##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





Form 10-K


|           |  |                                                                                             
|---------- |  | --------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                             
|þ          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934    
|          
|           |  | For the fiscal year ended December 31, 2004                                                 
|          
|or        
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934
|          
|           |  | For the transition period
    from          to          .                                   

Commission File Number 0-26660





ESS Technology, Inc.


(Exact name of Registrant as specified in its charter)


|                                                                   |  |                                         
|------------------------------------------------------------------ |  | ----------------------------------------
|California                                                         |  | 94-2928582                              
|(State or other jurisdiction of
    incorporation or organization) |  | (I.R.S. Employer
    Identification No.)
|                                                                  
|48401 Fremont Blvd., Fremont, California                           |  | 94538                                   
|(Address of principal executive offices)                           |  | (Zip Code)                              

Registrants telephone number, including area code:


(510) 492-1088


Securities registered pursuant to Section 12(b) of the
Act:


None


Securities registered pursuant to Section 12(g) of the
Act:


Common Stock, no par value


(Title of Class)


þ o


o


þ o






DOCUMENTS INCORPORATED BY REFERENCE












---










ESS TECHNOLOGY, INC.


2004 FORM 10-K


TABLE OF CONTENTS


|              |  |                                                                                                                          |    |      |    | 
|------------- |  | ------------------------------------------------------------------------------------------------------------------------ | -- | ---- | -- | 
|              |  |                                                                                                                          |    | Page |   
|              |  |                                                                                                                          |    |      |   
|PART I       
|Item 1.       |  | Business                                                                                                                 |    |      | 1  | 
|Item 2.       |  | Properties                                                                                                               |    |      | 11 | 
|Item 3.       |  | Legal Proceedings                                                                                                        |    |      | 12 | 
|Item 4.       |  | Submission of Matters to a Vote of Security
    Holders                                                                  |    |      | 13 | 
|             
|PART II      
|Item 5.       |  | Market for the Registrants Common
    Equity, Related Shareholder Matters and Issuer Purchases of
    Equity Securities |    |      | 14 | 
|Item 6.       |  | Selected Financial Data                                                                                                  |    |      | 15 | 
|Item 7.       |  | Managements Discussion and Analysis
    of Financial Condition and Results of Operations                                |    |      | 16 | 
|Item 7A.      |  | Quantitative and Qualitative Disclosures
    about Market Risk                                                           |    |      | 38 | 
|Item 8.       |  | Financial Statements and Supplementary
    Data                                                                          |    |      | 40 | 
|Item 9.       |  | Changes in and Disagreements with
    Accountants on Accounting and Financial Disclosure                                 |    |      | 78 | 
|Item 9A.      |  | Controls and Procedures                                                                                                  |    |      | 78 | 
|Item 9B.      |  | Other Information                                                                                                        |    |      | 78 | 
|             
|PART III     
|Item 10.      |  | Directors and Executive Officers of the
    Registrant                                                                   |    |      | 78 | 
|Item 11.      |  | Executive Compensation                                                                                                   |    |      | 79 | 
|Item 12.      |  | Security Ownership of Certain Beneficial
    Owners and Management                                                       |    |      | 79 | 
|Item 13.      |  | Certain Relationships and Related
    Transactions                                                                       |    |      | 79 | 
|Item 14.      |  | Principal Accountant Fees and Services                                                                                   |    |      | 79 | 
|             
|PART IV      
|Item 15.      |  | Exhibits and Financial Statement
    Schedules                                                                           |    |      | 80 | 
|Signatures    |  |                                                                                                                          | 81 |     
|EXHIBIT 10.29
|EXHIBIT 10.30
|EXHIBIT 11   
|EXHIBIT 21   
|EXHIBIT 23   
|EXHIBIT 31.1 
|EXHIBIT 31.2 
|EXHIBIT 32.1 
|EXHIBIT 32.2 



Certain information contained in or incorporated by reference
in this Report contains forward-looking statements that involve
risks and uncertainties. The statements contained in this Report
that are not purely historical are forward-looking statements
within the meaning of Section 27A of the Securities Act of
1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended, including statements regarding
our expectations, beliefs, intentions or strategies regarding
the future. All forward-looking statements included in this
Report are based on information available to us on the date
hereof, and we assume no obligation to update any such
forward-looking statements. Our actual results could differ
materially from those discussed herein. Factors that could cause
or contribute to such differences include, but are not limited
to, those discussed in Factors That May Affect Future
Results, in the section captioned Item 7,
Managements Discussion and Analysis of Financial Condition
and Results of Operations and elsewhere in this Report.
References herein to ESS, the Company,
we, our, us and similar
words or phrases are references to ESS Technology, Inc. and its
subsidiaries, unless the context otherwise requires. Unless
otherwise provided in this Report, trademarks identified
by-Registered Trademark- and -TM- are registered trademarks or
trademarks, respectively, of ESS Technology, Inc. or its
subsidiaries. All other trademarks are the properties of their
respective owners.


i



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PART I







|        |         
|------- | --------
|Item 1. | Business







Industry Background






1



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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | DVD Players. DVD players provide significantly higher
    quality playback than is possible with VCR or VCD technology
    through the use of Motion Picture Experts Group
    (MPEG) 2 and MPEG4 video decoding and high quality
    digital audio technologies.                                                                                                                                                                                                                                                                                                                                                          
|
| |  | Video CD (VCD) Players. VCD players are music
    CD players that have been modified to display video on a
    television and typically sell for less than a low end VCR. VCD
    offers quality comparable to VCR, but is limited to
    approximately 73 minutes of video information, using an MPEG1
    format standard for compression. The VCD market is divided into
    the standard VCD market, and the subsequently developed super
    VCD (SVCD) market. VCD is popular in many developing
    countries while SVCD is almost exclusively sold in China.                                                     
|
| |  | Digital Set-Top Boxes (STBs). Digital STBs
    enable subscriber-based television through cable, terrestrial
    broadcast, digital subscriber line, or DSL, and satellite
    transmissions.                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| |  | Digital Video Recorders (DVRs). DVRs provide
    local hard disk memory storage and enable storage and playback
    of live video streams on a real-time basis. DVRs can be in the
    form of standalone players or be incorporated into digital STBs
    to enhance their functionality.                                                                                                                                                                                                                                                                                                                                 
|
| |  | Recordable DVD Players. Recordable DVD players add high
    quality video and audio recording capabilities to the DVD disc
    through the addition of a writable optical drive.                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| |  | Consumer Digital Audio Players. Consumer digital audio
    players include multi-channel surround sound products with movie
    theater quality sound systems. Our chips incorporate this
    digital audio processor as components of a home entertainment
    system.                                                                                                                                                                                                                                                                                                                                                      
|
| |  | Digital Amplifiers. Consumer video and audio players
    require an amplifier to boost the sound signal to drive
    loudspeakers in automobiles, homes and mobile devices. Our chips
    convert the digital sound into Pulse Width Modulation
    (PWM) digital pulses enabling them to be directly
    and digitally amplified without sacrificing sound quality while
    drastically reducing size and power requirements. Our digital
    amplifier chips interface directly with digital audio sources
    such as DVD and CD players, surround sound systems, audio
    receivers, boom boxes and televisions sets.
|
| |  | Camera Enabled Cellular Phones. Camera enabled cellular
    phones use a lens module made up of a lens, CMOS image sensor,
    housing and flex cable to enable cellular phones to have image
    capture and processor capabilities and display those images on
    the cell phone display or transmit them to someone else. Camera
    enabled cell phones may use either a stand-alone image processor
    chip or a broadband processor chip to process the image.                                                                                                                                                       



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Our Solution












| |   |                                                                                                                                                                                                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Our highly programmable chips offer a flexible architecture,
    allowing us to efficiently add new capabilities that address
    advances in entertainment technologies and enable our customers
    to accelerate their time to market;                                              
|
| |  | Our digital processor chips offer a broad array of advanced
    features and functionality;                                                                                                                                                                                            
|
| |  | Our MPEG2 and MPEG4 encoder chips offer very high video and
    audio recording quality for DVR, recordable DVD, and SD
    camcorder products;                                                                                                                                        
|
| |  | Our image sensor chips have a CMOS process and architecture that
    enable low light sensitivity at small lens sizes;                                                                                                                                                                 
|
| |  | Our large workforce of engineers (over 50% of our employees),
    together with our team of over 100 sales and support personnel
    worldwide, are continually developing sophisticated solutions
    and enhancing feature sets custom tailored to our
    customers evolving needs;
|
| |  | We work closely with our customers to develop cost-effective
    design solutions incorporating our high-functionality chips that
    enable our customers to lower their total manufacturing cost;                                                                                    
|
| |  | We work closely with our suppliers to improve yields, ensure
    capacity and strengthen supply chain reliability, thereby
    continuously reducing the manufacturing cost of our products and
    improving the quality and reliability of our products; and                         

3



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| |   |                                                                                                                                                                       
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Our longstanding strategic relationships in China position us to
    capture additional business as consumer electronics
    manufacturing continues to grow in China.

Our Strategy




Leverage Our Proprietary Technology.




| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Multiple Processors. We believe our design approach of
    using multiple processors allows us to provide efficient,
    cost-effective solutions for our customers. We believe this
    design approach will allow us to develop digital entertainment
    processors that integrate multiple functions on a single chip in
    order to reduce cost and time-to- market while producing smaller
    products with reduced power consumptions.                                                                                                                                                                                                                                                                                                     
|
| |  | Highly Programmable Chips. Our highly programmable chips
    enable us to add or modify features more quickly than
    competitors whose chips are less programmable. In the past we
    have successfully added significant features such as MP3 and
    Kodak picture CD capabilities through software enhancements
    without the need for hardware redesign and refabrication. This
    programmability also enables us to tailor our chips to meet our
    customers specific needs by making minor modifications
    that allow our customers to enhance features and improve
    time-to-market with new products.                                                                                                                         
|
| |  | Continuously Introduce New Products and Features To Drive
    Growth. We focus our research and development efforts on
    products and features we believe are going to drive demand in
    the marketplace for consumer electronic entertainment products.
    We work closely with our various Original Design Manufacturers
    (ODMs) and Original Equipment Manufacturers
    (OEMs) customers to identify those products and
    features.                                                                                                                                                                                                                                                                                               
|
| |  | Single Chip DVD Decoder Solution. We are continuing to
    integrate DVD functionality, enhance the feature set and reduce
    the cost of our single-chip DVD player solution that integrates
    the front-end servo capability with the high performance
    back-end DVD processor. This chip targets the low cost DVD
    player market and is intended to entice large volume
    manufacturers with an attractive selling price.                                                                                                                                                                                                                                                                                                             
|
| |  | MPEG4 DVD and VCD Decoder Solutions. We recently
    introduced new families of MPEG4 playback chips for the DVD and
    VCD markets to take advantage of MPEG4s greater
    compression rates to deliver multimedia content over broadband
    connectivity and to increase the amount of multimedia content
    archived on a given amount of optical or magnetic storage.                                                                                                                                                                                                                                                                                                                                                                       
|
| |  | State of the Art Codec Solutions for the Recordable DVD.
    We recently introduced integrated DVD encoder and decoder
    (codec) into a single chip for both DVR and
    recordable DVD players.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| |  | Digital Amplifier Solution. We recently introduced our
    class-D multi-channel digital amplifier chip for home theater
    applications. The chip provides eight channels of high
    performance processing for digital audio amplification and is
    specifically designed to work with our video chips to provide a
    low-cost, totally digital DVD receiver solution.                                                                                                                                                                                                                                                                                                                                                                      
|
| |  | Develop the Next Generation Processor Chip for the DHS.
    We are developing the next generation DVD chip that will
    incorporate many new advanced capabilities. We are designing
    this chip with a third independent processor to enable us to
    support the following standard operating systems: Linux,
    PocketPC (formerly WinCE) and VxWorks. By supporting standard
    operating systems, we can leverage third-party software
    applications, such as standard web browsers, and third-party
    software drivers to support printers, digital cameras and other
    consumer electronics products. The development of this product
    includes network functionality, which may be incorporated into
    other DVD products.
|
| |  | Video Graphic Adaptor (VGA) Resolution 1.3 and
    2.0 Megapixel Image Sensors. We are continuing to develop
    our expertise in mixed-signal implementation, advanced pixel
    design, feature                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

4



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| |  |                                                                                                                                                                                                                                                                                                                                                                                                                               
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | integration, and manufacturing processes and controls. We are
    continuing to develop improved quality, cost-down VGA resolution
    products and enhancing our current 1.3 Megapixel product for the
    cellular phone market and are working on the development of
    future generations of higher Megapixel image sensor and our
    recently introduced 2.0 Megapixel sensor for the cellular camera
    phone market.

Leverage Expertise Across Multiple Mass Market
Applications.


Offer a Low-Cost Total Solution.


Leverage Our Relationships with Low-Cost OEMs and ODMs to
Capture Additional Worldwide Market Share.


Expand Relationships with Leading Consumer Electronics
Companies.


Employ Our Software Expertise to Develop New
Technologies.


Leverage Our Relationships with Large Suppliers to Be One of
the Low-Cost Providers.


Pursue Acquisitions of Complementary and Advanced
Technologies.


Pursue Licenses of Complementary Technologies.


Products




5



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DVD Decoder Chips.


Video CD Chips.


Image Sensor Chips.


Image Processor Chips.


DVD Encoder Chips.


Consumer Digital Audio Chips.


Communication Chips.


PC Audio Chips.


6



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|                |  |                    |     |   |      |  |     |      |  |  |     |  
|--------------- |  | ------------------ | --- | - | ---- |  | --- | ---- |  |  | --- | -
|                |  | Percentage of Net  |    
|                |  | Revenues for Years |    
|                |  | Ended              |    
|                |  | December 31,       |    
|                |  |                    |    
|                |  | 2004               |     |   | 2003 |  |     | 2002 | 
|                |  |                    |     |   |      |  |     |      | 
|DVD             |  |                    | 54  | % |      |  | 40  | %    |  |  | 59  | %
|VCD             |  |                    | 27  | % |      |  | 38  | %    |  |  | 31  | %
|Digital imaging |  |                    | 6   | % |      |  | 8   | %    |  |  |    |  
|Recordable      |  |                    | 3   | % |      |  | 6   | %    |  |  |    |  
|Royalty         |  |                    | 8   | % |      |  | 3   | %    |  |  |    |  
|Other           |  |                    | 2   | % |      |  | 5   | %    |  |  | 10  | %
|                |  |                    |     |   |      |  |     |      | 
|Total           |  |                    | 100 | % |      |  | 100 | %    |  |  | 100 | %
|                |  |                    |     |   |      |  |     |      | 

Technology and Research and Development














7



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Customers






Sales and Distribution










8



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Manufacturing






Competition










9



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Proprietary Technology








Backlog




Employees




Available Information




10



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Executive Officers of the Registrant




|                |  |     |    |  |          |                                                                           
|--------------- |  | --- | -- |  | -------- | --------------------------------------------------------------------------
|Name            |  | Age |    |  | Position
|                |  |     |    |  |         
|Fred S.L. Chan  |  |     | 58 |  |          | Chairman of the Board of Directors                                        
|Robert L. Blair |  |     | 57 |  |          | President, Chief Executive Officer and Director                           
|James B. Boyd   |  |     | 52 |  |          | Chief Financial Officer, Senior Vice President and Assistant
    Secretary

Fred S.L. Chan


Robert L. Blair


James B. Boyd









|        |           
|------- | ----------
|Item 2. | Properties



11



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|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings







12



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|        |                                                    
|------- | ---------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security Holders



|                |  |     |            |  |          |  |           | 
|--------------- |  | --- | ---------- |  | -------- |  | --------- | 
|Nominee         |  | For |            |  | Withheld | 
|                |  |     |            |  |          | 
|Fred S. L. Chan |  |     | 35,014,969 |  |          |  | 1,988,753 | 
|Robert Blair    |  |     | 35,043,716 |  |          |  | 1,960,006 | 
|Gary L. Fischer |  |     | 33,577,945 |  |          |  | 3,425,777 | 
|David S. Lee    |  |     | 33,371,836 |  |          |  | 3,631,886 | 
|Peter T. Mok    |  |     | 33,410,063 |  |          |  | 3,593,659 | 
|Alfred J. Stein |  |     | 33,488,321 |  |          |  | 3,515,401 | 





13



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PART II





Item 5.     Market for the
Registrants Common Equity, Related Shareholder Matters and
Issuer Purchases of Equity Securities




|             |                                        |      |   |       |     |  |   |       | 
|------------ | -------------------------------------- | ---- | - | ----- | --- |  | - | ----- | 
|             |                                        | High |   |       | Low | 
|             |                                        |      |   |       |     | 
|Fiscal 2004: |                                        |      |   |       |     |  |   |      
|             | First Quarter ended March 31, 2004     |      | $ | 19.23 |     |  | $ | 12.40 | 
|             | Second Quarter ended June 30, 2004     |      | $ | 15.90 |     |  | $ | 10.28 | 
|             | Third Quarter ended September 30, 2004 |      | $ | 9.88  |     |  | $ | 6.35  | 
|             | Fourth Quarter ended December 31, 2004 |      | $ | 7.75  |     |  | $ | 6.54  | 
|Fiscal 2003: |                                        |      |   |       |     |  |   |      
|             | First Quarter ended March 31, 2003     |      | $ | 7.09  |     |  | $ | 5.40  | 
|             | Second Quarter ended June 30, 2003     |      | $ | 9.75  |     |  | $ | 6.04  | 
|             | Third Quarter ended September 30, 2003 |      | $ | 11.22 |     |  | $ | 8.54  | 
|             | Fourth Quarter ended December 31, 2003 |      | $ | 17.40 |     |  | $ | 11.11 | 





ISSUER PURCHASES OF EQUITY SECURITIES


|                                     |  |                  |   |  |                    |                     |   |           |                     |  |                    |  |  |  |           | 
|------------------------------------ |  | ---------------- | - |  | ------------------ | ------------------- | - | --------- | ------------------- |  | ------------------ |  |  |  | --------- | 
|                                     |  |                  |   |  |                    | Total Number of     |   |           |                    
|                                     |  |                  |   |  |                    | Shares Purchased as |   |           | Maximum Number of   | 
|                                     |  |                  |   |  |                    | Part of Publicly    |   |           | Shares that may yet | 
|                                     |  | Total Number of  |   |  | Average Price Paid |                     |   | Announced |                     |  | be Purchased under | 
|Period                               |  | Shares Purchased |   |  | per Share          |                     |   | Programs  |                     |  | Programs(1)(2)     | 
|                                     |  |                  |   |  |                    |                     |   |           |                     |  |                    | 
|October 1, 2004  October 31, 2004   |  |                  |  |  |                    |                     |  |           |                     |  |                   |  |  |  | 5,202,000 | 
|November 1, 2004  November 30, 2004 |  |                  |  |  |                    |                     |  |           |                     |  |                   |  |  |  | 5,202,000 | 
|December 1, 2004  December 31, 2004 |  |                  |  |  |                    |                     |  |           |                     |  |                   |  |  |  | 5,202,000 | 
|                                     |  |                  |   |  |                    |                     |   |           |                     |  |                    | 
|Total                                |  |                  |  |  |                    |                     |  |           |                     |  |                   |  |  |  |           | 
|                                     |  |                  |   |  |                    |                     |   |           |                     |  |                    | 






|    |                                                                                                                                                                                                                                                                            
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | We announced on August 8, 2002 that our Board of Directors
    authorized us to repurchase up to 5.0 million shares of our
    common stock. As of December 31, 2004, we have
    approximately 202,000 shares remaining available for
    repurchase under this program.  
|   
|(2) | We announced on April 16, 2003 that our Board of Directors
    authorized us to repurchase up to 5.0 million shares of our
    common stock. As of December 31, 2004, we had an aggregate
    5.0 million shares remaining available for repurchase under
    this program.

