**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C.20549**

 

**FORM 10-KSB**

 

| **ý** |   | **ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934**     |
|------------|--------|----------------------------------------------------------------------------------------------|
|       |   |                                                                                         |
|       |   | **For the fiscal  year ended December 31, 2003**                                        |
|       |   |                                                                                         |
|       |   | **OR**                                                                                       |
|       |   |                                                                                         |
| **o**      |   | **TRANSITION REPORT UNDER  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|       |   |                                                                                         |
|       |   | **Commission file  number: 0-23000**                                                         |

 

**TRESTLE HOLDINGS, INC.**

(Name of Small Business Issuer in its charter)

 

| **DELAWARE**                                        |   | **95-4217605**                                      |
|-----------------------------------------------------|--------|-----------------------------------------------------|
| (State or Other Jurisdiction  of Organization)      |   | (IRS Employer Incorporation or  Identification No.) |
|                                                |   |                                                |
| **199 TECHNOLOGY,  SUITE 105,  IRVINE, CALIFORNIA** |   | **92618**                                           |
| (Address of Principal Executive Offices)            |   | (Zip Code)                                          |

 

Issuer’s Telephone Number, Including Area Code: **949-673-1907**

 

Securities registered under Section 12(b) of the Exchange Act: **NONE**

 

Securities registered under Section 12(g) of the Exchange Act:

 

**COMMON STOCK, NO PARVALUE**

(Title of class)

 

Checkwhether the issuer: (1) filed all reports required to be filed bySection 13 or 15(d) of the Exchange Act during the past 12 months (orfor such shorter period that the issuer was required to file such reports), and(2) has been subject to such filing requirements for past90 days: Yes  ý   No o

 

Checkif there is no disclosure of delinquent filers in response to Item 405 of Regulation S-Bcontained in this form, and no disclosure will be contained, to the best ofissuer’s knowledge, in definitive proxy or information statements incorporatedby reference in Part III of this Form 10-KSB or any amendment to theForm 10-KSB:  ý

 

State issuer’s revenue for its most recent fiscal year: $1,961,000

 

Statethe aggregate market value of the voting and non-voting common equity held bynon-affiliates computed by reference to the price at which the stock was sold,or the average bid and asked prices of such stock, as of February 27,2004, a date within the past 60 days, is: $8,631,000

 

Statethe number of shares outstanding of each of issuer’s classes of common equity,as of February 27, 2004: 3,063,447

 

TransitionalSmall Business Disclosure Format: Yes:  o   No:  ý

 

**Documents Incorporated By Reference**

Thefollowing documents are incorporated by reference into this report: None.

 

 

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**FORWARD-LOOKINGSTATEMENTS**

 

This reportincludes forward-looking statements with-in the meaning of Section 27A ofthe Securities Act (the “Securities Act”) and Section 21E of theSecurities Exchange Act of 1934, as amended (the “Exchange Act”). We have basedthese statements on our beliefs and assumptions, based on information currentlyavailable to us. These forward-looking statements are subject to risks anduncertainties. Forward-looking statements include the information concerningour possible or assumed future results of operations set forth under thesections entitled “Business” and “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.”

 

Forward-lookingstatements are not guarantees of performance. Our future results andrequirements may differ materially from those described in the forward-lookingstatements. Many of the factors that will determine these results andrequirements are beyond our control. In addition to the risks and uncertaintiesdiscussed in “Business” and “Management’s Discussion and Analysis of FinancialCondition and Results of Operations,” investors should consider those discussedunder “Risk Factors” and, among others, the following:

 

•        our ability tosuccessfully implement our business strategy,

•        changing consumerpreferences,

•   the impact of competition and changes to thecompetitive environment on our products and services, and

•   other factors detailed from time to time inour filings with the Securities and Exchange Commission.

 

Theseforward-looking statements speak only as of the date of this report. We do notintend to update or revise any forward-looking statements to reflect changes inour business strategy or planned capital expenditures, or to reflect theoccurrence of unanticipated events.

 

**PARTI**

 

**ITEM 1.    BUSINESS**

 

Trestle Holdings, Inc.develops and sells digital imaging and telemedicine applications linkingdispersed users and data primarily in the healthcare and pharmaceuticalmarkets.  Trestle’s digital imagingproducts - MedMicroä and MedScanä -provide a digital platform to share, store, and analyze tissue images.  Trestle’s MedReachäproduct provides healthcare organizations with a cost effective platform forremote examination, diagnosis, and treatment of patients.

 

Our customers includesome of the world’s leading pharmaceutical, research and healthcareorganizations; our top twenty-five customers are Pfizer, Aventis, Merck,GlaxoSmithKline, the Kingdom of Saudi Arabia, Walter Reed Army Medical Center,Addus Healthcare, Hawaii Health Systems, Scott & White Hospitals, LouisianaTelemedicine Consortium, Shriners Hospitals, Texas A&M, National CancerInstitute, Baystate Medical Center, Health Network Laboratories, LongviewMedical Laboratories, MobilePath, Newark Beth Israel, Saint Joseph Healthcare,University of Maryland, University of Louisville, Columbia PresbyterianUniversity, Ohio State University, University of California at San Francisco,and University of Southern California. We have only sold a limited amount of our products to customers and havenot generated significant revenues to date.

 

### ***DigitalImaging***

Trestle’s digital imagingproducts, MedMicroä and MedScanä,have the potential to transform the pathologist’s work environment by capturingdigital images of tissue samples and enabling the sharing, archiving, andanalysis of these images.  The Company’sfirst product, MedMicro, is a remote controlled, digital microscope thatenables pathologists in dispersed locations to simultaneously review the sametissue sample at sub-micron (1/1,000,000 of a meter) resolution in realtime.  By enabling multiple pathologiststo view the same tissue sample concurrently from remote locations, MedMicro cansave time, reduce expenses and increase quality of service.  MedMicro was introduced commercially in 1999and now represents over 80 microscope sites in eight countries serving over 400installed viewing stations.

 

The Company is leveragingits position in shared microscopy through the introduction of high productivitytissue scanners to further digitize the pathologist workflow under the nameMedScan.  By digitizing whole glassslides, MedScan transforms the pathologist work environment, enabling efficientimage archiving, management and analysis.  For pharmaceutical and biotechnology companies, MedScan enablesimprovements to both the pre-clinical and clinical

 

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phases of research anddevelopment through better capture, database management and analysis of tissuesample information.   We shippedour first MedScan beta system to a pharmaceutical user in the fourth quarter of2003.  We expect to begin fillingexisting orders for MedScan in the second quarter of 2004, and to be ready forvolume production in the second half of the year.

 

### ***Telemedicine***

Telemedicine enables theremote delivery of patient care using integrated health information systems andtelecommunications technologies.  TheCompany’s telemedicine product, MedReach, consists of proprietary client-serversoftware that integrates videoconferencing, clinical devices, medical imagesand patient data.   MedReach allowshealthcare organizations to remotely examine, diagnose, and treat patients andenables improved service, increased patient traffic and improved patient accessto specialists.  MedReach was firstreleased commercially in 1998 and is now installed in over 60 medical facilities.  Through collaboration with our keycustomers, we plan to improve integration with healthcare information systemsand introduce new MedReach products tailored to specific clinical applications.

 

### ***Acquisitionof Trestle’s Business and Assets***

On May 20, 2003,following approval of the Bankruptcy Court of the Eastern District of New York,the Company through its wholly owned subsidiary, TRAC, purchased substantiallyall of the assets of Trestle Corporation, a Delaware corporation (“OldTrestle”), pursuant to an Asset Purchase Agreement, dated April 16,2003.  Old Trestle was historically inthe telepathology and telemedicine industries. Under the terms of the acquisition, TRAC paid the sellers $1,250,000 incash, and assumed certain liabilities of Old Trestle consisting ofapproximately $369,000 of accounts payable and accrued liabilities and certainamounts of deferred revenue on contracts in progress.  The acquired assets included (a) intellectual property,(b) tangible personal property, (c) accounts receivable,(d) cash and cash equivalents, (e) certain real and personal propertylease agreements and leasehold improvements, (f) software and thecontracts related thereto used or held for use in or relating to the OldTrestle business and (g) certain assumed contracts.

 

## **IndustryOverview**

Trestle develops andsells digital imaging and telemedicine products primarily into the healthcareand pharmaceutical markets.  Digitalimaging products are utilized by human and animal pathologists in both clinicalpractice and research.  Telemedicineproducts are used by medical specialists and administrative staff in a range ofclinical settings.

 

Telemedicine can be theuse of communication equipment to link healthcare providers and patients indifferent locations.  In contrast to themore traditional ways of providing medical care (e.g., face-to-faceconsultations or examinations), telemedicine is a cost-effectivealternative.  Telemedicine offersincreased cost efficiency, reduced transportation expenses, improved patientaccess to specialists, improved quality of care, and better communication amongproviders.

 

Both the healthcare andpharmaceutical markets share common requirements, including: increasedproductivity; accelerated time to diagnosis; improved access to information;and automation of repetitive tasks.

 

#### ***DigitalImaging***

Trestle’s originaldigital imaging product, MedMicro, is a live microscopy product designed toenable pathologists in dispersed locations to review the same tissue samplessimultaneously.  The Company’s latestproduct, MedScan, is designed to further digitize the pathologist workflow bycapturing and storing images from whole glass slides.  These applications transform the pathologist work environmentenabling more efficient image sharing, archiving, management and analysis.

 

According to Microscopy,Marketing and Education (“MME”), the microscope replacement market generatesapproximately $2 billion in revenue per year. Management estimates that Trestle’s digital imaging products are potentialnear-term replacements for more than 35% of this market or $700 millionannually.  Currently, according toPharmaceutical Research and Manufacturers of America, over $32 billion is spenton pharmaceutical research and development. The Company’s digital database and analysis tools under development aredesigned to streamline research and development processes and workflow, and areexpected to provide additional revenue opportunities.

 

The digital imagingmarkets can be categorized by type of tissue (human or animal) and use(diagnostic or research).

 

### ***HumanPathology***

Pathologists focusing onhuman disease study the origin, course and indicators of disease.  Pathology divides into clinical pathology –the analysis of fluids such as urine and blood – and Trestle’s market, anatomicpathology – the analysis of tissue. Clinical pathology market is dominated by large national laboratoriesthat use large-scale automation

 

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and is generally a highvolume, low margin business.  Thetechnology for the automation of anatomic pathology has not been historicallyavailable.  As a result, anatomicpathology remains a less consolidated and higher margin industry.

 

According to CreditSuisse First Boston, the worldwide anatomic pathology market is approximately$10 billion annually.  According to theCollege of American Pathologists, the market’s growth is correlated to cancerrates and expected to grow at 6-8% per year with the aging of the currentpopulation.

 

The College of AmericanPathologists reports a total of 16,500 pathologists in the United States, withapproximately two-thirds or 11,000 practicing anatomic pathology.  These pathologists generally practice withinone or more market segments, including pathology labs, integrated healthsystems, and commercial and academic research.

 

### ***AnimalPathology***

Animal pathology includestesting in research and diagnostic treatment of both pets and livestock.  Animal pathology for treatment is mainlyconducted by labs providing services to veterinary practices.  The majority of animal pathology isconducted by pharmaceutical and biotechnology companies for drug development.

 

The dynamics ofveterinary pathology for treatment resemble human diagnostic pathology.  Veterinary pathologists seek to improveaccess to specialists, management and archiving of data, and improved workflowand tissue analysis.

 

The pharmaceutical andbiotechnology industries develop and market products for the treatment ofdisease and improvements in health. Potential drugs are eliminated prior to testing on humans through highvolume animal toxicity testing. Companies seek to improve this process in order to eliminate toxic drugsearly and speed effective compounds to market. Companies also address potential bottlenecks by streamlining thepathologist workflow and automating repetitive tasks.

 

The key market segmentsin animal pathology are pharmaceutical toxicology groups, academic andgovernment research, contract research organizations (CROs), and biotechnologyfirms.

 

### ***DigitalImaging Applications***

Digital imaging products share common uses in both human and animalpathology, including consultation, communication and collaboration; educationand publication; archiving and management; workflow; and analysis, as describedbelow.

 

### ***Consultation,Communication and Collaboration***

Pathologistsfrequently consult with other pathologists and specialists in carrying outtheir daily work.   There are oftendelays in consulting due to the transportation of slides or having to travel todistant locations in order to meet face-to-face.  Trestle’s products allow sharing of images real time, eliminatingthe need for slide transportation or travel.  Pathologists and specialists are able to simultaneously view andmanipulate the slides and provide consultation in real-time.  In addition, communication is improved asmultiple pathologists and specialists can view and manipulate the same slidesimultaneously.

 

### ***Educationand Publication***

Tissueimages are critical to pathology publications and instruction.   Traditional publications are limited to theinclusion of a snapshot of one location on the slide or references to glassslide archives.  Trestle’s productsallow whole slides to be cited in publications and accessed in a digitalformat, improving the availability of high quality samples and facilitatingsample access.

 

### ***Archivingand Management***

Viewingand accessing multiple tissue samples is critical to anatomic pathologyworkflow.   Typically, tissue images areincomplete and stored in cumbersome formats with no efficient links toassociated data.  Trestle’s productsunder development are designed to link a digital slide together with relevantdata in a flexible and easily accessible digital archive.

 

### ***Workflow***

Pathologistswork predominantly with traditional microscopes.   Microscopes are both ergonomically inefficient and makecross-referencing images and other data difficult.   Trestle’s products under

 

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developmentwill enable a pathologist to view multiple diagnostic-quality images andassociated information simultaneously.

 

### ***Analysis***

Analysisof tissue samples is still predominantly done by humans rather thancomputers.   Limitations on automationhave resulted from, among other things, the difficulty of capturing data, thecomplexity of data and the pattern recognition required for evaluation.  Trestle’s MedScan product facilitates thedata capture process, enabling further development of digital analysisapplications.

 

#### ***Telemedicine***

Historically, customershave been slow to adopt telemedicine in their daily work environment due tolimited telecommunications infrastructure and limited insurance reimbursementand physician licensure.  However, astelecommunications costs decrease and access improves, and as reimbursement andregulatory policies improve, adoption of remote medicine tools is increasing.

 

Key market sectors intelemedicine include healthcare providers, biomedical and pharmaceuticalcompanies, employers, prisons, and assisted living institutions.  These market segments share the common goalof providing services via electronic networks rather than through physicalpresence.  These market segments alsoshare many of the goals of telemedicine, including:

 

•                                          expansion of markets;

 

•                                          generation of additional revenue;

 

•                                          reduction of patient acquisition andretention costs; and

 

•                                          reduction in staffing and operationalcosts.

 

According to BCC, theentire United States telemedicine market was over $4.3 billion in 2003, of which$1.2 billion was software sales in 2003. According to BCC, this market will grow to approximately $6.9 billion in2007, of which $2.0 billion is projected to be software sales.   Our telemedicine products are primarilysoftware, with some hardware device integration and resale.

 

## **Productsand Technology**

### ***DigitalImaging Products***

Digital imaging is usedin pathology for capturing, storing, and distributing digital images in twocategories: live virtual microscopy and stored virtual microscopy.  In live virtual microscopy, digital imagesare captured and viewed in real time while the slide is on the microscope. Instored virtual microscopy, an image is digitally captured, processed and storedelectronically for viewing and analyzing at a later time.  Thus, the original data source, themicroscopic slide, does not need to be on the image acquisition device in orderto be viewed.

 

Live and stored digitalimaging each have their strengths and weaknesses, with each serving particularneeds in the pathology workplace. With MedMicro and MedScan, Trestle hascreated products for both applications. Taken together, they provide the foundation for a fully digitalenvironment that combines live virtual microscopy and stored virtual microscopyto deliver a comprehensive solution for digital microscopy.

 

In areas of science andmedicine other than pathology, transforming data from a physical format (suchas paper or tissue) to a computer-based format (such as text or digital image)has not only enhanced existing methods of work, but also enabled whole newworking techniques and applications. The Company believes the field of pathology will be no exception.

 

MedMicro, the Company’sfirst digital microscopy product, provides live, easily-manipulated, diagnosticquality images from a remote microscope. MedMicro products consist of proprietary software combined withoff-the-shelf automation components, laboratory microscopes, digital cameras,and a standard personal computer for operation.  MedMicro customers may also upgrade their purchases withmulti-slide loaders and additional objectives.

 

The Company’s digitalimaging products under development include: 1) enhancements to MedScan, adigital slide scanner enabling the capture of whole glass slides; 2) automatedslide loaders to allow higher volume automated

 

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digitization of slides;3) database tools to enable workflow management, association and referencing ofdigital slides; and 4) image analysis tools to facilitate diagnostic screening.

 

### ***TelemedicineProducts***

The Company’stelemedicine product, MedReach, consists of proprietary software whichintegrates videoconferencing, clinical devices, medical images and patientdata.   MedReach enables healthcareorganizations to remotely examine, diagnose and treat patients and allowsimproved service and increased patient traffic with minimal additionalpersonnel or facilities.

 

MedReach provides secureremote access to clinical data based on object-oriented design models.  MedReach also enables compliance withhealthcare-specific standards such as Health Insurance Portability andAccountability Act of 1996 and Digital Imaging and Communications in Medicineinterfaces.

 

MedReach has beendesigned to meet workflow needs and legacy environments of healthcareinstitutions.  An implementation iscustomized to meet the needs of the specific customers, and generally consistsof the backbone WebServer software, hardware, various media applications, andclient workstations.

 

## **Competition**

The digital imaging andtelemedicine markets are highly competitive, and many have greater resourcesand better name recognition than we do.

 

Our competitors in thedigital imaging market include Advanced Database Systems, Aperio, FairfieldImaging, Tissue Informatics, Midwest Information Systems, Scimagix, ApolloTelemedicine, Bacus Labs, Interscope Technologies, Chromavision, AppliedImaging, Nikon, and Soft Imaging.

 

Our competitors in thetelemedicine market include, VitelNet, Polycom, Tandberg, Televital, HealthHero Networks, Healthtek Solutions, Visual Telecommunications Network,Healthcare Vision, Second Opinion, and Siemens.

 

## **RegulatoryIssues**

### ***Medicare***

The Balanced Budget Actof 1997 authorized payment for telemedicine services and mandated that Medicarereimburse telemedicine care and fund telemedicine demonstration projects.  This act had many restrictions that causedproblems for telemedicine service providers. On October 1, 2001, new legislation, the Medicare, Medicaid, andSCHIP Benefits Improvement and Protection Act of 2000 went into effect thatcreated favorable changes to telemedicine reimbursement.  These changes include:

 

•                                          Expanded payment sites (Originating Site)to include physician and practitioner offices, critical access hospitals, ruralhealth clinics, federally qualified health centers and hospitals.

 

•                                          Increased Originating Site fees of $20per visit, increasing over time.

 

•                                          Expanded billable telemedicine servicesto include direct patient care, physician consultations and office psychiatryservices.

 

•                                          Equalized physician payments fortelemedicine services to standard clinical services.

 

•                                          Expanded the geographic regions that areauthorized for reimbursement.

 

•                                          Initiated pilot to reimburse for use ofstore and forward applications in Alaska and Hawaii.

 

•                                          Authorized prospective payment fortelemedicine services applicable to home care.

 

### ***Medicaid***

Medicaid is a jointlyfunded Federal-state health insurance program for persons with low incomeand/or disabilities.  Medicaidreimbursement for services furnished through telemedicine applications isavailable at the state’s option.  Stateswhich currently authorize fees for service reimbursement include Arkansas,California, Georgia, Illinois, Iowa, Kansas, Louisiana, Minnesota, Montana,Nebraska, North Carolina, North Dakota, Oklahoma, South Dakota,

 

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Texas, Utah, Virginia,and West Virginia.  Two additionalstates, Kentucky and Maine, are enacting regulations to cover telemedicine.

 

### ***Commercial***

Commercial insurers’reimbursement for telemedicine services varies by organization and state.  Some of the larger insurers, including BlueCross/Blue Shield, not only reimburse for these services but are also leadersin developing telemedicine programs. Many states including California, Louisiana, Texas and others, havepassed laws or have laws pending that prevent discrimination between regularand telemedicine visits.

 

### ***Foodand Drug Administration***

Trestle’s products can beconsidered medical devices and subject to regulation by the United States Foodand Drug Administration (“FDA”).  TheFDA categorizes medical devices into three classes; these classes are referredto as Class I, Class II, and Class III. Class I devices (“general controls”) are the lowest category and manyare exempt from FDA pre-market notification or approval requirements.

