable network via a standard TV coaxial cable connector.

 

The following table shows revenues attributable to Correlant’s *DOCSIS1.0/1.1* cable modems (*in thousands*):

 

| **Year Ended  June 30,** |   | **Revenue** |   | **Percentage  of  Total Revenue** |   |
|--------------------------|--------|-------------|--------|-----------------------------------|--------|
| 2002                     |   | $           | 34,713 |                              | 62     | % |
| 2001                     |   | 253,548     |   | 96                                | %      |
| 2000                     |   | 69,220      |   | 96                                | %      |
| 1999                     |   | 3,726       |   | 100                               | %      |
|                          |        |             |        |                                   |        |  |

 

MAC+Software.  As part of theaforementioned change in business model, Correlant began selling a keycomponent of the completed cable modem, MAC+software, rather than the completedcable modem effective February, 2002. The following table shows revenue attributable to MAC+Software (*in thousands*):

 

| **Year Ended  June 30,** |   | **Revenue** |   | **Percentage  of  Total Revenue** |   |
|--------------------------|--------|-------------|--------|-----------------------------------|--------|
| 2002                     |   | $           | 19,672 |                              | 35     | % |
| 2001                     |   | 7,055       |   | 3                                 | %      |
| 2000                     |   | 2,372       |   | 3                                 | %      |
| 1999                     |   | —      |   | —                            | %      |
|                          |        |             |        |                                   |        |  |

 

Infrastructure Equipment. During fiscal 2002, Correlant completed initial development of a CMTS tocomplement its cable modems.  Its CMTSwas designed to enable cable operators to provide a complete solution for two-waydata transfer between the Internet and the end-user, utilizing its cable modemat one end and its

 

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head-end equipment at the other. CMTS sales were limited during fiscal 2002.

 

*Significant Countries*

 

The following table shows revenue to significant countries *(inthousands):*

 
|          |   | **Year Ended  June 30,** |   |
|---------------|--------|--------------------------|--------|
|          |   | **2002**                 |   | **2001** |   | **2000** |   | **1999** |   |
| Japan         |   | $                        | 30,033 |   | $ | 175,893 |   | $ | 48,993 |   | $ | 3,726 |   |
| Taiwan        |   | 20,757                   |   | 9,178 |   | 2,372 |   | — |   |
| United States |   | 5,090                    |   | 78,121 |   | 20,474 |   | 7 |   |
|          |   | $                        | 55,880 |   | $ | 263,192 |   | $ | 71,839 |   | $ | 3,733 |   |

 

Segment disclosures and geographical information for fiscal 2002, 2001,2000 and 1999 are presented in “Item 8. Restated Financial Statements andSupplementary Data Note 18 – Segment and Geographic Information.”

 

#### ***Research and Development***

 

The following table shows Correlant-sponsored research and developmentexpenses (*inthousands*):

#### *** ***

|                     |   | **Research  and development  including amortization of  deferred stock compensation** |   | **Research  and development  excluding amortization of  deferred stock  compensation** |   |
|--------------------------|--------|---------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------|--------|
| **Year ended  June 30,** |   | **Dollars**                                                                           |   | **Percentage  of  Total  Revenues**                                                    |   | **Dollars** |   | **Percentage  of  Total  Revenues** |   |
| 2002                     |   | $                                                                                     | 9,977  |                                                                                   | 18     | % | $ | 8,690 |   | 16 | % |
| 2001                     |   | 16,695                                                                                |   | 6                                                                                      | %      | 9,570 |   | 4 | % |
| 2000                     |   | 7,479                                                                                 |   | 10                                                                                     | %      | 5,854 |   | 8 | % |
| 1999                     |   | 711                                                                                   |   | 19                                                                                     | %      | 711 |   | 19 | % |
|                          |        |                                                                                       |        |                                                                                        |        |  |  |  |  |  |  |

#### ** **

#### ***Customers***

 

Correlant sold its data-over-cable products to vendors who then soldthe equipment under their brand name to cable operators.  A relatively small number of customersaccounted for a significant percentage of the Company’s revenues.  The percentage of revenues derived fromsignificant customers is detailed as follows:

 
|                                                                 |   | **Year Ended  June 30,** |   |
|----------------------------------------------------------------------|--------|--------------------------|--------|
|                                                                 |   | **2002**                 |   | **2001** |   | **2000** |   | **1999** |   |
| Toshiba, a related party                                             |   | 54                       | %      | 67 | % | 68 | % | 100 | % |
| TurboComm Technologies, Inc(“TurboComm”, a  related party) |   | 37                       | %      | 3 | % | 3 | % | — | % |
| Terayon                                                              |   | 8                        | %      | 13 | % | 11 | % | — | % |
| COM21                                                                |   | —                   | %      | 11 | % | 13 | % | — | % |

 

At March 31, 2004 TurboComm owed Correlant $2,053,000.

 

#### ***Manufacturing and Distribution***

 

During fiscal 2002, Correlant had limited in-house manufacturingcapability at its facility in San Diego, California.  This facility was used for design, assembly and testing ofprototypes, pilot production of new modem designs, sample testing of productsreceived from other manufacturers, developing the manufacturing process anddocumentation for new products in preparation for outsourcing.

 

Correlant had an established relationship and manufacturing contractwith TurboComm, a company located in Taiwan, that manufactured the high-speeddata-over-cable technology products. From the early stages of design and development, Correlant workedclosely with TurboComm’s engineers to ensure optimal and cost effectivemanufacturing. Correlant’s manufacturing agreement with TurboComm providedTurboComm would supply all of Correlant’s forecasted orders for cable modems atprices to be agreed to by Correlant and TurboComm on a

 

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quarterly basis.  TurboComm isobligated to repair or replace any defective cable modems and CMTS units.  Although the term of the original contractwent through May 2003, both Correlant and TurboComm mutually agreed to continuethe relationship beyond that date.

 

Correlant sold its data-over-cable products to vendors who soldequipment under their brand name to cable operators.  This market had, and still has, a limited number of existing andpotential customers.  Correlant alreadyhad established relationships with several existing vendors.  As a result, Correlant required only alimited sales and marketing infrastructure.

 

#### ***Backlog***

 

Correlant’s general practicewas to contract with TurboComm and fill orders within delivery dates requiredby customers, with some adjustments based on Correlant’s forecast. Duringfiscal 2002, substantially all Correlant’s products were produced in accordancewith specifications and production schedules determined by Correlant based onorders placed by its primary customers. The amount of unfilled orders at anyparticular time could be affected by a number of factors including, but notlimited to, the availability of cable modem components, and the manufacturingand assembly capacity of Correlant’s third party manufacturer. Accordingly,backlog information is not meaningful to an understanding of its business andmay not be indicative of actual shipments made to customers in any period.

 

#### ***Working Capital and Raw Materials***

 

As result of Correlantproducing products in accordance with customer orders and its third partymanufacturer procuring a large portion of cable modem components, Correlant wasnot required to carry finished goods inventory.  Occasionally, when Correlant did carry a raw materials inventory,the amount was not material. Accordingly, inventory requirements, and the impact of inventoryrequirements on working capital, are not meaningful to an understanding of ourbusiness.

 

#### ***Intellectual Property***

 

Although Correlant developedand owns the proprietary software used in its cable modem products, Correlantnever held any patents or copyrights on its technology. Due to the rapid changein technology and the high cost associated with obtaining and defending apatent, Correlant management never applied for a patent.  Instead, Correlant entered intoconfidentiality and invention assignment agreements with employees, and enteredinto non-disclosure agreements with key suppliers, distributors and customersto limit access to and disclosure of proprietary information.  However, these contractual arrangements maynot prove sufficient to prevent misappropriation of Correlant’s technology ordeter independent third-party development of similar technologies. In addition,the laws of some foreign countries may not protect Correlant’s intellectualproperty rights to the same extent as do the laws of the United States.

 

#### ***Competition***

 

Correlant sold itsdata-over-cable products to vendors who sold equipment under their brand namesto cable operators. However, many of these vendors have chosen to, and othersmay in the future choose to, design and manufacture their own DOCSIS cablemodems.  During fiscal 2002, Correlant’sprimary competitors for the sale of cable modems included Askey, AmbitMicrosystems and Motorola.  Primarycompetitors during fiscal 2002 for the sale of the CMTS included ADC, Arris,Cisco, Com21, Motorola and Terayon. Other potential competitors included, among others, Alcatel, Best Data,Dassault, Ericcson, Future Networks, NEC, NetGear, Nortel, Pace, Phasecom,Samsung, Scientific-Atlanta, Riverstone, Sony, Thomson Consumer Electronics andZoom Telephonics.

 

#### **Correlant’s principal competitive factors included:**

#### ** **

•                  The othertechnologies described above;

•                  The ability toreceive the DOCSIS certification;

•                  Price;

•                  Quality;

•                  Ensuring productavailability through effective planning and procurement of key components; and

•                  Product support.

 

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***Other BusinessDevelopments and Subsidiary Activity During Fiscal 2002***

 

To further new management’s restructuring effort, the Companyconsummated the following transactions during fiscal 2002:

 

As previously reported, on December 11, 2001, the Company mergedAcumen into the Company.  As a result ofthe merger, the Company assumed all the rights and obligations of Acumen andacquired the assets of Acumen that included, without limitation, shares ofstock of Correlant and Arescom. Acumen had no operations other than serving asa holding company for the shares of stock of Correlant and Arescom.

 

As previously reported, on December 11, 2001, the Company sold toSolomon Extreme International Ltd. (BVI), 24,234,738 shares of common stockof the Company’s subsidiary, Arescom, representing approximately 65% of theoutstanding shares of Arescom, for $10,000,000 in cash.  The Company determined that Arescom wouldnot generate consistent cash flow from operations in the foreseeable future, anddecided to sell its interests for cash to pursue other business opportunities.The Company retained approximately 6% of the outstanding common shares and11,048 shares of subordinated preferred stock of Arescom.

 

Pursuant to the terms of the Company’s acquisition of Arescom inMarch 1999, an aggregate of 3,885,856 shares of the Company’s common stockissued to the former shareholders of Arescom in exchange for their shares ofArescom were restricted and could not be sold until Arescom’s annual gross revenueand net income before taxes reached certain levels.  As previously reported, in connection with the transactioninvolving the sale of the Company’s controlling interest in Arescom, theCompany agreed to release the restrictions previously imposed on the shares ofcommon stock of the Company held by the former shareholders of Arescom.

 

As previously reported, on March 12, 2002, the Company and Lotus Worldentered into an Asset Purchase and Assignment and Assumption Agreement withAvtech Technology, whereby the Company assigned its rights to certain contractsand related intangibles to Avtech in exchange for Avtech’s assumption of all ofthe Lotus World’s obligations under the contracts assigned.  Subsequent to the completion of thetransaction, the Company dissolved Lotus World.

 

***Significant BusinessDevelopments and Subsidiary Activity Subsequent to Fiscal 2002***

 

Significant business developments, other than the legal proceedingsdescribed in “Item 3. Legal Proceedings,” subsequent to fiscal 2002, but beforethe filing of this report are summarized below:

 

*New Joint Venture*

 

As previously reported, in January 2003, the Company finalized anagreement to form a joint venture with Beijing Youbang Online ElectronicsTechnology Co., Ltd. (“Youbang”), TCL Computer Technology Co., Ltd. and all theequity holders of Youbang, pursuant to which the Company acquired a 50%interest in a new joint venture to own substantially all of Youbang’soperations.  Pursuant to the agreement,all of Youbang’s assets, other than real estate, were transferred to a newlyformed Beijing, China joint venture named TCL Digital Technologies, Ltd. (“TCLDigital”), a computer notebook manufacturing company in China.  The Company agreed to contribute approximately$5,240,000, payable in three installments and representing 50% of the totalinvestment amount.  At the time, theinvestment was part of the Company’s business strategy to seek businesses tomaximize the Company’s growth potential based on its assets.  However, shortly after it began running thejoint venture, the Company deemed the joint venture’s business model did notfit with the Company’s long-term business strategy, and diverted managementresources from the operations of other subsidiaries, notably Opta Systems, LLC,a Delaware limited liability company (“Opta Systems” or “GoVideo”), asdiscussed below under “Acquisition of New Subsidiary.”  In September 2003, the Company entered intoan agreement with TCL Information Technology Industrial (Group) Ltd. (“TCLInformation”), whereby the Company sold its 50% interest in TCL Digital forapproximately $5,600,000 cash.  Thetransaction was completed in December 2003.

 

*Cessation ofCorrelant’s Historical Operations*

 

In February 2003, Lotus Pacific, as majority stockholder of Correlant,appointed four new members to the Board of Directors of Correlant, effectivelytaking control of Correlant’s Board of Directors. Prior to this, Lotus Pacifichad only one representative on Correlant’s Board of Directors and did notcontrol Correlant’s Board or its operations. Immediately thereafter, the Board of Directors created a new ExecutiveCommittee of the Board,

 

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comprised of two members who are Lotus Pacific employees, to act onbehalf of the Board of Directors and oversee Correlant’s management andoperations.

 

As previously reported, effective July 31, 2003, Harold Tuan,President, Chief Executive Officer and co-founder of Correlant resigned as adirector of Correlant and no longer serves as President and CEO of Correlant.From such date until December 23, 2003, Correlant attempted to find a permanentCEO to replace Mr. Tuan and retained outside consultants to advise and assistduring the transition period.  Suchconsultants were charged with evaluating Correlant’s business operations, itsproducts and demand for its products, and future business prospects.

 

Upon recommendation of its consultants, following Mr. Tuan’sresignation as CEO, Correlant began a substantial reduction in its workforceand operations to reduce operating expenses, reducing the number of Correlantemployees from 34 as of August 1, 2003 to 18 employees as of December 23, 2003and three employees as of March 31, 2004.

 

As previously reported, as a result of declining margins and demand forits products, Correlant’s Board of Directors approved the wind down andcessation of Correlant’s historical operations in the cable modem and CMTSbusiness effective December 23, 2003. As part of the wind down of Correlant,the Company plans to license and sell Correlant’s technology.  The wind down of Correlant’s operations wassubstantially completed by March 31, 2004.

 

Concurrently, Correlant has been exploring opportunities to acquire orinvest in other businesses or technologies. The Company currently expects that Correlant will identify marketopportunities and implement a new business plan complementary with theCompany’s business and long-term strategies.

 

*Settlement withArescom*

 

As previously reported, effective September 10, 2003, Lotus Pacificdivested its remaining 6% ownership in Arescom by settling all legal claimsagainst Arescom.

 

*Acquisition of NewSubsidiary*

 

As previously reported, in April 2003, the Company loaned $5,986,000 toOpta Systems, which was used, in addition to a deposit of $250,000 paid by OptaSystems to complete its purchase of substantially all assets and assumption ofcertain liabilities of a product line known as “GoVideo” from SONICblueIncorporated, a Delaware corporation (NASDAQ: SBLU), and Sensory Science Corporation,a Delaware corporation and wholly-owned subsidiary of SONICblue, pursuant to apurchase agreement and an order issued by the United States Bankruptcy Court,Northern District of California, San Jose Division overseeing SONICblue’sbankruptcy case.

 

Immediately subsequent to Opta System’s purchase of the GoVideo productline, the Company purchased 100% of the outstanding membership interests ofOpta Systems from Carmco Investments, LLC, a Connecticut limited liabilitycompany, for $420,000, representing the return of the $250,000 deposit used inthe acquisition of the GoVideo product line and related transaction fees andexpenses. Subsequent to the closing, the Company paid an additional $294,000 inconnection with these items.  Inconnection with this agreement, the $5,986,000 originally loaned to OptaSystems was converted to a capital contribution, resulting in a total purchaseprice, including actual out-of-pocket expenses of approximately$6,770,000.  In October 2003, thepurchase price was reduced by $962,000 based on a purchase price adjustment,resulting in an adjusted purchase price of $5,808,000 for GoVideo.

 

The GoVideo product line, established in 1984, designs and manufacturesproduct lines in the consumer electronics industry, including digital videodisc (“DVD”) players, portable DVD, DVD-Video Cassette Recorder (“VCR”) Combo,the Dual-Deck VCR, DVD Recorder, DVD Recorder + VCR, and LCD TV. GoVideo holdsvarious patents covering Dual-Deck technology as well as other electronicsproducts and systems.

 

Current management intends to rebuild the Company’s business based onits newly acquired subsidiary, GoVideo, and concentrate its future business inthe related industries of consumer electronics and telecommunications.

 

The Company further seeks to improve the efficiencies of the Company’soperations and accelerate growth by

 

9

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utilizing its competitive advantages. The Company believes thesecompetitive advantages include the significant experience of current managementin the communications and consumer electronics industry and businessopportunities presented to the Company in China and Asia through the strengthof its relationships with its significant shareholders, including TCL.  TCL is an affiliated company of TCLInternational Holdings Limited (HKSE: 1070) (“TCL International”), a leadingmultimedia consumer electronics product manufacturer, with a strong brandpresence in China and Asia.  TCL International’score products include televisions, mobile handsets, personal computers,audio-visual equipment as well as information technology services.  Under its highly recognized andwell-established TCL brand, it is one of the strongest players in the TV andmobile handset marketplace in China. Headquartered in China, it operates anumber of highly efficient manufacturing bases in Asia.

 

*Employees*

 

As of June 30, 2002, Lotus Pacific had eight employees in sales generaland administration.  Correlant had 49full-time employees, including 39 in research and development and ten in sales,general and administration.

 

As of March 31, 2004, Lotus Pacific had seven employees in sales,general and administration.  Correlanthad three employees in sales, general and administration.  See “Significant Business Developments andSubsidiary Activity Subsequent to Fiscal 2002.”  GoVideo had 62 full-time employees, including five in researchand development and 57 in sales, general and administration.  No employees are represented by anycollective bargaining organization, and the Company has never experienced awork stoppage.

 

**Item 2. Properties**

 

At June 30, 2002, Lotus Pacific’s executive offices were located at18200 Von Karman, Avenue, Suite 730, Irvine, California and consisted ofapproximately 2,250 square feet.  Thelease expired in July 2003.  Currently,Lotus Pacific’s executive offices are located at 2402 Michelson Drive, Suite220, Irvine, California and consist of approximately 2,100 square feet under amonth-to-month lease.  Correlant leasesapproximately 26,000 square feet of office space in San Diego, California,which expires November 2007.

 

Due to the shut down of operations, Correlant’s interim management hasattempted to either sublease the San Diego facility or negotiate a lease buyout with the landlord.  Due to the weakcommercial real estate market in San Diego, interim management has not beensuccessful.    Additionally, there canbe no guarantees that interim management will successfully sublease thebuilding or buy out the lease in the future. If Correlant’s management is successful, Correlant will operate fromLotus Pacific’s office for the interim. After Correlant’s facilities closure, the Company believes itsfacilities will be suitable for their respective uses and adequate for the Company’sneeds.

 

GoVideo leases two facilities in Scottsdale, Arizona.  One facility, used for warehousing, isapproximately 13,100 square feet.  Thelease expires October 2009, with a five year renewal option.  The other facility, used for administration,warehousing and distribution, is approximately 33,000 square feet.  The lease expires February 2006, with athree year renewal option.  The leasedspace is suitable for GoVideo’s current needs.

 

**Item 3. Legal Proceedings**

 

Legal proceedings, other than ordinary routine litigation incidental tothe Company’s business, to which the Company became, or was, a party duringfiscal 2002 or subsequent thereto, but before the filing of this report aresummarized below:

 

*Lotus Pacific v.William Hu and Lotus Pacific v.USS Online et al.*

 

On January 3, 2001, Lotus Pacific filed a lawsuit in the UnitedDistrict Court Eastern District of New York against William Hu, which complaintwas subsequently amended July 30, 2002. In the amended complaint, Lotus Pacific brought claims for breach offiduciary duty, professional negligence, accounting and conversion relating totransfers in December 2000 of approximately $3,600,000 from Mr. Hu’s attorneytrust account.  Mr. Hu was alleged to bethe Company’s counsel from January 1998 and later its former CEO from January2001 to June 29, 2001.

 

On January 16, 2002, Lotus Pacific filed a lawsuit in the Supreme Courtof the State of New York, New York County against USS Online, TravelwayInternational Ltd. (“TIL”), and Huaya Lu Tung, seeking to recover approximately$1,800,000 in principal and interest due on loans made to USS Online, andseeking to pierce the

 

10

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corporate veil and recover such amounts from defendants TIL and HuayaLu Tung.  The Company asserted that Ms.Tung was the Chairperson and sole owner of TIL and the Chairperson of USSOnline and the former Treasurer of Lotus Pacific.

 

In order to avoid the costs of litigation, after evaluation of theCompany’s likelihood of recovering any assets from the defendants in the twocases cited above and the defendants’ ability to pay any judgment securedagainst them, if any, in  February 2003,the Company entered into a settlement agreement with USS Online, TIL, Mr. Hu,Ms. Tung, Lotus International Holdings Corp. a shareholder of the Company(“LIH”), and three individuals to settle all claims against the defendants inthe two cases cited above, subject to a number of conditions.  In entering into the settlement agreement,none of the defendants admitted or conceded any liability in connection withthe claims asserted in the cases.  Asconditions to the settlement agreement, the Company was required to receive:(a) 3,000,000 shares of the Company’s common stock; (b) a promissory note ofLIH in the principal amount of $4,000,000, payable on February 19, 2008, withinterest accruing at a rate of 3% per annum (the “Note”); (c) a stock pledgeagreement, granting to the Company a first priority security agreement in1,000,000 shares of the Company’s common stock as partial security for the Note(the “Pledged Shares”); (d) original stock certificates representing thePledged Shares; (e) personal guaranty of the Note; and (f) all of the assets ofUSSF. To date, the Company has not received stock certificates for the PledgedShares or the assets of USSF.  TheCompany has made demand on the other parties for fulfillment of the conditionsto the settlement and has entered into negotiations with the other parties tosettle these demands.  To date, nosettlement has been achieved.  TheCompany has reserved the right to take all actions for breach of thesettlement, including reinstituting the original actions.

 

### **Item 4.  Submission of Matters to a Vote of Security Holders**

 

No matters were submitted to a vote of security holders during thefourth quarter of fiscal 2002.

 

** **

**PART II**

 

**Item 5. Market for Registrant’s common equity and related stockholder matters.**

 

Lotus Pacific’s common stock began trading on the over-the-counter(“OTC”) Bulletin Board under the symbol “LPFC” on December 1, 1994. Aspreviously reported, on November 5, 2002, the Company’s shares of commonstock were removed from the OTC Bulletin Board for failure to comply with NASDRule 6530, as a result of the Company’s inability to timely file itsForm 10-K for the period ended June 30, 2002. EffectiveNovember 5, 2002, the Company’s shares of common stock are quoted on theNational Quotation Bureau’s “Pink Sheets,” under the symbol “LPFC.PK.”   Trading in the Company’s common stock hasbeen minimal with limited or sporadic quotations and there is no establishedpublic trading market for the Company’s common stock.  The high and low common stock prices per share were as follows:

 

|         |   | **High** |   | **Low** |   |
|--------------|--------|----------|--------|---------|--------|
| Fiscal 2003: |   |     |   |    |   |
|         |   |     |   |    |   |
| 1st Quarter  |   | $        | 0.13   |    | $      | 0.03 |   |
| 2nd Quarter  |   | 0.10     |   | 0.01    |   |
| 3rd Quarter  |   | 0.10     |   | 0.05    |   |
| 4th Quarter  |   | 0.10     |   | 0.05    |   |
|         |   |     |   |    |   |
| Fiscal 2002: |   |     |   |    |   |
|         |   |     |   |    |   |
| 1st Quarter  |   | $        | 1.25   |    | $      | 0.75 |   |
| 2nd Quarter  |   | 0.85     |   | 0.05    |   |
| 3rd Quarter  |   | 0.45     |   | 0.07    |   |
| 4th Quarter  |   | 0.45     |   | 0.05    |   |
|         |   |     |   |    |   |
| Fiscal 2001: |   |     |   |    |   |
| 1st Quarter  |   | $        | 10.25  |    | $      | 6.12 |   |
| 2nd Quarter  |   | 6.81     |   | 1.31    |   |
| 3rd Quarter  |   | 2.12     |   | 0.68    |   |
| 4th Quarter  |   | 1.90     |   | 0.35    |   |

 

11

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These OTC market quotations reflect inter-dealer prices, without retailmark-up, mark down or commission and may not necessarily represent actualtransactions.

 

As of March 31, 2004, there were 50,970,016 shares of Common Stockissued and outstanding, held by approximately 800 shareholders of record asindicated on the records of the Company’s transfer agent.

 

To date, the Company has not declared or paid any cash dividends on itscommon stock. The Company anticipates that it will retain all available fundsfor use in operation and expansion of its business, and no cash dividends areexpected to be paid on the common stock in the foreseeable future.

 

In May 1997, Lotus Pacific granted 1,090,000 options to certainofficers and key employees with an exercise price of $6.00 per share, which wasthe market price of Lotus Pacific’s common stock at the time of grant.  Options were 100% vested when granted andexpire five years from grant date. There were 1,090,000 options outstanding as of June 30, 2001, 2000 and1999.  All options expired during fiscal2002 and as such there were no options outstanding as of June 30, 2002.

 

The shareholders approved the 2000 Equity Incentive Plan (“IncentivePlan”) on April 28, 2000. The Board of Directors administers the IncentivePlan. Employees, directors, and consultants of the Company and its affiliates,who in the judgment of the Board render significant service to the Company, areeligible to participate. The Incentive Plan provides for the award of a broadvariety of stock-based compensation alternatives such as nonstatutory stock options,incentive stock options, restricted stock, performance awards and stockappreciation rights. The Incentive Plan provided 11,355,000 shares of commonstock to be offered. The vesting provisions of individual options may vary. Theexercise price shall not be less than 100% of the fair market value of a commonstock on the grant date. No options have been granted since the IncentivePlan’s adoption.

 

As part of the 1999 acquisitions of Correlant and Arescom, Lotus Pacific entered into shareexchange agreements with both Correlant and Arescom.  As stipulated by the agreements, Lotus Pacific set aside a totalof 1,708,000 of contingently issuable shares of Lotus Pacific commonstock.  The contingent shares were to beissued as Correlant and Arescom stock options, specified in the purchaseagreements, were exercised.  For eachoption exercised by a Correlant stock option holder, 81% of such shares were tobe transferred to Lotus Pacific in exchange for 0.5364 shares of Lotus Pacificcommon stock for each share of Correlant stock transferred.  For each option exercised by an Arescomstock option holder, 81% of such shares were to be transferred to Lotus Pacificin exchange for 0.02915 shares of Lotus Pacific common stock for each share ofArescom stock transferred.  There were atotal of 1,134,000, 1,551,000, 1,602,000 and 775,000 Lotus Pacific sharescontingently issuable in connection with both share exchange agreements as ofJune 30, 2002, 2001, 2000 and 1999, respectively.  Due to the sale of Arescom, there were no contingently issuableshares with respect to Arescom options as of June 30, 2002.  Due to the wind down of Correlant’shistorical operations, there were 17,000 Lotus Pacific shares contingentlyissuable with respect to the Correlant shares as of March 31, 2004.

 

There were no sales of unregistered securities by the Company duringfiscal 2002.

 

**Item 6.  Selected Consolidated Financial Data**

 

The following selected consolidated financial data should be read inconjunction with “Management’s Discussion and Analysis of Financial Conditionand Results of Operations,” the Consolidated Financial Statements of theCompany and related notes included elsewhere in this Annual Report on Form10-K.

 

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|                                                          |   | **As of or for  the Fiscal Year Ended June 30,** |        |
|---------------------------------------------------------------|--------|--------------------------------------------------|-------------|
| ***(in thousands, except per share amounts)***                |   | **2002 (1)**                                     |        | **2001** |   | **2000 (2)** |   | **1999 (3)** |   | **1998** |   |
|                                                          |   |                                             |        | **(Restated)** |   | **(Restated)** |   | **(Restated)** |   | **(Unaudited)** |   |
| **Results of Operations**                                     |   |                                             |        |   |   |   |   |   |   |   |   |
| Net revenues                                                  |   | **$**                                            | **55,880**  |   | $ | 263,192 |   | $ | 71,839 |   | $ | 3,733 |   | $ | — |   |
| Loss from continuing operations                               |   | **$**                                            | **(36,529** | ) | $ | (7,433 | ) | $ | (2,249 | ) | $ | (6,606 | ) | $ | (10,405 | ) |
| Net income (loss) per common share – basic  and diluted: |   |                                             |        |   |   |   |   |   |   |   |   |
| Loss from continuing operations                               |   | **$**                                            | **(0.57**   | ) | $ | (0.12 | ) | $ | (0.04 | ) | $ | (0.13 | ) | $ | (0.22 | ) |
| Total gain (loss) from discontinued  operations               |   | **$**                                            | **0.27**    |   | $ | (0.45 | ) | $ | (0.19 | ) | $ | (0.05 | ) | $ | — |   |
| Net income (loss)                                             |   | **$**                                            | **(0.30**   | ) | $ | (0.57 | ) | $ | (0.23 | ) | $ | (0.18 | ) | $ | (0.22 | ) |
| Cash dividends per share                                      |   | **$**                                            | **—**  |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| **Financial Position**                                        |   |                                             |        |   |   |   |   |   |   |   |   |
| Total assets from continuing operations                       |   | **$**                                            | **53,342**  |   | $ | 117,214 |   | $ | 121,737 |   | $ | 158,624 |   | $ | 3,679 |   |
| Long-term obligations, less current portion                   |   | **$**                                            | **—**  |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Total stockholders’ equity                               |   | **$**                                            | **36,560**  |   | $ | 54,328 |   | $ | 83,730 |   | $ | 94,801 |   | $ | 914 |   |

 

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(1) Fiscal 2002 included: (a) $20,071,000 asset impairment and (b)$17,554,000 total gain from discontinued operations, net of related taxes, as aresult of selling our former subsidiary, Arescom, on December 18, 2001.

 

(2) Fiscal 2000 included a $50,512,000 gain related to the sale of oursubsidiary’s common stock.

 

(3) We purchased Correlant on March 31, 1999.  Therefore results of operations for fiscal 2002, 2001 and 2000include 12 months of Correlant’s activity compared to only three months ofCorrelant’s activity during fiscal 1999.

 

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

 

The following discussion of the financial condition and results ofoperations should be read in conjunction with the Restated ConsolidatedFinancial Statements and Notes thereto included elsewhere in this report.

 

We begin Management’s Discussion and Analysis of Financial Conditionand Results of Operations (“MD&A”) with a description of Lotus Pacific’sbusiness.  This is followed by adiscussion of why we were unable to timely file our Form 10-K for the yearended June 30, 2002, and the major events that lead up to the requirement torestate prior financial information. The next discussion relates to material acquisitions and dispositionsand a comparison of our results of operations as follows:

 

•              Fiscal 2002 compared to fiscal2001;

•              Fiscal 2001 compared to fiscal2000; and

•              Fiscal 2000 compared to fiscal1999.

 

These comparisons are provided solely for readers to understand thehistorical results of our operations during the time periods covered.  However, due to the strategic change indirection of Lotus Pacific discussed in “Item 1. Business,” and throughout theMD&A section, these results are not indicative of future results.

 

After the results of operations we analyze the changes in our cashflows, and discuss our financial commitments in the section entitled “Liquidityand Capital Resources.”  We then addressour “Business Outlook” from March 31, 2004.  We conclude this MD&A with (I) A discussion of the CriticalAccounting Estimates we believe are important to understanding the assumptionsand judgments incorporated in our reported financial results; and (II) RecentlyIssued Accounting Standards and the impact they had or will have on our resultsof operations.

 

This MD&A should be read in conjunction with the other sections ofthis Annual Report on Form 10-K including:

 

•              Item 1.  Business;

•              Item 6.  Selected Financial Data; and

•              Item 8.  Restated Financial Statements and Supplementary Data.

 

The various sections of this MD&A contain a number offorward-looking statements, all of which are based on our current expectationsand could be affected by the uncertainties and risk factors describedthroughout this filing and particularly in the “Business Outlook” section.  Our actual results may differ materiallyfrom these forward-looking statements.

 

## **Description of Business**

 

Lotus Pacific, a Delaware corporation, is a holding company and weconduct our business through our subsidiaries. We presently develop, manage,and operate emerging communications and consumer electronics companies,focusing on developing next generation consumer electronics and communicationproducts. We provide our subsidiaries with capital and strategic andinfrastructure services.

 

***Explanatory Note -Restatement of Prior Financial Information and Delays in Reporting***

 

As previously reported, on June 29, 2001, a majority of our stockholders,led by TCL, were successful in a hostile consent solicitation to gain controlof Lotus Pacific and replace prior management of the Company.   On June 29, 2001, new directors andofficers were appointed and the then existing directors and officers wereimmediately removed from office. Following the termination of our relationship with prior independentaccountants, new management concluded that a reaudit of the financialstatements for fiscal 2001, 2000 and 1999 was required.  Effective July 24, 2002, we engaged our newindependent accountants to reaudit and restate these prior periods.

 

This Annual Report for fiscal 2002 restates our consolidated financialstatements for fiscal 2001, 2000 and 1999 to reclassify or restate certainrevenues and expenses, and to restate certain other transactions and makecertain other adjustments.  For moredetails see “Item 8. Restated Financial Statements and Supplementary Data Note2 – Restatement of Previously Issued Financial Statements and Delays inReporting.”

 

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***Explanatory Note -Events Resulting in Reclassification***

 

In December 2001, we sold a major portion of our investment in and cashadvances to our subsidiary, Arescom. This sale required the reclassification of all periods to presentArescom as discontinued operations. As the results of Arescom’s operations arenot included in our continuing operations, the following discussion does notinclude Arescom.   We included in “Item8.  Financial Statements and SupplementaryData Note 2 – Restatement of Previously Issued Financial Statements and Delaysin Reporting and Note 4 – Acquisitions and Dispositions – Majority OwnedSubsidiaries,” a more comprehensive discussion about our discontinuedoperations.

 

***Acquisitions andDispositions***

 

During fiscal 2002, 2001, 2000 and 1999, we engaged in multipleacquisitions and dispositions.  Thedetails of these transactions are described in detail in “Item 8. RestatedFinancial Statements and Supplementary Data Note 4 – Acquisitions andDispositions – Majority Owned Subsidiaries, Note 5 – Acquisitions andDispositions – Equity Method Investees and Note 6 – Acquisitions andDispositions – Cost Method Investees.” However, unless specifically addressed in MD&A, these acquisitionsand dispositions were not material to our results of operations and theunderstanding of our business.  As such,the details have been omitted from MD&A.