14



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Dividend Policy









|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data





|                                                    |              |                                       |         |        |       |   |         |        |      |   |         |        |      |      |         |        |       |   |         |         |       |  
|--------------------------------------------------- | ------------ | ------------------------------------- | ------- | ------ | ----- | - | ------- | ------ | ---- | - | ------- | ------ | ---- | ---- | ------- | ------ | ----- | - | ------- | ------- | ----- | -
|                                                    |              | Years Ended December 31,              |        
|                                                    |              |                                       |        
|                                                    |              | 2004                                  |         |        | 2003  |   |         | 2002   |      |   | 2001    |        |      | 2000 |        
|                                                    |              |                                       |         |        |       |   |         |        |      |   |         |        |      |      |        
|                                                    |              | (In thousands, except per share data) |        
|Statement of Operations Data:                       |              |                                       |         |        |       |   |         |        |      |   |         |        |      |      |         |        |       |   |         |        
|Net revenues                                        |              | $                                     | 257,278 |        |       | $ | 195,273 |        |      | $ | 273,442 |        |      | $    | 271,380 |        |       | $ | 303,436 |        
|Cost of revenues                                    |              |                                       | 219,397 |        |       |   | 132,690 |        |      |   | 176,454 |        |      |      | 180,231 |        |       |   | 192,452 |        
|                                                    |              |                                       |         |        |       |   |         |        |      |   |         |        |      |      |        
|                                                    | Gross profit |                                       |         | 37,881 |       |   |         | 62,583 |      |   |         | 96,988 |      |      |         | 91,149 |       |   |         | 110,984 |      
|Operating expenses:                                 |              |                                       |         |        |       |   |         |        |      |   |         |        |      |      |         |        |       |   |         |        
|Research and development                            |              |                                       | 37,467  |        |       |   | 33,184  |        |      |   | 26,964  |        |      |      | 27,957  |        |       |   | 27,832  |        
|In-process research and development(1)              |              |                                       |        |        |       |   | 2,690   |        |      |   |        |        |      |      |        |        |       |   | 2,625   |        
|Selling, general and administrative                 |              |                                       | 41,056  |        |       |   | 31,761  |        |      |   | 34,170  |        |      |      | 40,689  |        |       |   | 36,225  |        
|                                                    |              |                                       |         |        |       |   |         |        |      |   |         |        |      |      |        
|Operating income (loss)                             |              |                                       | (40,642 | )      |       |   | (5,052  | )      |      |   | 35,854  |        |      |      | 22,503  |        |       |   | 44,302  |        
|Non-operating income (loss), net                    |              |                                       | 3,360   |        |       |   | 45,946  |        |      |   | 2,407   |        |      |      | (18,780 | )      |       |   | 41,810  |        
|                                                    |              |                                       |         |        |       |   |         |        |      |   |         |        |      |      |        
|Income before provision for income taxes            |              |                                       | (37,282 | )      |       |   | 40,894  |        |      |   | 38,261  |        |      |      | 3,723   |        |       |   | 86,112  |        
|Provision for (benefit from) income taxes           |              |                                       | (1,732  | )      |       |   | 15,603  |        |      |   | 984     |        |      |      | (7,262  | )      |       |   | 22,946  |        
|                                                    |              |                                       |         |        |       |   |         |        |      |   |         |        |      |      |        
|Net income from continuing operations               |              |                                       | (35,550 | )      |       |   | 25,291  |        |      |   | 37,277  |        |      |      | 10,985  |        |       |   | 63,166  |        
|Discontinued operation, net of minority interest(2) |              |                                       |        |        |       |   |        |        |      |   |        |        |      |      | (12,802 | )      |       |   | (14,860 | )      
|                                                    |              |                                       |         |        |       |   |         |        |      |   |         |        |      |      |        
|Net income (loss)                                   |              | $                                     | (35,550 | )      |       | $ | 25,291  |        |      | $ | 37,277  |        |      | $    | (1,817  | )      |       | $ | 48,306  |        
|                                                    |              |                                       |         |        |       |   |         |        |      |   |         |        |      |      |        
|Net income (loss) per share:                        |              |                                       |         |        |       |   |         |        |      |   |         |        |      |      |         |        |       |   |         |        
|                                                    | Basic        |                                       |         |        |       |   |         |        |      |   |         |        |      |      |         |        |       |   |         |         |      
|                                                    |              | Continuing operations                 |         | $      | (0.90 | ) |         | $      | 0.64 |   |         | $      | 0.85 |      |         | $      | 0.26  |   |         | $       | 1.49  |  
|                                                    |              | Discontinued operations               |         |        |      |   |         |        |     |   |         |        |     |      |         |        | (0.30 | ) |         |         | (0.35 | )
|                                                    |              |                                       |         |        |       |   |         |        |      |   |         |        |      |      |        
|                                                    |              | $                                     | (0.90   | )      |       | $ | 0.64    |        |      | $ | 0.85    |        |      | $    | (0.04   | )      |       | $ | 1.14    |        
|                                                    |              |                                       |         |        |       |   |         |        |      |   |         |        |      |      |        
|                                                    | Diluted      |                                       |         |        |       |   |         |        |      |   |         |        |      |      |         |        |       |   |         |         |      
|                                                    |              | Continuing operations                 |         | $      | (0.90 | ) |         | $      | 0.61 |   |         | $      | 0.80 |      |         | $      | 0.24  |   |         | $       | 1.37  |  
|                                                    |              | Discontinued operations               |         |        |      |   |         |        |     |   |         |        |     |      |         |        | (0.28 | ) |         |         | (0.32 | )
|                                                    |              |                                       |         |        |       |   |         |        |      |   |         |        |      |      |        
|                                                    |              | $                                     | (0.90   | )      |       | $ | 0.61    |        |      | $ | 0.80    |        |      | $    | (0.04   | )      |       | $ | 1.05    |        
|                                                    |              |                                       |         |        |       |   |         |        |      |   |         |        |      |      |        
|Shares used in calculating net income per share:    |              |                                       |         |        |       |   |         |        |      |   |         |        |      |      |         |        |       |   |         |        
|                                                    | Basic        |                                       |         | 39,476 |       |   |         | 39,517 |      |   |         | 44,044 |      |      |         | 42,274 |       |   |         | 42,548  |      
|                                                    |              |                                       |         |        |       |   |         |        |      |   |         |        |      |      |        
|                                                    | Diluted      |                                       |         | 39,476 |       |   |         | 41,238 |      |   |         | 46,731 |      |      |         | 45,262 |       |   |         | 45,943  |      
|                                                    |              |                                       |         |        |       |   |         |        |      |   |         |        |      |      |        

15



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|                                                                  |  |                                       |         |  |      |   |         |      |  |   |         |  |  |      |         |  |  |   |         | 
|----------------------------------------------------------------- |  | ------------------------------------- | ------- |  | ---- | - | ------- | ---- |  | - | ------- |  |  | ---- | ------- |  |  | - | ------- | 
|                                                                  |  | Years Ended December 31,              |        
|                                                                  |  |                                       |        
|                                                                  |  | 2004                                  |         |  | 2003 |   |         | 2002 |  |   | 2001    |  |  | 2000 |        
|                                                                  |  |                                       |         |  |      |   |         |      |  |   |         |  |  |      |        
|                                                                  |  | (In thousands, except per share data) |        
|Balance Sheet Data:                                               |  |                                       |         |  |      |   |         |      |  |   |         |  |  |      |         |  |  |   |         | 
|Cash, cash equivalents and short-term investments                 |  | $                                     | 126,688 |  |      | $ | 164,846 |      |  | $ | 199,102 |  |  | $    | 129,034 |  |  | $ | 58,838  | 
|Working capital excluding net assets of discontinued operation(2) |  | $                                     | 107,305 |  |      | $ | 145,221 |      |  | $ | 210,001 |  |  | $    | 156,966 |  |  | $ | 138,541 | 
|Total assets                                                      |  | $                                     | 283,744 |  |      | $ | 352,593 |      |  | $ | 281,602 |  |  | $    | 237,965 |  |  | $ | 294,391 | 
|Current liabilities                                               |  | $                                     | 90,384  |  |      | $ | 113,804 |      |  | $ | 44,558  |  |  | $    | 54,056  |  |  | $ | 73,901  | 
|Total shareholders equity                                        |  | $                                     | 192,912 |  |      | $ | 227,081 |      |  | $ | 229,368 |  |  | $    | 176,978 |  |  | $ | 211,429 | 



|    |                                                                                                                                                                                                                                                                                   
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | See Note 3, Significant Business Combinations,
    to the consolidated financial statements in Item 8 of this
    Report.                                                                                                                                                       
|   
|(2) | Effective as of August 21, 2001, we spun off Vialta by
    distributing to our shareholders all the Vialta common stock
    then held by us. For the years ended 2001 and 2000 presented,
    Vialta is accounted for as a discontinued operation in our
    financial statements.






|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis of Financial
    Condition and Results of Operation



Executive Overview




16



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Critical Accounting Policies and Estimates




| |                 
| | ----------------
| | Use of Estimates





| |   |                                     
| | - | ------------------------------------
| |  | Revenue Recognition                 
|
| |  | Inventories and Inventory Reserves  
|
| |  | Goodwill and Other Intangible Assets
|
| |  | Impairment of Long-lived Assets     
|
| |  | Income Taxes                        
|
| |  | Legal Contingencies                 



17



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| |                    
| | -------------------
| | Revenue Recognition









| |                                   
| | ----------------------------------
| | Inventories and Inventory Reserves









| |                                                                          
| | -------------------------------------------------------------------------
| | Impairment of Goodwill, Intangible Assets and Other
    Long-Lived Assets





| |   |                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------
| |  | Significant decrease in the market value of an asset.                                                          
|
| |  | Significant changes in the extent or manner for which the asset
    is being used or in its physical condition.
|
| |  | A significant change, delay or departure in our business
    strategy related to the asset.                    

18



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| |   |                                                                                                                                                                                            
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Significant negative changes in the business climate, industry
    or economic conditions.                                                                                                 
|
| |  | Current period operating losses or negative cash flow combined
    with a history of similar losses or a forecast that indicates
    continuing losses associated with the use of an asset.







| |             
| | ------------
| | Income Taxes





| |                    
| | -------------------
| | Legal Contingencies





Recent Accounting Pronouncements


, , s


19



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Comparison of Twelve Months ended December 31, 2004 and
December 31, 2003


Results of Operations




|                                             |                                     |                                        |         |        |                |  |        |             |  |   |         |        |  |  |       |      |  |  |        |       |   
|-------------------------------------------- | ----------------------------------- | -------------------------------------- | ------- | ------ | -------------- |  | ------ | ----------- |  | - | ------- | ------ |  |  | ----- | ---- |  |  | ------ | ----- | --
|                                             |                                     | Year Ended December 31,                |         |        | 2004 over 2003 | 
|                                             |                                     |                                        |         |        |                | 
|                                             |                                     | 2004                                   |         |        | 2003           |  |        | % of Change | 
|                                             |                                     |                                        |         |        |                |  |        |             | 
|                                             |                                     | (In thousands, except percentage data) |        
|Net revenues                                 |                                     | $                                      | 257,278 |        |                |  | 100.0% |             |  | $ | 195,273 |        |  |  | 100.0 | %    |  |  | 31.8   | %    
|Cost of revenues                             |                                     |                                        | 219,397 |        |                |  | 85.3   |             |  |   | 132,690 |        |  |  | 68.0  |      |  |  | 65.3   | %    
|                                             |                                     |                                        |         |        |                |  |        |             |  |   |         |        |  |  |      
|                                             | Gross profit                        |                                        |         | 37,881 |                |  |        | 14.7        |  |   |         | 62,583 |  |  |       | 32.0 |  |  |        | (39.5 | )%
|Operating expenses:                          |                                     |                                        |         |        |                |  |        |             |  |   |         |        |  |  |       |      |  |  |        |      
|                                             | Research and development            |                                        |         | 37,467 |                |  |        | 14.5        |  |   |         | 33,184 |  |  |       | 17.0 |  |  |        | 12.9  | % 
|                                             | In-process research and development |                                        |         |       |                |  |        |            |  |   |         | 2,690  |  |  |       | 1.4  |  |  |        | n/a   |   
|                                             | Selling, general and administrative |                                        |         | 41,056 |                |  |        | 16.0        |  |   |         | 31,761 |  |  |       | 16.2 |  |  |        | 29.3  | % 
|                                             |                                     |                                        |         |        |                |  |        |             |  |   |         |        |  |  |      
|Operating loss                               |                                     |                                        | (40,642 | )      |                |  | (15.8  | )           |  |   | (5,052  | )      |  |  | (2.6  | )    |  |  | 704.5  | %    
|Non-operating income, net                    |                                     |                                        | 3,360   |        |                |  | 1.3    |             |  |   | 45,946  |        |  |  | 23.5  |      |  |  | (92.7  | )%   
|                                             |                                     |                                        |         |        |                |  |        |             |  |   |         |        |  |  |      
|Income (loss) before income taxes            |                                     |                                        | (37,282 | )      |                |  | (14.5  | )           |  |   | 40,894  |        |  |  | 20.9  |      |  |  | (191.2 | )%   
|Provision for (benefit from) income taxes    |                                     |                                        | (1,732  | )      |                |  | (0.7   | )           |  |   | 15,603  |        |  |  | 8.0   |      |  |  | (111.1 | )%   
|                                             |                                     |                                        |         |        |                |  |        |             |  |   |         |        |  |  |      
|Net income (loss) from continuing operations |                                     | $                                      | (35,550 | )      |                |  | (13.8  | )%          |  | $ | 25,291  |        |  |  | 12.9  | %    |  |  | (240.6 | )%   
|                                             |                                     |                                        |         |        |                |  |        |             |  |   |         |        |  |  |      



20



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| |             
| | ------------
| | Net Revenues





|                |  |              |     |   |                |  |     |             |  |  |       |   
|--------------- |  | ------------ | --- | - | -------------- |  | --- | ----------- |  |  | ----- | --
|                |  | Year Ended   |     |   |               
|                |  | December 31, |     |   | 2004 over 2003 | 
|                |  |              |     |   |                | 
|                |  | 2004         |     |   | 2003           |  |     | % of Change | 
|                |  |              |     |   |                |  |     |             | 
|DVD             |  |              | 54  | % |                |  | 40  | %           |  |  | 76.8  | % 
|VCD             |  |              | 27  | % |                |  | 38  | %           |  |  | (6.8  | )%
|Digital imaging |  |              | 6   | % |                |  | 8   | %           |  |  | 2.1   | % 
|Recordable      |  |              | 3   | % |                |  | 6   | %           |  |  | (41.7 | )%
|Royalty         |  |              | 8   | % |                |  | 3   | %           |  |  | 300.0 | % 
|Other           |  |              | 2   | % |                |  | 5   | %           |  |  | (31.4 | )%
|                |  |              |     |   |                |  |     |             | 
|Total           |  |              | 100 | % |                |  | 100 | %           |  |  | 31.8  | % 
|                |  |              |     |   |                |  |     |             | 













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| |             
| | ------------
| | Gross Profit







| |                         
| | ------------------------
| | Research and Development





| |                                    
| | -----------------------------------
| | In-Process Research and Development





| |                                             
| | --------------------------------------------
| | Selling, General and Administrative Expenses





| |                          
| | -------------------------
| | Non-operating Income, Net



22



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| |                                          
| | -----------------------------------------
| | Provision for (Benefit from) Income Taxes







Comparison of Twelve Months ended December 31, 2003 and
December 31, 2002




|                                    |  |                                        |         |   |                |  |       |             |  |   |         |  |  |  |       |   |  |  |         |   
|----------------------------------- |  | -------------------------------------- | ------- | - | -------------- |  | ----- | ----------- |  | - | ------- |  |  |  | ----- | - |  |  | ------- | --
|                                    |  | Year Ended December 31,                |         |   | 2003 over 2002 | 
|                                    |  |                                        |         |   |                | 
|                                    |  | 2003                                   |         |   | 2002           |  |       | % of Change | 
|                                    |  |                                        |         |   |                |  |       |             | 
|                                    |  | (In thousands, except percentage data) |        
|Net revenues                        |  | $                                      | 195,273 |   |                |  | 100.0 | %           |  | $ | 273,442 |  |  |  | 100.0 | % |  |  | (28.6   | )%
|Cost of revenues                    |  |                                        | 132,690 |   |                |  | 68.0  |             |  |   | 176,454 |  |  |  | 64.5  |   |  |  | (24.8   | )%
|                                    |  |                                        |         |   |                |  |       |             |  |   |         |  |  |  |      
|Gross profit                        |  |                                        | 62,583  |   |                |  | 32.0  |             |  |   | 96,988  |  |  |  | 35.5  |   |  |  | (35.5   | )%
|Operating expenses:                 |  |                                        |         |   |                |  |       |             |  |   |         |  |  |  |       |   |  |  |         |   
|Research and development            |  |                                        | 33,184  |   |                |  | 17.0  |             |  |   | 26,964  |  |  |  | 10.0  |   |  |  | 23.1    | % 
|In-process research and development |  |                                        | 2,690   |   |                |  | 1.4   |             |  |   |        |  |  |  |      |   |  |  |        |   
|Selling, general and administrative |  |                                        | 31,761  |   |                |  | 16.2  |             |  |   | 34,170  |  |  |  | 12.5  |   |  |  | (7.1    | )%
|                                    |  |                                        |         |   |                |  |       |             |  |   |         |  |  |  |      
|Operating income (loss)             |  |                                        | (5,052  | ) |                |  | (2.6  | )           |  |   | 35,854  |  |  |  | 13.0  |   |  |  | (114.1  | )%
|Non-operating income, net           |  |                                        | 45,946  |   |                |  | 23.5  |             |  |   | 2,407   |  |  |  | 0.9   |   |  |  | 1,808.8 | % 
|                                    |  |                                        |         |   |                |  |       |             |  |   |         |  |  |  |      
|Income before income taxes          |  |                                        | 40,894  |   |                |  | 20.9  |             |  |   | 38,261  |  |  |  | 13.9  |   |  |  | 6.9     | % 
|Provision for income taxes          |  |                                        | 15,603  |   |                |  | 8.0   |             |  |   | 984     |  |  |  | 0.3   |   |  |  | 1,485.7 | % 
|                                    |  |                                        |         |   |                |  |       |             |  |   |         |  |  |  |      
|Net Income                          |  | $                                      | 25,291  |   |                |  | 12.9  | %           |  | $ | 37,277  |  |  |  | 13.6  | % |  |  | (32.2   | )%
|                                    |  |                                        |         |   |                |  |       |             |  |   |         |  |  |  |      



| |             
| | ------------
| | Net Revenues



23



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|                |  |              |     |   |                |  |     |             |  |  |       |   
|--------------- |  | ------------ | --- | - | -------------- |  | --- | ----------- |  |  | ----- | --
|                |  | Year Ended   |     |   |               
|                |  | December 31, |     |   | 2004 over 2003 | 
|                |  |              |     |   |                | 
|                |  | 2003         |     |   | 2002           |  |     | % of Change | 
|                |  |              |     |   |                |  |     |             | 
|DVD             |  |              | 40  | % |                |  | 59  | %           |  |  | (51.5 | )%
|VCD             |  |              | 38  | % |                |  | 31  | %           |  |  | (11.7 | )%
|Digital imaging |  |              | 8   | % |                |  |    |             |  |  | n/a   |   
|Recordable      |  |              | 6   | % |                |  |    |             |  |  | n/a   |   
|Royalty         |  |              | 3   | % |                |  |    |             |  |  | n/a   |   
|Other           |  |              | 5   | % |                |  | 10  | %           |  |  | (61.4 | )%
|                |  |              |     |   |                |  |     |             | 
|Total           |  |              | 100 | % |                |  | 100 | %           |  |  | (28.6 | )%
|                |  |              |     |   |                |  |     |             | 













24



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| |             
| | ------------
| | Gross Profit





| |                         
| | ------------------------
| | Research and Development





| |                                    
| | -----------------------------------
| | In-Process Research and Development





| |                                             
| | --------------------------------------------
| | Selling, General and Administrative Expenses





| |                          
| | -------------------------
| | Non-operating Income, Net





| |                                          
| | -----------------------------------------
| | Provision for (Benefit from) Income Taxes



25



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Acquisitions and Related Charges




| |      
| | -----
| | Divio





| |       
| | ------
| | Pictos



Liquidity and Capital Resources








26



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27



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| |                                                           
| | ----------------------------------------------------------
| | Contractual Obligations, Commitments and
    Contingencies



|                            |  |                        |        |           |        |                |        |           |           |   |           |  |  |         |    |  |  |  |   | 
|--------------------------- |  | ---------------------- | ------ | --------- | ------ | -------------- | ------ | --------- | --------- | - | --------- |  |  | ------- | -- |  |  |  | - | 
|                            |  | Payment Due by Periods |       
|                            |  |                        |       
|                            |  |                        |        | Less than |        |                |        |           | More than |  
|Contractual Obligations     |  | Total                  |        |           | 1 Year |                |        | 1-3 Years |           |   | 3-5 Years |  |  | 5 Years |   
|                            |  |                        |        |           |        |                |        |           |           |   |           |  |  |         |   
|                            |  |                        |        |           |        | (In thousands) |        |           |          
|Operating lease obligations |  | $                      | 3,837  |           |        | $              | 2,854  |           |           | $ | 967       |  |  | $       | 16 |  |  |  |  | 
|Purchase order commitments  |  |                        | 31,716 |           |        |                | 31,716 |           |           |   |          |  |  |         |   |  |  |  |  | 
|                            |  |                        |        |           |        |                |        |           |           |   |           |  |  |         |   
|Total                       |  | $                      | 35,553 |           |        | $              | 34,570 |           |           | $ | 967       |  |  | $       | 16 |  |  |  |  | 
|                            |  |                        |        |           |        |                |        |           |           |   |           |  |  |         |   







Factors That May Affect Future Results




| |                                          
| | -----------------------------------------
| | We operate in highly competitive markets.