 

MedMicro is registeredwith the FDA as Class I Medical Device. The medical device components in MedReach have been registered by themanufacturing companies as Class I.  Aspart of continued FDA compliance efforts, Trestle operates under Current GoodManufacturing Practice guidelines. Certain next generation applications may require more detailed FDAapproval processes.

 

## **IntellectualProperty**

Trestle has one issuedand three pending patents on its products, including SmartFocusä, acontinuous focus system improving the capture of accurate, in-focus tissuesample information at sub-micron resolution despite sample variations anddefects, and while maintaining high speed. We also rely on trade secrets and proprietary know-how that we seek toprotect, including with confidentiality agreements.

 

## **Employees**

The Company currently has30 full-time employees.

 

#### **FactorsWhich May Affect Future Results**

 

In connection with the“safe harbor” provisions of the Private Securities Litigation Reform Act of1995, the Company wishes to caution that the following important factors, amongothers, in some cases have affected and in the future could affect theCompany’s actual results and could cause such results to differ materially fromthose expressed in forward-looking statements made by or on behalf of theCompany.

 

## **RisksRelated To Our Business**

#### ***We have a history of net losses and may never achieve ormaintain profitability.***

We have a history ofincurring losses from operations.  As ofDecember 31, 2003, we had an accumulated deficit of approximately$39,696,000, of which approximately $37,635,000 was incurred prior to theacquisition of Old Trestle.  Weanticipate that our operating expenses will increase substantially in theforeseeable future as we increase our sales and marketing activities, andcontinue to develop our technology, products and services.  These efforts may prove more expensive thanwe currently anticipate and we may incur significant additional costs andexpenses in connection with our business development activities.  Such costs and expenses could prevent usfrom achieving or maintaining profitability in future periods.  If we do achieve profitability in anyperiod, we may not be able to sustain or increase our profitability on aquarterly or annual basis.

 

#### ***We recently acquired Old Trestle and have limited operatinghistory.***

We recently acquiredsubstantially all of the assets of Old Trestle.  Prior to our acquisition of Old Trestle’s assets and our recentPepin/Merhi film library sale, we were involved in the production anddistribution of filmed entertainment. Your evaluation of our business and prospects may be difficult becauseof our limited operating history with Old Trestle’s products.  There can be no assurance that we will besuccessful in developing and managing the operations of Old Trestle’sproducts.  We face certain risks as aresult of the recent acquisition, including:

 

•                                          risks of entering into industries andmarkets or developing and producing products where we have limited or noexperience,

 

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•                                          the potential loss of key customers ofTrestle, and

 

•                                          the potential loss of key personnel ofTrestle.

 

Even when an acquiredcompany has already developed and marketed products, there can be no assurancethat the products will continue to be successful, that product enhancementswill be made in a timely fashion or we will have identified all possible issuesthat might arise with respect to the acquired company or its products.

 

#### ***We have substantial funding requirements.  Additional funding may not be available tous or may not be available on acceptable terms.***

We currently estimatethat our existing capital resources will enable us to sustain operations for atleast three months.  We have expendedand will continue to expend substantial amounts of money for research anddevelopment, capital expenditures, working capital needs and manufacturing andmarketing of our products.  Our futureresearch and development efforts, in particular, are expected to includedevelopment of additional applications of our current products and additionalproduct lines including, digital backbone systems and image analysis systems,which will likely require additional funds.

 

The exact timing andamount of spending required cannot be accurately determined and will depend onseveral factors, including:

 

•                                          progress of our research and developmentefforts,

 

•                                          competing technological and marketdevelopments,

 

•                                          commercialization of products currentlyunder development by us and our competitors, and

 

•                                          market acceptance and demand for ourproducts.

 

We cannot assure you thatadditional financing will be available when needed or on terms acceptable tous.  If adequate and acceptablefinancing is not available, we may have to delay development orcommercialization of certain of our products or eliminate some or all of ourdevelopment activities.  We may alsoreduce our marketing or other resources devoted to our products.  Any of these options could reduce our salesgrowth and result in continued net losses.

 

#### ***If we lose key personnel or are unable to hire additionalqualified personnel, it could impact our ability to grow our business.***

We believe our futuresuccess will depend in large part upon our ability to attract and retain highlyskilled technical, managerial, sales and marketing, finance and operationspersonnel.  Currently, we are in theprocess of seeking a qualified individual to serve as our President.  We face intense competition for all suchpersonnel, and we may not be able to attract and retain these individuals.  Our failure to do so could delay product development,affect the quality of our products and services, and/or prevent us fromsustaining or growing our business.  Inaddition, employees may leave our company and subsequently compete againstus.  Our key employees include MichaelDoherty, our Chairman, Jack Zeineh, MD, our Chief Scientific Officer and GaryFreeman, our Chief Financial Officer.

 

We have taken steps toretain our key employees, including the granting of stock options and warrantsthat vest over time, and we have entered into employment agreements with someof our key employees.  The loss of keypersonnel, especially if without advanced notice, or the inability to hire orretain qualified personnel, including a President, could harm our ability tomaintain and build our business operations. Furthermore, we have no key man life insurance on any of our keyemployees.

 

#### ***Rapid growth may place significant demands on our personnel.***

We currently have limitedmanagement and administrative resources. If we are successful in implementing our strategy, we may experience aperiod of rapid growth and expansion which could place significant additionaldemands on our management and administrative resources.  Our management team’s failure to manage thispotential growth effectively could have a material adverse effect on ourbusiness.

 

#### ***Undetected errors or failures in our software could resultin loss or delay in the market acceptance for our product, lost sales or costlylitigation.***

Because our softwareproducts are complex, they may contain errors that can be detected at any pointin a product’s lifecycle.  While wecontinually test our products for errors, errors in our products may be foundin the future

 

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even after our productshave been commercially introduced. Detection of any significant errors may result in, among other things,loss of, or delay in, market acceptance and sales of our products, diversion ofdevelopment resources, injury to our reputation, increased service and warrantycosts or costly litigation. Additionally, because our products support or rely on other systems andapplications, any software errors or bugs in these systems or applications mayresult in errors in the performance of our software, and it may be difficult orimpossible to determine where the error resides.  Product errors could harm our business and have a materialadverse effect on our results of operations.

 

#### ***A successful products liability claim could require us topay substantial damages and result in harm to our business reputation.***

The manufacture and saleof our products involve the risk of product liability claims.  We do not carry product liabilityinsurance.  A successful claim broughtagainst us could require us to pay substantial damages and result in harm toour business reputation, remove our products from the market or otherwise adverselyaffect our business and operations.

 

#### ***Our products could infringe on the intellectual propertyrights of others, which may lead to costly litigation, lead to payment ofsubstantial damages or royalties and/or prevent us from manufacturing andselling our current and future products.***

If third parties assertthat our products or technologies infringe their intellectual property rights,our reputation and ability to license or sell our products could beharmed.  Whether or not the litigationhas merit, it could be time consuming and expensive for us and divert theattention of our technical and management personnel from other work.  In addition, these types of claims could becostly to defend and result in our loss of significant intellectual property rights.

 

A determination that weare infringing the proprietary rights of others could have a material adverseeffect on our products, revenues and income. In the event of any infringement by us, we cannot assure you that wewill be able to successfully redesign our products or processes to avoidinfringement.  Accordingly, an adversedetermination in a judicial or administrative proceeding or failure to obtainnecessary licenses could prevent us from manufacturing and selling our productsand could require us to pay substantial damages and/or royalties.

 

#### ***Any disruption or delay in the supply of components orcustom subassemblies could require us to redesign our products or otherwisedelay our ability to assemble our products, which could cause our sales to declineand result in continued net losses.***

We assemble our productsfrom a combination of (i) commodity technology components, such as computersand monitors, (ii) custom subassemblies, (iii) proprietary hardware forscanning microscopy, (iv) commodity operating systems, and (v) proprietaryapplications software.  While wetypically use components and subassemblies that are available from alternatesources, any unanticipated interruption of the supply of these components orsubassemblies could require us to redesign our products or otherwise delay ourability to assemble our products, which could cause our sales to decline andresult in continued net losses.

 

#### ***Our auditors have expressed a going concern opinion.***

Primarily as a result ofour recurring losses and our lack of available capital, the Company hasreceived a report from our independent auditors that includes an explanatoryparagraph describing the uncertainty as to our ability to continue as a goingconcern.

 

#### ***If we fail to accurately forecast component and materialrequirements for our products, we could incur additional costs and significantdelays in shipments, which could result in loss of customers.***

We must accuratelypredict both the demand for our products and the lead times required to obtainthe necessary components and materials. Lead times for components and materials that we order vary significantlyand depend on factors including the specific supplier requirements, the size ofthe order, contract terms and current market demand for components.  If we overestimate our component andmaterial requirements, we may have excess inventory, which would increase ourcosts, impair our available liquidity and could have a material adverse effecton our business, operating results and financial condition.  If we underestimate our component andmaterial requirements, we may have inadequate inventory, which could interruptand delay delivery of our products to our customers.  Any of these occurrences would negatively impact our net sales,business and operating results and could have a material adverse effect on ourbusiness, operating results and financial condition.

 

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## **RisksRelated To The Industry**

#### ***If we fail to successfully introduce new products, our futuregrowth may suffer.  Certain products atan early stage of development are the areas of future growth for Trestle andsustainability of Trestle.***

As part of our growthstrategy, we intend to develop and introduce a number of new products,including digital backbone systems and image analysis systems.  Such products are currently in research anddevelopment, and we have generated no revenues from such potential products andmay never generate revenues.  Asubstantial portion of our resources have been and for the foreseeable futurewill continue to be dedicated to our research programs and the development ofproducts.  If we do not introduce thesenew products on a timely basis, or if they are not well accepted by the market,our business and the future growth of our business may suffer.  There can be no assurance that we will beable to develop a commercial product from these projects.  Our competitors may succeed in developingtechnologies or products that are more effective than ours.

 

#### ***If we do not update and enhance our technologies, they willbecome obsolete or noncompetitive.  Ourcompetitors may succeed in developing products, and obtaining relatedregulatory approvals, faster than us.***

We operate in a highlycompetitive industry and competition is likely to intensify.  Emerging technologies, extensive researchand new product introductions characterize the market for our products andservices.  We believe that our future successwill depend in large part upon our ability to conduct successful research inour fields of expertise, to discover new technologies as a result of thatresearch, to develop products based on our technologies, and to commercializethose products.  If we fail to stay atthe forefront of technological development, we will be unable to competeeffectively.

 

Our existing andpotential competitors may possess substantial financial and technical resourcesand production and marketing capabilities greater than ours.  We cannot assure you that we will be able tocompete effectively with existing or potential competitors or that thesecompetitors will not succeed in developing technologies and products that wouldrender our technology and products obsolete and noncompetitive.  Our position in the market could be erodedrapidly by our competitors’ product advances.

 

In addition, because ourproducts are dependent upon other operating systems, we will need to continueto respond to technological advances in these operating systems.

 

#### ***Our success depends, in part, on attracting customers whowill embrace the new technologies offered by our products.***

It is vital to ourlong-term growth that we establish customer awareness and persuade the marketto embrace the new technologies offered by our products.  This may require in certain instances amodification to the culture and behavior of customers to be more accepting oftechnology and automation. Organizations may be reluctant or slow to adopt changes or new ways ofperforming processes and instead may prefer to resort to habitual behaviorwithin the organization.  Our marketingplan must overcome this obstacle, invalidate deeply entrenched assumptions andreluctance to behavioral change and induce customers to utilize our productsrather than the familiar options and processes they currently use.  If we fail to attract additional customersat this early stage, our business and the future growth of our business maysuffer.

 

#### ***Our success depends, in part, on our ability to protect ourintellectual property rights.***

Our success is heavilydependent upon protecting our ability to protect our proprietarytechnology.  We rely on patents, tradesecrets, copyrights, know-how, trademarks, license agreements and contractualprovisions to establish our intellectual property rights and protect ourproducts.  These legal means, however,afford only limited protection and may not adequately protect our rights.  Litigation may be necessary in the future toenforce our intellectual property rights, protect our trade secrets or determinethe validity and scope of the proprietary rights of others.  Litigation could result in substantial costsand diversion of resources and management attention.

 

We cannot assure you thatcompetitors or other parties have not filed or in the future will not fileapplications for, or have not received or in the future will not receive,patents or obtain additional proprietary rights relating to products orprocesses used or proposed to be used by us. In that case, our competitive position could be harmed and we may berequired to obtain licenses to patents or proprietary rights of others.

 

In addition, the laws ofsome of the countries in which our products are or may be sold may not protectour products and intellectual property to the same extent as U.S. laws, if atall.  We may be unable to protect ourrights in proprietary technology in these countries.

 

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#### ***We depend on third-party licenses for our products.***

We rely on certainsoftware technology which we license from third parties and use in our productsto perform key functions and provide additional functionality.  Because our products incorporate softwaredeveloped and maintained by third parties, we are, to a certain extent,dependent upon such third parties’ ability to maintain or enhance their currentproducts, to develop new products on a timely and cost-effective basis, and torespond to emerging industry standards and other technological changes.  Further, these third-party technologylicenses may not always be available to us on commercially reasonable terms orat all.

 

If our agreements withthird-party vendors are not renewed or the third-party software fails toaddress the needs of our software products, we would be required to findalternative software products or technologies of equal performance orfunctionality.  We cannot assure that wewould be able to replace the functionality provided by third-party software ifwe lose the license to this software, it becomes obsolete or incompatible withfuture versions of our products or is otherwise not adequately maintained orupdated.

 

#### ***Certain of our customers rely on the availability ofthird-party reimbursement or third-party funding for the purchase of ourproducts.  Failure of sufficientreimbursement from third-party payors or sufficient funding could cause oursales and the future potential growth of our business to decline.***

Hospitals and otherhealthcare institutions in the U.S. that purchase our products generally relyon third-party payors and other sources for reimbursement of healthcare coststo reimburse all or part of the cost of the procedures in which our productsare used.  If hospitals and otherhealthcare institutions are unable to obtain adequate reimbursement fromthird-party payors for the procedures in which our products or productscurrently under development are intended to be used, our sales and futuregrowth of our business could be adversely affected.  We cannot estimate what amount of our product is eligible forreimbursement approval.  In addition,changes in the healthcare system may affect the reimbursability of futureproducts.

 

Market acceptance of ourproducts and products under development in countries outside of the U.S. isalso dependent on availability of reimbursement within prevailing healthcarepayment systems in those countries. Reimbursement and healthcare payment systems in international marketsvary significantly by country, and include both government-sponsored healthcareand private insurance.  We cannot assureyou that we will be able to obtain international reimbursement approvals in atimely manner, if at all.  Failure toreceive international reimbursement approvals could harm the market acceptanceof our products in the international markets in which such approvals aresought.

 

Other consumers inindustries such as pathology, pharmaceutical and biotechnology that purchaseour products generally rely on funding or grants from governments and privatefoundations to fund the purchase of our products.  If such consumers are unable to obtain adequate funding sourcesfor the purchase of our products, our sales and future growth of our businesscould be adversely affected.

 

#### ***The marketing and sale of our future products will requireregulatory approval and on-going certifications.  Failure to obtain and maintain required regulatory approvals andcertifications could prevent or delay our ability to market and sell our futureproducts and may subject us to significant regulatory fines or penalties.***

The United States Foodand Drug Administration (the “FDA”) regulates design, testing, manufacturing,labeling, distribution, marketing, sales and service of image analysisproducts.  Such products are marketed inthe U.S. according to premarket notifications to the FDA underSection 510(k) of the Federal Food, Drug and Cosmetic Act.  Unless an exemption applies, each imageanalysis product that we wish to market in the U.S. must first receive either510(k) clearance or premarket approval from the FDA.  The process of obtaining required regulatory approval or clearancecan be lengthy, expensive and uncertain. Moreover, regulatory clearance or approval, if granted, may includesignificant limitations on the indicated uses for which a product may bemarketed.

 

Delays in obtainingclearances or approvals will adversely affect our ability to market and sellour image analysis products and may subject us to significant regulatory finesor penalties, which would result in a decline in revenue and profitability.

 

Failure to comply withapplicable requirements in the United States can result in fines, recall orseizure of products, total or partial suspension of production, withdrawal ofexisting product approvals or clearances, refusal to approve or clear newapplications or notices and criminal prosecution.

 

Our image analysisproducts are subject to similar regulation in other countries.   Sales of our image analysis productsoutside the United States are subject to foreign regulatory requirements thatvary from country to country.  The

 

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time required to obtainapprovals from foreign countries may be longer or shorter than that requiredfor FDA approval, and requirements for foreign licensing may differ from FDArequirements.

 

#### ***Our future products may require compliance with qualitysystem regulations which is difficult and costly.***

We operate under theCurrent Good Manufacturing Practice guidelines adopted by the FDA.  In connection with the development of newproducts, we may be required to be in compliance with the quality regulationsystem, which include production design controls, testing, quality control,storage and documentation procedures. Compliance with quality system regulations is difficult and costly.  We cannot assure you that we will be able tocomply with quality system regulation requirements.  If we do not achieve compliance, the FDA may deny marketingclearance which would harm our business. In addition, we may not be found to be compliant as a result of futurechanges in, or interpretations of, regulations by the FDA or other regulatoryagencies.

 

## **RisksRelated To Securities**

#### ***Any future sale of a substantial number of shares of ourcommon stock could depress the trading price of our common stock, lower ourvalue and make it more difficult for us to raise capital.***

Any sale of a substantialnumber of shares of our common stock (or the prospect of sales) may have theeffect of depressing the trading price of our common stock.  In addition, these sales could lower ourvalue and make it more difficult for us to raise capital.  Further, the timing of the sale of theshares of our common stock may occur at a time when we would otherwise be ableto obtain additional equity capital on terms more favorable to us.

 

#### ***Our stock price is likely to be highly volatile because ofseveral factors, including a limited public float.***

The market price of ourstock is likely to be highly volatile because there has been a relatively thintrading market for our stock, which causes trades of small blocks of stock tohave a significant impact on our stock price. You may not be able to resell our common stock following periods ofvolatility because of the market’s adverse reaction to volatility.

 

Other factors that couldcause such volatility may include, among other things:

 

•                                          actual or anticipated fluctuations in ouroperating results,

 

•                                          announcements concerning our business orthose of our competitors or customers,

 

•                                          changes in financial estimates bysecurities analysts or our failure to perform as anticipated by the analysts,

 

•                                          announcements of technologicalinnovations,

 

•                                          conditions or trends in the industry,

 

•                                          litigation,

 

•                                          patents or proprietary rights,

 

•                                          departure of key personnel,

 

•                                          failure to hire a President or other keypersonnel, and

 

•                                          general market conditions.

 

#### ***Because our common stock is considered a penny stock, anyinvestment in our common stock is considered to be a high-risk investment andis subject to restrictions on marketability.***

Our common stock iscurrently traded on the Over-The-Counter Bulletin Board (“OTC Bulletin Board”)and is considered a “penny stock.”  TheOTC Bulletin Board is generally regarded as a less efficient trading marketthan the Nasdaq SmallCap Market.

 

The SEC has adopted rulesthat regulate broker-dealer practices in connection with transactions in “pennystocks.”  Penny stocks generally areequity securities with a price of less than $5.00 (other than securitiesregistered on certain national securities exchanges or quoted on the NASDAQsystem, provided that current price and volume information with respect totransactions in such securities is provided by the exchange or system).  The penny stock rules

 

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require a broker-dealer,prior to a transaction in a penny stock not otherwise exempt from those rules,to deliver a standardized risk disclosure document prepared by the SEC, whichspecifies information about penny stocks and the nature and significance ofrisks of the penny stock market.  Thebroker-dealer also must provide the customer with bid and offer quotations forthe penny stock, the compensation of the broker-dealer and any salesperson inthe transaction, and monthly account statements indicating the market value ofeach penny stock held in the customer’s account.  In addition, the penny stock rules require that, prior to atransaction in a penny stock not otherwise exempt from those rules, thebroker-dealer must make a special written determination that the penny stock isa suitable investment for the purchaser and receive the purchaser’s writtenagreement to the transaction.  Thesedisclosure requirements may have the effect of reducing the trading activity inthe secondary market for our common stock.