 

*Regent ElectronicsCorporation*

 

In April and May 1997, we acquired 70% of the common stock of Regent.  Regent designed, developed, manufactured andmarketed Internet-related products that offered Internet access throughtelephone lines and cable television lines. In June 1997, Regent acquired Amiga-based, multimedia technology relatedassets and rights from Rightiming.  OnJune 26, 2001, we spun-off Regent to Regent’s management.

 

*CorrelantCommunications, Inc*

 

Correlant is a major subsidiary of Lotus Pacific and representedessentially 100% of our consolidated revenues, cost of revenues and research anddevelopment expense during fiscal 2002, 2001, 2000 and 1999 from continuingoperations.

 

On March 31, 1999, we entered into a share exchange agreement whichprovided for the acquisition of 95% of the issued and outstanding common sharesof Correlant, representing an 81% ownership interest in Correlent inconsideration for the issuance of 9,656,946 common shares of the Company valuedat $7.21 per share plus contingently issuable shares of up to 1,435,000. Thecontingent shares will be issued as Correlant options specified in theagreement are exercised.  For eachoption exercised, 81% of such shares were to be transferred to us in exchangefor 0.5364 shares of Lotus Pacific common stock for each share of Correlant stocktransferred.   At the acquisition date,the excess of the purchase price and related costs over the value assigned tothe net tangible assets acquired was $74,545,000 and was assigned togoodwill.  During fiscal 2001 and 2000,we recorded an additional $18,000 and $554,000, respectively as additionalgoodwill as a result of the issuance of 79,000 of the contingently issuableshares.  As of March 31, 2004 there wereonly 17,000 contingently issuable shares outstanding.

 

At the purchase date, shares of Lotus Pacific stock exchanged wererestricted and could not be sold until Correlant achieved sales of$30,000,000 and net income before income taxes of $6,000,000. EffectiveAugust 31, 2000, the restrictions were removed.

 

During March 2000, we sold, to unrelated parties, 3,657,000 shares ofCorrelant stock, which reduced our ownership to 65%.  During September 2000, we sold to unrelated parties, 656,000shares of Correlant stock, which further reduced our ownership to 62%.

 

*Demand forCorrelant’s products*

 

During the first half of calendar year 2000, cable modem manufacturersexperienced shortages and long lead times for component materials such as flashmemory and capacitors.  Due to theseshortages, the production of cable modems was constrained and our customersplaced substantial orders for our cable modems.  We believe cable operators also overbought in the second half ofcalendar year 2000 to ensure they had sufficient product to meet subscriberdemand.  As a result, we believe therewas an inflated demand for cable modems for the first six months of fiscal2001, June 2000 through December 2000. Starting in January 2001, our customer orders began dropping sharplyresulting in lower demand as end customers started to work through theirinventory levels.  This lower demandcontinued through June 30, 2002.

 

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The extremely competitive nature of the market for broadband accesssystems resulted in significant price erosion over time.  We experienced downward pressure on ourcompleted cable modem average selling price per unit.  This downward pressure on the completed cable modem selling priceplaces downward pressure on cable modem components, including theMAC+software.  Therefore, Correlantexperienced continued price erosion under its new business model.  This price erosion continued until Correlantdiscontinued selling cable modem and cable modem-related products as discussedbelow.

 

*Change inCorrelant’s Business Model*

 

Prior to January 31, 2002, Correlant sold DOCSIS certified cable modemsand in certain instances, the Media Access Controller (“MAC”) bundled withCorrelant’s cable modem software (“MAC+software”), which were both keycomponents of the completed cable modem. Correlant developed and owns the proprietary software used in the cablemodem.  Effective January 31, 2002,Correlant changed its business model whereby they only sell the completed cablemodem in certain circumstances.  Insteadof focusing on selling the completed cable modem, Correlant concentratedefforts toward selling only the MAC+software. The new business model was a result of Correlant’s attempt to increasegross profit percentage, streamline business operations and reduce operatingexpenses.  This change had the followingimpacts to our results of operations, cash flows and financial position:

 

•                  *Decreasedrevenues cost of revenues, inventory, accounts receivable and accounts payable*.  Because the sales price and the related costof the MAC+software were substantially lower than the completed cable modems,our revenues, cost of revenues, inventory, accounts receivable and accountspayable all decreased.

•                  *Unchangedgross profit dollars*. Previous to the change in Correlant’s business model, all the profitrealized from selling the completed cable modem was attributable to theMAC+software.  Therefore on a per unitbasis, gross profit dollars remained unchanged.

•                  *Increasedgross profit percentage*. Because gross profit dollars remained unchanged while the sales pricedecreased, gross profit percentage increased.

•                  *Decreasedselling, general and administrative expense.*  As a result of the change in business model,Correlant closed its Taiwan branch.

 

The change in Correlant’s business model and the fluctuation of demandfor our product resulted in a material impact to our results of operations,financial position and cash flows as of or for the years ended June 30, 2002,2001, and 2000.

 

*Cessation ofCorrelant’s Historical Operations*

 

As previously reported, effective July 31, 2003, Harold Tuan,President, Chief Executive Officer and co-founder of Correlant resigned as adirector of Correlant and no longer serves as President and CEO of Correlant.From such date until December 23, 2003, Correlant worked to find a permanentCEO to replace Mr. Tuan and retained outside consultants to advise and assistduring the transition period.  Suchconsultants were charged with evaluating Correlant’s business operations, itsproducts and demand for its products, and future business prospects.

 

Upon recommendation of its consultants, following Mr. Tuan’sresignation as CEO, Correlant began a substantial reduction in its workforceand operations to reduce operating expenses, reducing the number of Correlantemployees from 34 as of August 1, 2003 to 18 employees as of December 23, 2003and three employees as of March 31, 2004.

 

On December 23, 2003, upon recommendation of its consultants,Correlant’s Board of Directors approved the wind down and cessation ofCorrelant’s historical operations in the cable modem and cable modem softwarebusiness.  The wind down wassubstantially completed by March 31, 2004.

 

Concurrently, Correlant has been exploring opportunities to acquire orinvest in other businesses or technologies. We expect Correlant to identify market opportunities and implement a newbusiness plan complementary with our business and long-term strategies.  See “Business Outlook.”

 

Due to the cessation of Correlant’s historical operations, futurefinancial statements will not be comparable to our historical financialstatements.

 

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*USS Online, Inc.,Professional Market Brokerage, Inc and US Securities & Futures Corp*

 

In February 1999, we acquired 100% of PMB, a Chicago-based financialtrading firm that provided online trading services and 100% of USSF, a fullservice brokerage firm in New York, NY. In June 1999, we created USS Online, awholly-owned subsidiary, and transferred all of our ownership interests in eachof USSF and PMB to USS Online to run those two financial service subsidiaries. InFebruary 2000, we sold 72% of our ownership in USS Online to TIL, in exchangefor 733,000 shares of our common stock.

 

*Lotus World, Inc.*

 

On April 22, 1999, we organized Lotus World to offer Auction Live, anonline auction service, to international clients.  The wholly-owned subsidiary was incorporated in Delaware in April1999, and was a private-label Asian language e-commerce service provider,targeting business-to-business and business-to-customer markets, portals andISP companies.  Due to the negativeresponse in general to e-commerce, the operations of Lotus World were suspendedin 2001.  On March 12, 2002, we enteredinto an Asset Purchase and Assignment and Assumption Agreement with AvtechTechnology, whereby we assigned our rights to certain contracts and relatedintangibles to Avtech in exchange for Avtech’s assumption of all of LotusWorld’s obligations under the contracts assigned.  Subsequent to the completion of the transaction, we dissolvedLotus World.

## ** **

## **Results of Operations**

 

**Comparison of Fiscal2002 to Fiscal 2001**

 

The following table summarizes certain aspects of our results ofoperations for fiscal 2002 compared to fiscal 2001 (*in thousands):*

 
|                                 |   | **June 30,** |   |           |   |         |   |
|--------------------------------------|--------|--------------|--------|----------------|--------|--------------|--------|
|                                 |   | **2002**     |   | **2001**       |   | **$ Change** |   | **% Change** |   |
|                                 |   |         |   | **(Restated)** |   |         |   |   |   |
| Revenues                             |   | $            | 55,880 |           | $      | 263,192      |   | $ | (207,312 | ) | (79 | )% |
|                                 |   |         |   |           |   |         |   |   |   |
| Gross profit                         |   | 5,939        |   | 32,591         |   | (26,652      | )      | (82 | )% |
| As a percentage of revenues          |   | 11           | %      | 12             | %      |         |   |   |   |
|                                 |   |         |   |           |   |         |   |   |   |
| Selling, general and administrative  |   | 4,700        |   | 13,151         |   | (8,451       | )      | (64 | )% |
| Depreciation and amortization        |   | 12,782       |   | 12,460         |   | 322          |   | 3 | % |
| Research and development             |   | 9,977        |   | 16,695         |   | (6,718       | )      | (40 | )% |
| Impairment of assets                 |   | 20,071       |   | —         |   | 20,071       |   | N/A |   |
|                                 |   |         |   |           |   |         |   |   |   |
| Total other income (expense), net    |   | 638          |   | (2,937         | )      | 3,575        |   | 122 | % |
|                                 |   |         |   |           |   |         |   |   |   |
| Provision (benefit) for income taxes |   | (3,181       | )      | (6,434         | )      | (3,253       | )      | (51 | )% |
|                                      |        |              |        |                |        |              |        |  |  |  |  |  |

 

*Revenues*

 

The significant decreasein overall revenues for fiscal 2002 as compared to fiscal 2001 was primarilyattributable to the following factors:

 

•      Unit sales of DOCSIS cable modems sold by Correlantdecreased approximately 80%;

•                  An industry-wide downturn in broadbandequipment purchase as cable operators, and in turn our customers, workedthrough their excess inventory;

•                  Average sales price of our DOCSIS cablemodems sold by Correlant declined approximately 9% due to heavy pricecompetition; and

•      The aforementioned change in Correlant’sbusiness model.

 

Revenues generated by international sales as a percentage of totalrevenues increased to 91% from 70% during fiscal 2002 as compared to fiscal2001.  The large increase was primarilyattributable to the loss of Correlant’s

 

17

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significant US customers, as a result of customers developing their ownDOCSIS cable modems, and to a lesser extent the aforementioned change inCorrelant’s business model.

 

Due to the significant economic slowdown in the cable modem industry,both domestic and international, we experienced a slowdown in customer ordersduring fiscal 2002.  Subsequent tofiscal 2002, revenues continued to be negatively impacted.  Additionally, the average sales price ofcable modems continued to decline, which in turn placed price pressure on thecable modem components.  Ultimately,this significant slowdown and continued pricing pressure resulted in thecessation of Correlant’s historical operations in the cable modem industryDecember, 2003.

 

*Gross Profit*

 

The decrease in gross profit dollars for fiscal 2002 compared to fiscal2001 was a direct result of reduced revenue from declining cable modem unitsales and severe price competition. Cable modem selling prices decreased faster than the associated productcost reductions, which resulted in selling cable modems at negative grossprofit in order to keep market share.

 

Although the gross profit dollars decreased, and the gross profitpercentage realized from cable modem sales decreased, the overall gross profitpercentage remained fairly constant for fiscal 2002 compared to fiscal2001.  This was due to a higherproportion of overall revenues generated from the sale of Correlant’sMAC+software, which bears a higher gross profit percentage than cable modems.

 

*Operating Expenses*

 

Selling, general and administrative (“SG&A”).  SG&A expense consists primarily ofpersonnel costs, including amortization of deferred stock compensation for ouradministrative and support personnel, allowance for doubtful accounts, andlegal and accounting fees.  The decreasein SG&A expense for fiscal 2002 as compared to fiscal 2001 was due to thefollowing factors:

 

•                  $4,433,000 decrease in allowance fordoubtful accounts to $44,000 in fiscal 2002 from $4,477,000 in fiscal2001.  Fiscal 2002 allowance related toCorrelant’s smaller customers not being able to pay due to the significanteconomic slowdown in the modem industry. Fiscal 2001 allowance related to the forgiveness of $4,098,000 due fromour subsidiary, Regent, in connection with the spin off of Regent.  The remaining allowance for doubtfulaccounts in fiscal 2001 was due to a $300,000 cash advance to our formersubsidiary PMB, who subsequently defaulted, and $79,000 accrued interest on ourloans to USS Online and PMB.

•                  Decrease of $1,696,000 in amortization ofdeferred stock compensation as a result of accounting for stock options underthe accelerated provisions allowed by Financial Accounting Standards Board(“FASB”) Interpretation (“FIN”) 44, *Accounting for Certain Transactions Involving StockCompensation – An Interpretation of APB Opinion No. 25*;

•                  Decrease of $1,000,000 legal andaccounting fees associated with a contemplated initial public offering (“IPO”)Correlant in 2001, which in 2002 was put on hold indefinitely;

•                  Closure of Correlant’s Taiwan branchoffice; and

•                  Decreased salary expense associated witha reduction in force.

 

The above decreases were slightly offset by an increase in legal andaccounting fees resulting from the previously discussed takeover of LotusPacific by TCL and the subsequent replacement of prior Lotus Pacificmanagement.

 

Depreciation and amortization (“D&A”).  D&A expense consists of goodwill amortization related to thepurchase of Correlant and depreciation of property and equipment.  Goodwill amortization stayed fairly constantfrom fiscal 2002 compared to fiscal 2001 as there were no significant businessacquisitions or dispositions resulting in a change to goodwillamortization.  As described below, thegoodwill associated with Correlant was considered impaired at June 30, 2002 andfully written off.  Depreciation expenseincreased slightly as capital expenditures increased to support our expandingtechnology infrastructure during fiscal 2002.

 

Research and development (“R&D”). R&D expense consists primarily of personnel costs, includingamortization of deferred stock compensation of employees engaged in research,design and development

 

18

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activities and, to a lesser extent, design prototype materialexpenditures and equipment and supplies required to develop new products andenhance existing products.  The decreasein R&D expense for fiscal 2002 as compared to fiscal 2001 was primarilyattributable to the following factors:

 

•      Decrease of $5,838,000 in amortization ofdeferred stock compensation; and

•      Decreased salary expense associated withnatural attrition without replacing vacant positions.

 

The above decreases werepartially offset by increased fees related to the DOCSIS cable modemcertification process.

 

Impairment ofassets.  Impairment of assets duringfiscal 2002 related to the goodwill associated with the purchase ofCorrelant.  As of June 30, 2002, wedeemed the goodwill impaired due to the competitive nature of Correlant’sindustry and its significant reduction in revenues.  As a result, the $20,071,000 of remaining goodwill was fullywritten off.

 

*Total other income (expense)*

 

Total other income (expense) consists of interest income, interestexpense foreign exchange gain (loss) and other non-operating items.  We experienced net other income duringfiscal 2002 primarily due to interest income earned on our cash andinvestments, which was offset slightly by our foreign exchange loss from ourTaiwan branch and interest expense.  Weexperienced net other expense during fiscal 2001 primarily due to the followingtransactions undertaken by prior management:

 

•                  In January 2001,prior management agreed to refund, in exchange for stock, $7,100,000 to severalinvestors who had purchased a total of 355,000 shares of Correlant common stockduring fiscal 2000.  Prior managementgave $7,100,000 to Hywin Investments Limited (“Hywin”), a shareholder of theCompany, who was to return the funds to the individual investors and return thestock to Lotus Pacific.  However, theshares were never returned to the Company.  In connection with the refund, Hywin refunded to us $1,065,000 ofcommissions relating to the shares to be returned. The Company investigated thetransaction and was unable to recover the funds.  As a result, the net amount of $6,035,000 was expensed.

•                  In December2000, prior management agreed to refund, in exchange for stock, $1,500,000received in connection with Lotus Pacific’s previous sale of shares of Arescomstock.  Lotus Pacific gave the refundamount to William Hu, the Company’s attorney at that time, to process therefund.   However, the refund was never returnedto the investors and the shares were never returned to us.  We investigated the transaction and havebeen unable to recover the funds.  See“Item 3. Legal Proceedings.”  As aresult, the $1,500,000 was expensed.

•                  In October 2000,prior management sold shares of Correlant common stock owned by the Company tovarious unrelated parties.  Although theCorrelant shares were transferred to the parties, the Company did not receiveany of the proceeds. We investigated the transaction and have been unable torecover the funds, and as a result we expensed $2,266,000.

 

19

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The above fiscal 2001 expenses were offset by the $3,886,000 gain onthe spin off of Regent and interest income earned on our cash and investments.

 

*Provision (benefit) for income taxes*

 

We record an asset or liability for tax assessments based on ourestimate of the potential assessments. Among other reasons, new laws and new interpretations of laws andrulings may affect the liability for potential tax assessments by taxauthorities.  Due to the subjectivityand complex nature of the underlying issues, actual payments or refunds orassessments may differ from our estimates. To the extent our estimates differ from actual payments or refunds orassessments, income tax expense is adjusted. In June, 2003, we were notified by the Internal Revenue Service (“IRS”)that it would be reviewing our tax returns for the years ended June 30, 2001,2000 and 1999.    Subsequently, we filedamended returns for the years ended June 30, 2001, 2000 and 1999.  The amendments relate to the restatement ofour financial statements as well as the deconsolidation of consolidated taxreturns and subsequent filing of separate returns by us and each of oursubsidiaries.  Because we filed taxreturns separate from our subsidiaries, we could no longer offset income fromits sale of stock in subsidiaries against operating losses within itssubsidiaries.  However, because weexperienced losses in subsequent years these losses were available to carrybackagainst these gains.

 

**Comparison of Fiscal2001 to Fiscal 2000**

 

The following table summarizes certain aspects of our results ofoperations for fiscal 2001 compared to fiscal 2000 (*in thousands*):

 
|                                 |   | **Year ended  June 30,** |    |           |   |         |   |
|--------------------------------------|--------|--------------------------|---------|----------------|--------|--------------|--------|
|                                 |   | **2001**                 |    | **2000**       |   | **$ Change** |   | **% Change** |   |
|                                 |   | **(Restated)**           |    | **(Restated)** |   |         |   |   |   |
| Revenues                             |   | $                        | 263,192 |           | $      | 71,839       |   | $ | 191,353 |   | 266 | % |
|                                 |   |                     |    |           |   |         |   |   |   |
| Gross profit                         |   | 32,591                   |    | 14,607         |   | 17,984       |   | 123 | % |
| As a percentage of revenues          |   | 12                       | %       | 20             | %      |         |   |   |   |
|                                 |   |                     |    |           |   |         |   |   |   |
| Selling, general and administrative  |   | 13,151                   |    | 16,132         |   | (2,981       | )      | (18 | )% |
| Depreciation and amortization        |   | 12,460                   |    | 14,763         |   | (2,303       | )      | (16 | )% |
| Research and development             |   | 16,695                   |    | 7,479          |   | 9,216        |   | 123 | % |
| Impairment of assets                 |   | —                   |    | 3,486          |   | (3,486       | )      | (100 | )% |
|                                 |   |                     |    |           |   |         |   |   |   |
| Total other income (expense), net    |   | (2,937                   | )       | 46,424         |   | (49,361      | )      | (106 | )% |
|                                 |   |                     |    |           |   |         |   |   |   |
| Provision (benefit) for income taxes |   | (6,434                   | )       | 21,099         |   | (27,533      | )      | (130 | )% |
|                                      |        |                          |         |                |        |              |        |  |  |  |  |  |

 

*Revenues*

 

The significant increasein overall revenues for fiscal 2001 as compared to fiscal 2000 was primarilyattributable to the 333% increase in unit sales of DOCSIS cable modems.  The increase in cable modem unit sales wassomewhat offset by the decrease in the average selling price of our cablemodems as discussed below.   Revenuesgenerated by international sales as a percentage of total revenues remainedfairly constant with 70% and 72% of revenue generated from international salesfor fiscal 2001 and 2000, respectively.

 

*Gross Profit*

 

The decrease in gross profit dollars as well as the gross profitpercentage was due to the following:

 

•                  An approximate41% decrease in the average sales price of our DOCSIS cable modems sold byCorrelant as a result of heavy price competition.  Selling prices decreased faster than the associated product costreductions, which reduced approximately 24%;

•                  Loss on purchasecommitments of cable modem components as we adjusted our inventories to reflectthe decrease in forecasted product demand; and

 

20

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•                  Write down ofcomponent inventories to market value.

 

*Operating Expenses*

 

SG&A.  The decrease inSG&A was due to a decrease in cash transfer and exchanges between entitiesunder common control to $3,000 in fiscal 2001 from $9,260,000 in fiscal 2000.  Our subsidiaries, Regent and Lotus World,engaged in extensive transactions with companies owned and managed by priormanagement.  These transactions includedadvances, lease expense for the use of facilities, payroll expense for the useof employees, consulting expense, and other office expense.  This decrease was offset by the following:

 

•                  $3,122,000 increase in allowance fordoubtful accounts to $4,477,000 in fiscal 2001 from $1,355,000 in fiscal 2000.For 2001 details, see “**Comparison of Fiscal 2002 to Fiscal 2001.**”  Fiscal 2000 allowance related to apromissory note with our former subsidiary USS Online of $1,300,000 principaland $55,000 accrued interest.

•                  $1,663,000 increased amortization ofdeferred stock compensation;

•                  $1,000,000 increase legal and accountingfees associated with Correlant’s contemplated IPO; and

•                  Increased salary expense associated withan increased staff to support Correlant’s contemplated IPO.

 

D&A.  We sold 656,000 sharesof our Correlant stock, which reduced our ownership percentage from 65% to 62%.  As a result of the ownership decrease, theassociated amortization of goodwill decreased. Depreciation expense increased slightly as capital expendituresincreased to support our growing staff and to support Correlant’s contemplatedIPO.

 

R&D.  The increase inR&D expense for fiscal 2001 as compared to fiscal 2000 was primarilyattributable to the following factors:

 

•                  $5,500,000 increase in amortization ofdeferred stock compensation; and

•                   Increased salary expense associated witha 52% increase in headcount to support the growing demand for current andanticipated future products.

 

Impairment of assets. We evaluated our long-lived assets as of June 30, 2001 and concluded thecarrying value of all our assets exceeded the expected future cash flows fromthe use of our assets.  Therefore, therewas no impairment of assets during fiscal 2001.  During fiscal 2000, we incurred an impairment of assets relatedto the following:

 

•                  Our $3,106,000investment in USS Online.  As of June30, 2000, we determined the investment was impaired and wrote it off; and

•                  Write off ofobsolete property and equipment with a net book value of $380,000.

 

*Total other income (expense)*

 

We experienced net other expense during fiscal 2001 as previouslydescribed at “**Comparison of Fiscal 2002 to Fiscal 2001.**”  We experienced other income during fiscal2000 primarily due to the $50,512,000 gain realized from the sale of 3,657,000shares of Correlant stock.  This wasslightly offset by a loss on the sale of a joint venture.  On June 28, 1999 we entered into anagreement with TCL Holdings (BVI) Co., Ltd. (“TCL BVI”) to establish TCLInternational (US), Inc., a 50-50 joint venture. At June 30, 2002, TCL BVI’sparent company owned 14.6% of our outstanding common stock.  During fiscal 2000 we invested $4,814,000 inthe joint venture. The purpose of the joint venture was to develop and market aset top box (“STB”) for the China market. The STB accessed the Internet via a television and was marketed tohouseholds with no computer Internet access. Once the STB was installed, the joint venture planned to provideInternet access for a monthly fee. However, because technology for computer Internet access was deployed soquickly in China, there was virtually no demand for the STB once the jointventure completed the product development. As such, the joint venture ceased operations.  On June 16, 2000 we sold our stock in TCL International to arelated party for a note in the amount of $560,000, which was deemed to be thefair value of our portion of the winding down joint venture.  We recorded a loss of $4,254,000 on thedisposition. The remaining other income (expense) related to interest incomeearned on our cash and investments and interest expense.

 

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**Comparison of Fiscal2000 to Fiscal 1999**

 

The following table summarizes certain aspects of our results ofoperations for fiscal 2000 compared to fiscal 1999 *(in thousands*):

 
|                                 |   | **Year ended  June 30,** |   |           |   |         |   |
|--------------------------------------|--------|--------------------------|--------|----------------|--------|--------------|--------|
|                                 |   | **2000**                 |   | **1999**       |   | **$ Change** |   | **% Change** |   |
|                                 |   | **(Restated)**           |   | **(Restated)** |   |         |   |   |   |
| Revenues                             |   | $                        | 71,839 |           | $      | 3,733        |   | $ | 68,106 |   | 1,824 | % |
|                                 |   |                     |   |           |   |         |   |   |   |
| Gross profit                         |   | 14,607                   |   | 463            |   | 14,144       |   | 3,055 | % |
| As a percentage of revenues          |   | 20                       | %      | 12             | %      |         |   |   |   |
|                                 |   |                     |   |           |   |         |   |   |   |
| Selling, general and administrative  |   | 16,132                   |   | 3,835          |   | 12,297       |   | 321 | % |
| Depreciation and amortization        |   | 14,763                   |   | 3,796          |   | 10,967       |   | 289 | % |
| Research and development             |   | 7,479                    |   | 711            |   | 6,768        |   | 952 | % |
| Impairment of assets                 |   | 3,486                    |   | —         |   | 3,486        |   | N/A |   |
|                                 |   |                     |   |           |   |         |   |   |   |
| Total other income (expense), net    |   | 46,424                   |   | 1,084          |   | 45,340       |   | N/M |   |
|                                 |   |                     |   |           |   |         |   |   |   |
| Provision (benefit) for income taxes |   | 21,099                   |   | 9              |   | 21,090       |   | N/M |   |
|                                 |   |                     |   |           |   |         |   |   |   |
| N/M – Not Meaningful            |   |                     |   |           |   |         |   |   |   |
|                                      |        |                          |        |                |        |              |        |  |  |  |  |  |

 

*Revenues*

 

The significant increasein overall revenues for fiscal 2000 as compared to fiscal 1999 was primarilyattributable to the following factors:

 

•                  The acquisition of Correlant.  Fiscal 2000 included 12 months ofCorrelant’s activity compared to three months of Correlant’s activity duringfiscal 1999;

•                  Correlant’s cable modems received theDOCSIS 1.0 certification in April, 1999;

•      The growth of Correlant’s customer basefrom one major customer to three major customers; and

•                  The increased demand for Correlant’scable modems as the DOCSIS certified cable modem moved to mass production.

 

*Gross Profit*

 

The increase in gross profit dollars for fiscal 2000 as compared tofiscal 1999 was directly attributable to the increased revenues.  The increase in gross profit percentage wasa result of shipping low volume and sample cable modems during fiscal 1999,which bear a higher cost than large volume cable modems.

 

*Operating Expenses*

 

SG&A.  The increase inSG&A expense for fiscal 2000 as compared to fiscal 1999 was due to thefollowing factors:

 

•                  $9,260,000 cash transfer and exchangesbetween entities under common control during fiscal 2000 as compared to$1,143,000 in fiscal 1999.  Oursubsidiaries, Regent and Lotus World, engaged in extensive transactions withcompanies owned and managed by prior management.  These transactions included advances, lease expense for the use offacilities, payroll expense for the use of employees, consulting expense, andother office expense.

•      The acquisition of Correlant;

•                  $1,355,000 increase in allowance fordoubtful accounts as previously described at “**Comparison of Fiscal 2001 to Fiscal 2000;**”and

•      $401,000 increased amortization ofdeferred stock compensation.

 

D&A.  The increase in D&A was due to theacquisition of Correlant.  Fiscal 2000amortization is slightly

 

22

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decreased from annualizedfiscal 1999 amortization.  This is aresult of selling 3,657,000 shares of our Correlant stock, which reduced ourpercentage ownership from 81% to 65%. As a result of the ownership decrease, the associated amortization ofgoodwill decreased.

 

R&D.  The increase inR&D expense for fiscal 2000 as compared to fiscal 1999 was primarilyattributable to the following factors:

 

•      The acquisition of Correlant;

•      $1,625,000 increased amortization ofdeferred stock compensation; and

•                  Increased salary expense associated witha 55% increase in headcount to support the growing demand for current andanticipated future products.

 

Impairment of assets. We evaluated our long-lived assets as of June 30, 2000 and incurred animpairment of assets as described at “**Comparison of Fiscal 2001 to Fiscal 2000.**”  We evaluated our long-lived assets as ofJune 30, 1999 and concluded the carrying value of all our assets exceeded theexpected future cash flows from the use of our assets.  Therefore, there was no impairment of assetsduring fiscal 1999.

 

*Total other income (expense)*

 

Our increase in net other income was primarily due to the $50,512,000gain realized from the sale of Correlant stock slightly offset by a loss on thesale of our joint venture during fiscal 2000 as described at “**Comparisonof Fiscal 2001 to Fiscal 2000.**” Additionally, we sold 72% of our interest in USS Online during fiscal2000.  Therefore, our equity earnings inaffiliated entity decreased to $177,000 in fiscal 2000 from $1,075,000 infiscal 1999.

 

**Liquidity and Capital Resources**

 

The following table summarizes our liquidity position and cash flows asof and for the year ended June 30, 2002 (*in thousands*):

 
|                                  |   | **As of or  for  The Year Ended  June 30, 2002** |   |
|---------------------------------------|--------|--------------------------------------------------|--------|
| Cash and cash equivalents             |   | $                                                | 32,647 |   |
| Short-term investments                |   | 4,977                                            |   |
| Working Capital                       |   | 46,962                                           |   |
| Cash used by operating activities     |   | (5,799                                           | )      |
| Cash provided by investing activities |   | 16,217                                           |   |
| Cash provided by financing activities |   | 9                                                |   |
|                                       |        |                                                  |        |  |

 

As of June 30, 2002, our principal source of liquidity included cashand cash equivalents and short-term investments of $37,624,000.  We used $5,799,000 to fund operatingactivities during fiscal 2002.  Themajority of our fiscal 2002 net loss from continued operations wassubstantially offset by non-cash expenses including amortization of goodwill,and deferred stock compensation and impairment of assets.  The remaining cash used in operatingactivities was to pay vendors according to current payment terms, partiallyoffset by a decrease in inventory and collection on accounts receivable andaccounts receivable from related parties. The largest use of operating cash was to pay down accounts payable to arelated party as a result of the change in Correlant’s business model.  We expect future cash provided (used) byoperating activities to fluctuate, primarily as a result of fluctuations in ouroperating results, the timing of product shipments, accounts receivablecollections, inventory management and the timing of vendor payments.

 

For fiscal 2002, our principal investing activities included: (1)selling a controlling portion of interest in our subsidiary Arescom; (2) netsales of short-term investments; and (3) repayment of notes receivable from arelated party.  Cash provided by investingactivities was partially offset by capital expenditures to accommodate ourexpanding research and development technology infrastructure.

 

23

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*Cash and WorkingCapital Requirements*

 

At June 30, 2002, we had working capital of $46,962,000 compared to$24,447,000 at June 30, 2001.  Theincrease in working capital was primarily due to the sale of our controllinginterest in Arescom and the cancellation of Correlant’s line of credit, whichrequired $5,500,000 of restricted cash.

 

For the 12 months following the date of this filing, our cash andworking capital requirements will be primarily to fund operations as well asoperations of our subsidiary, GoVideo. This may include research and development, capital expenditures and cashacquisitions that we may undertake. We expect our cash and cash equivalents onhand and cash generated from operations will be sufficient to meet our cashrequirements for the 12 months following the date of this filing. However,should our capital requirements exceed cash available from operations we cannotassure that additional sources of financing would be available to us oncommercially favorable terms, or at all.

 

*ContractualObligations*

 

The following table summarizes our contractual obligations at June 30,2002, and the effect such obligations are expected to have on our liquidity andcash flows in future periods (*in thousands*):

 
|                               |   | **Payments  Due by Period** |   |
|------------------------------------|--------|-----------------------------|--------|
|                               |   | **Total**                   |   | **Less Than  1 Year** |   | **1-3 Years** |   | **3-5 Years** |   | **More Than  5 Years** |   |
|                               |   |                        |   |   |   |   |   |   |   |   |   |
| Operating lease obligations        |   | $                           | 1,808  |   | $ | 379 |   | $ | 815 |   | $ | 614 |   | $ | — |   |
| Capital lease obligations          |   | —                      |   | — |   | — |   | — |   | — |   |
| Inventory purchase obligations     |   | —                      |   | — |   | — |   | — |   | — |   |
| Total contractual cash obligations |   | $                           | 1,808  |   | $ | 379 |   | $ | 815 |   | $ | 614 |   | $ | — |   |

 

Substantially all our operating lease obligations are building leases.

 

*Off-Balance SheetArrangements*

 

At June 30, 2002, we did not have any relationship with unconsolidatedentities or financial partnerships, which other companies have established forthe purpose of facilitating off-balance sheet arrangements or othercontractually narrow or limited purposes as defined in Item 303(a)(4)(ii) ofSEC Regulation S-K. Therefore, we are not materially exposed to any financing,liquidity, market or credit risk that could arise if we had engaged in suchrelationships.

 

***Business Outlook***

 

Following the hostile takeover of the Board of Directors of the Companyon June 29, 2001, new management of the Company began a thorough review ofall aspects of the business operations of the Company and its subsidiaries.  Since the takeover, we have engaged innumerous transactions to restructure and refocus our business.

 

Since the takeover, our primary strategy for business operations hasbeen to restructure our unprofitable businesses, acquire undervalued companies(such as GoVideo) and focus on profitable growth.  We aggressively sold, restructured or shutdown our businesseswhich were either not consistently generating cash from operations or whichcould have required future significant cash investments to become consistentlycashflow positive.  As a result of thiseffort, we currently have one subsidiary with operations (GoVideo) and onesubsidiary with no operations (Correlant) but with significant cash and otherassets.  We seek to identify marketopportunities that will complement current operations, create and acceleratethe growth and success of GoVideo and to implement new business plans toimprove the returns on these businesses.

 

We plan to further improve the efficiencies of our consolidated operationsand accelerate growth by utilizing our competitive advantages. We believe ourcompetitive advantages include, but are not limited to, the following:

 

•                  Significantexperience of current management in the communications and consumer electronicsindustry;

•                  Businessopportunities in China and Asia through the strength of our relationships withsignificant shareholders, including TCL. TCL is an affiliated company of TCL International (HKSE: 1070), a

 

24

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leading multimedia consumer electronics product manufacturer, with astrong brand presence in China and Asia. TCL International’s core products include televisions, mobile handsets,personal computers, audio-visual equipment as well as information technologyservices.  Under its highly recognizedand well-established TCL brand, it is one of the strongest players in the TVand mobile handset marketplace in China. Headquartered in China, it operates anumber of highly efficient manufacturing bases in Asia.  On November 3, 2003, TCL International andThomson (Euronext Paris: 18453; NYSE: TMS) signed a memorandum of understandingto form a joint venture company named TCL-Thomson Electronics for thedevelopment, manufacturing and distribution of television sets and relatedproducts and services. The joint venture’s objectives are to consolidate itsglobal TV leader position, offer a complete and high-quality product range frombasic to high-end innovative products, address all key markets competitively byleveraging an efficient cost structure, and seize development opportunities inthe fast-growing Chinese market.

