##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 Form 10-K (Mark One)þ
    
    Annual Report
Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934.
 For the Fiscal Year ended December 31, 2003. OR o
    
    Transitional
Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
 For the transition period from: ______ to: ______. Commission file number 0-32809 Vialta, Inc. (Exact name of registrant as specified in its charter)
 Delaware(State or Other Jurisdiction of
Incorporation or Organization)
    
    94-3337236(I.R.S. Employer Identification No.)
 48461 Fremont Boulevard
Fremont, California 94538(Address, including zip code, of Registrants principal executive offices) (510) 870-3088(Registrants telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes
þ  No o Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or any
amendments to this Form 10-K. þ Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 126-2) Yes
o  No
þ The aggregate market value of the voting and non-voting common equity held
by non-affiliates of the registrant on June 30, 2003 (based on the average bid
and ask price on the OTC Bulletin Board as of such date) was approximately
$16,500,000. The number of outstanding shares of the registrants common stock, par
value $0.001 per share, on March 5, 2004 was 82,841468 shares. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrants definitive proxy statement relating to its
2004 annual meeting of stockholders to be filed with the Securities and Exchange Commission not
later than 120 days after the end of the fiscal year to which this Report
relates, are incorporated by reference into Part III of this Form 10-K Report.    1




---



VIALTA, INC. FORM 10-K For the Fiscal Year Ended December 31, 2003 INDEX 
 PagePART IItem 1.
    
    Business
    
    
    4Item 2.
    
    Properties
    
    
    6Item 3.
    
    Legal Proceedings
    
    
    6Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    6PART IIItem 5.
    
    Market for the
Registrants Common Equity and Related Shareholder Matters
    
    
    7Item 6.
    
    Selected Financial Data
    
    
    8Item 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    9Item 7A.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    23Item 8.
    
    Financial Statements and Supplementary Data
    
    
    24Item 9.
    
    Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    42Item 9A.
    
    Controls and Procedures
    
    
    42PART IIIItem 10.
    
    Directors and Executive Officers of the Registrant
    
    
    43Item 11.
    
    Executive Compensation
    
    
    43Item 12.
    
    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    43Item 13.
    
    Certain Relationships and Related Transactions
    
    
    43Item 14.
    
    Principle Accountants Fees and Services
    
    
    43PART IVItem 15.
    
    Exhibits, Financial Statement Schedules, and Reports on Form 8-K Signatures
    
    
    44SIGNATURES
    
    
    
    
    45EXHIBIT
INDEX
    
    
    
    
    46EXHIBIT 10.2EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
 2




---



##### Table of Contents



CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This report contains forward-looking statements that involve risks and
uncertainties. All statements contained in this report that are not purely
historical could be deemed forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. When used in this report, words
such as may, might, will, should, expects, plans, anticipates,
believes, estimates, predicts, potential, intend, continue, and
similar expressions, are intended to identify forward-looking statements. These
forward-looking statements might include, without limitation, projections of
our future financial performance, our anticipated growth and anticipated trends
in our businesses; the features, benefits and advantages of our products; the
development of new products, enhancements or technologies; business and sales
strategies; developments in our target markets; matters relating to
distribution channels, proprietary rights, facilities needs, competition and
litigation; future gross margins and operating expense levels; and capital
needs. These statements reflect the current views of Vialta or its management
with respect to future events and are subject to risks, uncertainties and
assumptions. Should one or more of these risks or uncertainties materialize, or
should underlying assumptions proved incorrect, our actual results, performance
or achievements in fiscal 2004 and beyond could differ materially from those
expressed in, or implied by, these forward-looking statements. Factors that
could cause or contribute to material differences include, but are not limited
to, those discussed below in Item 7 under the heading Other Factors That May
Affect Our Business and Future Results: and the risks discussed in our other
filings with the Securities and Exchange Commission. We encourage you to read
that section carefully. You should not regard the inclusion of forward-looking
information as a representation by us or any other person that the future
events, plans or expectations contemplated by us will be achieved. Vialta
undertakes no obligation to release publicly any updates or revisions to any
forward-looking statements to reflect events or circumstances occurring after
the date of this report. 3




---



##### Table of Contents



PART I 
 Item 1:Business We develop, design and market consumer electronics products designed to
maximize the benefits of digital technology in a convenient and easy-to-use
manner. Our primary products are the Beamer videophone line and the
VistaFrame digital picture frame. Our Beamer videophone products add color
video to phone calls, enabling users to see the person they are calling. Since
both parties to a video call must have a Beamer videophone product (or
compatible videophone), our videophone products are primarily sold in pairs and
are all compatible with each other. Our Beamer videophone products work with
any home phone over any standard (analog) home phone line, at no additional
cost to a regular phone call. Our latest product, VistaFrame, is a digital
picture frame that allows users to display photographs directly from a digital
camera memory card or from VistaFrames internal memory. We were incorporated in April 1999 as a wholly owned subsidiary of ESS
Technology, Inc. (ESS). In August 2001, we were spun off from ESS Technology,
Inc. and operate as a stand-alone entity. See Item 8 Financial Statements and Supplementary Data for additional
financial information regarding our business. Products We have developed and introduced two distinct product lines: Beamer
videophones and VistaFrame, both designed to offer greater convenience and
ease-of-use to consumers. Our Beamer videophone products include models that are standalone (such as
our first videophone product known as Beamer) or connect through most
televisions (the Beamer TV), and may include the ability to send and receive
digital pictures (the Beamer FX). All of our Beamer videophone products are
compatible with any home phone over any standard (analog) home phone line and
do not require any additional equipment (other than a compatible television, in
the case of Beamer TV) or wiring. In addition, our Beamer videophone products
provide the consumer with three viewing options (the calling party, the
receiving party, or picture-in-picture) and the ability to adjust the level of
movement fluidity in relation to detail. Our videophone products also have a
snapshot feature that temporarily pauses any new video transmission,
resulting in a higher resolution image on the LCD or television screen,
depending on the model. A video start feature gives users full control over
initiating the video transmission to another user, for complete video privacy
whenever desired. Beamer won a 2003 Best of Innovations award in the
telephone category from the Consumer Electronics Association based on criteria
consisting of value to users, aesthetics, innovativeness, and contributions to
quality of life. Beamer also won a 2003 Good Buy award from Good Housekeeping
magazine based on criteria including ingenuity, value and exceptional
performance. In addition, Beamer TV won a 2004 Best of Innovations Honoree
Award from the Consumer Electronics Association. VistaFrame is our digital picture frame that allows users to display
photographs directly from a digital camera memory card or from VistaFrames
internal memory. VistaFrame is compatible with most standard digital camera
memory card formats and does not require a camera or computer connection,
special wiring or web based services to display digital photographs. With
VistaFrame consumers can view digital pictures individually or in a custom
slideshow format with the user selecting the pictures, the display sequence,
display interval and the transition effect. The first product we developed was ViDVD, a multimedia DVD player that
offered enhanced features such as CD, MP3 and karaoke disc playback, Internet
connectivity and the ability to view digital photographs. We are not currently
marketing the ViDVD. We also developed ViMagazine, a proprietary, encrypted,
magazine-style DVD-format disc, to be used exclusively in conjunction with our
ViDVD. As a result of our decision not to continue marketing ViDVD, we have not
introduced ViMagazine. Sales and Marketing We began nationwide retail distribution of our first Beamer videophone
during the third quarter of 2002. Beamer TV, Beamer FX and VistaFrame began
nationwide retail distribution in the third quarter of 2003. Our Beamer
videophone products are currently carried by retailers such as Best Buy, Frys
Electronics, The Good Guys, Cinmar (The Frontgate Catalog) and The Sharper
Image, among others. VistaFrame is currently carried by retailers such as The
Sharper Image, Cinmar and The Good Guys. We market our Beamer videophone
products and VistaFrame to retailers and distributors in the U.S. market
through a combination of our direct sales force and independent sales
representatives. All of our products may also be purchased directly by
consumers from our on-line web store. We believe that retail stores will be the
primary distribution channel for our products in the U.S. market, and we are
working to 4




---



##### Table of Contents



increase the number of retailers carrying our products. During 2003 we
significantly expanded our retail and consumer marketing initiatives. These
initiatives included targeted print advertising such as in product circulars
and catalogs, special promotions and price rebates. During the fourth quarter
of 2003 we expanded our marketing initiatives to include in-store
demonstrations and television commercials that aired in the San Francisco Bay
Area and the Los Angeles markets. We believe these initiatives increased brand
awareness and generated additional sales activity during the fourth quarter of
2003. In 2003 we expanded our distribution for Beamer in the international
consumer market through distributors and strategic partners in such countries
as China, Taiwan, Korea, Portugal and Belgium. In 2004, we expect to continue
to expand our distribution for Beamer, BeamerTV and VistaFrame in the
international consumer marketplace through similar distribution relationships. To continue to build consumer demand and acceptance for our products, we
expect to continue to expand our retail and consumer initiatives, including
direct mail, e-marketing campaigns, in-store promotions and other initiatives.
Whenever possible, we will combine branding with product promotion
opportunities. In addition, we will continue to place an emphasis on generating
favorable press from industry analysts, trade reporters and the general
consumer media. Product Development Our product development efforts focus on bringing innovative digital
consumer electronics products to the retail marketplace. Because much of the
core development related to our Beamer videophone products and VistaFrame has
already been completed, our engineers are engaged in the development of new
products and other improvements and modifications to our existing products. We
are currently developing a Beamer videophone product for broadband, however we
have not determined when we may commercially introduce such a product, if at
all. Intellectual Property We rely on a combination of patent, trademark and copyright law, trade
secret protection and confidentiality or license agreements with our employees,
customers, partners and others to protect proprietary rights. We have filed two
patent applications, one to cover ViDVD proprietary functions and digital
encoder and decoder solutions and another to cover audio compression
technology. In addition, we have filed similar applications in Taiwan and under
the Patent Cooperation Treaty. To date, none of the patents have been issued. We have filed trademark applications in the U.S., Brazil, Canada, China,
the European Union, Hong Kong, Japan, Singapore and Taiwan. The marks for which
we have filed applications include, among others, the Vialta logo, Beamer,
Phone Video Station, PVS and Viewphone. In connection with our spin-off by ESS, we entered into a master
technology ownership and license agreement with ESS, pursuant to which we and
ESS acknowledged the specific technology and trademarks related to our business
that are owned by us. At the time of our formation, we entered into several intellectual
property agreements with ESS. We purchased from ESS all of ESS proprietary
rights and benefits conferred under U.S. laws with respect to its videophone
business. The master technology ownership and license agreement supercedes
prior intellectual property and research and development agreements between us
and ESS. In addition, we entered into a purchase agreement under which ESS
agreed to provide us with semiconductor products. See Note 9  Related Party
Transactions on page 37. Manufacturing We have developed all of our products internally and outsource
manufacturing. Our Beamer videophone products and VistaFrame are currently
manufactured by two contract manufacturers located in China. We believe these
manufacturers will provide us with sufficient manufacturing capacity to meet
our current product demand. Our quality assurance engineers are located in
China to oversee our contract manufacturers. We outsource import and export
logistics, including clearance of Chinese and U.S. customs and ocean freight.
We currently handle warehousing and all shipments to retail distribution
centers, individual retailers and individual customers purchasing our products
online. Seasonality We expect that our operating results will be subject to seasonality and to
quarterly and annual fluctuations. Domestic consumer electronic product sales
have traditionally been much higher during the holiday shopping season than
during other times of the year. 5




---



##### Table of Contents



Our domestic sales this past year reflected this anticipated seasonality. Competition Our Beamer videophone products compete directly with several other
companies in the videophone market that offer products delivering similar
features. We believe none of these companies has secured nationwide retail
distribution relationships. The majority of our competitors videophone
products are primarily available through specialized retailers and websites.
Furthermore, the majority of other videophone models have been integrated with
handsets and have a significantly higher per unit retail price than our Beamer
videophone products. We believe the key competitive factors for videophone
products are price, cost to use, quality of the video (especially moving
images), retail distribution, brand awareness and ease of installation and use.
We believe that among manufacturers of videophones that use analog phone lines,
we compete favorably on the basis of price, video quality, product availability
and ease of installation and use. In addition, we face competition from other
video communication products utilizing Internet and broadband connections and
digital camera cellular telephones. Internet and broadband products, which
frequently are priced less than our Beamer videophone products, utilize a
personal computer or television, currently require subscription to an ISP and
may require additional subscription services. These products may also be
interoperable with users of competitive products, provide multiple transmission
and storage options, and act as a digital camera. Digital camera cellular
telephones are relatively new and most only offer still picture transmission or
reception and require a digital cellular connection. Many of the current and
prospective competitors in this market are larger, better known and have
greater resources and experience than us. VistaFrame competes directly with several other companies in the digital
picture frame market that offer products that are similar to VistaFrame. The
majority of these products are primarily available through specialized or
regional retailers and websites. In addition other digital picture frame
products either have limited digital camera memory card compatibility or
require a phone line connection and a fee-based subscription service in order
to download pictures into the frame. Financial Information about Segments and Geographic Areas We operate as one business segment in two geographic areas  domestic and
international. Financial information about our business and geographic areas is
set forth in Note 14 of the Notes to Consolidated Financial Statements in Item
8 of this report. Employees As of February 29, 2004, we had 52 employees, including 15 in research and
development, 11 in marketing, sales and support, 13 in manufacturing and
operations and 13 in finance and administration. 
 Item 2:Properties As of February 29, 2004, our corporate headquarters occupies approximately
31,000 square feet of a building located in Fremont, California, under a lease
from ESS that expires in July, 2005. We also lease office space in Los Angeles,
California and a research and development center in Hong Kong. We believe that
our existing facilities are adequate for our current needs. 
 Item 3:Legal Proceedings We are not a party to any litigation at the present time. 
 Item 4:Submission of Matters to a Vote of Security Holders There were no matters submitted to a vote of security holders during the
fourth quarter of the fiscal year ended December 31, 2003. 6




---



##### Table of Contents



PART II 
 Item 5:Market for the Registrants Common Equity and Related Shareholder
Matters Our common stock has been quoted on the OTC Bulletin Board under the
symbol VLTA since August 21, 2001. The following table sets forth the high
and low bid prices for the common stock as reported by the OTC Bulletin Board
during the periods indicated. Such prices reflect inter-dealer prices, without
retail mark-up, mark-down or commission and may not necessarily represent
actual transactions. High
    
    LowFiscal 2002:First Quarter ended March 31, 2002
    
    $
    1.50
    
    
    $
    1.01Second Quarter ended June 30, 2002
    
    $
    1.07
    
    
    $
    0.45Third Quarter ended September 30, 2002
    
    $
    1.18
    
    
    $
    0.59Fourth Quarter ended December 31, 2002
    
    $
    0.72
    
    
    $
    0.26Fiscal 2003:First Quarter ended March 31, 2003
    
    $
    0.45
    
    
    $
    0.30Second Quarter ended June 30, 2003
    
    $
    0.51
    
    
    $
    0.28Third Quarter ended September 30, 2003
    
    $
    0.49
    
    
    $
    0.33Fourth Quarter ended December 31, 2003
    
    $
    0.81
    
    
    $
    0.35
 As of March 5, 2004, there were approximately 312 record holders of our
common stock. We have never declared or paid any cash dividends on our common stock. We
currently anticipate that we will retain any earnings for use in our business,
and we do not anticipate paying any cash dividends in the foreseeable future. 7




---



##### Table of Contents



Item 6:Selected Consolidated Financial Data You should read the selected consolidated financial data set forth below
in conjunction with Managements Discussion and Analysis of Financial
Condition and Results of Operations and our consolidated financial statements
and related notes included elsewhere in this report. The selected consolidated
statement of operations data set forth below is derived from our audited
consolidated financial statements. The information below is not necessarily
indicative of the results of operations to be expected for any future period. Period fromApril 20,1999 (Date ofInception)ThroughYears Ended December
31,
    
    December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999(In thousands, except per share amounts)Consolidated Statement of Operations Data:Revenue, net
    
    $
    10,331
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Cost of good sold
    
    
    2,941
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Gross profit
    
    
    7,390
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating expenses:Product costs
    
    
    
    
    
    
    10,421
    
    
    
    
    
    
    
    
    
    
    
    Engineering and development
    
    
    2,557
    
    
    
    13,264
    
    
    
    25,250
    
    
    
    19,558
    
    
    
    1,369Sales and marketing
    
    
    4,427
    
    
    
    3,100
    
    
    
    3,738
    
    
    
    2,927
    
    
    
    662General and administrative
    
    
    5,753
    
    
    
    5,643
    
    
    
    9,301
    
    
    
    6,699
    
    
    