28



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| |   |                                                                                                        
| | - | -------------------------------------------------------------------------------------------------------
| |  | The timing and success of our new product introductions and
    those of our customers and competitors;
|
| |  | The timely shipment of our Vibratto II chip with our own servo
    IP in it;                           
|
| |  | The timely shipment of a recordable servo product;                                                     
|
| |  | The timely shipment of our new VCD chip;                                                               
|
| |  | The timely shipment of our new 2.0 Megapixel sensor chip;                                              
|
| |  | The timely shipment of our new UNIVGA and new UNI Megapixel
    products;                              
|
| |  | The timely shipment of our new Vibratto II CL and Vibratto III
    products;                           
|
| |  | The price, quality and performance of our products and the
    products of our competitors;            
|
| |  | The emergence of new multimedia standards;                                                             
|
| |  | The development of technical innovations;                                                              
|
| |  | The ability to obtain adequate foundry capacity and sources of
    raw materials;                      
|
| |  | The rate at which our customers integrate our products into
    their products;                        
|
| |  | The number and nature of our competitors in a given market; and                                        
|
| |  | The protection of our intellectual property rights.                                                    



| |                                                                                          
| | -----------------------------------------------------------------------------------------
| | Our business is highly dependent on the expansion of the
    consumer electronics market.







| |                                                                                                                                      
| | -------------------------------------------------------------------------------------------------------------------------------------
| | Our quarterly operating results are subject to
    fluctuations that may cause volatility or a decline in the price
    of our stock.





| |   |                                                                                                   
| | - | --------------------------------------------------------------------------------------------------
| |  | Charges related to the net realizable value of inventories
    and/or excess inventories;         
|
| |  | Changes in demand for our products;                                                               
|
| |  | Changes in the mix of products sold and our revenue mix;                                          
|
| |  | Increasing pricing pressures and resulting reduction in the ASP
    of any or all of our products;
|
| |  | Gain or loss of significant customers;                                                            

29



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| |   |                                                                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Seasonal customer demand;                                                                                                                                                           
|
| |  | The cyclical nature of the semiconductor industry;                                                                                                                                  
|
| |  | The timing of our and our competitors new product
    announcements and introductions and the market acceptance of new
    or enhanced versions of our and our customers products;
|
| |  | The timing of significant customer orders;                                                                                                                                          
|
| |  | Loss of key employees which could impact sales or the pace of
    product development;                                                                                              
|
| |  | The turns basis of most of our orders, which makes
    backlog a poor indicator of the next quarters revenue;                                                                    
|
| |  | The lead time we normally receive for our orders, which makes it
    difficult to predict sales until the end of the quarter;                                                       
|
| |  | Availability and cost of raw materials;                                                                                                                                             
|
| |  | Significant increases in expenses associated with the expansion
    of operations;                                                                                                  
|
| |  | Availability and cost of foundry capacity; and                                                                                                                                      
|
| |  | A shift in manufacturing of consumer electronic products away
    from China.                                                                                                       



| |                                                                                                                                                                         
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We often purchase inventories based on sales forecasts and
    if anticipated sales do not materialize, we may continue to
    experience significant inventory charges.





| |                                                                                                                                                                                                                 
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may need to acquire other companies or technologies to
    successfully compete in our industry and we may not be
    successful acquiring key targets or integrating our acquisitions
    into our business.





| |   |                                                                                                                                                                                   
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The failure of the acquired products or technology to attain
    market acceptance, which may result from our inability to
    leverage such products and technology successfully;
|
| |  | The failure to integrate acquired products and business with
    existing products and corporate culture;                                                                         

30



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| |   |                                                                                                                                                                                                                   
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The inability to retain key employees from the acquired company;                                                                                                                                                  
|
| |  | Diversion of management attention from other business concerns;                                                                                                                                                   
|
| |  | The potential for large write-offs;                                                                                                                                                                               
|
| |  | Issuances of equity securities dilutive to our existing
    shareholders;                                                                                                                                         
|
| |  | The incurrence of substantial debt and assumption of unknown
    liabilities; and                                                                                                                                 
|
| |  | Our ability to properly access and maintain an effective
    internal control environment over an acquired company in order
    to comply with the recently adopted and pending public reporting
    requirements.



| |                                                                                                                                                                                                                 
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our operating results could be adversely affected as a
    result of purchase accounting treatment and the impact of
    amortization and impairment of intangible assets relating to
    business combinations.





| |                                                                                           
| | ------------------------------------------------------------------------------------------
| | Our research and development investments may fail to
    enhance our competitive position.







| |                                                                               
| | ------------------------------------------------------------------------------
| | Our sales may fluctuate due to seasonality and changes in
    customer demand.



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| |                                                                                                                                                                                   
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our success within the semiconductor industry depends upon
    our ability to develop new products in response to rapid
    technological changes and evolving industry standards.





| |   |                                                                                           
| | - | ------------------------------------------------------------------------------------------
| |  | Anticipation of market trends;                                                            
|
| |  | Timely completion of product development, design and testing;                             
|
| |  | Market acceptance of our products and the products of our
    customers;                  
|
| |  | Offering new products at competitive prices;                                              
|
| |  | Meeting performance, quality and functionality requirements of
    customers and OEMs; and
|
| |  | Meeting the timing, volume and price requirements of customers
    and OEMs.              





| |                                                              
| | -------------------------------------------------------------
| | Our products are subject to increasing pricing
    pressures.





| |                                                                                     
| | ------------------------------------------------------------------------------------
| | We may lose business to competitors who have significant
    competitive advantages.





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| |                                                                                         
| | ----------------------------------------------------------------------------------------
| | Our business is dependent upon retaining key personnel and
    attracting new employees.







| |                                                                                                                                                                           
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We rely on a single distributor for a significant portion
    of our revenues and if this relationship deteriorates our
    financial results could be adversely affected.





| |                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------
| | Our customer base is highly concentrated, so the loss of a
    major customer could adversely affect our business.



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| |                                                                                                                                                                                                                             
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may continue to expand into new businesses and product
    lines in which there may be a concentrated customer base and for
    which we may be required to purchase custom inventories to meet
    our customers needs.







| |                                                                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may not be able to adequately protect our intellectual
    property rights from unauthorized use and we may be subject to
    claims of infringement of third-party intellectual property
    rights.







| |                                                                                                                                                  
| | -------------------------------------------------------------------------------------------------------------------------------------------------
| | We have significant international sales and operations
    that are subject to the special risks of doing business outside
    the United States.



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| |   |                                                                                                                                                                                           
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Unexpected changes in legislative or regulatory requirements and
    related compliance problems;                                                                                         
|
| |  | Political, social and economic instability;                                                                                                                                               
|
| |  | Lack of adequate protection of our intellectual property rights;                                                                                                                          
|
| |  | Changes in diplomatic and trade relationships, including changes
    in most favored nations trading status;                                                                              
|
| |  | Tariffs, quotas and other trade barriers and restrictions;                                                                                                                                
|
| |  | Longer payment cycles and greater difficulties in accounts
    receivable collection;                                                                                                     
|
| |  | Potentially adverse tax consequences, including withholding in
    connection with the repatriation of earnings and restrictions on
    the repatriation of earnings;                     
|
| |  | Difficulties in obtaining export licenses for technologies;                                                                                                                               
|
| |  | Language and other cultural differences, which may inhibit our
    sales and marketing efforts and create internal communication
    problems among our U.S. and foreign counterparts; and
|
| |  | Currency exchange risks.                                                                                                                                                                  



| |                                                                
| | ---------------------------------------------------------------
| | Our products are manufactured by independent third
    parties.





| |   |                                                                                                                                                                                       
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The possibility of an interruption or loss of manufacturing
    capacity;                                                                                                             
|
| |  | Reduced control over delivery schedules, manufacturing yields
    and costs; and                                                                                                      
|
| |  | The inability to reduce our costs as rapidly as competitors who
    perform their own manufacturing and who are not bound by volume
    commitments to subcontractors at fixed prices.







| |                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------
| | Because we are dependent upon a limited number of
    suppliers, we could experience delivery disruptions or
    unexpected product cost increases.



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| |                                                                                                                                   
| | ----------------------------------------------------------------------------------------------------------------------------------
| | We have extended sales cycles, which increase our costs in
    obtaining orders and reduce the predictability of our
    earnings.





| |                                          
| | -----------------------------------------
| | Our products are subject to recall risks.





| |                                                                                               
| | ----------------------------------------------------------------------------------------------
| | The semiconductor industry is subject to cyclical
    variations in product supply and demand.





| |                                                                                                                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may need additional funds to execute our business plan,
    and if we are unable to obtain such funds, we may not be able to
    expand our business, and if we do raise such funds, your
    ownership in ESS may be subject to dilution.



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| |                                                                                  
| | ---------------------------------------------------------------------------------
| | The value of our common stock may be adversely affected by
    market volatility.





| |   |                                                                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Future announcements concerning us, our competitors or our
    principal customers, such as quarterly operating results,
    changes in earnings estimates by analysts, technological
    innovations, new product introductions, governmental
    regulations, or litigation;
|
| |  | Changes in accounting rules, particularly those related to the
    expensing of stock options;                                                                                                                                                                                
|
| |  | The liquidity within the market for our common stock;                                                                                                                                                                                                                         
|
| |  | Sales by our officers, directors, other insiders and large
    shareholders;                                                                                                                                                                                                  
|
| |  | Investor perceptions concerning the prospects of our business
    and the semiconductor industry;                                                                                                                                                                             
|
| |  | Market conditions and investor sentiment affecting market prices
    of equity securities of high technology companies; and                                                                                                                                                   
|
| |  | General economic, political and market conditions, such as
    recessions or international currency fluctuations.                                                                                                                                                             



| |                                                                                                                                                              
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We are incurring additional costs and devoting more
    management resources to comply with increasing regulation of
    corporate governance and disclosure.





| |                                                                                                                                                 
| | ------------------------------------------------------------------------------------------------------------------------------------------------
| | Failure to maintain effective internal controls could have
    a material adverse effect on our business, operating results and
    stock price.



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| |                                                                                                                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Changes in stock option accounting rules may adversely
    impact our reported operating results prepared in accordance
    with generally accepted accounting principles, our stock price
    and our competitiveness in the employee marketplace.



, . , . s







|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures about Market
    Risk



Foreign Exchange Risks




Interest Rate Risks




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Investment Risk






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|        |                                            
|------- | -------------------------------------------
|Item 8. | Financial Statements and Supplementary Data



|   |  |                                                                                                              |  |   
|-- |  | ------------------------------------------------------------------------------------------------------------ |  | --
|   |  | Managements Report on Internal
    Control over Financial Reporting                                         |  | 41
|   |  | Report of Independent Registered Public
    Accounting Firm                                                  |  | 42
|  
|1. |  | Financial Statements:                                                                                        |  |   
|   |  | Consolidated Balance Sheets as of
    December 31, 2004 and 2003                                             |  | 44
|   |  | Consolidated Statements of Operations for
    the years ended December 31, 2004, 2003 and 2002               |  | 45
|   |  | Consolidated Statements of
    Shareholders Equity for the years ended December 31,
    2004, 2003 and 2002 |  | 46
|   |  | Consolidated Statements of Cash Flows for
    the years ended December 31, 2004, 2003 and 2002               |  | 47
|   |  | Notes to Consolidated Financial
    Statements                                                               |  | 48
|  
|2. |  | Financial statement schedule:                                                                                |  |   
|   |  | Valuation and Qualifying Accounts for each of the three years
    ended December 31, 2004, 2003 and 2002     |  | 76
|  
|3. |  | Supplementary Data:                                                                                          |  |   
|   |  | Selected Quarterly Financial Data                                                                            |  | 77

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MANAGEMENTS REPORT ON INTERNAL CONTROL OVER FINANCIAL
REPORTING




Internal Control  Integrated
Framework,




|    |  |                                                           |  |     |  |                                                         
|--- |  | --------------------------------------------------------- |  | --- |  | --------------------------------------------------------
|By: |  | /s/ ROBERT L. BLAIR                                       |  | By: |  | /s/ JAMES B. BOYD                                       
|    |  |                                                           |  |     |  |                                                         
|    |  | ROBERT L. BLAIR
    President and Chief Executive Officer |  |     |  | JAMES B. BOYD
    Vice President and Assistant Secretary



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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM






Consolidated financial statements and financial statement
schedule




Internal control over financial reporting


Internal Control  Integrated Framework Internal Control 
Integrated Framework




42



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|   |                      
|-- | ---------------------
|1. | Financial Statements:

ESS TECHNOLOGY, INC.





CONSOLIDATED BALANCE SHEETS


|                                              |                                                                                                                                                            |                                            |        |         |         |   |         |         |         | 
|--------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | ------- | ------- | - | ------- | ------- | ------- | 
|                                              |                                                                                                                                                            | December 31,                               |       
|                                              |                                                                                                                                                            |                                            |       
|                                              |                                                                                                                                                            | 2004                                       |        |         | 2003    |  
|                                              |                                                                                                                                                            |                                            |        |         |         |  
|                                              |                                                                                                                                                            | (In thousands)                             |       
|ASSETS                                       
|Cash and cash equivalents                     |                                                                                                                                                            | $                                          | 41,527 |         |         | $ | 56,517  |        
|Short-term investments                        |                                                                                                                                                            |                                            | 85,161 |         |         |   | 108,329 |        
|Accounts receivable, net                      |                                                                                                                                                            |                                            | 21,094 |         |         |   | 49,326  |        
|Related party receivable  Vialta             |                                                                                                                                                            |                                            | 128    |         |         |   | 281     |        
|Other receivables                             |                                                                                                                                                            |                                            | 234    |         |         |   | 8,067   |        
|Inventories                                   |                                                                                                                                                            |                                            | 45,669 |         |         |   | 33,546  |        
|Prepaid expenses and other assets             |                                                                                                                                                            |                                            | 3,876  |         |         |   | 2,959   |        
|                                              |                                                                                                                                                            |                                            |        |         |         |  
|                                              |                                                                                                                                                            | Total current assets                       |        |         | 197,689 |   |         |         | 259,025 | 
|Property, plant and equipment, net            |                                                                                                                                                            |                                            | 23,009 |         |         |   | 24,629  |        
|Goodwill                                      |                                                                                                                                                            |                                            | 43,391 |         |         |   | 43,789  |        
|Other intangible assets, net                  |                                                                                                                                                            |                                            | 6,414  |         |         |   | 11,510  |        
|Other assets                                  |                                                                                                                                                            |                                            | 13,241 |         |         |   | 13,640  |        
|                                              |                                                                                                                                                            |                                            |        |         |         |  
|                                              |                                                                                                                                                            | Total assets                               |        | $       | 283,744 |   |         | $       | 352,593 | 
|                                              |                                                                                                                                                            |                                            |        |         |         |  
|                                             
|LIABILITIES AND SHAREHOLDERS EQUITY         
|Accounts payable and accrued expenses         |                                                                                                                                                            | $                                          | 50,646 |         |         | $ | 84,414  |        
|Income tax payable and deferred income taxes  |                                                                                                                                                            |                                            | 39,738 |         |         |   | 29,390  |        
|                                              |                                                                                                                                                            |                                            |        |         |         |  
|                                              |                                                                                                                                                            | Total current liabilities                  |        |         | 90,384  |   |         |         | 113,804 | 
|Non-current deferred tax liability            |                                                                                                                                                            |                                            | 448    |         |         |   | 11,708  |        
|                                              |                                                                                                                                                            |                                            |        |         |         |  
|                                              |                                                                                                                                                            | Total liabilities                          |        |         | 90,832  |   |         |         | 125,512 | 
|                                              |                                                                                                                                                            |                                            |        |         |         |  
|Commitments and contingencies (Note 15)       |                                                                                                                                                            |                                            |        |         |         |   |         |        
|Shareholders equity:                         |                                                                                                                                                            |                                            |        |         |         |   |         |        
|                                              | Preferred stock, no par value, 10,000 shares authorized;
    none issued and outstanding                                                                   |                                            |        |        |         |   |         |        |        
|                                              | Common stock, no par value, 100,000 shares authorized;
    39,681 and 39,246 shares issued and outstanding at
    December 31, 2004 and 2003, respectively |                                            |        | 178,030 |         |   |         | 175,546 |        
|Accumulated other comprehensive income (loss) |                                                                                                                                                            |                                            | (174   | )       |         |   | 929     |        
|Retained earnings                             |                                                                                                                                                            |                                            | 15,056 |         |         |   | 50,606  |        
|                                              |                                                                                                                                                            |                                            |        |         |         |  
|                                              |                                                                                                                                                            | Total shareholders equity                 |        |         | 192,912 |   |         |         | 227,081 | 
|                                              |                                                                                                                                                            |                                            |        |         |         |  
|                                              |                                                                                                                                                            | Total liabilities and shareholders equity |        | $       | 283,744 |   |         | $       | 352,593 | 
|                                              |                                                                                                                                                            |                                            |        |         |         |  



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ESS TECHNOLOGY, INC.





CONSOLIDATED STATEMENTS OF OPERATIONS


|                                                        |                                     |                                       |         |         |      |   |         |         |  |   |         |         | 
|------------------------------------------------------- | ----------------------------------- | ------------------------------------- | ------- | ------- | ---- | - | ------- | ------- |  | - | ------- | ------- | 
|                                                        |                                     | Years Ended December 31,              |        
|                                                        |                                     |                                       |        
|                                                        |                                     | 2004                                  |         |         | 2003 |   |         | 2002    | 
|                                                        |                                     |                                       |         |         |      |   |         |         | 
|                                                        |                                     | (In thousands, except per share data) |        
|Net revenues                                            |                                     | $                                     | 256,496 |         |      | $ | 194,815 |         |  | $ | 272,039 |        
|Net revenues from related party  Vialta                |                                     |                                       | 782     |         |      |   | 458     |         |  |   | 1,403   |        
|                                                        |                                     |                                       |         |         |      |   |         |         | 
|                                                        | Total net revenues                  |                                       |         | 257,278 |      |   |         | 195,273 |  |   |         | 273,442 | 
|Cost of revenues                                        |                                     |                                       | 219,397 |         |      |   | 132,690 |         |  |   | 176,454 |        
|                                                        |                                     |                                       |         |         |      |   |         |         | 
|                                                        | Gross profit                        |                                       |         | 37,881  |      |   |         | 62,583  |  |   |         | 96,988  | 
|Operating expenses:                                     |                                     |                                       |         |         |      |   |         |         |  |   |         |        
|                                                        | Research and development            |                                       |         | 37,467  |      |   |         | 33,184  |  |   |         | 26,964  | 
|                                                        | In-process research and development |                                       |         |        |      |   |         | 2,690   |  |   |         |        | 
|                                                        | Selling, general and administrative |                                       |         | 41,056  |      |   |         | 31,761  |  |   |         | 34,170  | 
|                                                        |                                     |                                       |         |         |      |   |         |         | 
|Operating income (loss)                                 |                                     |                                       | (40,642 | )       |      |   | (5,052  | )       |  |   | 35,854  |        
|Non-operating income, net                               |                                     |                                       | 3,360   |         |      |   | 45,946  |         |  |   | 2,407   |        
|                                                        |                                     |                                       |         |         |      |   |         |         | 
|Income (loss) before income taxes                       |                                     |                                       | (37,282 | )       |      |   | 40,894  |         |  |   | 38,261  |        
|Provision for (benefit from) income taxes               |                                     |                                       | (1,732  | )       |      |   | 15,603  |         |  |   | 984     |        
|                                                        |                                     |                                       |         |         |      |   |         |         | 
|Net income (loss)                                       |                                     | $                                     | (35,550 | )       |      | $ | 25,291  |         |  | $ | 37,277  |        
|                                                        |                                     |                                       |         |         |      |   |         |         | 
|Net income (loss) per share:                            |                                     |                                       |         |         |      |   |         |         |  |   |         |        
|                                                        | Basic                               |                                       | $       | (0.90   | )    |   | $       | 0.64    |  |   | $       | 0.85    | 
|                                                        |                                     |                                       |         |         |      |   |         |         | 
|                                                        | Diluted                             |                                       | $       | (0.90   | )    |   | $       | 0.61    |  |   | $       | 0.80    | 
|                                                        |                                     |                                       |         |         |      |   |         |         | 
|Shares used in calculating net income (loss) per share: |                                     |                                       |         |         |      |   |         |         |  |   |         |        
|                                                        | Basic                               |                                       |         | 39,476  |      |   |         | 39,517  |  |   |         | 44,044  | 
|                                                        |                                     |                                       |         |         |      |   |         |         | 
|                                                        | Diluted                             |                                       |         | 39,476  |      |   |         | 41,238  |  |   |         | 46,731  | 
|                                                        |                                     |                                       |         |         |      |   |         |         | 



45



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ESS TECHNOLOGY, INC.





CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY


|                             |                                                                              |                |        |        |               |             |         |          |   |       |               |        |   |               |        |         |              |   |         |         |   |   |         |         |  
|---------------------------- | ---------------------------------------------------------------------------- | -------------- | ------ | ------ | ------------- | ----------- | ------- | -------- | - | ----- | ------------- | ------ | - | ------------- | ------ | ------- | ------------ | - | ------- | ------- | - | - | ------- | ------- | -
|                             |                                                                              |                |        |        |               | Accumulated |         |          |   |       |               |        |  
|                             |                                                                              |                |        | Other  |               |             |         |          |   |       |              
|                             |                                                                              | Common Stock   |        |        | Comprehensive |             |         |          |   | Total |               |        |  
|                             |                                                                              |                |        |        | Income        |             |         | Retained |   |       | Shareholders |        |   | Comprehensive |       
|                             |                                                                              | Shares         |        |        | Amount        |             |         | (Loss)   |   |       | Earnings      |        |   | Equity        |        |         | Income(Loss) |  
|                             |                                                                              |                |        |        |               |             |         |          |   |       |               |        |   |               |        |         |              |  
|                             |                                                                              | (In thousands) |       
|Balance at December 31, 2001 |                                                                              |                | 42,334 |        |               |             | 153,678 |          |   | $     | (1,374        | )      |   | $             | 24,674 |         |              | $ | 176,978 |         |   |   |         |        
|                             | Issuance of common stock upon exercise of options                            |                |        | 1,203  |               |             |         | 7,935    |   |       |               |       |   |               |        |        |              |   |         | 7,935   |   |   |         |         |  
|                             | Issuance of common stock for employee stock purchase plan                    |                |        | 216    |               |             |         | 1,452    |   |       |               |       |   |               |        |        |              |   |         | 1,452   |   |   |         |         |  
|                             | Issuance of common stock from secondary public offering                      |                |        | 2,500  |               |             |         | 45,181   |   |       |               |       |   |               |        |        |              |   |         | 45,181  |   |   |         |         |  
|                             | Income tax benefit on disqualifying disposition of common stock
    options  |                |        |       |               |             |         | 1,025    |   |       |               |       |   |               |        |        |              |   |         | 1,025   |   |   |         |         |  
|                             | Repurchase of common stock                                                   |                |        | (2,948 | )             |             |         | (13,228  | ) |       |               |       |   |               |        | (29,431 | )            |   |         | (42,659 | ) |   |         |         |  
|                             | Stock-related compensation charge                                            |                |        |       |               |             |         | 301      |   |       |               |       |   |               |        |        |              |   |         | 301     |   |   |         |         |  
|                             | Unrealized gain on marketable securities                                     |                |        |       |               |             |         |         |   |       |               | 260    |   |               |        |        |              |   |         | 260     |   |   | $       | 260     |  
|                             | Net income                                                                   |                |        |       |               |             |         |         |   |       |               |       |   |               |        | 37,277  |              |   |         | 37,277  |   |   |         | 37,277  |  
|                             | Write-down of Cisco shares                                                   |                |        |       |               |             |         |         |   |       |               | 1,573  |   |               |        |        |              |   |         | 1,573   |   |   |         | 1,573   |  
|                             | Loss on sale of marketable security                                          |                |        |       |               |             |         |         |   |       |               | 45     |   |               |        |        |              |   |         | 45      |   |   |         | 45      |  
|                             |                                                                              |                |        |        |               |             |         |          |   |       |               |        |   |               |        |         |              |  
|Total comprehensive income   |                                                                              |                |       |        |               |             |        |          |   |       |              |        |   |               |       |         |              |   |        |         |   | $ | 39,155  |        
|                             |                                                                              |                |        |        |               |             |         |          |   |       |               |        |   |               |        |         |              |  
|Balance at December 31, 2002 |                                                                              |                | 43,305 |        |               |             | 196,344 |          |   |       | 504           |        |   |               | 32,520 |         |              |   | 229,368 |         |   |   |         |        
|                             | Issuance of common stock upon exercise of options                            |                |        | 642    |               |             |         | 3,872    |   |       |               |       |   |               |        |        |              |   |         | 3,872   |   |   |         |         |  
|                             | Issuance of common stock for employee stock purchase plan                    |                |        | 159    |               |             |         | 750      |   |       |               |       |   |               |        |        |              |   |         | 750     |   |   |         |         |  
|                             | Income tax reversal on disqualifying disposition of common stock
    options |                |        |       |               |             |         | (3,324   | ) |       |               |       |   |               |        |        |              |   |         | (3,324  | ) |   |         |         |  
|                             | Repurchase of common stock                                                   |                |        | (4,860 | )             |             |         | (22,096  | ) |       |               |       |   |               |        | (7,205  | )            |   |         | (29,301 | ) |   |         |         |  
|                             | Unrealized gain on marketable Securities                                     |                |        |       |               |             |         |         |   |       |               | 425    |   |               |        |        |              |   |         | 425     |   |   | $       | 425     |  
|                             | Net income                                                                   |                |        |       |               |             |         |         |   |       |               |       |   |               |        | 25,291  |              |   |         | 25,291  |   |   |         | 25,291  |  
|                             |                                                                              |                |        |        |               |             |         |          |   |       |               |        |   |               |        |         |              |  
|Total comprehensive income   |                                                                              |                |       |        |               |             |        |          |   |       |              |        |   |               |       |         |              |   |        |         |   | $ | 25,716  |        
|                             |                                                                              |                |        |        |               |             |         |          |   |       |               |        |   |               |        |         |              |  
|Balance at December 31, 2003 |                                                                              |                | 39,246 |        |               |             | 175,546 |          |   |       | 929           |        |   |               | 50,606 |         |              |   | 227,081 |         |   |   |         |        
|                             | Issuance of common stock upon exercise of options                            |                |        | 275    |               |             |         | 1,582    |   |       |               |       |   |               |        |        |              |   |         | 1,582   |   |   |         |         |  
|                             | Issuance of common stock for employee stock purchase plan                    |                |        | 160    |               |             |         | 880      |   |       |               |       |   |               |        |        |              |   |         | 880     |   |   |         |         |  
|                             | Income tax reversal on disqualifying disposition of common stock
    options |                |        |       |               |             |         | (117     | ) |       |               |       |   |               |        |        |              |   |         | (117    | ) |   |         |         |  
|                             | Stock-related compensation charge                                            |                |        |       |               |             |         | 139      |   |       |               |       |   |               |        |        |              |   |         | 139     |   |   |         |         |  
|                             | Unrealized loss on marketable securities                                     |                |        |       |               |             |         |         |   |       |               | (1,103 | ) |               |        |        |              |   |         | (1,103  | ) |   | $       | (1,103  | )
|                             | Net loss                                                                     |                |        |       |               |             |         |         |   |       |               |       |   |               |        | (35,550 | )            |   |         | (35,550 | ) |   |         | (35,550 | )
|                             |                                                                              |                |        |        |               |             |         |          |   |       |               |        |   |               |        |         |              |  
|Total comprehensive loss     |                                                                              |                |       |        |               |             |        |          |   |       |              |        |   |               |       |         |              |   |        |         |   | $ | (36,653 | )      
|                             |                                                                              |                |        |        |               |             |         |          |   |       |               |        |   |               |        |         |              |  
|Balance at December 31, 2004 |                                                                              |                | 39,681 |        |               | $           | 178,030 |          |   | $     | (174          | )      |   | $             | 15,056 |         |              | $ | 192,912 |         |   |   |         |        
|                             |                                                                              |                |        |        |               |             |         |          |   |       |               |        |   |               |        |         |              |  



46



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##### Table of Contents



ESS TECHNOLOGY, INC.





CONSOLIDATED STATEMENTS OF CASH FLOWS


|                                                     |                                                                                                        |                                                                                        |                                              |                                                     |       |         |         |          |       |         |         |          |       |         |          |  
|---------------------------------------------------- | ------------------------------------------------------------------------------------------------------ | -------------------------------------------------------------------------------------- | -------------------------------------------- | --------------------------------------------------- | ----- | ------- | ------- | -------- | ----- | ------- | ------- | -------- | ----- | ------- | -------- | -
|                                                     |                                                                                                        | Years Ended December 31,                                                               |                                             
|                                                     |                                                                                                        |                                                                                        |                                             
|                                                     |                                                                                                        | 2004                                                                                   |                                              |                                                     | 2003  |         |         | 2002     |      
|                                                     |                                                                                                        |                                                                                        |                                              |                                                     |       |         |         |          |      
|                                                     |                                                                                                        | (In thousands)                                                                         |                                             
|Cash flows from operating activities:                |                                                                                                        |                                                                                        |                                              |                                                     |       |         |         |          |       |         |         |         
|Net income (loss)                                    |                                                                                                        | $                                                                                      | (35,550                                      | )                                                   |       | $       | 25,291  |          |       | $       | 37,277  |         
|                                                     | Adjustments to reconcile net income (loss) to net cash provided
    by (used in) operating activities: |                                                                                        |                                              |                                                     |       |         |         |          |       |         |         |          |      
|                                                     |                                                                                                        | Depreciation                                                                           |                                              |                                                     | 5,489 |         |         |          | 3,948 |         |         |          | 5,685 |        
|                                                     |                                                                                                        | Amortization                                                                           |                                              |                                                     | 4,796 |         |         |          | 2,899 |         |         |          | 395   |        
|                                                     |                                                                                                        | Write-down of intangible asset  Pictos                                                |                                              |                                                     | 300   |         |         |          |      |         |         |          |      |        
|                                                     |                                                                                                        | Write-off of NetRidium goodwill                                                        |                                              |                                                     | 398   |         |         |          |      |         |         |          |      |        
|                                                     |                                                                                                        | (Gain) loss on sale of property, plant and equipment                                   |                                              |                                                     | 12    |         |         |          | 54    |         |         |          | (85   | )      
|                                                     |                                                                                                        | Charges for purchased in-process research and development                              |                                              |                                                     |      |         |         |          | 2,690 |         |         |          |      |        
|                                                     |                                                                                                        | (Gain) loss from sale of investments                                                   |                                              |                                                     | (231  | )       |         |          | (185  | )       |         |          | 189   |        
|                                                     |                                                                                                        | Write-down of investments                                                              |                                              |                                                     |      |         |         |          | 1,986 |         |         |          | 3,612 |        
|                                                     |                                                                                                        | Stock-based compensation                                                               |                                              |                                                     | 139   |         |         |          |      |         |         |          | 301   |        
|                                                     |                                                                                                        | Income tax benefit (reversal) on disqualifying disposition
    of common stock options |                                              |                                                     | (117  | )       |         |          | 331   |         |         |          | 1,025 |        
|                                                     |                                                                                                        | Changes in assets and liabilities, net of effect of business
    combinations:         |                                              |                                                     |       |         |         |          |       |         |         |          |       |        
|                                                     |                                                                                                        |                                                                                        | Accounts receivable, net                     |                                                     |       | 36,065  |         |          |       | (27,421 | )       |          |       | 14,160  |         
|                                                     |                                                                                                        |                                                                                        | Related party receivable  Vialta            |                                                     |       | 153     |         |          |       | (248    | )       |          |       | 14      |         
|                                                     |                                                                                                        |                                                                                        | Inventories                                  |                                                     |       | (12,123 | )       |          |       | (6,381  | )       |          |       | 13,297  |         
|                                                     |                                                                                                        |                                                                                        | Prepaid expenses and other assets            |                                                     |       | 3,435   |         |          |       | (1,786  | )       |          |       | (1,208  | )       
|                                                     |                                                                                                        |                                                                                        | Accounts payable and accrued expenses        |                                                     |       | (33,768 | )       |          |       | 40,958  |         |          |       | (13,978 | )       
|                                                     |                                                                                                        |                                                                                        | Related party payable  Vialta               |                                                     |       |        |         |          |       |        |         |          |       | (111    | )       
|                                                     |                                                                                                        |                                                                                        | Income tax payable and deferred income taxes |                                                     |       | (236    | )       |          |       | 14,071  |         |          |       | 4,179   |         
|                                                     |                                                                                                        |                                                                                        |                                              |                                                     |       |         |         |          |      
|                                                     |                                                                                                        |                                                                                        |                                              | Net cash provided by (used in) operating activities |       |         | (31,238 | )        |       |         | 56,207  |          |       |         | 64,752   |  
|                                                     |                                                                                                        |                                                                                        |                                              |                                                     |       |         |         |          |      
|Cash flows from investing activities:                |                                                                                                        |                                                                                        |                                              |                                                     |       |         |         |          |       |         |         |         
|                                                     | Purchase of property, plant and equipment                                                              |                                                                                        |                                              | (3,914                                              | )     |         |         | (7,962   | )     |         |         | (2,147   | )    
|                                                     | Sales of property, plant and equipment                                                                 |                                                                                        |                                              | 34                                                  |       |         |         |         |       |         |         |         |      
|                                                     | Purchase of short-term investments                                                                     |                                                                                        |                                              | (129,527                                            | )     |         |         | (161,188 | )     |         |         | (295,349 | )    
|                                                     | Sale of short-term investments                                                                         |                                                                                        |                                              | 152,369                                             |       |         |         | 236,989  |       |         |         | 143,112  |      
|                                                     | Purchase of long-term investments                                                                      |                                                                                        |                                              | (5,176                                              | )     |         |         | (5,298   | )     |         |         | (5,212   | )    
|                                                     | Sale of long-term investments                                                                          |                                                                                        |                                              |                                                    |       |         |         |         |       |         |         | 440      |      
|                                                     | Cash paid for acquisitions, net of cash acquired                                                       |                                                                                        |                                              |                                                    |       |         |         | (52,052  | )     |         |         |         |      
|                                                     |                                                                                                        |                                                                                        |                                              |                                                     |       |         |         |          |      
|                                                     |                                                                                                        |                                                                                        |                                              | Net cash provided by (used in) investing activities |       |         | 13,786  |          |       |         | 10,489  |          |       |         | (159,156 | )
|                                                     |                                                                                                        |                                                                                        |                                              |                                                     |       |         |         |          |      
|Cash flows from financing activities:                |                                                                                                        |                                                                                        |                                              |                                                     |       |         |         |          |       |         |         |         
|                                                     | Repurchase of common stock                                                                             |                                                                                        |                                              |                                                    |       |         |         | (29,301  | )     |         |         | (42,659  | )    
|                                                     | Issuance of common stock from secondary public offering                                                |                                                                                        |                                              |                                                    |       |         |         |         |       |         |         | 45,181   |      
|                                                     | Issuance of common stock under employee stock purchase plan and
    stock option plans                 |                                                                                        |                                              | 2,462                                               |       |         |         | 4,622    |       |         |         | 9,387    |      
|                                                     |                                                                                                        |                                                                                        |                                              |                                                     |       |         |         |          |      
|                                                     |                                                                                                        |                                                                                        |                                              | Net cash provided by (used in) financing activities |       |         | 2,462   |          |       |         | (24,679 | )        |       |         | 11,909   |  
|                                                     |                                                                                                        |                                                                                        |                                              |                                                     |       |         |         |          |      
|Net increase (decrease) in cash and cash equivalents |                                                                                                        |                                                                                        | (14,990                                      | )                                                   |       |         | 42,017  |          |       |         | (82,495 | )       
|Cash and cash equivalents at beginning of year       |                                                                                                        |                                                                                        | 56,517                                       |                                                     |       |         | 14,500  |          |       |         | 96,995  |         
|                                                     |                                                                                                        |                                                                                        |                                              |                                                     |       |         |         |          |      
|Cash and cash equivalents at end of year             |                                                                                                        | $                                                                                      | 41,527                                       |                                                     |       | $       | 56,517  |          |       | $       | 14,500  |         
|                                                     |                                                                                                        |                                                                                        |                                              |                                                     |       |         |         |          |      
|Supplemental disclosure of cash flow information     |                                                                                                        |                                                                                        |                                              |                                                     |       |         |         |          |       |         |         |         
|                                                     | Cash paid for income taxes                                                                             |                                                                                        | $                                            | (460                                                | )     |         | $       | (2,926   | )     |         | $       | (237     | )    
|                                                     | Cash refund for income taxes                                                                           |                                                                                        | $                                            | 1,872                                               |       |         | $       | 1,566    |       |         | $       | 4,520    |      



47



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##### Table of Contents



ESS TECHNOLOGY, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




|        |            
|------- | -----------
|Note 1. | The Company









|        |                                           
|------- | ------------------------------------------
|Note 2. | Summary of Significant Accounting Policies



| |                 
| | ----------------
| | Use of Estimates





| |                      
| | ---------------------
| | Basis of Presentation





48



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |                             
| | ----------------------------
| | Foreign Currency Translation





| |                                                   
| | --------------------------------------------------
| | Cash, Cash Equivalents, and Short-Term Investments









| |                                    
| | -----------------------------------
| | Fair Value of Financial Instruments





| |            
| | -----------
| | Inventories





| |                       
| | ----------------------
| | Property and Equipment



|                                   |  |  |            | 
|---------------------------------- |  |  | ---------- | 
|Building and building improvements |  |  | 7-30 years | 
|Machinery and equipment            |  |  | 3-5 years  | 
|Furniture and fixtures             |  |  | 3-5 years  | 

49



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






| |                   
| | ------------------
| | Equity Investments





| |         
| | --------
| | Goodwill





| |   |                                                                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------
| |  | a significant adverse change in legal factors or in the business
    climate;                                                                       
|
| |  | an adverse action or assessment by a regulator;                                                                                                     
|
| |  | unanticipated competition;                                                                                                                          
|
| |  | a loss of key personnel;                                                                                                                            
|
| |  | a more-likely-than-not expectation that a reporting unit or a
    significant portion of a reporting unit will be sold or
    otherwise disposed of;
|
| |  | the testing for recoverability of a significant asset group
    within a reporting unit; and                                                        
|
| |  | recognition of goodwill impairment loss in the financial
    statements of a subsidiary that is a component of a reporting
    unit.                





| |                                      
| | -------------------------------------
| | Acquisition-Related Intangible Assets





| |                                
| | -------------------------------
| | Impairment of Long-Lived Assets



50



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






| |                    
| | -------------------
| | Revenue Recognition









| |                               
| | ------------------------------
| | Research and Development Costs





| |                                    
| | -----------------------------------
| | In-Process Research and Development





| |             
| | ------------
| | Income Taxes





| |                            
| | ---------------------------
| | Net Income (Loss) Per Share





| |                         
| | ------------------------
| | Stock Based Compensation