•                  GoVideo brandrecognition; and

•                  The ability toincrease market share by introducing TCL products into the US using oursubsidiary – GoVideo’s – existing distribution channels.

 

As we look ahead to the rest of fiscal 2004 and beyond, we are planningfor growth in annual revenues as a result of revenues generated fromGoVideo.  And although consumerelectronics historically have lower gross margins than our past gross marginsrealized from cable modems and cable modem-related products, we expect grossmargin dollars to increase as a result of increased revenue.  Our strategy will remain within our corecompetency of telecommunications and consumer electronics as we attempt to gainstrength, momentum and market share in the US and abroad.

 

Our future results of operations and the other forward-lookingstatements contained in this filing, including this MD&A, involve a numberof risks and uncertainties–in particular, the statements regarding plans tocultivate new businesses that complement existing consumer electronicsbusiness, revenue and gross margin.  Inaddition to various factors that we have discussed above, a number of otherfactors could cause actual results to differ materially from our expectations.

 

***Critical AccountingPolicies***

 

The discussion and analysis of our financial condition and results ofoperations are based on the consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in theU.S.  The preparation of these financialstatements requires estimates and assumptions that affect the reported amountsand disclosures.

 

We believe the following, among others, to be critical accountingpolicies.  That is, they are bothimportant to the portrayal of our financial condition and results ofoperations, and they require critical management judgments and estimates aboutmatters that are inherently uncertain. Although we believe our judgments andestimates are appropriate and correct, actual future results may differ fromour estimates.

 

•                  *Revenuerecognition.*  We recognizerevenue upon passage of title of our product in accordance with the Securitiesand Exchange Commission (SEC) Staff Accounting Bulletin 101*, Revenue Recognition in FinancialStatements* (SAB 101), as amended by SAB 101A and 101B.  We do not provide a product warranty.  The warranty liability for defective cablemodems is the responsibility of our third-party manufacturer.

 

•                  *Bad debtreserves*.  We conductbusiness and extend credit based on an evaluation of our customers’ financialcondition generally without requiring collateral. Exposure to losses on tradereceivables is expected to vary by customer due to the financial condition ofeach customer. We monitor exposure to credit losses and maintain allowances foranticipated losses considered necessary under the circumstances. Delinquentnotes and trade accounts receivable are charged against the allowance fordoubtful accounts once uncollectibility has been determined. The allowance isdetermined through an analysis of the aging of accounts receivable andassessments of risk based on historical trends and an evaluation of the impactof current and projected economic conditions. We evaluate the past-due status of our notes and related parties andtrade receivables based on contractual terms of sale. If the financialcondition of our customers were to deteriorate, resulting in an impairment ofability to make payments, additional allowances may be required.

 

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•                  *Relatedparty transactions.*  We havesignificant related party transactions and agreements; many of which arecomplex.  We believe such transactionshave been accounted for at fair value. We utilized our best estimate of the value of these transactions andagreements.  Had alternative assumptionsbeen used, the values obtained may have been different.

 

•                  *Inventories.*  Inventories consist primarily of integratedcircuits and other components to be used in the manufacture of cablemodems.  Inventories are stated at thelower of cost or market with cost being determined on a first-in, first-outbasis.  We write down our inventory forestimated obsolescence or unmarketable inventory equal to the differencebetween the cost of the inventory and the estimated market value based uponassumptions about future demand and market conditions.  Due to the aforementioned change inCorrelant’s business model and the timing of Correlant’s product life cycle,the inventory was fully reserved at June 30, 2002. It remained fully reserveduntil the shutdown of Correlant’s historical operations in the cable modem andcable modem-related market.

 

•                  *Investments.*  Our investments consist primarily of debtsecurities.  Investments are stated atfair value based on quoted market prices obtained from an independentbanker.  Investments are classified asavailable-for-sale based on management’s intended use.  As of June 30, 2002 the cost of ourinvestments approximated fair value. Currently we do not have any equity investments in publicly tradedcompanies.  During the period covered bythis Annual Report, we held noncontrolling interests in private companies withno active market, which required fair values to be estimated.  We recorded an investment impairment chargewhen we believe an investment has experienced a decline in value that is otherthan temporary.

 

•                  *Valuation ofgoodwill*.  We activelypursued the acquisition of businesses, which resulted in significantgoodwill.  We assess the impairment ofgoodwill whenever events or changes in circumstances indicate the carryingvalue may not be recoverable.  Factorswhich trigger a goodwill impairment review include, but are not limited to, thefollowing: (1) significant negative industry or economic trends; (2) current,historical or projected losses that indicate continuing losses; and (3) asignificant decline in our market capitalization relative to net bookvalue.  When we determine there is anindicator the carrying value of the goodwill may not be recoverable, we measureimpairment based on estimates of future cash flow.  These estimates include assumptions about future conditionswithin the Company as well as the entire industry.

 

•                  *Income taxes*.  We recorded a valuation allowance to reducethe deferred tax assets to the amount that is more likely than not to berealized in the future.  We consideredfuture taxable income and ongoing tax planning strategies in assessing the needfor the valuation allowance. If we determine that we will not realize all orpart of our net deferred tax assets in the future, we will make an adjustmentto the deferred tax assets, which will increase income tax expense in theperiod of such determination.

 

***Recently Issued AccountingStandards***

 

In June 2002, the FASB issued SFAS 146, *Accounting for Costs Associated withExit or Disposal Activities* (SFAS 146), which addresses accountingfor restructuring and similar costs. SFAS 146 supersedes previous accountingguidance, principally Emerging Issues Task Force (EITF) Issue 94-3, *LiabilityRecognition for Certain Employee Termination Benefits and Other Costs to Exitan Activity* (including Certain Costs Incurred in a Restructuring)(EITF 94-3). The Company will be required to adopt the provisions of SFAS 146for restructuring activities initiated after December 31, 2002. SFAS 146requires the liability for costs associated with an exit or disposal activitybe recognized when the liability is incurred. Under EITF 94-3, a liability foran exit cost was recognized at the date of the Company’s commitment to an exitplan. SFAS 146 also states the liability should initially be measured andrecorded at fair value. Accordingly, SFAS 146 may affect the timing ofrecognizing future restructuring costs as well as the amounts recognized. TheCompany will adopt SFAS 146 on January 1, 2003. The adoption of SFAS 146 in notexpected to have a material effect on the Company’s financial position, resultsof operations, or cash flows.

 

In November 2002, the FASB issued FASB Interpretation (FIN) 45, *Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others* (FIN 45).  FIN 45 requires that upon issuance of aguarantee, the guarantor must recognize a liability for the fair value of the

 

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obligation it assumes under that guarantee. The provisions for initialrecognition and measurement are effective on a prospective basis for guaranteesissued or modified after December 31, 2002, irrespective of a guarantor’syear-end. The disclosure requirements of FIN 45 are effective for interim andannual periods ending after December 15, 2002, and are applicable to theCompany’s product warranty liability and other guarantees.  The adoption of FIN 45 is not expected tohave a material effect on the Company’s financial position, results ofoperations, or cash flows.

 

In December 2002, the FASB issued SFAS 148, *Accounting for Stock-BasedCompensation–Transition and Disclosure* (SFAS 148), which amends SFAS123.  SFAS 148 provides alternativemethods of transition for an entity that voluntarily changes to the fair valuebased method of accounting for stock-based employee compensation. It alsoamends the disclosure provisions of SFAS 123 to require prominent disclosureabout the effects an entity’s accounting policy decisions with respect tostock-based employee compensation have on reported net income in both annualand interim periods. SFAS 148 is effective for annual periods ending afterDecember 15, 2002 and interim periods beginning after December 15, 2002.  The adoption of the disclosure requirementsof SFAS 148 will not have a material effect on the Company’s financialposition, results of operations, or cash flows.

 

In January 2003, the FASB issued FIN 46, *Consolidation of Variable InterestEntities*. (FIN 46), which establishes accounting guidance forconsolidation of a variable interest entity (VIE), formerly referred to asspecial purpose entities. FIN 46 applies to any business enterprise, bothpublic and private, that has a controlling interest, contractual relationshipor other business relationship with a VIE. FIN 46 provides guidance fordetermining when an entity (Primary Beneficiary) should consolidate a VIE thatfunctions to support the activities of the Primary Beneficiary. The Company hasno contractual relationship or other business relationship with a VIE, andtherefore the adoption of FIN46 will not have an effect on its financialposition, results of operations, or cash flows.

 

In January 2003, the EITF published EITF Issue 00-21, *RevenueArrangements with Multiple Deliverables* (EITF 00-21), which requirescompanies to determine whether an arrangement involving multiple deliverablescontains more than one unit of accounting. In applying EITF 00-21, revenuearrangements with multiple deliverables should be divided into separate unitsof accounting, if the deliverables in the arrangement meet certain criteria.Arrangement consideration should be allocated among the separate units ofaccounting based on their relative fair values. This issue is effective forrevenue arrangements entered into in fiscal periods beginning after June 15,2003. The Company does not expect the adoption of EITF 00-21 will have amaterial impact on its financial position, results of operations, or cashflows.

 

In April 2003, the FASB issued SFAS 149, *Amendment of Statement 133 onDerivative Instruments and Hedging Activities*(SFAS 149).  SFAS149 amends and clarifies financial accounting and reporting for derivativeinstruments and hedging activities.  SFAS 149 is effective for contractsentered into or modified after June 30, 2003.  The Company does not expectSFAS 149 to have a material impact on its financial position, results ofoperations, or cash flows.

 

In May 2003, the FASB issued SFAS 150, *Accounting for Certain FinancialInstruments with Characteristics of both Liabilities and Equity*(SFAS150).  SFAS 150 represents the first phase of the FASB’s project toclarify the accounting treatment of certain instruments that possesscharacteristics of both liabilities and equity.  SFAS 150 generallyrequires that freestanding financial instruments that obligate the issuer toredeem the holders’ shares, or are indexed to such an obligation, and aresettled in cash or settled with shares meeting certain conditions be treated asliabilities.  The provisions of SFAS 150 are effective immediately forinstruments entered into or modified after May 31, 2003 and to all other instrumentsthat exist as of the beginning of the first interim financial reporting periodbeginning after June 15, 2003, with the exception of mandatorily redeemableinstruments of non-public companies, which become subject to SFAS 150 forfiscal periods beginning after December 15, 2003.  The Company does notexpect SFAS 150 to impact the classification of its outstanding preferred stockinstruments upon the Company’s adoption effective July 1, 2003.

 

***Certain Factors ThatMay Affect Future Results***

 

*ForwardLooking Statements. *ThisAnnual Report on Form 10-K contains certain statements that are forward lookingwithin the meaning of Section 27A of the Securities and Exchange Act of 1933,as amended, and Section 21E of the Securities and Exchange Act of 1934, asamended, that involve risks and uncertainties. Any

 

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statements contained herein (including, withoutlimitation, statements to the effect that the Company or management“estimates,” “expects,” “anticipates,” “plans,” “believes,” “projects,”“continues,” “may,” or “will” or statements concerning “potential” or“opportunity” or variations thereof or comparable terminology or the negativethereof), that are not statements of historical fact should be construed as forwardlooking statements.   All statementsthat address operating performance, events or developments that our managementexpects or anticipates to incur in the future, including statements relating tosales and earnings growth or statements expressing general optimism aboutfuture operating results, are forward-looking statements.  These forward-looking statements are basedon our management’s current views and assumptions regarding future events andoperating performance.  Many factorscould cause actual results to differ materially from estimates contained in ourmanagement’s forward-looking statements including the factors listed at pages27 - 29.   The differences may be causedby a variety of factors, including but not limited to adverse economic conditions,competitive pressures, inadequate capital, unexpected costs, lower revenues,net income and forecasts, the possibility of fluctuation and volatility of ouroperating results and financial condition, inability to carry out marketing andsales plans and loss of key executives, among other things.  Because of these and other factors that mayaffect our operating results, past performance should not be considered anindicator of future performance and investors should not use historical resultsto anticipate results or trends in future periods.

 

*Therestatement and reaudit of our financial statements and the potential forreview of our financial disclosure could materially impact our business andresults of operations. *Followingthe replacement of prior management, the new management began reviewing varioustransactions undertaken by old management prior to June 29, 2001.  During its preliminary investigation, newmanagement identified certain material transactions undertaken by priormanagement that impact reported financial and operating results with respect toits consolidated financial statements for the fiscal years ended June 30, 2001,2000 and 1999.  Due to the preliminaryresults, the Company dismissed the then existing independent accountants, hirednew independent accountants and re-audited all periods underinvestigation.  Accordingly, the Companywas unable to file its Form 10-K for the period ending June 30, 2002 untilApril 2004.

 

As a result of the restatement and reaudit of ourfinancial statements for fiscal 2001, 2000 and 1999 and the resulting delay infiling SEC reports, the SEC or other governmental authorities may choose toreview our SEC filings.  If we arerequired to respond to the SEC or other governmental authorities or otherwise takeactions in response to, arising out of, or relating to the restatement andreaudit of our financial statements, such actions may require significantattention and resources of management and, regardless of the outcome, couldmaterially impact our business and results of operations.

 

If we become subject to such heightened scrutiny, thiscould adversely affect investor confidence, our ability to access the capitalmarkets and cause the trading price for our securities to decline. In addition,we cannot assure you that we will not have to further restate earnings orfurther revise our reports for prior periods as a result of any SECreview.  Any such restatement couldfurther impact investor confidence, our ability to access the capital marketsand the trading price of our securities.

 

*We are exposed tothe risks associated with the recent decision to cease cable modem-relatedbusiness by Correlant, our subsidiary.*The Company isactively seeking a viable business model for Correlant that would maximize ourshareholders’ interest. Even if a viable business model is found that willcorrespond with Correlant’s available cash size, there is still no guaranteethe model will succeed.

 

*The Company’sbusiness operation is facing very tough competition.*TheCompany’s current subsidiary GoVideo plays a unique niche in a highlycompetitive industry: consumer electronics. This industry is empirically facinga trend of declining gross margin resulted from emerging global market andcompetition. While GoVideo is profitable in fiscal 2003, the competitive natureof the industry may negatively affect the Company’s earning if GoVideo isunable to quickly adapt to the technological and market changes of theindustry.

 

*We may not be ableto produce sufficient quantities of our products as we obtain components from,and depend on, a limited number of key suppliers. *All of our TV and DVD player productscontain one or more components that are available from a single supply sourceand other components that are available from limited sources.  We depend on these sources to meet ourproduction requirements.  We do not haveany long term supply contracts. Although we do not presently anticipate a disruption in this source ofsupply, if it is necessary for us to obtain these key components from analternative supplier, it could take several months before we would beginreceiving adequate supplies, and during this time we would be unable to satisfyour customers’ demands.  In such event,

 

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prolonged delays could result in the cancellation of orders and theloss of customers*.*

 

*Our new products maynot be well accepted.* Our future success depends on GoVideo’s ability to continue to designand develop and win acceptance of its products and services, which are offeredin highly competitive markets characterized by continual new productintroductions, rapid development in technology, and subjective and changingconsumer preferences.

 

*The introduction orexpected introduction of new products or technologies may depress sales ofexisting products and technologies*. This may result indeclining prices and inventory obsolescence. As GoVideo maintains asubstantial investment in product inventory, declining prices and inventoryobsolescence could have a material adverse effect on our business and financialresults.

 

*Our stock price maynot come back. *TheCompany’s stock was removed from OTC Bulletin Board as a result of theCompany’s failure to timely submit the Form 10-K for the year of 2002. Thecurrent trading of the Company’s stock is sporadic and minimal and there is noestablished public trading market for our common stock. In addition, the stockmarket has experienced extreme price and volume fluctuations that have affectedthe market price of many technology companies, in particular, and that haveoften been unrelated to the operating performance of these companies. Thesefactors, as well as general economic and political conditions, may materiallyadversely affect the market price of our common stock in the future.Additionally, volatility or a lack of positive performance in our stock pricemay adversely affect our ability to retain key employees.

 

*Our executiveofficers and key personnel are critical to our business and the loss of their servicescould disrupt our operations and our customer relationships. *Our success dependsto a significant degree upon the continuing contributions of our keymanagement, technical, marketing and sales employees.  There can be no assurance that we will be successful in retainingour key employees or that we can attract and retain additional skilledpersonnel as required. The loss of the services of key personnel couldsignificantly harm our results of operations and business.

 

Because of these and other factors affecting our operating results,past financial performance should not be considered an indicator of futureperformance, and investors should not use historical trends to anticipateresults or trends in future periods.

 

**Item 7A.  Quantitative and Qualitative Disclosuresabout Market Risk**

 

*Interest Risk*.   Our exposure to market risk for changes ininterest rates relates primarily to our investment portfolio. We do not usederivative financial instruments in our investment portfolio.  We place our investments with high creditquality issuers and, by policy, limit the amount of credit exposure to any oneissuer.  We are averse to principal lossand ensure the safety and preservation of invested funds by limiting defaultrisk, market risk, and reinvestment risk. We minimize our risk by investing in only the safest and highest creditquality securities and by constantly positioning our portfolio to respondappropriately to a significant reduction in a credit rating of any investmentissuer or guarantor.  Our portfolioincludes only corporate debt securities and municipal bonds.

 

*Foreign CurrencyRisk*.   UntilJanuary 31, 2002 a large portion of our business was transacted in Taiwan.  However, the functional currency of ourTaiwan branch was the US dollar.  Only asmall number of transactions were denominated in the Taiwan dollar and exposedto foreign currency exchange rate risk. Subsequent to January 31, 2002, as part of the change in Correlant’sbusiness model, we closed our Taiwan branch and all transactions are nowdenominated in the US dollar. Therefore, we do not have any hedging or similar foreign currencycontracts.  To date, we have notexperienced any material foreign currency exchange rate gains or lossesassociated with transactions denominated in the Taiwan dollar and do not expectany significant changes in foreign currency exposure in the near future.

 

**Item 8. Financial Statements**

 

The information required by Item 8 is included on pages F-1 to F-39.

 

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**Item 9.  Changes in and Disagreements WithAccountants on Accounting and Financial Disclosure**

 

(a)           The Companypreviously reported the dismissal of Larson, Allen, Weishair & Co. asits independent accountants and the appointment of Hein & AssociatesLLP (“Hein”) as its new independent accountants in current reports on Form 8-Kand 8-K/A as filed with the Commission on March 26, March 27 and April 12,2002.

 

The Company previously reported the dismissal of Ernst & Young LLPas the independent accountant of Correlant, a “significant subsidiary” (asdefined in Rule 1-02 of Regulation S-X) of the Company, and the engagement ofHein as the new independent accountant of Correlant on April 23, 2002 asapproved by the Board, in the Company’s current reports on Form 8-K and 8-K/Aas filed with the Commission on April 25 and June 4, 2002.

 

(b)           In connection withthe change in accountants referenced above, there were no disagreements withthe former accountants on any matter of accounting principles or practices,financial statement disclosure, or auditing scope or procedure, whichdisagreements, if not resolved to the satisfaction of the former accountants,would have caused them to make reference to the subject matter of thedisagreement in connection with their reports. In connection with the change inaccountants referenced above, there were no “reportable events” of the typedescribed in Item 304(a)(1)(v).

 

**Item 9A.  Controls andProcedures**

 

**Evaluation ofdisclosure controls and procedures**

 

The Company carried out an evaluation, under the supervision and withthe participation of the Chief Executive Officer and Chief Financial Officer,of the effectiveness of the design and operation of our disclosure controls andprocedures pursuant to Rule 13a-14 of the Securities Exchange Act of 1934 (the“Exchange Act”). Based upon that evaluation, the Chief Executive Officer andChief Financial Officer concluded that as of June 30, 2002, the end of theperiod covered by this report, the Company’s disclosure controls and procedureswere effective at the reasonable assurance level in timely alerting them tomaterial information relating to the Company (including its consolidatedsubsidiaries) required to be included in our Exchange Act filings.

 

**Changes in internalcontrol over financial reporting**

 

Except as set forth below, during fiscal 2002, there were nosignificant changes in our internal control over financial reporting thatmaterially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

As previously reported, following the replacement of prior managementon June 29, 2001, new management began an extensive undertaking to reviewvarious transactions undertaken by and involving old management prior to June29, 2001.  As a consequence of itspreliminary review, effective March 25, 2002, the Company terminated its auditrelationship with its then existing independent accountants and replaced suchfirm with new independent accountants. As previously reported, during its preliminaryinvestigation, new management of the Company identified various transactionsinvolving a former subsidiary and other transactions undertaken by priormanagement which impacted reported financial and operating results with respectto its consolidated financial statements for the fiscal years ended June 30,2001, 2000 and 1999 and ultimately concluded that a reaudit of the financialstatements for the fiscal years ended June 30, 2001, 2000 and 1999 wasrequired. Effective July 24, 2002, the Company engaged its new independentaccountants, to perform such reaudit and the Company concluded that it mustrestate these prior periods.  During thecourse of its review and investigation of various transactions undertaken byand involving old management, and its completion of such restatement andreaudit, new management of the Company has established its own systems ofinternal controls over financial reporting.

 

**PART III**

 

**Item 10. Directors and Executive Officers of the Registrant**

 

*(A) Lotus PacificDirectors*

 

The Company has five Directorselected in three separate classes. One Director serves as a Class I Director,and will serve for a term which was scheduled to expire at the 2002 AnnualMeeting of stockholders, or until his successor is duly elected and qualifiedor until his death, resignation or removal. One director serves as a

 

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Class II Director, and willserve for a term which was scheduled to expire at the 2003 Annual Meeting ofstockholders, or until his successor is duly elected and qualified or until hisdeath, resignation or removal. Three Directors serve as Class III Directors,and each will serve for a term which was scheduled to expire at the 2004 AnnualMeeting of stockholders, or until their successors are duly elected andqualified or until their death, resignation or removal. The following tablesets forth certain information with respect to the directors and executiveofficers of the Company as of March 31, 2004.

 
| **Name**          |   | **Age** |   | **Office**                                            |
|-------------------|--------|---------|--------|-------------------------------------------------------|
| LI, Dongsheng     |   | 45      |   | Chairman of the Board and Class III Director          |
| YAN, Vincent Yong |   | 41      |   | President, Chief Executive Officer, Class II Director |
| LIU, James Jian   |   | 48      |   | Class III Director                                    |
| LIN, Zuoquan      |   | 40      |   | Class I Director                                      |
| LIN, Jih-Ming     |   | 52      |   | Class III Director                                    |

 

Mr. Dongsheng Li was elected as a Class III Director of theCompany on June 29, 2001. Mr. Li also has served as Chairman of the boardof directors of the Company’s subsidiary, Correlant, since February 2003.  Mr. Li has been Chairman of the boardof directors and President of TCL Corporation (formerly TCL HoldingsCo., Ltd.), a People’s Republic of China company (and TCL’s parentcompany), since 1996. Mr. Li is also the Chairman of the board ofdirectors of TCL International Holdings, Ltd. Mr. Li has 20 years of experience in the telecommunicationequipment and consumer electronics industry. Mr. Li holds a Bachelordegree in Engineering from South China University of Technology.

 

Mr. Vincent Yong Yan was elected as a Class II Director of the Companyon June 29, 2001. Mr. Yan has been the President, CEO and Secretary of theCompany since June 29, 2001. Mr. Yan was the CFO of the Company from June 29,2001 until November 2002.  Mr. Yan alsohas served as a Vice President, director and member of the Executive Committeeof the board of directors of Correlant since February 2003.  Mr. Yan has been Executive Director andChief Financial Officer of TCL International Holdings, Ltd., a publicly traded consumerelectronics and information technology company since 1999. Prior to joiningTCL, Mr. Yan served as PRC Country Manager of Tulip Computers (Asia) Ltd., asubsidiary of a European computer manufacturer. Mr. Yan has over ten years ofexperience in the computer and consumer goods industries. Mr. Yan holds an MBAfrom Stanford University and a Masters degree in Computer Science from PekingUniversity.

 

Mr. James Jian Liu was appointed as a Class III Director ofthe Company on August 6, 2001. Mr. Liu also has served as a director ofCorrelant since February 2003. Mr. Liu served as President of JBLInternational Inc., an apparel agent in New York, New York, fromJanuary 1996 to the present.  Heearned his BA degree from Nanjing University, China.

 

Professor Zuoquan Lin was appointed as a Class I Director on March 25,2002. Professor Lin also has served as a director of Correlant since February2003. He is currently the Dean of the Department of Information Science, aposition he has held since 1998, and is the Director of the Networking Researchand Development Center at Peking University, China, having held the positionsince 1999. His main areas of research include computer software, artificialintelligence, network economy and management information system. Professor Linalso is currently an independent consultant in enterprise strategy andinformation technology. From 1995 to 1997, he was the Director of the Instituteof Computer Sciences at Shantou University, China.  Professor Lin holds a Ph.D. in computer science from Bei Hang Univerityin Beijing, China.

 

Mr. Jih-Ming Lin was elected a Class III Director of theCompany on June 29, 2001. Mr. Lin has been Vice President of TechlabTech Inc., a Taiwanese semiconductor manufacturer, since 1998. From 1992to 1998, Mr. Lin served as Vice President of National Advantages Computer, Inc.,a computer products manufacturer. Mr. Lin has 16 years of experiencein the semiconductor industry. Mr. Lin is a graduate of Defense MedicalIndustry in Taiwan.

 

*(B) Lotus PacificExecutive Officers*

 
| **Name**          |   | **Age** |   | **Office**                                            |
|-------------------|--------|---------|--------|-------------------------------------------------------|
| YAN, Vincent Yong |   | 41      |   | President, Chief Executive Officer, Class II Director |
| DAVIS, Steve      |   | 35      |   | Chief Financial Officer                               |

 

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See discussion related to Mr. Yan above.

 

Mr. Davis was appointed as the Company’s Chief Financial Officer inMarch 2004 and will serve until his successor is appointed and approved.  Mr. Davis previously served as the Company’sController since October 2002.  Mr.Davis also has served as Vice President of Correlant since March 2003 and ChiefFinancial Officer of the Company’s subsidiary Opta Systems, LLC, dba GoVideo,since July 2003.  Prior to joining theCompany, Mr. Davis served as Controller and Chief Financial Officer for anumber of start-up or financially distressed companies including BuyGolf.com,iWear Corp and Aviation Distributors, Inc. from July 1998 until October2002.   Prior to this Mr. Davis was withErnst & Young LLP for eight years, from September 1990 to July 1998, mostrecently as Senior Manager.

 

None of the members of the Board of Directors or executive officers ofthe Company are related to one another.

 

(C)  *Section 16(a) Beneficial Ownership ReportingCompliance*

 

During fiscal 2002, the following directors had delayed filings of Form3: Li Dongsheng and Vincent Yan (10 days), and James Jian Liu (20 days). Thedelay was due to the fact that when the current management took over theCompany in June 2001, it needed time to contract a professional agent to do thefiling for the Company.

 

The following four directors did not tender their Form 4 when theirassociation with the Company was terminated: Robert Lo, Chris Ching, Chung-IChiang, and William Hu.

 

(D) *Codeof Ethics*

 

The Company has adopted a code of ethics that applies to all employees,executive officers and all members of our finance department, including theprincipal accounting officer.  TheCompany will provide a copy of our code of ethics to any person, free ofcharge, upon written request sent to our principal executive office.

 

(E)  *Audit Committee*

 

The Company has a separately designated standing Audit Committee of theCompany’s Board of Directors established in accordance withSection 3(a)(58)(A) of the Securities Exchange Act of 1934, as amended.Jian Liu and Zuoquan Lin are the members of our Audit Committee.  The Audit Committee shall represent theBoard of Directors in discharging its responsibility relating to theaccounting, reporting and financial practices of the Company and itssubsidiaries and shall have general responsibility for surveillance of thesystems of internal controls, which management and the Board of Directors haveestablished, the performance and selection of independent auditors, and ouraudit and financial reporting processes.

 

**Item 11.  ExecutiveCompensation**

 

The following table sets forth for the periods presented thecompensation for services in all capacities to the Company of the persons whowere the (i) the chief executive officer of the Company, and(ii) other executive officers of the Company who received over $100,000 incompensation during the fiscal year (collectively, the “Named Officers”).

 

**SummaryCompensation Table**

 
|                              |   | **Annual  Compensation** |   | **Long Term  Compensation** |    |      |   |
|-----------------------------------|--------|--------------------------|--------|-----------------------------|---------|-----------|--------|
| **Name and Principal  Position**  |   | **Year**                 |   | **Salary**                  |    | **Bonus** |   | **Other  Annual  Compensation** |   | **Restricted  Stock  Awards** |   | **Securities  Underlying Options** |   | **LTIP  Payouts** |   | **All Other  Compensation** |   |
| Vincent Y Yan (1)                 |   | 2002                     |   | $                           | 120,000 |      | — |   | — |   | — |   | — |   | — |   | — |   |
| President, Chief                  |   | 2001                     |   | 120,000                     |    | —    |   | — |   | — |   | — |   | — |   | — |   |
| Executive Officer                 |   | 2000                     |   | N/A                         |    | —    |   | — |   | — |   | — |   | — |   | — |   |
| CFO                               |   |                     |   |                        |    |      |   |   |   |   |   |   |   |   |   |   |   |
| William G. Hu (2)  |   | 2002                     |   | N/A                         |    | —    |   | — |   | — |   | — |   | — |   | — |   |
| CEO                               |   | 2001                     |   | $                           | 120,000 |      | — |   | — |   | — |   | — |   | — |   | — |   |
|                              |   | 2000                     |   | N/A                         |    | —    |   | — |   | — |   | — |   | — |   | — |   |
| Jeremy Wang (3)                   |   | 2002                     |   | N/A                         |    | —    |   | — |   | — |   | — |   | — |   | — |   |
| President                         |   | 2001                     |   | $                           | 160,000 |      | — |   | — |   | — |   | — |   | — |   | — |   |
|                              |   | 2000                     |   | 120,000                     |    | —    |   | — |   | — |   | — |   | — |   | — |   |
| David Li                          |   | 2002                     |   | N/A                         |    | —    |   | — |   | — |   | — |   | — |   | — |   |
| CFO                               |   | 2001                     |   | $                           | 120,000 |      | $      | 90,000 |   | — |   | — |   | — |   | — |   | — |   |
|                              |   | 2000                     |   | 66,607                      |    | —    |   | — |   | — |   | — |   | — |   | — |   |
| Hsing Chih Tuan    |   | 2002                     |   | $                           | 140,250 |      | $      | 4,000 |   | — |   | — |   | — |   | — |   | — |   |
| President - Correlant             |   | 2001                     |   | 165,000                     |    | 5,000     |   | — |   | — |   | — |   | — |   | — |   |
|                              |   | 2000                     |   | 114,045                     |    | —    |   | — |   | — |   | — |   | — |   | — |   |
| Max Lu(4)                         |   | 2002                     |   | Unknown                     |    | Unknown   |   |   |   | — |   | — |   | — |   | — |   |
| President - Arescom               |   | 2001                     |   | $                           | 168,000 |      | — |   | — |   | — |   | — |   | — |   | — |   |
|                              |   | 2000                     |   | $                           | 163,384 |      | — |   | — |   | — |   | — |   | — |   | — |   |
|                                   |        |                          |        |                             |         |           |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

32

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----

(1) Vincent Yan has an employment contract with the Company signed onJune 29, 2001. The contract was automatically extended for a year on June 30,2003.

 

(2) Reflects annual salary paid during the portion of fiscal 2001 whileemployed by the Company. Employment was terminated on June 29, 2001.

 

(3) Reflects annual salary paid during the portion of fiscal 2001 whileemployed by the Company.   Employmentwas terminated December, 2000.

 

(4)  Due to the sale of Arescom,this information is unavailable for fiscal 2002.

 

**Stock Options**

 

No current executive officer or director of the Company holds any stockoptions. No stock option grants were made during fiscal 2002. No stockappreciation rights were granted during fiscal 2002.

 

**Option Exercises andHoldings**

 

No current Executive Officer or director of the Company holds anyoption, and no options were exercised during fiscal 2002.

 

**Director Compensation**

 

For fiscal 2002, non-employee directors of the Company were each paid$1,000 for each regular meeting of the Board of Directors which they attendedand $800 for each special or committee meeting of the Board of Directors whichthey attended, plus, in each case, actual out-of-pocket expenses forattendance. Non-employee directors were eligible to receive an option topurchase 5,000 shares of the Company’s common stock for each fiscal year thatthey serve as Directors. For fiscal 2002, no directors received cash paymentsor stock options for their service on the Board of the Directors.

 

Directors who are also employees of the Company do not receive cashpayments or stock options for their service on the Board of the Directors.

 

**Employment Contracts,Termination of Employment, and Change in Control Agreements**

 

None of the other employees besides Mr. Yan has any employment orseverance agreement with the Company and their employment may be terminated atany time at the discretion of the Board of Directors.

 

On June 29, 2001, the Company entered into a one-year employmentagreement with Mr. Yan for the positions of President, Chief ExecutiveOfficer, Chief Financial Officer and Secretary of the Company. This agreementmay be extended for successive one-year periods by the Company andMr. Yan. For his services, Mr. Yan is paid an annual salary of$120,000 and an annual bonus to be determined in the discretion of the SpecialCommittee of the Board of Directors of the Company. A copy of the employmentcontract with Vincent Yan was attached in the Company’s Form 10-K filed onOctober 12, 2001.  During fiscal 2002,the employment agreement entered into between the Company and Vincent Yan, CEOand President of the Company, was extended for one year without any changes.

 

33

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**CompensationCommittee Interlocks and Insider Participation**

 

The compensation for executive officers of the Company is reviewed anddetermined on an annual basis by the Compensation Committee of the Company’sBoard; the Compensation Committee was approved by the Board in March 2004.  The members of the Compensation Committee,Jian Liu and Zuoquan Lin, are independent directors and are not employees ofthe Company.  Neither of them are orwere officers or employees of Lotus Pacific or any of its subsidiaries.

 

Before the Compensation Committee was created, compensation wasdetermined by three members of the Board of Directors, Jian Liu and Zuoquan Linwho are independent directors and are not employees of the Company, and LiDongsheng, Chairman of the Board.