 

Since our common stock issubject to the regulations applicable to penny stocks, the market liquidity forour common stock could be adversely affected because the regulations on pennystocks could limit the ability of broker-dealers to sell our common stock andthus your ability to sell our common stock in the secondary market.

 

#### ***We may experience volatility in the price of our commonstock, which could negatively affect your investment, and you may not be ableto resell your shares at or above the offering price.***

The offering price of ourcommon stock may vary from the market price of our common stock.  The market price of our common stock mayfluctuate significantly in response to a number of factors, some of which arebeyond our control, including:

 

•                                          a quarterly variations in operatingresults;

 

•                                          changes in financial estimates bysecurities analysts;

 

•                                          changes in market valuations of othersimilar companies;

 

•                                          announcements by us or our competitors ofnew products or of significant technical innovations, contracts, acquisitions,strategic partnerships or joint ventures;

 

•                                          additions or departures of key personnel;

 

•                                          any deviations in net sales or in lossesfrom levels expected by securities analysts; and

 

•                                          future sales of common stock.

 

In addition, the stockmarket has recently experienced extreme volatility that has often beenunrelated to the performance of particular companies.  These market fluctuations may cause our stock price to fallregardless of our performance.

 

#### ***We have additional securities available for issuance,including preferred stock, which if issued could adversely affect the rights ofthe holders of our common stock.***

Our articles ofincorporation authorize the issuance of 40,000,000 shares of common stock and5,000,000 shares of preferred stock (of which 75,000 shares designated asSeries A Convertible Preferred Stock and 250,000 shares designated as Series BConvertible Preferred Stock).  Thecommon stock and the preferred stock can be issued by, and the terms of thepreferred stock, including dividend rights, voting rights, liquidationpreference and conversion rights can generally be determined by, our board ofdirectors without stockholder approval. Any issuance of preferred stock could adversely affect the rights of theholders of common stock by, among other things, establishing preferentialdividends, liquidation rights or voting powers.  Accordingly, our stockholders will be dependent upon the judgmentof our management in connection with the future issuance and sale of shares ofour common stock and preferred stock, in the event that buyers can be foundtherefore.  Any future issuances ofcommon stock or preferred stock would further dilute the percentage ownershipof our Company held by the public stockholders.  Furthermore, the issuance of preferred stock could be used todiscourage or prevent efforts to acquire control of our Company throughacquisition of shares of common stock.

 

**ITEM 2.    PROPERTIES**

 

Our executive officesconsist of approximately 14,000 square feet of general office space located at11835 W. Olympic Blvd., Suite 550, Los Angeles, California 90064.  We entered into a seven-year lease for suchoffice space commencing in December 1999, with a five-year option torenew.  As of March 31, 2004, wehave subleased

 

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approximately 2,000square feet of this office space.  Welease approximately 7,000 square feet of office, production and warehouse****spaceat 199 Technology Dr. Suite 105, Irvine, California 92618 for our principaloffices.  We recorded rent expense of$452,000 for our executive and principle offices during the year endedDecember 31, 2003.

 

We also leaseapproximately 9,000 square feet of office space in Santa Monica pursuant to aten-year lease commencing in July 1994. We subleased the Santa Monicaspace to an unaffiliated person until July of 2004.  We recorded rent expense of $399,000 for ourSanta Monica offices during the year ended December 31, 2003.

 

**ITEM 3.    LEGALPROCEEDINGS**

 

The Company is notcurrently involved in any material legal proceedings.

 

**ITEM 4.    SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS**

 

A special meeting ofstockholders was held on August 29, 2003.  Shareholders owning455,017 shares of common stock, 5,375 shares of Series A Preferred Stock and12,682 shares of Preferred Stock outstanding were entitled to vote as of therecord date for the meeting.  Due to the conversion feature of theunderlying security, owners of the Company’s preferred stock had 14.82 votesper preferred share owned.  At the meeting, stockholders voted to approveall of the proposals listed in the Company’s proxy statement.  Thespecific results of the stockholder voting are as follows:

 
| **Proposal**                       |   | **For** |   | **Against** |   | **Abstain** |   |
|------------------------------------|--------|---------|--------|-------------|--------|-------------|--------|
| 1.  Sale of Assets            |   | 485,807 |   | 84,470      |   | 152,439     |   |
| 2.  Corporate Reorganization  |   | 485,802 |   | 84,455      |   | 152,459     |   |
| 3.  2003 Stock Incentive Plan |   | 462,565 |   | 107,882     |   | 152,269     |   |
| 4.  Adjournment Proposal      |   | 480,690 |   | 89,757      |   | 152,269     |   |

 

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**PARTII**

 

**ITEM 5.    MARKET FORISSUER’S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS**

 

**Market Prices**

The shares of our commonstock have been listed and principally quoted on the OTC Bulletin Board underthe trading symbol “TLHO.OB” since October 6, 2003.  Prior to October 6, 2003, the Company’scommon stock was traded on the OTC Bulletin Board under the symbol “SLDE.OB”and prior to August 9, 2002, the Company’s common stock was traded on theOTC Bulletin Board under the symbol “SUNE.OB.”

 

The following table setsforth, for the fiscal quarters indicated, the high and low sale price for ourcommon stock, as reported on the OTC Bulletin Board.

 
| **Quarterly period**                      |   | **High** |   | **Low** |   |
|-------------------------------------------|--------|----------|--------|---------|--------|
|                                      |   |     |   |    |   |
| Fiscal year ended December 31, 2002: |   |     |   |    |   |
| First Quarter                             |   | $        | 1.10   |    | $      | 0.80 |   |
| Second Quarter                            |   | $        | 1.20   |    | $      | 0.70 |   |
| Third Quarter                             |   | $        | 1.00   |    | $      | 0.70 |   |
| Fourth Quarter                            |   | $        | 0.72   |    | $      | 0.45 |   |
|                                      |   |     |   |    |   |
| Fiscal year ended December 31, 2003: |   |     |   |    |   |
| First Quarter                             |   | $        | 0.62   |    | $      | 0.50 |   |
| Second Quarter                            |   | $        | 0.70   |    | $      | 0.50 |   |
| Third Quarter                             |   | $        | 4.00   |    | $      | 0.40 |   |
| Fourth Quarter                            |   | $        | 7.75   |    | $      | 3.50 |   |

 

**Holders**

As of February 29, 2004, there were approximately 164 holders ofrecord of the Company’s Common Stock.

 

**Dividends**

We have not paid any cashdividends on our common stock since our inception and do not anticipate payingany cash dividends on our common stock in the foreseeable future.  We expect to retain our earnings, if any, toprovide funds for the expansion of our business.  Future dividend policy will be determined periodically by ourboard of directors based upon conditions then existing, including our earningsand financial condition, capital requirements and other relevant factors.

 

**Equity Compensation Plan Information**

The following table sets forth certain information regarding theCompany’s equity compensation plans as of December 31, 2003.

 

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|                                                        |   | **Number of  securities to  be issued upon exercise  of outstanding options,  warrants and rights** |   | **Weighted-average  exercise price of  outstanding options,  warrants and rights** |   | **Number of  securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected in  column (a))** |    |
|-------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------|---------|
|                                                        |   | **(a)**                                                                                             |   | **(b)**                                                                            |   | **(c)**                                                                                                                                                |    |
| Equity compensation plans approved by  security holders     |   | 393,250                                                                                             |   | $                                                                                  | 3.48   |                                                                                                                                                   | 461,750 |   |
| Equity compensation plans not approved by  security holders |   | 1,057,153                                                                                           |   | 24.30                                                                              |   | 0                                                                                                                                                      |    |
| **Total**                                                   |   | 1,450,403                                                                                           |   | $                                                                                  | 18.66  |                                                                                                                                                   | 461,750 |   |

 

Our current employeestock option plans (the “Plans”) provide for the grant of non-statutory orincentive stock options to the Company’s employees, officers, directors orconsultants.

 

The Compensation Committeeof our board of directors administers the Plans, selects the individuals towhom options will be granted, determines the number of options to be granted,and the term and exercise price of each option.  Stock options granted pursuant to the terms of the Plansgenerally cannot be granted with an exercise price of less than 100% of thefair market value on the date of the grant (110% for awards issued to a 10% ormore stockholder).  The term of theoptions granted under the Plans cannot be greater than 10 years; 5 years for a10% or more stockholder.  Options vestat varying rates generally over five years. An aggregate of 855,000 shares were reserved under the Plans, of which461,750 shares were available for future grant at December 31, 2003.

 

**ITEM 6.    MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**Overview**

Trestle Holdings(Delaware), Inc. (“Trestle Holdings” or “Company”), through its whollyowned subsidiary, Trestle Acquisition Corp. (“Trestle”), develops and sellsdigital imaging and telemedicine applications linking dispersed users and dataprimarily in the healthcare and pharmaceutical markets.  Trestle’s digital imaging products -MedMicroä and MedScanä -provide a digital platform to share, store, and analyze tissue images.  Trestle’s MedReachäproduct provides healthcare organizations with a cost effective platform forremote examination, diagnosis, and treatment of patients.

 

OnMay 20, 2003, Trestle Holdings entered this line of business through itspurchase of substantially all of the assets of Trestle Corporation, a Delawarecorporation (“Old Trestle”), and certain assets of Med Diversified, Inc., aNevada corporation and parent corporation of Old Trestle (“Med”), and two ofMed’s non-debtor subsidiaries.

 

On August 29, 2003,a shareholder meeting was held where a plan was approved to reorganize theCompany.  Under the reorganization plan,the remaining entertainment assets of the Company were sold pursuant to termsentered into April 10, 2003.  Seediscussion of the divestiture in Note 3. In addition, (1) a pro rata cash distribution of $2,000,000 was made tothe holders of the Company’s preferred stock on or about October 3, 2003;  (2) Sunland Entertainment Co., Inc.(“Sunland”) officially changed its name to Trestle Holdings, Inc.; and (3) allissued and outstanding shares of the Company’s preferred stock were convertedinto 2,578,000  shares of common stock,giving the Company  3,033,000 shares ofcommon stock outstanding immediately subsequent to the reorganization.

 

## **Criticalaccounting policies and estimates**

The SEC recently issuedFinancial Reporting Release No. 60, “Cautionary Advice RegardingDisclosure About Critical Accounting Policies” (“FRR60”), suggesting companiesprovide additional disclosure and commentary on those accounting policiesconsidered most critical.  FRR 60considers an accounting policy to be critical if it is important to theCompany’s financial condition and results of operations, and requiressignificant judgment and estimates on the part of

 

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management in itsapplication.  For a summary of theCompany’s significant accounting policies, including the critical accountingpolicies discussed below, see the accompanying notes to the consolidatedfinancial statements in the section entitled “*Financial Statements*” beginning on page 44.

 

The preparation of theCompany’s financial statements in conformity with accounting principlesgenerally accepted in the United States of America (“GAAP”) requires managementto make estimates, judgments and assumptions that affect the reported amountsof assets and liabilities, disclosure of contingent assets and liabilities atthe date of the financial statements and the reported amount of expenses duringthe reporting period.  On an ongoingbasis, the Company evaluates its estimates which are based on historicalexperience and on various other assumptions that are believed to be reasonableunder the circumstances.  The result ofthese evaluations forms the basis for making judgments about the carryingvalues of assets and liabilities and the reported amount of expenses that arenot readily apparent from other sources. Actual results may differ from these estimates under differentassumptions.  The following accountingpolicies require significant management judgments and estimates:

 

•                                          The Company recognizes revenue on productsales after shipment of the product to the customer and formal acceptance bythe customer has been received. Depending upon the specific agreement with the customer, such acceptancenormally occurs subsequent to one or more of the following events:  receipt of the product by the customer,installation of the product by the Company and training of customer personnelby the Company.  Revenue collected inadvance of product shipment or formal acceptance by the customer is reflectedas deferred revenue.  Revenueattributable to software maintenance and support is deferred and recognizedratably over the term of the maintenance agreement, generally one year.

 

•                                          The Company accounts for its businessacquisitions under the purchase method of accounting in accordance with SFAS141, “Business Combinations.”  The totalcost of acquisitions is allocated to the underlying net assets, based on theirrespective estimated fair values.  Theexcess of the purchase price over the estimated fair value of the tangible netassets acquired is recorded as intangibles. Determining the fair value of assets acquired and liabilities assumedrequires management’s judgment and often involves the use of significantestimates and assumptions, including assumptions with respect to future cashinflows and outflows, discount rates, asset lives, and market multiples, amongother items.

 

•                                          The Company assesses the potentialimpairment of long-lived assets and identifiable intangibles under the guidanceof SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”which states that a long-lived asset should be tested for recoverabilitywhenever events or changes in circumstances indicate that the carrying amountof the long-lived asset exceeds its fair value.  An impairment loss is recognized only if the carrying amount ofthe long-lived asset exceeds its fair value and is not recoverable.

 

•                                          The Company adopted SFAS 142 “AccountingFor Goodwill and Other Intangible Assets” in the first quarter of 2002.  SFAS No. 142 requires that goodwill andintangible assets with indefinite useful lives no longer be amortized toearnings, but instead be reviewed for impairment in accordance with thisstandard.  The impairment charge takenin the first quarter of 2002 was recognized as a cumulative effect of a changein accounting principle.

 

The Company bases itsestimates on historical experience and on various other assumptions that arebelieved to be reasonable under the circumstances, the results of which formthe basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources.  There can be no assurance that actualresults will not differ from these estimates.

 

**Fiscal Year 2003 Compared to Fiscal Year 2002**

## ** **

## **ResultsFrom Operations**

### ***Revenues***

Revenues were $1,961,000and zero for the years ended December 31, 2003 and 2002,respectively.  Revenues consisted of$1,477,000 of installation revenues and $484,000 of software supportrevenues.   The increase in revenue isdue to revenues generated by the Company’s newly acquired Trestle business.

 

### ***Cost of Sales***

Cost of sales was$535,000 and zero for the years ended December 31, 2003 and 2002,respectively.  The increase in cost ofsales is due to the increase in revenues described above.

 

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

Research and developmentexpenses were $1,228,000 and zero for the years ended December 31, 2003and 2002, respectively.  The increase inresearch and development results from the acquisition of Trestle.  The principal component of this expense iscompensation expense paid to consultants and employees of $973,000.

 

### ***Selling, General and Administrative Expenses***

Selling, general andadministrative expenses were $3,909,000 and $1,021,000 for the years endedDecember 31, 2003 and 2002, respectively, an increase of $2,888,000.  The increase in selling, general andadministrative expenses is principally attributed to an increase incompensation expenses due to our addition of Trestle’s personnel as of the dateof acquisition. The principal component of this expense is compensation expensepaid to consultants and employees of $1,220,000.

 

### ***Interest Income/(Expense)***

Interest income was$39,000 and $139,000 in the years ended December 31, 2003 and 2002,respectively.  Interest income consistedprimarily from amounts earned on a tax receivable.

 

### ***Discontinued Operations***

Income/(Loss) fromdiscontinued operations was $1,876,000 and $(6,252,000) in the years ended December 31, 2003 and 2002,respectively.   The increase of$8,128,000 can be principally attributed to the gain on sale of the PMEntertainment Library in 2003 and a one-time, non-cash charge of $2,861,000 in2002 due to the Company changing its method of accounting for goodwill from anamortization method to an impairment only method.

 

## **Liquidityand Capital Resources**

Net cash used inoperating activities was $4,582,000 and $67,000 in the years endedDecember 31, 2003 and 2002, respectively. The increase of $4,515,000 in cash used by operating activities wasprimarily due to operating expenses from the Trestle business.  Prior to the Trestle Acquisition, we were alicensor of filmed entertainment with few employees.  The increase in cash used in operating activities was primarilydue to a decrease in net income, investment in film inventory, gains ondisposition of assets and settlement of debt, prepaids and accounts receivable,offset by a decrease in the amortization of deferred financing charges,accounts payable, participations and residuals and deferred revenue balances.

 

Net cash provided byinvesting activities was $2,969,000 and zero in the years endedDecember 31, 2003 and 2002, respectively. Investing activities in 2003 principally resulted from the purchase ofsubstantially all of the assets of Old Trestle and the sale of the PMEntertainment Library.

 

Net cash providedby/(used in) financing activities was zero and zero in 2003 and 2002,respectively.

 

The Company has sufferedrecurring losses from operations and has an accumulated deficit of $39,696,000at December 31, 2003.  Primarily asa result of our recurring losses and our lack of capital, the Company hasreceived a report from our independent auditors that includes an explanatoryparagraph describing the uncertainty as to our ability to continue as a goingconcern.  On March 3, 2004, the Companyraised $420,000 pursuant to a bridge financing agreement with ZaykowskiPartners, LP to meet its short-term operating cash needs.  Under this agreement, the Company issued aconvertible promissory note in the principal amount of $420,000, which issecured by all the assets of the Company, and a warrant to purchase 9,300shares of common stock at $4.40 per share. The promissory note bares interest at the rate of ten percent per annumpayable in six month increments and matures on March 3, 2005.  The principal and any accrued interest ofthe note is convertible at the option of the Company at the per share price ofthe next financing in the event that the Company receives equity financing ofat least $1,000,000.  Managementanticipates that our existing cash and cash equivalents will be sufficient tofund our operations through June 2004. However, to continue our operations beyond that date, or if our currentlevel of operations change, the Company will be required to secure additionalworking capital, by way of equity or debt financing, or otherwise, to sustaincontinuing operations.  There can be noassurance that the Company will be able to secure sufficient financing or onterms acceptable to the Company.  Ifadditional funds are raised through the issuance of equity securities, thepercentage ownership of our current stockholders is likely to or will bereduced.

 

Following is a summary ofour contractual obligations as of December 31, 2003 (in thousands):

 
|                               |   | **Payments  Due by Period** |   |
|------------------------------------|--------|-----------------------------|--------|
| **Contractual Obligations**        |   | **Total**                   |   | **Less than  1 year** |   | **Between  2-3  years** |   | **Between 4-  5 years** |   | **After 5  years** |   |
| Operating leases                   |   | $                           | 1,684  |   | $ | 690 |   | $ | 994 |   | $ | 0 |   | $ | 0 |   |
| Total Contractual Cash Obligations |   | $                           | 1,684  |   | $ | 690 |   | $ | 994 |   | $ | 0 |   | $ | 0 |   |

 

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## **FactorsThat Might Affect Future Results**

We have experiencedsignificant fluctuations in our quarterly operating results in the past, and weexpect to experience fluctuations in the future. Our customers, who areprimarily public and private clinical laboratories, research organizations andhospitals, generally operate on annual budgets. Their spending practices,business cycles and budgeting cycles affect our revenues. Factors that may havean influence on our operating results in any particular quarter include: demandfor our products, seasonality of our sales, new product introductions by us orour competitors, and the costs and time required for a transition to the newproducts, timing of orders and shipments for capital equipment sales, our mixof sales between our distributors and our direct sales force, competition(including pricing pressures), timing and amount of research and developmentexpenses (including clinical trial-related expenditures), foreign currencyfluctuations, delays between our incurrence of expenses to develop new products(including expenses related to marketing and service capabilities), and thetiming of sales and payments received for the new products and the uncertaintyof FDA or other domestic and international regulatory clearances or approvals.

 

Due to the factors notedabove, our future earnings and stock price may be subject to significantvolatility, particularly on a quarterly basis. It is possible that our futureoperating results will be below the expectations of public market analysts andinvestors. If our operating results fall below market expectations, the priceof our common stock could decline significantly.

 

**ITEM 7.    FINANCIALSTATEMENTS**

 

See the Company’s audited financial statements in pages F-1 throughF-18.

 

**ITEM 8. CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

Not Applicable

 

**ITEM8A.****                    CONTROLS ANDPROCEDURES**

 

Within 90 days prior to the filing of this report,members of the Company’s management, including the Company’s Interim President,Crosby Haffner, and Chief Financial Officer, Gary Freeman, evaluated theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures pursuant to Exchange Act Rule 13a-14.  Based upon that evaluation, Mr. Haffner and Mr. Freeman believe that,as of the date of the evaluation, the Company’s disclosure controls andprocedures are effective in making known to them material information relatingto the Company (including its consolidated subsidiaries) required to beincluded in this report.

 

Disclosure controls and procedures, no matterhow well designed and implemented, can provide only reasonable assurance ofachieving an entity’s disclosure objectives. The likelihood of achieving such objectives is affected by limitationsinherent in disclosure controls and procedures.  These include the fact that human judgment in decision-making canbe faulty and that breakdowns in internal control can occur because of humanfailures such as simple errors or mistakes or intentional circumvention of theestablished process.

