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UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549




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Form 10-K

|           |  |                                                                                             
|---------- |  | --------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                             
|þ          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934    
|          
|           |  | For the fiscal year ended December 31,
    2003                                             
|          
|or        
|          
|o          |  | 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



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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(Address of principal executive
    offices) |  | 94538(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)


Indicate by check
mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days.     Yes þ          No o

Indicate by check
mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be
contained, to the best of the registrants knowledge, in
definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to
this
Form 10-K.     o

Indicate by check
mark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the
Act).     Yes þ          No o

The aggregate
market value of the voting and non-voting common equity held by
non-affiliates of the registrant, computed by reference to
$9.75, the closing price of ESS common stock as reported on the
NASDAQ National Market on June 30, 2003, the last business
day of the registrants most recently completed second
fiscal quarter, was approximately $255,185,316. The aggregate
market value of the voting stock held by non-affiliates of the
registrant as of December 31, 2003, based upon the closing
sale price of $17.03, reported by the NASDAQ National Market on
that date, was approximately $475,319,885. Shares of common
stock held by each officer and director and by each person who
owned 5% or more of the registrants outstanding common
stock on that date have been excluded in that such persons may
be deemed to be affiliates. This determination of affiliate
status is not necessarily a conclusive determination for other
purposes.

As of
February 26, 2004, registrant had outstanding
39,325,142 shares of common stock.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the
Proxy Statement for Registrants 2004 Annual Meeting of
Shareholders are incorporated by reference in Part III of
this Report.



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ESS TECHNOLOGY, INC.

2003 FORM 10-K

TABLE OF CONTENTS






|              |  |                                                                                          |    |      |    | 
|------------- |  | ---------------------------------------------------------------------------------------- | -- | ---- | -- | 
|              |  |                                                                                          |    | Page
|              |  |                                                                                          |    |     
|PART I        |  |                                                                                          |    |     
|Item 1.       |  | Business                                                                                 |    |      | 1  | 
|Item 2.       |  | Properties                                                                               |    |      | 12 | 
|Item 3.       |  | Legal Proceedings                                                                        |    |      | 13 | 
|Item 4.       |  | Submission of Matters to a
    Vote of Security Holders                                  |    |      | 14 | 
|PART II       |  |                                                                                          |    |     
|Item 5.       |  | Market for the
    Registrants Common Equity and Related Shareholder
    Matters        |    |      | 15 | 
|Item 6.       |  | Selected Financial Data                                                                  |    |      | 16 | 
|Item 7.       |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operation |    |      | 17 | 
|Item 7A.      |  | Quantitative and Qualitative
    Disclosures about Market Risk                           |    |      | 41 | 
|Item 8.       |  | Financial Statements and
    Supplementary Data                                          |    |      | 43 | 
|Item 9.       |  | Changes in and Disagreements
    with Accountants on Accounting and Financial Disclosure |    |      | 76 | 
|Item 9A.      |  | Controls and Procedures                                                                  |    |      | 76 | 
|PART III      |  |                                                                                          |    |     
|Item 10.      |  | Directors and Executive
    Officers of the Registrant                                   |    |      | 77 | 
|Item 11.      |  | Executive Compensation                                                                   |    |      | 77 | 
|Item 12.      |  | Security Ownership of
    Certain Beneficial Owners and Management                       |    |      | 77 | 
|Item 13.      |  | Certain Relationships and
    Related Transactions                                       |    |      | 78 | 
|Item 14.      |  | Principal Accountant Fees
    and Services                                               |    |      | 78 | 
|PART IV       |  |                                                                                          |    |     
|Item 15.      |  | Exhibits, Financial
    Statement Schedules, and Reports on Form 8-K                     |    |      | 78 | 
|Signatures    |  |                                                                                          | 84 |     
|EXHIBIT 10.55
|EXHIBIT 11   
|EXHIBIT 21   
|EXHIBIT 23.1 
|EXHIBIT 31.1 
|EXHIBIT 31.2 
|EXHIBIT 32.1 
|EXHIBIT 32.2 



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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
Operation and elsewhere in this Report. References herein
to 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.




PART I






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

We are a leading designer, developer and marketer
of highly integrated analog and digital processor chips, imaging
sensor chips, digital amplifiers, and camera lens modules. Our
digital processor chips are the primary processors driving
digital video and audio devices, including DVD, Video CD
(VCD), digital cameras, digital camcorders, consumer
digital audio players, and digital media players. Our imaging
chips utilize advanced Complimentary Metal Oxide Semiconductor
(CMOS) sensor technology to capture an image for
digital still cameras and cellular camera phone applications.
Our camera lens modules are made up of a lens, image sensor
chip, housing and flex cable necessary to provide camera
capabilities to electronic devices such as cellular phones and
Personal Digital Assistants (PDAs). Our digital
amplifiers boost the digital sound to a level required to drive
loudspeakers, in such applications as DVD and CD players, home
theater systems, audio receivers, boom boxes and televisions
sets. We have also developed encoding processors to address the
growing demand for digital video recorders (DVRs),
recordable DVD players, digital still cameras and digital
camcorders. We believe that multi-featured DVD, DVR and
recordable DVD players will serve as a platform for the digital
home system (DHS), integrating various digital home
entertainment and information delivery products into a single
box. We are also a supplier of chips for use in modems, other
communication devices, and PC audio products. Our chips use
multiple processors and a programmable architecture that enable
us to offer a broad array of features and functionality. We
outsource all of our chip fabrication and assembly as well as
the majority of our test operations, allowing us to focus on our
design and development strengths.

We market our products worldwide through our
direct sales force, distributors and sales representatives.
Substantially all of our sales are to customers in Hong Kong,
Taiwan, China, Korea, Japan, and the Czech Republic. We employ
sales and support personnel located outside of the United States
in China, Hong Kong, Taiwan, Japan and Korea to support these
international sales efforts. We expect that international sales
will continue to represent a significant portion of our net
revenue. In addition, substantially all of our products are
manufactured, assembled and tested by independent third parties
in Asia. We also have a limited number of employees engaged in
research and development efforts outside of the United States.
There are special risks associated with conducting business
outside of the United States. See Item 7, Factors
That May Affect Future Results  We have significant
international sales and operations that are subject to the
special risks of doing business outside the United States.

We were incorporated in California in 1984 and
became a public company in 1995. In April 1999, we expanded our
business beyond the semiconductor segment by establishing
Vialta, Inc. (Vialta), a subsidiary that would
operate in the internet segment. In April 2001, our Board of
Directors adopted a plan to distribute to our shareholders all
of our shares in Vialta. The Vialta spin-off was completed on
August 21, 2001. See

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Note 6, Discontinued Operation,
and Note 15, Related Party Transactions with Vialta,
Inc., to the consolidated financial statements in
Item 8 of this Report. On June 9, 2003, we acquired
100% of the outstanding shares of Pictos Technologies, Inc., a
Delaware corporation (Pictos). On August 15,
2003, we acquired 100% of the outstanding shares of Divio, Inc.,
a California corporation (Divio). See Note 5,
Acquisition and Related Charges, to the consolidated
financial statements in Item 8 of this Report.


Industry Background

The conversion of analog to digital technology is
creating a revolution in audio and video consumer electronics.
Digital technology continues to improve the consumer
entertainment experience with such products as large screen
televisions, multi-featured DVD players, home theater systems,
navigational systems, digital still cameras, camera enabled
cellular phones, and digital camcorders. Technology advancements
have enhanced the clarity, color, sound, functionality and
convenience of consumer entertainment products. In particular,
the transition from analog to digital formats has allowed audio
and video data to be compressed with little or no perceptible
audio and image degradation, improving storage and transmission
efficiency. Digital formats provide users with several benefits,
including greatly expanded content selection, accelerated
transmission of video and audio content, random access to data,
superior editing capabilities and enhanced security features
such as protection against unauthorized copying.

The television, the telephone and the personal
computer (PC) have emerged as the three principal
systems that manage digital entertainment and information. The
television and the PC are the principal devices for viewing and
manipulating digital content. Digital Set-Top Boxes, DVD players
and game consoles connected to televisions are emerging as the
principal platforms for viewing and listening to entertainment,
while PCs remain the principle platform for storing, and
manipulating data and accessing the internet. The cellular phone
is emerging as the principal mobile device for viewing and
transmitting digital content. However, because of size
limitations for screens and keypads other mobile devices such as
PDAs, MPEG Audio Layer  3 (MP3s) players,
and portable DVD players also enjoy sizable end markets.

Increasing advances in semiconductor technology
are allowing digital products to converge, resulting in cost
savings and added convenience for consumers. At the same time,
advances in communication allow better distribution of
information and entertainment content and provide opportunities
for further development of multimedia products. As digital
processing and transmission technology improves, we believe
additional entertainment products will continue to be introduced.

Some of the more significant digital
entertainment products available today include:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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 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 VCRs, 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.                                                                                                                                                                                                                                                                                                                                                                                 

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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.
|
| |  | Digital Still Cameras (DSCs).DSCs use a CMOS chip or charged
    coupled device (CCD) technology to capture light
    coming into the camera lens and convert it into digital
    information that is compressed and stored in memory until the
    information is downloaded into a computer or DVR. Our CMOS image
    sensor chips capture the light and our image processor chips
    process the digital information into pictures that digital
    display devices such as PCs, televisions equipped with digital
    media cards, and DVD and VCD players can display.                                           
|
| |  | Camera Enabled Cellular
    Phones.Camera enabled cellular phones
    use a lens module made up of a lens, 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.                                                                                                                                                        

As digital entertainment products converge and
become increasingly complex, makers of these consumer electronic
devices increasingly require sophisticated semiconductor chips
that are multi-featured, adaptable and cost-effective.
Companies, such as ESS, which provide a highly integrated chip
with multiple processors and a programmable architecture to
address the needs of the latest entertainment products, are well
positioned to benefit from growth in these markets.

Our Solution

Our chips are the primary processors driving
multi-featured video, audio and imaging products, and
incorporate the latest video standards including MPEG1, MPEG2
and MPEG4. Our chips use multiple processors and a programmable
architecture that enable us to offer a broad array of features
and functionality. Our decoder chips play DVD, VCD, MPEG4, CD,
MP3, WMA (Windows media audio) and other video formats and
support high quality audio formats, including full-featured
karaoke, Dolby Digital, DTS Surround, DVD audio and Sonys
Super Audio CD (SACD) audio. Our decoder chips also
allow consumers to view digital photo CDs with the music
slideshow feature on their televisions.

We also have MPEG2 and MPEG4 encoder chips that
provide the digital recording function that enable DVD players
to become DVR and recordable DVD players. We believe that
multi-featured DVD, DVR and recordable DVD players will serve as
a platform integrating various digital home entertainment and
information delivery products into a single box, which we call
the Digital Home System (DHS). Our digital encoding
products include a digital camcorder, a DVR and a recordable DVD
player.

We also supply digital image processors and image
sensors used to manufacture digital still cameras and camera
enabled cellular phones. Our CMOS image sensors integrate
several functions including image capture, image processing,
color processing and the conversion and output of a fully
processed image or video stream. Our image processors can be
connected directly to a CCD or CMOS sensor, process the video
information in real time, compress the captured image to a flash
memory, and interface to a LCD or micro display. We are also a
supplier of chips for use in PC audio products and modems and
other communication products.

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We believe we have the following competitive
advantages:



| |   |                                                                                                                                                                                                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Our highly programmable chips offer more 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 superior
    video and audio recording quality for DVR, recordable DVD, and
    SD camcorder products;                                                                                                                                         
|
| |  | Our image sensor chips have a unique 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                      
|
| |  | Our longstanding strategic relationships in China
    position us to capture additional business as consumer
    electronics manufacturing increasingly migrates to China.                                                                                                             

Our Strategy

Our objective is to become the leading supplier
of digital semiconductor chips to the consumer electronics
entertainment product market. To achieve our objective, we are
pursuing the following strategies:



| |                                                                                                                                                                                               
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Leverage Our Proprietary Technology.Our chips are based on a programmable
    architecture that uses multiple processors working
    independently, which provides us with several advantages:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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, time-to-market speed and produce 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                                                                                                                                                                                                                                                                                                                  

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | 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 are introducing 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 are continuing the
    development of the next generation of 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 and 1.3 Megapixel Image
    Sensors.We are continuing to develop
    our expertise in mixed-signal implementation, advanced pixel
    design, feature integration, and manufacturing processes and
    controls. We are currently developing new, 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 sensors for the cellular camera phone and digital still
    camera markets.                                                                                                                                    
|
| |  | Image Processor.We
    are developing the next generation of our image processor, which
    is a 4-6 Megapixel processor for digital still cameras, as
    well as continuing to enhance the quality, performance and cost
    of our current 3 Megapixel and under resolution image
    processors.                                                                                                                                                                                                                                                                                                                                                                                                                                               



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Leverage Expertise Across Multiple Mass Market
    Applications.We intend to continue to
    focus on the DVD, VCD, digital camcorder, digital still camera,
    and cellular camera phone market applications. We believe
    additional markets will emerge as digital media technology and
    products converge. We plan to share and leverage our expertise
    in audio, video and imaging technology to strengthen and broaden
    our product offerings in existing markets, to expand into other
    existing digital media markets and to introduce new products
    into new markets as they emerge in the field of digital
    entertainment. Past examples of such expansion include, digital
    media players, boom boxes, audio receivers, digital television
    products, and cellular camera phones.
|
| | Offer a Low-Cost Total Solution.Our engineers have significant system
    design expertise at the consumer product level. We design our
    chips to either work with lower-cost components or to decrease
    the number of components in our customers products to
    lower their total manufacturing cost. We also work in close
    collaboration with our customers in their product development
    processes to reduce the cost of our semiconductor products. By
    helping our customers design their products using our chips, we
    can lower their total bill of material. We believe this approach
    enables us to provide our customers with a low-cost total
    solution.                                                                                                                        
|
| | Leverage Our Relationships with Low-Cost OEMs
    and ODMs to Capture Additional Worldwide Market
    Share.We believe that consumer
    electronics companies will continue to move contract
    manufacturing to lower-cost manufacturers located in China. We
    are a leading supplier of video system                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | processor chips to OEMs and to ODMs, located in
    China. Our customers in China manufacture and sell DVD and VCD
    players both as contract manufacturers for well-known brand
    labels and under their own brands. We believe we can leverage
    our position in China to gain design wins with additional key
    consumer electronics companies as they migrate their
    manufacturing to China.                                                                                                                                                                                                                                                                                         
|
| | Expand Relationships with Leading Consumer
    Electronics Companies.We are
    increasing our sales efforts to, and actively pursuing key
    design wins with, leading consumer electronics companies located
    in Asia, Europe and South America.                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| | Employ Our Software Expertise to Develop New
    Technologies.More than 50% of our
    employees are engineers, a significant number of whom are
    software engineers. We have a diversified base of technologies
    and a strong track record for developing new technologies
    in-house. We intend to leverage our software expertise to
    continue to develop new technologies and add features to our
    products.                                                                                                                                                                                                                                                                      
|
| | Leverage Our Relationships with Large
    Suppliers to Be One of the Low-Cost
    Providers.We believe consumer
    electronics markets are so competitive and rapidly changing that
    a manufacturer of fabless semiconductor products must focus on
    being one of the low-cost providers of digital media chips in
    the world. To do so, our products must have a relatively small
    die size and achieve high yields throughout the manufacturing
    process. We also utilize long-standing and close relationships
    with some of the largest third party fabrication companies and
    assemblers in the world. We are one of the larger customers of
    many of these companies.
|
| | Pursue Acquisitions of Complementary and
    Advanced Technologies.We have in the
    past acquired and will continue to consider acquiring
    complementary technologies or product lines to enhance our own
    product offerings and to accelerate our time to market.                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| | Pursue Licenses of Complementary Technologies.We have in the past licensed and will
    continue to consider licensing complementary technologies or
    product lines to enhance our own product offerings and to
    accelerate our time to market.                                                                                                                                                                                                                                                                                                                                                                                                                                               

Products

We offer an array of DVD decoder chips, Video CD
chips, image sensor chips, image processor chips, DVD encoder
chips, consumer digital audio chips, communication chips and PC
audio chips.