 

**Stock PricePerformance Graph**

 

The line graph below compares the cumulative total shareholder returnon our Lotus Pacific common stock with the cumulative total return for theStandard & Poor’s SmallCap 600 Index, and an index of peer group companiesselected by us for the period from June 30, 1998 through June 30, 2002.  The graph assumes the value of the investmentin our Lotus Pacific common stock and each index was $100 at June 30,1998.  It also assumes that alldividends paid by those companies included in the indexes were reinvested.  No cash dividends have been declared on ourLotus Pacific common stock.

 

Comparison of 5 Year Cumulative Total Return*

Among Lotus Pacific, Inc, the Standard &Poor’s SmallCap 600 Index,

And a Peer Group

 

* $100 invested on June 30, 1998 in stock or index — includingreinvestment of dividends.  Fiscal yearending June 30.

 
|                 |   | **June 30,** |   |
|----------------------|--------|--------------|--------|
|                 |   | **1998**     |   | **1999** |   | **2000** |   | **2001** |   | **2002** |   |
| Lotus Pacific        |   | $            | 100.00 |   | $ | 103.70 |   | $ | 97.53 |   | $ | 9.38 |   | $ | 0.59 |   |
| S&P SmallCap 600 |   | 100.00       |   | 355.35 |   | 403.57 |   | 443.72 |   | 443.15 |   |
| Peer Group           |   | 100.00       |   | 80.30 |   | 151.12 |   | 13.01 |   | 2.97 |   |
|                      |        |              |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

34

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The peer group is composed of the publicly-traded common stock of twocompanies that sell cable modems and cable-modem related equipment.  We believe the peer group is representativeof the industry in which our most significant subsidiary, Correlant, operatedduring the years presented in this report. Stockholder returns over the indicated period should not be consideredindicative of future stockholder returns.

 

**Item 12.  Security Ownership of Certain Beneficial Owners and Management**

 

The following table sets forth information with respect to the numberof shares of Common Stock beneficially owned as of March 31, 2004 by(i) all persons who are beneficial owners of five percent or more of theCompany’s Common Stock, (ii) the Company’s executive officers named in theSummary Compensation Table above, (iii) each director and nominee fordirector of the Company, and (iv) all current executive officers anddirectors as a group as of March 31, 2004:

 
|                                                                                                                                                         |   | **Shares of  Stock  Beneficially  Owned (1)** |   | **Percentage  of  Class (1)** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------|--------|-------------------------------|--------|
| Lotus International Holdings Ltd.(2)   Suite 13 First Fl., Oliaji Trade Center   Francis Rachel Street   Victoria, Mahe Republic Of Seychelle |   | 12,000,000                                    |   | 35.3                          | %      |
| TCL Industries Holdings (HK) Ltd.(3)   13/F TCL Tower  8 Tai Chung Road  Tsuen Wan, Hong Kong                                                 |   | 9,606,671                                     |   | 17.4                          | %      |
| LI, Dongsheng                                                                                                                                                |   | —                                        |   | —                        |   |
| YAN, Vincent Yong                                                                                                                                            |   | —                                        |   | —                        |   |
| LIU, James Jiam                                                                                                                                              |   | —                                        |   | —                        |   |
| LIN, Zuoquan                                                                                                                                                 |   | —                                        |   | —                        |   |
| LIN, Jih-Ming                                                                                                                                                |   | —                                        |   | —                        |   |
| DAVIS, Steve                                                                                                                                                 |   | —                                        |   | —                        |   |
| All directors and executive officers as a  group (consisting of 6 persons)                                                                                   |   | —                                        |   | —                        |   |

 

----

(1) All information is as of February 29, 2004 and was determined inaccordance with Rule 13d-3 under the Securities Exchange Act of 1934, asamended, based solely upon information furnished by the persons listed or containedin filings made by them with the Securities and Exchange Commission.

(2) Lotus International Holdings Ltd. is controlled by TCLIndustries Holdings (HK) Ltd.

(3) TCL Industries Holdings (HK) Ltd. is an affiliate of TCLHoldings Group.

 

**Item 13.  Certain Relationships and Related Transactions**

 

To the knowledge of the Company, during fiscal 2002, Lotus Pacific hadno related party transactions of the kind described in Item 404 ofRegulation S-K.

 

Subsequent to fiscal 2002, Lotus Pacific entered into the followingtransactions required to be reported under Item 404 of Regulation S-K:

 

Effective January 30, 2003, Lotus Pacific and TCL, a Lotus Pacificstockholder with holdings of greater than 10% of Lotus Pacific’s outstandingshares, settled all disputes with prior independent accountants of the Companyconcerning their audits of the Company for fiscal 2001 and prior. The priorauditors deny that they are liable for any damages to Lotus Pacific, butconsented to the settlement to avoid the costs of litigation.  Pursuant to an agreement dated March 24,2003 between Lotus Pacific and TCL, Lotus Pacific and TCL agreed on theallocation of the settlement funds, whereby TCL Industries received $6,500,000in cash, Lotus Pacific received $3,500,000 in cash and Lotus Pacific will beentitled to receive up to an additional $3,500,000 in cash held in an escrowaccount, plus interest accrued therein.  In connection with the agreement,Lotus Pacific and TCL agreed

 

35

----

 

to forbear from bringing claims against each other with respect to theallocation of funds or otherwise.

 

On September 30, 2003, Lotus Pacific sold its entire equity interest inTCL Digital to TCL Information for a cash price of approximately $5,600,000 USdollars.   The Company invested$5,280,000 US dollars to acquire the sold equity in TCL Digital. TCLInformation is an affiliate of TCL, a stockholder of the Company.  Li Dongsheng and Vincent Yan, directors ofthe Company, are directors and officers of TCL International, a publicly tradedcompany on the Hong Kong Stock Exchange (HKSE: 1070.HK), an affiliate of TCL.

 

On February 17, 2003, the Lotus Pacific Board of Directors approved therepurchase of approximately 623,000 shares of Lotus Pacific common stock at$0.30 per share from Gordon Lum.  Mr.Lum was appointed as a Class II Director of the Company on August 6, 2001.  In connection with the stock repurchase, Mr.Lum resigned from the Board of Directors.

 

**Item 14 – PrincipalAccounting Fees and Services**

The following is a summary of the fees billed to us by Hein forprofessional services rendered from the date Hein was engaged.  Hein was engaged March 25, 2002 to audit theyear ended June 30, 2002 and July 24, 2002 for the reaudit of the years endedJune 30, 2001, 2000 and 1999.

 

| **Fee Category**   |   | **Six months  ended  December  31, 2003** |    | **Year ended  June 30,  2003** |   | **Year ended  June 30,  2002** |   |
|--------------------|--------|-------------------------------------------|---------|--------------------------------|--------|--------------------------------|--------|
| Audit fees         |   | $                                         | 133,000 |                           | $      | 476,000                        |   | $ | 21,000 |   |
| Audit-related fees |   | 7,000                                     |    | 15,000                         |   | 7,000                          |   |
| Tax fees           |   | 54,000                                    |    | 93,000                         |   | 1,000                          |   |
| All other fees     |   | —                                    |    | —                         |   | —                         |   |
|                    |        |                                           |         |                                |        |                                |        |  |  |  |

 

***Audit Fees***.Consists of fees billed for professional services rendered for the audit andrestatement of our consolidated financial statements and review of our interimconsolidated financial statements included in quarterly reports and servicesthat are normally provided by Hein in connection with statutory and regulatoryfilings or engagements.

 

***Audit-Related Fees.***Consists of fees billed for assurance and related services that are reasonablyrelated to the performance of the audit or review of our consolidated financialstatements and are not reported under “Audit fees.” These services includeemployee benefit plan audits, accounting consultations in connection withacquisitions, attest services that are not required by statute or regulation,and consultations concerning financial accounting and reporting standards.

 

***Tax Fees***.Consists of fees billed for professional services for tax compliance, taxadvice, and tax planning. These services include assistance regarding federal,state and international tax compliance, tax audit defense, mergers andacquisitions, and international tax planning.

 

***Policy Related toAudit Committee Pre-Approval of Audit and Permissible Non-Audit Services ofIndependent Auditors.***  Our Audit Committee’s has a policy of pre-approving all audit andpermissible non-audit services provided by the independent auditors. Theseservices may include audit services, audit-related services, tax services, andother services. Pre-approval is generally provided for up to one year and anypre-approval is detailed as to the particular service or category of servicesand is generally subject to a specific budget. The independent auditors andmanagement are required to periodically report to the Audit Committee regardingthe extent of services provided by the independent auditors in accordance withthis pre-approval, and the fees for the services performed to date. The AuditCommittee may also pre-approve particular services on a case-by-case basis.

 

36

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**PART IV**

**Item 15****.  Exhibits, FinancialStatement Schedules and Reports on Form 8-K**

** **
| (a)    | Documents filed as part of this report. |                                                                                                                                          |
|--------|-----------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------|
| **1.** | **Financial  Statements**               |                                                                                                                                          |
|   |                                    |                                                                                                                                          |   |   |
|   |                                    | (i)                                                                                                                                           | Report of Hein & Associates LLP,   Independent Auditors |   |
|   |                                    |                                                                                                                                          |   |   |
|   |                                    | (ii)                                                                                                                                          | Consolidated Balance Sheets. |   |
|   |                                    |                                                                                                                                          |   |   |
|   |                                    | (iii)                                                                                                                                         | Consolidated Statements of Operations. |   |
|   |                                    |                                                                                                                                          |   |   |
|   |                                    | (iv)                                                                                                                                          | Consolidated Statements of Stockholders’ Equity. |   |
|   |                                    |                                                                                                                                          |   |   |
|   |                                    | (v)                                                                                                                                           | Consolidated Statements of Cash Flows. |   |
|   |                                    |                                                                                                                                          |   |   |
|   |                                    | (vi)                                                                                                                                          | Notes to Consolidated Financial Statements. |   |
|   |                                    |                                                                                                                                          |   |   |
|   | **2.**                                  | **Financial Statement  Schedules**                                                                                                            |   |
|   |                                    |                                                                                                                                          |   |
|   |                                    | All schedules are omitted because they are not applicable or the  required information is shown in the financial statements or related notes. |   |
|   |                                    |                                                                                                                                          |   |   |
|   | **3.**                                  | **Exhibits**                                                                                                                                  |   |

 
| **Exhibit  Number** |   | **Description  of Exhibit**                                                                                                            |   | **Method of  Filing**                                                                          |
|---------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------|
| 3.1                 |   | Certificate of Amendment of Certificate of Incorporation dated as  May 25, 1999                                                   |   | Incorporated by reference to Exhibit 3.1 to Form 10/A, filed June 17,  1999                    |
| 3.2                 |   | Certificate of Amendment of Certificate of Incorporation dated as  June 15, 1998                                                       |   | Incorporated by reference to Exhibit 3.1 to Form 10, filed October  27, 1998                   |
| 3.3                 |   | Certificate of Incorporation, as amended                                                                                               |   | Incorporated by reference to Exhibit 3.2 to Form 10, filed October  27, 1998                   |
| 3.4                 |   | Amended and Restated Bylaws                                                                                                            |   | Incorporated by reference to Exhibit 3.3 to Form 10-K, filed  October 13, 2000            |
| 3.5                 |   | Amendment to Bylaws                                                                                                                    |   | Incorporated by reference to Exhibit 99.1 to Form 8K, filed  July 2, 2001       |
| 10.1                |   | 2000 Equity Incentive Plan                                                                                                             |   | Incorporated by reference to Exhibit A to Proxy Statement on Schedule  14A filed April 4, 2000 |
| 10.2                |   | Agreement dated September 30, 2000, between the registrant and  TurboNet Communications (now Correlant Communications, Inc.) |   | Incorporated by reference to Exhibit 10.10 to Form 10-K, filed October  13, 2000               |
| 10.3                |   | Lotus Pacific Inc., Executive Employment Agreement                                                                                     |   | Incorporated by reference to Exhibit 10.11 to Form 10-K, filed  October 15, 2001               |
| 10.4                |   | Opta Systems, LLC dba GoVideo Executive Employment Agreement                                                                           |   | Filed herewith                                                                                 |
| 10.5                |   | Exchange Agreement between Registrant and ARESCOM Inc. dated December  11, 2001                                                        |   | Filed herewith                                                                                 |
| 10.6                |   | Stock Purchase Agreement between Registrant and Solomon Extreme  International Ltd. dated December 11, 2001                            |   | Filed herewith                                                                                 |
| 10.7                |   | Acquisition Agreement of TCL Digital dated January 18, 2003                                                                            |   | Filed herewith                                                                                 |
| 10.8                |   | Opta LLC Interest Purchase Agreement between Registrant and Carmco                                                                     |   | Filed herewith                                                                                 |

 

37

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|   |   | Investment, LLC, dated April 17, 2003                                                                                                   |   |                                                                         |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------|
| 10.9   |   | Sale agreement of TCL Digital dated December 20,2003                                                                                    |   | Filed herewith                                                               |
| 10.10  |   | Current Lease – GoVideo Office Lease                                                                                               |   | Filed herewith                                                               |
| 10.11  |   | Current Lease – Go Video Lease for Commercial Space                                                                                |   | Filed herewith                                                               |
| 16.1   |   | Letter re Change in Certifying Accountant                                                                                               |   | Incorporated by reference to Exhibit 16.1 to Form 8-K, filed April  12, 2002 |
| 16.2   |   | Letter re Change in Certifying Accountant                                                                                               |   | Incorporated by reference to Exhibit 16.2 to Form 8-K, filed June 4,  2002   |
| 21     |   | List of Subsidiaries                                                                                                                    |   | Filed herewith                                                               |
| 31.1   |   | Certification of Principal Executive Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                            |   | Filed herewith                                                               |
| 31.2   |   | Certification of Principal Financial Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                            |   | Filed herewith                                                               |
| 32.1   |   | Certification of Chief Executive Officer Pursuant to  Section 1350 Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002 |   | Filed herewith                                                               |
| 32.2   |   | Certification of Chief Financial Officer Pursuant to  Section 1350 Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002 |   | Filed herewith                                                               |

 

(b)  Reports on Form 8-K.

 

During the fourth quarter ended June 30, 2002, the registrantfiled the following reports on Form 8-K:

 

•Form 8-K/A Amendment No. 2 as filed April 12, 2002, regarding changes inRegistrant’s independent accountants.

 

•Form 8-K as filed April 24, 2002, regarding changes in the independentaccountants for Correlant.

 

38

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**Signatures**

 

Pursuant to the requirements of Section 13 and 15(d) of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.

 
| **Signature**             |   | **Title** |                                                   | **Date** |
|---------------------------|--------|-----------|--------------------------------------------------------|----------|
|                      |   |      |                                                   |     |
| */s/**YAN,  Vincent Yong* |   |      | President, Chief Executive Officer, Director           |     | April 15, 2004 |
| YAN, Vincent Yong         |   |      |                                                   |     |
|                      |   |      |                                                   |     |
| */s/**DAVIS,  Steve*      |   |      | Chief Financial Officer (Principal Accounting Officer) |     | April 15, 2004 |
| DAVIS, Steve              |   |      |                                                   |     |

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons in the capacities andon the dates indicated.

 
| **Signature**             |   | **Title** |                                         | **Date** |
|---------------------------|--------|-----------|----------------------------------------------|----------|
|                      |   |      |                                         |     |
| */s/**LI,  Dongsheng*     |   |      | Chairman of the Board                        |     | April 15, 2004 |
| LI Dongsheng.             |   |      |                                         |     |
|                      |   |      |                                         |     |
| */s/**YAN,  Vincent Yong* |   |      | President, Chief Executive Officer, Director |     | April 15, 2004 |
| YAN, Vincent Yong.        |   |      |                                         |     |
|                      |   |      |                                         |     |
| */s/**LIU,  Jian*         |   |      | Director                                     |     | April 15, 2004 |
| LIU, Jian                 |   |      |                                         |     |
|                      |   |      |                                         |     |
| */s/**LIN,  Zouquan*      |   |      | Director                                     |     | April 15, 2004 |
| LIN, Zouquan              |   |      |                                         |     |

 

39

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**Item 8.    RESTATED FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

 

*The restated consolidated financial statements and supplementary data,including the notes to the restated consolidated financial statements, setforth in this Item 8 have been revised to reflect the reaudit of the yearsended June 30, 2001, 2000 and 1999, which occurred subsequent to thefiling of the Company’s Form 10-K for the year ended June 30,2001.  See further discussion and detailsat Note 2 – Restatement of Previously Issued Financial Statements and Delays inReporting.*

 

Index to Consolidated Financial Statements

 
|   | Financial Statements:                                                                                              |   |
|--------|--------------------------------------------------------------------------------------------------------------------|--------|
|   |                                                                                                               |
|   | Report of Independent Auditors.                                                                                    |   |
|   |                                                                                                               |   |
|   | Consolidated Balance Sheets as of June 30, 2002, 2001, 2000 and  1999.                                        |   |
|   |                                                                                                               |   |
|   | Consolidated Statements of Operations for  the years ended June 30, 2002, 2001, 2000 and 1999.                |   |
|   |                                                                                                               |   |
|   | Consolidated Statements of Stockholders’  Equity for the years ended June 30, 2002, 2001, 2000 and 1999. |   |
|   |                                                                                                               |   |
|   | Consolidated Statements of Cash Flows for the  years ended June 30, 2002, 2001, 2000 and 1999.                |   |
|   |                                                                                                               |   |
|   | Notes to Consolidated Financial Statements                                                                         |   |
|        |                                                                                                                    |        |  |

 
|   | Financial Statement Schedules: |
|--------|--------------------------------|

 

All schedules are omitted because they are not required or the requiredinformation is included in the consolidated financial statements or notesthereto.

 

----

 

**REPORT OF INDEPENDENT AUDITORS**

 

 

To the Board of Directors and Stockholders of

Lotus Pacific, Inc.

 

We have audited the accompanying consolidated balance sheets of LotusPacific, Inc. and subsidiaries as of June 30, 2002, 2001, 2000 and 1999,and the related consolidated statements of operations, stockholders’ equity,and cash flows for the years then ended. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these consolidated financial statements based on our audits.

 

Except as explained in the following paragraph, we conducted our auditsin accordance with auditing standards generally accepted in the United Statesof America.  Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

 

We were unable to audit the financial information of one of theCompany’s significant subsidiaries that is consolidated in the June 30,2001, 2000, and 1999 financial statements as discontinued operations becausethe subsidiary would not provide the necessary information to allow us tocomplete the audits.  Due to thesubsidiary’s lack of cooperation, we were unable to satisfy ourselves about thesubsidiary’s account balances by means of other auditing procedures.

 

Because of the matter discussed in the preceding paragraph, the scopeof our work was not sufficient to enable us to express, and we do not express,an opinion on the consolidated financial statements for the years June 30,2001, 2000, and 1999.

 

As discussed in Note 2 to the consolidated financial statements, theaccompanying consolidated balance sheet as of June 30, 2001, 2000, and1999 and the related consolidated statements of operations, cash flows, andstockholders’ equity for the years then ended have been restated.

 

In our opinion, the June 30, 2002 consolidated financialstatements present fairly, in all material respects, the financial position ofLotus Pacific, Inc. and subsidiaries as of June 30, 2002, and the resultsof its operations and cash flows for the year then ended, in conformity withaccounting principles generally accepted in the United States of America.

 

 
| /s/ HEIN & ASSOCIATES LLP |   |
|-------------------------------|--------|
| Orange County, California     |
|                          |
| November 20, 2003        |

 

----

 

**LOTUS PACIFIC, INC.**

**CONSOLIDATED BALANCE SHEETS**

(in thousands)

 
|                                                                                                                                                                                       |   | **June 30** |       |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------|------------|
|                                                                                                                                                                                       |   | **2002**         |       | **2001** |   | **2000** |   | **1999** |   |
|                                                                                                                                                                                       |   |             |       | **(Restated)** |   | **(Restated)** |   | **(Restated)** |   |
|                                                                                                                                                                                       |   |             |       |   |   |   |   |   |   |
| **ASSETS**                                                                                                                                                                                 |   |             |       |   |   |   |   |   |   |
|                                                                                                                                                                                       |   |             |       |   |   |   |   |   |   |
| Current  assets:                                                                                                                                                                           |   |             |       |   |   |   |   |   |   |
| Cash and cash  equivalents                                                                                                                                                                 |   | **$**            | **32,647** | ** ** | $ | 22,220 |   | $ | 23,224 |   | $ | 24,697 |   |
| Short-term  investments                                                                                                                                                                    |   | **4,977**        | ** ** | 4,237 |   | — |   | — |   |
| Accounts  receivable, net                                                                                                                                                                  |   | **281**          | ** ** | 5,504 |   | 9,016 |   | — |   |
| Accounts  receivable, related parties                                                                                                                                                      |   | **7,075**        | ** ** | 14,822 |   | 5,654 |   | 2,569 |   |
| Inventories,  net                                                                                                                                                                          |   | **—**       | ** ** | 6,482 |   | 636 |   | 131 |   |
| Due from  related parties                                                                                                                                                                  |   | **—**       | ** ** | — |   | 2,981 |   | 24,253 |   |
| Notes and  interest receivable from related parties, net                                                                                                                                   |   | **3,522**        | ** ** | 3,300 |   | 10,560 |   | — |   |
| Notes  receivable                                                                                                                                                                          |   | **—**       | ** ** | 2,784 |   | — |   | — |   |
| Income tax  receivable                                                                                                                                                                     |   | **3,201**        | ** ** | 1,682 |   | — |   | — |   |
| Deferred  income tax asset                                                                                                                                                                 |   | **—**       | ** ** | 1,997 |   | — |   | — |   |
| Prepaid  expenses and other current assets                                                                                                                                                 |   | **265**          | ** ** | 149 |   | 1,181 |   | 151 |   |
| Current assets  of discontinued operations                                                                                                                                                 |   | **—**       | ** ** | 19,417 |   | 20,449 |   | 267 |   |
| Total current  assets                                                                                                                                                                      |   | **51,968**       | ** ** | 82,594 |   | 73,701 |   | 52,068 |   |
|                                                                                                                                                                                       |   |             | ** ** |   |   |   |   |   |   |
| Restricted  cash                                                                                                                                                                           |   | **—**       | ** ** | 5,500 |   | 300 |   | 90 |   |
| Property and  equipment, net                                                                                                                                                               |   | **1,323**        | ** ** | 2,151 |   | 1,628 |   | 698 |   |
| Goodwill                                                                                                                                                                                   |   | **—**       | ** ** | 46,386 |   | 65,493 |   | 96,781 |   |
| Investment in affiliated  entity, at cost plus equity  in undistributed earnings                                                                                                           |   | **—**       | ** ** | — |   | — |   | 9,232 |   |
| Investment in  related party, at cost                                                                                                                                                      |   | **—**       | ** ** | — |   | 686 |   | — |   |
| Other assets                                                                                                                                                                               |   | **51**           | ** ** | — |   | 378 |   | 22 |   |
| Non-current  assets of discontinued operations                                                                                                                                             |   | **—**       | ** ** | 1,614 |   | 1,156 |   | 567 |   |
|                                                                                                                                                                                       |   | **$**            | **53,342** |   | $ | 138,245 |   | $ | 143,342 |   | $ | 159,458 |   |
|                                                                                                                                                                                       |   |             | ** ** |   |   |   |   |   |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                              |   |             | ** ** |   |   |   |   |   |   |
|                                                                                                                                                                                       |   |             | ** ** |   |   |   |   |   |   |
| Current  liabilities:                                                                                                                                                                      |   |             | ** ** |   |   |   |   |   |   |
| Accounts  payable to related parties                                                                                                                                                       |   | **$**            | **247**    | ** ** | $ | 26,072 |   | $ | 17,984 |   | $ | 3,744 |   |
| Accounts  payable and accrued expenses                                                                                                                                                     |   | **4,759**        | ** ** | 5,462 |   | 1,583 |   | 814 |   |
| Due to related  parties                                                                                                                                                                    |   | **—**       | ** ** | — |   | — |   | 21,795 |   |
| Notes payable                                                                                                                                                                              |   | **—**       | ** ** | — |   | — |   | 22,906 |   |
| Income tax  payable                                                                                                                                                                        |   | **—**       | ** ** | 366 |   | 12,871 |   | 21 |   |
| Current  liabilities of discontinued operations                                                                                                                                            |   | **—**       | ** ** | 26,247 |   | 18,475 |   | 950 |   |
| Total current  liabilities                                                                                                                                                                 |   | **5,006**        | ** ** | 58,147 |   | 50,913 |   | 50,230 |   |
|                                                                                                                                                                                       |   |             | ** ** |   |   |   |   |   |   |
| Commitments  and contingencies (Note 16)                                                                                                                                                   |   |             | ** ** |   |   |   |   |   |   |
|                                                                                                                                                                                       |   |             | ** ** |   |   |   |   |   |   |
| Non-controlling  interest in subsidiaries                                                                                                                                                  |   | **11,776**       | ** ** | 25,770 |   | 8,699 |   | 14,427 |   |
|                                                                                                                                                                                       |   |             | ** ** |   |   |   |   |   |   |
| Stockholders’  equity:                                                                                                                                                                |   |             | ** ** |   |   |   |   |   |   |
| Preferred  stock Series A, $.001 par value:  100  shares authorized, 4 shares issued and outstanding at June 30, 2002,  2001, 2000 and 1999; $10 per share liquestion preference |   | **—**       | ** ** | — |   | — |   | — |   |
| Common stock,  $.001 par value:  100,000 shares  authorized, 64,233, 64,233, 64,231, and 61,759 shares issued and outstanding  at June 30, 2002, 2001, 2000 and 1999             |   | **64**           | ** ** | 64 |   | 64 |   | 62 |   |
| Additional  paid-in capital                                                                                                                                                                |   | **137,816**      | ** ** | 136,529 |   | 129,525 |   | 116,502 |   |
| Stock warrants                                                                                                                                                                             |   | **—**       | ** ** | 80 |   | 80 |   | 80 |   |
| Less: treasury  stock at cost, 733 shares at June 30, 2002, 2001 and 2000                                                                                                             |   | **(9,797**       | **)**      | (9,797 | ) | (9,797 | ) | — |   |
| Accumulated  deficit                                                                                                                                                                       |   | **(91,523**      | **)**      | (72,548 | ) | (36,142 | ) | (21,843 | ) |
| Total  stockholders’ equity                                                                                                                                                           |   | **36,560**       | ** ** | 54,328 |   | 83,730 |   | 94,801 |   |
|                                                                                                                                                                                       |   | **$**            | **53,342** |   | $ | 138,245 |   | $ | 143,342 |   | $ | 159,458 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

F-3

----

 

**LOTUS PACIFIC, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

(in thousands, except per share amounts)

 
|                                                                                                                          |   | **Year Ended  June 30,** |        |
|-------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------|-------------|
|                                                                                                                          |   | **2002**                      |        | **2001** |   | **2000** |   | **1999** |   |
|                                                                                                                          |   |                          |        | **(Restated)** |   | **(Restated)** |   | **(Restated)** |   |
| Revenues:                                                                                                                     |   |                          |        |   |   |   |   |   |   |
| Products                                                                                                                      |   | **$**                         | **5,090**   | ** ** | $ | 78,121 |   | $ | 20,474 |   | $ | — |   |
| Products – related party                                                                                                 |   | **50,416**                    | ** **  | 183,845 |   | 51,365 |   | 3,733 |   |
| Other – related party                                                                                                    |   | **374**                       | ** **  | 1,226 |   | — |   | — |   |
| Total revenues                                                                                                                |   | **55,880**                    | ** **  | 263,192 |   | 71,839 |   | 3,733 |   |
|                                                                                                                          |   |                          | ** **  |   |   |   |   |   |   |
| Cost of  revenues:                                                                                                            |   |                          | ** **  |   |   |   |   |   |   |
| Products                                                                                                                      |   | **5,395**                     | ** **  | 62,695 |   | 15,474 |   | — |   |
| Products – related party                                                                                                 |   | **44,546**                    | ** **  | 164,013 |   | 41,758 |   | 3,270 |   |
| Write down of inventory to lower of cost or  market                                                                           |   | **—**                    | ** **  | 3,893 |   | — |   | — |   |
| Total cost of  revenues                                                                                                       |   | **49,941**                    | ** **  | 230,601 |   | 57,232 |   | 3,270 |   |
|                                                                                                                          |   |                          | ** **  |   |   |   |   |   |   |
| Gross profit                                                                                                                  |   | **5,939**                     | ** **  | 32,591 |   | 14,607 |   | 463 |   |
|                                                                                                                          |   |                          | ** **  |   |   |   |   |   |   |
| Operating expenses:                                                                                                           |   |                          | ** **  |   |   |   |   |   |   |
| Selling, general and administrative  (includes amounts to related parties of   $46, $3, $9,260 and $1,143, respectively) |   | **4,700**                     | ** **  | 13,151 |   | 16,132 |   | 3,835 |   |
| Depreciation and amortization                                                                                                 |   | **12,782**                    | ** **  | 12,460 |   | 14,763 |   | 3,796 |   |
| Research and development                                                                                                      |   | **9,977**                     | ** **  | 16,695 |   | 7,479 |   | 711 |   |
| Impairment of assets                                                                                                          |   | **20,071**                    | ** **  | — |   | 3,486 |   | — |   |
| Total operating expenses                                                                                                      |   | **47,530**                    | ** **  | 42,306 |   | 41,860 |   | 8,342 |   |
|                                                                                                                          |   |                          | ** **  |   |   |   |   |   |   |
| Loss from operations                                                                                                          |   | **(41,591**                   | **)**       | (9,715 | ) | (27,253 | ) | (7,879 | ) |
|                                                                                                                          |   |                          | ** **  |   |   |   |   |   |   |
| Other income (expense):                                                                                                       |   |                          | ** **  |   |   |   |   |   |   |
| Gain on sale of investments                                                                                                   |   | **—**                    | ** **  | 3,560 |   | 50,512 |   | — |   |
| Loss on sale of interest in joint venture                                                                                     |   | **—**                    | ** **  | — |   | (4,254 | ) | — |   |
| Interest income                                                                                                               |   | **851**                       | ** **  | 920 |   | 561 |   | 56 |   |
| Interest expense                                                                                                              |   | **(65**                       | **)**       | (24 | ) | (644 | ) | (60 | ) |
| Equity in earnings of affiliated entity                                                                                       |   | **—**                    | ** **  | — |   | 177 |   | 1,075 |   |
| Other                                                                                                                         |   | **(148**                      | **)**       | (7,393 | ) | 72 |   | 13 |   |
| Total other income (expense), net                                                                                             |   | **638**                       | ** **  | (2,937 | ) | 46,424 |   | 1,084 |   |
| Income (loss) from continuing operations  before income taxes and non-controlling interest                                    |   | **(40,953**                   | **)**       | (12,652 | ) | 19,171 |   | (6,795 | ) |
| Provision (benefit) for income taxes                                                                                          |   | **(3,181**                    | **)**       | (6,434 | ) | 21,099 |   | 9 |   |
| Loss from continuing operations before  non-controlling interest                                                              |   | **(37,772**                   | **)**       | (6,218 | ) | (1,928 | ) | (6,804 | ) |
|                                                                                                                          |   |                          | ** **  |   |   |   |   |   |   |
| Non-controlling interest in income (loss)  of consolidated subsidiaries                                                       |   | **1,243**                     | ** **  | (1,215 | ) | (321 | ) | 198 |   |
|                                                                                                                          |   |                          | ** **  |   |   |   |   |   |   |
| Loss from continuing operations                                                                                               |   | **(36,529**                   | **)**       | (7,433 | ) | (2,249 | ) | (6,606 | ) |
|                                                                                                                          |   |                          | ** **  |   |   |   |   |   |   |
| Discontinued operations, net of tax:                                                                                          |   |                          | ** **  |   |   |   |   |   |   |
| Gain on sale of discontinued operations,  including applicable tax benefit of ($1,802)                                        |   | **16,765**                    | ** **  | — |   | — |   | — |   |
| Gain (loss) on discontinued operations,  less applicable tax                                                                  |   | **789**                       | ** **  | (28,973 | ) | (12,050 | ) | (2,769 | ) |
| Total gain (loss) from discontinued  operations, net of tax                                                                   |   | **17,554**                    | ** **  | (28,973 | ) | (12,050 | ) | (2,769 | ) |
|                                                                                                                          |   |                          | ** **  |   |   |   |   |   |   |
| Net loss                                                                                                                      |   | **$**                         | **(18,975** | **)** | $ | (36,406 | ) | $ | (14,299 | ) | $ | (9,375 | ) |
|                                                                                                                          |   |                          | ** **  |   |   |   |   |   |   |
| Net loss per common share – basic and  diluted:                                                                          |   |                          | ** **  |   |   |   |   |   |   |
| Loss from continuing operations                                                                                               |   | **$**                         | **(0.57**   | **)** | $ | (0.12 | ) | $ | (0.04 | ) | $ | (0.13 | ) |
| Gain (loss) on discontinued operations                                                                                        |   | **0.27**                      | ** **  | (0.45 | ) | (0.19 | ) | (0.05 | ) |
| Net loss                                                                                                                      |   | **$**                         | **(0.30**   | **)** | $ | (0.57 | ) | $ | (0.23 | ) | $ | (0.18 | ) |
|                                                                                                                          |   |                          | ** **  |   |   |   |   |   |   |
| Weighted average common shares outstanding  – basic and diluted                                                          |   | **64,233**                    | ** **  | 64,232 |   | 62,469 |   | 51,657 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

F-4

----

 