    510Amortization and impairment of content licenses
    
    
    
    
    
    
    11,395
    
    
    
    
    
    
    
    
    
    
    
    Total operating expenses
    
    
    12,737
    
    
    
    43,823
    
    
    
    38,289
    
    
    
    29,184
    
    
    
    2,541Operating loss
    
    
    (5,347
    )
    
    
    (43,823
    )
    
    
    (38,289
    )
    
    
    (29,184
    )
    
    
    (2,541
    )Interest income, net
    
    
    733
    
    
    
    1,244
    
    
    
    3,606
    
    
    
    7,688
    
    
    
    512Gain on investment
    
    
    571
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other income (expense)
    
    
    
    
    
    
    
    
    
    
    (1,266
    )
    
    
    (1,682
    )
    
    
    9Loss before income tax benefit
    
    
    (4,043
    )
    
    
    (42,579
    )
    
    
    (35,949
    )
    
    
    (23,178
    )
    
    
    (2,020
    )Income tax benefit
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    260
    
    
    
    800Net loss
    
    $
    (4,043
    )
    
    $
    (42,579
    )
    
    $
    (35,949
    )
    
    $
    (22,918
    )
    
    $
    (1,220
    )Net loss per share:Basic and diluted
    
    $
    (0.05
    )
    
    $
    (0.51
    )
    
    $
    (0.83
    )
    
    $
    (3.68
    )
    
    $
    (0.71
    )Weighted average common shares outstanding:Basic and diluted
    
    
    82,285
    
    
    
    83,578
    
    
    
    43,248
    
    
    
    6,222
    
    
    
    1,716
 December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999(in thousands)Consolidated Balance Sheet Data:Cash and cash equivalents and short-term
investments
    
    $
    24,308
    
    
    $
    32,701
    
    
    $
    67,428
    
    
    $
    136,490
    
    
    $
    112,844Restricted cash
    
    
    2,226
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Working capital
    
    
    25,365
    
    
    
    30,201
    
    
    
    66,830
    
    
    
    109,870
    
    
    
    111,920Total assets
    
    
    37,114
    
    
    
    40,327
    
    
    
    83,866
    
    
    
    153,691
    
    
    
    114,580Total current liabilities
    
    
    9,061
    
    
    
    7,949
    
    
    
    3,587
    
    
    
    33,594
    
    
    
    940Redeemable convertible preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    142,600
    
    
    
    114,780Total stockholders equity (deficit)
    
    
    28,053
    
    
    
    32,378
    
    
    
    80,279
    
    
    
    (22,503
    )
    
    
    (1,140
    )
 8




---



##### Table of Contents



Item 7:Managements Discussion and Analysis of Financial Condition and
Results of Operations The following discussion includes forward-looking statements with respect
to our future financial performance. Actual results may differ materially from
those currently anticipated depending on a variety of factors, including those
described below under the sub-heading, Cautionary Statement Regarding
Forward-Looking Statements as well as Other Factors That May Affect Our
Business and Future Results and the risks discussed in our most recent filing
with the Securities and Exchange Commission. This following discussion should
be read in conjunction with the Selected Consolidated Financial Data and the
Consolidated Financial Statements and notes thereto that appear elsewhere in
this report. Overview We were incorporated in April 1999 as a wholly owned subsidiary of ESS
Technology, Inc. In August 2001, we were spun off from ESS and operate as a
stand-alone entity. We develop, design and market consumer electronics products
designed to maximize the advantages of digital technology in a convenient and
easy-to-use manner. Our primary products are the Beamer personal videophone
line and the VistaFrame digital picture frame. Our Beamer videophone products
add color video to phone calls, enabling users to see the person they are
calling. Since both parties to a video call must have a Beamer videophone
product (or compatible videophone), our products are primarily sold in pairs
and are all compatible with each other. Our Beamer videophones work with any
home phone over any standard (analog) home phone line, at no additional cost to
a regular phone call. Our videophone products include models that are
standalone (such as our first videophone product known as Beamer) or connect
through most televisions (the Beamer TV), and may include the ability to send
and receive digital pictures (the Beamer FX), depending on the model. Beamer
began nationwide retail distribution during the third quarter of 2002. You can
find our Beamer videophone products carried by such retailers as Best Buy,
Frys Electronics, The Good Guys, The Sharper Image and Cinmar (The Frontgate
Catalog). Our latest product, VistaFrame, is a digital picture frame that allows
users to display photographs directly from a digital camera memory card or from
VistaFrames internal memory. VistaFrame is compatible with most standard card
formats and does not require a camera or computer connection, special wiring or
web based services. With VistaFrame consumers can view digital pictures
individually or in a custom slideshow format with the user selecting the
pictures, the display sequence, display interval and the transition effect.
VistaFrame is currently available at retailers such as The Sharper Image, The
Good Guys and Cinmar. The first product we developed was ViDVD, a multimedia DVD player that
offered enhanced features such as CD, MP3 and karaoke disc playback, Internet
connectivity and the ability to view digital photographs. We are not currently
marketing the ViDVD. We also developed ViMagazine, a proprietary, encrypted,
magazine-style DVD-format disc, to be used exclusively in conjunction with our
ViDVD. As a result of our decision not to continue marketing ViDVD, we have not
introduced ViMagazine. Since our inception, we have financed our operations primarily from funds
raised in private offerings of convertible preferred stock and common stock and
through vendor credit. For the years ended December 31, 2003, 2002 and 2001 we
had net losses of $4.0 million, $42.6 million and $35.9 million, respectively,
and expect to incur losses in 2004. As of December 31, 2003, we had an
accumulated deficit of $106.7 million. From our inception through December 31, 2002, we were a development stage
enterprise. During the first quarter of 2003, we commenced principal operations
and are no longer classified as a development stage company. Results of Operations For the year ended December 31, 2003 compared with the year ended December
31, 2002 Net revenue.Net revenue was $10.3 million for the year ended December 31,
2003. There was no revenue for the year ended December 31, 2002. Included in
net revenue for 2003 was approximately $7.1 million in domestic sales and
approximately $3.2 million from international sales. In addition to revenue
generated from our first videophone product, Beamer, we also recorded domestic
net revenue during the fourth quarter of 2003 from sales activity related to
our new products BeamerTV, BeamerFX (which was introduced in the fourth quarter
of 2003 on a very limited basis) and VistaFrame. Net revenue from sales of our
Beamer videophone products accounted for 97% of total net revenue for the year
ended December 31, 2003. During the first quarter of 2003, we began to
recognize revenue on sales of Beamer, net of estimated warranty claims and
estimated returns. We began nationwide distribution of Beamer during the third
quarter of 2002 and more significant shipments during the fourth quarter of
2002. For most of these shipments, the standard warranty and return period had
not been completed as of December 31, 2002. Due to a limited history of
warranty and sales returns for Beamer, we did not recognize revenue for sales
through December 31, 2002. As a result, revenue for 9




---



##### Table of Contents



the year ended December 31, 2003, includes the recognition of deferred
revenue of approximately $3.2 million related to shipments of Beamer, which
were made during the third and fourth quarters of 2002. Cost of goods sold. Cost of goods sold was $2.9 million for the year ended
December 31, 2003. There was no similar expense for the year ended December 31,
2002. Because a significant portion of our inventory for raw materials and
finished goods for our Beamer videophone products was expensed in prior
periods, cost of goods sold for the year ended December 31, 2003 was lower than
what would otherwise have been recorded. If we had not previously expensed
inventory costs, our cost of goods sold would have been $7.8 million for the
year ended December 31, 2003. Gross profit. Gross profit was $7.4 million for the year ended December
31, 2003. If we had not previously expensed inventory costs, our gross profit
would have been approximately $2.5 million for the year ended December 31,
2003. Product Costs.Product costs were $10.4 million for the year ended
December 31, 2002. Product costs represent inventory expenditures for raw
materials and finished goods related to our Beamer videophone products. At
September 30, 2002, we had no historical experience selling Beamer (our first
videophone product) and there was significant uncertainty regarding our ability
to recover costs incurred in building inventories related to Beamer. As a
result, we expensed Beamer inventory costs as incurred through the third
quarter of 2002. Following the nationwide commercial launch of Beamer, we began
to capitalize the additional value of Beamer inventory costs in the fourth
quarter of 2002. There is no comparable expense for the year ended December 31,
2003. Engineering and development.Engineering and development expenses were
$2.6 million for the year ended December 31, 2003, compared to $13.3 million
for the year ended December 31, 2002. The decrease was primarily due to
reductions in engineering and development personnel and other development
expenditures as we shifted our focus to sales and marketing efforts from core
development activities. Included in engineering and development expenses for
the year ended December 31, 2002 were development expenses related to ViDVD and
ViMagazine as well as expenses related to our Internet Service Provider, known
as ViZip. Since all development activities related to ViDVD, ViMagazine and
ViZip were discontinued during 2002, there were no comparable expenses for the
year ended December 31, 2003. We expect engineering and development expenses to
be relatively constant in future periods. Sales and Marketing.Sales and marketing expenses were $4.4 million for
the year ended December 31, 2003, compared to $3.1 million for the year ended
December 31, 2002. The increase in sales and marketing expenses is primarily
due to $2.1 million in television commercials that aired in certain markets
(Los Angeles and San Francisco) and in-store demonstration programs (in
selected stores and regions), which occurred, in the fourth quarter of 2003.
This increase was partially offset by an overall decrease in sales and
marketing expenses for the year ended December 31, 2003 when compared to the
prior fiscal year. We expect sales and marketing spending to be relatively
constant in future periods to support retail and consumer marketing
initiatives, including direct mail, e-marketing campaigns, in-store promotions,
targeted advertising and other initiatives, for our products. We do not
currently have the resources to support a significant and sustained national
advertising and consumer awareness program which may be necessary to
significantly increase sales. General and Administrative.General and administrative expenses were $5.8
million for the year ended December 31, 2003, compared to $5.6 million for the
year ended December 31, 2002. We expect general and administrative expenses to
be relatively constant in future periods. Amortization and Impairment of Content Licenses.Amortization and
impairment of content licenses for ViMagazine was $11.4 million in the year
ended December 31, 2002. During January 2002, we licensed feature film content
from Artisan Entertainment for $10.0 million to use as part of our ViMagazine.
Starting in the first quarter of 2002, we began to expense our content
licenses, based on the greater of the royalty amounts due or amortization on a
straight-line basis over an estimated life of three years. During the fourth
quarter of 2002, we concluded that the content licenses had suffered a
permanent decline in value, as a result of our decision not to market
ViMagazine, and the remaining unamortized balance of $8.3 million was written
down to zero. The $10.0 million license fee to Artisan Entertainment included a
$5.0 million note that matures in January 2005 and would convert to a license
fee if certain events occurred. We continue to receive current interest
payments on the note and, since conversion is unlikely, we may receive the
principal at maturity. If we were to be paid at maturity we would recognize a
gain at that time. There is no comparable expense for the year ended December
31, 2003. Interest Income, Net.Interest income was $733,000 for the year ended
December 31, 2003, compared to $1.2 million for the year ended December 31,
2002. The decrease in interest income was primarily due to lower cash balances
and lower yields on available-for-sale securities during the year ended
December 31, 2003 as compared to the year ended December 31, 2002. 10




---



##### Table of Contents



Gain on Investment.During the fourth quarter of 2003 we recorded a gain
on investments of $571,000. The gain on investments was attributable to a cash
dividend paid to us on preferred shares we previously acquired in an unrelated
company. Our original investment in this company had been written down to zero
in a prior period. For the year ended December 31, 2002 compared with the year ended December
31, 2001 Net Revenue.We had no revenue in 2002 and 2001, as we were a
development stage company. Product Costs.Product costs were $10.4 million for the year ended
December 31, 2002. Product costs represent inventory expenditures for raw
materials and finished goods related to our Beamer videophone products. At
September 30, 2002, we had no historical experience selling Beamer and there
was significant uncertainty regarding our ability to recover costs incurred in
building inventories related to Beamer. As a result, we expensed Beamer
inventory costs as incurred through the third quarter of 2002. Following the
nationwide commercial launch of Beamer, we began to capitalize the additional
value of Beamer inventory costs in the fourth quarter of 2002. All costs
related to ViDVD products during the year ended December 31, 2001 were included
in research and development. Engineering and Development.Research and development expenses were $13.3
million for the year ended December 31, 2002, compared to $25.3 million for the
year ended December 31, 2001. The decrease in research and development expenses
was due to significant reductions in personnel expenses as we shifted our focus
to sales and marketing efforts from core development activities and the fact
that product costs for Beamer were presented as a separate category in 2002.
All costs related to ViDVD products in development during the year ended
December 31, 2001 were included in research and development. During the fourth
quarter of 2002, we discontinued our Internet Service Provider (ISP) business,
ViZip, and recorded a charge of $0.9 million related to the exit of this
business. As a result of the decision to stop marketing ViDVD, we also reduced
our research and development expense relating to both ViDVD and ViMagazine. Sales and Marketing.Sales and marketing expenses were $3.1 million for
the year ended December 31, 2002, compared to $3.7 million for the year ended
December 31, 2001. The decrease in sales and marketing expenses was primarily
due to reductions in personnel expenses as a result of the suspension of ViDVD
sales and marketing activities and improved organizational efficiencies. General and Administrative.General and administrative expenses were $5.6
million for the year ended December 31, 2002, compared to $9.3 million for the
year ended December 31, 2001. The decrease in general and administrative
expenses was primarily due to significant reductions in personnel and other
corporate expenses and lower reimbursements to ESS for administrative and
management services. Amortization and Impairment of Content Licenses.Amortization and
impairment of content licenses for ViMagazine was $11.4 million in the year
ended December 31, 2002. During January 2002, we licensed feature film content
from Artisan Entertainment for $10.0 million to use as part of our ViMagazine.
Starting in the first quarter of 2002, we began to expense our content
licenses, based on the greater of the royalty amounts due or amortization on a
straight-line basis over an estimated life of three years. During the fourth
quarter of 2002, we concluded that the content licenses had suffered a
permanent decline in value, as a result of our decision not to market
ViMagazine, and the remaining unamortized balance of $8.3 million was written
down to zero. The $10.0 million license fee to Artisan Entertainment included a
$5.0 million note that matures in January 2005 and would convert to a license
fee if certain events occurred. We continue to receive current interest
payments on the note and, since conversion is unlikely, we may receive the
principal at maturity. If we were to be paid at maturity we would recognize a
gain at that time. Other Income, Net.Interest income was $1.2 million for the year ended
December 31, 2002, compared to $3.6 million for the year ended December 31,
2001. The decrease in interest income was primarily due to lower cash balances
and lower yields on available-for-sale securities during the year ended
December 31, 2002 as compared to the year ended December 31, 2001. During the
year ended December 31, 2001, we recorded other expenses of $1.3 million
related to investment write-offs. The investments were written off because we
concluded that the investments had suffered a permanent decline in value based
on our assessment of the financial condition of the companies in which we had
invested and the markets that they serve. There were no investment write-offs
for the year ended December 31, 2002. Off-Balance Sheet Arrangements In January 2000, we entered into a three-year non-cancelable lease
agreement for our headquarters with ESS. In July 2003, we amended the lease.
The terms of the amendment include a 60% reduction in the amount of square
footage leased, a reduction in the 11