51



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)








|                                       |                                                                                      |                                       |   |         |      |  |   |         |   |  |   |         |  
|-------------------------------------- | ------------------------------------------------------------------------------------ | ------------------------------------- | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                       |                                                                                      | Years Ended December 31,              |  
|                                       |                                                                                      |                                       |  
|                                       |                                                                                      | 2004                                  |   |         | 2003 |  |   | 2002    |  
|                                       |                                                                                      |                                       |   |         |      |  |   |         |  
|                                       |                                                                                      | (In thousands, except per share data) |  
|Net income (loss):                     |                                                                                      |                                       |   |         |      |  |   |         |   |  |   |        
|                                       | As reported                                                                          |                                       | $ | (35,550 | )    |  | $ | 25,291  |   |  | $ | 37,277  |  
|                                       | Stock-based employee compensation expense included in reported
    net income (loss) |                                       |   | 39      |      |  |   |        |   |  |   |        |  
|                                       | Amortization of stock compensation expense                                           |                                       |   | (3,787  | )    |  |   | (10,142 | ) |  |   | (10,827 | )
|                                       |                                                                                      |                                       |   |         |      |  |   |         |  
|                                       | Pro forma net income (loss)                                                          |                                       | $ | (39,298 | )    |  | $ | 15,149  |   |  | $ | 26,450  |  
|                                       |                                                                                      |                                       |   |         |      |  |   |         |  
|Net income (loss) per share  basic:   |                                                                                      |                                       |   |         |      |  |   |         |   |  |   |        
|                                       | As reported                                                                          |                                       | $ | (0.90   | )    |  | $ | 0.64    |   |  | $ | 0.85    |  
|                                       | Pro forma                                                                            |                                       | $ | (1.00   | )    |  | $ | 0.38    |   |  | $ | 0.60    |  
|Net income (loss) per share  diluted: |                                                                                      |                                       |   |         |      |  |   |         |   |  |   |        
|                                       | As reported                                                                          |                                       | $ | (0.90   | )    |  | $ | 0.61    |   |  | $ | 0.80    |  
|                                       | Pro forma                                                                            |                                       | $ | (1.00   | )    |  | $ | 0.37    |   |  | $ | 0.57    |  



|                                          |  |                        |      |   |      |   |      |      |  |   |      |  
|----------------------------------------- |  | ---------------------- | ---- | - | ---- | - | ---- | ---- |  | - | ---- | -
|                                          |  | Employee Stock Options |     
|                                          |  |                        |     
|                                          |  | 2004                   |      |   | 2003 |   |      | 2002 | 
|                                          |  |                        |      |   |      |   |      |      | 
|Expected dividend yield                   |  |                        | 0.0  | % |      |   | 0.0  | %    |  |   | 0.0  | %
|Weighted average risk-free interest rate  |  |                        | 3.43 | % |      |   | 2.13 | %    |  |   | 3.69 | %
|Expected volatility                       |  |                        | 82   | % |      |   | 94   | %    |  |   | 102  | %
|Weighted average expected life (in years) |  |                        | 4    |   |      |   | 4    |      |  |   | 4    |  
|Weighted average grant date fair value    |  | $                      | 7.58 |   |      | $ | 5.79 |      |  | $ | 9.70 |  

52



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                                       |  |                     |      |   |      |   |      |      |  |   |      |  
|-------------------------------------- |  | ------------------- | ---- | - | ---- | - | ---- | ---- |  | - | ---- | -
|                                       |  | 1995 Employee Stock |     
|                                       |  | Purchase Plan       |     
|                                       |  |                     |     
|                                       |  | 2004                |      |   | 2003 |   |      | 2002 | 
|                                       |  |                     |      |   |      |   |      |      | 
|Expected dividend yield                |  |                     | 0.0  | % |      |   | 0.0  | %    |  |   | 0.0  | %
|Risk-free interest rate                |  |                     | 1.61 | % |      |   | 0.97 | %    |  |   | 3.69 | %
|Expected volatility                    |  |                     | 82   | % |      |   | 60   | %    |  |   | 102  | %
|Expected life (in months)              |  |                     | 6    |   |      |   | 6    |      |  |   | 6    |  
|Weighted average grant date fair value |  | $                   | 3.32 |   |      | $ | 2.01 |      |  | $ | 3.45 |  





| |         
| | --------
| | Warranty



|                                               |  |                |      |   |              |   |      |              |  |   |        |  
|---------------------------------------------- |  | -------------- | ---- | - | ------------ | - | ---- | ------------ |  | - | ------ | -
|                                               |  | Year Ended     |      |   | Year Ended   |   |      | Year Ended   | 
|                                               |  | December 31,   |      |   | December 31, |   |      | December 31, | 
|                                               |  | 2004           |      |   | 2003         |   |      | 2002         | 
|                                               |  |                |      |   |              |   |      |              | 
|                                               |  | (In thousands) |     
|Beginning balance                              |  | $              | 800  |   |              | $ | 550  |              |  | $ | 544    |  
|Accruals for warranties issued during the year |  |                | 152  |   |              |   | 628  |              |  |   | 1,067  |  
|Settlements made during the year               |  |                | (416 | ) |              |   | (378 | )            |  |   | (1,061 | )
|Adjustments                                    |  |                | (212 | ) |              |   |     |              |  |   |       |  
|                                               |  |                |      |   |              |   |      |              | 
|Ending balance                                 |  | $              | 324  |   |              | $ | 800  |              |  | $ | 550    |  
|                                               |  |                |      |   |              |   |      |              | 



| |                            
| | ---------------------------
| | Comprehensive Income (Loss)





| |                        
| | -----------------------
| | Risks and Uncertainties



53



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |                             
| | ----------------------------
| | Concentration of Credit Risk











| |                 
| | ----------------
| | Reclassification





| |                                 
| | --------------------------------
| | Recent Accounting Pronouncements

, , s


54



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)












|        |                                  
|------- | ---------------------------------
|Note 3. | Significant Business Combinations



| |      
| | -----
| | Divio



55



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                                    |                       |                |        |        | 
|----------------------------------- | --------------------- | -------------- | ------ | ------ | 
|Purchase Price Allocation           |                       | Amounts        |       
|                                    |                       |                |       
|                                    |                       | (In thousands) |       
|Tangible assets                     |                       | $              | 1,661  |       
|Identifiable intangible assets      |                       |                | 6,310  |       
|Goodwill                            |                       |                | 23,535 |       
|                                    |                       |                |       
|                                    | Total assets acquired |                |        | 31,506 | 
|Deferred tax liabilities            |                       |                | (2,587 | )     
|                                    |                       |                |       
|                                    | Net assets acquired   |                |        | 28,919 | 
|In-process research and development |                       |                | 1,270  |       
|                                    |                       |                |       
|Total consideration                 |                       | $              | 30,189 |       
|                                    |                       |                |       



|                                             |                                      |                      |       |       |                |  |          |  | 
|-------------------------------------------- | ------------------------------------ | -------------------- | ----- | ----- | -------------- |  | -------- |  | 
|Identifiable Intangible Assets               |                                      | Estimated Fair Value |       |       | Estimated Life | 
|                                             |                                      |                      |       |       |                | 
|                                             |                                      | (In thousands)       |      
|Existing technology                          |                                      | $                    | 4,790 |       |                |  | 3 years  | 
|Patents and core technology                  |                                      |                      | 820   |       |                |  | 3 years  | 
|Customer contacts and related relationships  |                                      |                      | 510   |       |                |  | 3 years  | 
|Partner agreements and related relationships |                                      |                      | 110   |       |                |  | 3 years  | 
|Order backlog                                |                                      |                      | 80    |       |                |  | 3 months | 
|                                             |                                      |                      |       |       |                | 
|                                             | Total identifiable intangible assets |                      | $     | 6,310 |                |  |          |  | 
|                                             |                                      |                      |       |       |                | 



| |       
| | ------
| | Pictos



56



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                                    |                       |                |        |        | 
|----------------------------------- | --------------------- | -------------- | ------ | ------ | 
|Purchase Price Allocation           |                       | Amounts        |       
|                                    |                       |                |       
|                                    |                       | (In thousands) |       
|Tangible assets                     |                       | $              | 8,160  |       
|Identifiable intangible assets      |                       |                | 7,850  |       
|Goodwill                            |                       |                | 18,180 |       
|                                    |                       |                |       
|                                    | Total assets acquired |                |        | 34,190 | 
|Liabilities assumed                 |                       |                | (4,938 | )     
|Deferred tax liabilities            |                       |                | (3,219 | )     
|                                    |                       |                |       
|                                    | Net assets acquired   |                |        | 26,033 | 
|In-process research and development |                       |                | 1,420  |       
|                                    |                       |                |       
|Total consideration                 |                       | $              | 27,453 |       
|                                    |                       |                |       



|                               |                                      |                      |       |       |                |  |          |  | 
|------------------------------ | ------------------------------------ | -------------------- | ----- | ----- | -------------- |  | -------- |  | 
|Identifiable Intangible Assets |                                      | Estimated Fair Value |       |       | Estimated Life | 
|                               |                                      |                      |       |       |                | 
|                               |                                      | (In thousands)       |      
|Existing technology            |                                      | $                    | 3,600 |       |                |  | 3 years  | 
|Patents and core technology    |                                      |                      | 1,800 |       |                |  | 3 years  | 
|Customer relationships         |                                      |                      | 1,080 |       |                |  | 3 years  | 
|Distributor relationships      |                                      |                      | 90    |       |                |  | 2 years  | 
|Foundry agreement              |                                      |                      | 930   |       |                |  | 2 years  | 
|Order backlog                  |                                      |                      | 350   |       |                |  | 6 months | 
|                               |                                      |                      |       |       |                | 
|                               | Total identifiable intangible assets |                      | $     | 7,850 |                |  |          |  | 
|                               |                                      |                      |       |       |                | 



| |                                
| | -------------------------------
| | Pro forma Financial Information



|                        |         |                          |         |      |      |   |         |      | 
|----------------------- | ------- | ------------------------ | ------- | ---- | ---- | - | ------- | ---- | 
|                        |         | Twelve Months Ended      |        
|                        |         | December 31,             |        
|                        |         |                          |        
|                        |         | 2003                     |         |      | 2002 |  
|                        |         |                          |         |      |      |  
|                        |         | (In thousand, except per |        
|                        |         | share data)              |        
|Total revenues          |         | $                        | 198,997 |      |      | $ | 282,819 |     
|Operating income (loss) |         | $                        | (20,844 | )    |      | $ | 11,790  |     
|Net income              |         | $                        | 8,610   |      |      | $ | 10,646  |     
|Net income per share:   |         |                          |         |      |      |   |         |     
|                        | Basic   |                          | $       | 0.22 |      |   | $       | 0.24 | 
|                        | Diluted |                          | $       | 0.21 |      |   | $       | 0.23 | 



57



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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






|        |                                     
|------- | ------------------------------------
|Note 4. | Goodwill and Other Intangible Assets



|                        |  |                |        |  |           |  |   |              |        |  |        |              |  |      |      |   |  |   |        | 
|----------------------- |  | -------------- | ------ |  | --------- |  | - | ------------ | ------ |  | ------ | ------------ |  | ---- | ---- | - |  | - | ------ | 
|                        |  | December 31,   |        |  |           |  |   |              | Write- |  |        | December 31, | 
|                        |  | 2003           |        |  | Additions |  |   | Amortization |        |  | Off    |              |  | 2004 |     
|                        |  |                |        |  |           |  |   |              |        |  |        |              |  |      |     
|                        |  | (In thousands) |       
|Goodwill                |  | $              | 43,789 |  |           |  |  |              |        |  |       |              |  |      | (398 | ) |  | $ | 43,391 | 
|Other intangible assets |  | $              | 11,510 |  |           |  |  |              |        |  | (4,796 | )            |  |      | (300 | ) |  | $ | 6,414  | 





|                                       |  |                |       |  |      |   |        | 
|-------------------------------------- |  | -------------- | ----- |  | ---- | - | ------ | 
|                                       |  | December 31,   |      
|                                       |  |                |      
|                                       |  | 2004           |       |  | 2003 |  
|                                       |  |                |       |  |      |  
|                                       |  | (In thousands) |      
|Acquired other intangible assets, net: |  |                |       |  |      |   |        | 
|Pictos                                 |  | $              | 3,039 |  |      | $ | 6,009  | 
|Divio                                  |  |                | 3,375 |  |      |   | 5,451  | 
|NetRidium                              |  |                |      |  |      |   | 50     | 
|                                       |  |                |       |  |      |  
|Total intangible assets, net           |  | $              | 6,414 |  |      | $ | 11,510 | 
|                                       |  |                |       |  |      |  



|                                   |                                             |                                      |   |                          |              |  |   |              |       |  |   |       |       | 
|---------------------------------- | ------------------------------------------- | ------------------------------------ | - | ------------------------ | ------------ |  | - | ------------ | ----- |  | - | ----- | ----- | 
|                                   |                                             |                                      |   | Accumulated Amortization |             
|                                   |                                             | Gross                                |   |                          |              | 
|                                   |                                             | Carrying                             |   |                          | December 31, |  |   | December 31, |      
|                                   |                                             | Amounts                              |   |                          | 2004         |  |   | 2003         |      
|                                   |                                             |                                      |   |                          |              |  |   |              |      
|Amortized other intangible assets: |                                             |                                      |   |                          |              |  |   |              |       |  |   |      
|                                   | Existing technology                         |                                      | $ | 8,390                    |              |  | $ | 4,065        |       |  | $ | 1,269 |      
|                                   | Patents and core technology                 |                                      |   | 2,620                    |              |  |   | 1,311        |       |  |   | 437   |      
|                                   | Customer relationships                      |                                      |   | 1,590                    |              |  |   | 1,095        |       |  |   | 265   |      
|                                   | Distributor relationships                   |                                      |   | 90                       |              |  |   | 70           |       |  |   | 25    |      
|                                   | Partner agreement and related relationships |                                      |   | 110                      |              |  |   | 50           |       |  |   | 14    |      
|                                   | Foundry agreement                           |                                      |   | 930                      |              |  |   | 725          |       |  |   | 260   |      
|                                   | Order backlog                               |                                      |   | 430                      |              |  |   | 430          |       |  |   | 430   |      
|                                   | Technical infrastructure                    |                                      |   | 797                      |              |  |   | 797          |       |  |   | 747   |      
|                                   |                                             |                                      |   |                          |              |  |   |              |      
|                                   |                                             | Total identifiable intangible assets |   | $                        | 14,957       |  |   | $            | 8,543 |  |   | $     | 3,447 | 
|                                   |                                             |                                      |   |                          |              |  |   |              |      

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                                            |  |             
|------------------------------------------- |  | ------------
|Existing technology                         |  | 3 years     
|Patents and core technology                 |  | 3 years     
|Customer relationships                      |  | 3 years     
|Distributor relationships                   |  | 2 years     
|Partner agreement and related relationships |  | 3 years     
|Foundry agreement                           |  | 2 years     
|Order backlog                               |  | 3  6 months
|Technical infrastructure                    |  | 4 years     





|        |                         
|------- | ------------------------
|Note 5. | Balance Sheet Components

|                           |                                                      |                |        |        |      |   |         |         |  
|-------------------------- | ---------------------------------------------------- | -------------- | ------ | ------ | ---- | - | ------- | ------- | -
|                           |                                                      | December 31,   |       
|                           |                                                      |                |       
|                           |                                                      | 2004           |        |        | 2003 |  
|                           |                                                      |                |        |        |      |  
|                           |                                                      | (In thousands) |       
|Cash and cash equivalents: |                                                      |                |        |        |      |   |         |        
|                           | Cash and money market accounts                       |                | $      | 40,140 |      |   | $       | 27,318  |  
|                           | U.S. government and corporate debt securities        |                |        | 1,387  |      |   |         | 29,199  |  
|                           |                                                      |                |        |        |      |  
|                           |                                                      | $              | 41,527 |        |      | $ | 56,517  |        
|                           |                                                      |                |        |        |      |  
|Short-term investments:    |                                                      |                |        |        |      |   |         |        
|                           | U.S. government and corporate debt securities        |                | $      | 85,668 |      |   | $       | 108,280 |  
|                           | Unrealized gain (loss) on marketable securities, net |                |        | (507   | )    |   |         | 49      |  
|                           |                                                      |                |        |        |      |  
|                           |                                                      | $              | 85,161 |        |      | $ | 108,329 |        
|                           |                                                      |                |        |        |      |  
|Accounts receivable, net:  |                                                      |                |        |        |      |   |         |        
|                           | Accounts receivable                                  |                | $      | 21,881 |      |   | $       | 50,316  |  
|                           | Less: Allowance for doubtful accounts                |                |        | (787   | )    |   |         | (990    | )
|                           |                                                      |                |        |        |      |  
|                           |                                                      | $              | 21,094 |        |      | $ | 49,326  |        
|                           |                                                      |                |        |        |      |  
|Other receivables:         |                                                      |                |        |        |      |   |         |        
|                           | Receivable from vendor                               |                | $      |       |      |   | $       | 7,787   |  
|                           | Other                                                |                |        | 234    |      |   |         | 280     |  
|                           |                                                      |                |        |        |      |  
|                           |                                                      | $              | 234    |        |      | $ | 8,067   |        
|                           |                                                      |                |        |        |      |  
|Inventories:               |                                                      |                |        |        |      |   |         |        
|                           | Raw materials                                        |                | $      | 15,857 |      |   | $       | 1,735   |  
|                           | Work-in-process                                      |                |        | 7,286  |      |   |         | 9,516   |  
|                           | Finished goods                                       |                |        | 22,526 |      |   |         | 22,295  |  
|                           |                                                      |                |        |        |      |  
|                           |                                                      | $              | 45,669 |        |      | $ | 33,546  |        
|                           |                                                      |                |        |        |      |  

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


|                                       |                                                                                       |                |        |         |      |   |        |         |  
|-------------------------------------- | ------------------------------------------------------------------------------------- | -------------- | ------ | ------- | ---- | - | ------ | ------- | -
|                                       |                                                                                       | December 31,   |       
|                                       |                                                                                       |                |       
|                                       |                                                                                       | 2004           |        |         | 2003 |  
|                                       |                                                                                       |                |        |         |      |  
|                                       |                                                                                       | (In thousands) |       
|Prepaid expenses and other assets:     |                                                                                       |                |        |         |      |   |        |        
|                                       | Insurance                                                                             |                | $      | 961     |      |   | $      | 1,016   |  
|                                       | Maintenance                                                                           |                |        | 759     |      |   |        | 1,084   |  
|                                       | Advanced payments                                                                     |                |        | 1,200   |      |   |        |        |  
|                                       | Other                                                                                 |                |        | 956     |      |   |        | 859     |  
|                                       |                                                                                       |                |        |         |      |  
|                                       |                                                                                       | $              | 3,876  |         |      | $ | 2,959  |        
|                                       |                                                                                       |                |        |         |      |  
|Property, plant and equipment:         |                                                                                       |                |        |         |      |   |        |        
|                                       | Land                                                                                  |                | $      | 2,860   |      |   | $      | 2,860   |  
|                                       | Building and building improvements                                                    |                |        | 24,734  |      |   |        | 24,139  |  
|                                       | Machinery and equipment                                                               |                |        | 36,189  |      |   |        | 34,406  |  
|                                       | Furniture and fixtures                                                                |                |        | 20,233  |      |   |        | 18,754  |  
|                                       |                                                                                       |                |        |         |      |  
|                                       |                                                                                       |                | 84,016 |         |      |   | 80,159 |        
|                                       | Less: Accumulated depreciation and amortization                                       |                |        | (61,007 | )    |   |        | (55,530 | )
|                                       |                                                                                       |                |        |         |      |  
|                                       |                                                                                       | $              | 23,009 |         |      | $ | 24,629 |        
|                                       |                                                                                       |                |        |         |      |  
|Other assets:                          |                                                                                       |                |        |         |      |   |        |        
|                                       | Investments  Best Elite (Note 7)                                                     |                | $      | 10,000  |      |   | $      | 5,000   |  
|                                       | Investments  other                                                                   |                |        | 3,029   |      |   |        | 4,076   |  
|                                       | Other                                                                                 |                |        | 212     |      |   |        | 4,564   |  
|                                       |                                                                                       |                |        |         |      |  
|                                       |                                                                                       | $              | 13,241 |         |      | $ | 13,640 |        
|                                       |                                                                                       |                |        |         |      |  
|Accounts payable and accrued expenses: |                                                                                       |                |        |         |      |   |        |        
|                                       | Accounts payable                                                                      |                | $      | 18,124  |      |   | $      | 47,672  |  
|                                       | Accrued compensation costs                                                            |                |        | 6,323   |      |   |        | 6,887   |  
|                                       | Accrued commission and royalties                                                      |                |        | 9,212   |      |   |        | 12,290  |  
|                                       | Deferred revenue related to distributor sales, net of deferred
    cost of goods sold |                |        | 8,041   |      |   |        | 8,229   |  
|                                       | Adverse purchase order commitments                                                    |                |        | 4,960   |      |   |        | 368     |  
|                                       | Other accrued liabilities                                                             |                |        | 3,986   |      |   |        | 8,968   |  
|                                       |                                                                                       |                |        |         |      |  
|                                       |                                                                                       | $              | 50,646 |         |      | $ | 84,414 |        
|                                       |                                                                                       |                |        |         |      |  