DVD Decoder Chips.Our customers can choose from a wide
variety of DVD chips with various feature combinations and price
points. We provide highly integrated chips using multiple
processors and a programmable architecture that enables us to
offer a broad array of features and functionality. Our DVD chips
enable consumers to play DVD, CD, VCD, MP3, JPEG, WMA (Windows
Media Audio), DVD audio, full-featured karaoke and other audio
and video formats. Our DVD chips support high quality video
formats such as Progressive Scan, and high quality audio
formats, including Dolby Digital, DTS Surround, and DVD audio.
These chips can also be used as the primary processor in digital
media players. With the popularity of digital media such as
Smart Media, Compact Flash, Memory Stick and Secure Digital,
there is a growing demand for digital media players that
incorporate digital media interface and thereby allow consumers
to view digital media content on their consumer electronics
device. We offer both MPEG2 and MPEG4 decoding products and
various levels of integrated products incorporating such
capabilities as TV encoder, RF, and servo controller.

Video CD Chips.Our
VCD products consist of both standard VCD chips and an enhanced
version known as SVCD chips. Our customers can choose from a
variety of VCD and SVCD chip products, each with various feature
combinations and price points. Our VCD chips include an MPEG1
video and audio system decoder. They deliver full-screen,
full-motion video at 30 frames per second with selectable
CD-quality audio. The video quality of SVCD is roughly
comparable to that of a high-quality VCR, and VCDs have slightly
lower quality video. These chips are used in relatively low-cost
VCD players that are sold primarily in China, South East Asia,
India and other emerging countries.

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Image Sensor Chips.We are a recent entrant to this market, our CMOS image sensors
provide excellent low light sensitivity for a given lens size.
Our VGA and 1.3 Megapixel products are used in digital
still cameras and camera enabled cellular phones.

Image Processor Chips.We also offer image processor chips
that perform the image processing, color processing and the
conversion and output of a fully processed image or video
stream. We currently offer 4 to 6 Megapixel products for
the digital still camera market.

DVD Encoder Chips.We are leveraging our existing DVD
relationships with our customers to offer our DVD encoder chips
to enable them to build DVR or recordable DVD players to broaden
their products range. Current designs utilize a two-chip
solution and a DVD encoder chip combination with a DVD decoder
to produce a recordable device. We recently introduced our
Vantage II product, an integrated encoder and decoder solution
in a simple package. A recordable DVD can record the video and
audio signal to an optical drive where the content is stored on
a DVD disk while a DVR records the video and audio signal to a
magnetic drive (typically referred to as a hard drive) with
video editing, instant replay and time delay features. We offer
both MPEG2 and MPEG4 encoding products as well as non-integrated
and integrated encode and decode versions of our chips.

Consumer Digital Audio Chips.With the advancement in the high
quality audio formats such as Dolby Digital, Dolby ProLogic,
Dolby ProLogic II, Dolby Ex, Dolby Virtual Speaker, DTS
Surround, DTS ES, MP3, WMA, DVD audio and Sonys SACD
audio, our consumer digital audio chips enable consumer
electronics manufacturers to build high quality, low cost
5.1 channel audio video receivers (AVR) that
compliment the existing installed base of DVD players. Our newly
introduced class-D multi-channel digital audio amplifier chip
further enables us to deliver a total solution for home theater
system.

Communication Chips.Internet-related applications, such as voice e-mail, internet
radio and audio home pages and news-on-demand, are increasing
the demand for integrated audio and computer fax, modem and
network functions on the PC. Our modem chips comply with
worldwide modem standards and have various feature combinations
and price points.

PC Audio Chips.Our
PC audio chips enable PC manufacturers to provide audio
capabilities on add-in sound cards and directly on the
motherboards of desktop and notebook computers. We were the
pioneers in this market by offering the first single-chip PC
audio solution with high-quality sound reproduction. We provide
PC audio chips with various feature combinations and price
points, but we are no longer emphasizing this business and
expect that sales of PC audio chips will continue to decline.

Sales of these products accounted for the
following percentages of our net revenues in the past three
years:

|                        |  |                   |     |      |  |      |     |   |  |  |     |  
|----------------------- |  | ----------------- | --- | ---- |  | ---- | --- | - |  |  | --- | -
|                        |  |                  
|                        |  | Percentage of Net
|                        |  | Revenues         
|                        |  | for Years Ended  
|                        |  | December 31,     
|                        |  |                  
|                        |  | 2003              |     | 2002 |  | 2001
|                        |  |                   |     |      |  |     
|DVD                     |  |                   | 43  | %    |  |      | 59  | % |  |  | 37  | %
|VCD                     |  |                   | 38  | %    |  |      | 31  | % |  |  | 40  | %
|Digital imaging         |  |                   | 8   | %    |  |      |    |   |  |  |    |  
|Recordable              |  |                   | 6   | %    |  |      |    |   |  |  |    |  
|Consumer digital media  |  |                   | 2   | %    |  |      |    |   |  |  |    |  
|Communication and other |  |                   | 2   | %    |  |      | 6   | % |  |  | 7   | %
|PC audio                |  |                   | 1   | %    |  |      | 4   | % |  |  | 16  | %
|                        |  |                   |     |      |  |      |     |   |  |  |     |  
|Total                   |  |                   | 100 | %    |  |      | 100 | % |  |  | 100 | %
|                        |  |                   |     |      |  |      |     |   |  |  |     |  

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Technology and Research and
Development

Our DVD decoder chips incorporate a digital
signal processor (DSP) and a reduced instruction set
computer processor (RISC). The two processors work
in parallel on separate tasks, which allows us to build a highly
integrated chip. In 2001, we integrated a TV encoder into our
DVD decoder engine (labeled the Vibratto family of products) to
cut down the number of components required to build a DVD
player. In 2003, we enhanced the decoder engine to handle MPEG4
technology. The enhanced architecture formed the basis of all
our current DVD product offerings, including the integrated
front-end, back-end or single chip decoder chip called the
Vibratto II, and our newest integrated encoder/decoder chip
called the Vantage II.

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. We believe this product will
evolve into a second intelligent and commutative platform in the
home and share a home networking backbone and files with the PC.

Our digital imaging chips are manufactured using
the CMOS process, the most widely used method of producing
modern integrated circuits and thus also the lowest cost method.
Recent advances in manufacturing processes and design techniques
have led to increased performance and quality. Our products are
produced by a proprietary CMOS process and have a unique
architecture and design that produces excellent low light
sensitivity at comparative lens sizes. Our digital imaging chips
are highly integrated and fully programmable, allowing us to
quickly add features and adapt the chip to each customers
unique requirements.

In the digital media marketplace we must
continually design, develop and introduce new products that take
advantage of market opportunities and address emerging technical
standards. We intend to leverage our base of design expertise,
analog, digital and mixed-signal design capabilities and process
technologies, and software and systems expertise to continue to
develop audio, video imaging and communication solutions for the
consumer electronics marketplace.

Our design environment is based on workstations,
dedicated product simulators, system simulation with hardware
and software modeling, and a high-level, design-description
language. We invest regularly in new advanced equipment and
software tools and we intend to maintain and enhance our library
of core cells.

On research and development activities, we spent
approximately $33.2 million during 2003, $27.0 million
during 2002 and $28.0 million during 2001, excluding
charges of $2.7 million in 2003 for acquired in-process
research and development.

Customers

We sell our chips to distributors and OEMs of
DVD, VCD, MP3, digital still cameras, digital camcorders,
consumer digital audio, digital media players, cellular phones,
modem and PC products. Our customers manufacture and sell these
products both as contract manufacturers for well-known brand
labels and under their own brands. As a result, our chips can be
found in a diverse array of DVD, VCD, camera, cell phone, and PC
products on store shelves in the United States, Asia and Europe.

A substantial portion of our net revenues have
been derived from sales to a small number of our customers.
Sales to our top five end-customers accounted for approximately
34% of our net revenues in 2003 compared to 37% of our net
revenues in 2002. ATLM, one of our top end-customers, accounted
for approximately 12% and 3% of our net revenues for 2003 and
2002, respectively. Rikai, another one of our top end-customers,
accounted for approximately 11% and 7% of our net revenues for
2003 and 2002, respectively. No other end-customers accounted
for more than 10% of our net revenues during 2003 and 2002.
Information on net sales from external customers and long lived
assets attributable to our geographic regions is included in
Note 13, Business and Geographical Segment, to
the consolidated financial statements in Item 8 of this
Report.

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Sales and Distribution

We market our products worldwide through our
direct sales force, distributors and sales representatives. We
have sales and support offices in the United States, China, Hong
Kong, Taiwan, Japan and Korea.

We believe customer service and technical support
are important competitive factors in selling to major customers.
Sales representatives and distributors supplement our efforts by
providing additional customer service at the local level. We
believe close contact with our customers not only improves the
customers level of satisfaction, but also provides
important insight into future market direction.

International sales comprised approximately 99%
of our net revenues in 2003, 99% of our net revenues in 2002 and
97% of our net revenues in 2001. International sales are based
upon destination of the shipment. Our international sales in
2003, 2002 and 2001 were derived primarily from Asian customers
who manufacture DVD, VCD, cameras, cell phones, communications
and PC audio products. Companies in Asia manufacture a large
percentage of the worldwide supply of these products. We believe
a significant portion of our chip products are incorporated into
consumer electronic devices that are ultimately sold into the
United States. We have direct sales personnel and technical
staff located in Hong Kong, Taiwan, China, Korea and Japan where
significant portions of our sales have historically been
derived. Our products are also sold internationally through
distributors and sales representatives located in Hong Kong,
Korea, Japan and Singapore. For fiscal 2003, net sales to
customers (including distributors) in each region as a
percentage of our total net sales were: Hong Kong 66%, Taiwan
9%, China 6%, Korea 5%, Japan 4%, the Czech Republic 4%, and
Singapore 2%. Our business is usually seasonal due to the
Christmas holiday season in America and Europe, and the Chinese
New Year season in China and Asia. Our sales representatives and
distributors are not subject to minimum purchase requirements
and can discontinue marketing any of our products at any time.
In addition, certain of our distributors have rights of return
for unsold product and rights to pricing allowances to
compensate for rapid, unexpected price changes.

We rely on our largest distributor, Dynax
Electronics (HK), (Dynax Electronics), for a
significant portion of our revenues. Sales through Dynax
Electronics were approximately 63%, 57% and 56% of our net
revenues in 2003, 2002 and 2001, respectively. Dynax Electronics
is not subject to any minimum purchase requirements and can
discontinue marketing any of our products at any time. In
addition, Dynax Electronics has rights of return for unsold
product and rights to pricing allowances to compensate for
rapid, unexpected price changes, therefore we do not recognize
revenue until Dynax Electronics sells through to our
end-customers.

Manufacturing

We contract with third parties for all of our
fabrication and assembly as well as the majority of our test
operations. This manufacturing strategy enables us to focus on
our design and development strengths, minimize fixed costs and
capital expenditures and gain access to advanced manufacturing
capabilities. Semiconductor manufacturing consists of foundry
activity where wafer fabrication takes place, as well as chip
assembly and testing activities. We use several independent
foundries that use advanced manufacturing technologies to
fabricate our chips. Substantially all of our products are
manufactured by Taiwan Semiconductor Manufacturing Company
(TSMC), which has manufactured products for us since
1989, United Microelectronics Corporation (UMC),
which is also located in Taiwan, Jazz Semiconductor, which is
located in United States, and other independent Asian foundries.
Most of our products are currently fabricated using both
mixed-signal and logic CMOS 0.25 to 0.18 micron process
technologies. Manufacturing requires raw materials and a variety
of components to be manufactured to our specifications. We
depend on a limited number of suppliers to obtain adequate
supplies of quality raw materials on a timely basis. We do not
generally have guaranteed supply arrangements with our
suppliers, and we depend on foundries such as TSMC, UMC and
others for foundry capacity to produce products of acceptable
quality and with acceptable manufacturing yields in a timely
manner. As of December 31, 2003, we believe we have
sufficient foundry capacity to meet our forecasted needs for the
next 12 months.

After wafer fabrication by the foundry, all of
our semiconductor products and lens modules are assembled and
tested by third-party vendors, primarily Advanced Semiconductor
Engineering, TSMC and Amkor

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Technology in Taiwan. We have internally designed
and developed our own test software and purchased certain test
equipment, which are provided to our test vendors. See
Item 7, Factors That May Affect Future
Results  Our products are manufactured by independent
third parties.


Competition

Our markets are intensely competitive and are
characterized by rapid technological change, price reductions
and rapid product obsolescence. Competition typically occurs at
the design stage, where the customer evaluates alternative
design approaches that require integrated circuits. Because of
shortened product life cycles, there are frequent design win
competitions for next-generation systems. We expect competition
to remain intense from existing competitors and from companies
that may enter our existing or future markets. In general,
product prices in the semiconductor industry have decreased over
the life of a particular product. The markets for our products
are characterized by intense price competition. As the markets
for our products mature and competition increases, we anticipate
that prices for our products will continue to rapidly decline.

Our existing and potential competitors consist of
medium and large domestic and international companies, many of
whom have substantially greater financial, manufacturing,
technical, marketing, distribution and other resources, greater
intellectual property rights, broader product lines and
longer-standing relationships with customers than we have. Our
competitors also include a number of smaller and emerging
companies.

Our principal competitors in the DVD market
include MediaTek Incorporation (MediaTek), Zoran,
Sony, Panasonic, STMicroelectronic, LSI Logic, Sunplus and
Cirrus Logic. In addition, we expect that the DVD platform will
face competition from other platforms including STBs, as well as
multi-function game boxes. Some of our competitors may supply
chips for multiple platforms, such as LSI Logic and
STMicroelectronics, each of which makes chips for both DVD
players and STBs. We also face strong competition from Sunplus,
a competitor in the VCD market. Our competitors in the digital
imaging market include Omnivision, as well as other emerging
companies.

Many of our current and potential competitors
have longer operating histories as well as greater name
recognition than we have. Any of these competitors may be able
to respond more quickly to new or emerging technologies and
changes in customer requirements and to devote greater resources
to the development, promotion and sale of their products than we
can.

In addition, as the market for the DHS develops,
a number of companies with significantly greater resources than
us could attempt to increase their presence in the market by
acquiring or forming strategic alliances with our competitors
resulting in increased competition to us. In the past years,
LSI Logic acquired C-Cube Microsystems; Cirrus Logic
acquired LuxSonor Semiconductors; Oak Technology acquired
TeraLogic; and Zoran acquired Oak Technology.

Proprietary Technology

We rely on a combination of patents, trademarks,
copyrights, trade secret laws and confidentiality procedures to
protect our intellectual property rights. As of
December 31, 2003, we had 54 patents granted in the United
States, which are going to expire over time commencing in 2008
and ending in 2022. In addition, as of December 31, 2003 we
had 15 corresponding foreign patents, which are going to
expire over time commencing in 2005 and ending in 2020. We have
several patent applications pending and intend to seek further
U.S. and international patents on our technology whenever
possible.

The semiconductor industry is characterized by
vigorous protection and pursuit of intellectual property rights
or positions, which have resulted in significant and often
protracted and expensive litigation. As of December 31,
2003, there was one intellectual property litigation matter
pending against us which we are vigorously defending and believe
will not have a material adverse effect on our business. See
Item 3, Legal Proceedings.