---



##### Table of Contents



monthly rent to current market rates and an extension of the term from
December 31, 2003 to June 30, 2005. Under the terms of this and other leases,
with various expiration dates through 2006, our future minimum rental payments
as of December 31, 2003 are as follows: $529,000, $320,000 and $126,000 for the
years 2004, 2005 and 2006 respectively. Apart from operating leases disclosed above, we do not have any
off-balance sheet arrangements. Liquidity and Capital Resources As of December 31, 2003, we had $26.5 million in cash and cash
equivalents, restricted cash and short-term investments compared to $32.7
million as of December 31, 2002, representing a decrease of $6.2 million. Our principal sources of liquidity are cash and cash equivalents and
investments. Net cash used in operating activities was $7.9 million for the
year ended December 31, 2003 compared to $23.3 million for the year ended
December 31, 2002, representing a decrease of approximately $15.4 million. The
decrease in cash used in operating activities during the year ended December
31, 2003 compared to the year ended December 31, 2002 was primarily due to a
significant reduction in our operating expenses combined with cash received
from sales of our products. In addition, our cash flow from operations for the
year ended December 31, 2003 benefited from sales of products (Beamer) during
the year that were purchased and expensed in the prior year. Net cash provided by investing activities for the year ended December 31,
2003 was $98,000 compared to $11.6 million of cash used in investing activities
for the year ended December 31, 2002. Net cash provided by investing activities
for the year ended December 31, 2003 was primarily related to the proceeds from
the sale of short-term investments. Net cash used in investing activities for
the year ended December 31, 2002 was primarily related to the purchases of
content licenses for $10.0 million. Net cash used in financing activities was $285,000 for the year ended
December 31, 2003 and $5.1 million for the year ended December 31, 2002,
primarily related to repurchases of our common stock. Capital expenditures for the 12-month period ending December 31, 2004 are
anticipated to be approximately $100,000, primarily to acquire capital
equipment. We may utilize cash to acquire or invest in complementary businesses
or products or to obtain the right to use complementary technologies. Any such
acquisition or investment may significantly increase our planned requirements
for capital. From time to time, in the ordinary course of our business, we may
evaluate potential acquisitions of or investments in such businesses, products
or technologies owned by third parties. In September 2001, the Board of Directors authorized the repurchase of up
to 10,000,000 shares of our common stock in open market or private transactions
over a twelve-month period. In June 2002, the Board of Directors authorized the
existing stock repurchase program be extended to include the repurchase of up
to an additional 10,000,000 shares of common stock. Through December 31, 2002,
we repurchased approximately 11,205,000 shares of common stock at an aggregate
cost of $9.1 million. During the first quarter of 2003, we repurchased
approximately 759,000 shares for an aggregate cost of approximately $295,000.
There were no common stock repurchases in the second, third and fourth quarters
of 2003. As of December 31, 2003, approximately 8,036,000 shares remain
authorized for repurchase. We believe that our existing cash and cash equivalents and investments
will be sufficient to fund our operations through December 31, 2004. However,
to continue our operations beyond that date, or if our current level of
operations change, or to achieve our longer-term goals of introducing
additional products to consumers, we believe we will need to raise additional
capital, which may not be available on acceptable terms, if at all. We have
historically used vendor credit as well as private offerings of convertible
preferred stock and common stock to fund operations and provide for capital
requirements. However, the price per share of any future equity-related
financing will be determined at the time the offering is made and cannot be
anticipated at this time. If additional funds are raised through the issuance
of equity securities, the percentage ownership of current stockholders is
likely to or will be reduced and such equity securities may have rights,
preferences or privileges better than those of current stockholders. We cannot
assure you that any additional financing will be available or that, if
available, it will be sufficient or it can be obtained on terms favorable to us
or our stockholders. If adequate funds are not available if and when needed, we
would be required to delay, limit or eliminate some or all of our proposed
operations. Critical Accounting Policies The preparation of financial statements and the related disclosures in
conformity with accounting principles generally accepted in the United States
requires management to make estimates and judgments that affect the reported
amounts of assets, liabilities, 12




---



##### Table of Contents



revenues and expenses, and related disclosure of contingent assets and
liabilities. We base our estimates on historical experience and on various
other assumptions that are believed to be reasonable under the circumstances.
On an ongoing basis, we evaluate our estimates to ensure that our estimates
remain reasonable under current conditions. Actual results may differ from
these estimates, which may have a material impact on our results of operations
and financial condition. Critical accounting policies that require significant judgments and
estimates for the preparation of our consolidated financial statements are as
follows: Revenue recognition We generally recognize revenue on products sold to end customers upon
shipment provided that we have no post-sale obligations, we can reliably
estimate and accrue warranty costs and sales returns, the price is fixed or
determinable and collection of the resulting receivable is reasonably assured.
For sales to international distributors and strategic partners we generally
recognize revenue based on the above criteria and upon receipt of payment in
full. For sales to end customers that do not meet the above criteria, revenue
is deferred until such criteria are met. Products sold to retailers and distributors are subject to rights of
return. We defer recognition of revenue on products sold to retailers and
distributors until the retailers and distributors sell the products to their
customers. We recognize revenue from retailers and distributors according to
information on shipments to their customers as provided by those retailers and
distributors. If information on shipments to their customers is not provided in
a timely and accurate manner, there may be a material impact on our reported
results of operations and financial condition. Revenue is also deferred for the
initial thirty-day period during which our direct customers, retailers and
distributors have the unconditional right to return products. Allowances for sales returns Allowances are provided for estimated returns. Provision for return
allowances are recorded at the time when revenue is recognized based on
historical returns, current economic trends and changes in customer demand.
Such allowances are adjusted periodically to reflect actual experience and
anticipated returns. Warranty We provide a limited warranty on our products for periods ranging from 90
days to 12 months from the date of sale to the end customers. We estimate
warranty costs based on historical experience and accrue for estimated costs as
a charge to cost of sales when revenue is recognized. The following table shows
the details of the product warranty accrual, as required by FASB Interpretation
No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others, for the year ended
December 31, 2003 (in thousands): December 31,2003Beginning balance
    
    $
    Accruals for warranties issued during the period
    
    
    814Settlements made during the period
    
    
    (330
    )Ending balance
    
    $
    484
 Valuation of Inventories Inventories are stated at the lower of cost or market, with cost being
determined by the first-in, first-out method. We record our inventory reserve
for estimated losses based on assumptions about future demand and market
conditions. If actual demand or market conditions are less favorable than those
projected by management, additional inventory reserves may be required. Since our inception through December 31, 2001, we expensed inventory costs
related to ViDVD of $9.0 million, as commercial shipments of ViDVD were
limited. During the year ended December 31, 2002 we discontinued marketing
ViDVD and no additional ViDVD inventories were purchased. We expensed $10.4 million of inventory costs on our Beamer videophone
products, through September 30, 2002. We began
capitalizing our inventory costs in the fourth quarter of 2002 because we
experienced an increase in shipments since Beamer was 13




---



##### Table of Contents



commercially introduced
nationwide in the third quarter of 2002. Additional inventory reserves may be
needed if actual demand or market conditions are less favorable than
managements projection. Property and Equipment Property and equipment are stated at cost less accumulated depreciation
and amortization. Depreciation is generally computed using the straight-line
method over the estimated useful lives of the assets. Computer equipment
    
    3-5 yearsFurniture and fixtures
    
    5 yearsSoftware and web site development costs
    
    1-3 years
 Repairs and maintenance costs are expensed as incurred. Valuation of Long-Lived Assets We review long-lived assets based upon an undiscounted cash flow basis and
will record an impairment whenever events or changes in circumstances indicate
the carrying amount of the assets may not be fully recoverable. If an asset is
considered impaired, the asset is written down to carrying value based on
undiscounted cash flows. During the fourth quarter of 2002, we wrote the
remaining unamortized balance of $9.2 million of content licenses down to zero.
Future cash flows could be different from those estimated by our management. Stock-Based Compensation We account for stock-based compensation using the intrinsic value method
prescribed in Accounting Principles Board Opinion No. 25, or APB No. 25,
Accounting for Stock Issued to Employees. Under APB No. 25, compensation cost
is measured as the excess, if any, of the quoted market price of its stock at
the date of grant over the exercise price of the option granted. Compensation
cost for stock options, if any, is recognized ratably over the vesting period.
We provide additional pro forma disclosures as required under SFAS No. 123,
Accounting for Stock-Based Compensation and SFAS No. 148, Accounting for
Stock-Based Compensation, Transition and Disclosure. Recent Accounting Pronouncements In November 2002, the Emerging Issues Task Force (EITF) reached a
consensus on Issue No. 00-21, Accounting for Revenue Arrangements with
Multiple Deliverables (EITF Issue No. 00-21). EITF Issue No. 00-21 provides
guidance on how to account for arrangements that involve the delivery or
performance of multiple products, services and/or rights to use assets. The
provisions of EITF Issue No. 00-21 apply to revenue arrangements entered into
in fiscal periods beginning after June 15, 2003. Adoption of EITF Issue No.
00-21 did not have a material impact on our consolidated financial statements. In January 2003, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest
Entities, an Interpretation of ARB No. 51. FIN 46 requires certain variable
interest entities to be consolidated by the primary beneficiary of the entity
if the equity investors in the entity do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. During December 2003, the FASB issued FIN 46R, a
revision to FIN 46. FIN 46R provides a broad deferral of the latest date by
which all public entities must apply FIN 46 to certain variable interest
entities, to the first reporting period ending after March 15, 2004. We do not
expect the adoption of FIN 46 to have a material impact upon our financial
position, cash flows or results of operations. In May 2003, the Financial Accounting Standard Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 150, Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity. SFAS No. 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. SFAS No. 150 requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). Many of those instruments were previously classified as equity.
SFAS No. 150 is effective for financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the first
fiscal period beginning after June 15, 2003. SFAS No. 150 is to be implemented
by reporting the cumulative effect of a change in an accounting principle for
financial instruments created before the issuance date of SFAS No. 150 and still
existing at the beginning of the interim period of adoption. 14




---



##### Table of Contents



Restatement is not
permitted. We believe that the adoption of this standard will not have a
material impact on our consolidated financial statements. Other Factors That May Affect Our Business and Future Results Our future business, operating results and financial condition are subject
to various risks and uncertainties, including those described below. If our products do not achieve broad market acceptance, we may not be able to
continue operating our business. We are currently marketing a limited number of products. As a result, our
success is highly dependent upon consumer acceptance of these products.
Consumer acceptance requires, among other things, that we:  
    
    educate consumers on the advantages of our Beamer videophone products and VistaFrame;
    
    commit a substantial amount of human and financial resources to support the retail distribution of our products;
    
    continue to develop our sales, marketing and support activities to consumers and retailers; and
    
    expand the number and location of retailers carrying our products. We may not achieve any or all of these objectives. As a result despite our
national retail presence, consumers may not be aware of our products. This
could delay or prevent our ability to achieve broad market acceptance of our
products. We do not currently have the resources to support a significant and
sustained national advertising and consumer awareness program which may be
necessary to significantly increase sales. The failure of our products to
achieve sufficient consumer and retailer acceptance would impair our ability to
continue operating our business. We have incurred net losses and may never achieve significant revenues or
profitability. We have incurred losses and have had negative cash flow since our
inception. As of December 31, 2003, we had $26.5 million in cash and cash
equivalents, restricted cash and short-term investments. For the fiscal year
ended December 31, 2003, we had a net loss of $4.0 million. We expect to
continue to incur operating and non-operating expenses over the next several
years as part of the potential expansion of our business. As a result, we
expect to continue to incur losses for the foreseeable future. The size of
these net losses will depend in part on our recent and any future product
launches, any growth in sales of our products and the rate of increase in our
expenses. As a result, we will need to generate significant revenues to achieve
profitability. Several factors, including consumer acceptance, retailer
arrangements and competitive factors make it impossible to predict when or
whether we will generate significant revenues or attain profitability.
Consequently, we may never achieve significant revenues or profitability, and
even if we do, we may not sustain or increase profitability on a quarterly or
annual basis in the future. It may take a substantial amount of time and resources to achieve broad market
acceptance of our products, and we cannot be sure that these efforts will
generate the level of broad market acceptance necessary to generate sufficient
revenues to sustain our business. The current videophone end-user market is relatively small. Although
videophones have been commercially available for many years, previous
videophone models have had high retail prices, limited retail distribution,
limited functionality, poor video quality and have been integrated with a
handset. Even though we believe our Beamer videophone products have addressed
many of the limitations associated with videophones and videophone technology,
consumer demand remains low and may not increase. Similar to the videophone
end-user market, the digital picture frame market is small and only a recent
phenomenon resulting from the growth of the digital camera market. Although
VistaFrame is compatible with most standard digital camera memory card formats
and does not require a camera or computer connection, special wiring or web
based services, consumer demand is low and may not increase. Even after
educating consumers on the features of our products, consumers may still
perceive little or no benefit or may already own other products that provide
similar benefits or functionality. As a result, consumers may not value, or may
be unwilling to purchase, our products at profitable prices. We also do not
have an established brand image, and the expense of a national advertising
campaign to build and sustain brand awareness is not within our reach.
Accordingly, to develop market acceptance of our products, we will need to
devote a substantial amount of resources to educate consumers about the
features and benefits of our products via alternative means
including targeted public relations, promotional campaigns and extensive
retail distribution. However, we cannot assure you that this 15




---



##### Table of Contents



commitment of
resources will be successful in generating the revenues required to sustain our
business. If we are unsuccessful, the future of our Company will be in doubt. If we are unable to raise additional capital on acceptable terms, our ability
to develop and market our products and operate our business could be harmed. To introduce follow-on products and sustain and grow our business, we must
continue to make significant investments to develop, enhance and market our
products. We will also need significant working capital to take advantage of
future opportunities and to respond to competitive pressures or unanticipated
requirements. We expect that our existing capital resources will be sufficient
to meet our cash requirements through December 31, 2004, although our current
resources could be exhausted more quickly depending on the payment terms that
we are able to negotiate with our vendors and suppliers and our success in
generating and collecting on accounts receivable. The magnitude of our future
capital requirements will depend on many factors, including, among others,
promotional campaigns, investments in working capital, and the amount of
income, if any, generated by operations. When we do need to raise additional capital, that capital may not be
available on acceptable terms, or at all. If we cannot raise necessary
additional capital on acceptable terms, we may not be able to develop or
enhance our products, take advantage of future opportunities, respond to
competitive pressures or unanticipated requirements or even continue operating
our business. If additional capital is raised through the issuance of equity securities,
the percentage ownership of our existing stockholders will decline. Also, if
any securities are issued, our stockholders may experience dilution in net book
value per share, and these securities may have rights, preferences or
privileges superior to those of the holders of our common stock. Any debt
financing, if available, may also require limitations or restrictions on our
operations or future opportunities. Our limited operating history may make it difficult for us or investors to
evaluate trends and other factors that affect our business. We were incorporated in April 1999 and have a limited operating history.
As a result of our limited operations, our historical financial and operating
information is of limited value in evaluating our future potential operating
results. In addition, any evaluation of our business and prospects must be made
in light of the risks and difficulties encountered by start-up companies
developing products in new and rapidly evolving markets. For example, it may be
difficult to accurately predict our future revenues, costs of revenues,
expenses or results of operations. Our Beamer videophone products, VistaFrame
and any other future products represent new products for most consumers. It may
be difficult to predict the creation of any market or the growth rate, if any,
or size of the market for our existing products or other new products we may
develop. We may be unable to accurately forecast customer needs or behavior or
recognize or respond to emerging trends, changing preferences or competitive
factors facing us. As a result, we may be unable to make accurate financial
forecasts or adjust our spending in a timely manner to compensate for any
unexpected changes or revenue shortfall. This inability could cause our results
of operations in a given quarter to be worse than expected, and could cause the
price of our stock to decline. We face intense competition from participants in the consumer electronics
market, which may impair our revenues and ability to generate customers. The consumer electronics market is intensely competitive and rapidly
evolving. Existing participants and new entrants in this market currently offer
and may develop and offer additional products that will compete directly with
our existing products or future products that we may develop. The consumer electronics industry in particular is characterized by rapid
technological innovation and intense price competition. The competition for
consumer spending and acceptance is also intense. Our Beamer videophone
products compete directly with several other companies in the videophone
market. All of these companies currently offer videophone products to consumers
that operate over standard (analog) phone lines with no additional cost to the
user, similar to our Beamer videophone products. In addition to these
companies, we face competition from a competitively priced videophone product
that utilizes a consumers broadband connection (as opposed to a standard phone
line) to deliver a video image over a consumers television during a phone
call. Our Beamer videophone products also face competition from PC-based
Internet video and from digital camera cellular telephones manufacturers and
potential future offerings from current telephone manufacturers. Like our
Beamer videophones, VistaFrame competes directly with several other companies
in the digital picture frame marketplace. Although lacking some of the features
of our VistaFrame product, these companies offer digital picture frame products
which provide features similar to VistaFrame. In addition, many of the manufacturers and distributors of these competing
products have substantially greater brand recognition, 16