 

There were no significant changes in the Company’s internal controls orin other factors that could significantly affect these internal controls, knownto Mr. Haffner or Mr. Freeman, after the date of the most recent evaluation.

 

19

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**PART III**

 

**ITEM 9.    DIRECTORS,EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITHSECTION 16(a) OF THE EXCHANGE ACT.**

 

**MANAGEMENT**

 

The following is a listof the names and ages of our directors and executive officers:

 
| **Name**           |   | **Age** |   | **Position**            |
|--------------------|--------|---------|--------|-------------------------|
| Michael S. Doherty |   | 50      |   | Chairman of the Board   |
| Crosby Haffner     |   | 31      |   | Interim President       |
| Jack Zeineh        |   | 33      |   | Chief Science Officer   |
| Gary Freeman       |   | 36      |   | Chief Financial Officer |
| William D. Dallas  |   | 49      |   | Director                |
| Michael S. Hope    |   | 61      |   | Director                |
| Gary M. Gray       |   | 59      |   | Director                |
| Paul Guez          |   | 60      |   | Director                |

 

MICHAEL S. DOHERTY hasbeen a Director of the Company since December 1997 and Chairman of theBoard since May 2003.  SinceNovember 1999, Mr. Doherty has been President of Doherty & Company,LLC, a firm specializing in venture capital and private equity funding fordevelopment stage companies. From February 1999 to October 1999, Mr.Doherty served as Senior Managing Director of Spencer Trask SecuritiesIncorporated. Mr. Doherty served as Managing Director and Director of PrivateEquity at Cruttenden Roth Incorporated from October 1996 toFebruary 1999. From 1992 to October 1996, he served as Vice Presidentof Arnhold and S. Bleichroeder, Inc., a New York-based investment banking, brokerageand asset management firm.  Mr. Dohertywas a director of Zyan Communications, Inc. from July 1999 toDecember 2000, and Chairman of the Board of Directors from July 1999to March 2000; Zyan filed for Chapter 11 bankruptcy proceedings inDecember 2000.  Mr. Doherty wasalso a non-executive director of ACLN, Ltd. from January 1999 toMarch 2002.  ACLN was a foreignprivate issuer whose shares were suspended from the New York Stock Exchangefollowing an order from the SEC and a subsequent enforcement action againstACLN and three of its officers.

 

CROSBY HAFFNER wasappointed Interim President of the Company in November 2003, and was aconsultant to the Company from June 2003 through November 2003.  Mr. Haffner became a Managing Director ofDoherty & Company, LLC in November 2003.  From December 2001 to October 2003, Mr. Haffner was aconsultant to technology companies. Prior to these engagements, Mr. Haffner was the President and ChiefOperating Officer at Zyan Communications, Inc. from 1995 to November 2000,and its Chairman and Chief Executive Officer from December 2000 toDecember 2001.  Zyan filed forChapter 11 bankruptcy proceedings in December 2000.

 

JACK ZEINEH, M.D. wasappointed Chief Science Officer in May 2003. Prior to joining the Company, Dr. Zeineh was co-founder of Illumea andthe inventor of the MedMicro and MedScan products.  Dr. Zeineh was the Chief Scientific Officer of TrestleCorporation, a subsidiary of Med Diversified, Inc., which filed for Chapter 11bankruptcy proceedings in November 2002. Dr. Zeineh brings experience inthe biomedical industry with a specialty in computer imaging systems andsoftware design.  Dr. Zeineh haspublished 12 articles on biomedical techniques, including telepathology.  Dr. Zeineh was educated in BiologicalSciences at University of California at Irvine and received his medical degreeat the University of California at San Diego — School of Medicine.

 

GARY FREEMAN was electedCo-President and Chief Financial Officer of the Company in January 2003,and resigned the position of Co-President in September 2003.  Mr. Freeman is also currently a VicePresident and director of Kellogg & Andelson, a Southern California basedpublic accounting firm.  In 2000, Mr.Freeman co-founded Catalyst Business Systems, a consulting firm, which mergedwith Kellogg & Andelson in 2002. From 1990 to 2000, Mr. Freeman worked at BDO Seidman, LLP in variouscapacities, including as a partner from 1998 to 2000.

 

WILLIAM D. DALLAS wasappointed as a Director of the Company in March of 2001.  Mr. Dallasalso served as a Director of the Company from May 2000 throughDecember 2000.  Mr. Dallas is currently the Chairman of the Board ofDallas Capital Management, a diverse private equity, advisory firm that hefounded in 1999.  Mr. Dallas is also

 

20

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currently the Chairmanand Chief Executive Officer of the following companies:  SysdomeCorporation, MindBox, LLC and Diversified Capital, and was a director of Castle& Cooke from 2000 to 2002.  Mr. Dallas was the founder of FirstFranklin and served as its Chairman from 1981 to 1999.  First Franklin waspurchased in 1999 by National City Corporation.

 

MICHAEL S. HOPE has beena Director of the Company since November 2003 and is Chairman of our AuditCommittee.  Mr. Hope has acted as afinancial consultant to various companies since 1997, including acting as theInterim Chief Financial Officer and Corporate Secretary of the Company fromMarch 1998 to April 1999. Prior to his various financial consulting assignments, Mr. Hope servedas Executive Vice President of Metro-Goldwyn-Mayer Inc. from 1993 to 1997.Prior to joining MGM, Mr. Hope was Executive Vice President, Planning andOperations and Chief Financial Officer for Paramount Communications Inc.  Mr. Hope was previously a member of theBoard of Directors of Zyan Communications, which filed for Chapter 11bankruptcy proceedings in December 2000.

 

GARY M. GRAY has been aDirector of the Company since 1991 and served as the Chairman of the Board fromMarch 1998 to April 1999.  Mr.Gray is currently a Managing Director of Selected Equities Limited.  From 1999 to 2003, Mr. Gray was a ManagingDirector of Milestone Capital, Inc., a firm based in Houston, Texas which, inconcert with affiliated foreign entities, invested in or acquires control ofprivate companies.  Prior to locating inHouston in 1997, from 1994 to 1997, Mr. Gray practiced law and providedbusiness consulting services to foreign clients from offices based in Oklahomaand, from 1991 to 1993, practiced law in New York. Prior to attending HarvardLaw School from 1987 to 1990, Mr. Gray was involved in various investment andbanking activities, principally in Oklahoma.

 

PAUL GUEZ has been aDirector of the Company since 1999. As an investor in many business activities,Mr. Guez is also chairman of the board of DVT 3000, a DVD company, and has beenthe president of Stone Canyon International, a movie production firm, since1998.  For the past thirteen years, Mr.Guez has been overseeing Azteca Production, a clothing manufacturing companythat he founded with his brother, Hubert Guez in 1990. Prior to Azteca, Mr.Guez headed the JAG clothing label, which he purchased in 1984, as well as theSassoon Jeans label which he launched in 1976.

 

The Company’s Bylawsallow our board to fix the number of directors between five and nine.  The number of directors is currently fixedat five.  Our board of directorscurrently has an Audit Committee, comprised of Mr. Hope (Chairman) and Mr.Dallas, and a Compensation Committee, comprised of Mr. Gray (Chairman) and Mr.Hope.  The board has identified Mr.Hope, an independant director, as its Audit Committee’s financial expert.  The Company has adopted a Code of Ethicswhich applies to our principal executive officer, principal financial officer,and principal accounting officer.  Acopy of the Code of Ethics may be obtained by any person without change uponwritten request to the Company, attention: Investor Relations in care of theCompany’s principal offices.

 

COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES ACT OF 1934

 

Section 16(a) of the Securities Act of 1934 requires the Company’sdirectors and executive officers, and persons who own more than ten percent ofa registered class of the Company’s equity securities, to file with theSecurities and Exchange Commission (“SEC”) and the National Association ofSecurities Dealers, Inc. initial reports of ownership and reports ofchanges in ownership of Common Stock and other equity securities of theCompany.  Officers, directors andgreater than ten-percent shareholders are required by SEC regulations tofurnish the Company with copies of all Section 16(a) forms they file.

 

To the Company’s knowledge, based solely on review of the copies ofsuch reports furnished to the Company and certain other representations that noother reports were required, during the year ended December 31, 2003, allSection 16(a) filing requirements applicable to its officers, directorsand greater than ten-percent beneficial owners were complied with.

 

21

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**ITEM 10.    EXECUTIVECOMPENSATION**

 

**EXECUTIVECOMPENSATION AND OTHER REMUNERATION**

 

The following table and related footnotes show the compensation paidduring the fiscal years ended December 31, 2003, 2002, and 2001 to theCompany’s principal executive officer and the two most highly compensatedofficers, for the year ended December 31, 2003.

 

**SUMMARY COMPENSATIONTABLE**

 
|                                   |   |       |   | **Annual  Compensation** |          | **Long Term  Compensation** |   |
|----------------------------------------|--------|------------|--------|--------------------------|---------------|-----------------------------|--------|
| **Name and Principal Position (2)**    |   | **Year**   |   | **Salary**               |          | **Bonus**                   |   | **Common  Stock  Underlying  Options and  Warrants** |   | **All Other  Compensation** |   |
| Roger A. Burlage                       |   | 2003  |   | $                        | 231,170  |                        | N/A    |   | N/A |   | N/A  |   |
| Chairman, Chief Executive Officer, and |   | 2002  |   | $                        | 560,314  |                        | N/A    |   | N/A |   | $ | 7,500  | (1) |
| Co-President (2)                       |   | 2001       |   | $                        | 543,734       |                        | N/A    |   | N/A |   | $ | 7,500 | (1) |
|                                   |   |       |   |                     |          |                        |   |   |   |   |   |
| Andrew Borsanyi                        |   | 2003       |   | $                        | 141,026       |                        | N/A    |   | 50,000 |   | N/A |   |
| President                              |   |       |   |                     |          |                        |   |   |   |   |   |
|                                   |   |       |   |                     |          |                        |   |   |   |   |   |
| Crosby Haffner                         |   | 2003       |   | $                        | 40,000        |                        | N/A    |   | 112,500 |   | N/A |   |
| Interim President                      |   |       |   |                     |          |                        |   |   |   |   |   |
|                                   |   |       |   |                     |          |                        |   |   |   |   |   |
| Gary Freeman                           |   | 2003       |   | $                        | 164,016       |                        | N/A    |   | 35,000 |   | N/A |   |
| Chief Financial Officer                |   |       |   |                     |          |                        |   |   |   |   |   |
|                                   |   |       |   |                     |          |                        |   |   |   |   |   |
| Jack Zeineh                            |   | 2003       |   | $                        | 123,077       |                        | N/A    |   | 187,500 |   | N/A |   |
| Chief Science Officer                  |   |       |   |                     |          |                        |   |   |   |   |   |

 

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(1) Representsbenefits paid under Mr. Burlage’s employment contract related to countryclub dues.

 

(2)  Roger Burlage’s employment agreement endedon April 30, 2003.  OnJanuary 15, 2003, the Board of Directors of the Company authorized thecreation of the Office of the President to provide for a smooth transition duringthe remainder of Mr. Burlage’s employment term.  The Office of the President was created to provide generalsupervision, direction and control of the Company.  Roger Burlage, David Weiner, and Gary Freeman were appointed toserve in the Office of the President. Andrew Borsanyi was appointed to serve in the Office of thePresident.  Mr. Freeman was also electedthe Company’s Chief Financial Officer and Corporate Secretary.  Currently, Crosby Haffner serves as theInterim President of the Company.

 

**OPTION AND WARRANTGRANTS IN LAST FISCAL YEAR**

 

The followingtable and related footnotes set forth the number of securities underlyingoptions and warrants granted in the last fiscal year (2003) and held by theCompany’s Executive Officers.

 
| **Name**         |   | **Number of  Securities  Underlying  Options and  Warrants Granted** |   | **Percent of  Total  Options and  Warrants Granted  in Fiscal Year** |   | **Exercise  or Base  Price($/Share)** |   | **Expiration  Date** |       |
|------------------|--------|----------------------------------------------------------------------|--------|----------------------------------------------------------------------|--------|---------------------------------------|--------|----------------------|------------|
| Roger A. Burlage |   | 0                                                                    |   | N/A                                                                  |   | N/A                                   |   | N/A                  |       |
| Andrew Borsanyi  |   | 50,000                                                               |   | 4.16                                                                 | %      | $                                     | 0.51   |                 | 10/31/2013 |   |
| Crosby Haffner   |   | 50,000                                                               |   | 4.16                                                                 | %      | $                                     | 0.50   |                 | 9/2/2008   |   |
|             |   | 25,000                                                               |   | 2.08                                                                 | %      | $                                     | 4.36   |                 | 10/27/2008 |   |
|             |   | 37,500                                                               |   | 3.12                                                                 | %      | $                                     | 5.40   |                 | 1/26/2009  |   |
| Gary Freeman     |   | 35,000                                                               |   | 2.91                                                                 | %      | $                                     | 0.62   |                 | 9/26/2008  |   |
| Jack Zeineh      |   | 187,500                                                              |   | 15.6                                                                 | %      | $                                     | 0.51   |                 | 5/20/2013  |   |

 

22

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**AGGREGATED OPTIONEXERCISES IN THE LAST FISCAL YEAR**

 

**AND FISCAL YEAR-ENDOPTION VALUES**

 
| **Name**         |   | **Shares  Acquired on  Exercise (#)** |   | **Value  Realized ($)** |   | **Number of  Securities  Underlying  Unexercised  Options at 12/31/03** |   | **Value of  Unexercised  In-the-Money  Options at 12/31/03** |   |
|------------------|--------|---------------------------------------|--------|-------------------------|--------|-------------------------------------------------------------------------|--------|--------------------------------------------------------------|--------|
| Roger A. Burlage |   | 0                                     |   | N/A                     |   | 64,032                                                                  |   | $                                                            | 0      |   |
| Andrew Borsanyi  |   | 0                                     |   | N/A                     |   | 50,000                                                                  |   | 249,500                                                      |   |
| Crosby Haffner   |   | 0                                     |   | N/A                     |   | 112,500                                                                 |   | 282,250                                                      |   |
| Gary Freeman     |   | 0                                     |   | N/A                     |   | 35,000                                                                  |   | 170,000                                                      |   |
| Jack Zeineh      |   | 0                                     |   | N/A                     |   | 187,500                                                                 |   | 936,563                                                      |   |
|                  |        |                                       |        |                         |        |                                                                         |        |                                                              |        |  |

 

**DIRECTOR COMPENSATION**

 

Directors of the Company who are neither employees of the Company norof the Company’s affiliates receive $20,000 in cash each year for serving onthe Board. Each Director receives 10,000 options at the beginning of each year,at market, vesting 25% at the end of each quarter.  Committee chairpersons receive 10,000 options granted at theinception of such member’s tenure and at the beginning of each year served.  Such grants are made at market at the timeof grant, and will vest 25% at the end of each quarter.  Committee members receive 5,000 optionsgranted at the inception of such member’s tenure and at the beginning of eachyear served.  Such grants are made atmarket at the time of grant, and will vest 25% at the end of each quarter.  New committee members receive a one-timeoption grant of 30,000 on the date of appointment, vesting 25% each quarter.

 

Employment and other arrangements between the Company and any namedexecutive officer are described in Part III, Item 12, of this Form 10-KSB andare incorporated herein by this reference.

 

**ITEM 11.    SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS**

 

The following table sets forth, as of February 29, 2004, certaininformation regarding the beneficial ownership of the Company’s Common Stockby: (i) each person known by the Company to be the beneficial owner ofmore than 5% of the outstanding shares of Common Stock, (ii) each directorand the executive officer identified above, and (iii) all directors andthe executive officer as a group:

 
| **Name and Address of Beneficial  Owner**                   |   | **Amount of  Common Stock and  Nature of Beneficial Owner** |   | **Percent of  Class of  Common Stock (1)** |    |
|-------------------------------------------------------------|--------|-------------------------------------------------------------|--------|--------------------------------------------|---------|
|                                                        |   |                                                        |   |                                       |    |
| Michael S. Doherty (2)                                      |   | 35,500                                                      |   | 1.13                                       | %       |
| Chairman of the Board                                       |   |                                                        |   |                                       |    |
| William Dallas (3)                                          |   | 234,361                                                     |   | 7.45                                       | %       |
| Director                                                    |   |                                                        |   |                                       |    |
| Gary M. Gray (4)                                            |   | 52,750                                                      |   | 1.67                                       | %       |
| Director                                                    |   |                                                        |   |                                       |    |
| Paul Guez (5)                                               |   | 1,013,194                                                   |   | 32.26                                      | %       |
| Director                                                    |   |                                                        |   |                                       |    |
| Michael Hope (6)                                            |   | 28,750                                                      |   |                                       | *  |
| Director                                                    |   |                                                        |   |                                       |    |
| Crosby Haffner (7)                                          |   | 112,500                                                     |   | 3.50                                       | %       |
| Interim President                                           |   |                                                        |   |                                       |    |
| Gary Freeman (8)                                            |   | 35,000                                                      |   | 1.12                                       | %       |
| Chief Financial Officer                                     |   |                                                        |   |                                       |    |
| Jack Zeineh, MD (9)                                         |   | 0                                                           |   |                                       | *       |
| Chief Science Officer                                       |   |                                                        |   |                                       |    |
| All Executive Officers and Directors as a group (8 persons) |   | 1,512,055                                                   |   | 43.84                                      | %       |

 

----

*                                         Represents less than 1%.

 

23

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(1)           The percent of Common Stock owned iscalculated using the sum of (A) the number of shares of Common Stock owned, and(B) the number of warrants and options of the beneficial owner that areexercisable within 60 days, as the numerator, and the sum of (Y) the totalnumber of shares of Common Stock outstanding (**3,063,447**),and (Z) the number of warrants and options of the beneficial owner that areexercisable within 60 days, as the denominator.

 

(2)           The address of Michael Doherty is c/oTrestle Holdings., Inc., 199 Technology Drive, Suite 105, Irvine, California92618. Percent of class of Common Stock includes exercisable options/warrantsto purchase 35,500 shares of Common Stock within 60 days. This amount does notinclude 485,566 options and warrants which are exercisable after 60 days.

 

(3)           The address of William Dallas is c/oTrestle Holdings., Inc., 199 Technology Drive, Suite 105, Irvine, California92618. Percent of class of Common Stock includes exercisable options/warrantsto purchase 43,309 shares of Common Stock within 60 days.

 

(4)           The address of Gary M. Gray is c/oMilestone Capital Inc., 1800 West Loop South, Suite 1075, Houston, Texas77027.  Percent of class of Common Stockincludes exercisable options/warrants to purchase 52,750 shares of Common Stockwithin 60 days.

 

(5)           The address of Paul Guez is c/oTrestle Holdings., Inc., 199 Technology Drive, Suite 105, Irvine, California92618. Percent of class of Common Stock includes exercisable options/warrantsto purchase 37,795 shares of Common Stock within 60 days.

 

(6)           The address of Michael Hope is c/oTrestle Holdings., Inc., 199 Technology Drive, Suite 105, Irvine, California92618. Percent of class of Common Stock includes exercisable options/warrantsto purchase 28,750 shares of Common Stock within 60 days.

 

(7)           The address of Crosby Haffner is c/oTrestle Holdings., Inc., 199 Technology Drive, Suite 105, Irvine, California92618. Percent of class of Common Stock includes exercisable options/warrantsto purchase 112,500 shares of Common Stock within 60 days.

 

(8)           The address of Gary Freeman is c/oTrestle Holdings., Inc., 199 Technology Drive, Suite 105, Irvine, California92618. Percent of class of Common Stock includes exercisable options/warrantsto purchase 35,000 shares of Common Stock within 60 days.

 

(9)           The address of Jack Zeineh, MD is c/oTrestle Holdings., Inc., 199 Technology Drive, Suite 105, Irvine, California92618.  Dr. Zeineh was appointed ChiefScience Officer in May 2003.  Dr. Zeinehdoes not currently own any Trestle securities or warrants/options to purchaseTrestle securities.  This amount doesnot include 187,500 options which are exercisable after 60 days.