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We currently license certain of the technology we
use in our products, and we expect to continue to do so in the
future. We have, in the past, granted limited licenses to
certain of our technology, some of which have expired. We have
not derived material revenues from these licenses in recent
periods. See Item 7, Factors That May Affect Future
Results  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.

Employees

As of December 31, 2003, we had 498
full-time employees, including 219 in research and
development, 159 in marketing, sales and support,
68 in operations, finance and administration and 52 in
manufacturing. Over 50% of our employees are engineers, and a
significant number of them are software engineers. Our future
success will depend, in part, on our ability to continue to
attract, retain and motivate highly qualified technical and
management personnel, particularly highly-skilled semiconductor
design personnel and software engineers involved in new product
development, for whom competition can be intense, particularly
in the Silicon Valley. Our employees are not represented by any
collective bargaining unit, and we have never experienced a work
stoppage. We believe our relationship with our employees is good.

Executive Officers of the Registrant

The following table sets forth certain
information regarding our current executive officers:

|                |  |     |    |          |  |                                                                           
|--------------- |  | --- | -- | -------- |  | --------------------------------------------------------------------------
|Name            |  | Age |    | Position
|                |  |     |    |         
|Fred S.L. Chan  |  |     | 57 |          |  | Chairman of the Board of Directors                                        
|Robert L. Blair |  |     | 56 |          |  | President, Chief Executive Officer and Director                           
|Patrick Ang     |  |     | 44 |          |  | Chief Operating Officer and Executive Vice
    President                  
|James B. Boyd   |  |     | 51 |          |  | Chief Financial Officer, Senior Vice President
    and Assistant Secretary

Fred S.L. Chanhas
been a director since January 1986 and has served as Chairman of
the Board since October 1992. Mr. Chan is also the Chairman
of the Board for Vialta, Inc. and has served in that capacity
since September 1999. Mr. Chan served as President and
Chief Executive Officer of Vialta from September 1999 to August
2001. Mr. Chan served as our President from November 1985
until October 1996 and from February 1997 to September 1999. He
served as our Chief Executive Officer from June 1994 until
September 1999. Mr. Chan served as our Chief Financial
Officer from October 1992 to May 1995. From 1984 to 1985,
Mr. Chan was founder, President and Chief Executive Officer
of AC Design, Inc., a VLSI chip design center providing
computer aided design (CAD), engineering and other
design services. From 1982 to 1984, he was co-founder, President
and Chief Executive Officer of CADCAM Technology, Inc., a
company in the business of computer aided engineering (CAE)
systems development. Mr. Chan holds B.S.E.E. and M.S.C.
degrees from the University of Hawaii.

Robert L. Blairhas
been our President and Chief Executive Officer since September
1999. Mr. Blair was elected as a director in 1999.
Mr. Blair served as our Executive Vice President of
Operations from April 1997 to September 1999. From December 1994
to March 1997, he was our Vice President of Operations. From
December 1991 to November 1994, he was Senior Vice President of
Operations (Software Packaging & Printing Division) of
Logistix Corporation, a software turnkey company, and from 1989
to November 1991, he was Vice President and co-owner of Rock
Canyon Investments, a real estate development-planning firm in
California. From 1986 to 1989, he held various positions at
Xidex Corporation, a computer diskette manufacturer, including
President and General Manager at XEMAG, a division of Xidex
Corporation. From 1973 to 1986, he held several positions
including Vice President, High Reliability Operations at
Precision Monolithics, Inc.

Patrick Anghas been
our Chief Operating Officer and Executive Vice President with
responsibilities in worldwide sales and marketing since December
2001. From March 1998 to September 2001, Mr. Ang served

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as President and Chief Executive Officer of
Broadxent, Inc. (formerly known as Digicom Systems, Inc.), a
broadband communications equipment manufacturer, and from
November 1997 to December 1999, Mr. Ang served as President
of Ectiva, Inc., an internet appliance manufacturer, which was
acquired by Creative Technology Ltd. in November 1997. From
December 1993 to November 1997, Mr. Ang was employed as
Division President for OPTi, Inc., a supplier of semiconductor
products for the personal computer market. He was the founder of
MediaSonics and co-founder of MediaChips, which was acquired by
OPTi, Inc. in November 1993. Mr. Ang has more than
20 years of management, systems and semiconductor
experience and had held various R&D positions at Telmos,
Sierra Semiconductor and Triptech Microelectronics. Mr. Ang
holds a B.S. in Electrical Engineering from the National
University of Singapore. He serves on the boards of directors
for Sunrise Telecom, Inc.


James B. Boydhas
been our Chief Financial Officer since August 2000.
Mr. Boyd was also elected as a Senior Vice President in
2003 and as Assistant Secretary in August 2000. Prior to joining
ESS, Mr. Boyd served from March 1998 until July 2000 as
Chief Financial Officer of Gatefield Corporation, a
Fremont-based manufacturer of field programmable electronic
circuits used in PCs and consumer electronics. From August 1997
until January 1998, he was Chief Financial Officer of AirMedia,
a developer of wireless communications software and from March
1996 until August 1997, he was Corporate Controller at Farallon
Communications, a manufacturer and developer of internet
hardware and software products. He has also held senior
management positions with Fritz Companies, GTE Sprint
Communications and Southern Pacific Companies. Mr. Boyd
holds B.S. and MBA degrees from the University of
Wisconsin  Madison and a J.D. from Golden Gate
University.

The information concerning compliance with
Section 16 of the Securities Exchange Act of 1934 is
incorporated by reference from the section in the proxy
statement for the 2004 Annual Shareholders Meeting
entitled Compliance under Section 16(a) of the
Securities Exchange Act of 1934.

Backlog

Our products are generally sold pursuant to
standard purchase orders, which are often issued only days in
advance of shipment and are frequently revised to reflect
changes in the customers requirements. Product deliveries
are scheduled when we receive purchase orders. Generally, these
purchase orders allow customers to reschedule delivery dates and
cancel purchase orders without significant penalties. For these
reasons, we believe that our backlog, while useful for
scheduling production, is not necessarily a reliable indicator
of future revenues. Delays in delivery schedules and/or a
reduction of backlog during any particular period could have a
material adverse effect on our business and results of
operations. As of December 31, 2003, our backlog amounted
to approximately $27.6 million.

Available Information

Our website is http://www.ESSTECH.com. We make
available free of charge, on or through our website, our annual,
quarterly and current reports, and any amendments to those
reports, as soon as reasonably practicable after electronically
filing such reports with the Securities and Exchange Commission
(the SEC). In addition, our Code of Ethics as well
as the respective charters for the Audit, Compensation and
Corporate Governance and Nominating Committees of our Board of
Directors are available on our web site. Information contained
on our website is not part of this Report.




Item 2.     Properties

We own nearly 12 acres of land in Fremont,
California, on which we built our two-story,
93,000 square-foot corporate headquarters as well as a
77,000 square-foot building next to our corporate
headquarters, 50% of which is currently leased to Vialta, Inc.
(our former subsidiary) under the Real Estate Matters Agreement.
On July 1, 2003, we entered into the First Amendment to the
Amended and Restated Commercial Lease Agreement with Vialta to
reduce the size of the Fremont facility subject to the lease and
to adjust the rental amount. See Note 15 Related
Party Transactions with Vialta, Inc., to the consolidated
financial statements in Item 8 of this Report.

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In addition we own an adjacent 11,000 square-foot
dormitory building used to house visitors and guest workers. We
also maintain leased office space in various locations.
Additionally, we have an approximately 5,000 square-foot
warehouse next to our corporate headquarters in Fremont,
California.

We are productively utilizing most of the above
facilities and we consider the above facilities suitable and
adequate to meet our current requirements. There are no liens on
any of our owned land and buildings.




Item 3.     Legal
Proceedings

On March 12, 2001, we filed a complaint in
the U.S. District Court for the Northern District of
California (Case No. C01-20208) against Brent Townshend,
alleging unfair competition and patent misuse. The complaint
seeks specific performance of contractual obligations and
declarations of patent misuse, unenforceability, and estoppels
against asserting patent rights. All of the claims relate to the
refusal of Mr. Townshend to provide us with a license on
reasonable and nondiscriminatory terms, as is required by
applicable law. The patents relate to the manufacture and sale
of high-speed modems. On April 30, 2002, we filed an
amended complaint. On September 27, 2002, Townshend filed
an answer and counterclaims, alleging patent infringement. We
filed our answer to the counterclaims on October 17, 2002,
Townshend also filed patent infringement actions against Agere
Systems Inc., Analog Devices Inc., Cisco Systems, Inc.,
(Cisco) and Intel Corporation, alleging infringement
of the same patents. On March 7, 2003, the court issued an
order finding that the cases are related and should be tried
together. Analog Devices has individually settled their claims
with Townshend. As of December 31, 2003, the remaining
parties were involved with discovery and claim construction
proceedings. The estimated trial date is July 2005. The Company
will vigorously pursue this litigation.

On September 27, 2002, we filed a complaint
in the United States District Court for the Northern District of
California (Case No. C02-04705) against MediaTek, a
Taiwanese company, alleging copyright infringement and unfair
competition. The complaint sought damages and an injunction
barring importation into the United States of certain MediaTek
semiconductor chips alleged to infringe our proprietary
intellectual property as well as all downstream products,
specifically DVD players, incorporating such MediaTek chips. We
believed that MediaTek unlawfully acquired and copied our
proprietary source code and graphical user interface relating to
its DVD products, and then used that technology to target our
customers and market MediaTeks chips in unfair
competition. Simultaneous with the complaint, we filed a motion
for expedited discovery to force MediaTek to turn over the
suspected infringing code for expert analysis in support of a
temporary restraining order. MediaTeks source code was
produced at the end of December 2002. On February 26, 2003,
MediaTek answered the complaint, asserting affirmative defenses
and counterclaims for a declaratory judgment of non-infringement
and for trade secret misappropriation. On March 7, 2003, we
filed a motion for preliminary injunction against
MediaTeks manufacture, distribution, and importation of
DVD chips, or in the alternative, for an expedited trial on our
copyright claims. We also sought a recall order requiring
MediaTek to recall all DVD chips from its customers,
distributors, retailers, and end users. Following mediation, on
June 11, 2003, we entered into a License Agreement and
Mutual Release (the Settlement Agreement) with
MediaTek. Under the terms of Settlement Agreement, both sides
have terminated all claims against each other and MediaTek
received a non-exclusive worldwide license to our proprietary
DVD user interface and other key DVD software. Under the
Settlement Agreement, MediaTek paid us a one-time license fee of
$45.0 million related to sales of certain DVD products and
is required to pay ongoing royalties with a quarterly cap of
$5.0 million and lifetime cap of $45.0 million. The
maximum total payments under the Settlement Agreement are
$90.0 million.

After we revised our revenues and earnings
guidance for the third quarter of 2002 on September 12,
2002, several holders of our common stock, purporting to
represent a class of similarly aggrieved shareholders, filed
lawsuits against us. The complaints allege that we issued
misleading statements regarding our business and failed to
disclose material facts during the alleged class period
(January 23, 2002 through September 12, 2002). To
date, eight putative class action lawsuits have been filed in
the United States District Court, Northern District of
California. These cases are: Daniel C. Rann v.
ESS Technology, Inc., et al. (Case No. C02-4497),
filed September 13, 2002; James W. Becker and Randy
Bohart v. ESS Technology, Inc., et al. (Case
No. C02-4695), filed September 27, 2002; Palmer
Fauconnier v. ESS Technology, Inc., et al.

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(Case No. C02-4734), filed
September 30, 2002; Mike Forrestal v.
ESS Technology, Inc., et al. (Case No. C02-4739),
filed September 30, 2002; Sandy Dorman v.
ESS Technology, Inc., et al. (Case No. C02-4732),
filed September 30, 2002; Patriot Shipping
Corporation v. ESS Technology, Inc., et al. (Case
No. C02-4749), filed October 1, 2002; Adam D.
Saphier v. ESS Technology, Inc., et al. (Case
No. C02-5028), filed October 17, 2002; and Mayer
Abramowitz v. ESS Technology, Inc., et al. (Case
No. C02-5354), filed on November 7, 2002. These
actions have been consolidated and are proceeding as a single
action under the caption In re ESS Technology
Securities Litigation. The plaintiffs are seeking
unspecified damages for the class and unspecified costs and
expenses. On May 20, 2003, the plaintiffs filed an amended
complaint. We filed a motion to dismiss on June 18, 2003,
which was granted by the court on October 3, 2003. The
plaintiffs were granted leave to amend, and filed their second
amended consolidated complaint on November 3, 2003. We
filed our second motion to dismiss on December 18, 2003,
which the court is scheduled to hear on March 19, 2004.
Discovery remains on hold and no trial date has been set.


Similarly after we revised our revenues and
earnings guidance for the third quarter of 2002 on
September 12, 2002, several holders of our common stock,
purporting to represent the corporation, have brought derivative
suits against us as a nominal defendant and certain of our
officers and directors, alleging, among other things, breaches
of fiduciary duty and insider trading. To date, three derivative
suits have been filed in the California Superior Court, Alameda
County. These cases are: Robert Haven, Derivatively on Behalf of
ESS Technology v. Blair, et al. (Case No. 02-67527), filed
October 3, 2002, James Shroff, Derivatively on Behalf of
ESS Technology v. Blair, et al. (Case No. 02-68418), filed
Octobers 10, 2002 and David Chestnut, Derivatively on behalf of
ESS Technology v. Chan, et al. (Case No. 02-69064), filed
October 16, 2002. These actions have been consolidated and
are proceeding as a single action entitled ESS
Cases. The derivative plaintiffs seek compensatory and
other damages, disgorgement of profits and other relief. With
respect to these state court derivative actions, we filed a
demurrer to the claims and a motion to stay discovery on
March 24, 2003. The demurrer and motion to stay discovery
were heard on May 15, 2003. The court denied the demurrer,
but issued an order staying discovery pending the resolution of
the pleading stage in the District Court case.

Although we believe that we and our officers and
directors have meritorious defenses to both actions and intend
to defend these suits vigorously, we cannot predict with
certainty the outcome of these lawsuits. Our defense against
these lawsuits may be costly and may require a significant
commitment of time and resources by our senior management.
Management believes that these lawsuits are subject to coverage
under our directors and officers liability insurance
policies, although to date our carriers have reserved their
rights with respect to coverage for these claims. In the event
of a determination adverse to us, either with respect to
coverage or with respect to the underlying merits of the
lawsuits, we may incur substantial monetary liability, which
could have a material adverse effect on our financial position,
results of operation and cash flows.




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

We did not submit any matter to a vote of
security holders during the quarter ended December 31, 2003.

14



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##### Table of Contents






PART II




Item 5.     Market
for the Registrants Common Equity and Related Shareholder
Matters

Our common stock has been trading on the NASDAQ
National Market under the symbol ESST since
October 6, 1995. The following table sets forth the high
and low sales prices for our common stock as reported by the
NASDAQ National Market during the periods indicated.

|             |                                        |      |   |       |  |  |   |       | 
|------------ | -------------------------------------- | ---- | - | ----- |  |  | - | ----- | 
|             |                                        | High |   | Low  
|             |                                        |      |   |      
|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 | 
|Fiscal 2002: |                                        |      |   |       |  |  |   |      
|             | First Quarter ended March 31, 2002     |      | $ | 25.99 |  |  | $ | 16.81 | 
|             | Second Quarter ended June 30, 2002     |      | $ | 21.98 |  |  | $ | 12.76 | 
|             | Third Quarter ended September 30, 2002 |      | $ | 20.25 |  |  | $ | 5.91  | 
|             | Fourth Quarter ended December 31, 2002 |      | $ | 9.32  |  |  | $ | 4.28  | 

As of February 26, 2004, there were
approximately 205 record holders of our common stock. Since most
shareholders are listed under their brokerage firms names,
the actual number of beneficial shareholders is higher.