---



##### Table of Contents



market presence,
distribution channels, financial resources and promotional and other strategic
partners than us. If we fail to create consumer demand and consumer acceptance of our Beamer
videophone products and VistaFrame, we may not be able to generate sufficient
revenues to sustain our business. The success of our existing products depends on a number of factors,
including, but not limited to, strategic allocation of our limited financial
and technical resources, accurate forecasting of consumer demand, timely
completion of product development and introduction to market, and market and
industry acceptance of our future and existing products. If we are unable to develop and introduce new products, we may not be able to
generate sufficient revenues to sustain and grow our business. We develop and engineer all of our products in-house. To introduce
follow-on products as well as new products, we must continue to make
significant investments in product development and engineering. The development
of new products is a time consuming process and may result in products which,
although technically feasible, may not be commercially viable. In addition,
competitors with greater resources may be able to develop and introduce new
products that could eclipse our development initiatives and prevent us from
introducing similar products. If we fail to develop new products, we may not be
able to sustain our business. We depend on two contract manufacturers and a limited number of other third
parties, including ESS, to manufacture and supply critical components for our
products, and we may be unable to operate our business if those parties do not
perform their obligations. We rely on two contract manufacturers located in China to meet our current
product demand. We also rely on ESS and a limited number of other third party
suppliers for a number of key components for our products, including modem
chips, video chips and LCD screens. We do not have long-term agreements in
place with our suppliers. We do not control the time and resources that these
suppliers devote to our business. We cannot be sure that these suppliers will
perform their obligations as expected or that any revenue, cost savings or
other benefits will be derived from the efforts of these parties. Our need for
semiconductors as a key component of our products indirectly subjects us to a
number of risks relating to ESS and any other future semiconductor suppliers
reliance on independent foundries to produce those semiconductors, including
the absence of adequate capacity, the unavailability of, or interruption in
access to, certain process technologies and reduced control over delivery
schedules, manufacturing yields and costs, and risks related to the
international location of most major foundries. If any of our third party
suppliers breaches or terminates its agreement with us or otherwise fails to
perform its obligations in a timely manner, we may be delayed or prevented from
launching or marketing our products. Because our relationships with these
parties are non-exclusive, they may also support products that compete directly
with ours, or offer similar or greater support to our competitors. Any of these
events could require us to undertake unforeseen additional responsibilities or
devote additional resources to commercialize our products. This outcome would
harm our ability to compete effectively and quickly achieve market acceptance
and brand recognition. We may have potential business conflicts of interest with ESS with respect to
the companies ongoing relationships, and we may not be able to resolve these
conflicts on terms favorable to us. Conflicts of interest may arise between ESS and us in a number of areas
relating to ongoing relationships between the companies, including:  
    
    Although we entered into agreements with ESS that govern our business
relationship after the distribution of our stock to ESS shareholders,
ESS has no obligation to extend the terms of those agreements beyond
their stated duration;
    
    ESS may supply semiconductors to competitors, which may affect ESS
capacity to supply semiconductors to us;
    
    We may compete with ESS with respect to business opportunities that
are attractive to both companies, and ESS is not restricted from
competing with our business. If we are unable to maintain satisfactory relationships with, or increase the
number of, retailers and distributors that sell our products, our business will
suffer. In order to maintain our relationships with retailers and distributors we
may be required to accept arrangements and terms, which
may not be favorable to us. Such terms may include consignment
arrangements, pricing concessions, marketing incentives, aggressive 17




---



##### Table of Contents



return
allowances, commissions and other requirements, which could adversely affect
the profitability of our products. In addition, we expect that our retailers
and distributors will sell products offered by our competitors. If our
competitors offer retailers and distributors more favorable terms or have more
products available to meet their needs, those retailers and distributors may
decline to carry or may not adequately promote our products. Although we are
aggressively attempting to increase the number of retailers that market our
products to consumers, there can be no assurance that we will be able to do so.
If we are unable to maintain successful relationships with distributors and
retailers or to expand our distribution channels, our business may fail. We may need to expand our operations for future growth, and our failure to
manage any such growth could disrupt business and impair our ability to
generate revenues. We may need to expand our headcount, facilities and infrastructure to
support potential sales growth and to allow us to pursue market opportunities.
This potential expansion could place a significant strain on our management,
operational and financial resources and systems. Specific risks we face as our
business expands include:  
    
    We may need to attract and retain qualified personnel, and any
failure to do so may impair our ability to offer new products or grow
our business. We may be unable to successfully attract, integrate or
retain sufficiently qualified personnel. If we are unable to hire,
train, retain or manage the necessary personnel, we may be unable to
successfully introduce new products or otherwise implement our business
strategy.
    
    We may need to provide acceptable customer support, and any inability
to do so will impair our ability to develop consumer acceptance of our
products. We expect that some of our customers will require support when
using our products. We also anticipate that purchasers of any future
products will require support in their use of such products. We do not
have experience with widespread deployment of our products to a diverse
customer base, and we may not have adequate personnel to provide the
levels of support that our customers will require. Our failure to
provide adequate customer support for our products will damage our
reputation in the consumer electronics marketplace and strain our
relationships with customers and strategic partners. This could prevent
us from gaining new or retaining existing customers and could harm our
reputation and brand.
    
    We may need to improve our operational and financial systems,
procedures and controls to support our expected growth, and any
inability to do so will adversely impact our ability to grow our
business. Our current and planned systems, procedures and controls may
not be adequate to support our future operations and expected growth.
Delays or problems associated with any improvement or expansion of our
operational systems and controls could adversely impact our
relationships with customers and harm our reputation and brand. Product defects, system failures or interruptions may have a negative impact on
our revenues, reputation and ability to attract new customers. Errors and product defects can result in significant warranty and repair
problems, which could cause customer relations problems. Correcting product
defects requires significant time and resources, which could delay product
releases and affect market acceptance of our products. Any delivery by us of
products with undetected material product defects could harm our credibility
and market acceptance of our products. Our future results could be harmed by economic, political, regulatory and other
risks associated with our reliance on international sales and operations. Our products are currently manufactured, assembled and tested by two
contract manufacturers located in China. In addition, most of our suppliers are
located in China, Hong Kong and Taiwan. Because of our international operations
and relationships, and our reliance on foreign third-party manufacturing,
assembly and testing operations, we are subject to the risks of conducting
business outside of the United States, including:  
    
    changes in political and strategic relations between China, Taiwan and the U.S.;
    
    changes in foreign currency exchange rates;
    
    changes in a specific countrys or regions political or economic
conditions, particularly in China, Taiwan and other emerging Asian
markets; 18




---



##### Table of Contents




    
    trade protection measures and import or export licensing requirements;
    
    potentially negative consequences from changes in tax laws;
    
    difficulty in managing widespread sales and manufacturing operations;
    
    interuptions caused by an outbreak of SARS or another epidemic in Asia; and
    
    less effective protection of intellectual property. Our success partly depends on our ability to secure and protect our proprietary
rights. Our success and ability to compete are partly dependent upon our
internally developed technology. We rely on patent, trademark and copyright
law, trade secret protection and confidentiality or license agreements with our
employees, customers, partners and others to protect our proprietary rights.
However, the steps we take to protect our proprietary rights may be inadequate.
We have filed two U.S. patent applications, one to cover ViDVD proprietary
functions and digital encoder and decoder solutions and another to cover
digital audio signal compression and processing. In addition, we have filed
corresponding applications in Taiwan and with the patent cooperation treaty,
which reserves the right to file in foreign countries. To date, no patents have
been issued, and we cannot assure you that any patents will ever be issued,
that any issued patents will protect our intellectual property or that third
parties will not challenge any issued patents. Moreover, other parties may
independently develop similar or competing technologies designed around any
patents that may be issued to us. The laws of certain foreign countries in which our products are or may be
designed, manufactured or sold, including various countries in Asia, may not
protect our products or intellectual property rights to the same extent as do
the laws of the U.S., and thus make the possibility of piracy of our technology
more likely. We cannot assure you that the steps taken by us to protect our
proprietary information will be adequate to prevent misappropriation of our
technology or that our competitors will not independently develop technologies
that are substantially equivalent or superior to our technology. Our failure to
protect our proprietary rights could harm our business. We may be subject to claims that our intellectual property infringes upon the
proprietary rights of others, and a successful claim could harm our ability to
sell and develop our products. If other parties claim that our products infringe upon their intellectual
property, we could be forced to defend ourselves or our customers,
manufacturers or suppliers against those claims. We could incur substantial
costs to prosecute or defend those claims. A successful claim of infringement
against us, or any failure or inability of us to develop non-infringing
technology or license the infringed technology on acceptable terms and on a
timely basis, could harm our business, financial condition and results of
operations. If we lose key management personnel, we may not be able to successfully operate
our business. Our future performance is substantially dependent on the continued
services of our senior management, especially our Chairman, Fred S.L. Chan, our
President and Chief Executive Officer, Didier Pietri, and other key personnel.
The loss of any members of our executive management team and our inability to
hire additional executive management could harm our business and results of
operations. We employ our key personnel on an at-will basis. We do not maintain
key person insurance policies on any of the members of our executive management
team. Any future business acquisitions may disrupt our business, dilute stockholder
value or distract management attention. As part of our ongoing business strategy, we may consider acquisitions of,
or significant investments in, additional businesses that offer or develop
products and technologies complementary to our own. Such acquisitions could
materially adversely affect our operating results and/or the price of our
stock. Acquisitions also entail numerous risks, including:  
    
    difficulty of integrating the operations, products and personnel of the acquired businesses;
    
    potential disruption of our ongoing business; 19




---



##### Table of Contents




    
    unanticipated costs associated with the acquisition;
    
    inability of management to manage the financial and strategic position of acquired or developed products and technologies;
    
    inability to maintain uniform standards, controls, policies and procedures; and
    
    impairment of relationships with employees and customers that may
occur as a result of integration of the acquired business. To the extent that shares of our stock or other rights to purchase stock
are issued in connection with any future acquisitions, dilution to our existing
stockholders may result and our earnings per share may suffer. Any future
acquisitions or strategic investments may not generate additional revenue or
provide any benefit to our business, and we may not achieve a satisfactory
return on our investment in any acquired businesses. Laws or regulations that govern the consumer electronics industry, the
telecommunications industry, copyrighted works or the Internet could expose us
to legal action if we fail to comply or could require us to change our
business. Because our products are expected to provide our customers with access to
a variety of methods of electronic communication, it is difficult to predict
what laws or regulations will be applicable to our business. Therefore, it is
difficult to anticipate the impact of current or future laws and regulations on
our business. Among the many regulations that may be applicable to our business
are the following:  
    
    Federal Communications Commission regulations relating to the
electronic emissions of consumer products;
    
    Federal Communications Commission regulations relating to consumer
products that connect to the public telephone network;
    
    federal export regulations relating to the export of sensitive
computer technologies such as encryption and authentication software. Changes in the regulatory climate or the enforcement or interpretation of
existing laws could expose us to legal action if we fail to comply. In
addition, any of these regulatory bodies could promulgate new regulations or
interpret existing regulations in a manner that would cause us to incur
significant compliance costs or force us to alter the features or functionality
of our products. Our stock may be subject to the requirements for penny stocks, which could
adversely affect your ability to sell and the market price of our shares. Our stock may fit the definition of a penny stock. The Securities and
Exchange Act of 1934 defines a penny stock as any equity security that is not
traded on a national securities exchange or authorized for quotation on The
NASDAQ National Market and that has a market price of less than $5.00 per
share, with certain exceptions. Penny stocks are subject to Rule 15g under the
Securities and Exchange Act of 1934, which imposes additional sales practice
requirements on broker-dealers who sell such securities. In general, a
broker-dealer, prior to a transaction in a penny stock, must deliver a
standardized risk disclosure document that provides information about penny
stocks and the risks in the penny stock market. The broker-dealer must provide
the customer with current bid and offer quotations for the penny stock,
information about the commission payable to the broker-dealer and its
salesperson in the transaction and monthly statements that disclose recent
price information for each penny stock in the customers account. Finally,
prior to any transaction in a penny stock, the broker-dealer must make a
special written suitability determination for the purchaser and receive the
purchasers written consent to the transaction prior to sale. All of these
requirements may restrict your ability to sell our stock and could limit the
trading volume of our stock and adversely affect the price investors are
willing to pay for our stock. Our quarterly operating results may fluctuate significantly, which may
adversely affect the market prices of our stock and could lead to us becoming
the target of costly securities class action litigation. We expect our operating results, including any revenues we may generate,
to fluctuate significantly due to a number of factors, many of which are
outside of our control. Therefore, you should not rely on period-to-period
comparisons of results of operations as an indication of our future
performance. It is possible that in some future periods our operating results
may fall below the expectations of market analysts and investors. In this
event, the market prices of our stock would likely fall. Factors that may
affect our quarterly operating results include: 20




---



##### Table of Contents




    
    consumer awareness and demand for our products;
    
    ongoing demand and supply for our products;
    
    seasonality and other consumer and advertising trends;
    
    changes in the economic terms of our relationships with our strategic partners;
    
    shortfalls in the supply of components necessary for the manufacture of our products;
    
    changes in our pricing policies, the pricing policies of our
competitors and general pricing trends in the consumer electronics
market;
    
    unanticipated shortfalls in revenue due to the fact that our expenses precede associated revenues;
    
    changes in estimates of our financial performance or changes in recommendations by securities analysts;
    
    release of new or enhanced products or services or introduction of new marketing initiatives by us or our competitors;
    
    announcements by us or our competitors of the creation or termination
of significant strategic partnerships, joint ventures, significant
contracts, or acquisitions;
    
    the market price generally for consumer electronics and retail industry stocks;
    
    market conditions affecting the consumer electronics industry;
    
    additions or departures of key personnel;
    
    demand for and consumer acceptance of other anticipated future products offerings; and
    
    general economic conditions. In the past, securities class action litigation has often been brought
against a company following stock price declines. We may be the target of
similar litigation in the future if the price of our common stock declines.
Securities litigation could result in substantial costs and diversion of
management attention and resources, all of which could materially harm our
business, financial condition and results of operations. Seasonal trends may cause our quarterly operating results to fluctuate, which
may adversely affect the market price of our stock. Domestic consumer electronic product sales have traditionally been much
higher during the holiday shopping season than during other times of the year.
Although predicting consumer demand for our products and any future products
will be very difficult, we believe that sales of our existing products will be
higher during the holiday shopping season when compared to other times of the
year. We believe we have adequate capital to continue to operate for the
12-month period ending December 31, 2004. However, if we are unable to generate
sufficient revenues during the 2004 holiday shopping season, or any future
season, we may not be able to continue our business Our historical financial information may not be representative of our future
operating results as a separate company. Our historical financial information does not necessarily reflect what our
financial position, operating results and cash flows would have been had we
been a stand-alone entity during the periods presented. In addition, our
historical information is not necessarily indicative of what our operating
results, financial position and cash flows will be in the future. Conflicts of interest may arise because our Chairman is also the Chairman of
ESS and both he and another director own securities of both companies. Fred S.L. Chan, our Chairman, owns a significant amount of ESS stock and
our stock and options to purchase ESS stock and our 21




---



##### Table of Contents



stock. In addition, Matthew
K. Fong, a member of our board of directors, owns ESS stock and options to
purchase ESS stock. Mr. Chan is the Chairman of ESS. These factors could
create, or appear to create, potential conflicts of interest when these
directors are faced with decisions that could have different implications for
ESS and us. Our agreement to indemnify ESS for tax liabilities under certain circumstances
may affect our cash flow, discourage potential acquisition proposals or delay
or prevent a change in control of us, and limit the size of any future
offerings of our stock. Even if ESS distribution of our stock to its shareholders in August 2001
is otherwise a tax-free distribution, ESS may, under certain circumstances,
recognize gain for U.S. federal and state income tax purposes with respect to
the distribution if a 50% or greater interest in us is acquired during the
two-year period following the distribution. Certain sales of shares by us that
occurred during the two years immediately prior to the distribution may be
counted towards the 50% threshold. The amount of such gain would be the
difference between the fair market value of the stock distributed, on the date
of distribution, and ESS adjusted tax basis in the stock. Under a tax sharing
and indemnity agreement, we have agreed in certain circumstances to indemnify
ESS for ESS U.S. federal and state income tax liability which results as a
direct consequence of any acquisition of a 50% or greater interest in us after
the distribution. This indemnity obligation, if triggered, could have a
substantial effect on our available cash. In addition, the existence of the
indemnity obligation may discourage potential acquisition proposals and could
delay or prevent an acquisition of a 50% or greater interest in us. Because
future sales of stock could be deemed to be part of a related transaction that
results in an acquisition of a 50% or greater interest in us, our desire to
avoid triggering the indemnity obligation could limit the size of any offerings
of stock by us during the two-year period following the distribution. ESS submitted a request to the Internal Revenue Service (IRS) to rule that its
distribution of our shares to ESS shareholders was tax-free. The IRS determined
that it would not provide such a ruling. The IRS decision not to provide a ruling on the distribution does not mean
that the distribution is taxable. We believe that the distribution is tax-free.
ESS has advised us that they reported the distribution as tax-free in its
federal income tax filings. ESS has also advised us that it is seeking an
opinion from its tax advisors that the distribution is tax-free. No assurance
can be given that such an opinion will be obtained or the level of assurance
such opinion will provide. Even if such an opinion is obtained, no assurance can be given that the
IRS will not determine at a later date that the distribution is taxable. If the
IRS determines that the distribution is taxable, recipients of our stock in
distribution may be required to pay income taxes as a result of the
distribution, with the amount of ordinary income and gain dependent upon the
value of the stock they received and their share of ESS earnings and profits.
Determining whether or not the distribution will qualify for tax-free status
requires a complex analysis of many factors, including, among others, the
business purpose for the distribution, the nature of the business to be engaged
in by ESS and us following the distribution, and the extent to which ESS
remains in control of us following the distribution. Because of the
fact-intensive nature of this analysis, there will be substantial uncertainty
as to whether the distribution will qualify for tax-free treatment. ACCORDINGLY, WE CANNOT ASSURE RECIPIENTS OF OUR STOCK IN THE DISTRIBUTION
THAT THE IRS WILL NOT SUCCESSFULLY ASSERT THAT THE DISTRIBUTION IS TAXABLE. IN
ADDITION, SUCH RECIPIENTS MAY BE TAXED BY THE STATE, LOCAL OR FOREIGN
JURISDICTION IN WHICH THEY RESIDE. ACCORDINGLY, ALL RECIPIENTS OF OUR STOCK IN
THE DISTRIBUTION ARE STRONGLY URGED TO CONSULT WITH THEIR OWN FINANCIAL
ADVISORS REGARDING THE POTENTIAL TAX IMPACT TO THEM OF THE DISTRIBUTION AND TO
PREPARE FOR THE SIGNIFICANT POSSIBILITY THAT THE TRANSACTION WILL BE TAXABLE TO
THEM. If the distribution is taxable to them, the value of the shares they
received will be treated as taxable ordinary income, return of cost or as
taxable capital gain up to the value of the stock distributed. If the
distribution is taxable, they will incur this tax whether or not they decide to
sell the shares they receive in the distribution. Unless a recipient of shares
in the distribution is required to make quarterly estimated tax payments to the
IRS, this tax would generally have to be paid on or before the April 15, 2002
due date for the 2001 tax return. If such recipients do not have the cash
available to pay the tax at or before the time it is due, they may have to sell
all or a portion of their shares of our stock to pay the tax or risk incurring
interest and penalties imposed by the IRS. If holders of a significant
percentage our stock are also forced to sell in order to pay their taxes, or if
there is for any other reason, a decline in the trading price of our shares
following the distribution, recipients of our stock in the distribution may
have to sell their shares of our stock at a lower price than they might
otherwise have obtained. Provisions in our charter documents and Delaware law may delay or prevent
acquisition of us, which could decrease the value of our shares. Our amended and restated certificate of incorporation, amended and
restated bylaws and Delaware law contain provisions that 22