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|        |                      
|------- | ---------------------
|Note 6. | Marketable Securities



|                                 |                          |                |        |        |            |   |       |            |  |   |            |        |   |   |        |        | 
|-------------------------------- | ------------------------ | -------------- | ------ | ------ | ---------- | - | ----- | ---------- |  | - | ---------- | ------ | - | - | ------ | ------ | 
|                                 |                          |                |        | Gross  |            |   | Gross |            |  |  
|                                 |                          | Amortized      |        |        | Unrealized |   |       | Unrealized |  |   |           
|December 31, 2004                |                          | Cost           |        |        | Gains      |   |       | (Loss)     |  |   | Fair Value |       
|                                 |                          |                |        |        |            |   |       |            |  |   |            |       
|                                 |                          | (In thousands) |       
|Money market accounts            |                          | $              | 2,780  |        |            | $ |      |            |  | $ |           |        |   | $ | 2,780  |       
|Municipal bonds                  |                          |                | 47,560 |        |            |   |      |            |  |   | (31        | )      |   |   | 47,529 |       
|Corporate debt securities        |                          |                | 14,876 |        |            |   |      |            |  |   | (298       | )      |   |   | 14,578 |       
|Corporate equity securities      |                          |                | 2,802  |        |            |   | 814   |            |  |   | (587       | )      |   |   | 3,029  |       
|Government agency bonds          |                          |                | 24,619 |        |            |   |      |            |  |   | (178       | )      |   |   | 24,441 |       
|                                 |                          |                |        |        |            |   |       |            |  |   |            |       
|                                 | Total available-for-sale |                | $      | 92,637 |            |   | $     | 814        |  |   | $          | (1,094 | ) |   | $      | 92,357 | 
|                                 |                          |                |        |        |            |   |       |            |  |   |            |       
|Classified as:                   |                          |                |        |        |            |   |       |            |  |   |            |        |   |   |        |       
|Cash equivalents                 |                          |                |        |        |            |   |       |            |  |   |            |        |   | $ | 4,167  |       
|Short-term marketable securities |                          |                |        |        |            |   |       |            |  |   |            |        |   |   | 85,161 |       
|Long-term marketable securities  |                          |                |        |        |            |   |       |            |  |   |            |        |   |   | 3,029  |       
|                                 |                          |                |        |        |            |   |       |            |  |   |            |       
|                                 |                          |                |        |        |            |   |       |            |  |   |            |        |   | $ | 92,357 |       
|                                 |                          |                |        |        |            |   |       |            |  |   |            |       

|                                 |                          |                |        |         |            |   |       |            |  |   |            |      |   |   |         |         | 
|-------------------------------- | ------------------------ | -------------- | ------ | ------- | ---------- | - | ----- | ---------- |  | - | ---------- | ---- | - | - | ------- | ------- | 
|                                 |                          |                |        | Gross   |            |   | Gross |            |  |  
|                                 |                          | Amortized      |        |         | Unrealized |   |       | Unrealized |  |   |           
|December 31, 2003                |                          | Cost           |        |         | Gains      |   |       | (Loss)     |  |   | Fair Value |     
|                                 |                          |                |        |         |            |   |       |            |  |   |            |     
|                                 |                          | (In thousands) |       
|Money market accounts            |                          | $              | 10,486 |         |            | $ |      |            |  | $ |           |      |   | $ | 10,486  |        
|Municipal bonds                  |                          |                | 64,120 |         |            |   | 26    |            |  |   |           |      |   |   | 64,146  |        
|Corporate debt securities        |                          |                | 62,575 |         |            |   | 24    |            |  |   | (21        | )    |   |   | 62,578  |        
|Corporate equity securities      |                          |                | 2,626  |         |            |   | 1,618 |            |  |   | (168       | )    |   |   | 4,076   |        
|Government agency bonds          |                          |                | 10,784 |         |            |   | 20    |            |  |   |           |      |   |   | 10,804  |        
|                                 |                          |                |        |         |            |   |       |            |  |   |            |     
|                                 | Total available-for-sale |                | $      | 150,591 |            |   | $     | 1,688      |  |   | $          | (189 | ) |   | $       | 152,090 | 
|                                 |                          |                |        |         |            |   |       |            |  |   |            |     
|Classified as:                   |                          |                |        |         |            |   |       |            |  |   |            |      |   |   |         |        
|Cash equivalents                 |                          |                |        |         |            |   |       |            |  |   |            |      |   | $ | 39,685  |        
|Short-term marketable securities |                          |                |        |         |            |   |       |            |  |   |            |      |   |   | 108,329 |        
|Long-term marketable securities  |                          |                |        |         |            |   |       |            |  |   |            |      |   |   | 4,076   |        
|                                 |                          |                |        |         |            |   |       |            |  |   |            |     
|                                 |                          |                |        |         |            |   |       |            |  |   |            |      |   | $ | 152,090 |        
|                                 |                          |                |        |         |            |   |       |            |  |   |            |     



|                                                    |  |                |        | 
|--------------------------------------------------- |  | -------------- | ------ | 
|                                                    |  | Estimated Fair |       
|December 31, 2004                                   |  | Value          |       
|                                                    |  |                |       
|                                                    |  | (In thousands) |       
|Maturing 90 days or less from purchase              |  | $              | 35,090 | 
|Maturing between 90 days and one year from purchase |  |                | 22,372 | 
|Maturing more than one year from purchase           |  |                | 29,086 | 
|                                                    |  |                |       
|Total available-for-sale debt securities            |  | $              | 86,548 | 
|                                                    |  |                |       



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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






|                            |  |                                |        |                  |                                |   |     |            |                  |   |        |  |  |                  |    |  |        |   |        |  |  |   |       | 
|--------------------------- |  | ------------------------------ | ------ | ---------------- | ------------------------------ | - | --- | ---------- | ---------------- | - | ------ |  |  | ---------------- | -- |  | ------ | - | ------ |  |  | - | ----- | 
|                            |  | In Loss Position for Less than |        |                  | In Loss Position for More Than |   |     |           
|                            |  | 12 Months                      |        |                  | 12 Months                      |   |     | Total      |                 
|                            |  |                                |        |                  |                                |   |     |            |                 
|                            |  |                                |        | Gross Unrealized |                                |   |     |            | Gross Unrealized |   |        |  |  | Gross Unrealized |   
|                            |  | Fair Value                     |        |                  | Losses                         |   |     | Fair Value |                  |   | Losses |  |  | Fair Value       |    |  | Losses |  
|                            |  |                                |        |                  |                                |   |     |            |                  |   |        |  |  |                  |    |  |        |  
|                            |  | (In thousands)                 |        |                  |                                |   |    
|Municipal bonds             |  | $                              | 4,815  |                  |                                | $ | 28  |            |                  | $ | 2,063  |  |  | $                | 4  |  |        | $ | 6,878  |  |  | $ | 32    | 
|Corporate debt securities   |  |                                | 7,075  |                  |                                |   | 204 |            |                  |   | 4,113  |  |  |                  | 93 |  |        |   | 11,188 |  |  |   | 297   | 
|Corporate equity securities |  |                                | 729    |                  |                                |   | 587 |            |                  |   |       |  |  |                  |   |  |        |   | 729    |  |  |   | 587   | 
|Government agency bonds     |  |                                | 20,439 |                  |                                |   | 178 |            |                  |   |       |  |  |                  |   |  |        |   | 20,439 |  |  |   | 178   | 
|                            |  |                                |        |                  |                                |   |     |            |                  |   |        |  |  |                  |    |  |        |  
|                            |  | $                              | 33,058 |                  |                                | $ | 997 |            |                  | $ | 6,176  |  |  | $                | 97 |  |        | $ | 39,234 |  |  | $ | 1,094 | 
|                            |  |                                |        |                  |                                |   |     |            |                  |   |        |  |  |                  |    |  |        |  





|        |            
|------- | -----------
|Note 7. | Investments



| |                                 
| | --------------------------------
| | Best Elite International Limited





| |                  
| | -----------------
| | C-Com Corporation



62



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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






| |                                         
| | ----------------------------------------
| | MosChip Semiconductor Technology Limited





|        |                    
|------- | -------------------
|Note 8. | Inventory Provision









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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|        |                          
|------- | -------------------------
|Note 9. | Non-Operating Income, Net



|                                          |  |                          |       |  |      |   |        |      |  |   |        |  
|----------------------------------------- |  | ------------------------ | ----- |  | ---- | - | ------ | ---- |  | - | ------ | -
|                                          |  | Years Ended December 31, |      
|                                          |  |                          |      
|                                          |  | 2004                     |       |  | 2003 |   |        | 2002 | 
|                                          |  |                          |       |  |      |   |        |      | 
|                                          |  | (In thousands)           |      
|Licensing fee from MediaTek settlement    |  | $                        |      |  |      | $ | 45,000 |      |  | $ |       |  
|Legal fee related to MediaTek settlement  |  |                          |      |  |      |   | (515   | )    |  |   |       |  
|Consulting fees  Taiwanese tax exemption |  |                          |      |  |      |   | (1,500 | )    |  |   |       |  
|Interest income                           |  |                          | 1,971 |  |      |   | 2,486  |      |  |   | 3,586  |  
|Income (loss) on other investments        |  |                          |      |  |      |   | 774    |      |  |   | (189   | )
|Write-down on investments                 |  |                          |      |  |      |   | (1,986 | )    |  |   | (3,612 | )
|Vialta rental income                      |  |                          | 503   |  |      |   | 1,182  |      |  |   | 1,852  |  
|Other                                     |  |                          | 886   |  |      |   | 505    |      |  |   | 770    |  
|                                          |  |                          |       |  |      |   |        |      | 
|Total non-operating income                |  | $                        | 3,360 |  |      | $ | 45,946 |      |  | $ | 2,407  |  
|                                          |  |                          |       |  |      |   |        |      | 



| |                    
| | -------------------
| | MediaTek Settlement





|         |             
|-------- | ------------
|Note 10. | Income Taxes



|         |  |                          |         |   |      |   |        |      |  |   |        |  
|-------- |  | ------------------------ | ------- | - | ---- | - | ------ | ---- |  | - | ------ | -
|         |  | Years Ended December 31, |        
|         |  |                          |        
|         |  | 2004                     |         |   | 2003 |   |        | 2002 | 
|         |  |                          |         |   |      |   |        |      | 
|         |  | (In thousands)           |        
|Domestic |  | $                        | (12,561 | ) |      | $ | (5,211 | )    |  | $ | (2,248 | )
|Foreign  |  |                          | (24,721 | ) |      |   | 46,105 |      |  |   | 40,509 |  
|         |  |                          |         |   |      |   |        |      | 
|         |  | $                        | (37,282 | ) |      | $ | 40,894 |      |  | $ | 38,261 |  
|         |  |                          |         |   |      |   |        |      | 

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|         |         |                          |      |        |        |   |        |        |        |  |       |       |     | 
|-------- | ------- | ------------------------ | ---- | ------ | ------ | - | ------ | ------ | ------ |  | ----- | ----- | --- | 
|         |         | Years Ended December 31, |     
|         |         |                          |     
|         |         | 2004                     |      |        | 2003   |   |        | 2002   |       
|         |         |                          |      |        |        |   |        |        |       
|         |         | (In thousands)           |     
|Current: |         |                          |      |        |        |   |        |        |        |  |       |      
|         | Federal |                          | $    | (1,349 | )      |   | $      | 13,815 |        |  | $     | 1,086 |    
|         | State   |                          |      |       |        |   |        | 2,749  |        |  |       | 11    |    
|         | Foreign |                          |      | 551    |        |   |        | 140    |        |  |       | 141   |    
|         |         |                          |      |        |        |   |        |        |       
|         |         |                          | (798 | )      |        |   | 16,704 |        |        |  | 1,238 |      
|Deferred |         |                          |      |        |        |   |        |        |        |  |       |      
|         | Federal |                          |      | (923   | )      |   |        | (980   | )      |  |       | (224  | )  
|         | State   |                          |      | (11    | )      |   |        | (121   | )      |  |       | (30   | )  
|         |         |                          |      |        |        |   |        |        |       
|         |         |                          | (934 | )      |        |   | (1,101 | )      |        |  | (254  | )    
|         |         |                          |      |        |        |   |        |        |       
|         |         | Total                    |      | $      | (1,732 | ) |        | $      | 15,603 |  |       | $     | 984 | 
|         |         |                          |      |        |        |   |        |        |       



|                                               |  |                          |         |   |      |   |        |      |  |   |         |  
|---------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------ | ---- |  | - | ------- | -
|                                               |  | Years Ended December 31, |        
|                                               |  |                          |        
|                                               |  | 2004                     |         |   | 2003 |   |        | 2002 | 
|                                               |  |                          |         |   |      |   |        |      | 
|                                               |  | (In thousands)           |        
|Provision (benefit) at statutory rate          |  | $                        | (13,049 | ) |      | $ | 14,313 |      |  | $ | 13,047  |  
|Foreign income taxed at different rates        |  |                          | 14,976  |   |      |   | 581    |      |  |   | (15,007 | )
|State income taxes, net of federal tax benefit |  |                          | (2,089  | ) |      |   | 2,351  |      |  |   | 1,745   |  
|General business credit                        |  |                          | (1,670  | ) |      |   | (423   | )    |  |   | (1,111  | )
|Nondeductible research and development costs   |  |                          |        |   |      |   | 1,096  |      |  |   | 99      |  
|Other                                          |  |                          | 100     |   |      |   | (2,315 | )    |  |   | 2,211   |  
|                                               |  |                          |         |   |      |   |        |      | 
|Provision for (benefit from) income taxes      |  | $                        | (1,732  | ) |      | $ | 15,603 |      |  | $ | 984     |  
|                                               |  |                          |         |   |      |   |        |      | 

65



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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                                                                               |                                 |                |        |         |      |   |         |         |  
|------------------------------------------------------------------------------ | ------------------------------- | -------------- | ------ | ------- | ---- | - | ------- | ------- | -
|                                                                               |                                 | December 31,   |       
|                                                                               |                                 |                |       
|                                                                               |                                 | 2004           |        |         | 2003 |  
|                                                                               |                                 |                |        |         |      |  
|                                                                               |                                 | (In thousands) |       
|Current:                                                                       |                                 |                |        |         |      |   |         |        
|Accrued liabilities and reserves                                               |                                 | $              | 1,483  |         |      | $ | 1,055   |        
|Deferred tax asset (liability) arising from unrealized loss on
    investments |                                 |                | 107    |         |      |   | (713    | )      
|Other                                                                          |                                 |                | 1      |         |      |   | 90      |        
|                                                                               |                                 |                |        |         |      |  
|                                                                               | Current deferred tax assets     |                | $      | 1,591   |      |   | $       | 432     |  
|                                                                               |                                 |                |        |         |      |  
|Non-current:                                                                   |                                 |                |        |         |      |   |         |        
|Depreciation and amortization                                                  |                                 | $              | 4,054  |         |      | $ | 3,625   |        
|Acquired intangible assets                                                     |                                 |                | (2,604 | )       |      |   | (4,657  | )      
|Net operating loss carryforwards                                               |                                 |                | 24,304 |         |      |   | 23,907  |        
|Credit carryforwards                                                           |                                 |                | 6,293  |         |      |   | 5,695   |        
|Deferred foreign income                                                        |                                 |                |       |         |      |   | (9,139  | )      
|                                                                               |                                 |                |        |         |      |  
|                                                                               | Non-current deferred tax assets |                |        | 32,047  |      |   |         | 19,431  |  
|                                                                               |                                 |                |        |         |      |  
|                                                                               | Total deferred tax assets       |                |        | 33,638  |      |   |         | 19,863  |  
|                                                                               | Valuation allowance             |                |        | (32,495 | )    |   |         | (31,139 | )
|                                                                               |                                 |                |        |         |      |  
|Net deferred tax assets (liabilities)                                          |                                 | $              | 1,143  |         |      | $ | (11,276 | )      
|                                                                               |                                 |                |        |         |      |  









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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






|         |                            
|-------- | ---------------------------
|Note 11. | Net Income (Loss) Per Share



|                                              |  |                                       |         |   |        |  |           |        |  |   |       |  
|--------------------------------------------- |  | ------------------------------------- | ------- | - | ------ |  | --------- | ------ |  | - | ----- | -
|                                              |  | Net Income                            |         |   |        |  | Per Share |       
|                                              |  | (Loss)                                |         |   | Shares |  |           | Amount | 
|                                              |  |                                       |         |   |        |  |           |        | 
|                                              |  | (In thousands, except per share data) |        
|Year Ended December 31, 2004                  |  |                                       |         |   |        |  |           |        |  |   |       |  
|Basic net loss per share                      |  | $                                     | (35,550 | ) |        |  | 39,476    |        |  | $ | (0.90 | )
|Effects of dilutive securities: Stock options |  |                                       |        |   |        |  |          |        |  |   |      |  
|                                              |  |                                       |         |   |        |  |           |        | 
|Diluted net loss per share                    |  | $                                     | (35,550 | ) |        |  | 39,476    |        |  | $ | (0.90 | )
|                                              |  |                                       |         |   |        |  |           |        | 
|Year Ended December 31, 2003                  |  |                                       |         |   |        |  |           |        |  |   |       |  
|Basic net income per share                    |  | $                                     | 25,291  |   |        |  | 39,517    |        |  | $ | 0.64  |  
|Effects of dilutive securities: Stock options |  |                                       |        |   |        |  | 1,721     |        |  |   | (0.03 | )
|                                              |  |                                       |         |   |        |  |           |        | 
|Diluted net income per share                  |  | $                                     | 25,291  |   |        |  | 41,238    |        |  | $ | 0.61  |  
|                                              |  |                                       |         |   |        |  |           |        | 
|Year Ended December 31, 2002                  |  |                                       |         |   |        |  |           |        |  |   |       |  
|Basic net income per share                    |  | $                                     | 37,277  |   |        |  | 44,044    |        |  | $ | 0.85  |  
|Effects of dilutive securities: Stock options |  |                                       |        |   |        |  | 2,687     |        |  |   | (0.05 | )
|                                              |  |                                       |         |   |        |  |           |        | 
|Diluted net income per share                  |  | $                                     | 37,277  |   |        |  | 46,731    |        |  | $ | 0.80  |  
|                                              |  |                                       |         |   |        |  |           |        | 





|         |                     
|-------- | --------------------
|Note 12. | Shareholders Equity



| |             
| | ------------
| | Common Stock



| |                
| | ---------------
| | Public Offering



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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






| |                 
| | ----------------
| | Stock Repurchase









| |                       
| | ----------------------
| | 1992 Stock Option Plan







| |                           
| | --------------------------
| | 1995 Equity Incentive Plan





| |                                  
| | ---------------------------------
| | 1995 Employee Stock Purchase Plan



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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






| |                                 
| | --------------------------------
| | 1995 Directors Stock Option Plan





| |                           
| | --------------------------
| | 1997 Equity Incentive Plan





| |                                     
| | ------------------------------------
| | 2002 Non-executive Stock Option Plan





| |                           
| | --------------------------
| | Platform Stock Option Plan





| |                            
| | ---------------------------
| | Stock Option Exchange Offer