**LOTUS PACIFIC, INC.**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’EQUITY**

(in thousands)

 
|                                                                                          |   | **Preferred Stock** |       | **Common Stock** |       | **Additional  Paid-in  Capital** |   | **Stock  Warrants** |   | **Treasury  Stock** |   | **Earnings  Accumulated  Deficit** |    | **Total  Stockholders’  Equity *** |   |
|-----------------------------------------------------------------------------------------------|--------|---------------------|------------|------------------|------------|----------------------------------|--------|---------------------|--------|---------------------|--------|------------------------------------|---------|-----------------------------------------|--------|
| **Shares**                                                                                    |   | **Amount**          | **Shares** |             | **Amount** |
| Balances at June 30, 1998, as previously  reported                                       |   | 4                   |       | $                | —     |                             | 47,386 |                | $      | 48                  |   | $                                  | 38,708  |                                    | $      | 80 |   | $ | — |   | $ | (2,961 | ) | $ | 35,875 |   |
| Prior period adjustment                                                                       |   | —              |       | —           |       | —                           |   | —              |   | (29,031             | )      | —                             |    | —                                  |   | (7,756 | ) | (36,787 | ) |
| Balances at June 30, 1998, as adjusted                                                   |   | 4                   |       | —           |       | 47,386                           |   | 48                  |   | 9,677               |   | 80                                 |    | —                                  |   | (10,717 | ) | (912 | ) |
| Issuance of Common Stock in a private placement                                               |   | —              |       | —           |       | 408                              |   | —              |   | 2,164               |   | —                             |    | —                                  |   | — |   | 2,164 |   |
| Issuance of Common Stock for purchase of  subsidiaries                                        |   | —              |       | —           |       | 15,043                           |   | 15                  |   | 108,155             |   | —                             |    | —                                  |   | — |   | 108,170 |   |
| Reduction in Common Stock outstanding for shares  held by majority owned company              |   | —              |       | —           |       | (1,078                           | )      | (1                  | )      | (3,494              | )      | —                             |    | —                                  |   | — |   | (3,495 | ) |
| Distribution to entity under common control                                                   |   | —              |       | —           |       | —                           |   | —              |   | —              |   | —                             |    | —                                  |   | (1,751 | ) | (1,751 | ) |
| Net loss                                                                                      |   | —              |       | —           |       | —                           |   | —              |   | —              |   | —                             |    | —                                  |   | (9,375 | ) | (9,375 | ) |
| Balances at June 30, 1999                                                                |   | 4                   |       | —           |       | 61,759                           |   | 62                  |   | 116,502             |   | 80                                 |    | —                                  |   | (21,843 | ) | 94,801 |   |
| Issuance of common stock in exchange for  subsidiary preferred stock                          |   | —              |       | —           |       | 2,250                            |   | 2                   |   | 5,998               |   | —                             |    | —                                  |   | — |   | 6,000 |   |
| Issuance of Common Stock upon conversion of subsidiary  stock                                 |   | —              |       | —           |       | 77                               |   | —              |   | 554                 |   | —                             |    | —                                  |   | — |   | 554 |   |
| Issuance of stock by subsidiary                                                               |   | —              |       | —           |       | —                           |   | —              |   | 1,185               |   | —                             |    | —                                  |   | — |   | 1,185 |   |
| Compensation expense recognized by subsidiaries  upon issuance of options and warrants        |   | —              |       | —           |       | —                           |   | —              |   | 1,792               |   | —                             |    | —                                  |   | — |   | 1,792 |   |
| Repurchase of common stock from subsidiary                                                    |   | —              |       | —           |       | (733                             | )      | (1                  | )      | —              |   | —                             |    | (9,797                                  | )      | — |   | (9,798 | ) |
| Increase in common stock outstanding for shares  held by majority owned company that was sold |   | —              |       | —           |       | 878                              |   | 1                   |   | 3,494               |   | —                             |    | —                                  |   | — |   | 3,495 |   |
| Net loss                                                                                      |   | —              |       | —           |       | —                           |   | —              |   | —              |   | —                             |    | —                                  |   | (14,299 | ) | (14,299 | ) |
| Balance at June 30, 2000                                                                 |   | 4                   |       | —           |       | 64,231                           |   | 64                  |   | 129,525             |   | 80                                 |    | (9,797                                  | )      | (36,142 | ) | 83,730 |   |
| Issuance of Common Stock upon conversion of  subsidiary stock                                 |   | —              |       | —           |       | 2                                |   | —              |   | 18                  |   | —                             |    | —                                  |   | — |   | 18 |   |
| Issuance of stock by subsidiary                                                               |   | —              |       | —           |       | —                           |   | —              |   | 41                  |   | —                             |    | —                                  |   | — |   | 41 |   |
| Compensation expense recognized by subsidiaries  upon issuance of options and warrants        |   | —              |       | —           |       | —                           |   | —              |   | 6,945               |   | —                             |    | —                                  |   | — |   | 6,945 |   |
| Net loss                                                                                      |   | —              |       | —           |       | —                           |   | —              |   | —              |   | —                             |    | —                                  |   | (36,406 | ) | (36,406 | ) |
| Balance at June 30, 2001                                                                 |   | 4                   |       | —           |       | 64,233                           |   | 64                  |   | 136,529             |   | 80                                 |    | (9,797                                  | )      | (72,548 | ) | 54,328 |   |
| Issuance of stock by subsidiary                                                               |   | —              |       | —           |       | —                           |   | —              |   | 4                   |   | —                             |    | —                                  |   | — |   | 4 |   |
| Compensation expense recognized by subsidiaries  upon issuance of options and warrants        |   | —              |       | —           |       | —                           |   | —              |   | 1,203               |   | —                             |    | —                                  |   | — |   | 1,203 |   |
| Expiration of stock warrants                                                                  |   | —              |       | —           |       | —                           |   | —              |   | 80                  |   | (80                                | )       | —                                  |   | — |   | — |   |
| Net loss                                                                                      |   | —              |       | —           |       | —                           |   | —              |   | —              |   | —                             |    | —                                  |   | (18,975 | ) | (18,975 | ) |
| Balance at June 30, 2002                                                                 |   | 4                   |       | $                | —     |                             | 64,233 |                | $      | 64                  |   | $                                  | 137,816 |                                    | $      | — |   | $ | (9,797 | ) | $ | (91,523 | ) | $ | 36,560 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

F-5

----

 

**LOTUS PACIFIC, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(in thousands)

 
|                                                                    |   | **Year Ended  June 30,** |        |
|-------------------------------------------------------------------------|--------|-------------------------------|-------------|
|                                                                    |   | **2002**                      |        | **2001** |   | **2000** |   | **1999** |   |
|                                                                    |   |                          |        | **(Restated)** |   | **(Restated)** |   | **(Restated)** |   |
| **Operating activities**                                                |   |                          |        |   |   |   |   |   |   |
| Loss from continuing operations                                         |   | **$**                         | **(36,529** | **)** | $ | (7,433 | ) | $ | (2,249 | ) | $ | (6,606 | ) |
| Income (loss) from discontinued operations                              |   | **17,554**                    | ** **  | (28,973 | ) | (12,050 | ) | (2,769 | ) |
| Adjustments to reconcile net loss to cash  used in operating activities |   |                          | ** **  |   |   |   |   |   |   |
| Depreciation and amortization-continuing  operations                    |   | **12,782**                    | ** **  | 12,460 |   | 14,763 |   | 3,796 |   |
| Depreciation and amortization-discontinued  operations                  |   | **2,702**                     | ** **  | 5,404 |   | 5,466 |   | 1,367 |   |
| Reserve for uncollectible receivables                                   |   | **44**                        | ** **  | 4,477 |   | 1,355 |   | — |   |
| Reserve for obsolete and excess inventories                             |   | **—**                    | ** **  | 3,893 |   | — |   | — |   |
| Stock  compensation recorded by subsidiary-continuing operations        |   | **1,657**                     | ** **  | 9,189 |   | 2,027 |   | — |   |
| Stock compensation recorded by  subsidiary-discontinued operations      |   | **—**                    | ** **  | 47 |   | — |   | — |   |
| Loss (gain) on sale of property and  equipment                          |   | **—**                    | ** **  | (10 | ) | 19 |   | — |   |
| Gain on sale of investments                                             |   | **(14,963**                   | **)**       | (3,560 | ) | (50,512 | ) | — |   |
| Loss on sale of joint venture                                           |   | **—**                    | ** **  | — |   | 4,254 |   | — |   |
| Equity in earnings of affiliated entity                                 |   | **—**                    | ** **  | — |   | (177 | ) | (1,075 | ) |
| Impairment of assets                                                    |   | **20,071**                    | ** **  | — |   | 3,486 |   | — |   |
| Non-controlling interest in income (loss)  of subsidiaries              |   | **(1,243**                    | **)**       | 1,215 |   | 321 |   | (198 | ) |
| Change in deferred tax assets                                           |   | **1,997**                     | ** **  | (1,997 | ) | — |   | — |   |
| Changes in operating assets and  liabilities:                           |   |                          | ** **  |   |   |   |   |   |   |
| Accounts receivable,                                                    |   | **5,180**                     | ** **  | 727 |   | (9,016 | ) | — |   |
| Accounts receivable, related parties                                    |   | **7,747**                     | ** **  | (9,169 | ) | (3,084 | ) | (2,130 | ) |
| Inventories                                                             |   | **6,483**                     | ** **  | (9,739 | ) | (506 | ) | (49 | ) |
| Notes and interest receivable from related  parties                     |   | **—**                    | ** **  | (79 | ) | (55 | ) |   |   |
| Notes receivable                                                        |   | **2,784**                     | ** **  | — |   | — |   | — |   |
| Income tax receivable                                                   |   | **(1,520**                    | **)**       | (1,681 | ) | — |   | — |   |
| Prepaid expenses and other assets                                       |   | **(117**                      | **)**       | 1,032 |   | (1,029 | ) | (132 | ) |
| Assets of discontinued operations                                       |   | **3,307**                     | ** **  | 574 |   | (20,772 | ) | 2,699 |   |
| Other non current assets                                                |   | **(51**                       | **)**       | 367 |   | (356 | ) | — |   |
| Accounts payable to related parties                                     |   | **(25,825**                   | **)**       | 8,089 |   | 14,240 |   | 3,351 |   |
| Accounts payable and accrued expenses                                   |   | **(702**                      | **)**       | 3,882 |   | 768 |   | 85 |   |
| Income tax payable                                                      |   | **(366**                      | **)**       | (12,504 | ) | 12,850 |   | 21 |   |
| Liabilities of discontinued operations                                  |   | **(6,791**                    | **)**       | 7,772 |   | 17,525 |   | 504 |   |
| Cash used by operating activities                                       |   | **(5,799**                    | **)**       | (16,017 | ) | (22,732 | ) | (1,136 | ) |
|                                                                    |   |                          | ** **  |   |   |   |   |   |   |
| **Investing activities**                                                |   |                          | ** **  |   |   |   |   |   |   |
| Advances to related parties                                             |   | **(10**                       | **)**       | — |   | (12,808 | ) | (28,026 | ) |
| Payments received on advances to related  parties                       |   | **—**                    | ** **  | 2,981 |   | 34,079 |   | 5,351 |   |
| Issuance of notes receivable, related  parties                          |   | **—**                    | ** **  | (300 | ) | (11,300 | ) | — |   |
| Payments received on notes receivable,  related parties                 |   | **1,980**                     | ** **  | 7,560 |   | — |   | — |   |
| Purchase of property and equipment                                      |   | **(502**                      | **)**       | (1,486 | ) | (1,828 | ) | (168 | ) |
| Proceeds from sale of property and  equipment                           |   | **—**                    | ** **  | 80 |   | — |   | — |   |
| Cash acquired (forfeited) with subsidiary  purchase (sale)              |   | **—**                    | ** **  | (484 | ) | — |   | 502 |   |
| Investment in joint venture                                             |   | **—**                    | ** **  | — |   | (4,814 | ) | — |   |
| Investment in stock of affiliated entity                                |   | **—**                    | ** **  | — |   | (686 | ) | (2,990 | ) |
| Proceeds from sale of investments                                       |   | **10,000**                    | ** **  | 2,858 |   | 62,165 |   | — |   |
| Payment of non-controlling interest on  dissolution of subsidiary       |   | **(11**                       | **)**       | — |   | — |   | — |   |
| Purchase of short-term investments                                      |   | **(26,723**                   | **)**       | (9,437 | ) | (210 | ) | — |   |
| Proceeds from sale of short-term  investments                           |   | **31,483**                    | ** **  | — |   | — |   | — |   |
| Cash provided (used) by investing  activities                           |   | **16,217**                    | ** **  | 1,772 |   | 64,598 |   | (25,331 | ) |
|                                                                    |   |                          | ** **  |   |   |   |   |   |   |
| **Financing activities**                                                |   |                          | ** **  |   |   |   |   |   |   |
| Proceeds from advances from related parties                             |   | **—**                    | ** **  | — |   | — |   | 21,795 |   |
| Payments on advances from related parties                               |   | **—**                    | ** **  | — |   | (21,795 | ) | (120 | ) |
| Proceeds from notes payable                                             |   | **—**                    | ** **  | — |   | — |   | 22,900 |   |
| Payments of notes payable                                               |   | **—**                    | ** **  | — |   | (22,906 | ) | (8 | ) |
| Proceeds from issuance of common stock                                  |   | **—**                    | ** **  | — |   | — |   | 2,164 |   |
| Proceeds from issuance of stock by  subsidiaries                        |   | **9**                         | ** **  | 13,241 |   | 1,362 |   | 1,465 |   |
| Cash provided (used) by financing  activities                           |   | **9**                         | ** **  | 13,241 |   | (43,339 | ) | 48,196 |   |
|                                                                    |   |                          | ** **  |   |   |   |   |   |   |
| Increase (decrease) in cash and cash  equivalents                       |   | **10,427**                    | ** **  | (1,004 | ) | (1,473 | ) | 21,729 |   |
|                                                                    |   |                          | ** **  |   |   |   |   |   |   |
| Cash and cash equivalents at beginning of  year                         |   | **22,220**                    | ** **  | 23,224 |   | 24,697 |   | 2,968 |   |
|                                                                    |   |                          | ** **  |   |   |   |   |   |   |
| Cash and cash equivalents at end of year                                |   | **$**                         | **32,647**  | ** ** | $ | 22,220 |   | $ | 23,224 |   | $ | 24,697 |   |
|                                                                    |   |                          | ** **  |   |   |   |   |   |   |
| **Supplemental disclosures of cash flow  information**                  |   |                          | ** **  |   |   |   |   |   |   |
| Cash paid during the year for:                                          |   |                          | ** **  |   |   |   |   |   |   |
| Interest                                                                |   | **$**                         | **89**      | ** ** | $ | — |   | $ | 961 |   | $ | — |   |
| Income taxes                                                            |   | **$**                         | **614**     | ** ** | $ | 7,416 |   | $ | 8,251 |   | $ | — |   |
| Non-cash investing and financing activities                             |   |                          | ** **  |   |   |   |   |   |   |
| Acquisition of subsidiary stock  with issuance of stock            |   | **$**                         | **—**  | ** ** | $ | 18 |   | $ | 6,554 |   | $ | 108,170 |   |
| Distribution to entity under common control                             |   | **$**                         | **—**  | ** ** | $ | — |   | $ | — |   | $ | 1,751 |   |
| Repurchase of common stock in exchange for  investment in affiliate     |   | **$**                         | **—**  | ** ** | $ | — |   | $ | 9,798 |   | $ | — |   |
| Sale of investment for note payable                                     |   | **$**                         | **—**  | ** ** | $ | — |   | $ | 560 |   | $ | — |   |
| Conversion of trade receivable to note  receivable                      |   | **$**                         | **—**  | ** ** | $ | 2,784 |   | $ | — |   | $ | — |   |
| Transfer of restricted cash to short-term  investment                   |   | **$**                         | **5,500**   | ** ** | $ | — |   | $ | — |   | $ | — |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

F-6

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**LOTUS PACIFIC, INC. AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**Note 1 – Business andBackground**

 

***Description ofBusiness***

 

Lotus Pacific, Inc. (“LPFC”, “Lotus” or“Company”), a Delaware corporation, is a holding company whose operations areconducted through its subsidiaries. Lotus develops, manages, and operatesemerging communications and consumer electronics companies, focusing ondeveloping next generation consumer electronics and communication products.Lotus provides its subsidiaries with capital and strategic infrastructureservices.

 

In April 1997, the Company formed Richtime Far East Ltd.,(“Richtime”) a garment import and export business in Hong Kong.  Richtime received customer orders fromEurope and North America, and contracted the orders to garment manufacturersmainly in Nanjing, Jiangsu, China.  Itthen shipped the products overseas. In March 1998, the Company set up anew subsidiary LPF International (“LPF”) to expand the apparel business in theUS and transferred all equity interest in Richtime into LPF.  On September 30, 1998 the Company soldLPF and Richtime.  See Note 4.

 

In April and May 1997, the Company acquired 70% of the commonstock of Regent Electronics Corporation (“Regent”). In June 1997, Regentacquired Amiga-based, multimedia technology related assets and rights fromRightiming Electronics Corporation (“Rightiming”). See Notes 2 and 4.  On June 26, 2001, the Company spun-offRegent to Regent’s management.  See Note4.

 

In February 1999, the Company acquired 100% of Professional MarketBrokerage, Inc. (“PMB”), a Chicago-based financial trading firm that providesonline trading services and 100% of US Securities & Futures Corp. (“USSF”),a full service brokerage firm in New York, NY. In June 1999, the Companycreated USS Online, Inc., (“USS Online”) a wholly-owned subsidiary, andtransferred all of its ownership interests in each of USSF and PMB to USSOnline to run those two financial service subsidiaries. In February 2000,the Company sold 72% of its ownership in USS Online.  See Note 5.

 

In March 1999, the Company acquired 94.5% of the issued andoutstanding common shares of Correlant Communications, Inc. (formerly TurboNetCommunications, Inc.) (“Correlant”), representing an 81% ownership interest inCorrelant.  See Note 4.  Based in San Diego, California, Correlantdesigned, developed and marketed telecommunications products to cableoperators, network service providers, and communications network users in theUnited States and Asian countries.

 

In March 1999, the Company acquired 77% of the issued andoutstanding common shares of Arescom, Inc. (“Arescom”).  See Note 4. Based in Fremont, California, Arescom designs, manufactures and marketsa broad range of high quality remote access products, such as routers andremote managing software, and other inter-networking equipment for InternetService Providers (“ISP”), resellers, and system integrators in the NorthAmerica market.  In December 2001,the Company sold approximately 92% of its investment in Arescom, representing65% of the outstanding securities of Arescom to an unrelated third party.  See Note 4.

 

OnApril 22, 1999, the Company organized Lotus World, Inc. (“Lotus World”) tooffer Auction Live, an online auction service, to international clients.  In May 2002, the Company dissolved LotusWorld.  See Note 4.

 

OnNovember 13, 2000, the Company established a wholly-owned subsidiary,Acumen Technology, Inc. (“Acumen”), incorporated in the state of Delawareand in December 2000, the Company transferred all of the capital stock itheld in Correlant and Arescom to Acumen. Other than it’s holdings of theCorrelant and Arescom stock, Acumen had no material independent operations.  In December 2001, Acumen was mergedinto Lotus and all the assets and liabilities of Acumen were absorbed by theCompany.

 

InJune 2001, Acumen formed Lotus Pacific Communications Technology (Beijing)Co., Ltd. (“Beijing Lotus”), a wholly-owned subsidiary, to support businessactivity in Beijing.  Beijing Lotus hasno material independent operations.

 

F-7

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On June 29, 2001, a majority of the Company’s stockholders, led byT.C.L. Industries Holdings (H.K.) Limited (“TCL Industries”), were successfulin their hostile consent solicitation to gain control of the Company and toreplace prior management and Board of Directors of the Company.   On June 29, 2001, new directors andofficers were appointed and the then existing directors and officers wereimmediately terminated.

 

Following the hostile takeover of the Boardof Directors of the Company on June 29, 2001, new management of theCompany, began a thorough review of all aspects of the business operations ofthe Company and its subsidiaries and has engaged in numerous transactions toreorganize the Company’s business. Under new management, the Company’s primary strategy for businessoperations has been to reorganize its unprofitable businesses, acquireundervalued or underutilized companies and focus on profitable growth.  The Company has moved aggressively to sell,reorganize or shutdown its businesses which were either not operatingprofitably or may have required significant future cash investment.

 

As of June 30, 2002, Lotus had oneoperating subsidiary, Correlant. In February 2003, Lotus, as majoritystockholder of Correlant, appointed four new members to the Board of Directorsof Correlant, effectively taking control of Correlant’s Board of Directors. Priorto this, Lotus Pacific had only one representative on Correlant’s Board ofDirectors and did not control Correlant’s Board or its operations.  Immediately thereafter, the Board ofDirectors created a new Executive Committee of the Board, comprised of two memberswho are also Lotus Pacific employees, to act on behalf of the Board ofDirectors and oversee Correlant’s management and operations.  In July 2003, Harold Tuan, President,Chief Executive Officer and co-founder of Correlant resigned as a director ofCorrelant and no longer serves as President and CEO of Correlant.  In October 2003 Gordon Lum, VP ofEngineering, Secretary, and co-founder of Correlant resigned as director ofCorrelant and no longer serves as VP of Engineering and Secretary. Inconnection with their resignations, the Company entered into EmploymentSeparation and Consulting Agreements with both Mr. Tuan and Mr. Lum. See Note16. Upon recommendation of its consultants, following Mr. Tuan’s and Mr. Lum’sresignations, Correlant began a substantial reduction in its workforce andoperations to reduce operating expenses, reducing the number of Correlantemployees from 34 as of August 1, 2003 to 18 employees as ofDecember 23, 2003.  As a result ofdeclining margins and demand for its products, Correlant’s Board of Directorsapproved the wind down and cessation of Correlant’s historical operations inthe cable modem business effective December 23, 2003. As part of the winddown, Correlant intends to sell or license current technology.  Correlant’s wind down was substantiallycompleted by March 31, 2004. Correlant will continue to explore either acquiring or investing inother businesses to utilize its assets.

 

In January 2003, the Company enteredinto an agreement to form a joint venture with Beijing Youbang OnlineElectronics Technology Co., Ltd. (“Youbang”), TCL Computer Technology Co., Ltd.(“TCL Computer”), an affiliate of TCL Industries and all the equity holders ofYoubang, pursuant to which the Company acquired a 50% interest in a new joint venturewhich will own substantially all of Youbang’s operations. Pursuant to theagreement, all of Youbang’s assets, other than real estate, were transferred toa newly formed Beijing, China joint venture company named TCL DigitalTechnologies, Ltd., and operates as a computer notebook manufacturing companyin China. The Company will contribute 50% of the total investment amount orapproximately $5,240,000, payable in three installments. At the time, theinvestment was part of the Company’s business strategy to seek businesses tomaximize the Company’s growth potential based on its assets. However, shortlyafter it began running the joint, the Company deemed the joint venture’sbusiness model did not fit with the Company’s long-term business strategy, anddiverted management resources from the operations of other subsidiaries,notably Opta Systems, LLC, a Delaware limited liability company (“Opta Systems”or “GoVideo”), as discussed below.  InSeptember 2003, the Company entered into an agreement with TCL InformationTechnology Industrial (Group) Ltd, an affiliate of TCL Industries whereby theCompany sold its 50% interest in TCL Digital for an aggregate amount of$5,604,000, of which $1,842,000 was applied to repay the sum payable under thepromissory note dated August 18, 2003 issued by the Company in favor ofTCL International Holdings Limited (“TCL Holdings”), TCL Industries parentcompany and the balance of $3,762,000 was paid to the Company. At the date ofthe sale, the Company had invested $3,418,000 representing the first twoinstallments of the total investment.

 

F-8

----

 

In April 2003, the Company loaned$5,986,000 to Opta Systems, which was used, in addition to a deposit of$250,000 paid by Opta Systems to complete its purchase of substantially allassets and assumption of certain liabilities of a product line known as“GoVideo” from SONICblue Incorporated, a Delaware corporation (NASDAQ: SBLU),and Sensory Science Corporation, a Delaware corporation and wholly-ownedsubsidiary of SONICblue, pursuant to a purchase agreement and an order issuedby the United States Bankruptcy Court, Northern District of California, SanJose Division overseeing SONICblue’s bankruptcy case.

 

Immediately subsequent to Opta System’s purchase ofthe GoVideo product line, the Company purchased 100% of the outstandingmembership interests of Opta Systems from Carmco Investments, LLC, aConnecticut limited liability company (“Carmco”) for $420,000, representing thereturn of the $250,000 deposit used in the acquisition of the GoVideo productline and $170,000 for related transaction fees and expenses. In addition, Lotusagreed to pay up to an additional $200,000 for legal fees incurred by Carmcoand an additional $100,000 if certain significant vendors continued theirrelationship with Opta Systems through October 2003.  Subsequent to the closing, the Company paidan additional $294,000 in connection with these items.  In connection with this agreement, the$5,986,000 originally loaned to Opta Systems was converted to a capitalcontribution, resulting in a total purchase price, including actualout-of-pocket expenses of approximately $6,770,000.  In October 2003, the purchase price was reduced by $962,000based on the Purchase Price Adjustment as defined in the Asset PurchaseAgreement, resulting in an adjusted purchase price of $5,808,000. The $962,000was refunded to GoVideo and is recorded as a note payable to LotusPacific.  The following is a condensedbalance sheet showing the fair values of the assets acquired and theliabilities assumed on the date of acquisition:

 

| Accounts Receivable                     |   | $          | 2,959,000 |   |
|-----------------------------------------|--------|------------|-----------|--------|
| Inventory                               |   | 1,361,000  |      |
| Equipment                               |   | 814,000    |      |
| Intangibles not subject to amortization |   | 4,215,000  |      |
| Current liabilities                     |   | (3,541,000 | )         |
|                                    |   |       |      |
| Purchase price of net assets acquired   |   | $          | 5,808,000 |   |

 

***The amount allocatedto intangibles includes $2,420,000 allocated to the GoVideo Tradename, for***the acquisition cost of the tradename used to market the GoVideo products andgoodwill of $1,795,000, ***representingthe excess of the cost of the acquired company over the fair value of the netassets at the date of acquisition.  TheGoVideo Tradename and goodwill are not being amortized in accordance with***SFASNo. 142, *Goodwilland Other Intangible Assets* as the lives have been determined to beindefinite***. For income taxpurposes, the entire amount of the goodwill is deductible.***

 

Opta Systems dba GoVideo, (GoVideo) established in 1984, designs andmanufactures product lines in the consumer electronics industry, includingdigital video disc (“DVD”) players, portable DVD, DVD-Video Cassette Recorder(“VCR”) Combo, the Dual-DeckTM VCR, DVD Recorder, DVD Recorder + VCR, and LCDTV. Go Video holds various patents covering Dual-Deck technology as well asother electronics products and systems. Go Video was purchased as part of theCompany’s strategic direction of investing in companies which will benefit fromthe Company’s strategic relationships with Asian consumer electronicmanufacturers.  Go Video’s potential forgrowth under the Company’s ownership, the low price due to liquidation ofassets prior to the bankruptcy and the established brandname were the primaryreasons for the purchase of Go Video at a price resulting in goodwill beingrecognized.  As of December 31,2003, Go Video is the sole operating subsidiary of the Company. Opta Systemswas acquired after fiscal 2002, and as such its results of operations are notincluded in the consolidated financial statements presented herein.

 

The Company will continue to identify marketopportunities that will create and accelerate the growth and success of itssubsidiary companies and to implement new business plans to improve the returnson these businesses.

 

Unless the context indicates otherwise,reference to the Company shall include all of its wholly-owned andmajority-owned subsidiaries.

 

F-9

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**Note 2 – Restatementof Previously Issued Financial Statements and Delays in Reporting**

 

As disclosed above in Note 1, a majority of the Company’s stockholders,led by TCL, were successful in their hostile consent solicitation to gaincontrol of the Company and to replace prior management and Board of Directorsof the Company.

 

Following the replacement of prior management, the new management beganreviewing various transactions undertaken by old management prior toJune 29, 2001.  During itspreliminary investigation, new management of the Company identified certainmaterial transactions undertaken by prior management that impact reportedfinancial and operating results with respect to its consolidated financialstatements for the fiscal years ended June 30, 2001, 2000 and 1999.  Due to the preliminary results, the Companydismissed the then existing auditors, hired new auditors and re-audited allperiods under investigation. Accordingly, Lotus was unable to file its Form 10-K for the periodending June 30, 2002 until April 2004.

 

On January 30, 2003, the Company and TCL Industries, a stockholderof the Company with holdings of greater than 10% of the Company’s outstandingshares, settled all disputes with the prior auditors concerning their audits ofthe Company for fiscal 2001 and prior. The prior auditors deny that they areliable for any damages to Lotus, but consented to the settlement to avoid thecosts of litigation.  Pursuant to anagreement dated March 24, 2003 between the Company and TCL Industries, theCompany and TCL Industries agreed on the allocation of the settlement funds,whereby TCL Industries received $6,500,000 in cash, the Company received$3,500,000 in cash and the Company will be entitled to receive up to $3,500,000in cash held in an escrow account, plus interest accrued therein.  Inconnection with the agreement, Lotus and TCL agreed to forbear from bringingclaims against each other with respect to the allocation of funds or otherwise.

 

***Disclaimer of Audit Opinion -***TheCompany’s auditors were unable to audit the financial statements of Arescom, asignificant subsidiary, during the years ended June 30, 2001, 2000, and1999, because the subsidiary would not provide the necessary information toallow the auditors to complete the audits. Due to the subsidiary’s lack of cooperation, the Company’s auditors wereunable to attain satisfaction about the subsidiary’s account balances by meansof other auditing procedures.  As aresult, the Company’s auditors did not express an opinion on the consolidatedfinancial statements for the years June 30, 2001, 2000, and 1999.

 

During the re-audit, errors, irregularities and the misapplication ofcertain accounting principles and practices were identified.  The Company corrected the accounting errors,irregularities and misapplied accounting principles in its ConsolidatedFinancial Statements.  As a result ofthe foregoing, the Company restated its financial statements for the threeyears ended June 30, 2001.  Theeffects of the restatement on periods prior to 1999 are reflected as a priorperiod adjustment.

 

F-10

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The following tables present the impact of the restatement adjustmentson the Company’s previously reported 2001, 2000 and 1999 results on a condensedbasis (*in thousands, except per share data*):

 
|                                                                         |   | **As of or  for the year ended June 30,** |    |
|------------------------------------------------------------------------------|--------|------------------------------------------------|---------|
|                                                                         |   | **2001**                                       |    | **2000** |   | **1999** |   |
|                                                                         |   | **As  previously  reported**                   |    | **As  restated** |   | **As  previously  reported** |   | **As  restated** |   | **As  previously  reported** |   | **As  restated** |   |
| **Statement of  Operations:**                                                |   |                                           |    |   |   |   |   |   |   |   |   |   |   |
| Total revenues                                                               |   | $                                              | 294,987 |   | $ | 263,192 |   | $ | 95,496 |   | $ | 71,839 |   | $ | 42,507 |   | $ | 3,733 |   |
| Total cost of  revenues                                                      |   | 271,839                                        |    | 230,601 |   | 78,885 |   | 57,232 |   | 37,711 |   | 3,270 |   |
| Selling, general and administrative,  including depreciation and amortiation |   | 64,573                                         |    | 25,611 |   | 83,042 |   | 30,895 |   | 10,645 |   | 7,631 |   |
| Research and development                                                     |   | 17,249                                         |    | 16,695 |   | 14,698 |   | 7,479 |   | 2,215 |   | 711 |   |
| Impairment of assets                                                         |   | —                                         |    | — |   | — |   | 3,486 |   | — |   | — |   |
| Total other income (expense), net                                            |   | 657                                            |    | (2,937 | ) | 37,224 |   | 46,424 |   | 551 |   | 1,084 |   |
| Provision (benefit) for income taxes                                         |   | 4,960                                          |    | (6,434 | ) | 10,663 |   | 21,099 |   | — |   | 9 |   |
| Non-controlling interest in income (loss)  of consolidated subsidiaries      |   | 1,229                                          |    | (1,215 | ) | 3,713 |   | (321 | ) | 409 |   | 198 |   |
| Loss from continuing operations                                              |   | (61,748                                        | )       | (7,433 | ) | (50,855 | ) | (2,249 | ) | (7,104 | ) | (6,606 | ) |
| Loss on discontinued operations, net                                         |   | —                                         |    | (28,973 | ) | — |   | (12,050 | ) | (53 | ) | (2,769 | ) |
| Net loss                                                                     |   | $                                              | (61,748 | ) | $ | (36,406 | ) | $ | (50,855 | ) | $ | (14,299 | ) | $ | (7,157 | ) | $ | (9,375 | ) |
| Net loss per common share – basic and  diluted:                         |   |                                           |    |   |   |   |   |   |   |   |   |   |   |
| Loss from continuing operations                                              |   | $                                              | (0.96   | ) | $ | (0.12 | ) | $ | (0.80 | ) | $ | (0.04 | ) | $ | (0.14 | ) | $ | (0.13 | ) |
| Gain (loss) on discontinued operations                                       |   | —                                         |    | (0.45 | ) | — |   | (0.19 | ) | (0.01 | ) | (0.05 | ) |
| Net loss                                                                     |   | $                                              | (0.96   | ) | $ | (0.57 | ) | $ | (0.80 | ) | $ | (0.23 | ) | $ | (0.15 | ) | $ | (0.18 | ) |
|                                                                         |   |                                           |    |   |   |   |   |   |   |   |   |   |   |
| **Balance Sheet:**                                                           |   |                                           |    |   |   |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                                                   |   | $                                              | 29,231  |   | $ | 22,220 |   | $ | 27,942 |   | $ | 23,224 |   | $ | 30,779 |   | $ | 24,697 |   |
| Accounts  receivable, net                                                    |   | 12,772                                         |    | 5,504 |   | 19,535 |   | 9,016 |   | 27,656 |   | — |   |
| Amounts due  from related parties, net                                       |   | 14,822                                         |    | 18,122 |   | 5,654 |   | 19,195 |   | — |   | 26,822 |   |
| Other current  assets                                                        |   | 23,450                                         |    | 17,331 |   | 14,808 |   | 1,817 |   | 5,548 |   | 282 |   |
| Current assets  of discontinued operations                                   |   | —                                         |    | 19,417 |   | — |   | 20,449 |   | — |   | 267 |   |
| Property and  equipment, net                                                 |   | 3,598                                          |    | 2,151 |   | 2,810 |   | 1,628 |   | 1,869 |   | 698 |   |
| Goodwill, net                                                                |   | 43,031                                         |    | 46,386 |   | 64,577 |   | 65,493 |   | 128,157 |   | 96,781 |   |
| Total other  non-current assets                                              |   | 13,054                                         |    | 5,500 |   | 17,235 |   | 1,364 |   | 13,754 |   | 9,344 |   |
| Long term  assets of discontinued operations                                 |   | —                                         |    | 1,614 |   | — |   | 1,156 |   | — |   | 567 |   |
| Total assets                                                                 |   | $                                              | 139,958 |   | $ | 138,245 |   | $ | 152,561 |   | $ | 143,342 |   | $ | 207,763 |   | $ | 159,458 |   |
|                                                                         |   |                                           |    |   |   |   |   |   |   |   |   |   |   |
| Amounts due to  related party                                                |   | $                                              | 25,949  |   | $ | 26,072 |   | $ | 15,262 |   | $ | 17,984 |   | $ | — |   | $ | 25,539 |   |
| Accounts  payable and accrued expenses                                       |   | 32,571                                         |    | 5,462 |   | 19,233 |   | 1,583 |   | 8,950 |   | 814 |   |
| Current  liabilities of discontinued operations                              |   | —                                         |    | 26,247 |   | — |   | 18,475 |   | — |   | 950 |   |
| Total other  current liabilities                                             |   | 446                                            |    | 366 |   | 5,212 |   | 12,871 |   | 44,891 |   | 22,927 |   |
| Total other  long term liabilities                                           |   | —                                         |    | — |   | — |   | — |   | — |   | — |   |
| Non-controlling  interest in subsidiaries                                    |   | 18,454                                         |    | 25,770 |   | 6,426 |   | 8,699 |   | 8,512 |   | 14,427 |   |
| Total stockholders’  equity                                             |   | 62,538                                         |    | 54,328 |   | 106,428 |   | 83,730 |   | 145,410 |   | 94,801 |   |
| Total  liabilities and stockholders’ equity                             |   | $                                              | 139,958 |   | $ | 138,245 |   | $ | 152,561 |   | $ | 143,342 |   | $ | 207,763 |   | $ | 159,458 |   |

 

***DiscontinuedOperations -***In December 2001, the Companysold approximately 92% of its investment in Arescom, representing 65% of theoutstanding securities of Arescom to an unrelated third party, thus reducingits remaining ownership in Arescom to approximately 6%.   As previously reported, Arescom was notclassified as discontinued operations. In the restated financial statements, Arescom has been reflected as acomponent of discontinued operations and all years have been reclassified toreflect this presentation.  See Note 4.