---



##### Table of Contents



could make it more
difficult for a third party to acquire us without the consent of our board of
directors. Delaware law also imposes some restrictions on mergers and other
business combinations between us and any holder of 15% or more of our
outstanding shares. Although we believe these provisions provide for an
opportunity to receive a higher bid by requiring potential acquirers to
negotiate with our board of directors, these provisions apply even if the offer
may be considered beneficial by some stockholders. 
 Item 7A:Quantitative and Qualitative Disclosure About Market Risk Interest Rate Risks.We invest in short-term & long-term investments.
Consequently, we are exposed to fluctuation in interest rates on these
investments. Increases or decreases in interest rates generally translate into
decreases and increases in the fair value of these investments. In addition,
the credit worthiness of the issuer, relative values of alternative
investments, the liquidity of the instrument, and other general market
conditions may affect the fair values of interest rate sensitive investments.
In order to reduce the risk from fluctuation in rates, we invest in highly
liquid governmental notes and bonds with contractual maturities of less than
two years. All of the investments have been classified as available for sale,
and at December 31, 2003, are recorded at market values. Foreign Exchange Risks.Because our products are manufactured primarily
in Asia, we are exposed to market risk from changes in foreign exchange rates,
which could affect our results of operations and financial condition. In order
to reduce the risk from fluctuation in foreign exchange rates, our product
sales and all of our arrangements with our third party manufacturers and
component vendors are denominated in U.S. dollars. We do not engage in any
currency hedging activities. 23




---



##### Table of Contents



Item 8:Financial Statements and Supplementary Data The following documents are filed as part of this Report: PageREPORT OF INDEPENDENT AUDITORS
    
    
    25CONSOLIDATED BALANCE SHEETS
    
    
    26CONSOLIDATED STATEMENTS OF OPERATIONS
    
    
    27CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
    
    
    28CONSOLIDATED STATEMENTS OF CASH FLOWS
    
    
    29NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
    
    
    30Financial Statements SchedulesAll schedules have been omitted because they are not applicable, not required, or the
information required is included in the financial statements or notes theretoSUPPLEMENTARY FINANCIAL DATA
    
    
    41
 24




---



##### Table of Contents



REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Stockholders of Vialta, Inc.: In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, of stockholders equity and of
cash flows present fairly, in all material respects, the financial position of
Vialta, Inc. and its subsidiaries at December 31, 2003 and 2002, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2003, in conformity with accounting principles
generally accepted in the United States of America. These financial statements
are the responsibility of the Companys management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion. PricewaterhouseCoopers LLP
San Jose, California
February 26, 2004 25




---



##### Table of Contents



VIALTA, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands) December 31,2003
    
    2002ASSETSCurrent assets:Cash and cash equivalents
    
    $
    13,756
    
    
    $
    21,863Restricted cash
    
    
    2,226
    
    
    
    Short-term investments
    
    
    10,552
    
    
    
    10,838Accounts receivable, net
    
    
    3,941
    
    
    
    1,362Inventories
    
    
    5,196
    
    
    
    2,834Prepaid expenses and other current assets
    
    
    729
    
    
    
    1,253Total current assets
    
    
    36,400
    
    
    
    38,150Property and equipment, net
    
    
    685
    
    
    
    2,132Other assets
    
    
    29
    
    
    
    45Total assets
    
    $
    37,114
    
    
    $
    40,327LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    1,915
    
    
    $
    1,131Accrued expenses and other current liabilities
    
    
    3,149
    
    
    
    3,588Deferred profit
    
    
    3,997
    
    
    
    3,230Total current liabilities
    
    
    9,061
    
    
    
    7,949Commitments (Notes 15 and 16)Redeemable
convertible preferred stock, $0.001 par value; 30,000 shares authorized, no shares issued and outstanding (Note 8)
    
    
    
    
    
    
    Stockholders equity:Common stock, $0.001 par value, 400,000 shares authorized,
94,702 and 93,961 shares issued, 82,738 and 82,756
shares outstanding
    
    
    95
    
    
    
    94Additional paid-in capital
    
    
    144,114
    
    
    
    144,105Treasury stock
    
    
    (9,458
    )
    
    
    (9,163
    )Accumulated deficit
    
    
    (106,709
    )
    
    
    (102,666
    )Accumulated other comprehensive income
    
    
    11
    
    
    
    8Total stockholders equity
    
    
    28,053
    
    
    
    32,378Total liabilities, redeemable convertible preferred
stock and stockholders equity
    
    $
    37,114
    
    
    $
    40,327
 The accompanying notes are an integral part of these consolidated financial statements. 26




---



##### Table of Contents



VIALTA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts) Years Ended December 31,2003
    
    2002
    
    2001Revenue, net
    
    $
    10,331
    
    
    $
    
    
    
    $
    Cost of goods sold
    
    
    2,941
    
    
    
    
    
    
    
    Gross profit
    
    
    7,390
    
    
    
    
    
    
    
    Operating expenses:Product costs
    
    
    
    
    
    
    10,421
    
    
    
    Engineering and development
    
    
    2,557
    
    
    
    13,264
    
    
    
    25,250Sales and marketing
    
    
    4,427
    
    
    
    3,100
    
    
    
    3,738General and administrative
    
    
    5,753
    
    
    
    5,643
    
    
    
    9,301Amortization and impairment of content
licenses
    
    
    
    
    
    
    11,395
    
    
    
    Total operating expenses
    
    
    12,737
    
    
    
    43,823
    
    
    
    38,289Operating loss
    
    
    (5,347
    )
    
    
    (43,823
    )
    
    
    (38,289
    )Interest income, net
    
    
    733
    
    
    
    1,244
    
    
    
    3,606Gain on investment
    
    
    571
    
    
    
    
    
    
    
    Other expense
    
    
    
    
    
    
    
    
    
    
    (1,266
    )Net loss
    
    $
    (4,043
    )
    
    $
    (42,579
    )
    
    $
    (35,949
    )Net loss per share:Basic and diluted
    
    $
    (0.05
    )
    
    $
    (0.51
    )
    
    $
    (0.83
    )Weighted average common shares outstanding:Basic and diluted
    
    
    82,285
    
    
    
    83,578
    
    
    
    43,248
 The accompanying notes are an integral part of these consolidated financial statements. 27




---



##### Table of Contents



VIALTA, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
(in thousands) RedeemableConvertible
    
    Common Stock
    
    
    
    
    
    
    
    
    
    
    
    Accumulated
    
    TotalPreferred Stock
    
    (See Note 8)
    
    Additional Paid in
    
    Treasury
    
    Accumulated
    
    OtherComprehensive
    
    StockholdersEquity
    
    ComprehensiveShares
    
    Amount
    
    Shares
    
    Amount
    
    Capital
    
    Stock
    
    Deficit
    
    Income
    
    (Deficit)
    
    LossBalance at December 31, 2000
    
    
    91,000
    
    
    $
    142,600
    
    
    
    6,231
    
    
    $
    6
    
    
    $
    1,629
    
    
    $
    
    
    
    $
    (24,138
    )
    
    $
    
    
    
    $
    (22,503
    )Exercise of stock options before
recapitalization
    
    
    
    
    
    
    
    
    
    
    61
    
    
    
    
    
    
    
    16
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16Conversion of preferred stock to
common stock A
    
    
    (60,000
    )
    
    
    (62,000
    )
    
    
    60,000
    
    
    
    60
    
    
    
    61,940
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    62,000Conversion of preferred stock to
common stock B
    
    
    (31,000
    )
    
    
    (80,600
    )
    
    
    34,100
    
    
    
    34
    
    
    
    80,566
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    80,600Conversion of common stock to
common stock B
    
    
    
    
    
    
    
    
    
    
    589
    
    
    
    1
    
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Shares transferred by ESS
Technology, Inc. at spin-off
    
    
    
    
    
    
    
    
    
    
    (612
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Return of common stock reserved
for issuance upon exercise of
stapled options
    
    
    
    
    
    
    
    
    
    
    (9,840
    )
    
    
    (10
    )
    
    
    10
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exercise of stapled stock
options
    
    
    
    
    
    
    
    
    
    
    1,312
    
    
    
    1
    
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exercise of stock options
    
    
    
    
    
    
    
    
    
    
    20
    
    
    
    
    
    
    
    5
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5Repurchase of common stock
    
    
    
    
    
    
    
    
    
    
    (6,236
    )
    
    
    
    
    
    
    
    
    
    
    (4,046
    )
    
    
    
    
    
    
    
    
    
    
    (4,046
    )Components of comprehensive loss:Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (35,949
    )
    
    
    
    
    
    
    (35,949
    )
    
    $
    (35,949
    )Unrealized gains on
available-for-sale
investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    156
    
    
    
    156
    
    
    
    156Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (35,793
    )Balance at December 31, 2001
    
    
    
    
    
    
    
    
    
    
    85,625
    
    
    
    92
    
    
    
    144,164
    
    
    
    (4,046
    )
    
    
    (60,087
    )
    
    
    156
    
    
    
    80,279Shares transferred to ESS
Technology, Inc
    
    
    
    
    
    
    
    
    
    
    612
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exercise of stapled stock options
    
    
    
    
    
    
    
    
    
    
    1,419
    
    
    
    1
    
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exercise of stock options
    
    
    
    
    
    
    
    
    
    
    69
    
    
    
    1
    
    
    
    19
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20Repurchase of common stock
    
    
    
    
    
    
    
    
    
    
    (4,969
    )
    
    
    
    
    
    
    
    
    
    
    (5,117
    )
    
    
    
    
    
    
    
    
    
    
    (5,117
    )Income tax benefit on disqualified
disposition of stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (77
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (77
    )Components of comprehensive loss:Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (42,579
    )
    
    
    
    
    
    
    (42,579
    )
    
    $
    (42,579
    )Unrealized losses on
available-for-sale
investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (148
    )
    
    
    (148
    )
    
    
    (148
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (42,727
    )Balance at December 31, 2002
    
    
    
    
    
    
    
    
    
    
    82,756
    
    
    
    94
    
    
    
    144,105
    
    
    
    (9,163
    )
    
    
    (102,666
    )
    
    
    8
    
    
    
    32,378Exercise of stapled stock options
    
    
    
    
    
    
    
    
    
    
    701
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exercise of stock options
    
    
    
    
    
    
    
    
    
    
    40
    
    
    
    1
    
    
    
    9
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10Repurchase of common stock
    
    
    
    
    
    
    
    
    
    
    (759
    )
    
    
    
    
    
    
    
    
    
    
    (295
    )
    
    
    
    
    
    
    
    
    
    
    (295
    )Components of comprehensive loss:
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,043
    )
    
    
    
    
    
    
    (4,043
    )
    
    $
    (4,043
    )Unrealized gains on
available-for-sale
investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3
    
    
    
    3
    
    
    
    3Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    (4,040
    )Balance at December 31, 2003
    
    
    
    
    
    $
    
    
    
    
    82,738
    
    
    $
    95
    
    
    $
    144,114
    
    
    $
    (9,458
    )
    
    $
    (106,709
    )
    
    $
    11
    
    
    $
    28,053
 The accompanying notes are an integral part of these consolidated financial statements. 28




---



##### Table of Contents



VIALTA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands) Years Ended December 31,2003
    
    2002
    
    2001Cash flows from operating activities:Net loss
    
    $
    (4,043
    )
    
    $
    (42,579
    )
    
    $
    (35,949
    )Adjustments to reconcile net loss to net cash
used in operating activities:Depreciation and amortization
    
    
    1,638
    
    
    
    6,036
    
    
    
    5,834Amortization and impairment of content license fees
    
    
    
    
    
    
    11,395
    
    
    
    Write-down of investments
    
    
    
    
    
    
    
    
    
    
    1,083Changes in assets and liabilities:Accounts receivables, net
    
    
    (2,579
    )
    
    
    (1,362
    )
    
    
    Related party receivables/payables, net
    
    
    248
    
    
    
    97
    
    
    
    646Inventories
    
    
    (2,362
    )
    
    
    (2,834
    )
    
    
    2,057Prepaid expense and other assets
    
    
    540
    
    
    
    1,672
    
    
    
    1,335Restricted cash deposit
    
    
    (2,226
    )
    
    
    
    
    
    
    Deferred profit
    
    
    767
    
    
    
    3,115
    
    
    
    115Accounts payable and accrued liabilities
    
    
    97
    
    
    
    1,137
    
    
    
    (122
    )Net cash flows used in operating activities
    
    
    (7,920
    )
    
    
    (23,323
    )
    
    
    (25,001
    )Cash flows from investing activities:Purchase of short-term investments
    
    
    (21,440
    )
    
    
    (32,277
    )
    
    
    (18,088
    )Proceeds from sales of short-term investments
    
    
    21,729
    
    
    
    30,897
    
    
    
    33,650Purchase of content licenses
    
    
    
    
    
    
    (10,053
    )
    
    
    (1,342
    )Acquisition of property and equipment
    
    
    (191
    )
    
    
    (170
    )
    
    
    (2,686
    )Net cash flows provided by (used in) investing activities:
    
    
    98
    
    
    
    (11,603
    )
    
    
    11,534Cash flows from financing activities:Proceeds from (repayment) of notes payable to related party
    
    
    
    
    
    
    
    
    
    
    (30,000
    )Issuance of common stock
    
    
    10
    
    
    
    20
    
    
    
    21Repurchase of common stock
    
    
    (295
    )
    
    
    (5,117
    )
    
    
    (4,046
    )Net cash flows used in financing activities:
    
    
    (285
    )
    
    
    (5,097
    )
    
    
    (34,025
    )Net increase (decrease) in cash and cash equivalents
    
    
    (8,107
    )
    
    
    (40,023
    )
    
    
    (47,492
    )Cash and cash equivalents, beginning of the period
    
    
    21,863
    
    
    
    61,886
    
    
    
    109,378Cash and cash equivalents, end of the period
    
    $
    13,756
    
    
    $
    21,863
    
    
    $
    61,886Supplemental disclosure of cash flow information:Unrealized gains (losses) on available-for-sale investments
    
    $
    3
    
    
    $
    (148
    )
    
    $
    156Cash paid for interest
    
    $
    
    
    
    $
    
    
    
    $
    194
 The accompanying notes are an integral part of these financial statements. 29