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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






| |                                 
| | --------------------------------
| | Summary of Stock Option Activity



|                             |            |                |       |        |             |          |       |                |   |   |      |       | 
|---------------------------- | ---------- | -------------- | ----- | ------ | ----------- | -------- | ----- | -------------- | - | - | ---- | ----- | 
|                             |            |                |       |        |             | Weighted |      
|                             |            | Available      |       |        | Options     |          |       | Average        |  
|                             |            | for Grant      |       |        | Outstanding |          |       | Exercise Price |  
|                             |            |                |       |        |             |          |       |                |  
|                             |            | (In thousands) |      
|Balance at December 31, 2001 |            |                | 2,333 |        |             |          | 7,519 |                |   | $ | 8.34 |      
|                             | Authorized |                |       | 4,000  |             |          |       |               |   |   | $    |      | 
|                             | Granted    |                |       | (1,643 | )           |          |       | 1,643          |   |   | $    | 13.39 | 
|                             | Exercised  |                |       |       |             |          |       | (1,203         | ) |   | $    | 6.46  | 
|                             | Canceled   |                |       | 596    |             |          |       | (596           | ) |   | $    | 9.50  | 
|                             |            |                |       |        |             |          |       |                |  
|Balance at December 31, 2002 |            |                | 5,286 |        |             |          | 7,363 |                |   | $ | 9.64 |      
|                             | Authorized |                |       | 1,000  |             |          |       |               |   |   | $    |      | 
|                             | Granted    |                |       | (2,602 | )           |          |       | 2,602          |   |   | $    | 8.96  | 
|                             | Exercised  |                |       |       |             |          |       | (642           | ) |   | $    | 6.04  | 
|                             | Canceled   |                |       | 757    |             |          |       | (757           | ) |   | $    | 10.99 | 
|                             |            |                |       |        |             |          |       |                |  
|Balance at December 31, 2003 |            |                | 4,441 |        |             |          | 8,566 |                |   | $ | 9.58 |      
|                             | Authorized |                |       | 400    |             |          |       |               |   |   | $    |      | 
|                             | Granted    |                |       | (2,055 | )           |          |       | 2,055          |   |   | $    | 12.03 | 
|                             | Exercised  |                |       |       |             |          |       | (275           | ) |   | $    | 5.76  | 
|                             | Canceled   |                |       | 4,784  |             |          |       | (4,784         | ) |   | $    | 13.53 | 
|                             |            |                |       |        |             |          |       |                |  
|Balance at December 31, 2004 |            |                | 7,570 |        |             |          | 5,562 |                |   | $ | 7.29 |      
|                             |            |                |       |        |             |          |       |                |  



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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                         |       |                     |       |          |                     |  |      |          |  |                |                |      |  |          |       |       |  |   |       |      | 
|------------------------ | ----- | ------------------- | ----- | -------- | ------------------- |  | ---- | -------- |  | -------------- | -------------- | ---- |  | -------- | ----- | ----- |  | - | ----- | ---- | 
|                         |       | Options Outstanding |       |          |                    
|                         |       |                     |       |          | Options Exercisable | 
|                         |       |                     |       | Weighted |                     |  |      |          |  |               
|                         |       | Number              |       |          | Average             |  |      | Weighted |  |                | Number         |      |  | Weighted |      
|                         |       | Outstanding at      |       |          | Remaining           |  |      | Average  |  |                | Exercisable at |      |  | Average  |      
|                         |       | December 31,        |       |          | Contractual         |  |      | Exercise |  |                | December 31,   |      |  | Exercise |      
|Range of Exercise Prices |       | 2004                |       |          | Life                |  |      | Price    |  |                | 2004           |      |  | Price    |      
|                         |       |                     |       |          |                     |  |      |          |  |                |                |      |  |          |      
|                         |       | (In thousands)      |       |          | (In years)          |  |      |          |  | (In thousands) |                |      | 
|$ 0.03 - $ 4.70          |       |                     | 243   |          |                     |  | 2.92 |          |  | $              | 3.10           |      |  |          | 221   |       |  | $ | 2.95  |     
|$ 4.71 - $ 4.99          |       |                     | 1,904 |          |                     |  | 3.75 |          |  | $              | 4.88           |      |  |          | 1,749 |       |  | $ | 4.88  |     
|$ 5.00 - $ 7.99          |       |                     | 1,559 |          |                     |  | 8.04 |          |  | $              | 6.98           |      |  |          | 585   |       |  | $ | 6.52  |     
|$ 8.00 - $ 9.99          |       |                     | 1,106 |          |                     |  | 8.49 |          |  | $              | 9.10           |      |  |          | 442   |       |  | $ | 9.02  |     
|$10.00 - $23.25          |       |                     | 750   |          |                     |  | 6.84 |          |  | $              | 12.80          |      |  |          | 511   |       |  | $ | 12.60 |     
|                         |       |                     |       |          |                     |  |      |          |  |                |                |      |  |          |      
|                         | Total |                     |       | 5,562    |                     |  |      | 6.28     |  |                | $              | 7.29 |  |          |       | 3,508 |  |   | $     | 6.68 | 
|                         |       |                     |       |          |                     |  |      |          |  |                |                |      |  |          |      



Note 13.     Business Segment
Information and Concentration of Certain Risks




| |                 
| | ----------------
| | Business Segment





|                |  |                          |      |  |      |  |      |      |  |  |     |  
|--------------- |  | ------------------------ | ---- |  | ---- |  | ---- | ---- |  |  | --- | -
|                |  | Percentage of Net        |     
|                |  | Revenues for Years Ended |     
|                |  | December 31,             |     
|                |  |                          |     
|                |  | 2004                     |      |  | 2003 |  |      | 2002 | 
|                |  |                          |      |  |      |  |      |      | 
|DVD             |  |                          | 54%  |  |      |  | 40%  |      |  |  | 59  | %
|VCD             |  |                          | 27%  |  |      |  | 38%  |      |  |  | 31  | %
|Digital imaging |  |                          | 6%   |  |      |  | 8%   |      |  |  |    |  
|Recordable      |  |                          | 3%   |  |      |  | 6%   |      |  |  |    |  
|Royalty         |  |                          | 8%   |  |      |  | 3%   |      |  |  |    |  
|Other           |  |                          | 2%   |  |      |  | 5%   |      |  |  | 10  | %
|                |  |                          |      |  |      |  |      |      | 
|Total           |  |                          | 100% |  |      |  | 100% |      |  |  | 100 | %
|                |  |                          |      |  |      |  |      |      | 



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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |                    
| | -------------------
| | Geographic Segments



|                             |       |                |         |         |                   |   |        |        | 
|---------------------------- | ----- | -------------- | ------- | ------- | ----------------- | - | ------ | ------ | 
|                             |       | Net Sales      |         |         | Long-Lived Assets |  
|                             |       |                |         |         |                   |  
|                             |       | (In thousands) |        
|Year Ended December 31, 2004 |       |                |         |         |                   |   |        |       
|United States                |       | $              | 2,365   |         |                   | $ | 21,369 |       
|                             |       |                |         |         |                   |  
|Hong Kong                    |       |                | 135,954 |         |                   |   | 630    |       
|Taiwan                       |       |                | 38,683  |         |                   |   | 413    |       
|Japan                        |       |                | 22,489  |         |                   |   |       |       
|China (excluding Hong Kong)  |       |                | 14,466  |         |                   |   | 265    |       
|Korea                        |       |                | 11,730  |         |                   |   | 180    |       
|Turkey                       |       |                | 10,398  |         |                   |   |       |       
|Singapore                    |       |                | 9,409   |         |                   |   |       |       
|Rest of the world            |       |                | 11,784  |         |                   |   | 152    |       
|                             |       |                |         |         |                   |  
|Total foreign                |       |                | 254,913 |         |                   |   | 1,640  |       
|                             |       |                |         |         |                   |  
|                             | Total |                | $       | 257,278 |                   |   | $      | 23,009 | 
|                             |       |                |         |         |                   |  
|Year Ended December 31, 2003 |       |                |         |         |                   |   |        |       
|United States                |       | $              | 1,111   |         |                   | $ | 23,585 |       
|                             |       |                |         |         |                   |  
|Hong Kong                    |       |                | 129,002 |         |                   |   | 671    |       
|Taiwan                       |       |                | 17,836  |         |                   |   | 8      |       
|China (excluding Hong Kong)  |       |                | 10,936  |         |                   |   | 131    |       
|Korea                        |       |                | 8,787   |         |                   |   | 69     |       
|Japan                        |       |                | 8,432   |         |                   |   | 3      |       
|Czech Republic               |       |                | 7,936   |         |                   |   |       |       
|Singapore                    |       |                | 4,156   |         |                   |   |       |       
|Rest of the world            |       |                | 7,077   |         |                   |   | 162    |       
|                             |       |                |         |         |                   |  
|Total foreign                |       |                | 194,162 |         |                   |   | 1,044  |       
|                             |       |                |         |         |                   |  
|                             | Total |                | $       | 195,273 |                   |   | $      | 24,629 | 
|                             |       |                |         |         |                   |  
|Year Ended December 31, 2002 |       |                |         |         |                   |   |        |       
|United States                |       | $              | 2,453   |         |                   | $ | 18,366 |       
|                             |       |                |         |         |                   |  
|Hong Kong                    |       |                | 191,510 |         |                   |   | 619    |       
|Taiwan                       |       |                | 19,346  |         |                   |   |       |       
|Japan                        |       |                | 11,973  |         |                   |   |       |       
|Singapore                    |       |                | 5,244   |         |                   |   |       |       
|Rest of the world            |       |                | 42,916  |         |                   |   |       |       
|                             |       |                |         |         |                   |  
|Total foreign                |       |                | 270,989 |         |                   |   | 619    |       
|                             |       |                |         |         |                   |  
|                             | Total |                | $       | 273,442 |                   |   | $      | 18,985 | 
|                             |       |                |         |         |                   |  



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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |                                       
| | --------------------------------------
| | Significant Customers and Distributors





| |                                    
| | -----------------------------------
| | Transactions with Dynax Electronics







|                                                  |  |                                        |         |   |      |   |         |      |  |   |         |  
|------------------------------------------------- |  | -------------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                  |  | Years Ended December 31,               |        
|                                                  |  |                                        |        
|                                                  |  | 2004                                   |         |   | 2003 |   |         | 2002 | 
|                                                  |  |                                        |         |   |      |   |         |      | 
|                                                  |  | (In thousands, except percentage data) |        
|Net revenues                                      |  | $                                      | 257,278 |   |      | $ | 195,273 |      |  | $ | 273,442 |  
|Net revenues from Dynax Electronics               |  | $                                      | 131,684 |   |      | $ | 122,701 |      |  | $ | 156,963 |  
|Percentage of net revenues from Dynax Electronics |  |                                        | 51      | % |      |   | 63      | %    |  |   | 57      | %





|                                                               |  |                       |        |   |      |   |        |  
|-------------------------------------------------------------- |  | --------------------- | ------ | - | ---- | - | ------ | -
|                                                               |  | December 31,          |       
|                                                               |  |                       |       
|                                                               |  | 2004                  |        |   | 2003 |  
|                                                               |  |                       |        |   |      |  
|                                                               |  | (In thousands, except |       
|                                                               |  | percentage data)      |       
|Trade accounts receivable                                      |  | $                     | 21,881 |   |      | $ | 50,316 |  
|Trade accounts receivable from Dynax Electronics               |  | $                     | 15,827 |   |      | $ | 36,605 |  
|Percentage of trade accounts receivable from Dynax Electronics |  |                       | 72     | % |      |   | 73     | %



|         |                                             
|-------- | --------------------------------------------
|Note 14. | Related Party Transactions with Vialta, Inc.



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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






|                                                                                                       |  |                          |       |   |      |   |       |      |  |   |       |  
|------------------------------------------------------------------------------------------------------ |  | ------------------------ | ----- | - | ---- | - | ----- | ---- |  | - | ----- | -
|                                                                                                       |  | Transactions Between     |      
|                                                                                                       |  | ESS and Vialta           |      
|                                                                                                       |  |                          |      
|                                                                                                       |  | Years Ended December 31, |      
|                                                                                                       |  |                          |      
|                                                                                                       |  | 2004                     |       |   | 2003 |   |       | 2002 | 
|                                                                                                       |  |                          |       |   |      |   |       |      | 
|                                                                                                       |  | (In thousands)           |      
|Selling, general, administrative and other services provided to
    Vialta, net of charges from Vialta |  | $                        | 10    |   |      | $ | 70    |      |  | $ | (38   | )
|Lease charges to Vialta under Real Estate Matters Agreement                                            |  |                          | 503   |   |      |   | 1,182 |      |  |   | 1,852 |  
|Chip purchases by Vialta                                                                               |  |                          | 782   |   |      |   | 458   |      |  |   | 1,403 |  
|Products purchased from Vialta                                                                         |  |                          | (22   | ) |      |   | (2    | )    |  |   | (61   | )
|                                                                                                       |  |                          |       |   |      |   |       |      | 
|Total charges to Vialta, net of charges from Vialta                                                    |  | $                        | 1,273 |   |      | $ | 1,708 |      |  | $ | 3,156 |  
|                                                                                                       |  |                          |       |   |      |   |       |      | 





|         |                              
|-------- | -----------------------------
|Note 15. | Commitments and Contingencies



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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                         |  |        |       | 
|------------------------ |  | ------ | ----- | 
|Year Ending December 31, |  | Amount |      
|                         |  |        |      
|2005                     |  | $      | 2,854 | 
|2006                     |  |        | 822   | 
|2007                     |  |        | 145   | 
|2008                     |  |        | 16    | 
|                         |  |        |      
|Total                    |  | $      | 3,837 | 
|                         |  |        |      











|         |                      
|-------- | ---------------------
|Note 16. | Employee Benefit Plan



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|   |                              
|-- | -----------------------------
|2. | Financial Statement Schedule:

VALUATION AND QUALIFYING ACCOUNTS


|                             |                                 |                |   |           |            |  |   |            |  |            |        |       |  |  |   |       | 
|---------------------------- | ------------------------------- | -------------- | - | --------- | ---------- |  | - | ---------- |  | ---------- | ------ | ----- |  |  | - | ----- | 
|                             |                                 |                |   | Additions |            |  |   |            | 
|                             |                                 | Balance at     |   |           | Charged to |  |   |            |  | Balance at |       
|                             |                                 | Beginning      |   |           | Costs and  |  |   |            |  | Ending of  |       
|                             |                                 | of Period      |   |           | Expenses   |  |   | Deductions |  |            | Period |      
|                             |                                 |                |   |           |            |  |   |            |  |            |        |      
|                             |                                 | (In thousands) |  
|Year Ended December 31, 2004 |                                 |                |   |           |            |  |   |            |  |            |        |       |  |  |   |      
|                             | Allowance for doubtful accounts |                | $ | 990       |            |  | $ | 176        |  |            | $      | 379   |  |  | $ | 787   | 
|                             | Allowance for sales returns     |                | $ | 1,711     |            |  | $ | 653        |  |            | $      | 1,607 |  |  | $ | 757   | 
|Year Ended December 31, 2003 |                                 |                |   |           |            |  |   |            |  |            |        |       |  |  |   |      
|                             | Allowance for doubtful accounts |                | $ | 949       |            |  | $ | 369        |  |            | $      | 328   |  |  | $ | 990   | 
|                             | Allowance for sales returns     |                | $ | 1,048     |            |  | $ | 1,324      |  |            | $      | 661   |  |  | $ | 1,711 | 
|Year Ended December 31, 2002 |                                 |                |   |           |            |  |   |            |  |            |        |       |  |  |   |      
|                             | Allowance for doubtful accounts |                | $ | 899       |            |  | $ | 50         |  |            | $      |      |  |  | $ | 949   | 
|                             | Allowance for sales returns     |                | $ | 1,430     |            |  | $ | 1,008      |  |            | $      | 1,390 |  |  | $ | 1,048 | 



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|   |                    
|-- | -------------------
|3. | Supplementary Data:

Selected Quarterly Financial Data (unaudited)




|                                                        |                                     |                                       |        |        |         |   |        |          |  |   |         |        |  |         |        |        |         |   |        |          |  |   |         |        |  |   |         |        |   |   |         |        |  
|------------------------------------------------------- | ----------------------------------- | ------------------------------------- | ------ | ------ | ------- | - | ------ | -------- |  | - | ------- | ------ |  | ------- | ------ | ------ | ------- | - | ------ | -------- |  | - | ------- | ------ |  | - | ------- | ------ | - | - | ------- | ------ | -
|                                                        |                                     | 2003                                  |        |        | 2004    |  
|                                                        |                                     |                                       |        |        |         |  
|                                                        |                                     | Mar. 31                               |        |        | Jun. 30 |   |        | Sept. 30 |  |   | Dec. 31 |        |  | Mar. 31 |        |        | Jun. 30 |   |        | Sept. 30 |  |   | Dec. 31 |       
|                                                        |                                     |                                       |        |        |         |   |        |          |  |   |         |        |  |         |        |        |         |   |        |          |  |   |         |       
|                                                        |                                     | (In thousands, except per share data) |       
|Statement of Operations Data:                           |                                     |                                       |        |        |         |   |        |          |  |   |         |        |  |         |        |        |         |   |        |          |  |   |         |        |  |   |         |        |   |   |         |       
|Net revenues                                            |                                     | $                                     | 33,151 |        |         | $ | 31,011 |          |  | $ | 48,243  |        |  | $       | 82,868 |        |         | $ | 76,745 |          |  | $ | 76,813  |        |  | $ | 60,611  |        |   | $ | 43,109  |       
|Cost of revenues(1)                                     |                                     |                                       | 23,376 |        |         |   | 20,982 |          |  |   | 33,281  |        |  |         | 55,051 |        |         |   | 53,332 |          |  |   | 53,921  |        |  |   | 64,504  |        |   |   | 47,640  |       
|                                                        |                                     |                                       |        |        |         |   |        |          |  |   |         |        |  |         |        |        |         |   |        |          |  |   |         |       
|                                                        | Gross profit (loss)                 |                                       |        | 9,775  |         |   |        | 10,029   |  |   |         | 14,962 |  |         |        | 27,817 |         |   |        | 23,413   |  |   |         | 22,892 |  |   |         | (3,893 | ) |   |         | (4,531 | )
|Operating expenses:                                     |                                     |                                       |        |        |         |   |        |          |  |   |         |        |  |         |        |        |         |   |        |          |  |   |         |        |  |   |         |        |   |   |         |       
|                                                        | Research and development            |                                       |        | 6,256  |         |   |        | 8,750    |  |   |         | 11,360 |  |         |        | 9,508  |         |   |        | 9,293    |  |   |         | 10,537 |  |   |         | 9,017  |   |   |         | 8,620  |  
|                                                        | Selling, general and administrative |                                       |        | 6,674  |         |   |        | 6,660    |  |   |         | 8,874  |  |         |        | 9,553  |         |   |        | 11,742   |  |   |         | 9,766  |  |   |         | 10,179 |   |   |         | 9,369  |  
|                                                        |                                     |                                       |        |        |         |   |        |          |  |   |         |        |  |         |        |        |         |   |        |          |  |   |         |       
|Operating income (loss)                                 |                                     |                                       | (3,155 | )      |         |   | (5,381 | )        |  |   | (5,272  | )      |  |         | 8,756  |        |         |   | 2,378  |          |  |   | 2,589   |        |  |   | (23,089 | )      |   |   | (22,520 | )     
|Non-operating income, net                               |                                     |                                       | 944    |        |         |   | 44,187 |          |  |   | (659    | )      |  |         | 1,474  |        |         |   | 1,162  |          |  |   | 812     |        |  |   | 724     |        |   |   | 662     |       
|                                                        |                                     |                                       |        |        |         |   |        |          |  |   |         |        |  |         |        |        |         |   |        |          |  |   |         |       
|Income (loss) before income taxes                       |                                     |                                       | (2,211 | )      |         |   | 38,806 |          |  |   | (5,931  | )      |  |         | 10,230 |        |         |   | 3,540  |          |  |   | 3,401   |        |  |   | (22,365 | )      |   |   | (21,858 | )     
|Provision for (benefit from) income taxes               |                                     |                                       | (98    | )      |         |   | 22,905 |          |  |   | (8,680  | )      |  |         | 1,476  |        |         |   | 233    |          |  |   | 224     |        |  |   | (1,189  | )      |   |   | (1,000  | )     
|                                                        |                                     |                                       |        |        |         |   |        |          |  |   |         |        |  |         |        |        |         |   |        |          |  |   |         |       
|Net income (loss) from continuing operations            |                                     |                                       | (2,113 | )      |         |   | 15,901 |          |  |   | 2,749   |        |  |         | 8,754  |        |         |   | 3,307  |          |  |   | 3,177   |        |  |   | (21,176 | )      |   |   | (20,858 | )     
|                                                        |                                     |                                       |        |        |         |   |        |          |  |   |         |        |  |         |        |        |         |   |        |          |  |   |         |       
|Net income (loss)                                       |                                     | $                                     | (2,113 | )      |         | $ | 15,901 |          |  | $ | 2,749   |        |  | $       | 8,754  |        |         | $ | 3,307  |          |  | $ | 3,177   |        |  | $ | (21,176 | )      |   | $ | (20,858 | )     
|                                                        |                                     |                                       |        |        |         |   |        |          |  |   |         |        |  |         |        |        |         |   |        |          |  |   |         |       
|Net income (loss) per share:                            |                                     |                                       |        |        |         |   |        |          |  |   |         |        |  |         |        |        |         |   |        |          |  |   |         |        |  |   |         |        |   |   |         |       
|                                                        | Basic                               |                                       | $      | (0.05  | )       |   | $      | 0.41     |  |   | $       | 0.07   |  |         | $      | 0.22   |         |   | $      | 0.08     |  |   | $       | 0.08   |  |   | $       | (0.54  | ) |   | $       | (0.53  | )
|                                                        |                                     |                                       |        |        |         |   |        |          |  |   |         |        |  |         |        |        |         |   |        |          |  |   |         |       
|                                                        | Diluted                             |                                       | $      | (0.05  | )       |   | $      | 0.40     |  |   | $       | 0.07   |  |         | $      | 0.21   |         |   | $      | 0.08     |  |   | $       | 0.08   |  |   | $       | (0.54  | ) |   | $       | (0.53  | )
|                                                        |                                     |                                       |        |        |         |   |        |          |  |   |         |        |  |         |        |        |         |   |        |          |  |   |         |       
|Shares used in calculating net income (loss) per share: |                                     |                                       |        |        |         |   |        |          |  |   |         |        |  |         |        |        |         |   |        |          |  |   |         |        |  |   |         |        |   |   |         |       
|                                                        | Basic                               |                                       |        | 41,662 |         |   |        | 38,683   |  |   |         | 38,694 |  |         |        | 39,014 |         |   |        | 39,305   |  |   |         | 39,439 |  |   |         | 39,529 |   |   |         | 39,629 |  
|                                                        |                                     |                                       |        |        |         |   |        |          |  |   |         |        |  |         |        |        |         |   |        |          |  |   |         |       
|                                                        | Diluted                             |                                       |        | 41,662 |         |   |        | 39,842   |  |   |         | 40,579 |  |         |        | 42,169 |         |   |        | 42,657   |  |   |         | 41,732 |  |   |         | 39,529 |   |   |         | 39,629 |  
|                                                        |                                     |                                       |        |        |         |   |        |          |  |   |         |        |  |         |        |        |         |   |        |          |  |   |         |       






|    |                                                                                                                                                         
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Included net inventory provision of $19.3 million and
    $11.1 million in the quarter ended September 30, 2004
    and December 31, 2004, respectively.