 

F-11

----

 

Set forthbelow is a summary of the material restatement and prior period adjustmentsincluded in the restatement of the previously issued financial statements, eachof which is an “error” within the meaning of the Accounting Principles Board (APB)20, *Accounting Changes* (APB 20).

 

***RevenueRecognition***

 

During fiscal 2000, 1999, and 1998, Regent and Lotus originallyrecorded sales of approximately $9,503,000, $38,609,000, and $6,155,000respectively.  Based on evidencereviewed by current management and results of the re-audit, it was determinedthat the transactions recorded as sales transactions for Lotus and Regentduring fiscal 2000, 1999, and 1998 were actually transfers of cash amongstentities under common control. Therefore, the sales and cost of sales for the years were reversed andthe actual cash transferred amongst the entities was classified in the balancesheet as Due from Related Parties.  As aresult of this restatement adjustment, net sales were reduced by $9,503,000,$38,609,000, and $6,155,000 for fiscal 2000, 1999, and 1998, respectively andcost of sales were reduced by $8,756,000, $34,677,000, and $3,409,000,  respectively resulting in an increase to netloss of $747,000, $3,932,000, and $2,746,000, respectively. The amounts fromfiscal 1998 are reflected as a prior period adjustment.

 

***Transfers andExchanges between Entities Under Common Control***

 

In 1997, Regent acquired patents and equipment from Rightiming for$5,000,000 and 8,000,000 shares of Regent stock originally valued at$2,400,000, which was determined to be the fair value of the stock at the dateof acquisition, for total consideration of $7,400,000.  During the re-audit, it was determined thatRightiming and Regent were entities under common control.  As such, the assets should have been valuedat the historical cost of Rightiming, which was $2,400,000.  In addition, it was determined that thepatents and research and development equipment acquired from Rightiming had novalue as the technology acquired was never utilized.  As a result, the assets were written off prior to fiscal 1999.

 

In September 1997, the Company issued 6,000,000 shares of itscommon stock to Rightiming in exchange for 6,000,000 shares of the common stockof its majority-owned subsidiary Regent held by Rightiming. This transactionwas originally valued at $30,000,000, based on the value of the Company’s stockat the date of the transaction. During the re-audit, it was determined thatsince Rightiming and Regent were entities under common control, thetransactions should have been recorded at the book value of Regent, which was$1,532,000.

 

In February 1999, the Company acquired all of the outstandingsecurities of USSF from Travelway International (Travelway), the soleshareholder of USSF. Based on the re-audit it was determined that Travelway wasa Company owned and controlled by the same investors as the Company, and as aresult, the Company and Travelway were deemed to be under common control at thetime of the transaction.  As a result,the transaction was recorded at the book value of the assets acquired of$4,220,000 with the difference between the fair value and the book value of$1,751,000 treated as a distribution.  See Note 5.

 

In February 2000, the Company sold 72% of its interest in USS Onlineto Travelway, in exchange for the return of 733,000 shares of the Company’scommon stock.  The shares wereoriginally valued at $7,058,000, based on the fair value of the Company’scommon stock, which resulted in a loss of $4,122,000. Based on the re-audit itwas determined that the sale of USS Online to Travelway by the Company wasdeemed to be a sale of a company under common control.  As a result, the sale should have beenrecorded at the book value of the assets sold, resulting in no gain or loss.  See Note 5.

 

***Accountingfor Investments in Consolidated Subsidiaries***

 

In March 1999, the Company acquired an 81% ownership interest inCorrelant and Arescom.  During there-audit it was noted the total purchase price of Correlant and Arescom,calculated at the acquisition date, included a total of 1,708,000 shares thatwere contingently issuable.  As theCompany was not able to determine at the acquisition date if these shares wouldbe issued, the shares should not be shown as outstanding securities at the dateof acquisition. Instead, the shares should be issued as the contingencies arelifted. In addition, the price per share of the Company’s stock issued in theacquisitions was not calculated in accordance with the Acquisition Agreements.  See Note 4.

 

F-12

----

 

Additionally, the acquisition of Correlant was incorrectly accountedfor due to the treatment of the preferred stock outstanding at the date ofacquisition.  As the Company did notacquire any of the preferred stock of Correlant, and the preferred stock hasliquidation preference, the preferred stock is deducted from the net book valueat the date of the acquisition. However, as originally reported, the preferred stock was not deductedfrom the net book value resulting in an assumption that the Company purchased81% of the preferred stock instead of allocating it to non-controllinginterest.

 

As originally reported, the Company estimated the goodwill associatedwith the acquisition of Correlant and Arescom had an estimated 10-yearlife.  However, during the re-audit,management believed 10 years was not reasonable, as both Correlant and Arescomwere relatively new, with a new rapidly changing technology.  Based on management’s knowledge of Correlantand Arescom and the estimated lives used by companies in similar industriesduring this same time period, management believes five years is a morerealistic estimated life of the goodwill.

 

***StockHeld by a Subsidiary***

 

At June 30, 1999, two of the Company’ssubsidiaries held shares of the Company’s common stock.  As originally reported, the stock wasaccounted for as treasury stock and was valued based on the value of theCompany’s stock.  During the re-audit,it was determined the value of the stock in treasury should be based on thecost of the shares owned rather than the value of the Company’s stock atyear-end.

 

***StockExchange***

 

In February 1998, Regent issued1,500,000 shares of preferred stock and a warrant for the subscription of anadditional $6,000,000 worth of common stock to H&Q Asia Pacific Limited andAsia Pacific Growth Funds (“H&Q”) for $6,000,000.  In connection with this transaction, Lotus Pacific entered into aShare Exchange Agreement with H&Q, giving H&Q the right to exchange anyor all of these Regent shares for Lotus Pacific shares at the rate of 1.5 Lotusshares for each 1 Regent share.

 

In April 2000, H&Q exercised itsoption under the Share Exchange Agreement. As a result, the Company issued 2,250,000 shares of the Company’s commonstock in exchange for 1,500,000 preferred shares of Regent.  The Company originally valued thistransaction based on the fair value of the common stock issued at the date ofthe transaction, which resulted in a value of $21,234,000 and additionalgoodwill of $21,232,000.  As originallyreported,, the goodwill was deemed impaired as of June 30, 2000, and waswritten off.  During the re-audit it wasdetermined that the agreement for the exchange of shares was negotiated as partof the original agreement and the exchange in April 2000 was done inaccordance with the original agreement. As such, it was determined the exchange was analogous to the conversionfeature on a debt or equity security, and as a result, there is no gain or lossrecorded.  Thus, at the time of theexchange, the Company acquired an additional investment in Regent that shouldhave been recorded at the value that the Regent shares were originallyacquired. The reaudit adjustment resulted in a decrease in the net lossoriginally reported for fiscal 2000 of $21,234,000.

 

***Saleof Subsidiary Stock***

 

On September 30, 1998, the Company sold all its ownership in LPFand Richtime, including all assets and liabilities, to Clarinet Overseas Ltd.,a related party, for a total of $2,500,000 in cash, which was less than theCompany’s investment.  The Companyoriginally recorded a loss in fiscal 1999 of $591,000 on the sale of theinvestment.  However, during there-audit, the investment was deemed to be impaired as of June 30, 1998 andthe investment was reduced by $591,000, which is recorded as a prior periodadjustment. See Note 4.

 

During October 2000, the Company sold 656,000 shares of Correlantcommon stock to various unrelated parties. Although the Correlant shares were transferred to the parties, the Companydid not receive any of the proceeds. The Company investigated the transaction and was unable to recover thefunds, and as a result the Company recorded a loss of $2,266,000 during fiscal2001. See Note 4. This transaction was not reflected in the original filings.

 

F-13

----

 

In January 2001, the Company agreed to refund $7,100,000 toseveral investors who purchased shares of Correlant common stock during fiscal2000.  As previously disclosed in the original fillings, the refund increasedgoodwill by $6,858,000.  However, duringthe re-audit it was determined that although the Company refunded the$7,100,000, the shares were never returned to the Company.  The Company investigated the transaction andwas unable to recover the funds, and as a result, the $7,100,000 has beenexpensed. See Note 4.

 

DuringJuly 2000, the Company sold 300,000 shares of Arescom stock for totalproceeds of $1,500,000.  InDecember 2000, the Company agreed to refund the $1,500,000 received inconnection with the sale of Arescom stock. The Company refunded the $1,500,000, however the shares were neverreturned to the Company.  The Companyinvestigated the transaction and was unable to recover the funds.  As a result, the $1,500,000 has beenexpensed.  See Note 4. This transactionwas not reflected in the original filings.

 

***Related Party Transactions***

 

Material related party transactions were not properly disclosed underStatement of Financial Accounting Standards (SFAS) Statement 57, *RelatedParty Disclosures* (SFAS 57).  See Notes 4, 5, 6, 7, 12 and 13.

 

**Note 3 – SignificantAccounting Policies**

 

***Principles of Consolidation***

 

Theconsolidated financial statements include the accounts of Lotus and itssubsidiaries.  All significantintercompany transactions and balances have been eliminated.  Subsidiaries in which Lotus owns at least50% are consolidated, except for investments in which control is deemed to betemporary, in which case the equity method of accouting is used.  Equity investments in which Lotus owns atleast 20% of the voting securities are accounted for using the equity method,except for investments in which the Company is not able to exercise significantinfluence over the investee, in which case, the cost method of accounting isused.  The cost method of accounting isused for all investments in which Lotus owns less than 20%.

 

***Estimates andAssumptions***

 

Thepreparation of the consolidated financial statements in conformity withaccounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period. Significant estimates arerequired as part of inventory valuation, allowance for doubtful accounts,goodwill and long-lived asset impairments, valuation allowances on deferredincome taxes, the potential outcome of future tax consequences of eventsrecognized in our financial statements or tax returns, and determining wheninvestment impairments are other-than-temporary. Actual results and outcomesmay differ from management’s estimates and assumptions.

 

***Foreign Operations***

 

The functional currency of the Company is the U.S. dollar.  Any accounts denominated in a currency otherthan the U.S. dollar are re-measured and resultant gains and losses arerecorded in the Company’s consolidated statement of operations.  Foreign currency transaction gains andlosses are also included in the Company’s consolidated statement ofoperations.  The Company recordedtransaction gains (losses) in fiscal 2002, 2001, 2000 and 1999 of $(161,000),$147,000, $50,000, and $12,000, respectively, which are recorded in otherincome (expense) on the consolidated statement of operations.

 

***Cash and Cash Equivalents***

 

Cash and cash equivalents consist of cash and highly liquidinvestments, which include debt securities with remaining maturities whenacquired of three months or less and are stated at cost, which approximatesmarket.

 

F-14

----

 

***Short-TermInvestments***

 

The Company accounts for short-term investments in accordance with SFAS115, *Accounting for Certain Investments inDebt and Equity Securities* (SFAS 115), and classifies investments asavailable-for-sale in accordance with that standard.  Available-for-sale securities are carried at cost, whichapproximates fair value.  As ofJune 30, 2002 and 2001, unrealized holding gains and losses on securitiesclassified as available-for-sale were not material.

 

As of June 30, 2002 and 2001, short-term investments consist ofcorporate debt securities with maturity dates of less than one year.

 

***Fair Value ofFinancial Instruments***

 

The estimated fair values of all financial instruments on the Company’sbalance sheets were determined by using available market information andappropriate valuation methodologies. Fair value is described as the amount at which the instrument could beexchanged in a current transaction between informed willing parties, other thana forced liquidation.  However,considerable judgment is required in interpreting market data to develop theestimates of fair value.  Accordingly, theestimates presented herein are not necessarily indicative of the amounts theCompany could realize in a current market exchange.  The use of different market assumptions and/or estimationmethodologies may have a material effect on the estimated fair valueamounts.  The Company does not have anyoff balance sheet financial instruments.

 

The following methods and assumptions were used by the Company inestimating fair value disclosures for financial statements: cash andequivalents, trade accounts receivable, notes receivable, trade accountspayable and certain other current liability amounts are reported in the balancesheet at carrying value which approximates fair value due to the short-termmaturities of these instruments.

 

***Pledged Assets***

 

During fiscal2001, Correlant entered into a security agreement with a bank, wherebyCorrelant agreed to pledge approximately $5,500,000 in connection with thecollateralization of a line-of-credit. The cash pledged in connection with the agreement is included in theconsolidated balance sheets as restricted cash.  The security agreement was cancelled as of June 30, 2002.

 

***Concentration ofCredit Risk***

 

Credit risk represents the accounting loss that would be recognized atthe reporting date if counterparties failed completely to perform ascontracted. Concentrations of credit risk (whether on or off balance sheet)that arise from financial instruments exist for groups of customers orcounterparties when they have similar economic characteristics that would causetheir ability to meet contractual obligations to be similarly affected bychanges in economic or other conditions described below.

 

Financial instruments that subject the Company to credit risk consistof cash balances maintained in excess of federal depository insurance limitsand accounts receivable, which have no collateral or security.  The Company maintains several cash accountswith 4 financial institutions.  As ofJune 30, 2002, 2001, 2000 and 1999, the Company had combined balances of$31,504,000, $11,729,000, $14,964,000, and $23,227,000,respectively, which werenot guaranteed by Federal Deposit Insurance Corporation (“FDIC”). The Companyhas not experienced any losses in such accounts and believes it is not exposedto any significant credit risk on cash.

 

F-15

----

 

A relatively small number of customers account for a significantpercentage of the Company’s revenues. The percentage of revenues derived from significant customers isdetailed as follows:

 

|                                   |   | **Year ended  June 30,** |       |
|----------------------------------------|--------|-------------------------------|------------|
|                                   |   | **2002**                      |       | **2001** |   | **2000** |   | **1999** |   |
|                                   |   |                          |       | **(Restated)** |   | **(Restated)** |   | **(Restated)** |   |
| Toshiba (Related party, see Note 13)   |   | **54**                        | **%**      | 67 | % | 68 | % | 100 | % |
| TurboComm (Related party, see Note 13) |   | **37**                        | ** ** | 3 |   | 3 |   | — |   |
| Terayon                                |   | **8**                         | ** ** | 13 |   | 11 |   | — |   |
| COM21                                  |   | **—**                    | ** ** | 11 |   | 13 |   | — |   |

 

Accounts receivable from these customers totaled $7,335,000,$21,142,000, $13,251,000 and $2,569,000 at June 30, 2002, 2001, 2000 and1999, respectively.

 

***Allowance forDoubtful Accounts***

 

Notes andrelated parties and trade accounts receivable are recorded at net realizablevalue. The Company records interest income on interest-bearing loans receivableusing an appropriate rate of interest over the life of the loan. Related feesand/or costs are deferred and amortized over the life of the loan using the interestmethod.

 

The Companydoes business and extends credit based on an evaluation of the customers’financial condition generally without requiring collateral. Exposure to losseson trade receivables is expected to vary by customer due to the financial conditionof each customer. The Company monitors exposure to credit losses and maintainsallowances for anticipated losses considered necessary under the circumstances.

 

Interestincome accruals are suspended for interest-bearing loans receivable that are indefault during the period of time that collectibility is uncertain. Paymentsreceived on nonaccrual loans are first applied against any accrued interestbalance outstanding. Once collectibility is considered to be certain, interestincome accruals are resumed.

 

Delinquentnotes and trade accounts receivable are charged against the allowance fordoubtful accounts once uncollectibility has been determined. The allowance isdetermined through an analysis of the aging of accounts receivable andassessments of risk that are based on historical trends and an evaluation ofthe impact of current and projected economic conditions. The Company evaluatesthe past-due status of its notes and related parties and trade receivablesbased on contractual terms of sale. If the financial condition of the Company’scustomers were to deteriorate, resulting in an impairment of ability to makepayments, additional allowances may be required. There was no activity in theallowance for doubtful accounts except during those fiscal years shown below (*in thousands*):

 
| **Year ended June 30,**                                    |   | **Beginning  Balance** |       | **Expense/  (Recovery)** |   | **Write off  and other** |       | **Ending  Balance** |       |
|-----------------------------------------------------------------|--------|------------------------|------------|--------------------------|--------|--------------------------|------------|---------------------|------------|
| Allowance – Accounts receivable:                           |   |                   |       |                     |   |                     |       |                |       |
| **2002**                                                        |   | **$**                  | **—** | ** **               | **$**  | **44**                   | ** ** | **$**               | **—** | ** ** | **$** | **44** |   |
| Allowance – Notes and interest receivable,  related party: |   |                   |       |                     |   |                     |       |                |       |
| **2002**                                                        |   | **$**                  | **1,734**  | ** **               | **$**  | **—**               | ** ** | **$**               | **—** | ** ** | **$** | **1,734** |   |
| 2001 (Restated)                                                 |   | 1,355                  |       | 4,477                    |   | (4,098                   | )          | 1,734               |       |
| 2000 (Restated)                                                 |   | —                 |       | 1,355                    |   | —                   |       | 1,355               |       |

 

F-16

----

 

***Inventories***

 

Inventoriesare stated at the lower of cost (first-in, first-out) or market.  Inventories are comprised of raw materials,primarily integrated circuits and other electronic components, to be used inthe manufacture of cable modems and CMTS units.  The Company provides inventory reserves for estimatedobsolescence or unmarketable inventory equal to the difference between the costof inventory and the estimated realizable value based upon assumptions aboutfuture demand and market conditions. There was no activity in the allowance for obsolete and excess inventoryexcept during those fiscal years shown below (*inthousands*):

 
| **Year ended June 30,** |   | **Beginning  Balance** |   | **Expense/  (Recovery)** |   | **Write off  and other** |   | **Ending  Balance** |   |
|------------------------------|--------|------------------------|--------|--------------------------|--------|--------------------------|--------|---------------------|--------|
| **2002**                     |   | $                      | 3,811  |                     | $      | —                   |   | $                   | 3,211  |   | $ | 600 |   |
| 2001 (Restated)              |   | —                 |   | 3,893                    |   | (82                      | )      | 3,811               |   |
|                              |        |                        |        |                          |        |                          |        |                     |        |  |  |  |  |

 

***Shipping andHandling Charges***

 

The Company includes costs ofshipping and handling billed to customers in revenue and the related expense ofshipping and handling costs is included in cost of sales.

 

***Property andEquipment***

 

Property andequipment are stated at cost less accumulated depreciation.  Depreciation expense is provided using thestraight-line method over the estimated useful lives of the assets, which rangefrom 18 months to 5 years.  Leaseholdimprovements are amortized using the straight-line method over the shorter oftheir estimated useful lives or the lease period.

 

Depreciationexpense totaled $1,329,000, $871,000, $500,000 and $69,000 for the years endedJune 30, 2002, 2001, 2000 and 1999, respectively.

 

***Impairment ofLong-Lived Assets***

 

The Companyadopted SFAS 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets* (SFAS 144) during the quarter endedDecember 31, 2001. This statement supersedes SFAS 121, *Accountingfor the Impairment of Long-Lived Assets and for Assets to Be Disposed Of*(SFAS 121), and the accounting and reporting provisions of APB Opinion 30, *Reportingthe Results of Operations Reporting the Effects of Disposal of a Segment of aBusiness, and Extraordinary, Unusual and Infrequently Occurring Events andTransactions* (APB 30), for the disposal of a segment of a business(as previously defined in that opinion). SFAS 144 provides a single accountingmodel for disposal of long-lived assets. SFAS 144 also changes the criteria forclassifying an asset as held for sale and broadens the scope of businesses tobe disposed of that qualify for reporting as discontinued operations andchanges the timing of recognizing losses on such operations. The broadeneddefinition of discontinued operations with SFAS 144 has affected thepresentation and disclosure of our results of operations for the year ended2002 and prior years presented for comparison. In accordance with SFAS 144,long-lived assets, such as property, plant, and equipment, and purchased intangiblessubject to amortization, are reviewed for impairment whenever events or changesin circumstances indicate that the carrying amount of an asset may not berecoverable. Recoverability of assets to be held and used is measured by acomparison of the carrying amount of an asset to estimated undiscounted futurecash flows expected to be generated by the asset. If the carrying amount of anasset exceeds its estimated future cash flows, an impairment charge isrecognized by the amount by which the carrying amount of the asset exceeds thefair value of the asset. Assets to be disposed of would be separately presentedin the balance sheet and reported at the lower of the carrying amount or fairvalue less costs to sell, and are no longer depreciated. The assets andliabilities of a disposal group classified as held for sale would be presentedseparately in the appropriate asset and liability sections of the balancesheet.

 

F-17

----

 

During fiscal2000, the Company recorded a charge of $3,106,000 relating to the impairment ofits 28% investment in USS Online (See Note 5) and a charge of $380,000 relatingto the impairment of property and equipment of Lotus World.

 

***Goodwill***

 

In June 2001, the Financial Accounting Standards Board (FASB)issued SFAS 141*, Business Combinations*,and SFAS 142, *Goodwill and other IntangibleAssets*, effective for fiscal years beginning after December 15,2001.  Under the new rules, goodwill andintangible assets deemed to have indefinite lives will no longer be amortizedbut will be subject to annual impairment tests in accordance with thesestatements.  Other intangible assetswill continue to be amortized over their useful lives.  The Company adopted the new rules onaccounting for goodwill and other intangibles for the year ended June 30,2002.  As part of its annual review offinancial results, the Company noted indicators that the carrying value of itsgoodwill may not be recoverable.  Theimpairment review was performed due to the prolonged economic downturnaffecting Correlant’s operations and revenue forecasts. As the Companydetermined the continued decline in market conditions within Correlant’sindustry was significant and prolonged, the Company evaluated therecoverability of its goodwill associated with Correlant.  Based on the annual testing performed atJune 30, 2002, the Company recorded a goodwill impairment charge of$20,071,000 in fiscal 2002.

 

The following table summarizes the activity in the Company’s goodwillaccount associated with all acquisitions and dispositions (*in thousands*):

 

|                                                 |   | **Correlant** |   | **Arescom** |   | **Total** |   |
|------------------------------------------------------|--------|---------------|--------|-------------|--------|-----------|--------|
| Purchase of subsidiary                               |   | $             | 74,545 |        | $      | 27,330    |   | $ | 101,875 |   |
| Amortization expense, year ended  June 30, 1999 |   | (3,727        | )      | (1,367      | )      | (5,094    | )      |
| Balance at June 30, 1999                        |   | 70,818        |   | 25,963      |   | 96,781    |   |
| Acquisition of additional stock of  subsidiary       |   | 554           |   | —      |   | 554       |   |
| Sale of investment                                   |   | (12,113       | )      | —      |   | (12,113   | )      |
| Amortization expense, year ended  June 30, 2000 |   | (14,263       | )      | (5,466      | )      | (19,729   | )      |
| Balance at June 30, 2000                        |   | 44,996        |   | 20,497      |   | 65,493    |   |
| Acquisition of additional stock of  subsidiary       |   | 18            |   | —      |   | 18        |   |
| Sale of investment                                   |   | (1,901        | )      | (231        | )      | (2,132    | )      |
| Amortization expense, year ended  June 30, 2001 |   | (11,589       | )      | (5,404      | )      | (16,993   | )      |
| Balance at June 30, 2001                        |   | 31,524        |   | 14,862      |   | 46,386    |   |
| Sale of investment                                   |   | —        |   | (11,180     | )      | (11,180   | )      |
| Amortization fiscal 2002                             |   | (11,453       | )      | (2,702      | )      | (14,155   | )      |
| Impairment charge                                    |   | (20,071       | )      | (980        | )      | (21,051   | )      |
| Balance at June 30, 2002                        |   | $             | — |        | $      | —    |   | $ | — |   |

 

Correlant amortization and impairment charge is included in loss fromcontinuing operations.  Arescomamortization and impairment charge is included with gain (loss) on discontinuedoperations and gain on sale of discontinued operations, respectively.

 

***Warranty Reserves***

 

As of June 30, 2002, the Company does not provide a warranty forits products, primarily the cable modem and CMTS.  The warranty liability for defective products is theresponsibility of the Company’s third-party manufacturer.

 

***Treasury Stock***

 

Treasurystock is recorded at cost. In the event of subsequent reissue, the treasurystock account will be reduced by the cost of such stock on the average costbasis with any excess proceeds credited to additional paid-in capital.

 

F-18

----

 

***Comprehensive Income(Loss)***

 

Comprehensive income consists of net income and other gains and lossesaffecting shareholders’ equity that, under generally accepted accountingprinciples are excluded from net income in accordance with Statement onFinancial Accounting Standards No. 130, *Reporting Comprehensive Income*. Othercomprehensive income would include unrealized gains (losses) on marketablesecurities and foreign currency translation adjustments. The Company did nothave any significant other comprehensive income at June 30, 2002, 2001,2000 and 1999.

 

***RevenueRecognition***

 

The Company sells cable modems, CMTS and, in certain instances, theMedia Access Controller (MAC), a key component of the cable modem.  The Company developed and owns theproprietary technology used in the MAC. However, the manufacturing of both the MAC and the cable modem isoutsourced to manufacturers.  Cablemodem and CMTS revenue is recognized upon shipment of the completed unit to thecustomer.  In addition to supplying theMAC to the cable modem manufacturer for use in Correlant cable modems, theCompany also sells the MAC for use by the cable modem manufacturer innon-Correlant products.  MAC revenue isrecognized upon passage of title of the MAC for use by the cable modem manufacturerin its own product.

 

Contract services revenue is recognized over the term of the contract.

 

***Stock-BasedCompensation***

 

SFAS 123, *Accounting for Stock-BasedCompensation* (SFAS 123) encourages, but does not require, companiesto record compensation cost for stock-based employee compensation plans at fairvalue. The Company elected to continue to account for stock-based compensationusing the intrinsic value method prescribed in APB Opinion 25, *Accounting for Stock Issued to Employees*(APB 25) and related Interpretations. Under APB 25 and the intrinsic valuemethod, the exercise price of the Company’s employee stock options equals themarket price of the underlying stock on the date of grant or, in the case ofthe Company’s employee stock purchase plans since the plans arenon-compensatory, no compensation expense is recognized.

 

The following table illustrates the effect on the Company’s net lossand loss per share as if the Company had applied the fair value recognitionprovisions of SFAS 123 to its stock-based employee compensation awards, andrecognized expense over the applicable award vesting period (*in thousands, except per share amounts*):

 
|                                                                                                                                  |   | **Years  ended June 30,** |        |
|---------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------|-------------|
|                                                                                                                                  |   | **2002**                       |        | **2001** |   | **2000** |   | **1999** |   |
|                                                                                                                                  |   |                           |        | **(Restated)** |   | **(Restated)** |   | **(Restated)** |   |
| Net loss, as reported                                                                                                                 |   | **$**                          | **(18,975** | **)** | $ | (36,406 | ) | $ | (14,299 | ) | $ | (9,375 | ) |
| Add: Stock-based employee compensation  expense included in reported net loss                                                         |   | **1,657**                      | ** **  | 9,189 |   | 2,027 |   | — |   |
| Less: Stock-based employee compensation  expense determined under fair value based method for all awards, net of  related tax effects |   | **(3,470**                     | **)**       | (10,924 | ) | (2,533 | ) | (72 | ) |
| Pro-forma net loss                                                                                                                    |   | **$**                          | **(20,788** | **)** | $ | (38,141 | ) | $ | (14,805 | ) | $ | (9,447 | ) |
|                                                                                                                                  |   |                           | ** **  |   |   |   |   |   |   |
| Basic and diluted net loss per share, as  reported                                                                                    |   | **$**                          | **(0.30**   | **)** | $ | (0.57 | ) | $ | (0.23 | ) | $ | (0.18 | ) |
|                                                                                                                                  |   |                           | ** **  |   |   |   |   |   |   |
| Pro-forma basic and diluted net loss per  share                                                                                       |   | **$**                          | **(0.32**   | **)** | $ | (0.59 | ) | $ | (0.24 | ) | $ | (0.18 | ) |

 

These numbers do not include Arescom as this detail wasunavailable.  See Note 2.  The pro-forma effect for the years presentedis not likely to be representative of the pro-forma effect on reported netincome or loss in future years because these amounts reflect less than fouryears of vesting.

 

The Company’s assumptions made for purposes of estimating the fairvalue of its stock options, as well as a summary of the activity under theCompany’s stock option plan are included in Note 14.

 

F-19

----

 

***Research andDevelopment Costs***

 

**Costs incurred in connection with research and developmentare charged to operations as incurred.**

 

***Advertising Costs***

 

Advertising costsinclude payroll, employee benefits, and other headcount-related costs as wellas expenses related to advertising, promotions and tradeshows, and are expensedas incurred. Advertising expense included in continuing operations was $9,000,$38,000, $440,000 and $45,000 in fiscal 2002, 2001, 2000 and 1999,respectively.

 

***Income Taxes***

 

Current income tax expense or benefit is the amount of income taxesexpected to be payable or refundable for the current year.  A deferred income tax asset or liability iscomputed for the expected future impact of differences between the financialreporting and tax basis of assets and liabilities and for the expected futuretax benefit to be derived from tax credits and loss carryforwards.  Deferred tax assets are reduced by avaluation allowance when, in the opinion of management, it is more likely thannot that some portion or all of the deferred tax assets will not be realized.

 

***Net Income (Loss)per Share***

 

Basic net income (loss) per share is computed by dividing net income(loss) by the weighted average number of shares of common stock outstandingduring the period.  Diluted net income(loss) per share is computed by dividing net income (loss) by the weightedaverage number of shares of common stock and common stock equivalentsoutstanding during the period.  Therewere no employee stock options or common stock warrants outstanding as ofJune 30, 2002.  There were9,090,000 employee stock options and common stock warrants outstanding as ofJune 30, 2001, 2000 and 1999, respectively, and 1,134,000, 1,551,000,1,602,000 and 775,000 for shares contingently issuable in connection with shareexchange agreements (See Note 4), as of June 30, 2002, 2001, 2000, and1999, respectively, which were not considered in calculating basic and dilutednet loss per common share as their effect would be anti-dilutive. As a result,for all periods presented, the Company’s basic and diluted net loss per shareare the same.

 

The following table computes basic and diluted net loss per share (*in thousands**, except per share amounts*):

 

|                                                 |   | **Years  ended June 30,** |        |
|------------------------------------------------------|--------|--------------------------------|-------------|
|                                                 |   | **2002**                       |        | **2001** |   | **2000** |   | **1999** |   |
|                                                 |   |                           |        | **(Restated)** |   | **(Restated)** |   | **(Restated)** |   |
| Numerator:                                           |   |                           |        |   |   |   |   |   |   |
| Loss from continuing operations                      |   | **$**                          | **(36,529** | **)** | $ | (7,433 | ) | $ | (2,249 | ) | $ | (6,606 | ) |
| Total gain (loss) from discontinued  operations      |   | **17,554**                     | ** **  | (28,973 | ) | (12,050 | ) | (2,769 | ) |
| Net loss                                             |   | **$**                          | **(18,975** | **)** | $ | (36,406 | ) | $ | (14,299 | ) | $ | (9,375 | ) |
|                                                 |   |                           | ** **  |   |   |   |   |   |   |
| Net loss per common share – basic and  diluted: |   |                           | ** **  |   |   |   |   |   |   |
| Loss from continuing operations                      |   | **$**                          | **(0.57**   | **)** | $ | (0.12 | ) | $ | (0.04 | ) | $ | (0.13 | ) |
| Gain (loss) on discontinued operations               |   | **0.27**                       | ** **  | (0.45 | ) | (0.19 | ) | (0.05 | ) |
| Net loss                                             |   | **$**                          | **(0.30**   | **)** | $ | (0.57 | ) | $ | (0.23 | ) | $ | (0.18 | ) |
|                                                 |   |                           | ** **  |   |   |   |   |   |   |
| Denominator:                                         |   |                           | ** **  |   |   |   |   |   |   |
| Common shares outstanding – basic and  diluted  |   | **64,233**                     | ** **  | 64,232 |   | 62,469 |   | 51,657 |   |

 

F-20

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***RecentlyIssued Accounting Standards***

 

In June 2002, the FASB issued SFAS 146, *Accounting for Costs Associated with Exit or Disposal Activities*(SFAS 146), which addresses accounting for restructuring and similar costs.SFAS 146 supersedes previous accounting guidance, principally Emerging IssuesTask Force (EITF) Issue 94-3, *LiabilityRecognition for Certain Employee Termination Benefits and Other Costs to Exitan Activity (including Certain Costs Incurred in a Restructuring)*(EITF 94-3). The Company will be required to adopt the provisions of SFAS 146for restructuring activities initiated after December 31, 2002. SFAS 146requires the liability for costs associated with an exit or disposal activitybe recognized when the liability is incurred. Under EITF 94-3, a liability foran exit cost was recognized at the date of the Company’s commitment to an exitplan. SFAS 146 also states the liability should initially be measured andrecorded at fair value. Accordingly, SFAS 146 may affect the timing ofrecognizing future restructuring costs as well as the amounts recognized. TheCompany will adopt SFAS 146 on January 1, 2003. The adoption of SFAS 146is not expected to have a material effect on the Company’s financial position,results of operations, or cash flows.