The remaining information called for by this item
relating to Securities Authorized for Issuance Under
Equity Compensation Plans is reported in Item 12 of
this Report.

Dividend Policy

We have never declared or paid cash dividends. We
currently intend to retain all available funds and any future
earnings for use in the operation of our business and do not
anticipate paying any cash dividends in the foreseeable future.

15



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##### Table of Contents






Item 6.     Selected
Financial Data

The following data should be read in conjunction
with Item 7, Managements Discussion and
Analysis of Financial Condition and Results of Operation
and the financial statements and related notes thereto included
in Item 8 of this Report.

We derived the selected consolidated statement of
operations data for the years ended December 31, 2003, 2002
and 2001 and the selected consolidated balance sheet data as of
December 31, 2003 and 2002 from our audited consolidated
financial statements appearing elsewhere in this Report. We
derived the selected consolidated statement of operations data
for the years ended December 31, 2000 and 1999 and the
selected consolidated balance sheet data as of December 31,
2001, 2000 and 1999 from our audited consolidated financial
statements, which are not included in this Report.

|                                                 |              |                                       |         |        |      |      |         |        |      |      |         |        |       |   |         |         |       |   |         |         |       |  
|------------------------------------------------ | ------------ | ------------------------------------- | ------- | ------ | ---- | ---- | ------- | ------ | ---- | ---- | ------- | ------ | ----- | - | ------- | ------- | ----- | - | ------- | ------- | ----- | -
|                                                 |              |                                      
|                                                 |              | Years Ended December 31,(1)          
|                                                 |              |                                      
|                                                 |              | 2003                                  |         | 2002   |      | 2001 |         | 2000   |      | 1999
|                                                 |              |                                       |         |        |      |      |         |        |      |     
|                                                 |              |                                      
|                                                 |              | (In thousands, except per share data)
|Statement of Operations Data:                    |              |                                       |         |        |      |      |         |        |      |      |         |        |       |   |         |         |       |   |         |        
|Net revenues                                     |              | $                                     | 195,273 |        |      | $    | 273,442 |        |      | $    | 271,380 |        |       | $ | 303,436 |         |       | $ | 310,651 |        
|Cost of revenues                                 |              |                                       | 132,690 |        |      |      | 176,454 |        |      |      | 180,231 |        |       |   | 192,452 |         |       |   | 191,529 |        
|                                                 |              |                                       |         |        |      |      |         |        |      |      |         |        |       |   |         |         |       |   |         |        
|                                                 | Gross profit |                                       |         | 62,583 |      |      |         | 96,988 |      |      |         | 91,149 |       |   |         | 110,984 |       |   |         | 119,122 |      
|Operating expenses:                              |              |                                       |         |        |      |      |         |        |      |      |         |        |       |   |         |         |       |   |         |        
|Research and development                         |              |                                       | 33,184  |        |      |      | 26,964  |        |      |      | 27,957  |        |       |   | 27,832  |         |       |   | 36,028  |        
|In-process research and development (2)          |              |                                       | 2,690   |        |      |      |        |        |      |      |        |        |       |   | 2,625   |         |       |   |        |        
|Selling, general and administrative              |              |                                       | 31,761  |        |      |      | 34,170  |        |      |      | 40,689  |        |       |   | 36,225  |         |       |   | 38,558  |        
|                                                 |              |                                       |         |        |      |      |         |        |      |      |         |        |       |   |         |         |       |   |         |        
|Operating income (loss)                          |              |                                       | (5,052  | )      |      |      | 35,854  |        |      |      | 22,503  |        |       |   | 44,302  |         |       |   | 44,536  |        
|Non-operating income (loss), net                 |              |                                       | 45,946  |        |      |      | 2,407   |        |      |      | (18,780 | )      |       |   | 41,810  |         |       |   | 4,666   |        
|                                                 |              |                                       |         |        |      |      |         |        |      |      |         |        |       |   |         |         |       |   |         |        
|Income before provision for income taxes         |              |                                       | 40,894  |        |      |      | 38,261  |        |      |      | 3,723   |        |       |   | 86,112  |         |       |   | 49,202  |        
|Provision for (benefit from) income taxes        |              |                                       | 15,603  |        |      |      | 984     |        |      |      | (7,262  | )      |       |   | 22,946  |         |       |   | 7,877   |        
|                                                 |              |                                       |         |        |      |      |         |        |      |      |         |        |       |   |         |         |       |   |         |        
|Net income from continuing operations            |              | $                                     | 25,291  |        |      | $    | 32,277  |        |      | $    | 10,985  |        |       | $ | 63,166  |         |       | $ | 41,325  |        
|                                                 |              |                                       |         |        |      |      |         |        |      |      |         |        |       |   |         |         |       |   |         |        
|Discontinued operation, net of minority interest |              |                                       |        |        |      |      |        |        |      |      | (12,802 | )      |       |   | (14,860 | )       |       |   | (1,220  | )      
|                                                 |              |                                       |         |        |      |      |         |        |      |      |         |        |       |   |         |         |       |   |         |        
|Net income (loss)                                |              | $                                     | 25,291  |        |      | $    | 32,277  |        |      | $    | (1,817  | )      |       | $ | 48,306  |         |       | $ | 40,105  |        
|                                                 |              |                                       |         |        |      |      |         |        |      |      |         |        |       |   |         |         |       |   |         |        
|Net income (loss) per share:                     |              |                                       |         |        |      |      |         |        |      |      |         |        |       |   |         |         |       |   |         |        
|                                                 | Basic        |                                       |         |        |      |      |         |        |      |      |         |        |       |   |         |         |       |   |         |         |      
|                                                 |              | Continuing operations                 |         | $      | 0.64 |      |         | $      | 0.85 |      |         | $      | 0.26  |   |         | $       | 1.49  |   |         | $       | 1.02  |  
|                                                 |              | Discontinued operations               |         |        |     |      |         |        |     |      |         |        | (0.30 | ) |         |         | (0.35 | ) |         |         | (0.03 | )
|                                                 |              |                                       |         |        |      |      |         |        |      |      |         |        |       |   |         |         |       |   |         |        
|                                                 |              | $                                     | 0.64    |        |      | $    | 0.85    |        |      | $    | (0.04   | )      |       | $ | 1.14    |         |       | $ | 0.99    |        
|                                                 |              |                                       |         |        |      |      |         |        |      |      |         |        |       |   |         |         |       |   |         |        
|                                                 | Diluted      |                                       |         |        |      |      |         |        |      |      |         |        |       |   |         |         |       |   |         |         |      
|                                                 |              | Continuing operations                 |         | $      | 0.61 |      |         | $      | 0.80 |      |         | $      | 0.24  |   |         | $       | 1.37  |   |         | $       | 0.91  |  
|                                                 |              | Discontinued operations               |         |        |     |      |         |        |     |      |         |        | (0.28 | ) |         |         | (0.32 | ) |         |         | (0.03 | )
|                                                 |              |                                       |         |        |      |      |         |        |      |      |         |        |       |   |         |         |       |   |         |        
|                                                 |              | $                                     | 0.61    |        |      | $    | 0.80    |        |      | $    | (0.04   | )      |       | $ | 1.05    |         |       | $ | 0.88    |        
|                                                 |              |                                       |         |        |      |      |         |        |      |      |         |        |       |   |         |         |       |   |         |        
|Shares used in calculating net income per share: |              |                                       |         |        |      |      |         |        |      |      |         |        |       |   |         |         |       |   |         |        
|                                                 | Basic        |                                       |         | 39,517 |      |      |         | 44,044 |      |      |         | 42,274 |       |   |         | 42,548  |       |   |         | 40,640  |      
|                                                 |              |                                       |         |        |      |      |         |        |      |      |         |        |       |   |         |         |       |   |         |        
|                                                 | Diluted      |                                       |         | 41,238 |      |      |         | 46,731 |      |      |         | 45,262 |       |   |         | 45,943  |       |   |         | 45,625  |      
|                                                 |              |                                       |         |        |      |      |         |        |      |      |         |        |       |   |         |         |       |   |         |        

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|                                                                      |  |                                       |         |      |  |      |         |      |  |      |         |  |  |   |         |  |  |   |         | 
|--------------------------------------------------------------------- |  | ------------------------------------- | ------- | ---- |  | ---- | ------- | ---- |  | ---- | ------- |  |  | - | ------- |  |  | - | ------- | 
|                                                                      |  |                                      
|                                                                      |  | Years Ended December 31,(1)          
|                                                                      |  |                                      
|                                                                      |  | 2003                                  |         | 2002 |  | 2001 |         | 2000 |  | 1999
|                                                                      |  |                                       |         |      |  |      |         |      |  |     
|                                                                      |  |                                      
|                                                                      |  | (In thousands, except per share data)
|Balance Sheet Data:                                                   |  |                                       |         |      |  |      |         |      |  |      |         |  |  |   |         |  |  |   |         | 
|Cash, cash equivalents and short-term investments                     |  | $                                     | 164,846 |      |  | $    | 199,102 |      |  | $    | 129,034 |  |  | $ | 58,838  |  |  | $ | 68,687  | 
|Working capital excluding net assets of
    discontinued operation(1) |  | $                                     | 145,221 |      |  | $    | 210,001 |      |  | $    | 156,966 |  |  | $ | 138,541 |  |  | $ | 85,228  | 
|Total assets                                                          |  | $                                     | 352,593 |      |  | $    | 281,602 |      |  | $    | 237,965 |  |  | $ | 294,391 |  |  | $ | 226,922 | 
|Current liabilities                                                   |  | $                                     | 113,804 |      |  | $    | 44,558  |      |  | $    | 54,056  |  |  | $ | 73,901  |  |  | $ | 72,804  | 
|Total shareholders equity                                            |  | $                                     | 227,081 |      |  | $    | 229,368 |      |  | $    | 176,978 |  |  | $ | 211,429 |  |  | $ | 183,579 | 



---

|    |                                                                                                                                                                                                                                       
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | All of the data presented has been adjusted to
    give effect to the treatment of Vialta as a discontinued
    operation. See Note 6, Discontinued Operation to the
    consolidated financial statements in Item 8 of this Report.
|   
|(2) | See Note 5, Acquisition and Related
    Charges, to the consolidated financial statements in
    Item 8 of this Report.                                                                                                             




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

Certain information contained in or incorporated
by reference in the following Managements Discussion and
Analysis of Financial Condition and Results of Operation, in
Factors that May Affect Future Results below and
elsewhere in this Report, contain 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. Forward-looking
statements include statements concerning the future of our
industry, our product development, our business strategy, our
future acquisitions, the continued acceptance and growth of our
products, and our dependence on significant customers. Actual
results may differ materially from those projected in the
forward-looking statements as a result of various factors
including those discussed in Factors that May Affect
Future Results below and elsewhere in this Report. In some
cases, these statements can be identified by terminologies such
as may, will, expect,
anticipate, estimate,
continue, other similar terms or the negative of
these terms. Although we believe that the assumptions underlying
the forward-looking statements contained in this Report are
reasonable, they may be inaccurate. In light of the significant
uncertainties inherent in the forward-looking statements
included herein, the inclusion of such statements should not be
regarded as a representation by us or any other person that the
results or conditions described in such statements will be
achieved. We undertake no obligation to revise or update
publicly any forward-looking statements for any reason.

Overview

We are a leading designer, developer and marketer
of highly integrated analog and digital processor chips, imaging
sensor chips, digital amplifiers, and camera lens modules. Our
digital processor chips are the primary processors driving
digital video and audio devices, including DVD, VCD, digital
cameras, digital camcorders, consumer digital audio players, and
digital media players. Our imaging chips utilize advanced CMOS
sensor technology to capture an image for digital still cameras
and cellular camera phone applications. Our camera lens modules
are made up of a lens, image sensor chip, housing and flex cable
necessary to provide camera capabilities to electronic devices
such as cellular phones and PDAs. Our digital amplifiers boost
the digital sound to a level required to drive loudspeakers, in
such applications as DVD and CD players, home theater systems,
audio receivers, boom boxes and televisions sets. We have also
developed encoding processors to address the growing demand for
DVRs, recordable DVD players, digital still cameras and digital
camcorders. We believe that multi-featured DVD, DVR and
recordable DVD players will serve as a platform for the DHS,
integrating various digital home entertainment and information
delivery products into a single box. We are also a supplier of
chips for use in modems, other communication devices, and PC
audio products. Our chips use multiple processors and a
programmable architecture that enable us to offer a broad array
of features and

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functionality. We outsource all of our chip
fabrication and assembly as well as the majority of our test
operations, allowing us to focus on our design and development
strengths. The terms Company, we,
us, our, and similar terms refer to ESS
Technology, Inc. and its subsidiaries, unless the context
otherwise requires.


We market our products worldwide through our
direct sales force, distributors and sales representatives.
Substantially all of our sales are to customers in Hong Kong,
Taiwan, China, Korea, Japan, and the Czech Republic. We employ
sales and support personnel located outside of the United States
in China, Hong Kong, Taiwan, Japan and Korea to support these
international sales efforts. We expect that international sales
will continue to represent a significant portion of our net
revenue. In addition, substantially all of our products are
manufactured, assembled and tested by independent third parties
in Asia. We also have a limited number of employees engaged in
research and development efforts outside of the United States.
There are special risks associated with conducting business
outside of the United States. See Factors That May Affect
Future Results  We have significant international
sales and operations that are subject to the special risks of
doing business outside the United States.

We were incorporated in California in 1984 and
became a public company in 1995. In April 1999, we expanded our
business beyond the semiconductor segment by establishing
Vialta, a subsidiary that would operate in the internet segment.
In April 2001, our Board of Directors adopted a plan to
distribute to our shareholders all of our shares in Vialta. The
Vialta spin-off was completed on August 21, 2001. See
Note 6, Discontinued Operation and
Note 15, Related Party Transactions with Vialta,
Inc., to the consolidated financial statements in
Item 8 of this Report. On June 9, 2003, we acquired
100% of the outstanding shares of Pictos. On August 15,
2003, we acquired 100% of the outstanding shares of Divio. See
Note 5, Acquisition and Related Charges, to the
consolidated financial statements in Item 8 of this Report.

Critical Accounting Policies and
Estimates



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

Our consolidated financial statements are
prepared in accordance with accounting principles generally
accepted in the United States (GAAP). These
accounting principles require us to make certain estimates,
judgments and assumptions. We believe that the estimates,
judgments and assumptions upon which we rely are reasonable
based upon information available to us at the time that these
estimates, judgments and assumptions are made. These estimates,
judgments and assumptions can affect the reported amounts of
assets and liabilities as of the date of the financial
statements, as well the reported amounts of revenues and
expenses during the periods presented. To the extent there are
material differences between these estimates, judgments or
assumptions and actual results, our financial statements will be
affected. The significant accounting policies that we believe
are the most critical in understanding and evaluating our
reported financial results include the following:



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

In many cases, the accounting treatment of a
particular transaction is specifically dictated by GAAP and does
not require managements judgment in its application. There
are also cases in which managements judgment is required
in selecting appropriate accounting treatment among available
alternatives under GAAP. Our management has reviewed these
critical accounting policies and related disclosures with our
Audit Committee. See notes to consolidated financial statements
in Item 8 of this Report for additional information
regarding our accounting policies and other disclosures required
by GAAP.