---



##### Table of Contents



VIALTA, INC. Notes To Consolidated Financial Statements Note 1  The Company We develop, design and market consumer electronics products designed to
maximize the advantages of digital technology in a convenient and easy-to-use
manner. Our primary products are the Beamer personal videophone line and the
VistaFrame digital picture frame. Our Beamer videophone products add color
video to phone calls, enabling users to see the person they are calling. Since
both parties to a video call must have a Beamer videophone product (or
compatible videophone), our videophone products are primarily sold in pairs and
are all compatible with each other. Our Beamer videophone products work with
any home phone over any standard (analog) home phone line, at no additional
cost to a regular phone call. Our Beamer videophone products include models
that are standalone (such as our first videophone product known as Beamer) or
connect through most televisions (the Beamer TV), and may include the ability
to send and receive digital pictures (the Beamer FX), depending on the model.
Beamer began nationwide retail distribution during the third quarter of 2002.
Beamer videophone products are carried by such retailers as Best Buy, Frys
Electronics, The Good Guys, The Sharper Image and Cinmar (The Frontgate
Catalog). Our latest product, VistaFrame, is a digital picture frame that allows
users to display photographs directly from a digital camera memory card or from
VistaFrames internal memory. VistaFrame is compatible with most standard card
formats and does not require a camera or computer connection, special wiring or
web based services to display digital photographs. With VistaFrame, consumers
can view digital pictures individually or in a custom slideshow format with the
user selecting the pictures, the display sequence, display interval and the
transition effect. VistaFrame is currently available at retailers such as The
Sharper Image, The Good Guys and Cinmar. Since our inception, we have incurred substantial losses and negative cash
flows from operations. We expect operating losses and negative cash flows from
operations to continue for the foreseeable future and anticipate that losses
may increase from current levels because of additional costs and expenses
related to sales and marketing activities, continued expansion of operations,
expansion of product offerings and development of relationships with other
businesses. We believe that we have sufficient cash and cash equivalents,
restricted cash and investments to fund our operations through December 31,
2004. However, in the longer term, failure to generate sufficient revenues,
raise additional capital or reduce spending could have a material adverse
effect on our ability to continue to operate our business. From our inception through December 31, 2002, we were a development stage
enterprise. During the first quarter of 2003, we commenced principal operations
and are no longer classified as a development stage company. Note 2  Summary of Significant Accounting Policies Use of Estimates The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates. Principles of Consolidation The consolidated financial statements include the accounts of Vialta, Inc.
and our subsidiaries. All material intercompany accounts and transactions have
been eliminated in consolidation. Cash Equivalents and Investments We consider all highly liquid investments with an initial maturity of 90
days or less to be cash equivalents. Cash equivalents primarily represent money
market funds. Investments are comprised primarily of debt instruments that have been
classified as available-for-sale. Management determines the appropriate
classification of securities at the time of purchase and re-evaluates the
classification at each reporting date. Marketable 30




---



##### Table of Contents



equity and debt securities are carried at their fair market value based on
quoted market prices as of the balance sheet date. Realized gains or losses are
determined on the specific identification method and are reflected in income.
Net unrealized gains or losses are recorded directly in stockholders equity
except those unrealized losses that are deemed to be other than temporary,
which are reflected in investment losses. Investments
with maturity dates of 90 days or more are classified as
short-term investments since we have the ability to redeem them within the
year. Approximately $2.2 million of cash at December 31, 2003 is restricted as
collateral for letters of credit to a contract manufacturer and raw materials
supplier. Fair Value of Financial Instruments The reported amounts of certain of our financial instruments, including
cash and cash equivalents, short and long-term investments, accounts
receivable, and accounts payable approximated fair value due to their short
maturities. Inventories Inventories are stated at the lower of cost or market, with cost being
determined by the first-in, first-out method. Property and Equipment Property and equipment are stated at cost less accumulated depreciation
and amortization. Depreciation is generally computed using the straight-line
method over the estimated useful lives of the assets. Computer equipment
    
    3-5 yearsFurniture and fixtures
    
    5 yearsSoftware and web site development costs
    
    1-3 years
 Repairs and maintenance costs are expensed as incurred. Long-Lived Assets We review long-lived assets based upon an undiscounted cash flow basis and
will record an impairment whenever events or changes in circumstances indicate
the carrying amount of the assets may not be fully recoverable. If an asset is
considered impaired, the asset is written down to carrying value based on
undiscounted cash flows. Comprehensive Income (Loss) Comprehensive income (loss) is defined to include all changes in equity
during a period from non-owner sources. For the year ended December 31, 2003,
comprehensive loss approximated the net losses reported. The difference between
net loss and comprehensive loss year ended December 31, 2002 was approximately
$148,000, which related to unrealized losses on available-for-sale investments. Revenue Recognition We generally recognize revenue on products sold to end customers upon
shipment provided that we have no post-sale obligations, we can reliably
estimate and accrue warranty costs and sales returns, the price is fixed or
determinable and collection of the resulting receivable is reasonably assured.
For sales to international distributors and strategic partners we generally
recognize revenue based on the above criteria and upon receipt of payment in
full. For sales to end customers that do not meet the above criteria, revenue
is deferred until such criteria are met. Products sold to retailers and distributors are subject to rights of
return. We defer recognition of revenue on products sold to retailers and
distributors until the retailers and distributors sell the products to their
customers. We recognize revenue from retailers and distributors according to
information on shipments to their customers as provided by those retailers and
distributors. If information on shipments to their customers is not provided in
a timely and accurate manner, there may be a material impact on our 31




---



##### Table of Contents



reported results of operations and financial condition. Revenue is also
deferred for the initial thirty-day period during which our direct customers,
retailers and distributors have the unconditional right to return products. Allowances for Sales Return Allowances are provided for estimated returns. Provision for return
allowances are recorded at the time when revenue is recognized based on
historical returns, current economic trends and changes in customer demand.
Such allowances are adjusted periodically to reflect actual experience and
anticipated returns. Warranty We provide a limited warranty on our products for periods ranging from 90
days to 12 months from the date of sale to the end customers. We estimate
warranty costs based on historical experience and accrue for estimated costs as
a charge to cost of sales when revenue is recognized. The following table shows
the details of the product warranty accrual, as required by FASB Interpretation
No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others, for the year ended
December 31, 2003 (in thousands): December 31,2003Beginning balance
    
    $
    Accruals for warranties issued during the period
    
    
    814Settlements made during the period
    
    
    (330
    )Ending balance
    
    $
    484
 Engineering and Development Engineering and development costs are expensed as incurred. Advertising Costs Advertising production costs are expensed as incurred. Total advertising
and promotional expenses were approximately $2.3 million and $430,000 for the
years ended December 31, 2003 and 2002, respectively, and were not material for
the year ended December 31, 2001. Income Taxes We account for income taxes under the asset and liability approach that
requires the recognition of deferred tax liabilities and assets for the
expected future tax consequences of timing differences between the carrying
amounts and the tax bases of assets and liabilities. Foreign Currency Translation The functional currencies of our foreign subsidiaries are the local
currencies. Accordingly, all assets and liabilities of the foreign operations
are translated to U.S. dollars at current period end exchange rates, and
revenues and expenses are translated to U.S. dollars using average exchange
rates in effect during the period. Currency transaction and translation gains
and losses have not been significant. Net Income (Loss) Per Share Basic net income (loss) per share excludes dilution and is computed by
dividing net income (loss) by the weighted average number of common shares
outstanding for the period. Diluted net income per share reflects the potential
dilution that would occur if securities or other contracts to issue common
stock were exercised or converted into common stock. Stock-Based Compensation We account for stock-based compensation using the intrinsic value method
prescribed in Accounting Principles Board Opinion 32




---



##### Table of Contents



No. 25, or APB No. 25, Accounting for Stock Issued to Employees. Under
APB No. 25, compensation cost is measured as the excess, if any, of the quoted
market price of its stock at the date of grant over the exercise price of the
option granted. Compensation cost for stock options, if any, is recognized
ratably over the vesting period. We provide additional pro forma disclosures as
required under SFAS No. 123, Accounting for Stock-Based Compensation and SFAS
No. 148, Accounting for Stock-Based Compensation, Transition and Disclosure. The following table illustrates the effect on our net loss and net loss
per share if we had recorded compensation costs based on the estimated grant
date fair value as defined by SFAS No. 123 for all granted stock-based awards
(in thousands, except per share amounts). Years Ended December 31,2003
    
    2002
    
    2001Net loss, as reported
    
    $
    (4,043
    )
    
    $
    (42,579
    )
    
    $
    (35,949
    )Deduct: Stock-based employee compensation
expense determined under fair value
based method for all awards
    
    
    (1,738
    )
    
    
    (3,208
    )
    
    
    (6,335
    )Pro forma net loss
    
    $
    (5,781
    )
    
    $
    (45,787
    )
    
    $
    (42,284
    )Net loss per share  basic and diluted:As reported
    
    $
    (0.05
    )
    
    $
    (0.51
    )
    
    $
    (0.83
    )Pro forma
    
    $
    (0.07
    )
    
    $
    (0.55
    )
    
    $
    (0.98
    )
 Reclassification We have reclassified certain prior years information to conform to the
current financial statement. Recent Accounting Pronouncements In November 2002, the Emerging Issues Task Force (EITF) reached a
consensus on Issue No. 00-21, Accounting for Revenue Arrangements with
Multiple Deliverables (EITF Issue No. 00-21). EITF Issue No. 00-21 provides
guidance on how to account for arrangements that involve the delivery or
performance of multiple products, services and/or rights to use assets. The
provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered
into in fiscal periods beginning after June 15, 2003. Adoption of EITF Issue
No. 00-21 did not have a material impact on our consolidated financial
statements. In January 2003, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest
Entities, an Interpretation of ARB No. 51. FIN 46 requires certain variable
interest entities to be consolidated by the primary beneficiary of the entity
if the equity investors in the entity do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. During December 2003, the FASB issued FIN 46R, a
revision to FIN 46. FIN 46R provides a broad deferral of the latest date by
which all public entities must apply FIN 46 to certain variable interest
entities, to the first reporting period ending after March 15, 2004. We do not
expect the adoption of FIN 46 to have a material impact upon our financial
position, cash flows or results of operations. In May 2003, the Financial Accounting Standard Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 150, Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity. SFAS No. 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. SFAS No. 150 requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). Many of those instruments were previously classified as equity.
SFAS No. 150 is effective for financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the first
fiscal period beginning after June 15, 2003. SFAS No. 150 is to be implemented
by reporting the cumulative effect of a change in an accounting principle for
financial instruments created before the issuance date of SFAS No. 150 and
still existing at the beginning of the interim period of adoption. Restatement
is not permitted. We believe that the adoption of this standard will not have a
material impact on our consolidated financial statements. Note 3  Risks and Uncertainties Factors that could impact our future business, consolidated financial
position, results of operations or cash flows and cause future 33




---



##### Table of Contents



results to differ from our expectations include the following: the ability
to achieve revenues and profitability; the ability to raise additional capital;
competition; pricing pressures; the dependence on a limited number of products
and the need to develop new products and features; the success of our existing
products and other consumer products we may develop; component supply
shortages; potential conflicts with ESS Technology, Inc., our former parent;
the success of current distribution and retail relationships and the ability to
enter into additional distribution agreements; risks associated with the
expansion of our business, including increased costs and the strain on
management and other resources; the risk of product defects, system failures or
interruptions; general economic, political and regulatory changes including in
Asia; claims by third parties of intellectual property infringement; dependence
on key management personnel and the need to attract and retain additional
qualified personnel; risks associated with possible business acquisitions;
regulatory changes that affect consumer electronics, telecommunications,
copyrights or the internet; quarterly fluctuations in operating results; risks
of class action lawsuits based on fluctuations in our stock price; seasonal
trends; and risks identified in the our Annual Report on Form 10-K for the
fiscal year ended December 31, 2003 and other filings with the Securities and
Exchange Commission. We operate in a single business segment that is characterized by rapid
technological advances, changes in customer requirements and evolving industry
standards. Any failure by us to anticipate or respond to changes in demand
could have a material adverse effect on our business and operating results. Certain of our products contain critical components supplied by a single
or a limited number of third parties. We have been required to purchase and
inventory certain of the components around which we design our products to
ensure an available supply of products for our customers. Any significant
shortage of critical components or the failure of the third party suppliers to
maintain or enhance these products could materially adversely affect our
results of operations. Currently, we rely on two third party manufacturers for the manufacture of
our products. Reliance on third-party manufacturers involves a number of risks,
including the lack of control over the manufacturing process and the potential
absence or unavailability of adequate capacity. If our third party
manufacturers cannot or will not manufacture our products in required volumes,
on a cost-effective basis, in a timely manner, or at all, we will have to
secure additional manufacturing capacity. Even if the additional capacity is
available at commercially acceptable terms, the qualification process could be
lengthy and could cause interruptions in product shipments. Three customers comprise 62% of our gross accounts receivable balance of
$4.0 million at December 31, 2003. These customers represented between 11%, 17%
and 34% of total accounts receivable. Note 4  Revenue Recognition Beamer Products Revenue for the year ended December 31, 2003 was $10.3 million. There was
no revenue for the year ended December 31, 2002. Included in net revenue for
2003 was approximately $7.1 million in domestic sales and approximately $3.2
million from international sales. In addition to revenue generated from our
first videophone product, Beamer, we also recorded domestic net revenue during
the fourth quarter of 2003 from sales activity related to our new products
BeamerTV and VistaFrame. During the first quarter of 2003, we began to
recognize revenue on sales of Beamer, net of estimated warranty claims and
returns. We began nationwide distribution of Beamer during the third quarter of
2002 and experienced more significant shipments during the fourth quarter of
2002. For most of these shipments, the standard warranty period had not been
completed as of December 31, 2002. Due to a limited history of warranty and
sales returns for Beamer, we did not recognize revenue for sales through
December 31, 2002. As a result, revenue for the year ended December 31, 2003,
includes the recognition of deferred revenue of approximately $3.2 million
related to shipments of Beamer, which were made during the third and fourth
quarters of 2002. Note 5  Content Licenses During 2002 and 2001,we entered into licensing agreements with various
entertainment content providers in connection with ViMagazine, a proprietary,
encrypted, magazine-style DVD-format disk, which was designed to contain a wide
variety of entertainment that could be used exclusively with ViDVD products.
Starting in January 2002, we amortized prepaid content licenses based on the
greater of the royalty amounts due or amortization on a straight-line basis
over an estimated life of three years. In December 2002 we concluded that
content licenses had suffered a permanent decline in value, as a result of our
decision not to market ViMagazine, and the remaining unamortized balance was
written down to zero. The total amortization and impairment charge on content
licenses recognized by us during the year ended December 31, 2002 was $11.4
million. 34




---



##### Table of Contents



Note 6  Inventories The following table summarizes the activity in inventories and reserves
for the year ended December 31, 2003 (in thousands): Gross
    
    Reserve
    
    NetAs of December 31, 2001
    
    $
    
    
    
    $
    
    
    
    $
    Purchase of inventories
    
    
    13,255
    
    
    
    (10,421
    )
    
    
    2,834Shipments, net
    
    
    (1,816
    )
    
    
    1,816
    
    
    
    ViDVD parts transferred to Beamer inventory
    
    
    835
    
    
    
    (835
    )Use or disposal of inventories
    
    
    (408
    )
    
    
    408
    
    
    
    As of December 31, 2002
    
    
    11,866
    
    
    
    (9,032
    )
    
    
    2,834Purchase of inventories
    
    
    5,369
    
    
    
    
    
    
    
    5,369Shipments, net
    
    
    (7,361
    )
    
    
    4,603
    
    
    
    (2,758
    )Use or disposal of inventories
    
    
    (542
    )
    
    
    293
    
    
    
    (249
    )As of December 31, 2003
    
    $
    9,332
    
    
    $
    (4,136
    )
    
    $
    5,196Raw material
    
    $
    5,825
    
    
    $
    (1,999
    )
    
    $
    3,826Finished goods
    
    
    3,507
    
    
    
    (2,137
    )
    
    
    1,370$
    9,332
    
    
    $
    (4,136
    )
    
    $
    5,196
 Because a significant portion of our inventory expenditures for raw
materials and finished goods for our Beamer videophone products were expensed
in prior periods, the cost of goods sold related to revenue recognized during
the year ended December 31, 2003 was lower than what would have been recorded
had such inventory costs not been previously reserved. If we had not previously
expensed inventory costs, our cost of goods sold for the year ended December
31, 2003 would have been approximately $7.8 million. Inventories related to ViDVD products were fully reserved at December 31,
2002 as we did not have significant sales or gain market acceptance for these
products. These inventories and related reserves were written off during the
second quarter of 2003. Note 7  Other Balance Sheet Components (in thousands): December 31,
    