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|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosure








|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

Evaluation of Disclosure Controls and Procedures






Managements Report on Internal Control over Financial
Reporting




Changes in Internal Control over Financial Reporting









|         |                  
|-------- | -----------------
|Item 9B. | Other Information






PART III









|         |                                                   
|-------- | --------------------------------------------------
|Item 10. | Directors and Executive Officers of the Registrant



78



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http://www.ESSTECH.com.







|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation








|         |                                                                   
|-------- | ------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial Owners and
    Management





Equity Compensation Plan Information(1)


|                                                           |       |                         |           |           |                      |                      |      |                                 |  |  |           |           | 
|---------------------------------------------------------- | ----- | ----------------------- | --------- | --------- | -------------------- | -------------------- | ---- | ------------------------------- |  |  | --------- | --------- | 
|                                                           |       |                         |           |           |                      | Number of Securities |     
|                                                           |       | Number of Securities to |           |           | Weighted-Average     |                      |      | Remaining Available for Future  | 
|                                                           |       | be Issued upon Exercise |           |           | Exercise Price of    |                      |      | Issuance under Equity           | 
|                                                           |       | of Outstanding Options, |           |           | Outstanding Options, |                      |      | Compensation Plans              | 
|                                                           |       | Warrants and            |           |           | Warrants and         |                      |      | (Excluding Securities Reflected | 
|Plan Category                                              |       | Rights(a)(3)            |           |           | Rights(b)            |                      |      | in Column(a))(c)                | 
|                                                           |       |                         |           |           |                      |                      |      |                                 | 
|Equity compensation plans approved by security holders     |       |                         | 5,164,023 |           |                      | $                    | 7.20 |                                 |  |  | 6,389,726 | (2)      
|Equity compensation plans not approved by security holders |       |                         | 398,098   |           |                      | $                    | 8.37 |                                 |  |  | 1,588,072 |          
|                                                           |       |                         |           |           |                      |                      |      |                                 | 
|                                                           | Total |                         |           | 5,562,121 |                      |                      | $    | 7.29                            |  |  |           | 7,977,798 | 
|                                                           |       |                         |           |           |                      |                      |      |                                 | 






|    |                                                                                                                                                  
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes only options outstanding under ESS stock option
    plans, as no stock warrants or rights were outstanding as of
    December 31, 2004.
|   
|(2) | Includes 451,903 shares of common stock reserved for future
    issuance under the ESS Technology, Inc. 1995 Employee Stock
    Purchase Plan.   
|   
|(3) | Includes outstanding options to purchase 26,146 shares
    of ESS common stock assumed through the acquisition of Platform
    Technologies, Inc.








|         |                                               
|-------- | ----------------------------------------------
|Item 13. | Certain Relationships and Related Transactions








|         |                                       
|-------- | --------------------------------------
|Item 14. | Principal Accountant Fees and Services



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PART IV







|         |                                           
|-------- | ------------------------------------------
|Item 15. | Exhibits and Financial Statement Schedules

Financial Statements




| |                                                                                                                          
| | -------------------------------------------------------------------------------------------------------------------------
| | The consolidated financial statements of the registrant as set
    forth under Item 8 are filed as part of the Form 10-K.

Financial Statement Schedule




| |                                                                                                                                                                                                                         
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The independent registered public accounting firms report
    with respect to the financial statement and financial statement
    schedule listed in Item 15(a)(1) and 15(a)(2) above is on
    page 42 of this Report.

Exhibits




| |                                                                                                                                                     
| | ----------------------------------------------------------------------------------------------------------------------------------------------------
| | The exhibits listed in the accompanying Index to Exhibits are
    filed or incorporated by reference as part of this Annual Report
    on Form 10-K.

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SIGNATURES






| |                     
| | --------------------
| | ESS TECHNOLOGY, INC.
| | (Registrant)        



| |     |                    
| | --- | -------------------
| | By: | /s/ ROBERT L. BLAIR

| |                                      
| | -------------------------------------
| |                                      
| | Robert L. Blair                      
| | President and Chief Executive Officer



POWER OF ATTORNEY






|                                       |  |                                                                                                                                               |  |                |  | 
|-------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- |  | 
|Signature                              |  | Title                                                                                                                                         |  | Date          
|                                       |  |                                                                                                                                               |  |               
|                                      
|/s/ ROBERT L. BLAIRRobert
    L. Blair |  | President and Chief Executive Officer (principal executive
    officer)                                                                       |  | March 16, 2005
|                                      
|/s/ JAMES B. BOYDJames
    B. Boyd     |  | Chief Financial Officer, Senior Vice President and Assistant
    Secretary (principal financial officer and
    principal accounting officer) |  | March 16, 2005
|                                      
|/s/ FRED S.L. CHANFred
    S.L. Chan   |  | Chairman of the Board of Directors                                                                                                            |  | March 16, 2005
|                                      
|/s/ GARY L. FISCHERGary
    L. Fischer |  | Director                                                                                                                                      |  | March 16, 2005
|                                      
|/s/ DAVID S. LEEDavid
    S. Lee       |  | Director                                                                                                                                      |  | March 16, 2005
|                                      
|/s/ PETER T. MOKPeter
    T. Mok       |  | Director                                                                                                                                      |  | March 16, 2005
|                                      
|/s/ ALFRED J. STEINAlfred
    J. Stein |  | Director                                                                                                                                      |  | March 16, 2005

81



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INDEX TO EXHIBITS


|        |    |     |               |                                                                                                                                                                                                                                                                                                                                                                                      
|------- | -- | --- | ------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |     |              
|Number  |    |     | Exhibit Title
|        |    |     |              
|        | 2  | .04 |               | Master Distribution Agreement between the Registrant and Vialta,
    Inc. dated August 20, 2001, incorporated herein by
    reference to Exhibit 2.04 to the Registrants Current
    Report on Form 8-K (file no. 000-26660) filed September 5,
    2001.                                                                                                                           
|       
|        | 2  | .05 |               | Agreement and Plan of Merger dated June 9, 2003, by and
    among the Registrant, Pictos Technologies, Inc. and Pictos
    Acquisition Corporation, incorporated herein by reference to
    Exhibit 2.1 to the Registrants Current Report on From
    8-K (file no. 000-26660) filed June 24, 2003.                                                                                 
|       
|        | 2  | .06 |               | Agreement and Plan of Merger dated August 15, 2003, by and
    among the Registrant, Divio, Inc. and Divio Acquisition
    Corporation, incorporated herein by reference to
    Exhibit 2.1 to the Registrants Current Report on Form
    8-K (file no. 000-26660) filed September 2, 2003.                                                                                         
|       
|        | 3  | .01 |               | Registrants Articles of Incorporation, incorporated herein
    by reference to Exhibit 3.01 to the Registrants
    Form S-1 registration statement (file no. 33-95388)
    declared effective by the Securities and Exchange Commission on
    October 5, 1995 (the Form S-1).                                                                                                   
|       
|        | 3  | .02 |               | Registrants Bylaws as amended, incorporated herein by
    reference to Exhibit 3.02 to the Registrants Annual
    Report on Form 10-K for the year ended December 31, 1998
    (file no. 000-26660) filed on March 31, 1999.                                                                                                                                                       
|       
|        | 4  |     |               | Registrants Registration Rights Agreement dated
    May 28, 1993, by and among the Registrant and certain
    shareholders, incorporated herein by reference to
    Exhibit 10.07 to the Form S-1 (file no. 33-95388).                                                                                                                                                              
|       
|        | 10 | .1  |               | Registrants Amended 401(k) Plan, incorporated herein by
    reference to Exhibit 10.06 to the Form S-1 (file no.
    33-95388).*                                                                                                                                                                                                                                                    
|       
|        | 10 | .2  |               | Form of Indemnity Agreement entered into by Registrant with each
    of its directors and executive officers, incorporated herein by
    reference to Exhibit 10.11 to the Form S-1 (file no.
    33-95388).                                                                                                                                                                         
|       
|        | 10 | .3  |               | Option I Agreement between the Registrant and Taiwan
    Semiconductor Manufacturing Co., Ltd. (TSMC) dated
    November 30, 1995, as amended December 28, 1995,
    incorporated herein by reference to Exhibit 10.21 to the
    Registrants Annual Report on Form 10-K, dated
    February 29, 1996 as amended March 29, 1996 (file no.
    000-26660) (the 1995 Form 10-K).**
|       
|        | 10 | .4  |               | Option II Agreement between the Registrant and TSMC dated
    November 30, 1995, incorporated herein by reference to
    Exhibit 10.22 to the 1995 Form 10-K (file
    no. 000-26660).**                                                                                                                                                                                             
|       
|        | 10 | .5  |               | Foundry Venture Agreement between the Registrant and United
    Microelectronics Corporation (UMC) dated
    November 28, 1995, as amended January 31, 1996,
    incorporated herein by reference to Exhibit 10.23 to the
    1995 Form 10-K (file no. 000-26660).**                                                                                                               
|       
|        | 10 | .6  |               | 1995 Employee Stock Purchase Plan amended and restated as of
    April 26, 2003, incorporated herein by reference to
    Exhibit 10.49 to the Registrants Quarterly Report on
    Form 10-Q (file no. 000-26660) filed August 14, 2003.                                                                                                                                             
|       
|        | 10 | .7  |               | Master Technology Ownership and License Agreement between the
    Registrant and Vialta, Inc. dated August 20, 2001,
    incorporated herein by reference to Exhibit 10.38 to the
    Registrants Current Report on Form 8-K (file no.
    000-26660) filed September 5, 2001.                                                                                                      
|       
|        | 10 | .8  |               | Employee Matters Agreement between the Registrant and Vialta,
    Inc. dated August 20, 2001, incorporated herein by
    reference to Exhibit 10.39 to the Registrants Current
    Report on Form 8-K (file no. 000-26660) filed September 5,
    2001.                                                                                                                             
|       
|        | 10 | .9  |               | Tax Sharing and Indemnity Agreement between the Registrant and
    Vialta, Inc. dated August 20, 2001, incorporated herein by
    reference to Exhibit 10.40 to the Registrants Current
    Report on Form 8-K (file no. 000-26660) filed September 5,
    2001.                                                                                                                    
|       
|        | 10 | .10 |               | Real Estate Matters Agreement between the Registrant and Vialta,
    Inc. dated August 20, 2001, incorporated herein by
    reference to Exhibit 10.41 to the Registrants Current
    Report on Form 8-K (file no. 000-26660) filed September 5,
    2001.                                                                                                                          
|       
|        | 10 | .11 |               | Master Confidential Disclosure Agreement between the Registrant
    and Vialta, Inc. dated August 20, 2001, incorporated herein
    by reference to Exhibit 10.42 to the Registrants
    Current Report on Form 8-K (file no. 000-26660) filed
    September 5, 2001.                                                                                                               

82



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|        |    |     |               |                                                                                                                                                                                                                                                                                                                                             
|------- | -- | --- | ------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |     |              
|Number  |    |     | Exhibit Title
|        |    |     |              
|       
|        | 10 | .12 |               | Master Transitional Services Agreement between the Registrant
    and Vialta, Inc, incorporated herein by reference to
    Exhibit 10.43 to the Registrants Current Report on
    Form 8-K (file no. 000-26660) filed with the SEC on
    September 5, 2001.                                                                               
|       
|        | 10 | .13 |               | Registrants 1997 Equity Incentive Plan, amended and
    restated as of April 26, 2003, incorporated herein by
    reference to Exhibit 10.50 to the Registrants
    Quarterly Report on Form 10-Q (file no. 000-26660) filed
    August 14, 2003.                                                                                         
|       
|        | 10 | .14 |               | Registrants 2002 Non-Executive Stock Option Plan dated
    May 22, 2002, incorporated herein by reference to
    Exhibits 99.1 to the Form S-8 (file no. 333-89942) filed on
    June 6, 2002.*                                                                                                                                            
|       
|        | 10 | .15 |               | Joint Development Agreement dated December 14, 2001,
    incorporated herein by reference to Exhibit 10.50 to the
    Registrants Annual Report on Form 10-K (file no.
    000-26660) filed March 31, 2003.**                                                                                                                              
|       
|        | 10 | .16 |               | Amendment to Joint Development Agreement dated January 18,
    2003, incorporated herein by reference to Exhibit 10.51 to
    the Registrants Annual Report on Form 10-K (file no.
    000-26660) filed March 31, 2003.**                                                                                                                  
|       
|        | 10 | .17 |               | License Agreement and Mutual Release dated June 11, 2003,
    by and among the Registrant, ESS Technology International, Inc.
    and MediaTek Incorporation, incorporated herein by reference to
    Exhibit 10.51 to the Registrants Quarterly Report on
    Form 10-Q (file no. 000-26660) filed August 14, 2003.**                     
|       
|        | 10 | .18 |               | Addendum to the License Agreement and Mutual Release dated
    July 8, 2003, by and among the Registrant, ESS Technology
    International, Inc. and MediaTek Incorporation, incorporated
    herein by reference to Exhibit 10.52 to the
    Registrants Quarterly Report on Form 10-Q (file no.
    000-26660) filed November 14, 2003.**
|       
|        | 10 | .19 |               | First Amendment to the Amended and Restated Commercial Lease
    Agreement dated July 1, 2003, by and between ESS
    Technology, Inc. and Vialta, Inc., incorporated herein by
    reference to Exhibit 10.55 to the Annual Report on
    Form 10-K (file no. 000-26660) filed on March 15,
    2004.                                      
|       
|        | 10 | .20 |               | Registrants 1995 Equity Incentive Plan amended and
    restated as of January 25, 2003, incorporated herein by
    reference to Exhibit 10.57 to the Quarterly Report on Form
    10-Q (file no. 000-26660) filed on November 9, 2004.*                                                                                                    
|       
|        | 10 | .21 |               | Form of Stock Option Agreement under Registrants 1995
    Equity Incentive Plan, incorporated herein by reference to
    Exhibit 10.58 to the Quarterly Report on Form 10-Q (file
    no. 000-26660) filed on November 9, 2004.*                                                                                                           
|       
|        | 10 | .22 |               | Form of Stock Option Agreement under Registrants 1997
    Equity Incentive Plan, incorporated herein by reference to
    Exhibit 10.59 to the Quarterly Report on Form 10-Q (file
    no. 000-26660) filed on November 9, 2004.*                                                                                                           
|       
|        | 10 | .23 |               | Form of Directors Nonqualified Initial Stock Option Grant
    Agreement under Registrants 1995 Directors
    Stock Option Plan, incorporated herein by reference to
    Exhibit 10.60 to the Quarterly Report on Form 10-Q (file
    no. 000-26660) filed on November 9, 2004.*                                                           
|       
|        | 10 | .24 |               | Form of Directors Nonqualified Succeeding Stock Option Grant
    Agreement under Registrants 1995 Directors
    Stock Option Plan, incorporated herein by reference to
    Exhibit 10.61 to the Quarterly Report on Form 10-Q (file
    no. 000-26660) filed on November 9, 2004.*                                                        
|       
|        | 10 | .25 |               | Registrants 1995 Directors Stock Option Plan,
    incorporated herein by reference to Exhibit 10.62 to the
    Current Report on Form 8-K (file no. 000-26660) filed on
    November 30, 2004.*                                                                                                                                           
|       
|        | 10 | .26 |               | Form of Directors Nonqualified Initial Stock Option Grant
    Agreement under Registrants 1995 Directors
    Stock Option Plan, amended effective November 23, 2004,
    incorporated herein by reference to Exhibit 10.63 to the
    Current Report on Form 8-K (file no. 000-26660) filed on
    November 30, 2004.*                    
|       
|        | 10 | .27 |               | Form of Directors Nonqualified Succeeding Stock Option Grant
    Agreement Registrants 1995 Directors Stock
    Option Plan, amended effective November 23, 2004,
    incorporated herein by reference to Exhibit 10.64 to the
    Current Report on Form 8-K (file no. 000-26660) filed on
    November 30, 2004.*                       

83



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##### Table of Contents



|        |    |     |               |                                                                                                                                                                                                                                                                                                                                                  
|------- | -- | --- | ------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |     |              
|Number  |    |     | Exhibit Title
|        |    |     |              
|       
|        | 10 | .28 |               | Form of Stock Option Agreement under Registrants 1995
    Equity Incentive Plan, 1997 Equity Incentive Plan and 2002
    Non-Executive Stock Option Plan, amended effective
    November 23, 2004, incorporated herein by reference to
    Exhibit 10.65 to the Current Report on Form 8-K (file no.
    000-26660) filed on November 30, 2004.*
|       
|        | 10 | .29 |               | Form of Acceleration Agreement for Directors*                                                                                                                                                                                                                                                                                                    
|       
|        | 10 | .30 |               | Form of Acceleration Agreement for Officers*                                                                                                                                                                                                                                                                                                     
|       
|        | 11 |     |               | Computation of Net Income Per Share                                                                                                                                                                                                                                                                                                              
|       
|        | 21 |     |               | List of Registrants subsidiaries.                                                                                                                                                                                                                                                                                                               
|       
|        | 23 |     |               | Consent of Independent Registered Public Accounting Firm.                                                                                                                                                                                                                                                                                        
|       
|        | 24 |     |               | Power of Attorney (included on the signature page of this report
    on Form 10-K).                                                                                                                                                                                                                                                              
|       
|        | 31 | .1  |               | Certification of Chief Executive Officer Pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                          
|       
|        | 31 | .2  |               | Certification of Chief Financial Officer Pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                          
|       
|        | 32 | .1  |               | Certification Pursuant to 18 U.S.C. Section 1350, as
    adopted pursuant to Section 906 of the Sarbanes-Oxley Act
    of 2002.                                                                                                                                                                                                                  
|       
|        | 32 | .2  |               | Certification Pursuant to 18 U.S.C. Section 1350, as
    adopted pursuant to Section 906 of the Sarbanes-Oxley Act
    of 2002.                                                                                                                                                                                                                  






| |   |                                                                          
| | - | -------------------------------------------------------------------------
| | * | Represents a management contract or compensatory plan or
    arrangement.



|   |                                                                                                
|-- | -----------------------------------------------------------------------------------------------
|** | Confidential treatment has been granted with respect to certain
    portions of this agreement.

84