18



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##### Table of Contents





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

Revenue is primarily generated by product sales
and is generally recognized at the time of shipment when
persuasive evidence of an arrangement exists, the price is fixed
or determinable and collection of the resulting receivable is
reasonably assured, except for products sold to certain
distributors with certain rights of return and allowance, in
which case, revenue is deferred until such distributor resells
the products to a third party. Such deferred revenues related to
distributor sales, net of deferred cost of goods sold are
included in accrued expenses on our consolidated balance sheets.

We provide for rebates based on current
contractual terms and future returns based on historical
experiences at the time revenue is recognized as reductions to
product revenue. Actual amounts may be different from
managements estimates. Such differences, if any, are
recorded in the period they become known.

Income from MediaTek royalties for the sale of
products utilizing licensed technology is reported as revenue
based on the number of units sold as reported to us by MediaTek.



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

Our inventory is comprised of raw materials,
work-in-process and finished goods, all of which are
manufactured by third-party contractors. Inventory is valued at
the lower of standard cost (which approximates actual cost on a
first-in, first-out basis) or market. We reduce the carrying
value of inventory for estimated slow-moving, excess, obsolete,
damaged or otherwise unmarketable products by an amount that is
the difference between cost and estimated market value based on
forecasts of future demand and market conditions.

We evaluate excess or obsolete inventory
primarily by estimating demand for individual products within
specific time horizons, typically one year or less. We generally
provide a 100% reserve for the cost of products with on-hand and
committed quantities in excess of the estimated demand after
considering factors such as product life cycles. Once
established, reserves for excess or obsolete inventory are only
released when the reserved products are scrapped or sold. We
also evaluate the carrying value of inventory at the lower of
standard cost or market on an individual product basis, and
these evaluations are based on the difference between net
realizable value and standard cost. Net realizable value is the
forecasted selling price of the product less the estimated costs
of completion and disposal. When necessary, we reduce the
carrying value of inventory to net realizable value.

The estimates of future demand, forecasted sales
prices and market conditions used in the valuation of inventory
form the basis for our published and internal revenue forecast.
If actual results are substantially lower than the forecast, we
may be required to record additional write-downs of product
inventory in future periods and this may have a negative impact
on gross margins.



| |                                         
| | ----------------------------------------
| | Goodwill and Other Intangible
    Assets

Effective January 1, 2002, we adopted
Statement of Financial Accounting Standard (SFAS)
No. 142, Goodwill and Other Intangible Assets
(SFAS 142), which addresses the accounting that must
be applied to goodwill and intangible assets subsequent to their
initial recognition. SFAS 142 requires that goodwill no
longer be amortized, and instead, be tested for impairment at
the reporting unit level at least annually. We completed an
annual impairment test in the fourth quarter of 2003, and
determined that goodwill was not impaired.

We have goodwill and other intangible assets
related to our acquisitions of NetRidium Communications, Inc.
(Netridium) in 2000, Silicon Analog Systems
(SAS) in 2001, and Pictos and Divio in 2003. In
accordance with SFAS 142, we reclassified acquired
workforce intangible assets, which were previously recognized
apart from goodwill, as goodwill and ceased amortization of
goodwill as of January 1, 2002.

19



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##### Table of Contents





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

Pursuant to SFAS No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets, we
review the recoverability of our long-lived assets based upon
our estimates of the future undiscounted cash flows to be
generated by the long-lived assets and will reserve for
impairment whenever such estimated future cash flows indicate
the carrying amount of the assets may not be fully recoverable.



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

We account for income taxes under an asset and
liability approach that requires the recognition of deferred tax
liabilities and assets for the expected future tax consequences
of timing differences between the carrying amounts and the tax
bases of assets and liabilities. U.S. deferred income taxes are
not provided on all un-remitted earnings of our foreign
subsidiaries as such earnings are considered permanently
invested. Assumptions underlying recognition of deferred tax
assets and non-recognition of U.S. income tax on un-remitted
earnings can change if our business plan is not achieved or if
Congress adopts changes in the Internal Revenue Code of 1986, as
amended.



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

From time to time, we are subject to legal
proceedings and claims, including claims of alleged infringement
of patents, trademarks, copyrights and other intellectual
property rights and other claims arising out of the ordinary
course of business. Further, we are currently engaged in certain
shareholder class action and derivative lawsuits.

These contingencies require management judgment
in order to assess the likelihood of any adverse judgments or
outcomes and the potential range of probable losses. Liabilities
for legal matters are accrued for when it is probable that a
liability has been incurred and the amount of the liability can
be reasonably estimated, based upon current law and existing
information. Estimates of contingencies may change in the future
due to new developments or changes in legal approach.

Recent Accounting Pronouncements

In January 2003, the Financial Accounting
Standards Board (FASB) issued FASB Interpretation
No. 46, Consolidation of Variable Interest Entities,
an Interpretation of ARB No. 51 (FIN 46).
FIN 46 requires certain variable interest entities
(VIEs) to be consolidated by the primary beneficiary
of the entity if the equity investors in the entity do not have
the characteristics of a controlling financial interest or do
not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support
from other parties. FIN 46 is effective immediately for all
new VIEs created or acquired after January 31, 2003. For
arrangements entered into with VIEs created prior to
February 1, 2003, the provisions of FIN 46 were
originally effective as of July 1, 2003, however, the FASB
subsequently delayed the effective date of this provision until
the first interim or annual period ending after
December 15, 2003. In December 2003, the FASB issued a
revision to FIN 46 to address certain implementation issues. The
adoption of FIN 46 and revised FIN 46 did not have an impact on
our results of operations or financial position.

In December 2003, the SEC issued Staff Accounting
Bulletin (SAB) No. 104, Revenue
Recognition, (SAB 104) which supersedes
SAB 101, Revenue Recognition in Financial
Statements (SAB 101). SAB 104s
primary purpose is to rescind accounting guidance contained in
SAB 101 related to multiple element revenue arrangements,
superseded as a result of the issuance of Emerging Issues Task
Force (EITF) 00-21, Accounting for Revenue
Arrangements with Multiple Deliverables. Additionally,
SAB 104 rescinds the SECs Revenue Recognition in
Financial Statements Frequently Asked Question and Answers
issued with SAB 101 that had been codified in SEC
Topic 13. The revenue recognition principles of
SAB 101 remain largely unchanged by the issuance of
SAB 104. The adoption of SAB 104 did not have a
material effect on our financial condition or results of
operations.

20



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Results of Operations

Our consolidated financial information presents
the net effect of the discontinued operation separately from the
results of our continuing operations. Historical financial
information has been reclassified to present consistently the
discontinued operation of Vialta. The discussion and analysis
that follow below generally focus on the continuing operations.
Inflation has not had any material impact on our business to
date.

The following table sets forth certain operating
data as a percentage of net revenues:

|                                                 |                                     |                          |       |      |  |      |       |      |  |  |       |      | 
|------------------------------------------------ | ----------------------------------- | ------------------------ | ----- | ---- |  | ---- | ----- | ---- |  |  | ----- | ---- | 
|                                                 |                                     |                         
|                                                 |                                     | Years Ended December 31,
|                                                 |                                     |                         
|                                                 |                                     | 2003                     |       | 2002 |  | 2001
|                                                 |                                     |                          |       |      |  |     
|Net revenues                                     |                                     |                          | 100.0 | %    |  |      | 100.0 | %    |  |  | 100.0 | %   
|Cost of revenues                                 |                                     |                          | 68.0  |      |  |      | 64.5  |      |  |  | 66.4  |     
|                                                 |                                     |                          |       |      |  |      |       |      |  |  |       |     
|                                                 | Gross margin                        |                          |       | 32.0 |  |      |       | 35.5 |  |  |       | 33.6 | 
|Operating expenses:                              |                                     |                          |       |      |  |      |       |      |  |  |       |     
|                                                 | Research and development            |                          |       | 17.0 |  |      |       | 10.0 |  |  |       | 10.3 | 
|                                                 | In-process research and development |                          |       | 1.4  |  |      |       |     |  |  |       |     | 
|                                                 | Selling, general and administrative |                          |       | 16.2 |  |      |       | 12.5 |  |  |       | 15.0 | 
|                                                 |                                     |                          |       |      |  |      |       |      |  |  |       |     
|Operating income (loss)                          |                                     |                          | (2.6  | )    |  |      | 13.0  |      |  |  | 8.3   |     
|Non-operating income (loss), net                 |                                     |                          | 23.5  |      |  |      | 0.9   |      |  |  | (6.9  | )   
|                                                 |                                     |                          |       |      |  |      |       |      |  |  |       |     
|Income before income taxes                       |                                     |                          | 20.9  |      |  |      | 13.9  |      |  |  | 1.4   |     
|Provision for (benefit from) income taxes        |                                     |                          | 8.0   |      |  |      | 0.3   |      |  |  | (2.6  | )   
|                                                 |                                     |                          |       |      |  |      |       |      |  |  |       |     
|Net income from continuing operations            |                                     |                          | 13.0  |      |  |      | 13.6  |      |  |  | 4.0   |     
|Discontinued operation, net of minority interest |                                     |                          |      |      |  |      |      |      |  |  | (4.7  | )   
|                                                 |                                     |                          |       |      |  |      |       |      |  |  |       |     
|Net Income                                       |                                     |                          | 13.0  | %    |  |      | 13.6  | %    |  |  | (0.7  | )%  
|                                                 |                                     |                          |       |      |  |      |       |      |  |  |       |     

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



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

Net revenues were $195.3 million in 2003 and
$273.4 million in 2002. Net revenues decreased by
$78.1 million, or 28.6%, from 2002 to 2003 primarily due to
the decrease in DVD, VCD, PC audio and communication and other
revenue, partially offset by the increase in consumer digital
media revenue and the revenue from the digital imaging and
recordable products which were introduced through the
acquisitions of Pictos and Divio in 2003.

The following table summarizes revenues by our
major product categories.

|                        |  |               |     |      |  |  |     |  
|----------------------- |  | ------------- | --- | ---- |  |  | --- | -
|                        |  |              
|                        |  | Percentage of
|                        |  | Net Revenues 
|                        |  | for Years    
|                        |  | Ended        
|                        |  | December 31, 
|                        |  |              
|                        |  | 2003          |     | 2002
|                        |  |               |     |     
|DVD                     |  |               | 43  | %    |  |  | 59  | %
|VCD                     |  |               | 38  | %    |  |  | 31  | %
|Digital imaging         |  |               | 8   | %    |  |  |    |  
|Recordable              |  |               | 6   | %    |  |  |    |  
|Consumer digital media  |  |               | 2   | %    |  |  |    |  
|Communication and other |  |               | 2   | %    |  |  | 6   | %
|PC audio                |  |               | 1   | %    |  |  | 4   | %
|                        |  |               |     |      |  |  |     |  
|Total                   |  |               | 100 | %    |  |  | 100 | %
|                        |  |               |     |      |  |  |     |  

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DVD revenue includes revenue from sales of DVD
decoder chips. DVD revenues were $83.4 million in 2003, a
decrease of $78.3 million, or 48.4%, from 2002 to 2003,
primarily due to lower unit sales and lower average selling
price (ASP) per unit. Unit sales decreased by 36.8%
and ASP per unit decreased by 18.4%. We believe this decrease
resulted from the entry in the third quarter of 2002 of
MediaTek, a then new competitor based in Taiwan, who introduced
to the marketplace a DVD chip that we believed infringed our
intellectual property rights. We filed a lawsuit in the United
States against MediaTek requesting both damages and an
injunction to stop the importation into the United States of DVD
players containing products we believe infringed our
intellectual property rights. On June 11, 2003, we entered
into the Settlement Agreement with MediaTek relating to the
lawsuit we had filed relating to this activity. Under the terms
of the Settlement Agreement, both sides terminated all claims
against each other and MediaTek received a non-exclusive
worldwide license of our proprietary DVD user interface and
other key DVD software. In conjunction with the Settlement
Agreement, MediaTek paid us a one-time license fee of
$45.0 million related to sales of certain DVD products and
is required to pay ongoing royalties with a quarterly cap of
$5.0 million and lifetime cap of $45.0 million.
Despite the Settlement Agreement, we believe that we have lost
market share among some China based OEMs. We sold approximately
13.6 million units of our DVD chip products in 2003 as
compared to approximately 21.6 million units sold in 2002.

VCD revenue includes revenue from sales of VCD
and SVCD chips. VCD revenues were $74.8 million in 2003, a
decrease of $9.9 million, or 11.7%, from 2002 to 2003,
primarily due to lower ASP per unit. ASP per unit decreased by
44.1% while unit sales increased by 58.1%. The changes were
primarily due to the change in the product mix of the VCD group
from 2002 to 2003. Beginning in 2003, the VCD chipsets were
being phased out and replaced by Visba3 integrated chips. As a
result, unit sales of the Visba3 increased significantly while
the unit sales of the VCD chipsets declined. However, ASP per
unit of the Visba3 was lower than the ASP per unit of the VCD
chipsets. Therefore, the overall ASP per unit dropped. We sold
approximately 44.8 million units of our VCD chip products
in 2003 as compared to approximately 28.3 million units
sold in 2002. We continue to target the market for this product
line by lowering our product costs.

Digital imaging revenue includes revenue from
sales of image sensor chips and image processor chips. Digital
imaging revenues were $14.6 million in 2003 and $0 in 2002.
Digital imaging revenues derived from the sale of products of
Pictos, a company that we acquired in June 2003. We sold
approximately 1.3 million units of digital imaging chip
products in 2003.

Recordable revenue includes revenue from sales of
integrated encoder and decoder chips, and encoder and decoder
chips sold together as a chipset. Recordable revenues were
$12.0 million in 2003 and $0 in 2002. The revenue of the
encoding products of Divio, which we acquired in August 2003,
was approximately 27% of the total recordable revenues. We sold
approximately 0.4 million units of recordable chip products
in 2003.

Consumer digital media revenue includes revenue
from sales of consumer digital media chips. Consumer digital
media revenues were $4.5 million in 2003, an increase of
$4.0 million, or 793.6% from 2002 to 2003, primarily due to
higher unit sales. The consumer digital media products were
introduced during the fourth quarter of 2002. The 2002 revenue
of $0.5 million was classified as communication and other
revenue in 2002. We sold approximately 1.0 million units of
consumer digital media chip products in 2003 as compared to less
than 0.1 million units sold in 2002.

Communication and other revenues were
$3.6 million in 2003, a decrease of $12.2 million, or
77.2%, from 2002 to 2003, primarily due to lower unit sales and
lower ASP per unit. Unit sales decreased by 65.5% and ASP per
unit decreased by 33.9%, from 2002 to 2003. We are no longer
emphasizing this product line, which is a mature market
characterized by unit price declines. We sold approximately
1.9 million units of communication and other chip products
in 2003 as compared to approximately 4.1 million units sold
in 2002.

PC audio revenues were $2.4 million, a
decrease of $8.3 million in 2003, or 77.9%, from 2002 to
2003, primarily due to lower unit sales. Unit sales decreased by
78.1% from 2002 to 2003. We are no longer emphasizing this
product line, which is a declining market as this technology is
being incorporated into the PCs central processor chip. We
sold approximately 0.8 million units of PC audio chip
products in 2003 as compared to approximately 3.0 million
units sold in 2002.

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International revenues accounted for
approximately 99% of net revenues in both 2003 and 2002. Our
international sales are denominated in U.S. dollars. We expect
that international sales will continue to remain a high
percentage of our net revenues in the future.



| |             
| | ------------
| | Gross Margin

Gross profit decreased to $62.6 million in
2003 from $97.0 million in 2002. Gross margins were 32.0%
in 2003 and 35.5% in 2002. The decrease in gross margin was
primarily due to lower volume in our DVD business in 2003, and a
higher volume of lower margin VCD and digital imaging products,
partially offset by a net decrease in the provision for excess
and obsolete inventories of approximately $11.6 million,
and $5.0 million of MediaTek royalty revenue at 100% gross
margin. Excess and obsolete reserves released during the twelve
months ended December 31, 2003 amounted to
$6.3 million, compared to $5.3 million of reserves
provided during the twelve months ended December 31, 2002.
The released reserves were a result of the sale of products that
had previously been fully reserved.