    December 31,2003
    
    2002Cash and cash equivalentsCash and money market funds, at cost which
approximates fair value
    
    $
    13,756
    
    
    $
    21,863Restricted cashCash restricted under letters of credit
    
    $
    2,226
    
    
    $
    Short-term investmentsUS Government debt securities
    
    $
    3,480
    
    
    $
    1,509Corporate debt securities
    
    
    7,072
    
    
    
    9,32910,552
    
    
    
    10,838Due after one year
    
    
    1,974
    
    
    
    Due within one year
    
    $
    8,578
    
    
    $
    10,838Accounts receivable, netAccounts receivable
    
    $
    4,004
    
    
    $
    1,392Less: Allowance for doubtful accounts
    
    
    (63
    )
    
    
    (30
    )$
    3,941
    
    
    $
    1,362
 35




---



##### Table of Contents



December 31,
    
    December 31,2003
    
    2002Prepaid expenses and otherPrepaid inventory
    
    $
    
    
    
    $
    429Prepaid insurance
    
    
    308
    
    
    
    466Other current assets
    
    
    421
    
    
    
    358$
    729
    
    
    $
    1,253Property and equipment, netMachinery and equipment
    
    $
    5,918
    
    
    $
    7,155Furniture and fixtures
    
    
    561
    
    
    
    569Software and web site development cost
    
    
    5,323
    
    
    
    5,17311,802
    
    
    
    12,897Less: Accumulated depreciation
    
    
    (11,117
    )
    
    
    (10,765
    )$
    685
    
    
    $
    2,132Accrued liabilities and otherAccrued compensation costs
    
    $
    1,241
    
    
    $
    1,613Customer deposits
    
    
    764
    
    
    
    893Product return/warranty liability
    
    
    484
    
    
    
    Accrued facility charges, related party
    
    
    281
    
    
    
    33Accrued facility charges, non-related party
    
    
    
    
    
    
    402Other current liabilities
    
    
    379
    
    
    
    647$
    3,149
    
    
    $
    3,588Deferred profitDeferred revenue
    
    $
    5,198
    
    
    $
    3,230Deferred costs
    
    
    (1,201
    )
    
    
    Deferred profit
    
    $
    3,997
    
    
    $
    3,230
 Note 8  Spin-Off and Recapitalization of Equity Prior to August 21, 2001, we were a subsidiary of ESS Technology, Inc.
(ESS). On July 24, 2001, we were re-capitalized, pursuant to which we
separated our common stock into Class A common stock with 3.8 votes per share
and Class B common stock with one vote per share. Upon exchange of 5,892,000
shares of common stock for Class B common stock, we issued 589,000 additional
shares of Class B common stock to non-ESS common stockholders. Except for the
voting power, Class A and Class B stockholders had the same rights. We
authorized 30,000,000 shares of preferred stock and 400,000,000 shares of
common stock, 100,000,000 shares of which are designated Class A common stock,
50,000,000 of which are designated Class B common stock and 250,000,000 of
which are designated non-classified common stock. As part of the August 21, 2001 spin-off transaction, all preferred stock
owned by ESS converted to Class A common stock based on a conversion ratio of 1
to 1. All other preferred stock converted to Class B common stock at a ratio of
1 to 1.1. As a result, 91,000,000 shares of preferred stock were converted to
60,000,000 shares of Class A common stock and 34,100,000 shares of Class B
common stock. As part of the spin-off transaction, ESS returned approximately 9,840,000
shares of Class A common stock to us at no cost. These shares are reserved by
us for issuance upon exercise of stapled options that were granted by us to ESS
optionees as part of the spin-off transaction. In accordance with FIN No. 44,
no compensation expense has been or will be recorded in conjunction with these
stock option grants. The table below summarizes the effect of the these conversions of common
stock outstanding at December 31, 2001 (in thousands): 36




---



##### Table of Contents



Class A
    
    Class BPreferred
    
    Conversion
    
    Common
    
    Common
    
    OutstandingCapital Stock
    
    Shares
    
    Ratio
    
    Stock
    
    Stock
    
    TotalSeries A  ESS owned
    
    
    40,000
    
    
    
    1 to 1
    
    
    
    40,000
    
    
    
    
    
    
    
    40,000Series B  ESS owned
    
    
    20,000
    
    
    
    1 to 1
    
    
    
    20,000
    
    
    
    
    
    
    
    20,000Series B  third party owned
    
    
    31,000
    
    
    
    1.1 to 1
    
    
    
    
    
    
    
    34,100
    
    
    
    34,10091,000
    
    
    
    
    
    
    
    60,000
    
    
    
    34,100
    
    
    
    94,100Shares returned to Vialta by ESS,
reserved for issuance upon exercise
of stapled options
    
    
    
    
    
    
    
    
    
    
    (9,840
    )
    
    
    
    
    
    
    (9,840
    )Additional shares transferred by ESS
as part of the spin-off transaction
    
    
    
    
    
    
    
    
    
    
    (612
    )
    
    
    
    
    
    
    (612
    )Issuance of common stock upon
exchange of third party owned common
stock for Class B common stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    589
    
    
    
    589Conversion of original common stock
to Class A and Class B common stock
    
    
    
    
    
    
    
    
    
    
    400
    
    
    
    5,892
    
    
    
    6,292Total effect of re-capitalization and
spin-off transaction on Class A and
Class B common stock outstanding
    
    
    
    
    
    
    
    
    
    
    49,948
    
    
    
    40,581
    
    
    
    90,529
 In July 2002, each share of our outstanding Class A and Class B common
stock converted into a single class of common stock in accordance with the
provisions of our Articles of Incorporation. As a result of the above
conversion, approximately 53,141,000 shares, including 10,169,000 of shares
held by us as treasury stock, of issued Class A common stock and approximately
40,580,000 shares of issued Class B common stock were converted into
approximately 93,721,000 shares of the non-classified common stock. Holders of
the non-classified common stock are entitled to one vote per share on all
matters. In November 2002, we returned approximately 612,000 shares to ESS at no
cost. These shares were originally returned by ESS to us as part of spin-off
transaction in August 2001. Note 9  Related Party Transactions The following is a summary of major transactions between us and ESS
Technology, Inc., which was our parent company prior to August 2001, for the
periods presented (in thousands): Year Ended December 31,2003
    
    2002
    
    2001Net receivables (payables) at beginning of period
    
    $
    (33
    )
    
    $
    64
    
    
    $
    650Charges by Vialta to ESS:Administrative & management service fees
    
    
    
    
    
    
    223
    
    
    
    98Other
    
    
    4
    
    
    
    77
    
    
    
    74Charges by ESS to Vialta:Research and development service fees
    
    
    
    
    
    
    
    
    
    
    (1,895
    )Administrative & management service fees
    
    
    (73
    )
    
    
    (201
    )
    
    
    (3,140
    )Purchase of products
    
    
    (412
    )
    
    
    (1,403
    )
    
    
    (1,127
    )Building lease
    
    
    (1,182
    )
    
    
    (1,852
    )
    
    
    (640
    )Cash receipts from ESS
    
    
    (4
    )
    
    
    (424
    )
    
    
    (700
    )Cash payments made to ESS
    
    
    1,419
    
    
    
    3,483
    
    
    
    6,744Net receivables (payables) at end of period
    
    $
    (281
    )
    
    $
    (33
    )
    
    $
    64
 Note 10  Net Income (Loss) Per Share Basic and diluted net loss per share is computed by dividing net loss by
the weighted average number of common shares outstanding for the periods (in
thousands, except per share amounts). Years Ended December 31,2003
    
    2002
    
    2001Net loss
    
    $
    (4,043
    )
    
    $
    (42,579
    )
    
    $
    (35,949
    )Basic and diluted weighted average
common shares outstanding
    
    
    82,285
    
    
    
    83,578
    
    
    
    43,248Basic and diluted net loss per share
    
    $
    (0.05
    )
    
    $
    (0.51
    )
    
    $
    (0.83
    )
 37




---



##### Table of Contents



The following table sets forth potential shares of common stock that are
not included in the diluted net loss per share calculation above because to do
so would be anti-dilutive for the periods indicated (in thousands): Years Ended December 31,2003
    
    2002
    
    2001Effect of common stock equivalents:Options outstanding
    
    
    12,149
    
    
    
    11,255
    
    
    
    13,107Preferred stock outstanding
    
    
    
    
    
    
    
    
    
    
    91,000Total common stock equivalents excluded
    
    
    12,149
    
    
    
    11,255
    
    
    
    104,107
 The dilutive net loss per share calculation excludes the effect of the
preferred stock outstanding through July 24, 2001, the date of the
re-capitalization. Subsequent to this date, these stocks were included within
the weighted basic shares outstanding calculation. Note 11  Common Stock and Stock Options Common Stock Repurchases In September 2001, our Board of Directors authorized us to repurchase up
to 10 million shares of our common stock in the open market. During fiscal
2001, we repurchased a total of 6,236,000 shares of common stock for an
aggregate cost of $4.0 million. In June 2002, the Board of Directors authorized an additional 10 million
shares for repurchase. During fiscal 2002, we repurchased a total of 4,969,000
shares of common stock for an aggregate cost of $5.1 million. During fiscal
2003, we repurchased approximately 759,000 shares of common stock for an
aggregate cost of approximately $295,000. 1999 Stock Incentive Plan In August 1999, we adopted the 1999 stock incentive plan. Under the 1999
Plan, our incentive stock options may be granted to our employees, directors,
non-employee directors and consultants. The aggregate number of shares reserved
for awards under the 1999 Plan shall not exceed 10,000,000 shares. The exercise
price of the 1999 Plan shall not be less than 100% of the fair market value
(110% for 10 percent shareholders); the exercise price of a non-incentive stock
option shall not be less than 85% of the fair market value (110% for 10 percent
shareholders). Options shall generally vest over a four-year period. 2000 Directors Stock Option Plan In February 2000, we adopted the 2000 Directors Stock Option Plan. Under
the 2000 Director Plan, our nonqualified stock options may be granted to
nonemployee members of the board of directors. The aggregate number of shares
reserved for issuance is 300,000 shares subject to adjustment as provided in
this 2000 Director Plan. Each nonemployee director will automatically be
granted an option for 32,000 shares. The exercise price of the option shall be
the fair market value at the time the option is granted. Options shall
generally vest over a four-year period. On June 17, 2003 our shareholders approved the Amended and Restated 2000
Directors Stock Option plan, which increased the maximum number of shares under
the plan from 300,000 shares to 600,000 shares, decreased the initial grant of
options from 32,000 shares to 20,000 shares, and increased each annual grant to
nonemployee directors from 8,000 shares to 20,000 shares. 2001 Non-Statutory Stock Option Plan In August 2001, we adopted the 2001 non-statutory option plan. Under the
2001 Plan, our non-statutory stock options may be granted to our employees,
directors, non-employee directors and consultants. The aggregate number of
shares reserved for awards under the 2001 Plan shall not exceed 10,000,000
shares. The exercise price of a non-statutory stock option shall not be less
than 85% of the fair market value (110% for 10 percent shareholders). Options
shall generally vest over a four-year period. 38




---



##### Table of Contents



A summary of the activities in the 1999 Plan, the 2000 Director Plan and
the 2001 Plan is as follows: Options OutstandingWeightedAvailable
    
    Numbers
    
    Averagefor
    
    of
    
    ExerciseGrant
    
    Options
    
    PriceBalance at December 31, 2000
    
    
    8,133,300
    
    
    
    2,156,200
    
    
    
    0.87Adoption of the 2001 Plan
    
    
    10,000,000
    
    
    
    
    
    
    
    Granted
    
    
    (13,640,137
    )
    
    
    13,640,137
    
    
    
    0.25Cancelled
    
    
    1,296,832
    
    
    
    (1,296,832
    )
    
    
    1.22Exercised
    
    
    
    
    
    
    (1,392,899
    )
    
    
    0.02Balance at December 31, 2001
    
    
    5,789,995
    
    
    
    13,106,606
    
    
    
    0.29Granted
    
    
    (913,957
    )
    
    
    913,957
    
    
    
    0.85Cancelled
    
    
    1,277,205
    
    
    
    (1,277,205
    )
    
    
    0.79Exercised
    
    
    
    
    
    
    (1,488,670
    )
    
    
    0.01Balance at December 31, 2002
    
    
    6,153,243
    
    
    
    11,254,688
    
    
    
    0.31Granted
    
    
    (2,510,595
    )
    
    
    2,510,595
    
    
    
    0.35Cancelled
    
    
    875,842
    
    
    
    (875,842
    )
    
    
    0.71Exercised
    
    
    
    
    
    
    (740,697
    )
    
    
    0.02Balance at December 31, 2003
    
    
    4,518,490
    
    
    
    12,148,744
    
    
    
    0.31
 The options outstanding and currently exercisable at December 31, 2003 are
detailed as follows: Options OutstandingWeighted
    
    
    
    
    
    Options ExercisableAverage
    
    Weighted
    
    
    
    
    
    WeightedRemaining
    
    Average
    
    
    
    
    
    AverageExercise
    
    Number
    
    Contractual
    
    Exercise
    
    Number
    
    ExercisePrice
    
    Outstanding
    
    Life (Years)
    
    Price
    
    Exercisable
    
    Price$0.00
    
    
    5,382,944
    
    
    
    4.61
    
    
    $
    
    
    
    
    4,003,662
    
    
    $
    $0.25  $0.42
    
    
    4,810,800
    
    
    
    8.06
    
    
    
    0.35
    
    
    
    1,440,279
    
    
    
    0.37$0.47  $1.62
    
    
    1,850,000
    
    
    
    8.06
    
    
    
    1.00
    
    
    
    945,364
    
    
    
    1.14$1.95
    
    
    40,000
    
    
    
    6.13
    
    
    
    1.95
    
    
    
    38,333
    
    
    
    1.95$2.01
    
    
    65,000
    
    
    
    5.14
    
    
    
    2.01
    
    
    
    54,125
    
    
    
    2.0112,148,744
    
    
    
    6.51
    
    
    $
    0.31
    
    
    
    6,481,763
    
    
    $
    0.28
 The options with a $0.00 exercise price represent stapled options (see
Note 8) The weighted average fair value of options granted in fiscal years 2003,
2002 and 2001 was $0.27, $0.59 and $0.90, respectively. Options exercisable
were 6,481,763, 4,470,834 and 2,301,642 as of December 31, 2003, 2002 and 2001,
respectively. Fair Value Disclosures The fair value of each employee stock option grant is estimated on the
date of grant using the Black-Scholes option-pricing model with the following
assumptions: Years Ended December 31,2003
    
    2002
    
    2001Expected dividend yield
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %Risk-free interest rate
    
    
    1.29
    %
    
    
    3.50
    %
    
    
    4.45
    %Expected volatility
    
    
    99
    %
    
    
    96
    %
    
    
    90
    %Expected life (in years)
    
    
    4
    
    
    
    4
    
    
    
    4
 For the fiscal year ended December 31, 2001, we calculated all option
grants previous to August 21, 2001 using a 0% volatility and a 90% volatility
thereafter, in order to give effect to the spin-off transaction. The Black-Scholes option-pricing model was developed for use in estimating
the fair value of traded options, which have no vesting restrictions and are
fully transferable. In addition, option-pricing models require the input of
highly subjective assumptions, including expected stock price volatility. Because our employee stock
options have characteristics significantly different from those of 39




---



##### Table of Contents



traded
options, and because changes in the subjective input assumptions can materially
affect the fair value estimate, in managements opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of our
employee stock options. Note 12  Income Taxes There was no federal or state income tax provision in 2003, 2002 and
2001 because our operations resulted in pre-tax losses. A reconciliation between the benefit from (provision for) income taxes
computed at the federal statutory rate of 35% for the years ended December 31,
2003, 2002 and 2001 and the benefit from (provision for) income taxes is as
follows (amounts in thousands): December 31,2003
    
    2002
    
    2001Benefit from income taxes at statutory rate
    
    $
    1,415
    
    
    $
    14,903
    
    
    $
    12,582State income taxes net of federal tax benefit
    
    
    232
    
    
    
    1,971
    
    
    
    1,664Other
    
    
    636
    
    
    
    359
    
    
    
    Tax losses not benefited
    
    
    (2,283
    )
    
    
    (17,233
    )
    
    
    (14,246
    )Benefit from income taxes
    
    $
    
    
    
    $
    
    
    
    $
    
 Deferred income taxes reflect the net effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and those used for federal and state income tax purposes. Significant
components of deferred tax assets for federal and state income taxes are as
follows (amounts in thousands): December 31,2003
    