 

In November 2002, the FASB issued FASB Interpretation (FIN) 45, *Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others*(FIN45)*.* FIN 45 requires that upon issuance of a guarantee, the guarantormust recognize a liability for the fair value of the obligation it assumesunder that guarantee. The provisions for initial recognition and measurementare effective on a prospective basis for guarantees issued or modified afterDecember 31, 2002, irrespective of a guarantor’s year-end. The disclosurerequirements of FIN 45 are effective for interim and annual periods endingafter December 15, 2002, and are applicable to the Company’s productwarranty liability and other guarantees. The adoption of FIN 45 is not expected to have a material effect on theCompany’s financial position, results of operations, or cash flows.

 

In December 2002, the FASB issued SFAS 148, *Accounting for Stock-Based Compensation—Transitionand Disclosure* (SFAS 148), which amends SFAS 123.  SFAS 148 provides alternative methods oftransition for an entity that voluntarily changes to the fair value basedmethod of accounting for stock-based employee compensation. It also amends thedisclosure provisions of SFAS 123 to require prominent disclosure about theeffects an entity’s accounting policy decisions with respect to stock-basedemployee compensation have on reported net income in both annual and interimperiods. SFAS 148 is effective for annual periods ending afterDecember 15, 2002 and interim periods beginning after December 15,2002.  The adoption of the disclosurerequirements of SFAS 148 will not have a material effect on the Company’sfinancial position, results of operations, or cash flows.

 

In January 2003, the FASB issued FIN 46, *Consolidation of Variable Interest Entities*.FIN 46 establishes accounting guidance for consolidation of a variable interestentity (VIE), formerly referred to as special purpose entities. FIN 46 appliesto any business enterprise, both public and private, that has a controllinginterest, contractual relationship or other business relationship with a VIE.FIN 46 provides guidance for determining when an entity (Primary Beneficiary)should consolidate a VIE that functions to support the activities of thePrimary Beneficiary. The Company has no contractual relationship or otherbusiness relationship with a VIE, and therefore the adoption of FIN46 will nothave an effect on its financial position, results of operations, or cash flows.

 

In January 2003, the EITF published EITF Issue 00-21, *Revenue Arrangements with Multiple Deliverables*(EITF00-21), which requires companies to determine whether an arrangement involvingmultiple deliverables contains more than one unit of accounting. In applyingEITF 00-21, revenue arrangements with multiple deliverables should be dividedinto separate units of accounting, if the deliverables in the arrangement meetcertain criteria. Arrangement consideration should be allocated among theseparate units of accounting based on their relative fair values. This issue iseffective for revenue arrangements entered into in fiscal periods beginningafter June 15, 2003. The Company does not expect the adoption of EITF00-21 will have a material impact on its financial position, results ofoperations, or cash flows.

 

In April 2003, the FASB issued SFAS 149, *Amendment of Statement 133 on Derivative Instrumentsand Hedging Activities* (SFAS 149).  SFAS 149 amends andclarifies financial accounting and reporting for derivative instruments andhedging activities.  SFAS 149 is effective for contracts entered into ormodified after June 30, 2003.  The Company does not expect SFAS 149to have a material impact on its financial position, results of operations, orcash flows.

 

F-21

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In May 2003, the FASB issued SFAS 150, *Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity* (SFAS 150).  SFAS 150 represents the first phase of theFASB’s project to clarify the accounting treatment of certain instruments thatpossess characteristics of both liabilities and equity.  SFAS 150generally requires that freestanding financial instruments that obligate theissuer to redeem the holders’ shares, or are indexed to such an obligation, andare settled in cash or settled with shares meeting certain conditions betreated as liabilities.  The provisions of SFAS 150 are effectiveimmediately for instruments entered into or modified after May 31, 2003 and toall other instruments that exist as of the beginning of the first interimfinancial reporting period beginning after June 15, 2003, with theexception of mandatorily redeemable instruments of non-public companies, whichbecome subject to SFAS 150 for fiscal periods beginning after December 15,2003.  The Company does not expect SFAS 150 to impact the classificationof its outstanding preferred stock instruments upon the Company’s adoption effectiveJuly 1, 2003.

 

**Note 4 – Acquisitionsand Dispositions – Majority Owned Subsidiaries**

 

***LPF International Corp.and Richtime Far East, Ltd.***

 

On September 30, 1998, the Company sold all of its ownership inLPF and Richtime, including all assets and liabilities, to Clarinet OverseasLtd., a related party, for a total of $2,500,000 in cash, which was less thanthe Company’s investment.  As a result,the investment was deemed to be impaired as of June 30, 1998 and the investmentwas reduced to the sales price. Therefore, there was no gain or loss recognizedat the time of the sale. The operations from LPF and Richtime through the dateof the sale are included in Gain (Loss) from Discontinued Operations on theConsolidated Income Statement for fiscal 1999.

 

***Correlant Communications, Inc.***

 

On March 31, 1999, the Company entered into a share exchangeagreement which provided for the acquisition of 94.5% of the issued andoutstanding common shares of Correlant, representing an 81% ownership interestin Correlant, in consideration for the issuance of 9,657,000 common sharesvalued at $7.21 per share plus contingently issuable shares of up to1,435,000.  The contingent shares willbe issued as Correlant options specified in the agreement are exercised.  For each option exercised, 81% of suchshares were to be transferred to Lotus in exchange for 0.5364 shares of Lotuscommon stock for each share of Correlant stock transferred.  Due to the nature of the contingentconsideration, the Company cannot reasonably determine that the additionalshares will be issued. Accordingly, pursuant to the provisions of APB 16, thecontingent consideration is not recorded until such determination can bereasonably made.  At the acquisitiondate, the excess of the purchase price and related costs over the valueassigned to the net tangible assets acquired was $74,545,000 and was assignedto goodwill.  During fiscal 2001 and2000, the Company recorded an additional $18,000 and $554,000, respectively asadditional goodwill as a result of the issuance of 79,000 of the contingentlyissuable shares

 

At thepurchase date, Lotus’s stock was restricted and could not be sold untilCorrelant achieved sales of $30,000,000 and net income before income taxes of$6,000,000. Effective August 31, 2000, the restrictions were removed.

 

InApril 2000, as part of the Correlant acquisition agreement, Lotus providedCorrelant with $10,000,000 of non-interest bearing convertible debtfinancing.  All such debt was convertedinto 10,000 shares of Series D preferred stock on September 30, 2000.  Series D convertible preferred stock has aliquidation preference over the common stockholders of $1,000 per share and hasrights pari passu with the other series of preferred stock.  In the event the proceeds available fordistribution are insufficient to pay all Correlant preferred shareholders thefull amount of the liquidation preference, the available proceeds shall bedistributed ratably among Correlant’s preferred shareholders.

 

F-22

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FromDecember 1999 through March 2000, the Company sold 3,657,000 of itsshares in Correlant to various third parties, for total proceeds of$73,135,000.  In connection with thesale of the Correlant shares, the Company paid commissions totaling $10,970,000or 15% of the proceeds received to Hywin Investments Limited (Hywin) andrelated entities, which were related parties. The Company recorded a gain of $50,512,000 on the disposition.  This sale reduced the Company’s ownership inCorrelant to 76% of the outstanding common stock, representing a 65% ownershipinterest.

 

DuringOctober 2000, the Company sold 656,000 shares of Correlant common stock tovarious unrelated parties.  Although theCorrelant shares were transferred to the parties, the Company did not receiveany of the proceeds. The Company investigated the transaction and was unable torecover the funds, and as a result the Company recorded a loss of $2,266,000during fiscal 2001.   The sale reducedthe Company’s ownership in Correlant to 73% of the outstanding common stockrepresenting a 62% ownership interest.

 

InJanuary 2001, the Company agreed to refund $7,100,000 to several investorsthat purchased a total of 355,000 shares of Correlant common stock duringfiscal 2000.  The Company refunded the$7,100,000 to Hywin, who was to return the funds to the individualinvestors.  In connection with therefund, Hywin refunded $1,065,000 of commissions relating to the shares to bereturned.  However, the shares werenever returned to the Company.  The Companyinvestigated the transaction and was unable to recover the funds, and as aresult, the $6,035,000 was expensed by the Company and is included in Otherincome (expense) in the consolidated statement of operations.

 

***Arescom***

 

On March 31, 1999, the Company entered into a share exchangeagreement which provided for the acquisition of 81% of the issued andoutstanding common shares of Arescom in consideration for the issuance of3,886,000 common shares valued at $7.25 per share plus contingently issuableshares of up to 273,000.  The contingentshares will be issued as Arescom options specified in the agreement areexercised.  For each option exercised,81% of such shares were to be transferred to Lotus in exchange for 0.02915shares of Lotus common stock for each share of Arescom stock transferred.  Due to the nature of the contingentconsideration, the Company cannot reasonably determine that the additionalshares will be issued. Accordingly, pursuant to the provisions of APB 16, thecontingent consideration is not recorded until such determination can bereasonably made.  At the acquisitiondate, the excess of the purchase price and related costs over the valueassigned to the net tangible assets acquired was $27,330,000 and was assignedto goodwill.  The Company has not issuedany contingently issuable shares.

 

At thepurchase date, Lotus’s stock was restricted and could not be sold until Arescomachieved sales of $15,000,000 and net income before income taxes of $3,000,000.

 

DuringJuly 2000, Lotus sold, to unrelated parties, 300,000 shares of Arescomstock for total proceeds of $1,500,000. Pursuant to the terms of the agreement, the number of Arescom sharespurchased would be adjusted based on the occurrence of an initial publicoffering of Arescom.  In connection withthe sale, Lotus recorded a gain of $1,269,000 during fiscal 2001.  On January 31, 2002, the agreementswere amended to delete the section related to the adjustment to the numberof shares purchased.  As considerationfor this, the Company issued an additional 150,000 shares of Arescom stock tothe parties. Since the investment had no value at the time the shares wereissued, there was no gain or loss recorded for the issuance of the additionalshares.

 

InDecember 2000, the Company agreed to refund the $1,500,000 received inconnection with the sale of Arescom stock. The amount refunded to the Company’s attorney was to be returned to theindividual investors.  However, thefunds were not returned to the investors and the shares were never returned tothe Company.  The Company investigatedthe transaction and as a result, filed a claim against the individual. See Note16.  However, as the Company was unableto recover the funds, the $1,500,000 was expensed by the Company and isincluded in Other income (expense) in the consolidated statement of operations.

 

F-23

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EffectiveDecember 18, 2001, Lotus sold, to an unrelated party approximately 92% ofits investment in Arescom, representing 65% of the outstanding securities ofArescom for $10,000,000.  In connectionwith this agreement, the Share Exchange and related Agreements fromMarch 1999 were terminated thus eliminating the restrictions on the Company’scommon stock issued to Arescom shareholders and the Company was released fromall liability as a guarantor of Arescom’s indebtedness to an unrelated thirdparty.  In addition, the Company andArescom entered into an exchange agreement, whereby the Company forgave$13,235,000 due from Arescom in exchange for a new promissory note for theprincipal sum of $2,192,000 (See Note 10) and 11,000 shares of subordinatedpreferred stock of Arescom.  The Companydetermined that there was no value associated with the 11,000 shares ofsubordinated preferred stock of Arescom. Immediately following the sale of its majority interest in Arescom, theCompany determined that the value of its remaining 6% interest in Arescom wasimpaired.  The Company recognized a netgain of $16,765,000, which includes a tax benefit of $1,802,000, on the sale,exchange of the debt and impairment of the remaining value of itsinvestment.  The sale of Arescom and itsrelated operating results have been excluded from the results from continuingoperations and classified as a discontinued operation for all periods presentedin accordance with the requirements of SFAS 144.

 

As discussedin Note 2, the Company’s auditors were unable to audit the financial statementsof Arescom, a significant subsidiary, during the years ended June 30,2001, 2000, and 1999, as the subsidiary would not provide the necessaryinformation to allow the auditors to complete the audits.  Due to the subsidiary’s lack of cooperation,the Company’s auditors were unable to attain satisfaction about thesubsidiary’s account balances by means of other auditing procedures.  As a result, the Company’s auditors did notexpress an opinion on the consolidated financial statements for the yearsJune 30, 2001, 2000, and 1999.

 

The followingis a summary of the results of discontinued operations relating to Arescom forthe years ended June 30, 2002, 2001, 2000 and 1999:

 
|                            |   | **Years  ended June 30,** |       |
|---------------------------------|--------|--------------------------------|------------|
|                            |   | **2002**                       |       | **2001** |   | **2000** |   | **1999** |   |
|                            |   | **(Unaudited)**                |       | **(Unaudited)** |   | **(Unaudited)** |   | **(Unaudited)** |   |
|                            |   |                           |       |   |   |   |   |   |   |
| Revenues                        |   | **$**                          | **38,200** | ** ** | $ | 31,086 |   | $ | 13,716 |   | $ | 162 |   |
| Cost of revenues                |   | **27,295**                     | ** ** | 39,503 |   | 13,905 |   | 109 |   |
| Gross profit                    |   | **10,905**                     | ** ** | (8,417 | ) | (189 | ) | 53 |   |
|                            |   |                           | ** ** |   |   |   |   |   |   |
| Operating expenses              |   |                           | ** ** |   |   |   |   |   |   |
| General and administrative      |   | **7,342**                      | ** ** | 14,999 |   | 6,387 |   | 1,402 |   |
| Amortization                    |   | **2,702**                      | ** ** | 5,404 |   | 5,466 |   | 1,367 |   |
|                            |   |                           | ** ** |   |   |   |   |   |   |
| Loss from operations            |   | **861**                        | ** ** | (28,820 | ) | (12,042 | ) | (2,716 | ) |
| Other income (expense)          |   | **(72**                        | **)**      | (153 | ) | (8 | ) | — |   |
| Loss on discontinued operations |   | **$**                          | **789**    | ** ** | $ | (28,973 | ) | $ | (12,050 | ) | $ | (2,716 | ) |

 

F-24

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The table thatfollows presents a breakdown of the major components of assets and liabilitiesof discontinued operations:

 
|                                               |   | **Years  ended June 30,** |   |
|----------------------------------------------------|--------|--------------------------------|--------|
|                                               |   | **2001**                       |   | **2000** |   | **1999** |   |
|                                               |   | **(Unaudited)**                |   | **(Unaudited)** |   | **(Unaudited)** |   |
| ASSETS                                             |   |                           |   |   |   |   |   |
| Cash                                               |   | $                              | 2,288  |   | $ | 4,718 |   | $ | 4 |   |
| Cash, restricted                                   |   | 140                            |   | — |   | — |   |
| Accounts receivable                                |   | 3,079                          |   | 4,096 |   | 200 |   |
| Inventories                                        |   | 13,686                         |   | 11,281 |   | — |   |
| Prepaid expenses                                   |   | 224                            |   | 354 |   | 63 |   |
| Total current assets of discontinued  operations   |   | 19,417                         |   | 20,449 |   | 267 |   |
|                                               |   |                           |   |   |   |   |   |
| Property and equipment                             |   | 1,288                          |   | 802 |   | 483 |   |
| Other assets                                       |   | 326                            |   | 354 |   | 84 |   |
| Total long-term assets of discontinued  operations |   | 1,614                          |   | 1,156 |   | 567 |   |
| Total assets of discontinued operations            |   | $                              | 21,031 |   | $ | 21,605 |   | $ | 834 |   |
|                                               |   |                           |   |   |   |   |   |
| LIABILITIES                                        |   |                           |   |   |   |   |   |
| Short-term borrowings                              |   | $                              | 3,000  |   | $ | 2,778 |   | $ | 196 |   |
| Customer deposits                                  |   | 1,520                          |   | — |   | — |   |
| Accounts payable                                   |   | 16,359                         |   | 15,076 |   | 682 |   |
| Other accrued liabilities                          |   | 5,368                          |   | 621 |   | 72 |   |
| Total liabilities of discontinued  operations      |   | $                              | 26,247 |   | $ | 18,475 |   | $ | 950 |   |

 

In September 2003,the Company sold its remaining 6% interest in Arescom.  See Note 10.  On the sale date, the 6% ownership interest in Arescom had novalue.

 

***Lotus World, Inc***

 

OnApril 22, 1999, Lotus organized Lotus World and invested $1,000,000.  On March 12, 2002, the Company andLotus World entered into an Asset Purchase and Assignment and AssumptionAgreement with Avtech Technology, whereby the Company assigned its rights tocertain contracts and related intangibles to Avtech in exchange for Avtech’sassumption of all of the Lotus World’s obligations under the contractsassigned.  There was no gain or lossassociated with the transaction with Avtech. In connection with the agreement, Avtech agreed to pay the Company aconsulting fee of $4,125 per month through December 2002.  Subsequent to the completion of thetransaction, the Company dissolved Lotus World.

 

***Regent Electronics***

 

On June 26, 2001, the Company entered into an AcquisitionAgreement with the management of Regent providing for the transfer by the Companyof its 93% ownership of the outstanding shares of capital stock of Regent tothe Management of Regent. As consideration for the transfer of these shares toRegent’s management, Regent management agreed to pay the Company $1 and 50% ofthe earnings generated by Regent starting from the date of the agreement untilthe aggregated payment reaches $15,000,000. To date the Company has not received anything from Regent as Regent hashad no earnings. In connection withthe spin-off of Regent, the Company forgave amounts due from Regent in theamount of $4,098,000.   The Companyrecorded a net loss of $213,000 from the spin-off of Regent and forgiveness ofthe debt.

 

F-25

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**Note 5 – Acquisitionsand Dispositions – Equity Method Investees**

 

***USS Online, Inc.***

 

OnFebruary 23, 1999, Lotus acquired all of the outstanding securities of PMBfor $240,000 cash and 500,000 shares of Lotus’s common stock with a total valueof $3,471,000.  Subsequent to theacquisition date, Lotus invested an additional 500,000 shares of its commonstock with a total value of $3,471,000.

 

On February 23, 1999, the Company acquired all of the outstandingsecurities of USSF for $2,500,000 and 500,000 shares of the Company commonstock valued at $3,471,000 issued to Travelway, the sole shareholder of USSF,plus an additional investment of $250,000. Travelway was a company owned andcontrolled by the same investors as the Company and as a result, the Companyand Travelway were under common control at the time of the transaction.  As a result, the transaction was recorded atthe book value of the assets acquired of $4,220,000 with the difference betweenthe fair value and the book value of $1,751,000 treated as a distribution.

 

On June 28, 1999, Lotus formed USS Online to which it contributedall of the stock of PMB and USSF. As of June 30, 1999, PMB and USSF owned1,078,000 shares of the Company’s common stock, which is included in theCompany’s treasury stock.

 

On February 7, 2000, the Company sold 72% of its ownership in USSOnline to Travelway, in exchange for 733,000 shares of Lotus stock held byTravelway.  The sale was deemed to be asale of a company under common control due to the same ownership of the Companyand Travelway, and thus was recorded at the book value of the assets sold,which totaled $9,798,000.  The Companyaccounts for the 733,000 shares of its common stock received as treasury stockand 878,000 shares of the Company’s shares held by PMB and USSF were deemedreissued and shown as outstanding.

 

As the Company owned a majority interest in USS Online and itssubsidiaries for less than one year, it was determined that control wastemporary, and the investment is recorded using the equity method for fiscal1999. As of June 30, 2000, the remaining 28% investment in USS Online wasconsidered impaired and written off.

 

**Note 6 – Acquisitionsand Dispositions – Cost Method Investees**

 

Duringfiscal 2000, the Company purchased shares of stock of TurboComm Technology,(“TurboComm”) Correlant’s supplier and related party (See Note 13), for a totalof $686,000 from an existing shareholder of TurboComm.  The number of shares acquired represented asmall percentage of TurboComm, and thus the investment was carried atcost.  This investment was disposed ofin fiscal 2001 through the sale to another shareholder in TurboComm for totalproceeds of $1,358,000, resulting in a gain of $672,000.

 

**Note 7 – JointVenture**

 

On June 28, 1999 Lotus entered into anagreement with TCL Holdings (BVI) Co., Ltd. to establish TCL International(U.S.), Inc., a 50-50 joint venture. At June 30, 2002, TCL Holdings(BVI) Co., Ltd.’s parent company owned 14.6% of the Company’s outstandingcommon stock.  During fiscal 2000 theCompany invested $4,814,000 in the joint venture. The purpose of the jointventure was to develop and market a set top box (“STB”) for the Chinamarket.  The STB accessed the Internetvia a television and was marketed to households with no computer Internetaccess.  Once the STB was installed, thejoint venture planned to provide Internet access for a monthly fee.  However, since technology for computerInternet access was deployed so quickly in China, there was virtually no demandfor the STB once the joint venture completed the product development.  As such, the joint venture ceasedoperations.  On June 16, 2000 Lotussold its stock in TCL International (U.S.), Inc. to a related party for anote in the amount of $560,000 (See Note 10), which was deemed to be the fairvalue of the Company’s portion of the winding down joint venture.  The Company recorded a loss of $4,254,000 onthe disposition.

 

F-26

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**Note 8 – AccountsReceivable**

 

The following summarizes components of accountsreceivable  (*in thousands*):

 
|                            |   | **As of  June 30,** |    |
|---------------------------------|--------|--------------------------|---------|
|                            |   | **2002**                 |    | **2001** |   | **2000** |   | **1999** |   |
|                            |   |                     |    | **(Restated)** |   | **(Restated)** |   | **(Restated)** |   |
| Accounts receivable             |   | **$**                    | **325** | ** ** | $ | 5,504 |   | $ | 9,016 |   | $ | — |   |
| Allowance for doubtful accounts |   | **(44**                  | **)**   | — |   | — |   | — |   |
|                            |   | **$**                    | **281** |   | $ | 5,504 |   | $ | 9,016 |   | — |   |
|                                 |        |                          |         |  |  |  |  |  |  |  |  |  |  |

 

**Note 9 – Inventories**

 

The following summarizescomponents of inventories (*in thousands*):

 

 
|                             |   | **As of  June 30,** |       |
|----------------------------------|--------|--------------------------|------------|
|                             |   | **2002**                 |       | **2001** |   | **2000** |   | **1999** |   |
|                             |   |                     |       | **(Restated)** |   | **(Restated)** |   | **(Restated)** |   |
| Raw materials                    |   | **$**                    | **600**    | ** ** | $ | 6,741 |   | $ | 636 |   | $ | 131 |   |
| Finished goods                   |   | **—**               | ** ** | 3,552 |   | — |   | — |   |
|                             |   | **600**                  |       | 10,293 |   | 636 |   | 131 |   |
| Allowance for obsolete inventory |   | **(600**                 | **)**      | (3,811 | ) | — |   | — |   |
|                             |   | **$**                    | **—** |   | $ | 6,482 |   | $ | 636 |   | $ | 131 |   |

 

**Note 10 – Notes Receivable and InterestReceivable from Related Parties**

 

The following summarizes components of notes and interest receivablefrom related party (*in thousands*):

 
|                                  |   | **As of  June 30,** |      |
|---------------------------------------|--------|--------------------------|-----------|
|                                  |   | **2002**                 |      | **2001** |   | **2000** |   | **1999** |   |
|                                  |   |                     |      | **(Restated)** |   | **(Restated)** |   | **(Restated)** |   |
| Notes receivable from related parties |   | **$**                    | **5,256** | ** ** | $ | 5,034 |   | $ | 11,915 |   | $ | — |   |
| Allowance for doubtful accounts       |   | **(1,734**               | **)**     | (1,734 | ) | (1,355 | ) | — |   |
|                                  |   | **$**                    | **3,522** |   | $ | 3,300 |   | $ | 10,560 |   | $ | — |   |

 

As discussed in Note 4, inDecember 2001, the Company sold, to an unrelated party approximately 92%of its investment in Arescom for $10,000,000. In connection with this agreement, the Company and Arescom entered intoan exchange agreement, whereby the Company forgave $13,235,000 due from Arescomin exchange for a new promissory note for the principal sum of $2,192,000 and11,000 shares of subordinated preferred stock of Arescom. The New Note, dueNovember 3, 2002 accrues interest at a rate of 4% per annum.  Accrued and unpaid interest shall become dueand payable on November 3, 2002. The payment of principal under the New Note and interest thereon, shallbe secured by the grants to Lotus Pacific of a security interest in all of theCompany’s right, title and interest in all amounts owing to the Company fromMicrosoft Corporation under that certain Modem Purchase Agreement, datedFebruary 7, 2000 among Arescom and Microsoft Corporation pursuant to theLoan and Security Agreement.  Arescomwas unable to make payments in accordance with the terms of the agreement andbecame delinquent on the note.  In May2003, the Company filed an action against Arescom seeking to recover fromArescom $1,704,000, representing amounts previously due on the promissory noteand damages resulting from Arescom’s failure to cooperate with the Company inits efforts to restate and reaudit the Company’s consolidated financialstatements for prior periods. See Note 2. In September 2003, the Company settled all claims against Arescom,including all amounts previously due on the promissory note datedDecember 14, 2001 that were paid in installments through December 15,2003.  As part of the settlement, theCompany also exchanged with certain shareholders of Arescom all of the sharesof Arescom common stock and Series B Preferred Stock held by the Company forall of the shares of the Company’s common stock held by such shareholders.  Pursuant to the stock swap agreement, theCompany was to acquire a total of 3,886,000 shares of its stock.  Arescom agreed to hold in escrow all of theArescom shares previously held by Lotus for a period of one year.  At the end of such period, if any additionalshareholders have not then tendered their Lotus shares and as a result, Arescomhas not distributed the escrowed Arescom shares, Arescom

 

F-27

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will retain the escrowed Arescom shares andindemnify Lotus for any claims by shareholders who have not then tendered theirLotus shares.   The Company is in theprocess of acquiring the remaining shares.  There was no value on the Company’s books for the Arescom shares at thedate of the transactions (See Note 4), and as a result, there was no gain orloss associated with this transaction.

 

On April 7, 2000, the Company loaned $10,000,000 toTurboComm.  Originally the promissorynote was due one year from effective date with interest at the rate of 6% peryear.  TurboComm was unable to makepayments in accordance with the terms of the agreement and became delinquent onthe note.   As a result, the Companysuspended interest income accruals and all payments received were applied tothe principal balance.  The principalbalance due on the note was $1,320,000, $3,000,000 and $10,000,000 as ofJune 30, 2002, 2001 and 2000, respectively.  Payment of the remaining principal was received in fiscal 2003.

 

In fiscal 2000, the Company loaned USS Online $1,300,000.  The loan was originally due on demand, withinterest at the rate of 8% per year.  Asof June 30, 2000, the Company deemed the note and the accrued interest of$55,000 as uncollectible and fully reserved against the principal and interestdue.  In March 2001, the note wasrefinanced and interest accrued during fiscal 2001 and 2000 totaling $134,000was added to the note.  Subsequent tothe refinancing, the Company suspended interest income accruals.  In fiscal 2001, the Company advanced$300,000 to PMB, a subsidiary of USS Online. There was no interest and no due date associated with the advance.  As of June 30, 2001, Lotus deemed theadvance uncollectible and fully reserved against the amount owed by PMB.  To date, the amounts have not been collectedand Lotus entered into litigation to obtain the total amount due to them.  On February 18, 2003, the Companyentered into a settlement agreement to settle all the disputes with USS Onlineand subsidiaries.  See Note 16.

 

In association with the sale of the Company’s joint venture interest inTCL International (U.S.), Inc. (see Note 7), the Company received a promissorynote from the buyer, a related party, in the amount of $560,000.  Payment in full, including principal andinterest accrued at 6.5% per year, was received on the note’s maturity date ofDecember 15, 2000.

 

In July 1999, the Company extended Regent a line of credit of upto $20,000,000 due on demand with interest accruing at 8% per annum.  At the time of the spin-off, Regent owed theCompany $4,398,000 in principal and accrued interest.  Regent agreed to pay accrued interest on the note receivable of$300,000. The Company determined that it was unlikely that the remainingbalance would be collected, and wrote off $4,098,000, which is included in gainon sale of investments in the consolidated statement of operations.  See Note 4.

 

**Note 11 – Property and Equipment**

 

The following summarizes components of property and equipment (*in thousands*):

 

|                                      |   | **As of  June 30,** |   |
|-------------------------------------------|--------|--------------------------|--------|
|                                      |   | **2002**                 |   | **2001** |   | **2000** |   | **1999** |   |
|                                      |   |                     |   | **(Restated)** |   | **(Restated)** |   | **(Restated)** |   |
| Computer hardware and purchased software  |   | $                        | 2,007  |   | $ | 1,789 |   | $ | 835 |   | $ | 306 |   |
| Office furniture and lab equipment        |   | 2,136                    |   | 1,888 |   | 1,543 |   | 816 |   |
| Leasehold improvements                    |   | 176                      |   | 141 |   | 141 |   | 43 |   |
|                                      |   | 4,319                    |   | 3,818 |   | 2,519 |   | 1,165 |   |
| Accumulated depreciation and amortization |   | (2,996                   | )      | (1,667 | ) | (891 | ) | (467 | ) |
|                                      |   | $                        | 1,323  |   | $ | 2,151 |   | $ | 1,628 |   | $ | 698 |   |

 

F-28

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**Note 12 – Notes Payable**

 

In June 1999, H&Q’s Asia Pacific Growth Fund (“H&Q”)advanced $22,900,000 to the Company in the form of a 10-day loan that would beconverted into an investment if the Company was able to obtain another$22,900,000 from other investors within a specified 10-day period.  The Company transferred the $22,900,000 toother companies that were under common control of the Company and these relatedcompanies then, transferred $21,795,000 of the funds back to the Company to beinvested in the Company. H&Q requested that the Company return the 10-dayloan immediately. On December 28, 1999, a settlement was agreed to wherebythe Company was to return the $22,900,000 to H&Q plus interest at 8% perannum accruing daily from June 18, 1999, plus $320,000 for legal fees andexpenses. As of June 30, 1999, the $22,900,000 is recorded in notespayable and the amounts received from the entities under common controltotaling $21,795,000 are recorded in Due to related parties. All amounts werepaid during fiscal 2000.

 

In July 2003, GoVideo entered into a financing agreement lastamended and restated in January 2004. The maximum line of credit available is $20,000,000, limited by aborrowing base determined by specific inventory and receivable balances, andprovides for cash loans, letters of credit and acceptances.  The agreement, as amended, has a term ofthree years.  Interest is charged atprime plus 1/2 percent subject to a minimum of not less than $15,000 percalendar month.  GoVideo pays a monthlyfee on the unused balance of the line of credit of 0.25 percent per year.  The line of credit is collateralized by allof GoVideo’s assets and up to $5,000,000 of the credit facility is guaranteedby Lotus Pacific.

 

Through the date of the report, the Company advanced $8,653,000 toGoVideo to fund GoVideo’s inventory purchases and fund their operatingexpenses.  These advances, which accrueinterest at annual rates of 3% to 5%, were due through January 2004.  The advances have not been repaid, andGoVideo and the Company are currently negotiating an extension on the duedates.

 

In June 2003, GoVideo borrowed $6,283,000 from TCL Industries andan entity affiliated with TCL Industries to fund inventory purchases and theiroperating expenses.  These advances,which accrue interest at annual rates of 4% and are guaranteed by Lotus, weredue in December 2003.  The advanceshave not been repaid, and GoVideo and TCL Industries are currently negotiatingan extension on the due dates.

 

**Note 13 – RelatedParty Transactions**

 

Amounts due from related parties of $2,981,000 and $24,253,000 atJune 30, 2000 and 1999 consist of cash transfers between entities undercommon control.  See Note 2.

 

During fiscal 2001, 2000 and 1999, the Company’s subsidiaries, Regentand Lotus World, engaged in extensive transactions with companies owned andmanaged by prior management.  Thesetransactions included advances, lease expense for the use of facilities,payroll expense for the use of employees, consulting expense, and other officeexpense.  Expense incurred to affiliatedentities for the years ended June 30, 2001, 2000 and 1999, was $3,000,$9,260,000, and $1,143,000, respectively. As of June 30, 2000 and 1999, the Company had accounts payable dueto these entities of $2,270,000 and $965,000, respectively.  There were no transactions with theseentities during fiscal 2002.

 

During fiscal 2002, the Company incurred consulting expense in the amountof $46,000 to entities related to a significant shareholder of theCompany.  Additionally, during fiscal2002 the Company leased a portion of the building to a significant shareholder(See Note16) and shared employees with the significant shareholder.  Amounts due from the shareholder for suchservices as of June 30, 2002 were $5,000.

 

F-29

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***Correlant***

 

**Cooperative Research and DevelopmentAgreement**. Correlant has significant transactions with two related partystockholders.  In 1997, the Companyestablished a relationship with Toshiba Corporation (Toshiba), wherebyCorrelant and Toshiba entered into a cooperative research and developmentagreement.  As part of this arrangement,the Company will pay Toshiba a percentage of the selling price of eachdeveloped product sold to customers, other than Toshiba, which utilizes thetechnology developed under the agreement. Royalty expense to Toshiba was $52,000, $819,000, $639,000 and $0 forfiscal 2002, 2001, 2000 and 1999, respectively.  Accounts payable to Toshiba for unpaid royalties as ofJune 30, 2002, 2001 and 2000 were $9,000, $123,000, and $639,000,respectively, and are included in accounts payable to related parties.

 

Toshiba accounted for 54%, 67%, 68% and 100% of the Company’sconsolidated revenues for the years ended June 30, 2002, 2001, 2000 and1999, respectively.  Accounts receivablefrom Toshiba as of June 30, 2001, 2000 and 1999 were $13,968,000, $5,654,000and $2,569,000, respectively and are included in accounts receivable, relatedparties on the consolidated balance sheet. Effective February 1, 2002, Correlant ceased selling completedcable modems directly to Toshiba.  As aresult, accounts receivable from Toshiba as of June 30, 2002 was zero.

 

**Manufacturing and Sales.**  Correlant also has an establishedrelationship with TurboComm, a company located in Taiwan that manufactureshigh-speed data over cable technology products.  Prior to February 1, 2002, Correlant purchased the completedcable modems from TurboComm.  For theyears ended June 30, 2002, 2001, 2000 and 1999, purchases of completedcable modems from TurboComm were $20,439,000, $221,997,000, $56,322,000 and$3,270,000 respectively.  Accountspayable to TurboComm was $238,000, $25,949,000, $15,075,000, and $2,779,000 asof June 30, 2002, 2001, 2000 and 1999, respectively, and is included inaccounts payable, related party in the consolidated balance sheet.

 

Additionally, during fiscal 2001, Correlant began selling the MAC toTurboComm for use by them in their own products.  For the years ended June 30, 2002, 2001 and 2000, MAC salesto TurboComm accounted for 37%, 3%, and 3% of total revenues, respectively. Asa result of the above transactions, accounts receivable from TurboComm amountedto $7,070,000 and $854,000 as of June 30, 2002 and 2001, respectively andis included in accounts receivable, related parties in the consolidated balancesheet.