As a result of intense competition in our
markets, we expect the overall ASP per unit for our existing
products to decline their product lives, and in 2004 overall
gross margins may continue to shrink. We believe that in order
to maintain or increase gross profit in 2004, we must achieve
higher unit volume in shipments, reduce costs, add new features
as well as introduce new products at higher ASP.



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

Research and development expenses were
$33.2 million, or 17.0% of net revenues, in 2003 and
$27.0 million, or 9.9% of net revenues in 2002. Research
and development expenses increased by $6.2 million, or
23.1%, from 2002 to 2003, primarily due to the research and
development expenses of Pictos of $4.6 million and Divio of
$1.7 million, which we acquired in June 2003 and August
2003, respectively.



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

In-process research and development expenses were
$2.7 million, or 1.4% of net revenues, in 2003 and $0 in
2002. This increase related to the write-off of in-process
research and development expenses related to the digital imaging
products of Pictos, which we acquired in June 2003, and the
encoding products of Divio, which we acquired in August 2003.



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

Selling, general and administrative expenses were
$31.8 million, or 16.2% of net revenues, in 2003 and
$34.2 million, or 12.5% of net revenues, in 2002. Selling,
general and administrative expenses decreased by
$2.4 million, or 7.0%, from 2002 to 2003, primarily due to
the decrease of commission by $1.0 million as the result of
decreased sales, the decrease of our marketing development fund
(MDF) by $6.5 million due to the cancellation
of our MDF program with some customers, partially offset by the
increase of legal expense by $1.0 million related to
MediaTek lawsuit and insurance expense by $1.4 million due
to the increased director and officer insurance premiums as well
as the increase of $3.3 million of selling, general and
administrative expenses of Pictos and Divio that we acquired in
June 2003 and August 2003, respectively. The selling, general
and administrative expenses in 2003 included the amortization of
intangibles of $1.2 million and $0.3 million for
Pictos and Divio respectively. In 2004, the amortization of
intangibles is estimated to be $1.5 million and
$0.5 million for Pictos and Divio respectively.



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

Net non-operating income was $45.9 million
in 2003 and $2.4 million in 2002. In 2003, net
non-operating income consisted primarily of net license income
of $44.5 million from MediaTek settlement, interest income
of $2.5 million and rental income of $1.2 million from
Vialta, partially offset by the $2.0 million write-off of
investment in Broadmedia and a $1.5 million fee paid to
MediaTek for the successful application for exemption from the
Taiwan withholding tax on the $45.0 million of license
income from MediaTek. See Item 3, Legal
Proceedings, for a description of the MediaTek settlement.
In 2002, net non-operating

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##### Table of Contents



income consisted primarily of interest income of
$3.6 million and rental income of $1.9 million from
Vialta, partially offset by the $3.6 million write-down of
and sale of our investment in the stock of Cisco.




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

Our effective tax rate was 38% for 2003 compared
to a 3% effective tax rate for 2002. The primary reason for the
increase in our effective tax rate for 2003 was an accrual of
income taxes for the MediaTek license fee and royalty payments.

Our 38% tax rate for 2003 was lower than the
combined federal and state statutory rate of 40% primarily as a
result of a release of tax reserves related to the expiration of
the statute of limitations on our 1999 return offset in part by
nondeductible expenses. Our 3% tax rate for 2002 was lower than
the combined federal and state statutory rate primarily as a
result of the lower foreign tax rate on earnings from our
foreign subsidiary, which were considered to be permanently
reinvested, and tax credits.

Based on our forecast and the geographical mix of
our revenues, during 2004, we anticipate that our effective tax
rate will be between 7% and 8%.

The Companys general policy is to
permanently reinvest the net earnings of its foreign
subsidiaries. Accordingly, these earnings have not been subject
to U.S. income taxes. ESS Technology International, Inc., one of
our subsidiaries, organized under the laws of the Cayman
Islands, currently holds approximately $135.0 million in
cash. Under certain circumstances, if ESS Technology
International, Inc. were to transfer this cash, or a portion
thereof, to ESS Technology, Inc., we could be required to pay
taxes on the transfer, to the extent that ESS Technology
International, Inc. has earnings and profits for US income tax
purpose, at our effective tax rate for the year of the transfer,
which could be as high as 40%.



| |                  
| | -----------------
| | Net Income (Loss)

Net income was $25.3 million in 2003 and
$37.3 million in 2002. Net income decreased by
$12.0 million from 2002 to 2003, primarily due to lower
sales, lower gross margin and higher operating expense,
partially offset by the license income from MediaTek.

Comparison of Twelve Months Ended
December 31, 2002 and December 31, 2001



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

Net revenues were $273.4 million in 2002 and
$271.4 million in 2001. Net revenues increased by
$2.0 million, or 0.8%, from 2001 to 2002 primarily due to
the growth of our DVD business, partially offset by the decrease
in the ASP of our VCD chips and the decline in revenues of our
PC audio and communication products.

The following table summarizes revenues by our
major product categories:

|                        |  |               |     |      |  |  |     |  
|----------------------- |  | ------------- | --- | ---- |  |  | --- | -
|                        |  |              
|                        |  | Percentage of
|                        |  | Net Revenues 
|                        |  | for Years    
|                        |  | Ended        
|                        |  | December 31, 
|                        |  |              
|                        |  | 2002          |     | 2001
|                        |  |               |     |     
|DVD                     |  |               | 59  | %    |  |  | 37  | %
|VCD                     |  |               | 31  | %    |  |  | 40  | %
|Communication and other |  |               | 6   | %    |  |  | 7   | %
|PC audio                |  |               | 4   | %    |  |  | 16  | %
|                        |  |               |     |      |  |  |     |  
|Total                   |  |               | 100 | %    |  |  | 100 | %
|                        |  |               |     |      |  |  |     |  

DVD revenue includes revenue from sales of DVD
decoder chips. DVD revenues were $161.7 million, an
increase of $62.3 million, or 62.7%, from 2001 to 2002,
primarily due to higher unit sales, partially offset by lower
ASP per unit. While unit sales increased by 90.7%, ASP per unit
decreased by 14.7% from 2001 to 2002.

24



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##### Table of Contents



Although unit sales in 2002 were higher than in
2001, unit sales in the third and fourth quarter of 2002 were
lower than expected. We believe this decrease resulted from the
entry in the third quarter of 2002 of MediaTek, a then new
competitor based in Taiwan, who introduced to the marketplace a
DVD chip that we believed infringed our intellectual property
rights. We filed a lawsuit in the United States against MediaTek
requesting both damages and an injunction to stop the
importation into the United States of DVD players containing
products we believed infringed our intellectual property rights.
On June 11, 2003, we entered into the Settlement Agreement
with MediaTek relating to the lawsuit we had filed related to
this activity. Under the terms of the Settlement Agreement, both
sides terminated all claims against each other and MediaTek
received a non-exclusive worldwide license of our proprietary
DVD user interface and other key DVD software. MediaTek then
paid us a one-time license fee of $45.0 million related to
sales of certain DVD products and would is required to pay
ongoing royalties with a quarterly cap of $5.0 million and
lifetime cap of $45.0 million. Despite the Settlement
Agreement, we believe that we have lost market share among some
China based OEMs. We sold approximately 21.6 million units
of our DVD chip products in 2002.


VCD revenues were $84.7 million, a decrease
of $25.3 million, or 23.0%, from 2001 to 2002, primarily
due to a decrease in the ASP per unit, partially offset by an
increase in unit sales. ASP per unit decreased by 35.3%, whereas
unit sales increased by 19.1%. We continue to target the market
for this product line by lowering our product costs. We sold
approximately 28.3 million units of our VCD chip products
in 2002.

Communication and other revenue includes revenue
from sales of consumer digital media chips during the fourth
quarter of 2002. Communication and other revenues were
$16.3 million, a decrease of $3.1 million, or 16.0%,
from 2001 to 2002 primarily due to a decrease in both unit sales
and unit prices. Unit sales decreased by 2.2% and ASP per unit
decreased by 14.3% from 2001 to 2002. We are no longer
emphasizing this product line, which is in a mature market
characterized by unit price declines. We sold approximately
4.1 million units of our communication and other chip
products in 2002.

PC audio revenues were $10.7 million, a
decrease of $31.8 million, or 74.9%, from 2001 to 2002,
primarily due to a decrease in unit sales. Unit sales decreased
by 75.3%, from 2001 to 2002, as we are no longer emphasizing
this product line, which is a declining market as this
technology is being incorporated into the PCs central
processor chip. We sold approximately 3.0 million units of
our PC audio chip products in 2002.

International revenues accounted for
approximately 99% of net revenues in 2002 and 97% of net
revenues in 2001. Our international sales are denominated in
U.S. dollars. We expect that international sales will continue
to remain a high percentage of our net revenues.



| |             
| | ------------
| | Gross Margin

Gross profit increased to $97.0 million in
2002 from $91.1 million in 2001. Gross margins were 35.5%
in 2002 and 33.6% in 2001. The increase in gross margin was
primarily due to the growth of our DVD business in 2002,
substantially offset by reduced sales and profitability of our
other product categories. Although gross profit and margins
increased in 2002 as compared to the preceding year, in the
third quarter of 2002, we began experiencing increasing
competition and pricing pressures for both our DVD and VCD
products. As a result, overall gross margins of over 40%
reported in the first and second quarters of 2002 decreased to
26% in the fourth quarter. We expect that gross margins will
remain significantly below the levels experienced in the fiscal
year 2002 at least until such time as new products, with higher
ASPs are introduced, achieve market acceptance, and are sold in
volume.

As a result of intense competition in our
markets, we expect the overall ASP per unit for our existing
products to decline over their product lives. We believe that in
order to maintain or increase gross profit, we must achieve
higher unit volume in shipments, reduce costs, add new features
and introduce new products.



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

Research and development expenses were
$27.0 million, or 10.0% of net revenues, in 2002 and
$28.0 million, or 10.3% of net revenues, in 2001. Research
and development expenses decreased by $1.0 million, or
3.6%, from 2001 to 2002, primarily due to the decrease in
amortization expenses of

25



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##### Table of Contents



$3.9 million, partially offset by the
increase in salary expenses of $2.3 million from research
and development headcount increase. Amortization of goodwill was
discontinued in January 2002 in accordance with
SFAS 142. We expect that research and development will
continue to be critical to our business as we introduce new
products.




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

Selling, general and administrative expenses were
$34.2 million, or 12.5% of net revenues, in 2002 and
$40.7 million, or 15.0% of net revenues, in 2001. Selling,
general and administrative expenses decreased by
$6.5 million, or 16.0%, from 2001 to 2002, primarily due to
the decrease in legal expenses, MDF expenses and salary
expenses. Legal expenses decreased by $2.7 million from
2001 to 2002 because in 2001, there were expenses incurred for
trademark litigation and the filing and subsequent withdrawal of
a registration statement on Form S-3, with respect to a
proposed public offering by us that was abandoned in light of
market turmoil caused by the September 11 terrorist attack.
MDF expenses decreased by $2.0 million from 2001 to 2002,
primarily due to the cancellation of our MDF program with some
customers and the change to a rebate program from our MDF
program for the majority of the sales by some of our customers
and distributors. Salary expenses decreased by
$1.0 million, from 2001 to 2002, primarily due to the
decrease in sales and marketing headcounts.



| |                                     
| | ------------------------------------
| | Non-operating Income (Loss),
    Net

Net non-operating income (loss) was
$2.4 million in 2002 and ($18.8) million in 2001. In
2002, net non-operating income consisted primarily of interest
income of $3.6 million and rental income of
$1.9 million from Vialta, partially offset by the loss from
the ($2.6) million write-down of and sale our investment in the
stock of Cisco. In 2001, net non-operating loss consisted of
($21.2) million from the sale of 565,178 shares of Cisco
stock in June 2001, partially offset by interest income of
$2.0 million and rental income of $0.6 million from
Vialta.



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

Our effective tax rate was 3% for 2002 and (241%)
for 2001. Our effective tax rate, excluding the provision taken
on the exchange of Komodo Technology shares for Cisco stock and
subsequent sale of such Cisco stock, was 5% for 2002 and for
2001. We used an estimated 40% tax rate on the loss from the
($2.6) million write-down and sale of our investment in
Cisco stock, which resulted in a $1.0 million tax benefit
in 2002. We used an estimated 40% tax rate on the
$21.2 million loss from sale of Cisco stock, which resulted
in an $8.5 million tax benefit in 2001.

Our 5% tax rates for 2002 and 2001 were lower
than the combined federal and state statutory rate of 40%
primarily as a result of the lower foreign tax rate on earnings
from our foreign subsidiary, which was considered to be
permanently reinvested, and tax credits in both years.



| |                                          
| | -----------------------------------------
| | Net Income from Continuing
    Operations

Net income from continuing operations was
$37.3 million in 2002 and $11.0 million in 2001. Net
income from continuing operations increased by
$26.3 million from 2001 to 2002, primarily due to the
higher-margin product mix and a $6.5 million decrease in
selling, general and administrative expenses in 2002 and the
($21.2) million loss incurred on the sale of the Cisco stock in
2001.



| |                                                     
| | ----------------------------------------------------
| | Discontinued Operation, Net of Minority
    Interest

Discontinued operation, net of minority interest
was zero in 2002 and a loss of ($12.8) million in 2001. In 2001,
discontinued operation, net of minority interest consisted
primarily of the operating loss from Vialta and the loss from
disposal of discontinued operation for the spin-off of Vialta,
which was completed on August 21, 2001.

26



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##### Table of Contents





| |                  
| | -----------------
| | Net Income (Loss)

Net income in 2002 was $37.3 million and net
loss in 2001 was ($1.8) million. Net income increased by
$39.1 million from 2001 to 2002. The increase was primarily
due to the increase of $5.8 million in gross profit and the
decrease of $7.5 million in operating expenses from 2001 to
2002 and the ($12.8) million loss for the discontinued operation
recorded in 2001 and the ($21.2) million loss from the sale of
the Cisco stock recorded in 2001.

Acquisitions and Related Charges



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

On August 15, 2003, we acquired 100% of the
outstanding shares of Divio for $27.1 million in cash plus
transaction costs. Divio, formerly a privately held company
based in Sunnyvale, California, designs, manufactures and
markets digital encoding semiconductor products. The acquisition
expands our product lines in the digital consumer electronics
market with advanced MPEG 1, 2 and 4 encoders and DV codecs for
digital video recorders, digital still cameras and solid-state
digital camcorders. The acquisition was accounted for as a
purchase combination under SFAS No. 141, Business
Combination, (SFAS 141). Accordingly, the
estimated fair value of assets acquired and liabilities assumed
were included in our consolidated balance sheet as of
August 15, 2003, the effective date of the purchase. The
results of operations of Divio have been included in our
consolidated results of operations since the effective date of
the purchase. There were no significant differences between our
accounting policies and those of Divio.