 

(10)         Includes the beneficial ownership ofMessrs. Doherty, Dallas, Gray, Guez, Hope, Haffner, Freeman and Zeineh.  Total Voting Power calculation includes thetotal number of options/warrants of such persons exercisable within 60 daysheld by such persons to purchase 345,604 shares of common stock. Assuming that none of such persons exerciseswithin 60 days any of such his respective options or warrants, the Total VotingPower of the group is approximately **38%.**

 

**Equity PlanCompensation Information**

 

The Equity Plan Compensation Information identified in Part II, Item 5,above is incorporated into this Part III, Item 11, by this reference.

 

**ITEM 12. CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

 

Otherthan as listed below, we have not been a party to any transaction, proposedtransaction, or series of transactions in which the amount involved exceeds$60,000, and in which, to our knowledge, any of our directors, officers, fivepercent beneficial security holder, or any member of the immediate family ofthe foregoing persons has had or will have a direct or indirect materialinterest.

 

Duringthe year ended December 31, 2003, our Company incurred consulting fees and taxreturn preparation expenses in the amount of $184,000.  The consulting fees and tax returnpreparation expenses were charged by Kellogg & Andelson, a Southern Californiabased public accounting firm.  GaryFreeman, our Chief Financial Officer, is currently a Vice President anddirector of Kellogg & Andelson.

 

24

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Pursuantto a consulting agreement with our company, our Company paid consulting fees inthe amount of $40,000 to Crosby Haffner, who currently serves as our InterimPresident. As compensation for his services as the Company’s Interim President,we granted to Mr. Haffner 112,500 warrants with exercise prices between $0.50and $5.40 per share.

 

As aresult of the close of the acquisition of the assets of Old Trestle, asadditional compensation for their respective consulting services, we granted toMichael Doherty, our Chairman, and David Weiner, one of our Co-Presidents atthe time of the close of that transaction, warrants to purchase a number ofshares of our common stock equal to 2.5% and 1%, respectively, of our issuedand outstanding common stock on a fully diluted basis, as may be adjusted fromtime to time based on their respective anti-dilution provisions, each at anexercise price of $1.00 per share. Those warrants become exercisable on May 20, 2004.  Mr. Weiner also received a lump sum paymentof $50,000 on the close of that transaction.

 

Additionally,on September 26, 2003, we granted to Michael Doherty, our Chairman, warrants topurchase 406,714 shares of our common stock at an exercise price of $0.62 pershare.  Fifty percent of those warrantsbecome exercisable on May 5, 2004 and the remainder will vest in equal monthlyinstallments on the last day of each month over the following 12 months.

 

**ITEM13. EXHIBITS LIST AND REPORTS ON FORM 8-K**

** **
| **Exhibit  Number** |   | **Description of Exhibit**                                                                                                                                                                                                    |
|---------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                                                                                          |
| *2.1                |   | Third Amendment to Asset Purchase Agreement dated as  of September 3, 2003, by and among the Company, Pepin/Merhi  Entertainment, Inc. and Film Library Acquisition Corp.                                                |
| *2.2                |   | Asset Purchase Agreement dated as of April 16, 2003,  by and among the Trestle Acquisition Corp., Med Diversified, Inc. and Trestle  Corporation.                                                                             |
| *2.3                |   | Amendment No. 1 to Asset Purchase Agreement  dated as of May 20, 2003,  2003,   by and among the  Trestle  Acquisition  Corp.,  Med Diversified,  Inc. and Trestle Corporation.            |
| *2.4                |   | Asset Purchase   Agreement dated as of April 10, 2003, by and among the Company,  Pepin/Merhi Entertainment,  Inc. and  Film Library Acquisition Corp.                                                              |
| *3.1(i)             |   | Second Amended and Restated Articles of  Incorporation of the Company (incorporated herein by reference to  Exhibit 3.1 of Company’s Registration Statement No. 33-63363-LA)                                   |
| *3.2(i)             |   | First Amendment to Second Amended and Restated  Articles of Incorporation of the Company (incorporated herein by reference to  Exhibit 3.2 of Company’s Registration Statement No. 33-63363-LA)                |
| *3.3(i)             |   | Certificate of Determination filed with the  California Secretary of State of April 15, 1999 (incorporated by  reference to Exhibit 3.1 of the Company’s Form 8-K dated  April 26, 1999)             |
| *3.4(ii)            |   | Second Restated and Amended Bylaws of the Company  (incorporated herein by reference to Exhibit 3.3 of Company’s  Registration Statement No. 33-63363-LA)                                                      |
| *3.5(ii)            |   | First Amendment to Second Restated and Amended  Bylaws of the Company (incorporated herein by reference to Exhibit 3.4  of Company’s Registration Statement No. 33-63363-LA)                                   |
| *4.1                |   | Form of Stock Certificate (incorporated herein by  reference to Exhibit 4 of Company’s Registration Statement  No. 33-63363-LA)                                                                                |
| 10.1                |   | Warrant agreement between Company and Zaykowski  Partners, LP dated March 3, 2004.                                                                                                                                            |
| 10.2                |   | Convertible promissory note between the Company and  Zaykowski Partners, LP March 3, 2004.                                                                                                                                    |
| 10.3                |   | Security agreement between Company and Zaykowski  Partners, LP March 3, 2004.                                                                                                                                                 |
| 10.4                |   | Consulting agreement between the Company and Crosby  Haffner December 27, 2003.                                                                                                                                               |
| 10.5                |   | Warrant agreement between the Company and Crosby  Haffner December 27, 2003.                                                                                                                                                  |
| *10.6               |   | Consulting agreement between the Company and Andrew  Borsanyi                                                                                                                                                                 |
| *10.7               |   | Warrant agreement between the Company and Andrew  Borsanyi                                                                                                                                                                    |
| *10.8               |   | Warrant Agreement dated September 26, 2003, by and  between the Company and Michael Doherty.                                                                                                                                  |
| *10.9               |   | Warrant Agreement dated July 2, 2003, by and between  the Company and Michael Doherty.                                                                                                                                        |
| *10.10              |   | Warrant Agreement dated June 30, 2003, by and  between the Company and W-Net, Inc.                                                                                                                                            |
| *10.11              |   | Employment Term Sheet dated as of May 20,  2003,   by and between the Registrant and Andrew Borsanyi.                                                                                                               |
| *10.12              |   | Employment Term Sheet dated as of May 20,  2003,   by and between the Registrant and Jack Zeineh.                                                                                                                   |
| *10.13              |   | Registration Agreement, dated as of December 7,  1990, by and among the Company, AKAUSA and MCA (incorporated herein by  reference to Exhibit 10.11 of Company’s Registration Statement  No. 33-63363-LA) |
| *10.14              |   | Shareholders Agreement, dated as of December 7,  1990, by and among the Company, AKAUSA and MCA (incorporated herein by  reference to Exhibit 10.12 of Company’s Registration Statement  No. 33-63363-LA) |
| *10.15              |   | 1993 Stock Option Plan and Stock Option Agreements  (incorporated herein by reference to Exhibit 10.41 of Company’s  Registration Statement No. 33-63363-LA)                                                   |
| *10.16              |   | Special Salary Reduction Stock Option Plan of 1993  and Stock Option Agreements (incorporated herein by reference to  Exhibit 10.42 of Company’s Registration Statement No. 33-63363-LA)                       |

 

25

----

 
| **Exhibit  Number** |   | **Description of Exhibit**                                                                                                                                                                                                                                                                           |
|---------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *10.17              |   | Profit Sharing Plan and Trust Adoption Agreement  (incorporated herein by reference to Exhibit 10.43 of Company’s  Registration Statement No. 33-63363-LA)                                                                                                                            |
| *10.18              |   | Office Lease between Company and 100 Wilshire  Associates dated December 8, 1993 (incorporated herein by reference to  the Company’s Annual Report on Form 10-KSB for the year ended  December 31, 1993)                                                                         |
| *10.19              |   | 1994 Stock Option Plan (incorporated by reference to  the Company’s 1994 definitive Proxy Statement)                                                                                                                                                                                            |
| *10.20              |   | Sublease Agreement dated as of November 14,  1995 between the Company and Travelers Management, Inc., a California  corporation (incorporated herein by reference to the Company’s Annual Report  on Form 10-KSB for the year ended December 31, 1995)                      |
| *10.21              |   | Warrant Agreement with Arnhold and S. Bleichroeder  dated January 16, 1997 (incorporated herein by reference to the  Company’s Annual Report on Form 10-KSB for the year ended  December 31, 1996)                                                                               |
| *10.22              |   | Warrant Agreement with Michael Doherty dated  January 16, 1997 (incorporated herein by reference to the Company’s  Annual Report on Form 10-KSB for the year ended December 31, 1996)                                                                                            |
| *10.23              |   | The Harvey Entertainment Company 1997 Stock Option  Plan (incorporated herein by reference to the Company’s 1997 definitive Proxy  Statement)                                                                                                                                                   |
| *10.24              |   | Warrant Agreement dated March 23, 1998 between  the Company and Anthony J. Scotti, Michael S. Hope and Leonard Breijo  (incorporated herein by reference to the Company’s Quarterly Report on  Form 10-QSB for the quarter ended March 31, 1998)                                 |
| *10.25              |   | Stock Purchase Agreement dated as of April 7, 1999  by and among the Company, Michael R. Burns, Roger A. Burlage, Ken Slutsky and  The Kushner-Locke Company (incorporated by reference to Exhibit 10.1 of  the Company’s Form 8-K dated April 26, 1999)                    |
| *10.26              |   | Warrant Agreement dated as of April 26, 1999  among the Company, Roger A. Burlage, Michael R. Burns, The Kushner-Locke  Company, Al Checchi and Ken Slutsky (incorporated by reference to  Exhibit 10.2 of the Company’s Form 8-K dated April 26, 1999)                     |
| *10.27              |   | Registration Rights Agreement dated as of  April 26, 1999 by and among the Company, The Kushner-Locke Company,  Roger A. Burlage, Michael R. Burns, Al Checchi and Ken Slutsky (incorporated  by reference to Exhibit 10.3 of the Company’s Form 8-K dated  April 26, 1999) |
| *10.28              |   | Registration Rights Agreement dated as of  April 26, 1999 by and between The Kushner-Locke Company and the Company  (incorporated by reference to Exhibit 10.4 of the Company’s  Form 8-K dated April 26, 1999)                                                             |
| *10.29              |   | Employment Agreement dated as of April 5, 1999  by and between the Company and Roger A. Burlage (incorporated by reference to  Exhibit 10.5 of the Company’s Form 8-K dated April 26, 1999)                                                                                 |
| *10.30              |   | Warrant Agreement dated as of June 30, 1999  between the Company and Paul Guez (incorporated by reference to  Exhibit 10.64 of the Company’s Quarterly Report on Form 10-QSB for  the quarter ended June 30, 1999)                                                          |
| *10.31              |   | Registration Rights Agreement dated as of  June 30, 1999 by and between the Company and Paul Guez (incorporated by  reference to Exhibit 10.65 of the Company’s Quarterly Report on  Form 10-QSB for the quarter ended June 30, 1999)                                       |
| *10.32              |   | Lease Agreement dated September 22, 1999  between the Company and Douglas Emmett Realty Fund 1997, a California limited  partnership (incorporated by reference to Exhibit 10.76 of the Company’s  Annual Report on Form 10-KSB for the year ended December 31, 1999)       |
| *10.33              |   | Lease Agreement dated as of April 1, 2000, by  and between Pepin/Merhi Entertainment Group, Inc. and Pepin Merhi  Shamieh, LLC (incorporated by reference to Exhibit 10.78 of the Company’s  Form 8-K dated April 14, 2000)                                            |
| *10.34              |   | Sale and Assignment Agreement dated as of  April 3, 2000, by and among Inferno Acquisition Corp., Imperial Bank,  and Natexis Banque (incorporated by reference to Exhibit 10.79 of the  Company’s Form 8-K dated April 14, 2000)                                           |

 

26

----

 
| **Exhibit  Number** |   | **Description of Exhibit**                                                                                                                                                                                                                                                                                                                                                                                                                         |
|---------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *10.35              |   | Loan and Security Agreement dated as of  April 3, 2000, by and among Inferno Acquisition Corp., Imperial Bank and  Natexis Banque (incorporated by reference to Exhibit 10.80 of the  Company’s Form 8-K dated April 14, 2000)                                                                                                                                                                                            |
| *10.36              |   | Credit, Security, Guaranty and Pledge Agreement  dated as of April 3, 2000 among the Company, the other Borrowers  referred to therein, the Guarantors referred to therein, the Lenders referred  to therein and The Chase Manhattan Bank as Administrative Agent and Issuing  Bank (incorporated by reference to Exhibit 10.82 of the Company’s  Quarterly Report on Form 10-QSB for the quarter ended March 31,  2000.) |
| *10.37              |   | Securities Purchase Agreement dated July 2,  2001 by and among Sunland Entertainment, Inc. and SHO Investments, LLC  (incorporation by reference to Exhibit 10.52 of the Company’s Form 10-KSB for  the year ended December 31, 2001)                                                                                                                                                                                                    |
| *21                 |   | List of subsidiaries of Company (incorporated herein  by reference to Exhibit 22 of Company’s Registration Statement  No. 33-63363-LA)                                                                                                                                                                                                                                                                                              |
| *24.1               |   | Power of Attorney.                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 31.1                |   | Certification of President  pursuant to Exchange Act Rule 13a-14 and 15d-14 as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                 |
| 31.2                |   | Certification of CFO  pursuant to Exchange Act Rule 13a-14 and 15d-14 as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                       |
| 32.1                |   | Certification of the Company’s Chief Executive  Officer, pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section  906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                            |
| 32.1                |   | Certification of the Company’s  Chief Financial Officer, pursuant to 18  U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002.                                                                                                                                                                                                                                                                      |

 

----

*              Previously filed.

 

**Reports on Form 8-K**

 
| **Date**   |   |                                                                                                                                                                                |
|------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10/31/2003 |   | Effective October 31, 2003, Andrew Borsanyi resigned  as President of the Company                                                                                                   |
| 12/17/2003 |   | The Company intends to offer a minimum of 500,000  shares and up to a maximum of 1,000,000 shares of its common stock, $.001 par  value per share, for sale in a private placement. |
| 12/23/2003 |   | Press release announcing the purchase and  installation of its telemedicine product, MedReach, for Maine Health  Alliance.                                                          |

 

**ITEM 14.               PRINCIPAL ACCOUNTANT FEES ANDSERVICES**

 

Singer Lewak, our primary auditor, billed the Company $146,000 and$35,982 for audit fees during the years ended December 31, 2003 and 2002,respectively.  PricewaterhouseCoopersour former auditor, billed the Company $97,500 during the year ended December31, 2002.

 

27

----

 

#### **Signatures**

 

In accordance with Section 13 or 15(d) of the Exchange Act, theIssuer has caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 
| Trestle  Holdings, Inc. |   |                                                       |
|-------------------------|--------|------------------------------------------------------------|
|                    |   |                                                       |
| Date: March  30, 2004   | By:    | /s/  CROSBY HAFFNER                              |
|                    |   | Name: Crosby Freeman                                       |
|                    |   | *Title: Interim  President  (Principal Executive Officer)* |
|                    |   |                                                       |
| Date: March  30, 2004   | By:    | /s/  GARY FREEMAN                                |
|                    |   | Name: Gary Freeman                                         |
|                    |   | *Title: Chief  Financial Officer*                          |
|                    |   | *(Principal  Financial and  Accounting Officer)*           |

 

In accordance with the Exchange Act, this report has been signed belowby the following person on behalf of the registrant and in the capacities andon the date indicated:

 
| **SIGNATURE**                 |   | **TITLE** |                                          | **DATE** |           |
|-------------------------------|--------|-----------|-----------------------------------------------|----------|----------------|
|                          |   |      |                                          |     |           |
| /s/  CROSBY HAFFNER |   |      | Interim President                             |     | March 30, 2004 |   |
| Crosby Haffner                |   |      | (Principal Executive Officer)                 |     |           |   |
|                          |   |      |                                          |     |           |   |
| /s/   GARY FREEMAN  |   |      | Chief Financial Officer                       |     | March 30, 2004 |   |
| Gary Freeman                  |   |      | (Principal Financial and Accounting  Officer) |     |           |   |
|                          |   |      |                                          |     |           |   |
| *                             |   |      | Director                                      |     | March 30, 2004 |   |
| William Dallas                |   |      |                                          |     |           |   |
|                          |   |      |                                          |     |           |   |
| *                             |   |      | Director                                      |     | March 30, 2004 |   |
| Michael S. Doherty            |   |      |                                          |     |           |   |
|                          |   |      |                                          |     |           |   |
| *                             |   |      | Director                                      |     | March 30, 2004 |   |
| Michael Hope                  |   |      |                                          |     |           |   |
|                          |   |      |                                          |     |           |   |
| *                             |   |      | Director                                      |     | March 30, 2004 |   |
| Gary M. Gray                  |   |      |                                          |     |           |   |
|                          |   |      |                                          |     |           |   |
| *                             |   |      | Director                                      |     | March 30, 2004 |   |
| Paul Guez                     |   |      |                                          |     |           |   |
|                          |   |      |                                          |     |           |   |

 

----

| *****  | **By:** | /s/ Gary Freeman    |   |
|--------|---------|---------------------|--------|
|   |    | Gary Freeman        |   |
|   |    | As Attorney-In-Fact |   |

 

28

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**Exhibit Index**

 
| **Exhibit  Number** |   | **Description of Exhibit**                                                                                                                                                                                                    |
|---------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                                                                                          |
| *2.1                |   | Third Amendment to Asset Purchase Agreement dated as  of September 3, 2003, by and among the Company, Pepin/Merhi  Entertainment, Inc. and Film Library Acquisition Corp.                                                |
| *2.2                |   | Asset Purchase Agreement dated as of April 16, 2003,  by and among the Trestle Acquisition Corp., Med Diversified, Inc. and Trestle  Corporation.                                                                             |
| *2.3                |   | Amendment No. 1 to Asset Purchase Agreement  dated as of May 20, 2003,  2003,   by and among the  Trestle  Acquisition  Corp.,  Med Diversified,  Inc. and Trestle Corporation.            |
| *2.4                |   | Asset Purchase   Agreement dated as of April 10, 2003, by and among the Company,  Pepin/Merhi Entertainment,  Inc. and  Film Library Acquisition Corp.                                                              |
| *3.1(i)             |   | Second Amended and Restated Articles of  Incorporation of the Company (incorporated herein by reference to  Exhibit 3.1 of Company’s Registration Statement No. 33-63363-LA)                                   |
| *3.2(i)             |   | First Amendment to Second Amended and Restated  Articles of Incorporation of the Company (incorporated herein by reference to  Exhibit 3.2 of Company’s Registration Statement No. 33-63363-LA)                |
| *3.3(i)             |   | Certificate of Determination filed with the  California Secretary of State of April 15, 1999 (incorporated by  reference to Exhibit 3.1 of the Company’s Form 8-K dated  April 26, 1999)             |
| *3.4(ii)            |   | Second Restated and Amended Bylaws of the Company  (incorporated herein by reference to Exhibit 3.3 of Company’s  Registration Statement No. 33-63363-LA)                                                      |
| *3.5(ii)            |   | First Amendment to Second Restated and Amended  Bylaws of the Company (incorporated herein by reference to Exhibit 3.4  of Company’s Registration Statement No. 33-63363-LA)                                   |
| *4.1                |   | Form of Stock Certificate (incorporated herein by  reference to Exhibit 4 of Company’s Registration Statement  No. 33-63363-LA)                                                                                |
| 10.1                |   | Warrant agreement between Company and Zaykowski  Partners, LP dated March 3, 2004.                                                                                                                                            |
| 10.2                |   | Convertible promissory note between the Company and  Zaykowski Partners, LP March 3, 2004.                                                                                                                                    |
| 10.3                |   | Security agreement between Company and Zaykowski  Partners, LP March 3, 2004.                                                                                                                                                 |
| 10.4                |   | Consulting agreement between the Company and Crosby  Haffner December 27, 2003.                                                                                                                                               |
| 10.5                |   | Warrant agreement between the Company and Crosby  Haffner December 17, 2003.                                                                                                                                                  |
| *10.6               |   | Consulting agreement between the Company and Andrew  Borsanyi                                                                                                                                                                 |
| *10.7               |   | Warrant agreement between the Company and Andrew  Borsanyi                                                                                                                                                                    |
| *10.8               |   | Warrant Agreement dated September 26, 2003, by and  between the Company and Michael Doherty.                                                                                                                                  |
| *10.9               |   | Warrant Agreement dated July 2, 2003, by and between  the Company and Michael Doherty.                                                                                                                                        |
| *10.10              |   | Warrant Agreement dated June 30, 2003, by and  between the Company and W-Net, Inc.                                                                                                                                            |
| *10.11              |   | Employment Term Sheet dated as of May 20,  2003,   by and between the Registrant and Andrew Borsanyi.                                                                                                               |
| *10.12              |   | Employment Term Sheet dated as of May 20,  2003,   by and between the Registrant and Jack Zeineh.                                                                                                                   |
| *10.13              |   | Registration Agreement, dated as of December 7,  1990, by and among the Company, AKAUSA and MCA (incorporated herein by  reference to Exhibit 10.11 of Company’s Registration Statement  No. 33-63363-LA) |
| *10.14              |   | Shareholders Agreement, dated as of December 7,  1990, by and among the Company, AKAUSA and MCA (incorporated herein by  reference to Exhibit 10.12 of Company’s Registration Statement  No. 33-63363-LA) |
| *10.15              |   | 1993 Stock Option Plan and Stock Option Agreements  (incorporated herein by reference to Exhibit 10.41 of Company’s  Registration Statement No. 33-63363-LA)                                                   |
| *10.16              |   | Special Salary Reduction Stock Option Plan of 1993  and Stock Option Agreements (incorporated herein by reference to  Exhibit 10.42 of Company’s Registration Statement No. 33-63363-LA)                       |