 

**Note 14 – Stockholders’ Equity**

 

**PreferredStock**

 

Lotus has one class of preferred stock, which is designated Series Apreferred stock.  The par value is$0.001 per share and 100,000 shares are authorized.  Series A preferred stock has the same voting rights as commonstock, a liquidation preference of $10 per share, is entitled to the right toreceive dividends on the same per share basis as common shareholders and isredeemable by the Company, at its sole option in whole or in part, at any timeat $10 per share.  There are 4,000shares issued and outstanding at June 30, 2002, 2001, 2000 and 1999.

 

**Common Stock Transactions**

 

During the year ended June 30, 1999, the Company sold 385,000shares of common stock at stock prices ranging from $5.00 to $7.50 per sharefor cash consideration of $2,164,000. In connection with the sale of these shares, the Company issued 23,000shares of common stock to a related party for payment of commissions earned.

 

During the year ended June 30, 1999, the Company issued 15,043,000shares of common stock in exchange for securities of businesses acquired. SeeNotes 4 and 5.

 

During the year ended June 30, 2000, the Company issued 2,250,000shares of its common stock in exchange for 1,500,000 shares of outstandingpreferred stock of Regent.  See Note 2.

 

F-30

----

 

During the years ended June 30, 2001 and 2000, the Company issued2,000 and 77,000 shares of common stock valued at $18,000 and $554,000,respectively, to Correlant shareholders in connection with the Share ExchangeAgreement.  See Note 4.

 

In September 2003, the Company repurchased 4,241,000 shares ofcommon stock at $0.30 per share for a total cost of $1,272,000.

 

**Subsidiary Stock Transactions**

 

During the year ended June 30, 2001, Arescom sold preferred stockto third parties for net proceeds of $13,199,000, which has been recorded innon-controlling interest in subsidiaries on the consolidated balance sheet infiscal 2001.

 

During the years ended June 30, 2001 and 2000, Arescom issued31,000 and 3,000 shares upon the exercise of options for proceeds of $39,000and $4,000, respectively, which has been recorded in the Company’s consolidatedequity.  These transactions did not havea material effect on the Company’s ownership of Arescom.

 

During the year ended June 30, 2001, Arescom granted warrants toan affiliate of a bank in connection with the receipt of a waiver fornon-compliance with required covenants under their line of credit.  The estimated fair value of the warrant is$47,000, which was determined using the Black-Scholes valuation model.  The value of the warrants has been recordedin the Company’s consolidated equity.

 

During the years ended June 30, 2002, 2001 and 2000, Correlantissued  6,000, 6,000 and 177,000 sharesupon the exercise of options for proceeds of $9,000, $3,000 and $8,000,respectively. For the years ended June 30, 2002, 2001, and 2000, theCompany has recorded $4,000, $2,000, and $0 in consolidated equity for theissuance of these shares.  The remainingamount has been recorded in non-controlling interest in subsidiaries on theconsolidated balance sheet. These transactions did not have a material effecton the Company’s ownership of Correlant.

 

During the years ended June 30, 2002, 2001, and 2000, Correlentrecognized compensation expense of $1,657,000, $9,189,000, and $2,027,000,respectively for the difference between the exercise price and fair value ofstock options issued to employees. For the years ended June 30, 2002,2001, and 2000, the Company has recorded $1,203,000, $6,898,000, and $1,792,000in consolidated equity for the issuance of these shares.  The remaining amount has been recorded innon-controlling interest in subsidiaries on the consolidated balance sheet.

 

During the year ended June 30, 2000, Lotus World sold 592,942shares of common stock for proceeds of $1,350,000, of which $1,181,000 wasrecorded in the Company’s consolidated equity.

 

At the date the Company acquired a majority interest in Correlant,Correlant had preferred stock outstanding that Lotus did not acquire.  In addition, in April and May 1999,Correlant sold preferred stock to third parties for net proceeds of $1,463,000,which has been recorded in non-controlling interest in subsidiaries on theconsolidated balance sheet.  Thepreferred stock held by third parties has a preference in liquidation over thecommon shareholders of $8,425,000, which has been included in non-controllinginterest in subsidiaries on the consolidated balance sheets for fiscal 2002,2001, 2000 and 1999.

 

**Stock Warrants**

 

In May1997, the Company issued 8,000,000 common stock warrants for $80,000.  Each warrant entitled the holder to purchaseone share of the Company’s common stock at $6 per share. All warrants expiredMay 5, 2002 and as such, the $80,000 proceeds received were reclassed fromwarrants to additional paid in capital at June 30, 2002.

 

F-31

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**Stock Option Plans**

 

***Lotus***

 

In May 1997, Lotusgranted 1,090,000 options to certain officers and key employees with anexercise price of $6.00 per share, which was the market price of Lotus’s commonstock at the time of grant.  Optionswere 100% vested when granted and expire five years from grant date.  As of June 30, 2001, 2000 and 1999,1,090,000 options were outstanding.  Alloptions expired during the year ended June 30, 2002 and as such there wereno options outstanding as of June 30, 2002.

 

The shareholdersapproved the 2000 Equity Incentive Plan (Incentive Plan) on April 28,2000. The Board of Directors administers the Incentive Plan. Employees,directors, and consultants of the Company and its affiliates, who in thejudgment of the Board render significant service to the Company, are eligibleto participate. The Incentive Plan provides for the award of a broad variety ofstock-based compensation alternatives such as nonstatutory stock options, incentivestock options, restricted stock, performance awards and stock appreciationrights. The Incentive Plan provided 11,355,000 shares of common stock to beoffered. The vesting provisions of individual options may vary. The exerciseprice shall not be less than 100% of the fair market value of a common stock onthe grant date. No options have been granted since the Incentive Plan’sadoption.

 

***Correlant***

 

InMarch 1998, Correlant’s Board of Directors approved the 1998 StockOption/Stock Issuance Plan (1998 Plan) under which 8,500,000 shares of commonstock are authorized for issuance, and reserved for purchase upon exercise ofoptions granted.  The 1998 Plan providesfor the grant of incentive and non-statutory options and issuance of commonstock under the stock issuance program (as defined) to employees, directors,and consultants.

 

The exercise priceof incentive stock options must equal at least the fair value on the date ofgrant and the exercise price of non-statutory stock options and the issuance priceof common stock under the stock issuance program may be no less than 85% of thefair value on the date of grant or issuance. The options are exercisable for a period of up to ten years after thedate of grant.  Options granted prior toAugust 2001 vest over four years at the rate of 25% on each anniversary ofthe vesting start date.  Options grantedsubsequent to August 2001 vest over three years at the rate of 33% afterthe first and second anniversaries and the remainder after the thirdanniversary.

 

Correlant reviewedits exercise prices and arrived at the fair value for accounting purposes foreach option grant since July 1, 1999. With respect to the 597,000 options granted between July 1, 1999and June 30, 2000, the Company recorded deferred stock compensation of$5,144,000 for the difference between the exercise price per share determinedby Correlant’s Board of Directors and the fair value per share for accountingpurposes at the grant date.  Theapproximate weighted average fair value per share for accounting purposes was$14.23.  Deferred stock compensation isrecognized and amortized on an accelerated basis in accordance with FIN 28 overthe vesting period of the related options, generally four years.

 

In connection withthe acquisition by Lotus in March 1999, Lotus obtained the right toacquire up to 2,674,000 additional Correlant shares upon acquisition of suchshares by the option holders.  Alloptions granted by Correlant through December 21, 1999 are subject to anexchange agreement, whereby Lotus will acquire 81% of the shares exercised inexchange for 0.5364 shares of Lotus stock for each Correlant shareexchanged.  The Lotus shares into whichthe acquired shares are exchangeable were restricted from sale until Correlantmet certain financial milestones and the options were, at the time of grant,considered to be contingent.  EffectiveAugust 31, 2000, the restrictions were removed and, accordingly, theCompany recorded deferred stock compensation for 2,613,000 previouslycontingent options that were outstanding as of the date the restrictions werelifted.  The deferred stock compensationrecorded related to these shares is being amortized over the vesting periods ofthe related options on an accelerated basis in accordance with FASB Interpretation28, *Accountingfor Stock Appreciation Rights and Other Variable Stock Option or Award Plans*.   The total deferred compensation relating tothe previously contingent options is $9,034,000 based on the value of theoptions on the date the contingency was removed.

 

F-32

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The followingtable summarizes stock option activity under the 1998 Stock Option Plan andrelated information through June 30, 2002 (*in thousands*):

 

|                                          |   | **Options**   |       | **Weighted-  Average Exercise  Price** |       |
|-----------------------------------------------|--------|---------------|------------|----------------------------------------|------------|
| Outstanding at date of acquisition            |   | 1,157,000     |       | 0.06                                   |       |
| Granted                                       |   | —        |       | —                                 |       |
| Exercised                                     |   | —        |       | —                                 |       |
| Cancelled                                     |   | —        |       | —                                 |       |
| Outstanding at June 30, 1999  (Restated) |   | 1,157,000     |       | 0.06                                   |       |
| Granted                                       |   | 2,310,000     |       | 2.16                                   |       |
| Exercised                                     |   | (177,000      | )          | 0.04                                   |       |
| Cancelled                                     |   | (13,000       | )          | 0.06                                   |       |
| Outstanding at June 30, 2000  (Restated) |   | 3,277,000     |       | 1.54                                   |       |
| Granted                                       |   | —        |       | —                                 |       |
| Exercised                                     |   | (6,000        | )          | 0.48                                   |       |
| Cancelled                                     |   | (113,000      | )          | 0.79                                   |       |
| Outstanding at June 30, 2001  (Restated) |   | 3,158,000     |       | 1.57                                   |       |
| **Granted**                                   |   | **1,616,000** | ** ** | **1.50**                               | ** ** |
| **Exercised**                                 |   | **(6,000**    | **)**      | **1.50**                               | ** ** |
| **Cancelled**                                 |   | **(685,000**  | **)**      | **2.60**                               | ** ** |
| **Outstanding at  June 30, 2002**        |   | **4,083,000** | ** ** | **$**                                  | **1.37**   | ** ** |
|                                               |        |               |            |                                        |            |  |

 

As of June 30, 2002, 2001, 2000 and 1999 there were 2,080,000,1,108,000, 290,000, and 204,000 options exercisable at the weighted averageprice of $1.18, $1.14, $0.06, and $0.04 per share, respectively.  There are 4,183,000 shares are available forfuture grant at June 30, 2002.

 

The following table summarizes all options outstanding by price rangeas of June 30, 2002:

 
|                          |   | **Options  Outstanding** |      | **Options  Exercisable**                             |   |
|-------------------------------|--------|--------------------------|-----------|------------------------------------------------------|--------|
| **Range of  Exercise Prices** |   | **Number  Outstanding**  |      | **Weighted-  Average  Remaining  Contractual  Life** |   | **Weighted-  Average  Exercise Price** |   | **Number  Exercisable** |   | **Weighted-  Average  Exercise  Price** |   |
| $0.029 to 0.095               |   |                     | 938,000   |                                                 | 6.14   |   | $ | 0.07 |   | 739,000 |   | $ | 0 .07 |   |
| 1.00 to 1.50                  |   |                     | 3,020,000 |                                                 | 7.83   |   | 1.22 |   | 1,279,000 |   | 1.17 |   |
| 12.00 to 15.00                |   |                     | 125,000   |                                                 | 7.83   |   | 14.65 |   | 62,000 |   | 14.65 |   |
| $0.029 to 15.00               |   |                     | 4,083,000 |                                                 | 7.44   |   | $ | 1.37 |   | 2,080,000 |   | $ | 0.18 |   |

 

As discussed in Note 3, Correlant accounts for stock-based awards usingthe intrinsic value method in accordance with APB 25 and its relatedinterpretations. SFAS 123 requires the disclosure of pro forma net income(loss) and earnings (loss) per share as if Correlant adopted the fair valuemethod as of the inception of the company. The weighted-average fair value of options granted during the yearsended June 30, 2002 and 2000 was $1.14, and $11.31 respectively.  There were no options granted in 2001 or1999.  The calculations were made usingthe Black-Scholes option-pricing model. The fair value of the Company’sstock-based awards to employees was estimated assuming no expected dividend andthe following weighted-average assumptions for 2002 and 2000:  expected volatility of 78% and 62%,respectively; risk-free interest rate of 5.5% and 5.0%, respectively; and aweighted-average expected life of the options of five years.  For purposes of pro forma disclosures, theestimated fair value is amortized on an accelerated basis in accordance withFIN 28 over the vesting period.

 

F-33

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**Note 15 – Income Taxes**

 

The provision(benefit) for income taxes for the years ended June 30, 2002, 2001, 2000and 1999 is comprised of the following (*in thousands*):

 
|      |   | **Year Ended  June 30,** |   |
|-----------|--------|-------------------------------|--------|
|      |   | **2002**                      |   | **2001** |   | **2000** |   | **1999** |   |
|      |   |                          |   | **(Restated)** |   | **(Restated)** |   | **(Restated)** |   |
| Current:  |   |                          |   |   |   |   |   |   |   |
| Federal   |   | $                             | (5,016 | ) | $ | (4,691 | ) | $ | 16,621 |   | $ | 8 |   |
| State     |   | 2                             |   | (1,260 | ) | 4,478 |   | 1 |   |
| Foreign   |   | (164                          | )      | 1,514 |   | — |   | — |   |
|      |   | (5,178                        | )      | (4,437 | ) | 21,099 |   | 9 |   |
| Deferred: |   |                          |   |   |   |   |   |   |   |
| Federal   |   | 1,564                         |   | (1,564 | ) | — |   | — |   |
| State     |   | 433                           |   | (433 | ) | — |   | — |   |
| Foreign   |   | —                        |   | — |   | — |   | — |   |
|      |   | 1,997                         |   | (1,997 | ) | — |   | — |   |
| Total     |   | $                             | (3,181 | ) | $ | (6,434 | ) | $ | 21,099 |   | $ | 9 |   |

 

The reportedprovision (benefit) for income taxes for the year ended June 30, 2002,2001, 2000 and 1999 differ from the amount computed by applying the statutoryfederal income tax rate of 35 percent to the consolidated income (loss)before income taxes as follows (*in thousands*):

 
|                                             |   | **Year Ended  June 30,** |    |
|--------------------------------------------------|--------|-------------------------------|---------|
|                                             |   | **2002**                      |    | **2001** |   | **2000** |   | **1999** |   |
|                                             |   |                          |    | **(Restated)** |   | **(Restated)** |   | **(Restated)** |   |
| Provision (benefit) computed at statutory  rates |   | $                             | (13,899 | ) | $ | (4,853 | ) | $ | 6,598 |   | $ | (2,315 | ) |
| Increase (reduction) resulting from:             |   |                          |    |   |   |   |   |   |   |
| Permanent differences                            |   | 10,372                        |    | (1,933 | ) | 7,609 |   | 911 |   |
| State taxes, net of federal benefit              |   | 435                           |    | (1,534 | ) | 2,911 |   | 1 |   |
| Utilization of NOLs                              |   | (4,425                        | )       | (12,603 | ) | (2,258 | ) | — |   |
| Valuation allowance                              |   | 4,336                         |    | 14,489 |   | 6,239 |   | 1,412 |   |
| Total                                            |   | $                             | (3,181  | ) | $ | (6,434 | ) | $ | 21,099 |   | $ | 9 |   |

 

The components ofthe Company’s net deferred income tax asset as of June 30, 2002, 2001,2000 and 1999 are as follows (*in thousands*):

 
|                                        |   | **Year Ended  June 30,** |       |
|---------------------------------------------|--------|-------------------------------|------------|
|                                        |   | **2002**                      |       | **2001** |   | **2000** |   | **1999** |   |
|                                        |   |                          |       | **(Restated)** |   | **(Restated)** |   | **(Restated)** |   |
| Current deferred tax assets:                |   |                          |       |   |   |   |   |   |   |
| Accrued expenses                            |   | **$**                         | **215**    | ** ** | $ | 571 |   | $ | 1,021 |   | $ | 172 |   |
| Deferred compensation                       |   | **5,487**                     | ** ** | 4,652 |   | — |   | — |   |
| Deferred revenue                            |   | **126**                       | ** ** | 324 |   | — |   | — |   |
| Inventory reserves                          |   | **244**                       | ** ** | 1,553 |   | — |   | — |   |
| Allowance for bad debts                     |   | **69**                        | ** ** | — |   | 554 |   | — |   |
| Total                                       |   | **6,141**                     | ** ** | 7,100 |   | 1,575 |   | 172 |   |
| Valuation allowance for deferred tax assets |   | **(6,141**                    | **)**      | (5,103 | ) | (1,575 | ) | (172 | ) |
| Net deferred tax assets                     |   | **$**                         | **—** | ** ** | $ | 1,997 |   | $ | — |   | $ | — |   |
|                                        |   |                          | ** ** |   |   |   |   |   |   |
| Non-current deferred tax assets:            |   |                          | ** ** |   |   |   |   |   |   |
| Depreciation and amortization               |   | **$**                         | **—** | ** ** | $ | — |   | $ | 2 |   | $ | 2,441 |   |
| Net operating loss carryforwards            |   | **949**                       | ** ** | 1,756 |   | 7,172 |   | 5,115 |   |
| Tax credit carryforwards                    |   | **1,027**                     | ** ** | — |   | 1,581 |   | 922 |   |
| Total                                       |   | **1,976**                     | ** ** | 1,756 |   | 8,755 |   | 8,478 |   |
| Valuation allowance for deferred tax assets |   | **(1,976**                    | **)**      | (1,756 | ) | (8,755 | ) | (8,478 | ) |
| Net deferred tax assets                     |   | **$**                         | **—** | ** ** | $ | — |   | $ | — |   | $ | — |   |

 

F-34

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The net change in the total valuation allowance for the fiscal years2002, 2001, 2000, and 1999 was an increase of $1,258,000 a decrease of$3,471,000 an increase of $1,680,000 and an increase of $4,711,000 respectively.  In assessing the realizability of deferredtax assets, the Company considers whether it is more likely than not that someportion or all of the deferred tax assets will not be realized. The ultimaterealization of deferred tax assets is dependent upon the generation of futuretaxable income during the periods in which those temporary differences becomedeductible. The Company considers the projected future taxable income and taxplanning strategies in making this assessment. Based on the level of historicaloperating results and projections of taxable income for the future, the Companyhas determined that it is more likely than not that the deferred tax assetswill not be realized through future taxable earnings. Accordingly, a valuationallowance was recorded to reduce deferred tax assets to the amount that is morelikely than not to be realized. There can be no assurance that the Company willever be able to realize the benefit of some or all of the federal and stateloss carryforwards either due to ongoing operating losses or due to ownershipchanges, which limit the usefulness of the loss carryforwards.

 

At June 30, 2002, the Company has a California net operating losscarryforward of $10,835,000 which will begin to expire in 2013 unless previouslyutilized.  The federal net operatinglosses generated in fiscal 2002 and 2001 were carried back to fiscal 2000 andare reflected as an income tax receivable in fiscal 2002 and 2001.

 

The Company is currently under IRS audit for tax years endingJune 30, 2001, 2000, and 1999. The IRS may propose certain adjustments,which could be material in amount, in connection with its audit of theseperiods. The Company believes that it has provided sufficiently for all auditexposures.

 

At June 30, 2002, Correlant has federal and state research anddevelopment credit carryforwards of $421,000 and $442,000 respectively, whichwill begin to expire in 2022 unless previously utilized.

 

At June 30, 2002, Correlant has a foreign tax credit carryforwardof $164,000, which will begin to expire in 2007 unless previously utilized.

 

Federal and state tax laws impose restrictions on the utilization ofnet operating loss and tax credit carryforwards in the event of an “ownershipchange” for tax purposes as defined under Section 382 of the InternalRevenue Code.

 

On September 11, 2002, the Governor of California signed into lawnew tax legislation that suspends the use of NOL carryforwards into tax yearsbeginning on or after January 1, 2002 and 2003.  Should the Company have taxable income for the year endingJune 30, 2004, it may not look to California net operating lossesgenerated in prior years to offset taxable income.  This suspension will not apply to tax years beginning in 2005 andbeyond.

 

**Note 16 – Commitmentsand Contingencies**

 

***Leases***

 

The Company leases its facilities and certain equipment undernon-cancelable operating leases, expiring at various dates through 2007.  In addition, the Company leases a portion ofthe building to a significant shareholder of the Company. The following is aschedule by years of future minimum lease payments under operating leasesand future non-cancelable sublease income *(inthousands):*

 

| **Years Ended June 30,** |   | **Future  Minimum Lease  Payments** |   | **Future  Non-  cancelable  Sublease Income** |   | **Net Future  Minimum Lease  Payments** |   |
|-------------------------------|--------|-------------------------------------|--------|-----------------------------------------------|--------|-----------------------------------------|--------|
| 2003                          |   | $                                   | 379    |                                          | $      | 11                                      |   | $ | 368 |   |
| 2004                          |   | 404                                 |   | —                                        |   | 404                                     |   |
| 2005                          |   | 411                                 |   | —                                        |   | 411                                     |   |
| 2006                          |   | 389                                 |   | —                                        |   | 389                                     |   |
| 2007 and thereafter           |   | 225                                 |   | —                                        |   | 225                                     |   |
|                          |   | $                                   | 1,808  |                                          | $      | 11                                      |   | $ | 1,797 |   |

 

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Rent expensetotaled $496,000, $595,000, $416,000 and $357,000 for the years endedJune 30, 2002, 2001, 2000 and 1999, respectively.  During fiscal 2002, the Company received$8,000 in rental income from the significant shareholder.

 

In August 2003, the Company entered intoa new facility lease and moved its executive offices.  The lease, which commences on August 1, 2003, is on amonth-to month basis and provides for monthly rental of $4,000 per month.

 

Correlant leases approximately 26,000 squarefeet of office space in San Diego, California, which expiresNovember 2007.  Due to the shutdown of operations, Correlant’s interim management has attempted to eithersublease the San Diego facility or negotiate a lease buy out with thelandlord.  Due to the weak commercialreal estate market in San Diego, interim management has not been successful.

 

GoVideo, which was acquired inApril 2003, has an operating lease for a 33,000 square foot facility thatis used for both office space and warehousing. The remaining term of the lease is approximately two years.  Monthly rentals are based on a fixedschedule that provides for periodic rental adjustments during the leaseterm. The future minimum payments required under this lease are approximately$310,000 per year.

 

GoVideo also leases a 13,000 square footfacility under another operating lease that is used for warehousing.  The term of the lease is for five years andbegan on November 11, 1999. Monthly rentals are based on a fixed schedule that provides forperiodic rental adjustments during the lease term.  Upon expiration of the initial term of these leases, there is anoption to extend the term for an additional five years. The future minimumpayments required under this lease are approximately $150,000 per year.

 

**EmployeeSeparation Agreements**

 

In connection with Mr. Tuan’s resignationfrom Correlant in July 2003 (See Note 1), the Company entered into anEmployment Separation Agreement/Consulting Agreement with Mr. Tuan.  Under the terms of the agreement, Correlantagreed to pay to Mr. Tuan $20,000 and repurchase 327,000 Correlant shares heldby Mr. Tuan for $0.07 per share for a total of $23,000.  In addition, the Company will pay to Mr.Tuan $23,000 per month for one year for Mr. Tuan to provide advice and input onCorrelant business matters related to certain matters.

 

In connection with Mr. Lum’s resignation fromCorrelant in July 2003 (See Note 1), the Company entered into anEmployment Separation Agreement/Consulting Agreement with Mr. Lum.  Under the terms of the agreement, Correlantagreed to pay to Mr. Lum $2,000 and repurchase 272,000 Correlant shares held byMr. Lum for $0.07 per share for a total of $19,000.  In addition, the Company will pay to Mr. Lum $20,000 per monthfor one year for Mr. Lum to provide advice and input on Correlant businessmatters related to certain matters.

 

***Litigation***

 

On April 11, 2003 Sharp Electronicsfiled suit against Correlant in the United States District Court for theDistrict of Delaware. The complaint alleged cancellation of a purchase orderoutside the allowable cancellation timeframe under the terms of the purchaseorder.  The complaint sought payment ofthe purchase order totaling $1,150,000. Correlant filed an answer on June 16, 2003, stating the componentsdelivered by Sharp Electronics did not meet product specification and wereunusable.  On that same date, Correlantfiled a counter suit for seeking recovery of components previously delivered bySharp, which also did not meet product specification.  Correlant sought to recover damages totaling $1,450,000.  See Note 20.

 

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On January 3, 2001, Lotus Pacific fileda lawsuit in the United District Court Eastern District of New York againstWilliam Hu, which complaint was subsequently amended July 30, 2002.  In the amended complaint, Lotus Pacificbrought claims for breach of fiduciary duty, professional negligence,accounting and conversion relating to transfers in December 2000 ofapproximately $3,600,000 million from Mr. Hu’s attorney trust account.  Mr. Hu was alleged to be the Company’scounsel from January 1998 and later its former CEO from January 2001to June 29, 2001.

 

On January 16, 2002, Lotus Pacific fileda lawsuit in the Supreme Court of the State of New York, New York Countyagainst USS Online, Travelway, and Huaya Lu Tung, seeking to recover $1,800,000in principal and interest due on loans made to USS Online (See Note10), andseeking to pierce the corporate veil and recover such amounts from defendantsTravelway and Huaya Lu Tung. The Company is a holder of a 28% minority interestin USS Online, and Travelway is the 72% equity owner of USS Online.  The Company asserted that Ms. Tung was theChairperson and sole owner of Travelway and Chairperson of USS Online and the formerTreasurer of the Company.

 

In February 2003, the Company enteredinto a settlement agreement with USS Online, Travelway, Mr. Hu, Ms. Tung, LotusInternational Holdings Corp (LIH), a shareholder of the Company and threeindividuals to settle all claims against the defendants in the two cases citedabove, subject to a number of conditions. In entering into the settlement agreement, none of the defendantsadmitted or conceded any liability in connection with the claims asserted inthe cases.  As conditions to thesettlement agreement, the Company was required to receive: (a) 3,000,000 sharesof the Company’s common stock; (b) a promissory note of LIH in the principalamount of $4,000,000, payable on February 19, 2008, with interest accruingat a rate of 3% per annum (the “Note”); (c) a stock pledge agreement, grantingto the Company a first priority security agreement in 1,000,000 shares of theCompany’s common stock as partial security for the Note (the “Pledged Shares”);(d) original stock certificates representing the Pledged Shares; (e) personalguaranty of the Note; and (f) all of the assets of USSF. To date, the Companyreceived 3,000,000 shares of the Company’s common stock, however, they have notreceived stock certificates for the Pledged Shares or the assets of USSF andhas made demand on the other parties for fulfillment of the conditions to thesettlement.  The Company has reservedthe right to take all actions for breach of the settlement, including reinstitutingthe original action.

 

**Guarantees**

 

In October 2002, the Company guaranteedGoVideo’s performance under a vendor agreement for up to $5,000,000.

 

**Note 17 – EmployeeBenefit Plan**

 

Lotus has a 401(k) salary deferral Plan (Lotus Deferral Plan), which isfunded based on employee contributions. The terms of the original Lotus Deferral Plan does not require Lotus tomake contributions to the Deferral Plan on behalf of each eligibleemployee.  As such, Lotus did not makeDeferral Plan contributions for the years ended June 30, 2002, 2001, 2000 and1999.

 

Correlant has a 401(k) salary deferral Plan (Deferral Plan), which isfunded based on employee contributions. The terms of the original Deferral Plan provide for Correlant to makecontributions to the Deferral Plan on behalf of each eligible employee (asdefined) in an amount equal to 50% on the first 4% of the eligible employee’sdeferred compensation contribution (as defined).  Beginning January 1, 2001, Correlant changed itscontribution to 100% of the first 6% of the eligible employee’s deferredcompensation contributions.  Correlant’scontributions to the Deferral Plan were $196,000, $64,000, $56,000 and $24,000for the years ended June 30, 2002, 2001, 2000 and 1999, respectively.

 

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**Note 18 – Segment andGeographic Information**

 

The Company’s operating divisions consist of its geographically basedentities in the United States and Taiwan. All such operating divisions have similar economic characteristics asdefined by SFAS 131, *Disclosures about Segments of an Enterprise andRelated Information*. Accordingly, the Company operates in one industry segment: thedevelopment, manufacture and distribution of products used for broadbandInternet access, including data-over-cable equipment and digital subscriberline (DSL) access and networking devices. During fiscal 2002, 2001, 2000 and 1999, the Company recorded revenuesthroughout the United States, Taiwan and Japan as determined by the finaldestination of the product.  Thefollowing table summarizes total net revenues attributable to significantcountries (*inthousands*):

 
|           |   | **Year Ended June 30,** |   |
|----------------|--------|------------------------------|--------|
|           |   | **2002**                     |   | **2001** |   | **2000** |   | **1999** |   |
| Japan          |   | $                            | 30,033 |   | $ | 175,893 |   | $ | 48,993 |   | $ | 3,726 |   |
| Taiwan         |   | 20,757                       |   | 9,178 |   | 2,372 |   | — |   |
| United  States |   | 5,090                        |   | 78,121 |   | 20,474 |   | 7 |   |
|           |   | $                            | 55,880 |   | $ | 263,192 |   | $ | 71,839 |   | $ | 3,733 |   |

 

Presented below is informationregarding identifiable assets from continuing operations, classified byoperations located in the United States and Taiwan (*in thousands*):

 
|           |   | **Year Ended June 30,** |   |
|----------------|--------|------------------------------|--------|
|           |   | **2002**                     |   | **2001** |   | **2000** |   | **1999** |   |
| United  States |   | $                            | 52,842 |   | $ | 88,460 |   | $ | 108,684 |   | $ | 154,579 |   |
| Taiwan         |   | 500                          |   | 28,754 |   | 13,053 |   | 4,045 |   |
|           |   | $                            | 53,342 |   | $ | 117,214 |   | $ | 121,737 |   | $ | 158,624 |   |

 

**Note 19 – SelectedQuarterly Financial Data (unaudited)**

 

For adescription of the restatement items and the effect on annual periods forfiscal 2001, 2000 and 1999, which also affect the unaudited quarterly data, seeNote 2.  The following tablepresents the impact of the restatement adjustments on the Company’s previouslyreported quarterly financial results for the first three quarters of fiscal2002 (*inthousands, except per share data*). As we have not previously filed our June 30, 2002 Form 10-K, ourfourth quarter numbers have not been restated.

 
|                            |   | **Fiscal  2002**             |   |
|---------------------------------|--------|------------------------------|--------|
|                            |   | **First  Quarter**           |   | **Second  Quarter** |   | **Third  Quarter** |   | **Fourth  Quarter** |   |
|                            |   | **As  previously  reported** |   | **As  restated** |   | **As  previously  reported** |   | **As  restated** |   | **As  previously  reported** |   | **As  restated** |   |   |   |
| **Statement of  Operations:**   |   |                         |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total revenues                  |   | $                            | 36,672 |   | $ | 20,315 |   | $ | 32,804 |   | $ | 13,817 |   | $ | 11,184 |   | $ | 11,166 |   | $ | 10,582 |   |
| Gross profit                    |   | 2,137                        |   | 264 |   | 3,455 |   | 205 |   | 4,353 |   | 2,295 |   | 3,175 |   |
| Net loss                        |   | $                            | (5,869 | ) | $ | (6,454 | ) | $ | 27,973 |   | $ | 14,341 |   | $ | (380 | ) | $ | (3,679 | ) | $ | (23,183 | ) |
| Net loss per share – basic |   | $                            | (0.09  | ) | $ | (0.10 | ) | $ | 0.44 |   | $ | 0.22 |   | $ | (0.01 | ) | $ | (0.06 | ) | $ | (0.36 | ) |

 

The decrease in total revenues during the first two quarters isprimarily the result of reclassifying Arescom as discontinued operations.  Total revenue attributed to Arescom in theoriginal filings was $16,751,000 and $18,916,000 for the quarters endingSeptember 30, 2002 and December 31, 2002, respectively.  During the quarter ended September 30,2002, this decrease in revenues was slightly offset by an increase inCorrelant’s software license revenue of $374,000 to reflect the actual softwarelicense agreement.

 

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The decrease in gross profit during the first two quarters is primarilythe result of reclassifying Arescom as discontinued operations.  The total gross profit attributed to Arescomin the original filings was $3,791,000 and $3,180,000 for the quarters endingSeptember 30, 2002 and December 31, 2002, respectively.  During the quarter ended September 30,2002, this decrease was offset by a decrease in Correlant’s cost of revenuesdue to the reversal of a reserve originally recorded for obsolete inventory,$1,524,000, which was reversed during the third quarter.  During the quarter ended March 31,2003, the decrease in gross profit was the result of reversing the recovery ofinventory reserve booked by Correlant during the first quarter.

 

In addition to the items discussed above, the increase in net loss forthe first quarter is due to an increase in amortization of goodwill of$2,761,000 and a decrease in non-controlling interest in the net loss of theconsolidated subsidiaries of $914,000. This was slightly offset by a decrease in bonus expense.

 

In addition to the items discussed above, the decrease in the netincome for the second quarter is due a decrease in the gain recognized on thesale of Arescom of $15,534,000, (See Note 4) an increase in amortization ofgoodwill of $1,761,000, and a decrease in the minority interest in the net lossof the consolidated subsidiaries of $395,000. This was offset by an increase in the income tax benefit of $933,000 andan increase in net income attributable to discontinued operations of$3,008,000.

 

In addition to the items discussed above, the increase in net loss forthe third quarter is due to an increase in amortization of goodwill of $410,000and a decrease in the income tax benefit of $1,479,000.  This was slightly offset by a decrease innon-controlling interest in the net loss of subsidiaries of $714,000.

 

During the fourth quarter, the Company recorded an impairment relatingto the goodwill associated with Correlant of $20,071,000.  See Note 3.

 

**Note 20 – Subsequent Events (Unaudited)**

 

On January 21, 2004 Sharp agreed tosettle all disputes with Correlant for $500,000.  Additionally, as part of the settlement, Correlant dropped itscountersuit.

 

In February 2004, the Companyrepurchased 2,445,000 shares of common stock at $0.30 per share for a totalcost of $734,000.   The Board ofDirectors plans to continue to review potential repurchases of its common stockand will continue to approve the repurchase transactions on a case by casebasis.

 

In March 2004, GoVideo executed two-year employment agreementswith its top executives for an aggregate base salary of $779,000 per year, plusa severance package to include nine to ten months of base salary forterminations without cause.

 

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