We allocated the purchase price of
$27.1 million and $3.1 million of legal, other
professional expenses and other costs directly associated with
the acquisition as follows, based on managements estimates
and appraisal:

|                                    |                     |                       |        |        |        | 
|----------------------------------- | ------------------- | --------------------- | ------ | ------ | ------ | 
|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 |       
|                                    |                     |                       |        |       

The following table lists the components of
$6.3 million identifiable intangible assets and their
respective useful lives.

|                                             |                                      |                |       |           |  |  |          |  | 
|-------------------------------------------- | ------------------------------------ | -------------- | ----- | --------- |  |  | -------- |  | 
|                                             |                                      | Estimated Fair |       | Estimated
|Identifiable Intangible Assets               |                                      | Value          |       | 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     |  |  |          |  | 
|                                             |                                      |                |       |           |  |  |          | 

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Amortization expenses related to those
identifiable intangible assets were $858,000 for the year ended
December 31, 2003. The following table summarizes the
annual amortization expenses through 2006.

|                                                   |  |                |       | 
|-------------------------------------------------- |  | -------------- | ----- | 
|Amortization Expenses for Year Ending December 31, |  | Amounts       
|                                                   |  |               
|                                                   |  | (In thousands)
|2004                                               |  | $              | 2,077 | 
|2005                                               |  |                | 2,077 | 
|2006                                               |  |                | 1,298 | 
|                                                   |  |                |       | 
|Total                                              |  | $              | 5,452 | 
|                                                   |  |                |       | 



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

On June 9, 2003, we acquired 100% of the
outstanding shares of Pictos for $27.0 million in cash plus
transaction costs. Pictos, formerly a privately held company
based in Newport Beach, California, designs, manufactures and
markets digital imaging semiconductor products. The acquisition
expands our business into the digital imaging consumer
electronics market with advanced CMOS sensor and image processor
solutions for digital still cameras and cellular camera phones.
The acquisition was accounted for as a purchase combination
under SFAS 141. Accordingly, the estimated fair value of
assets acquired and liabilities assumed were included in our
consolidated balance sheet as of June 9, 2003, the
effective date of the purchase. The results of operations have
been included in our consolidated results of operations since
the effective date of the purchase. There were no significant
differences between our accounting policies and those of Pictos.

We allocated the purchase price of
$27.0 million and $453,000 of legal and other professional
expenses directly associated with the acquisition as follows,
based on managements estimates and appraisal.

|                                    |                       |                |        |        | 
|----------------------------------- | --------------------- | -------------- | ------ | ------ | 
|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 |       
|                                    |                       |                |        |       

The following table lists the components of
$7.9 million identifiable intangible assets and their
respective useful lives.

|                               |                                      |                |       |                |  |  |          |  | 
|------------------------------ | ------------------------------------ | -------------- | ----- | -------------- |  |  | -------- |  | 
|                               |                                      | Estimated Fair |       |               
|Identifiable Intangible Assets |                                      | 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          |  |  |          |  | 
|                               |                                      |                |       |                |  |  |          | 

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##### Table of Contents



Amortization expenses related to these
identifiable intangible assets were $1,841,000 for the year
ended December 31, 2003. The following table summarizes the
annual amortization expenses through 2006.

|                                                   |  |                |       | 
|-------------------------------------------------- |  | -------------- | ----- | 
|Amortization Expenses for Year Ending December 31, |  | Amounts       
|                                                   |  |               
|                                                   |  | (In thousands)
|2004                                               |  | $              | 2,670 | 
|2005                                               |  |                | 2,385 | 
|2006                                               |  |                | 954   | 
|                                                   |  |                |       | 
|Total                                              |  | $              | 6,009 | 
|                                                   |  |                |       | 

Summarized below are our unaudited pro forma
results, reflecting the results of the Pictos and Divio
acquisitions had they been consolidated from the beginning of
all periods indicated. Adjustments have been made for the
estimated increases in amortization of intangibles, amortization
of stock-based compensation and other appropriate pro forma
adjustments. The charges for purchased in-process research and
development are not included in the pro forma results, because
they are non-recurring.

|                        |         |                          |         |      |  |   |         |      | 
|----------------------- | ------- | ------------------------ | ------- | ---- |  | - | ------- | ---- | 
|                        |         |                         
|                        |         | Twelve Months Ended     
|                        |         | December 31,            
|                        |         |                         
|                        |         | 2003                     |         | 2002
|                        |         |                          |         |     
|                        |         |                         
|                        |         | (In thousand, except per
|                        |         | share data)             
|Total revenues          |         | $                        | 201,144 |      |  | $ | 282,819 |     
|Operating income (loss) |         | $                        | (25,248 | )    |  | $ | 11,790  |     
|Net income              |         | $                        | 4,210   |      |  | $ | 10,646  |     
|Net income per share:   |         |                          |         |      |  |   |         |     
|                        | Basic   |                          | $       | 0.11 |  |   | $       | 0.24 | 
|                        | Diluted |                          | $       | 0.10 |  |   | $       | 0.23 | 

The above amounts are based upon certain
assumptions and estimates, which we believe are reasonable, and
they do not reflect any potential benefit from the economy of
size, which may result from our combined operations. The pro
forma financial information presented above is not necessarily
indicative of either the results of operations that would have
occurred had the acquisitions taken place at the beginning of
the periods indicated or of future results of operations of the
combined companies.



| |    
| | ---
| | SAS

On April 12, 2001, we entered into a
definitive agreement to acquire SAS in a merger transaction
accounted for as a purchase business combination. SAS was a
Canadian start-up company engaged in developing single chip
solutions for wireless communications. We paid $1.0 million
on the effective date and an additional $1.0 million on
April 12, 2002. The total purchase price of
$2.0 million along with $75,000 of acquisition costs, were
primarily allocated to goodwill and other intangible assets,
based on managements estimates and appraisals. The assets,
liabilities and operating expenses for SAS were not material to
our financial position or results of operations.

At the time of acquisition, SAS had generated
approximately $300,000 in consulting revenue. SAS had also
developed intellectual property in wireless communications as
well as analog circuit design, areas of key interest to us.
Because of our experience with mixed signal products, we
expected that this acquisition would advance our expertise in
advanced analog design enabling us to develop intellectual
property for key products.

As of December 31, 2003, the SAS design team
is concentrating on video product development, and designs from
this group have been integrated into several video products. SAS
has several patent applications pending and intends to seek
further U.S. and international patents on its technology
whenever possible.

29



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##### Table of Contents



Selected Quarterly Financial Data

The following table sets forth our consolidated
statement of operations data for each of the eight quarters from
January 1, 2002 through December 31, 2003. We believe
that our results of operations will continue to be seasonal,
depending on the timing of customer orders and demand for the
holiday seasons, which typically occur during the third and
fourth quarters. The operating results for any quarter are not
necessarily indicative of results for any future period.

|                                          |                                     |                           |        |          |  |           |        |          |  |          |        |          |  |           |        |          |  |   |        |       |  |   |        |       |  |   |        |        |  |   |        |       | 
|----------------------------------------- | ----------------------------------- | ------------------------- | ------ | -------- |  | --------- | ------ | -------- |  | -------- | ------ | -------- |  | --------- | ------ | -------- |  | - | ------ | ----- |  | - | ------ | ----- |  | - | ------ | ------ |  | - | ------ | ----- | 
|                                          |                                     |                          
|                                          |                                     | Quarter Ended            
|                                          |                                     |                          
|                                          |                                     | Mar. 31,                  |        | Jun. 30, |  | Sept. 30, |        | Dec. 31, |  | Mar. 31, |        | Jun. 30, |  | Sept. 30, |        | Dec. 31,
|                                          |                                     | 2002                      |        | 2002     |  | 2002      |        | 2002     |  | 2003     |        | 2003     |  | 2003      |        | 2003    
|                                          |                                     |                           |        |          |  |           |        |          |  |          |        |          |  |           |        |         
|                                          |                                     |                          
|                                          |                                     | (Unaudited, in thousands)
|Net revenues                              |                                     | $                         | 79,115 |          |  | $         | 86,037 |          |  | $        | 60,746 |          |  | $         | 47,544 |          |  | $ | 33,151 |       |  | $ | 31,011 |       |  | $ | 48,243 |        |  | $ | 82,868 |      
|Cost of revenues                          |                                     |                           | 44,839 |          |  |           | 50,817 |          |  |          | 45,665 |          |  |           | 35,133 |          |  |   | 23,376 |       |  |   | 20,982 |       |  |   | 33,281 |        |  |   | 55,051 |      
|                                          |                                     |                           |        |          |  |           |        |          |  |          |        |          |  |           |        |          |  |   |        |       |  |   |        |       |  |   |        |        |  |   |        |      
|Gross profit                              |                                     |                           | 34,276 |          |  |           | 35,220 |          |  |          | 15,081 |          |  |           | 12,411 |          |  |   | 9,775  |       |  |   | 10,029 |       |  |   | 14,962 |        |  |   | 27,817 |      
|Operating Expenses:                       |                                     |                           |        |          |  |           |        |          |  |          |        |          |  |           |        |          |  |   |        |       |  |   |        |       |  |   |        |        |  |   |        |      
|                                          | Research and development            |                           |        | 6,381    |  |           |        | 7,043    |  |          |        | 7,160    |  |           |        | 6,380    |  |   |        | 6,256 |  |   |        | 7,330 |  |   |        | 10,090 |  |   |        | 9,508 | 
|                                          | In-process research and development |                           |        |         |  |           |        |         |  |          |        |         |  |           |        |         |  |   |        |      |  |   |        | 1,420 |  |   |        | 1,270  |  |   |        |      | 
|                                          | Selling, general and administrative |                           |        | 10,356   |  |           |        | 11,051   |  |          |        | 6,452    |  |           |        | 6,311    |  |   |        | 6,674 |  |   |        | 6,660 |  |   |        | 8,874  |  |   |        | 9,553 | 
|                                          |                                     |                           |        |          |  |           |        |          |  |          |        |          |  |           |        |          |  |   |        |       |  |   |        |       |  |   |        |        |  |   |        |      
|Operating income (loss)                   |                                     |                           | 17,539 |          |  |           | 17,126 |          |  |          | 1,469  |          |  |           | (280   | )        |  |   | (3,155 | )     |  |   | (5,381 | )     |  |   | (5,272 | )      |  |   | 8,756  |      
|Non-operating income (loss), net          |                                     |                           | (1,267 | )        |  |           | 1,085  |          |  |          | 1,438  |          |  |           | 1,151  |          |  |   | 944    |       |  |   | 44,187 |       |  |   | (659   | )      |  |   | 1,474  |      
|                                          |                                     |                           |        |          |  |           |        |          |  |          |        |          |  |           |        |          |  |   |        |       |  |   |        |       |  |   |        |        |  |   |        |      
|Income (loss) before income taxes         |                                     |                           | 16,272 |          |  |           | 18,211 |          |  |          | 2,907  |          |  |           | 871    |          |  |   | (2,211 | )     |  |   | 38,806 |       |  |   | (5,931 | )      |  |   | 10,230 |      
|Provision for (benefit from) income taxes |                                     |                           | (114   | )        |  |           | 889    |          |  |          | 148    |          |  |           | 61     |          |  |   | (98    | )     |  |   | 22,905 |       |  |   | (8,680 | )      |  |   | 1,476  |      
|                                          |                                     |                           |        |          |  |           |        |          |  |          |        |          |  |           |        |          |  |   |        |       |  |   |        |       |  |   |        |        |  |   |        |      
|Net income (loss)                         |                                     | $                         | 16,386 |          |  | $         | 17,322 |          |  | $        | 2,759  |          |  | $         | 810    |          |  | $ | (2,113 | )     |  | $ | 15,901 |       |  | $ | 2,749  |        |  | $ | 8,754  |      
|                                          |                                     |                           |        |          |  |           |        |          |  |          |        |          |  |           |        |          |  |   |        |       |  |   |        |       |  |   |        |        |  |   |        |      

Liquidity and Capital Resources

Since inception, we have financed our cash
requirements from cash generated by operations, the sale of
equity securities, and short-term and long-term debt. At
December 31, 2003, we had cash, cash equivalents and
short-term investments of $164.8 million and working
capital of $145.2 million. At December 31, 2003, we
had a $10.0 million unsecured line of credit with a bank,
which will expire on June 5, 2006. This line of credit
requires us to maintain certain financial ratios and operating
results. As of December 31, 2003 and as of the filing date
of this Report, we are in compliance with the borrowing criteria
and there was no borrowing under this line of credit.

On August 15, 2003, we acquired 100% of the
outstanding shares of Divio for $27.1 million in cash plus
transaction costs. On June 9, 2003, we acquired 100% of the
outstanding shares of Pictos for $27.0 million in cash plus
transaction costs.

In February 2002, we completed a public offering
of 5,520,000 shares of our common stock at a price of
$19.38 per share. We sold 2,500,000 shares, and
3,020,000 shares were sold by the selling shareholders. Net
of the underwriting discount, we received proceeds of
approximately $45.6 million before expenses. See
Note 9, Shareholders Equity, to the
consolidated financial statements in Item 8 of this Report.

In April 2001, our Board of Directors decided to
spin off Vialta, our majority-owned subsidiary. Accordingly, all
of Vialtas assets and liabilities as of December 31,
2000 were reclassified in the balance sheet to net assets of
discontinued operation, net of minority interest and its
revenues and expenses for all periods presented were
reclassified in the income statement to discontinued operation,
net of minority interest. The spin-off transaction was completed
in August 2001, and accordingly, we had no material assets,
liabilities or commitments relating to Vialta as of
December 31, 2003. Further, we do not have any contractual
obligations that are expected to have a material impact upon our
revenues, operating results or cash flows under any of the
spin-off agreements, which include the Master Distribution
Agreement and its ancillary agreements,

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consisting of the Master Technology Ownership and
License Agreement, the Employee Matters Agreement, the Tax
Sharing and Indemnity Agreement, the Real Estate Matters
Agreement, the Master Confidential Disclosure Agreement, and the
Master Transitional Services Agreement. On July 1, 2003, we
entered into the First Amendment to the Amended and Restated
Commercial Lease Agreement with Vialta to reduce the size of the
Fremont facility subject to the lease and adjust the rental
amount. Effective July 1, 2003, Vialta pays us
approximately $312,000 per year, payable in monthly installments
of approximately $26,000 pursuant to the amendment. The Master
Transitional Services Agreement terminated on August 21,
2002. See Note 6, Discontinued Operation and
Note 15, Related Party Transactions with Vialta,
Inc. to the consolidated financial statements in
Item 8 of this Report.


In April 2001, we acquired in a transaction
accounted for as a purchase business combination, all of the
outstanding shares of capital stock of SAS for $1.0 million
in cash, which was paid at the closing in April 2001, plus an
earn-out payment of $1.0 million, which was paid in April
2002.

Net cash provided by operating activities was
$56.2 million for the year ended December 31, 2003,
$64.8 million for the year ended December 31, 2002,
and $93.5 million for the year ended December 31,
2001. The net cash provided by operating activities for the year
ended December 31, 2003 was primarily attributable to a net
income of $25.3 million, depreciation and amortization of
$6.8 million, an increase in accounts payable and accrued
expenses of $41.0 million, primarily due to an increase in
inventory purchases, an increase in income tax payable and
deferred income taxes of $14.1 million, and charges for
purchased in-process research and development of
$2.7 million, partially offset by an increase in accounts
receivable of $27.4 million due to significantly increased
sales in the fourth quarter of 2003, compared to sales during
the fourth quarter of 2002, and an increase in inventories of
$6.4 million primarily due to inventories resulting from
the Pictos and Divio acquisitions. The net cash provided by
operating activities for the year ended December 31, 2002
was primarily attributable to a net income of
$37.3 million, depreciation and amortization of
$6.1 million, write-down of investments of
$3.6 million, a decrease in accounts receivable of
$14.2 million, a decrease in inventories of
$13.3 million, and an increase in income tax payable and
deferred income taxes of $4.2 million, partially offset by
a decrease in accounts payable and accrued expenses of
$14.0 million. The net cash provided by operating
activities for the year ended December 31, 2001 was
primarily attributable to a decrease in inventories of
$61.5 million, depreciation and amortization of
$14.6 million, a loss from discontinued operation of
$12.8 million, net loss from sales of investment of
$12.7 million, a decrease in accounts receivable of
$9.3 million, and an increase in income tax payable and
deferred income taxes of $4.0 million, offset by a decrease
in accounts payable and accrued expenses of $19.7 million.