 

29

----

 
| **Exhibit  Number** |   | **Description of Exhibit**                                                                                                                                                                                                                                                                           |
|---------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *10.17              |   | Profit Sharing Plan and Trust Adoption Agreement  (incorporated herein by reference to Exhibit 10.43 of Company’s  Registration Statement No. 33-63363-LA)                                                                                                                            |
| *10.18              |   | Office Lease between Company and 100 Wilshire Associates  dated December 8, 1993 (incorporated herein by reference to the  Company’s Annual Report on Form 10-KSB for the year ended  December 31, 1993)                                                                         |
| *10.19              |   | 1994 Stock Option Plan (incorporated by reference to  the Company’s 1994 definitive Proxy Statement)                                                                                                                                                                                            |
| *10.20              |   | Sublease Agreement dated as of November 14,  1995 between the Company and Travelers Management, Inc., a California  corporation (incorporated herein by reference to the Company’s Annual Report  on Form 10-KSB for the year ended December 31, 1995)                      |
| *10.21              |   | Warrant Agreement with Arnhold and S. Bleichroeder  dated January 16, 1997 (incorporated herein by reference to the  Company’s Annual Report on Form 10-KSB for the year ended  December 31, 1996)                                                                               |
| *10.22              |   | Warrant Agreement with Michael Doherty dated January 16,  1997 (incorporated herein by reference to the Company’s Annual Report on  Form 10-KSB for the year ended December 31, 1996)                                                                                            |
| *10.23              |   | The Harvey Entertainment Company 1997 Stock Option  Plan (incorporated herein by reference to the Company’s 1997 definitive Proxy  Statement)                                                                                                                                                   |
| *10.24              |   | Warrant Agreement dated March 23, 1998 between  the Company and Anthony J. Scotti, Michael S. Hope and Leonard Breijo  (incorporated herein by reference to the Company’s Quarterly Report on  Form 10-QSB for the quarter ended March 31, 1998)                                 |
| *10.25              |   | Stock Purchase Agreement dated as of April 7,  1999 by and among the Company, Michael R. Burns, Roger A. Burlage, Ken  Slutsky and The Kushner-Locke Company (incorporated by reference to  Exhibit 10.1 of the Company’s Form 8-K dated April 26, 1999)                    |
| *10.26              |   | Warrant Agreement dated as of April 26, 1999  among the Company, Roger A. Burlage, Michael R. Burns, The Kushner-Locke  Company, Al Checchi and Ken Slutsky (incorporated by reference to  Exhibit 10.2 of the Company’s Form 8-K dated April 26, 1999)                     |
| *10.27              |   | Registration Rights Agreement dated as of  April 26, 1999 by and among the Company, The Kushner-Locke Company,  Roger A. Burlage, Michael R. Burns, Al Checchi and Ken Slutsky (incorporated  by reference to Exhibit 10.3 of the Company’s Form 8-K dated  April 26, 1999) |
| *10.28              |   | Registration Rights Agreement dated as of  April 26, 1999 by and between The Kushner-Locke Company and the Company  (incorporated by reference to Exhibit 10.4 of the Company’s  Form 8-K dated April 26, 1999)                                                             |
| *10.29              |   | Employment Agreement dated as of April 5, 1999  by and between the Company and Roger A. Burlage (incorporated by reference to  Exhibit 10.5 of the Company’s Form 8-K dated April 26, 1999)                                                                                 |
| *10.30              |   | Warrant Agreement dated as of June 30, 1999  between the Company and Paul Guez (incorporated by reference to  Exhibit 10.64 of the Company’s Quarterly Report on Form 10-QSB for  the quarter ended June 30, 1999)                                                          |
| *10.31              |   | Registration Rights Agreement dated as of  June 30, 1999 by and between the Company and Paul Guez (incorporated by  reference to Exhibit 10.65 of the Company’s Quarterly Report on  Form 10-QSB for the quarter ended June 30, 1999)                                       |
| *10.32              |   | Lease Agreement dated September 22, 1999  between the Company and Douglas Emmett Realty Fund 1997, a California limited  partnership (incorporated by reference to Exhibit 10.76 of the Company’s  Annual Report on Form 10-KSB for the year ended December 31, 1999)       |
| *10.33              |   | Lease Agreement dated as of April 1, 2000, by  and between Pepin/Merhi Entertainment Group, Inc. and Pepin Merhi  Shamieh, LLC (incorporated by reference to Exhibit 10.78 of the  Company’s Form 8-K dated April 14, 2000)                                            |
| *10.34              |   | Sale and Assignment Agreement dated as of  April 3, 2000, by and among Inferno Acquisition Corp., Imperial Bank,  and Natexis Banque (incorporated by reference to Exhibit 10.79 of the  Company’s Form 8-K dated April 14, 2000)                                           |

 

30

----

 
| **Exhibit  Number** |   | **Description of Exhibit**                                                                                                                                                                                                                                                                                                                                                                                                                         |
|---------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *10.35              |   | Loan and Security Agreement dated as of  April 3, 2000, by and among Inferno Acquisition Corp., Imperial Bank and  Natexis Banque (incorporated by reference to Exhibit 10.80 of the  Company’s Form 8-K dated April 14, 2000)                                                                                                                                                                                            |
| *10.36              |   | Credit, Security, Guaranty and Pledge Agreement  dated as of April 3, 2000 among the Company, the other Borrowers  referred to therein, the Guarantors referred to therein, the Lenders referred  to therein and The Chase Manhattan Bank as Administrative Agent and Issuing  Bank (incorporated by reference to Exhibit 10.82 of the Company’s  Quarterly Report on Form 10-QSB for the quarter ended March 31,  2000.) |
| *10.37              |   | Securities Purchase Agreement dated July 2,  2001 by and among Sunland Entertainment, Inc. and SHO Investments, LLC  (incorporation by reference to Exhibit 10.52 of the Company’s Form 10-KSB for  the year ended December 31, 2001)                                                                                                                                                                                                    |
| *21                 |   | List of subsidiaries of Company (incorporated herein  by reference to Exhibit 22 of Company’s Registration Statement  No. 33-63363-LA)                                                                                                                                                                                                                                                                                              |
| *24.1               |   | Power of Attorney.                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|                |   |                                                                                                                                                                                                                                                                                                                                                                                                                                               |
| 31.1                |   | Certification of President  pursuant to Exchange Act Rule 13a-14 and 15d-14 as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                 |
| 31.2                |   | Certification of CFO  pursuant to Exchange Act Rule 13a-14 and 15d-14 as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                       |
| 32.1                |   | Certification of the Company’s Chief Executive  Officer, pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section  906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                            |
| 32.1                |   | Certification of the Company’s  Chief Financial Officer, pursuant to 18  U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002.                                                                                                                                                                                                                                                                      |

 

31

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# **ITEM7.          FINANCIAL STATEMENTS**

 

**TRESTLEHOLDINGS, INC. AND SUBSIDIARIES**

 

**TABLE OF CONTENTS**

 
| REPORT OF INDEPENDENT ACCOUNTANTS                                                                 |   |
|---------------------------------------------------------------------------------------------------|--------|
| CONSOLIDATED  FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2003 AND  2002 |   |
| Consolidated Balance Sheets                                                                       |   |
| Consolidated Statements of Operations                                                             |   |
| Consolidated Statements of Stockholders’  Equity                                             |   |
| Consolidated Statements of Cash Flows                                                             |   |
| Notes to Consolidated Financial Statements                                                        |   |

 

F-1

----

 

**INDEPENDENT AUDITOR’SREPORT**

 

To the Boardof Directors

Trestle Holdings, Inc.

Los Angeles, CA

 

We have audited the accompanying consolidated balance sheet of TrestleHoldings, Inc. and subsidiaries as of December 31, 2003 and 2002 and therelated consolidated statements of operations, stockholders’ equity and cashflows for the years then ended.  Thesefinancial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audit.

 

We conducted our audit in accordance with auditing standards generallyaccepted in the United States of America. Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation.  Webelieve that our audit provides a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the financial position of TrestleHoldings, Inc. and subsidiaries as of December 31, 2003 and 2002 and theresults of their operations and their cash flows for the years then ended inconformity with accounting principles generally accepted in the United Statesof America.

 

The accompanying financial statements have been prepared assuming thatthe Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company hassuffered recurring losses from operations and has an accumulated deficit.  This raises substantial doubt about theCompany’s ability to continue as a going concern.  Management’s plans in regard to these matters are also describedin Note 1.  The financial statements donot include any adjustments that might result from the outcome of thisuncertainty.

 

 

Singer Lewak Greenbaum & Goldstein LLP

 

Los Angeles, California

March 26, 2004

 

F-2

----

 

**TRESTLE HOLDINGS, INC. AND SUBSIDIARIES**

 

**CONSOLIDATED BALANCE SHEETS**

 
|                                                                                                           |   | **Years Ended December 31,** |      |
|----------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|-----------|
|                                                                                                           |   | **2003**                          |      | **2002** |   |
| **ASSETS**                                                                                                     |   |                              |      |   |   |
| CURRENT ASSETS                                                                                                 |   |                              |      |   |   |
| Cash and cash equivalents                                                                                      |   | $                                 | 363,000   |   | $ | 1,976,000 |   |
| Accounts receivable, net of allowance for doubtful accounts of $6,000  and zero in 2003 and 2002, respectively |   | 505,000                           |      | — |   |
| Inventory                                                                                                      |   | 223,000                           |      | — |   |
| Prepaid expenses and other assets                                                                              |   | 573,000                           |      | 300,000 |   |
| Income tax receivable                                                                                          |   | —                            |      | 7,000 |   |
| TOTAL CURRENT ASSETS                                                                                           |   | 1,664,000                         |      | 2,283,000 |   |
| Other assets                                                                                                   |   | 535,000                           |      | 220,000 |   |
| Fixed assets, net of accumulated depreciation of $1,170,000 and  $1,106,000 in 2003 and 2002, respectively     |   | 165,000                           |      | 86,000 |   |
| Goodwill                                                                                                       |   | 1,514,000                         |      | — |   |
| Intangible assets, net of accumulated amortization of $158,000 and  zero in 2003 and 2002, respectively        |   | 584,000                           |      | — |   |
| Net assets from discontinued operations                                                                        |   | —                            |      | 3,781,000 |   |
| TOTAL ASSETS                                                                                                   |   | $                                 | 4,462,000 |   | $ | 6,370,000 |   |

 

See accompanying notes to consolidated financial statements.

 

F-3

----

 

**TRESTLEHOLDINGS, INC. AND SUBSIDIARIES**

 

**CONSOLIDATED BALANCESHEETS**

 
|                                                                                                                                                                                                                                                                                          |   | **Years Ended December 31,** |      |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|-----------|
|                                                                                                                                                                                                                                                                                          |   | **2003**                          |      | **2002** |   |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                                |   |                              |      |   |   |
| CURRENT LIABILITIES:                                                                                                                                                                                                                                                                          |   |                              |      |   |   |
| Accounts payable and accrued expenses                                                                                                                                                                                                                                                         |   | $                                 | 1,068,000 |   | $ | 423,000 |   |
| Deferred revenue                                                                                                                                                                                                                                                                              |   | 554,000                           |      | — |   |
| Series A Convertible Preferred Stock, $1,000 stated value,  75,000 shares authorized, zero and 5,200 shares issued and outstanding at  December 31, 2003 and, 2002, respectively, liquidation preference of  zero and $5,186,000 at December 31, 2003 and 2002, respectively   |   | —                            |      | 4,326,000 |   |
|                                                                                                                                                                                                                                                                                          |   |                              |      |   |   |
| TOTAL CURRENT LIABILITIES                                                                                                                                                                                                                                                                     |   | 1,622,000                         |      | 4,749,000 |   |
|                                                                                                                                                                                                                                                                                          |   |                              |      |   |   |
| COMMITMENTS AND CONTINGENCIES                                                                                                                                                                                                                                                                 |   |                              |      |   |   |
|                                                                                                                                                                                                                                                                                          |   |                              |      |   |   |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                                                                                                                    |   |                              |      |   |   |
| Preferred stock, $10 par value, 4,675,000 shares authorized, zero and  zero shares issued and outstanding at December 31, 2003 and, 2002,  respectively                                                                                                                                  |   | —                            |      | — |   |
| Series B Convertible Preferred Stock, $1,000 stated value, 250,000  shares authorized, zero and 12,200 shares issued and outstanding at  December 31, 2003 and 2002, respectively, liquidation preference of zero  and $12,235,000 at December 31, 2003 and 2002, respectively |   | —                            |      | 12,235,000 |   |
| Common stock, $.001 par value, 40,000,000 shares authorized,  3,033,000 and 455,000 issued and outstanding at December 31, 2003 and  2002, respectively                                                                                                                                  |   | 3,000                             |      | — |   |
| Additional paid in capital                                                                                                                                                                                                                                                                    |   | 43,019,000                        |      | 26,459,000 |   |
| Deferred stock compensation                                                                                                                                                                                                                                                                   |   | (486,000                          | )         | — |   |
| Accumulated deficit                                                                                                                                                                                                                                                                           |   | (39,696,000                       | )         | (37,073,000 | ) |
| Total stockholders’ equity                                                                                                                                                                                                                                                               |   | 2,840,000                         |      | 1,621,000 |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                                               |   | $                                 | 4,462,000 |   | $ | 6,370,000 |   |

 

See accompanying notes to consolidated financial statements.

 

F-4

----

 

#### **TRESTLE HOLDINGS,INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

** **
|                                                                                  |   | **Years Ended December 31,** |       |
|---------------------------------------------------------------------------------------|--------|-----------------------------------|------------|
|                                                                                  |   | **2003**                          |       | **2002** |   |
| REVENUES                                                                              |   |                              |       |   |   |
| Product                                                                               |   | $                                 | 1,477,000  |   | $ | — |   |
| Software support                                                                      |   | 484,000                           |       | — |   |
| Total revenues                                                                        |   | 1,961,000                         |       | — |   |
| COST OF SALES                                                                         |   | 535,000                           |       | — |   |
| GROSS PROFIT                                                                          |   | 1,426,000                         |       | — |   |
| OPERATING EXPENSES                                                                    |   |                              |       |   |   |
| Research and development                                                              |   | 1,228,000                         |       | — |   |
| Selling, general and administrative expenses                                          |   | 3,909,000                         |       | 1,021,000 |   |
| Total operating expenses                                                              |   | 5,137,000                         |       | 1,021,000 |   |
| LOSS FROM OPERATIONS                                                                  |   | (3,711,000                        | )          | (1,021,000 | ) |
| Loss on impairment of marketable securities                                           |   | —                            |       | (5,000 | ) |
| Interest income/(expense), net                                                        |   | 39,000                            |       | 139,000 |   |
| LOSS FROM CONTINUING OPERATIONS                                                       |   | (3,672,000                        | )          | (887,000 | ) |
| Income / (Loss) from discontinued operations                                          |   | 232,000                           |       | (6,252,000 | ) |
| Gain on sale of discontinued operations                                               |   | 1,644,000                         |       | — |   |
| Total gain / (loss) from discontinued operations                                      |   | 1,876,000                         |       | (6,252,000 |   |
| NET LOSS                                                                              |   | (1,796,000                        | )          | (7,139,000 | ) |
| Preferred stock dividends                                                             |   | (827,000                          | )          | (1,168,000 | ) |
| NET LOSS APPLICABLE TO COMMON STOCKHOLDERS                                            |   | $                                 | (2,623,000 | ) | $ | (8,307,000 | ) |
|                                                                                  |   |                              |       |   |   |
| LOSS PER SHARE OF COMMON STOCK BEFORE DISCONTINUED OPERATIONS—Basic  and diluted |   | $                                 | (2.78      | ) | $ | (1.95 | ) |
| Discontinued operations                                                               |   | 1.42                              |       | (13.74 | ) |
| Preferred stock dividends                                                             |   | (.63                              | )          | (2.57 | ) |
| NET LOSS PER SHARE OF COMMON STOCK—Basic and diluted                             |   | $                                 | (1.99      | ) | $ | (18.26 | ) |
|                                                                                  |   |                              |       |   |   |   |   |
| WEIGHTED AVERAGE SHARES OUTSTANDING—Basic and diluted                            |   | 1,317,000                         |       | 455,000 |   |

 

See accompanying notes to consolidated financial statements.

 

F-5

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**SUNLANDENTERTAINMENT CO., INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’EQUITY**

**YEARS ENDED DECEMBER31, 2003 AND 2002**

 
|                              |       | **Series B Preferred** |       | **Common Stock** |       | **Additional  Paid in  Capital** |       | **Deferred  Stock  Compensation** |   | **Accumulated  Deficit** |   | **Total** |       |
|-----------------------------------|------------|------------------------|------------|------------------|------------|----------------------------------|------------|-----------------------------------|--------|--------------------------|--------|-----------|------------|
|                              | **Shares** |                   | **Amount** |             | **Shares** |                             | **Amount** |                              |   |                     |   |      |
| BALANCE,  DECEMBER 31, 2001       |       | 11,415                 |       | $                | 11,415,000 |                             | 455,000    |                              | $      | 0                        |   | $         | 26,459,000 |   | $ | 0 |   | $ | (28,766,000 | ) | $ | 9,108,000 |   |
| Stock  dividends declared         |       | 820                    |       | 820,000          |       |                             |       |                              |   |                     |   |      |       | (1,168,000 | ) | (348,000 | ) |
| Net  loss                         |       |                   |       |             |       |                             |       |                              |   |                     |   |      |       | (7,139,000 | ) | (7,139,000 | ) |
| BALANCE,  DECEMBER 31, 2002       |       | 12,235                 |       | 12,235,000       |       | 455,000                          |       | 0                                 |   | 26,459,000               |   | 0         |       | (37,073,000 | ) | 1,621,000 |   |
|                              |       |                   |       |             |       |                             |       |                              |   |                     |   |      |       |   |   |   |   |
| Stock  dividends declared         |       | 583                    |       | 583,000          |       |                             |       |                              |   |                     |   |      |       | (827,000 | ) | (244,000 | ) |
| Corporate  reorganization         |       | (12,818                | )          | (12,818,000      | )          | 2,578,000                        |       | 3,000                             |   | 15,386,000               |   |      |       |   |   | 2,571,000 |   |
| Issuance  of warrants and options |       |                   |       |             |       |                             |       |                              |   | 1,174,000                |   | (486,000  | )          |   |   | 688,000 |   |
| Net  loss                         |       |                   |       |             |       |                             |       |                              |   |                     |   |      |       | (1,796,000 | ) | (1,796,000 | ) |
| BALANCE,  DECEMBER 31, 2003       |       | 0                      |       | $                | 0          |                             | 3,033,000  |                              | $      | 3,000                    |   | $         | 43,019,000 |   | $ | (486,000 | ) | $ | (39,696,000 | ) | $ | 2,840,000 |   |

 

See accompanying notes to consolidated financial statements.