    2002Net operating loss carryforwards
    
    $
    31,161
    
    
    $
    26,068Depreciation and amortization
    
    
    3,519
    
    
    
    7,663Accruals and reserves
    
    
    3,806
    
    
    
    7,456Federal and state credits carryforward
    
    
    1,232
    
    
    
    1,801Other
    
    
    3,209
    
    
    
    (58
    )Gross deferred tax assets
    
    
    42,927
    
    
    
    42,930Valuation allowance
    
    
    (42,927
    )
    
    
    (42,930
    )Net deferred tax assets
    
    $
    
    
    
    $
    
 At December 31, 2003, we had approximately $83.5 million and $ 33.8
million of federal and state net operating loss carryforward, respectively.
These losses will begin expiring in 2020 and 2007, respectively. We also had
approximately $728,000 of federal and $336,000 of state research and
development tax credits available to offset future tax. The federal credits
begin to expire in 2020 for federal purposes if not utilized. Note 13  Employee Benefit Plans In August 2001, the Vialta, Inc. 401(k) Plan was adopted. Under the terms
of the 401(k) plan, eligible employees may elect to contribute a portion of
their compensation as salary deferral contributions to the 401(k) plan, subject
to certain statutorily prescribed limits. The 401(k) plan also permits, but
does not require, us to make discretionary matching contributions and
discretionary profit-sharing contributions. As a tax-qualified plan,
contributions to the 401(k) plan are generally deductible by us when made, and
are not taxable to participants until distributed from the 401(k) plan. Under
the 401(k) plan, participants may direct the trustees to invest their accounts
in selected investment options. We did not make any matching contributions or
discretionary profit-sharing contributions in the years ended December 31,
2003, 2002 and 2001. Note 14  Segment and Geographic Information We have operated as one segment since our inception on April 20, 1999
through December 31, 2003. Therefore, results of operations are reported on a
consolidated basis for purposes of segment reporting. As of December 31, 2003,
2002 and 2001, long-lived assets held outside the United States of America were
not material. Consolidated net revenue for the year ended December 31, 2003 was $10.3
million, consisting of domestic net revenue of $7.1
million and international net revenue of $3.2 million. 40




---



##### Table of Contents



Note 15  Commitments In January 2000, we entered into a three-year non-cancelable lease
agreement for our headquarters with ESS. In July 2003, we amended the lease.
The terms of the amendment include a 60% reduction in the amount of square
footage leased, a reduction in the monthly rent to current market rates and an
extension of the term from December 31, 2003 to June 30, 2005. Under the terms
of this and other leases, with various expiration dates through 2006, our
future minimum rental payments as of December 31, 2003 are as follows:
$529,000, $320,000 and $126,000 for the years 2004, 2005, and 2006
respectively. Apart from operations leases disclosed above, we do not have any
off-balance sheet arrangements. Rent expense was approximately $1.4, $2.3 million and, $1.1 million for
the years ended December 31, 2003, 2002 and 2001, respectively. Note 16  Legal Matters From time to time, we are involved in litigation in the normal course of
business. The outcome of matters to date will not have material adverse impact
on our consolidated financial position, results of operations or cash flows. 
 Selected Quarterly Operation Results (unaudited): The following
table presents unaudited quarterly financial information
for each of our last eight quarters. This information has been derived from our
unaudited financial statements and has been prepared on the same basis as the
audited Consolidated Financial Statements appearing elsewhere in this Form
10-K. In the opinion of management, all necessary adjustments, consisting only
of normal recurring adjustments, have been included to present fairly the
quarterly results (in thousands, except per share amounts). For the Three Months EndedMarch 31,
    
    June 30,
    
    September 30,
    
    December 31,2003
    
    2003
    
    2003
    
    2003Revenue
    
    $
    3,843
    
    
    $
    2,520
    
    
    $
    1,284
    
    
    $
    2,684Cost of goods sold
    
    
    863
    
    
    
    570
    
    
    
    517
    
    
    
    991Gross profit
    
    
    2,980
    
    
    
    1,950
    
    
    
    767
    
    
    
    1,693Operating expenses:Product costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Engineering and development
    
    
    968
    
    
    
    621
    
    
    
    480
    
    
    
    488Sales and marketing
    
    
    442
    
    
    
    641
    
    
    
    547
    
    
    
    2,797General and administrative
    
    
    1,730
    
    
    
    1,974
    
    
    
    1,091
    
    
    
    958Total operating expenses
    
    
    3,140
    
    
    
    3,236
    
    
    
    2,118
    
    
    
    4,243Operating loss
    
    
    (160
    )
    
    
    (1,286
    )
    
    
    (1,351
    )
    
    
    (2,550
    )Interest income, net
    
    
    188
    
    
    
    178
    
    
    
    168
    
    
    
    199Gain on investment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    571Net income (loss)
    
    $
    28
    
    
    $
    (1,108
    )
    
    $
    (1,183
    )
    
    $
    (1,780
    )Net income (loss) per share attributable
to common shares  basic & diluted
    
    $
    0.0
    
    
    $
    (0.01
    )
    
    $
    (0.01
    )
    
    $
    (0.02
    )Weighted average common shares outstanding
    
    
    82,238
    
    
    
    82,151
    
    
    
    82,227
    
    
    
    82,523
 41




---



##### Table of Contents



For the Three Months EndedMarch 31,
    
    June 30,
    
    September 30,
    
    December 31,2002
    
    2002
    
    2002
    
    2002Revenue
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Cost of goods sold
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Gross margin
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Operating expenses:Product costs
    
    
    
    
    
    
    1,137
    
    
    
    9,284
    
    
    
    Research and development
    
    
    4,223
    
    
    
    3,992
    
    
    
    2,928
    
    
    
    2,121Sales and marketing
    
    
    614
    
    
    
    732
    
    
    
    777
    
    
    
    977General and administrative
    
    
    1,812
    
    
    
    1,427
    
    
    
    1,216
    
    
    
    1,188Amortization and impairment of content
licenses
    
    
    253
    
    
    
    947
    
    
    
    948
    
    
    
    9,247Total operating expenses
    
    
    6,902
    
    
    
    8,235
    
    
    
    15,153
    
    
    
    13,533Operating loss
    
    
    (6,902
    )
    
    
    (8,235
    )
    
    
    (15,153
    )
    
    
    (13,533
    )Interest income, net
    
    
    363
    
    
    
    372
    
    
    
    330
    
    
    
    179Other income (expenses)
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    1Net income (loss)
    
    $
    (6,539
    )
    
    $
    (7,864
    )
    
    $
    (14,823
    )
    
    $
    (13,353
    )Net income (loss) per share attributable
to common shares  basic & diluted
    
    $
    (0.08
    )
    
    $
    (0.09
    )
    
    $
    (0.18
    )
    
    $
    (0.16
    )Weighted average common shares outstanding
    
    
    85,240
    
    
    
    83,752
    
    
    
    82,908
    
    
    
    83,246
 
 Item 9:Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure None 
 Item 9A:Controls and Procedures (a) Evaluation of disclosure controls and procedures. Our Chief
Executive Officer and Chief Financial Officer (our principal executive officer
and principal financial officer, respectively) have concluded, based on their
evaluation as of a date within 90 days prior to the date of filing of the
annual report, that our disclosure controls and procedures are effective to
ensure that material information required to be disclosed by us in report filed
or submitted by us under the Securities Exchange Act of 1934, as amended, is
recorded, processed, summarized and reported within the time period specified
in the SECs rules and forms, and includes controls and procedures designed to
ensure that material information required to be disclosed by us in such reports
is accumulated and communicated to our management, including our Chief
Executive Officer and Chief Financial Officer, as appropriate to allow timely
decisions regarding required disclosure. (b) Changes in internal controls.There have been no significant changes
in our internal controls or in other factors that could significantly affect
these controls subsequent to the date of our evaluation. 42




---



##### Table of Contents



PART III Certain information required by Part III is omitted from this Report since
we plan to file with the Securities and Exchange Commission the definitive
proxy statement for our 2004 Annual Meeting of Shareholders (the Proxy
Statement) not later than 120 days after the end of the fiscal year covered by
this Report, and certain information included therein is incorporated herein by
reference. 
 Item 10:Directors and Executive Officers of the Registrant The information required by this Item is incorporated by reference in our
Proxy Statement, which we will file with the Commission not later than 120 days
after our fiscal year-end. 
 Item 11:Executive Compensation The information required by this Item is incorporated by reference to the
sections in our Proxy Statement entitled Executive Compensation, which we
will file with the Commission not later than 120 days after our fiscal
year-end. 
 Item 12:Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters The information required by this Item is incorporated by reference in our
Proxy Statement, which we will file with the Commission not later than 120 days
after our fiscal year-end. The following table summarizes information with respect to options under
our equity compensation plans at December 31, 2003: Number of
    
    Weighted Average
    
    Number of SecuritiesSecurities to be
    
    Exercise Price of
    
    Remaining Available forIssued Upon Exercise
    
    Outstanding
    
    Future Issuance Underof Outstanding
    
    Options,
    
    Equity CompensationOptions, Warrants
    
    Warrants
    
    Plans (Excluding Securitiesand Rights (1)
    
    and Rights
    
    Reflected in Column (a))(a)
    
    (b)
    
    (c)Equity compensation plans
approved by security holders
    
    
    12,148,744
    
    
    $
    0.31
    
    
    
    4,518,490Equity compensation plans not
approved by security holders
    
    
    
    
    
    
    
    
    
    
    12,148,744
    
    
    $
    0.31
    
    
    
    4,518,490
  (1)
    
    Includes only options outstanding under our stock option plans, as no
stock warrants or rights were outstanding as of December 31, 2003. 
 Item 13:Certain Relationships and Related Transactions The information required by this Item is incorporated by reference in our
Proxy Statement, which we will file with the Commission not later than 120 days
after our fiscal year-end. 
 Item 14:Principle Accountant Fees and Services The information required by this Item is incorporated by reference in our
Proxy Statement, which we will file with the Commission not later than 120 days
after our fiscal year-end. 43




---



##### Table of Contents



PART IV 
 Item 15:Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a)(1) Financial Statements See the Consolidated Financial Statements and Supplementary Data at Item 8
of this report. (2) Financial Statement Schedules No schedules have been filed because the information required to be set
forth therein is not applicable or is shown in the Consolidated Financial
Statements and Supplementary Data or notes thereto at Item 8 of this report. (3) Exhibits See Exhibit Index for the exhibits filed as part of or incorporated by
reference into this report. (b) Reports on Form 8-K. We did not file any Reports on Form 8-K during the fourth quarter of 2003. With the exception of the information incorporated by reference to our
Proxy Statement for the 2004 Annual Meeting of Shareholders in Items 10, 11, 12
and 13 of Part III, the Proxy Statement is not deemed to be filed as part of
this Report. 44




---



##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized. VIALTA, INC.By:
    
    /s/ DIDIER PIETRIDidier PietriPresident and Chief Executive Officer
 Date: March 26, 2004 Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated. Signature
    
    Title
    
    Date/s/ DIDIER PIETRI
Didier Pietri
    
    President and Chief Executive Officer
(principal executive officer)
    
    March 26, 2004/s/ WILLIAM M. SCHARNINGHAUSEN
William M. Scharninghausen
    
    Chief Financial Officer
(principal financial officer)
    
    March 26, 2004/s/ FRED S.L. CHAN
Fred S.L. Chan
    
    Chairman of the Board
    
    March 26, 2004/s/ GEORGE M. CAIN
George M. Cain
    
    Director
    
    March 26, 2004/s/ HERBERT CHANG
Herbert Chang
    
    Director
    
    March 26, 2004/s/ MICHAEL S. DUBESTER
Michael S. Dubester
    
    Director
    
    March 26, 2004/s/ MATTHEW K. FONG
Matthew K. Fong
    
    Director
    
    March 26, 2004
 45




---



##### Table of Contents



EXHIBIT INDEX ExhibitNumber
    
    Description of Exhibit2.1
    
    Form of Master Distribution Agreement between the Registrant and ESS
Technology, Inc. (Exhibit No. 2.1 to Form 10 File No. 000-32809)2.2
    
    Form of Master Technology Ownership and License Agreement between the
Registrant and ESS Technology, Inc. (Exhibit No. 2.2 to Form 10 File No.
000-32809)2.3
    
    Form of Employee Matters Agreement between the Registrant and ESS
Technology, Inc. (Exhibit No. 2.3 to Form 10 File No. 000-32809)2.4
    
    Form of Tax Sharing and Indemnity Agreement between the Registrant and ESS
Technology, Inc. (Exhibit No. 2.4 to Form 10 File No. 000-32809)2.5
    
    Form of Real Estate Matters Agreement between the Registrant and ESS
Technology, Inc. (Exhibit No. 2.5 to Form 10 File No. 000-32809)2.6
    
    Form of Master Confidential Disclosure Agreement between the Registrant
and ESS Technology, Inc. (Exhibit No. 2.6 to Form 10 File No. 000-32809)2.7
    
    Form of Master Transitional Services Agreement between the Registrant and
ESS Technology, Inc. (Exhibit No. 2.7 to Form 10 File No. 000-32809)3.1
    
    Amended and Restated Certificate of Incorporation of the Registrant
(Exhibit No. 4.1 to Form S-8 File No. 333-65752)3.2
    
    Amended and Restated Bylaws of the Registrant (Exhibit No. 4.2 to Form S-8
File No. 333-65752)4.1
    
    Form of Class A Common Stock Certificate of the Registrant (Exhibit No.
4.1 to Form 10 File No. 000-32809)4.2
    
    Form of Class B Common Stock Certificate of the Registrant (Exhibit No.
4.2 to Form 10 File No. 000-32809)10.1
    
    1999 Stock Incentive Plan (Exhibit No. 10.1 to Form 10 File No. 000-32809)
*10.2
    
    2000 Directors Stock Option Plan,
as amended and restated (filed herewith) *10.3
    
    2001 Nonstatutory Stock Option Plan, as amended on August 1, 2001 (Exhibit
No. 10.3 to Form 10 File No. 000-32809) *10.4
    
    2001 Employee Stock Purchase Plan (Exhibit No. 10.4 to Form 10 File No.
000-32809) *10.5
    
    Lease Agreement between the Registrant and ESS Technology, Inc. for the
premises located at 48461 Fremont Boulevard, Fremont, California (Exhibit
No. 10.5 to Form 10 File No. 000-32809)10.6
    
    Purchase Agreement between the Registrant and ESS Technology, Inc.
(Exhibit No. 10.6 to Form 10 File No. 000-32809)10.7
    
    DVD Manufacturing License Agreement between the Registrant and Macrovision
Corporation (Exhibit No. 10.7 to Form 10 File No. 000-32809)10.8
    
    Offer Letter Agreement between the Registrant and Charles Root (Exhibit
No.
 46




---



##### Table of Contents



ExhibitNumber
    
    Description of Exhibit10.8 to Form 10 File No. 000-32809) *10.9
    
    Lease Agreement between the Registrant and 235 Investments Limited for the
premises located at 235 Yorkland Boulevard, Ontario, Canada (Exhibit No.
10.9 to Form 10 File No. 000-32809)10.10
    
    Lease Agreement between Vialta.com Hong Kong Company Limited and Upcentre
Investments Limited for the premises located at 238 Nathan Road, Kowloon,
Hong Kong (Exhibit No. 10.10 to Form 10 File No. 000-32809)10.11
    
    Trademark License Agreement between the Registrant and Digital Theater
Systems, Inc. (Exhibit No. 10.11 to Form 10 File No. 000-32809)10.12
    
    Software License Agreement between the Registrant and EnReach Technology,
Inc. (Exhibit No. 10.12 to Form 10 File No. 000-32809)10.13
    
    Offer Letter Agreement between the Registrant and Didier Pietri (Exhibit
No. 10.13 to Form 10 File No. 000-32809) *10.14
    
    Offer Letter Agreement between the Registrant and Steve Charng (Exhibit
No. 10.5 to Form 10 File No. 000-32809)10.15
    
    Offer Letter Agreement between the Registrant and Michael Wang (Exhibit
No. 10.9 to Form 10 File No. 000-32809)21.1
    
    Subsidiaries of the Registrant (Exhibit No. 21.1 to Form 10 File No.
000-32809)23.1
    
    Consent of PricewaterhouseCoopers LLP (filed herewith)31.1
    
    Certification pursuant to
Section 302 of the Sarbanes-Oxley Act of 200231.2
    
    Certification pursuant to Section
302 of the Sarbanes-Oxley Act of 200232.1
    
    Certification of Chief Executive
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2
    
    Certification of Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
   *
    
    Indicates a management contract or compensatory plan. 47