 

F-6

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**TRESTLE HOLDINGS,INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 
|                                                                                                                  |   | **Years Ended December 31** |       |
|-----------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|------------|
|                                                                                                                  |   | **2003**                    |       | **2002** |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                                                 |   |                        |       |   |   |
| Loss before discontinued operations                                                                                   |   | $                           | (3,672,000 | ) | $ | (887,000 | ) |
| Adjustments to reconcile loss before discontinued operations to net  cash provided by/(used in) operating activities: |   |                        |       |   |   |
| Depreciation and amortization                                                                                         |   | 222,000                     |       | 112,000 |   |
| Deferred stock compensation                                                                                           |   | 688,000                     |       | — |   |
| Changes in operating assets and liabilities, net of effects from  acquisition/disposition of business:                |   |                        |       |   |   |
| Marketable securities                                                                                                 |   | —                      |       | 5,000 |   |
| Accounts receivable                                                                                                   |   | (447,000                    | )          | — |   |
| Inventory                                                                                                             |   | 8,000                       |       | — |   |
| Prepaid expenses and other assets                                                                                     |   | (294,000                    | )          | 176,000 |   |
| Income taxes receivable                                                                                               |   | 7,000                       |       | 583,000 |   |
| Accounts payable and accrued expenses                                                                                 |   | (1,714,000                  | )          | (433,000 | ) |
| Deferred revenue                                                                                                      |   | (479,000                    | )          | — |   |
| Net cash provided by/(used in) continuing operations                                                                  |   | (5,681,000                  | )          | (444,000 | ) |
| Net cash provided by/(used in) discontinued operations                                                                |   | 1,099,000                   |       | 377,000 |   |
| Net cash provided by/(used in) operating activities                                                                   |   | (4,582,000                  | )          | (67,000 | ) |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                                                 |   |                        |       |   |   |
| Additions to fixed assets                                                                                             |   | (77,000                     | )          | — |   |
| Cash paid for acquisition of Trestle                                                                                  |   | (1,175,000                  | )          |   |   |
| Net proceeds from divesture of discontinued operations                                                                |   | 4,221,000                   |       | — |   |
| Net cash provided by/(used in) investing activities                                                                   |   | 2,969,000                   |       | — |   |
| NET INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS                                                                  |   | (1,613,000                  | )          | (67,000 | ) |
| CASH AND CASH EQUIVALENTS, Beginning of period                                                                        |   | 1,976,000                   |       | 2,043,000 |   |
| CASH AND CASH EQUIVALENTS, End of period                                                                              |   | $                           | 363,000    |   | $ | 1,976,000 |   |

 

See accompanying notes to consolidated financial statements 

 
|                                                   |   | **Years Ended December 31,** |   |
|--------------------------------------------------------|--------|------------------------------|--------|
|                                                   |   | **2003**                     |   | **2002** |   |
| **SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:** |   |                         |   |   |   |
| Cash received/(paid) during the period for:            |   |                         |   |   |   |
| Interest                                               |   | $                            | 39,000 |   | $ | 139,000 |   |
| Income taxes                                           |   | $                            | 75,000 |   | $ | (6,800 | ) |

 

**NON-CASH FINANCING ACTIVITY:**

 

See Notes 2 and 6 for disclosure of non-cash financing activities.

 

F-7

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**TRESTLEHOLDINGS, INC. AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**YEARS ENDED DECEMBER31, 2003 AND 2002**

 

**NOTE 1.    SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

 

***Current Operationsand Background***—TrestleHoldings (Delaware), Inc. (“Trestle Holdings” or “Company”), through itswholly owned subsidiary, Trestle Acquisition Corp. (“Trestle”), develops andsells digital imaging and telemedicine applications linking dispersed users anddata primarily in the healthcare and pharmaceutical markets.  Trestle’s digital imaging products -MedMicroä and MedScanä -provide a digital platform to share, store, and analyze tissue images.  Trestle’s MedReachäproduct provides healthcare organizations with a cost effective platform forremote examination, diagnosis, and treatment of patients.

 

OnMay 20, 2003, Trestle Holdings entered this line of business through itspurchase of substantially all of the assets of Trestle Corporation, a Delawarecorporation (“Old Trestle”), and certain assets of Med Diversified, Inc., aNevada corporation and parent corporation of Old Trestle (“Med”), and two ofMed’s non-debtor subsidiaries.  Seediscussion of the acquisition in Note 2.

 

OnAugust 29, 2003, a shareholder meeting was held where a plan was approvedto reorganize the Company.  Under thereorganization  plan, the remaining  entertainment assets of the Company weresold pursuant to terms  entered intoApril 10,  2003.  See discussion of the divestiture in Note3.  In addition,  (1) a pro rata cash  distribution  of $2,000,000 was made to the holders of the Company’s  preferred stock on or about October 3, 2003; (2) Sunland Entertainment Co., Inc. (“Sunland”) officially changed itsname to Trestle  Holdings,  Inc.; and (3) all issued and  outstanding shares of the Company’s preferred stock including the Series A that was classified as aliability at December 31, 2002 were converted into 2,578,000  shares of common stock,  giving the Company  3,033,000 shares of common stock outstanding immediatelysubsequent to the reorganization.

 

# ***GoingConcern*****— The accompanying financial statements have beenprepared assuming that the Company will continue as a going concern.  The Company has suffered recurring lossesfrom operations since its inception and has an accumulated deficit of$39,696,000at December 31, 2003.

 

Theconsolidated financial statements do not include any adjustments relating tothe recoverability and classification of recorded asset amounts or amounts andclassifications of liabilities that might be necessary should the Company beunable to continue its existence.  Therecovery of the Company’s assets is dependent upon continued operations of theCompany.

 

In addition,the Company’s recovery is dependent upon future events, the outcome of which isundetermined.  The Company intends tocontinue to attempt to raise additional capital, but there can be no certaintythat such efforts will be successful.

 

***Basis ofPresentation and Principles of Consolidation***— Theconsolidated financial statements reflect the financial position, results ofoperations and cash flows of the Company and its wholly ownedsubsidiaries.  All significantintercompany accounts and transactions have been eliminated on consolidation.

 

***Reincorporation toDelaware and Reverse Stock-Split***— On June 27,2002, a special meeting of shareholders was held at the Company’s offices,where the proposal to change Sunland’s state of incorporation from Californiato Delaware and enact a ten-for-one reverse split of the Company’s common andpreferred stock were approved.  TheCompany subsequently changed its stock symbol to SLDE effective August 9,2002.  The effect of this stock splitwas reflected in  the financialstatements retroactively as if the stock split occurred at the beginning of theearliest period reported.

 

***Use of Estimates***—Thepreparation of financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.Actual results could differ from those estimates.

 

***Cumulative Effect ofChange in Accounting Principles —***During thesecond quarter of 2002, in accordance with SFAS No. 142, the Company determinedthat its goodwill was impaired.  As aresult, a one-time, non-cash charge of $2,861,000 was recorded to write-off theremaining balance of goodwill on the Company’s balance sheet.  In accordance

 

F-8

----

 

with thetransitional guidance of  SFAS No.142,the charge is reflected in the Company’s Consolidated Statement of Operationsunder Loss from discontinued operations.

 

***Cash and CashEquivalents***— The Company considers investmentswith original maturities of 90 days or less to be cash equivalents.

 

***Fixed Assets***—Fixed assets are stated at cost and are depreciated using the straight-linemethod over their estimated useful lives, ranging from one to five years.  Leasehold improvements are amortized overthe shorter of the lease term or the estimated life of the improvement.

 

***Intangible Assets****—*In accordance with Statement of Financial Accounting Standards (“SFAS”)No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”,the Company evaluates long-lived assets, including intangible assets other thangoodwill, for impairment when indicators of impairment are present and theundiscounted cash flows estimated to be generated by those assets are less thenthe assets’ carrying amounts. Factors considered important which could triggeran impairment review include, but are not limited to, significantunderperformance relative to expected historical or projected future operatingresults, significant changes in the manner of use of the assets or the strategyfor the Company’s overall business and significant negative industry oreconomic trends. If such assets are identified to be impaired, the impairmentto be recognized is the amount by which the carrying value of the asset exceedsthe fair value of the asset.

 

***Goodwill and Other Indefinite LivedIntangibles***—**In accordance with SFAS No. 141,“Business Combinations” and SFAS No. 142, *“Goodwill and Other Intangible Assets”*,goodwill and other indefinite lived intangibles are not amortized, but aretested annually or on an interim basis if events or circumstances indicate thatthe fair value of the asset has decreased below its carrying value.

 

In 2001, the Company reduced the useful life of goodwill from ten yearsto a remaining period of three years commencing from January 2001.  The decision to reduce the useful life ongoodwill related to the PM Entertainment acquisition was made due to a change inthe Company’s business plan, resulting from a change in economic conditionsoccurring subsequent to the acquisition of PM Entertainment, not to finance newproduct and to operate as a scaled-back business focusing on sales of the PMEntertainment library.

 

During the second quarter of 2002, in accordance with SFAS No. 142, theCompany determined that its goodwill was impaired due to its continuedhistorical and forecasted future losses as a result of the changing economicconditions in the entertainment industry. As a result, a one-time, non-cash charge of $2,861,000 was recorded towrite-off the remaining balance of goodwill on the Company’s balancesheet.  In accordance with thetransitional guidance of  SFAS No.142, thecharge is reflected in the Company’s Consolidated Statement of Operations underLoss from discontinued operations.

 

***Revenue Recognition***—The Company recognizes revenues associated with the Trestle business on productsales after shipment of the product to the customer and formal acceptance bythe customer has been received.  Dependingupon the specific agreement with the customer, such acceptance normally occurssubsequent to one or more of the following events:  receipt of the product by the customer, installation of theproduct by the Company and/or training of customer personnel by theCompany.  Revenue collected in advanceof product shipment or formal acceptance by the customer is reflected asdeferred revenue.   Revenue attributableto software maintenance and support is deferred and recognized ratably over theterm of the maintenance agreement, generally one year.

 

***Research andDevelopment***— The Company charges research anddevelopment expenses to operations as incurred.

 

***Income Taxes***—TheCompany records income taxes in accordance with the provisions of SFASNo. 109, “Accounting for Income Taxes.” The standard requires, among other provisions, an asset and liabilityapproach to recognize deferred tax liabilities and assets for the expectedfuture tax consequences of temporary differences between the financialstatement carrying amounts and tax basis of assets and liabilities.  Valuation allowances are provided if, basedupon the weight of available evidence, it is more likely than not that some orall of the deferred tax assets will not be realized.

 

***Stock-Based Compensation—***Weaccount for stock-based employee compensation arrangements in accordance withthe provisions of Accounting Principles Board (“APB”) Opinion No. 25, *“Accountingfor Stock Issued to Employees,”* as amended by SFAS No. 148“Accounting for Stock-based Compensation—Transition and Disclosure” using theintrinsic value method.  Under APB No.25, compensation expense is based on the difference, if any, between the fairvalue of our stock and the exercise price on the date of the grant.

 

F-9

----

 

We account forequity instruments issued to non-employees in accordance with the provisionsSFAS No. 123 “Accounting for Stock-based Compensation” and Emerging Issues TaskForce (“EITF”) Issue No. 96-18, *“Accounting for Equity Instruments That Are Issued toOther Than Employees for Acquiring or in Conjunction With Selling Goods andServices.”*

 

***Net Income (Loss)Per Share***— The Company computes net loss pershare in accordance with SFAS No. 128, “Earnings per Share,” and Securities andExchange Commission Staff Accounting Bulletin No. 98 (“SAB 98”). Under theprovisions of SFAS No. 128 and SAB 98, basic and diluted net loss per share iscomputed by dividing the net loss available to common stockholders for theperiod by the weighted average number of shares of common stock outstandingduring the period.  Common equivalent shares related to stock options,warrants and convertible preferred stock have been excluded from thecomputation, for the years ended December 31, 2003 and 2002 because theireffect is anti-dilutive.

 

***Concentration ofCredit Risk***— Financial instruments thatpotentially subject the Company to a concentration of credit risk consist ofcash and cash equivalents and accounts receivable.  The Company maintains its cash and cash equivalents with highcredit quality financial institutions; at times, such balances with any onefinancial institution may exceed FDIC insured limits.  Concentration of credit risk associated with accounts receivableis significant due to the limited number of customers, as well as theirdispersion across geographic areas.  TheCompany performs ongoing credit evaluations of its customers and generallyrequires partial deposits.  Although theCompany has a diversified customer base, a substantial portion of its debtors’ability to honor their contracts is dependent upon financial conditions in thehealthcare industry.

 

***FinancialInstruments***—The Company’s financial instrumentsconsist of cash and cash equivalents, marketable securities classified asavailable for sale, accounts receivable, accounts payable, accrued expenses andnotes payable.  The carrying values ofcash and cash equivalents, accounts receivable, accounts payable, accruedexpenses and notes payable are representative of their fair values due to theirshort-term maturities.  Marketablesecurities classified as available for sale are stated at fair value inaccordance with SFAS No. 115, “Accounting for Certain Investments in Debtand Equity Securities.”

 

***Recently IssuedAccounting Pronouncements*****— In April 2003, theFinancial Accounting Standards Board (“FASB”) issued SFAS No. 149, “Amendmentof Statement 133 on Derivative Instruments and Hedging Activities.”  SFAS No. 149 amends and clarifies accountingand reporting for derivative instruments and hedging activities under SFAS No.133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No.149 is effective for derivative instruments and hedging activities entered intoor modified after June 30, 2003, except for certain forward purchase andsale securities.  For these forwardpurchase and sale securities, SFAS No. 149 is effective for both new andexisting securities after June 30, 2003. This statement is not applicable to the Company.

 

In May 2003, the FASB issued SFAS No. 150, “*Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity.*”  SFAS No. 150establishes standards for how an issuer classifies and measures in itsstatement of financial position certain financial instruments withcharacteristics of both liabilities and equity.  In accordance with the standard, financial instruments thatembody obligations for the issuer are required to be classified as liabilities.  SFAS No. 150 will be effective for financialinstruments entered into or modified after May 31, 2003 and otherwise willbe effective at the beginning of the first interim period beginning afterJune 15, 2003.  This statement isnot applicable to the Company.

 

**NOTE 2 – ACQUISITION OF TRESTLE**

 

On May 20, 2003, the Company, by and through its wholly-ownedsubsidiary, Trestle Acquisition Corp., purchased substantially all of theassets of Old Trestle and certain assets of Med and two of Med’s non-debtorsubsidiaries (together with Old Trestle and Med, the “Sellers”).  Old Trestle’s business was historically inthe telepathology and telemedicine industries. Under the terms of the acquisition, we, through our wholly-ownedsubsidiary, paid the Sellers $1,250,000 in cash, $100,000 of which waspreviously deposited in escrow as an earnest money deposit, and assumed certainliabilities of Old Trestle. Additionally, as additional compensation for their respective consultingservices, we issued to a director, and one of our former Co-Presidents,warrants to purchase a number of shares of our Common Stock equal to 2.5% and1%, respectively, of our issued and outstanding Common Stock each at anexercise price of $1.00 per share. These warrants are subject to anti-dilution provisions relating to theCorporate Reorganization.  This formerCo-President also received a lump sum payment of $50,000 on the close of thistransaction.  In addition, the Companyentered into employment agreements with Old Trestle’s President and its ChiefScience Officer each for terms of three years at a salary of $200,000 peryear.  Under these employment agreementsthe executives are entitled to bonuses under certain performance criteria andwere granted stock options equal to five percent of the fully diluted outstandingshares of the Company’s common stock on the

 

F-10

----

 

date of grant.

 

The total purchase price as allocated to assets and liabilities wasbased upon estimated fair market values obtained through an independentvaluation.  This allocation included therecording of approximately $742,000 to identifiable intangible assets(including $342,000 to purchased technology to be amortized over 3 years,$150,000 to trademarks to be amortized over 3 years, and $250,000 to customerlist to be amortized over 3 years) and $1,514,000 to goodwill.

 

A condensed, audited balance sheet reflecting the acquired assets andliabilities assumed as of the date of acquisition of the net assets of OldTrestle was as follows:

 
| Cash                |   | $         | 123,000   |   |
|---------------------|--------|-----------|-----------|--------|
| Accounts receivable |   | 51,000    |      |
| Inventory           |   | 224,000   |      |
| Prepaids and other  |   | 39,000    |      |
| Fixed assets        |   | 78,000    |      |
|                |   |      |      |
| Total assets        |   | $         | 515,000   |   |
|                |   |      |      |
| Accounts payable    |   | $         | 181,000   |   |
| Accrued expenses    |   | 227,000   |      |
| Deferred revenue    |   | 1,032,000 |      |
|                |   |      |      |
| Total liabilities   |   | $         | 1,440,000 |   |

 

Thefollowing summarized unaudited pro forma consolidated results of operationsreflect the effect of the Old Trestle acquisition as if it had occurred at thebeginning of the period presented. The unaudited pro forma consolidated resultsof operations presented below are not necessarily indicative of operatingresults which would have been achieved had the acquisition been consummated asof the beginning of the periods presented and should not be construed asrepresentative of future operations:

 
|               |   | **Year ended December 31,** |      |
|--------------------|--------|-----------------------------|-----------|
|               |   | **2003**                    |      | **2002** |   |
| Revenues           |   | $                           | 5,799,000 |   | $ | 1,880,000 |   |
| Cost of Sales      |   | 2,180,000                   |      | 893,000 |   |
| Gross Profit       |   | 3,619,000                   |      | 987,000 |   |
| Operating Expenses |   | 7,355,000                   |      | 9,629,000 |   |
| Operating Loss     |   | $                           | 3,736,000 |   | $ | 8,642,000 |   |

 

**NOTE 3 - DISCONTINUED OPERATIONS**

 

On September 4, 2003, the Company closed the previously  reported sale of its remaining  entertainment assets to Echo Bridge, LLC,formerly known as Film Library Acquisition Corp., (the “Purchaser”),  in exchange for the assumption of certainrelated  liabilities of the Company bythe Purchaser and a purchase price of approximately  $4,750,000.  Of this amount,  $750,000 was deposited in escrow for a period of two years following the  closing  of the transaction, subject  to  potential claims  by the  Purchaser against  us for  breaches of representations  andwarranties  contained in theagreement.  The purchase price wasdetermined by arms-length negotiation, and the Company recognized a gain on thesale of $1,644,000 during the year ended December 31, 2003.  Included in the income/(loss) fromdiscontinued operations for the years ended December 31, 2003 and 2002, arerevenues of $1,839,000 and $1,119,000, respectively, and income/(loss) fromdiscontinued operations of $232,000 and $(3,199,000), respectively.

 

**NOTE 4 - INVENTORY**

 

Inventoriesare stated at the lower of cost (first-in, first-out) or market and consist ofthe following at December 31, 2003 and 2002:

 

F-11

----

 
|            |   | **Years Ended December 31,** |    |
|-----------------|--------|------------------------------|---------|
|            |   | **2003**                     |    | **2002** |   |
| Work-in-process |   | $                            | 104,000 |   | $ | 0 |   |
| Finished goods  |   | 119,000                      |    | 0 |   |
| Total           |   | $                            | 223,000 |   | $ | 0 |   |

 

**NOTE 5 - FIXED ASSETS**

 

Fixed assets arecomprised of the following December 31, 2003 and 2002.

 
|                              |   | **Years Ended December 31,** |    |
|-----------------------------------|--------|------------------------------|---------|
|                              |   | **2003**                     |    | **2002** |   |
| Furniture, fixtures and equipment |   | $                            | 858,000 |   | $ | 715,000 |   |
| Leasehold improvements            |   | 477,000                      |    | 477,000 |   |
|                              |   | 1,335,000                    |    | 1,192,000 |   |
| Less accumulated depreciation     |   | (1,170,000                   | )       | (1,106,000 | ) |
| Total                             |   | $                            | 165,000 |   | $ | 86,000 |   |

 

**NOTE 6 - INTANGIBLE ASSETS**

 

Intangible assets are comprised of the following at December 31, 2003and 2002.

 
|                          |   | **Years Ended December 31,** |    |
|-------------------------------|--------|------------------------------|---------|
|                          |   | **2003**                     |    | **2002** |   |
| Intangible assets             |   | $                            | 742,000 |   | $ | — |   |
| Less accumulated amortization |   | (158,000                     | )       | — |   |
| Net intangible assets         |   | $                            | 584,000 |   | $ | — |   |

 

The estimatedamortization on these intangible assets for the years ended December 31, 2004,2005 and 2006 will be $247,000, $247,000 and $90,000.

 

**NOTE 7 - INCOME TAX**

 

The income tax (benefit)expense for the years ended December 31, 2003 and 2002 consist of the following:

 
|                       |   | **Years Ended December 31,** |   |
|----------------------------|--------|------------------------------|--------|
|                       |   | **2003**                     |   | **2002** |   |
| Current                    |   | $                            | — |   | $ | — |   |
| Deferred                   |   | 611,000                      |   | 2,427,000 |   |
| Valuation allowance        |   | (611,000                     | )      | (2,427,000 | ) |
| Provision for income taxes |   | $                            | — |   | $ | — |   |

 

Income tax (benefit)expense computed at the statutory federal income tax rate of 34% and theprovision for income tax (benefit) expense in the financial statements for theyears ended December 31, 2003 and 2002 differ as follows:

 
|                                     |   | **Years Ended December 31,** |     |
|------------------------------------------|--------|------------------------------|----------|
|                                     |   | **2003**                     |     | **2002** |   |
| Provision computed at the statutory rate |   | $                            | (611,000 | ) | $ | (2,427,000 | ) |
| Change in valuation allowance            |   | 611,000                      |     | 2,427,000 |   |
| Income tax provision (benefit)           |   | $                            | —   |   | $ | — |   |

 

F-12

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The following are the components of the Company’sdeferred tax assets and (liabilities) at December 31, 2003 and 2002:

 
|                                    |   | **Years Ended December 31,** |        |
|-----------------------------------------|--------|------------------------------|-------------|
|                                    |   | **2003**                     |        | **2002** |   |
| Federal net operating loss carryforward |   | $                            | 7,815,000   |   | $ | 6,622,000 |   |
| State net operating loss carryforward   |   | 1,370,000                    |        | 1,229,000 |   |
| Accounts receivable                     |   | 152,000                      |        | 341,000 |   |
| Equity based charges                    |   | 725,000                      |        | 457,000 |   |
| Capital loss carryforward               |   | 2,328,000                    |        | 2,328,000 |   |
| Film inventory                          |   | —                       |        | 1,453,000 |   |
| Goodwill                                |   | —                       |        | 1,024,000 |   |
|                                    |   |                         |        |   |   |
| Total deferred tax asset                |   | 12,390,000                   |        | 13,454,000 |   |
|                                    |   |                         |        |   |   |
| Film rights                             |   | —                       |        | (1,687,000 | ) |
| Goodwill                                |   | (12,000                      | )           | — |   |
| Deferred state taxes                    |   | (498,000                     | )           | (498,000 | ) |
|                                    |   |                         |        |   |   |
| Total deferred tax liability            |   | (510,000                     | )           | (2,185,000 | ) |
|                                    |   |                         |        |   |   |
| Valuation allowance                     |   | $                            | (11,880,000 | ) | $ | (11,269,000 | ) |
|                                    |   |                         |        |   |   |
| Net deferred tax asset/(liability)      |   | $                            | —      |   | $ | — |   |

 

*AtDecember 31, 2003, the Company has a net operating loss carryforward ofapproximately $23,000,000 and $16,200,000 for federal and state income taxpurposes, respectively. These net operating loss carryforwards begin to expirein 2018 and 2003, respectively. The net operating losses can be carried forwardto offset future taxable income, if any. Realization of the above carryforwards may be subject to utilizationlimitations, which may inhibit the Company’s ability to use these carryforwardsin the future.*

 

**NOTE 8 – PREFERRED STOCK**

 

On September 4, 2003, the Company restructured the Company’s capitalstructure.  Under the restructuring, (1)a cash  distribution  of $2,000,000 was made to the holders’ ofthe Company’s  Preferred  Stock; (2) Sunland officially changed its name to Trestle  Holdings, Inc.; and (3) all issued and outstanding  shares of theCompany’s preferred stock including the Series A that was classified as aliability at December 31, 2002 were converted into 2,578,000 shares of commonstock,  giving the Company  3,033,000 shares of common stock outstandingimmediately subsequent to the reorganization.

 

In April 1993, the Company authorized 300,000 shares ofconvertible preferred stock and in April and September 1999 designated30,000 shares as Series A Preferred Stock.  As part of a refinancing that occurred in 1999, the Companyissued 19,049 shares of Series A Preferred Stock.

 

The Company recorded a deduction for the beneficial conversion featureassociated with the issuance of Series A Preferred Stock based on the fairvalue of the underlying common stock at the date of issuance. The deduction wasrecorded ratably over a six-month period from April 1999 toOctober 1999, during which Series A Preferred Stock could not beconverted into the Company’s common stock.

 

The Series A Preferred Stock is presented as a liability inaccordance SFAS No. 150, on the Company’s balance sheet, and is not included instockholders’ equity, since, under certain circumstances beyond the control ofthe Company, the holders of Series A Preferred Stock may redeem the sharesin consideration for cash.  In order toincrease stockholders’ equity, in May 2000, the Company allowed holders ofSeries A Preferred Stock to exchange a portion of their shares for an equivalentnumber of shares of Series B Convertible Preferred Stock.  As described more fully in Note 9,Series B Preferred Stock has substantially similar characteristics tothose of Series A Preferred Stock, but is classified as permanentequity.  In May 2000, 8,460 sharesof Series A Preferred Stock were exchanged for an equivalent number ofSeries B Preferred shares.  In May2001, approximately 7,500 shares of Series A Convertible Preferred Stockwere exchanged for Series B Convertible Preferred Stock.  In July 2001, the Company purchased550 shares of Series A Preferred Stock from an affiliate of a companyowned by a preferred shareholder, who is also a director of the Company.

 

The Series A Preferred Stock has the following characteristics:

 

* Voting:*   Theholders of Series A Preferred Stock are entitled to elect two directors tothe Company’s Board of Directors and are entitled to the number of votes equalto the number of shares of common stock into which the Series A PreferredStock is then convertible.  On all othermatters, including the election of the other Company directors, holders of

 

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theSeries A Preferred Stock vote (on an as-converted basis) together withcommon stockholders and holders of Series B Preferred Stock (voting in anas-converted basis) as one class.

 

*Dividends:*   Theholders of the convertible preferred stock were entitled to receive dividendsequal to $70 per share per annum paid quarterly.

 

* LiquidationPreference:*   In the event of anyliquidation, dissolution or winding up of the affairs of the Company, theholders of the Company’s outstanding Series A Preferred Stock shallreceive for each share an amount equal to the sum of $1,000 per share,respectively, payable in preference and priority to any payments made to theholders of the then outstanding common stock.

 

Liquidation is deemed to include the Company’s sale of all orsubstantially all of its assets or the acquisition of the Company by anotherentity by means of merger or consolidation resulting from the transfer of 50%or more of the Company’s voting power.

 

Additionally, the Company may redeem, at its liquidation amount,Series A Preferred Stock five years following the date the shares wereissued.

 

*Conversion:*   Eachshare of Series A Preferred Stock, at the option of the holder, wasconvertible at any time into a number of shares of common stock as determinedby dividing the Original Issue Price of Series A Preferred Stock by theConversion Price, as defined, in effect at the time.

 

In May 2000, the Company designated 30,000 shares of authorizedPreferred Stock as Series B Preferred Stock.  The Company issued 8,460 shares of Series B Preferred Stockin exchange for an equivalent number of shares of Series A PreferredStock.

 

The Series B Preferred Stock has substantially similarcharacteristics to those of Series A Preferred Stock.  The liquidation provisions of Series BPreferred Stock differ from those of Series A Preferred Stock in that aliquidation event is not deemed to include the Company’s sale of all orsubstantially all of its assets or the acquisition of the Company by anotherentity by means of merger or consolidation resulting from the transfer of 50%or more of the Company’s voting power. At December 31, 2002, the Series B Preferred Stock wasconvertible into 181,000 shares of the Company’s common stock.

 

**NOTE 9 - STOCKHOLDERS’ EQUITY**

 

**Warrants**

 

During the year ended December 31, 2003, the Company issued 821,520warrants to management, board members and consultants.  The weightedaverage exercise price of the grants during the year ending December 31, 2003was $1.28. The vesting periods on these grants range from immediate to 3 years,and the lives range from 4 to 10 years.  To account for such grants tonon-employees, we recorded deferred stock compensation of $1,066,000, andrecognized compensation expense of $580,000 for the year ended December 31,2003.

 

As partial consideration for entering into a revolving credit facilityduring the year ended December 31, 2000, the Company granted warrants to a bankto purchase 12,600 shares of common stock at $67.50 per share, of which 12,600were outstanding at December 31, 2003. These warrants, which had a fair valueof $320,000 at the date of grant, are fully vested and expire ten years fromtheir issuance date.  The Companyrecorded the fair value of these warrants as deferred financing costs to beexpensed on a straight-line basis over the terms of the related revolvingcredit facility.

 

As part of the 1999 Refinancing, the Company granted warrants topurchase 134,462 shares of common stock at prices ranging between $90 to $120per share, of which 95,821 were outstanding at December 31, 2003. The warrantshad a fair value of $2,360,000 at the date of grant, are fully vested andexpire six to eight years from their issuance date.

 

As a result of the refinancing that took place in 1999, the Companygranted warrants, not covered by the Plans described above, to purchase 134,462shares of common stock to certain employees, officers and directors of which127,212 were outstanding at December 31, 2003. These warrants vest either onthe grant date or over three years from the grant date. The options areexercisable at prices ranging from $90 to $120 per share and expire six toeight years from their issuance date.

 

F-14

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**NOTE 10 - COMMITMENTS AND CONTINGENCIES**

 

***Leases***—TheCompany leases office space and office equipment under operating leasesexpiring through 2006. Future minimum lease payments due under non-cancelableoperating leases at December 31, 2003 are as follows:

 

 
|                         |   | **Years Ended December 31,** |      |
|------------------------------|--------|------------------------------|-----------|
| 2004                         |   | $                            | 690,000   |   |
| 2005                         |   | 489,000                      |      |
| 2006                         |   | 505,000                      |      |
| Total minimum lease payments |   | $                            | 1,684,000 |   |

 

The Company has entered into certain sublease arrangements for leasedoffice space no longer occupied. The term of the sublease expires in July**2004.

 

Rent expense charged to operations for the years ended December 31,2003 and 2002 was $859,000 and $905,000. Rent income from sublease arrangementsfor the years ended December 31, 2003 and 2002 was $464,000 and $469,000.Future minimum rental income under sublease arrangements is $267,000 for thefiscal year 2004*.*

 

***Litigation***—The Company is party to legal proceedings, which are routine and incidental tothe business. The Company believes the results of such litigation will not havea material adverse effect on the Company’s financial condition or results ofoperations.

 

***Employment Agreement***—   As discussed in Note 2, the Companyentered into employment agreements with Old Trestle’s President and its ChiefScience Officer each for terms of three years at a salary of $200,000 peryear.  In addition, under theseemployment agreements the executives are entitled to bonuses under certainperformance criteria and were granted stock options equal to five percent ofthe fully diluted outstanding shares of the Company’s common stock on the dateof grant.  The President resigned hisemployment with the Company effective October 31, 2003, and was given a 12month consulting agreement and 50,000 warrants exercisable at $0.51 per share.

 

The Company entered into an employment agreement with Roger A. Burlage,dated April 7, 1999 which provides that he would serve as the Company’sChairman and Chief Executive for a term of four years.  Mr. Burlage was entitled to an annualsalary of $500,000, with minimum annual increases of 7.5%.  Mr. Burlage was also eligible toreceive a discretionary bonus as determined by the Board.  As part of the agreement, Mr. Burlagewas granted warrants to purchase 40,000 shares of the Company’s Common Stock atexercise prices ranging from $90.00 to $120.00 per share, and was to receive upto an additional 20,000 warrants at his election under certain circumstanceswithin one year of the effective date of his employment agreement which did notoccur.  One half of the originalwarrants vested upon Mr. Burlage signing the agreement and the balancevest over a three-year period, with 25% vesting on the first anniversary, and12.5% vesting on each of the second and third anniversaries of theagreement.  Mr. Burlage was alsoentitled to be reimbursed for up to $7,500 per year for country club dues, andto receive all other benefits generally available to the Company’s other officers,including participation in stock incentive, retirement, medical, dental andaccidental benefit plans, life and disability insurance and vacation.  If Mr. Burlage’s position waseliminated as a result of a merger or consolidation of the Company, Mr. Burlagewould be entitled to terminate his employment within three months of such eventand to receive all salary, benefits and emoluments in effect as such datethrough the remainder of his four-year term.  In January of 2003, Mr. Burlage notified the Board of Directors that heintended to resign from his position at the expiration of his contract in Aprilof 2003.  On January 15, 2003, the Boardof Directors authorized the creation of the Office of the President to providefor a smooth transition during the remainder of Mr. Burlage’s employment term.Mr. Burlage’s employment agreement ended in April 2003.

 

**NOTE 11 - STOCK OPTION PLANS**

 

***Stock Option Plans***— The Company’s employee stock option plans (the “Plans”) provide for the grantof non-statutory or incentive stock options to the Company’s employees,officers, directors or consultants.

 

The Compensation Committee of the Company’s Board of Directorsadministers the Plans, selects the individuals to whom options will be granted,determines the number of options to be granted, and the term and exercise priceof each option. Stock options granted pursuant to the terms of the Plansgenerally cannot be granted with an exercise price of less than 100% of thefair market value on the date of the grant. The term of the options granted under the Plans cannot be

 

F-15

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greater than10 years.  Options vest at varyingrates generally over three to five years. An aggregate of 855,000 shares werereserved under the Plans, of which 462,000 shares were available for futuregrant at December 31, 2003.

 

The following tablesummarizes activity in the Company’s stock option plans during the years endedDecember 31, 2003 and 2002:

 
|                         |   | **Number of  Shares** |   | **Weighted  Average Price  Per Share** |   |
|------------------------------|--------|-----------------------|--------|----------------------------------------|--------|
| Balance, December 31, 2001   |   | 172,000               |   | $                                      | 96.10  |   |
| Canceled                     |   | (9,000                | )      | 8.00                                   |   |
|                         |   |                  |   |                                   |   |
| Balance at December 31, 2002 |   | 163,000               |   | $                                      | 101.02 |   |
| Granted                      |   | 643,000               |   | 1.74                                   |   |
| Expired                      |   | (150,000              | )      | 102.31                                 |   |
| Canceled                     |   | (263,000              | )      | .54                                    |   |
|                         |   |                  |   |                                   |   |
| Balance at December 31, 2003 |   | 393,000               |   | $                                      | 3.48   |   |

 

The following summarizespricing and term information for options issued to employees and directorswhich are outstanding as of December 31, 2003:

 
|                         |                    | **Options Outstanding**                        |    | **Options Exercisable**                             |   |
|------------------------------|-------------------------|------------------------------------------------|---------|-----------------------------------------------------|--------|
| **Range of Exercise Prices** |                    | **Number  Outstanding  at December  31, 2003** |    | **Weighted  Average  Remaining  Contractual  Life** |   | **Weighted  Average  Exercise  Price** |   | **Number  Exercisable  at December  31, 2003** |   | **Weighted  Average  Exercise  Price** |   |
|                         |                    |                                           |    |                                                |   |   |   |   |   |   |   |
| $                            | 0.50 - 1.00             |                                           | 320,000 |                                                | 9.67   |   | $ | 0.55 |   | 133,000 |   | $ | 0.62 |   |
|                         | 1.01 - 10.00            |                                           | 60,000  |                                                | 10.00  |   | 5.00 |   | 0 |   | 0 |   |
|                         | 45.00 -  50.00          |                                           | 1,000   |                                                | 6.42   |   | 45.00 |   | 1,000 |   | 45.00 |   |
|                         | 65.00 -  72.50          |                                           | 11,000  |                                                | 5.80   |   | 67.45 |   | 11,000 |   | 67.45 |   |
|                         | 105.00                  |                                           | 1,000   |                                                | 4.42   |   | 105.00 |   | 1,000 |   | 105.00 |   |
| $                            | 0.50 - 105.00 |                                           | 393,000 |                                                | 9.59   |   | $ | 3.48 |   | 146,000 |   | $ | 6.68 |   |

 

The Company recorded compensation expense of $89,000 for the year endedDecember 31, 2003 related to the stock option grants discussed above.  The following table illustrates what theCompany’s loss would have been if the Black-Scholes option-pricing method hadbeen used to calculate employee compensation expense.

* *
|                                                                                                                                 |   | **Year Ended  December 31,** |       |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|------------|
|                                                                                                                                 |   | **2003**                     |       |
| Net loss                                                                                                                             |   |                         |       |
| As reported                                                                                                                          |   | $                            | (2,623,000 | ) |
| Total stock-based employee compensation expense determined under fair  value based method for all awards, net of related tax effects |   | (199,000                     | )          |
| Pro forma                                                                                                                            |   | $                            | (2,822,000 | ) |
| Loss per share                                                                                                                       |   |                         |       |
| Basic and diluted EPS as reported                                                                                                    |   | $                            | (1.99      | ) |
| Pro forma basic and diluted EPS                                                                                                      |   | $                            | (2.14      | ) |

 

For the year ended December 31, 2002 the Company’s net loss and lossper share would not have been materially different than currently reported inthe Company’s Consolidated Statements of Operations.

 

F-16

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The fair value of option grants is estimated on the date of grantutilizing the Black-Scholes option-pricing model with the following weightedaverage assumptions for grants during the year ended December 31, 2003:expected life of option 6.67 years, expected volatility of 288%, risk freeinterest rate of 4.75% based upon the date of grant and a 0% dividend yield.The fair value, at date of grant, using these assumptions range from $0.42 to$2.45, and the weighted average was $1.01.

 

**NOTE 12 - EARNINGS PER SHARE**

 

The following table sets forth common stock equivalents (potentialcommon stock) for the years ended December 31, 2003 and 2002 that are notincluded in the loss per share calculation above because their effect would beanti-dilutive for the periods indicated:

 
|                                       |   | **Year Ended December 31,** |   |
|--------------------------------------------|--------|-----------------------------|--------|
|                                       |   | **2003**                    |   | **2002** |   |
| Weighted average common stock equivalents: |   |                        |   |   |   |
| Series A Preferred Stock                   |   | 0                           |   | 77,000 |   |
| Series B Preferred Stock                   |   | 0                           |   | 181,000 |   |
| Stock options                              |   | 393,000                     |   | 163,000 |   |
| Warrants                                   |   | 1,057,000                   |   | 138,000 |   |

 

**NOTE 13 - CONCENTRATION OF CREDIT RISK**

 

Although we are directly affected by the economic well being ofsignificant customers listed in the following paragraph, we do not believe thatsignificant credit risk exists at December 31, 2003. We perform ongoingevaluations of our customers and require letters of credit or other collateralarrangements as appropriate. Accordingly, trade receivable credit losses havenot been significant.

 

The Company had three customers that accounted for 16%, 13%, and 12% ofthe Company’s revenues for the year ended December 31, 2003.  As of December 31, 2003, the accountsreceivable for these customers as a percentage of the Company’s total accountsreceivable was 0%, 11%, and 0% of respectively.

 

**NOTE 14 - MARKETABLE SECURITIES**

 

During 2000, the Company received approximately 68,000 commonshares of Tutornet.com, Inc. (“Tutornet”) with a fair value of $500,000 for thelicensing of certain character rights for use on Tutornet’s website.  During 2001, the market value of thesecurities was approximately $26,000 and a loss impairment of $474,000 wastaken as the reduction in value was not deemed temporary. During 2002, thevalue of the stock decreased further, resulting in the Company writing off theremaining $26,000.

 

**NOTE 15 - RELATED PARTIES**

 

Inconnection with the acquisition of PM Entertainment in April 2000, the Companyentered into a 2-year lease agreement for the use of the business’s principaloffices.  The Company entered into thislease with an entity owned by stockholders of the Company, who were also theformer sole shareholders of PM Entertainment. The lease was classified as anoperating lease, and expired on March 31, 2002. Rent expense under theoperating lease in 2002 was $150,000.

 

**NOTE16 - SUBSEQUENT EVENT**

 

On March 3,2004, the Company entered into a bridge financing agreement to meet Short-termoperating cash needs.  Under thisagreement, $420,000 was exchanged for a convertible promissory note, which issecured by all the assets of the Company, and a warrant to purchase 9,300shares of common stock.  The Company mayconvert this note if the Company receives financing of at least $1,000,000 froma stock issuance at the per share price of the next financing.  The note earns interest at 10% and maturesin six months.  The warrants have anexercise price of $4.40 and expire in five years.

 

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