Net cash used in investing activities was
$70.7 million for the year ended December 31, 2003,
$35.6 million for the year ended December 31, 2002,
and $16.5 million for the year ended December 31,
2001. The net cash used in investing activities for the year
ended December 31, 2003 was primarily attributable to the
purchase of short-term and long-term investments of
$50.1 million and $5.3 million, respectively, cash
paid for acquisitions of Pictos and Divio, net of cash acquired
of $52.1 million, and the purchase of property, plant and
equipment of $8.0 million mainly for CAD software and
testers, partially offset by proceeds from sales of short-term
investments of $44.7 million. The net cash used in
investing activities for the year ended December 31, 2002
was primarily attributable to the purchase of short-term and
long-term investments of $55.4 million and
$5.2 million, respectively, and the purchase of property,
plant and equipment of $2.1 million, partially offset by
proceeds from sales of short-term and long-term investments of
$26.7 million and $0.4 million, respectively. The net
cash used in investing activities for the year ended
December 31, 2001 was primarily attributable to the
purchase of short-term and long-term investments of
$35.4 million and $2.1 million, respectively, and the
purchase of property, plant and equipment of $1.8 million,
offset by proceeds from sales of short-term investments of
$24.9 million.

Net cash used in financing activities was
$24.7 million for the year ended December 31, 2003,
net cash provided by financing activities was $11.9 million
for the year ended December 31, 2002 and net cash used in
financing activities was $5.7 million for the year ended
December 31, 2001. The net cash used in financing
activities for the year ended December 31, 2003 was
primarily attributable to cash paid for repurchase of common
stock of $29.3 million, partially offset by the proceeds
from the issuance of common stock under the employee stock
purchase plan and stock option plans of $4.6 million. The
net cash provided by financing

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activities for the year ended December 31,
2002 was primarily attributable to proceeds from the sale of
common stock in the secondary public offering of
$45.2 million and proceeds from the issuance of common
stock under the employee stock purchase plan and stock option
plans of $9.4 million, partially offset by cash paid for
repurchase of common stock of $42.7 million. The net cash
used in financing activities for the year ended
December 31, 2001 was primarily attributable to cash paid
for repurchase of common stock of $14.3 million, partially
offset by proceeds from the issuance of common stock under
employee stock plans of $8.6 million.


To date, we have not declared or paid cash
dividends to our shareholders and do not anticipate paying any
dividend in the foreseeable future due to a number of factors,
including the volatile nature of the semiconductor industry and
the potential requirement to finance working capital in the
event of a significant upturn in business. We reevaluate this
practice from time to time but are not currently contemplating
the payment of a cash dividend.

We have no long-term debt. Our capital
expenditures for the next twelve months are anticipated to be
approximately $3.0 million. We may also use cash to acquire
or invest in complementary business or products or to obtain the
right to use complementary technologies. From time to time, in
the ordinary course of business, we may evaluate potential
acquisitions of, or investment in, such businesses, products or
technologies owned by third parties. Also, from time to time the
Board of Directors may approve the expenditure of cash resources
to repurchase our common stock as market conditions warrant.
Based on past performance and current expectations, we believe
that our existing cash and short-term investments as of
December 31, 2003, together with funds expected to be
generated by operations, available borrowings under our line of
credit and other financing options, will be sufficient to
satisfy our working capital needs, capital expenditures, mergers
and acquisitions, strategic investment requirements,
acquisitions of property and equipment, stock repurchases and
other potential needs for the next twelve months.



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

The following table sets forth the amounts of
payments due under specified contractual obligations, aggregated
by category of contractual obligation, as of December 31,
2003.

|                            |  |                        |        |                  |  |           |        |           |  |                   |       |  |  |   |    |  |  |  |   | 
|--------------------------- |  | ---------------------- | ------ | ---------------- |  | --------- | ------ | --------- |  | ----------------- | ----- |  |  | - | -- |  |  |  | - | 
|                            |  |                       
|                            |  | Payment Due by Periods
|                            |  |                       
|Contractual Obligations     |  | Total                  |        | Less than 1 Year |  | 1-3 Years |        | 3-5 Years |  | More than 5 Years
|                            |  |                        |        |                  |  |           |        |           |  |                  
|                            |  |                       
|                            |  | (In thousands)        
|Operating Lease Obligations |  | $                      | 5,245  |                  |  | $         | 4,163  |           |  | $                 | 1,017 |  |  | $ | 65 |  |  |  |  | 
|Purchase Obligations        |  |                        | 89,401 |                  |  |           | 89,386 |           |  |                   | 15    |  |  |   |   |  |  |  |  | 
|                            |  |                        |        |                  |  |           |        |           |  |                   |       |  |  |   |    |  |  |  |   | 
|Total                       |  | $                      | 94,646 |                  |  | $         | 93,549 |           |  | $                 | 1,032 |  |  | $ | 65 |  |  |  |  | 
|                            |  |                        |        |                  |  |           |        |           |  |                   |       |  |  |   |    |  |  |  |   | 

We are not a party to any agreements with, or
commitments to, any special purpose entities that would
constitute material off-balance sheet financing other than the
operating lease commitments listed above.

As of December 31, 2003, our commitments to
purchase inventory from the third-party contractors aggregated
approximately $88.1 million. Under these contractual
agreements, we may order inventory from time to time, depending
on our needs. There is no termination date to these agreements.
Additionally, in the ordinary course of business, we enter into
various arrangements with vendors and other business partners,
principally for service, license and other operating supplies.
As of December 31, 2003, commitments under these
arrangements totaled $1.3 million. There are no material
commitments for these arrangements extending beyond 2006.

From time to time, we are subject to legal
proceedings and claims, including claims of alleged infringement
of trademarks, copyrights and other intellectual property rights
and other claims arising out of the ordinary course of business.
Further, we are currently engaged in certain shareholder class
action and derivative lawsuits. We intend to defend these suits
vigorously and we may incur substantial expenses in litigating
claims against third parties and defending against existing and
future third-party claims that may arise. In the event of a
determination adverse to us, we may incur substantial monetary
liability and be

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required to change our business practices. Either
of these results could have a material adverse effect on our
financial position, results of operations and cash flows. See
Part I, Item 3, Legal Proceedings.


Stock
Repurchase

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, in addition to all
shares that remained available for repurchase under previously
announced programs, on the same terms and conditions as those
prior repurchase programs. No purchase was made in 2003 under
this program. As of December 31, 2003, we have an aggregate
of 5,202,000 shares available for repurchase under our
stock repurchase programs.

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, in addition to all
shares that remain available for repurchase under previously
announced programs, on the same terms and conditions as these
prior repurchase programs. The repurchase program is being
effected from time to time, depending on market conditions and
other factors, through open market purchases. In the period from
January 1, 2003 through December 31, 2003, we
repurchased 4,797,764 shares of our common stock for an
aggregate price of $29.0 million at market prices ranging
from $5.43 to $6.70 per share under this program. Upon
repurchase, these shares were retired and no longer deemed
outstanding. As of December 31, 2003, we had approximately
202,000 shares available for repurchase under this program.

We announced on May 7, 2002 that our Board
of Directors authorized us to repurchase up to 3.0 million
shares of our common stock, inclusive of all shares that then
remained available for repurchase under previously announced
programs, on the same terms and conditions as our prior
repurchase programs. During 2002, we repurchased
2,937,828 shares for an aggregated price of
$42.5 million at market prices ranging from $5.27 to $18.20
per share. In the period from January 1, 2003 through
December 31, 2003, we repurchased 62,172 shares of our
common stock at an average market price of $5.43 per share to
complete the program. Upon repurchase, these shares were retired
and no longer deemed outstanding.

Factors That May Affect Future
Results

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

Since the second half of 2001, we have shifted
our primary focus from the PC audio business to developing
products primarily for the consumer electronics market,
including the consumer digital home entertainment market.
Currently, our sales of video system processor chips to the DVD
and VCD (including VCD and SVCD) player markets account for a
majority of our net revenues. We expect these products will
continue to account for a significant portion of our net
revenues for the foreseeable future. Further, we continue to
invest in new product lines such as our digital imaging products
that target the consumer electronics market. However, our
strategy in this market may not be successful. Given the current
economic environment and other consumer electronics products,
consumer spending on DVD players and other home electronics may
not increase as expected or may even weaken or fall. If the
markets for these products and applications decline or fail to
develop as expected, or we are not successful in our efforts to
market and sell our products to manufacturers who incorporate
integrated circuits into these products, our financial results
will be harmed.

In addition, the potential decline in consumer
confidence and consumer spending that may be occasioned by
terrorist attacks or armed conflict could have a material
adverse effect on our business, financial condition and results
of operations.

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

Historically, our quarterly operating results
have fluctuated significantly. Our future quarterly operating
results will likely fluctuate from time to time and may not meet
the expectations of securities analysts and

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investors in a particular future period. The
price of our common stock could decline due to such
fluctuations. The following factors may cause significant
fluctuations in our future quarterly operating results:




| |   |                                                                                                                                                                                         
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Changes in demand for our products;                                                                                                                                                     
|
| |  | Changes in the mix of products sold and our
    revenue mix;                                                                                                                            
|
| |  | Charges related to excess inventory;                                                                                                                                                    
|
| |  | Charges related the net realizable value of
    inventory;                                                                                                                              
|
| |  | Seasonal customer demand;                                                                                                                                                               
|
| |  | Increasing pricing pressures and resulting
    reduction in the ASP of any or all of our products;                                                                                      
|
| |  | Gain or loss of significant customers;                                                                                                                                                  
|
| |  | 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;                                                                                                                                              
|
| |  | Most of our orders are on a turns
    basis, which makes back log a poor indicator of the next
    quarters revenue;                                                                 
|
| |  | Orders are normally received with little lead
    time for customer deliveries, 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;                                                                                                                                              
|
| |  | A shift in manufacturing of consumer electronic
    products away from China; and                                                                                                       
|
| |  | Loss of key employees which could impact sales or
    the pace of product development.                                                                                                  

In addition, sales for any future quarter may
vary and accordingly be inconsistent with our plans. We
manufacture products based on a combination of limited, firm
order requirements and forecasts of our customer demands.
Products are typically shipped within one to eight weeks
following receipt of an order. Customers may cancel or
reschedule orders without significant penalty. Product sales are
also difficult to forecast because the consumer electronics
market is rapidly evolving and our sales cycle varies
substantially from customer to customer. Due to all of the
foregoing factors, it is possible that in one or more future
quarters, our results may fall below the expectations of public
market analysts and investors. In such event, the trading price
of our common stock would likely decrease.

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

We currently place non-cancelable orders to
purchase our products from independent foundries on an
approximately three-month rolling basis, while our customers
generally place purchase orders (frequently with short lead
times) with us that may be cancelled without significant
penalty. If anticipated sales and shipments in any quarter are
cancelled or do not occur as quickly as expected, expense and
inventory levels could be disproportionately high and we may be
required to record significant inventory charges in our
statement of operations in a particular period. As our business
grows, we may increasingly rely on distributors, which may
further impede our ability to accurately forecast product
orders. We have experienced significant inventory charges in the
past and we may continue to experience these charges in future
periods.

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

We invest a significant amount of time and
resources in our research and development activities to maintain
and enhance our competitive position. Technical innovations are
inherently complex and require long development cycles and the
commitment of extensive engineering resources. We incur
substantial research and development costs to confirm the
technical feasibility and commercial viability of a product that
in the end may not be successful. If we are not able to
successfully complete our research and development projects on a
timely basis, we may face competitive disadvantages. There is no
assurance that we will recover the development costs associated
with these projects or that we will be able to secure the
financial resources necessary to fund future research and
development efforts.

One of our significant projects is the
development of a next generation DVD processor chip that will
incorporate three independent processors and allow us to support
additional features, including the Linux, PocketPC (formerly
WinCE) and VxWorks operating systems. This will require a new
architecture and a complete system on a chip design, which is
extremely complex and may not be ultimately feasible. If we are
unable to successfully develop this next generation DVD
processor chip, or complete other significant research and
development projects, our business, financial condition and
results of operations could be materially adversely affected.

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 these
acquisitions with our business.

We will continue to regularly consider the
acquisition of other companies or the products and technologies
of other companies to complement our existing product offerings,
improve our market coverage and enhance our technological
capabilities. There may be technologies that we need to acquire
or license in order to remain competitive. However, we may not
be able to identify and consummate suitable acquisitions and
investments or be able to acquire them at costs that are
competitive. Acquisitions and investments carry risks that could
have a material adverse effect on our business, financial
condition and results of operations, including:



| |   |                                                                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The failure to integrate with existing products
    and corporate culture;                                                                                                                                         
|
| |  | The inability to retain key employees from the
    acquired company;                                                                                                                                               
|
| |  | Diversion of management attention from other
    business concerns;                                                                                                                                                
|
| |  | The potential for large write-offs;                                                                                                                                                                                
|
| |  | The failure of the acquired products or
    technology to attain market acceptance;                                                                                                                                
|
| |  | The failure to leverage the acquired products and
    technology to attain market acceptance;                                                                                                                      
|
| |  | 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 sales may fluctuate due to seasonality
and changes in customer demand.

Since we are primarily focused on the consumer
electronics market, we are likely to be affected both by changes
in consumer demand and by seasonality in the sales of our
products. Historically, over half of consumer electronic
products are sold during the holiday seasons. Consumer
electronic product sales have historically been much higher
during the holiday shopping season than during other times of
the year, although the manufacturers shipments vary from
quarter to quarter depending on a number of factors, including
retail levels and retail promotional activities. In addition,
consumer demand often varies from one product to another in
consecutive holiday seasons, and is strongly influenced by the
overall state of the economy. Because the consumer electronic
market experiences substantial seasonal fluctuations, seasonal

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trends may cause our quarterly operating results
to fluctuate significantly and our inability to forecast these
trends may adversely affect the market price of our common
stock. In 2003, for example, we did not experience as much of a
seasonal demand for our DVD chips as we expected. We believe
that this was due in part to the entry of a new competitor, but
also in part to lower than expected consumer demand for DVD
players, which experienced strong sales during the 2002 holiday
seasons. In the future, if the market for our products is not as
strong during the holiday seasons, whether as a result of
changes in consumer tastes or because of an overall reduction in
consumer demand due to economic conditions, we may fail to meet
expectation of securities analysts and investors which could
cause our stock price to fall.


Our products are subject to increasing
pricing pressures.

The markets for most of the applications for our
chips are characterized by intense price competition. The
willingness of OEMs to design our chips into their products
depends, to a significant extent, upon our ability to sell our
products at cost-effective prices. We expect the ASP of our
existing products (particularly our DVD decoder chip products)
to decline significantly over their product lives as the markets
for our products mature, new products or technology emerges and
competition increases. If we are unable to reduce our costs
sufficiently to offset declines in product prices or are unable
to introduce more advanced products with higher margins, our
gross margins may decline.

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

Our existing and potential competitors consist,
in part, of large domestic and international companies that have
substantially greater financial, manufacturing, technical,
marketing, distribution and other resources, greater
intellectual property rights, broader product lines and
longer-standing relationships with customers than we have. Our
competitors also include a number of independent and emerging
companies who may be able to better adapt to changing market
conditions and customer demand. In addition, some of our current
and potential competitors maintain their own semiconductor
fabrication facilities and could benefit from certain capacity,
cost and technical advantages. We expect that market experience
to date and the predicted growth of the market will continue to
attract and motivate more and stronger competitors.

DVD and VCD players face significant competition
from video-on-demand, VCRs and other video formats. In addition,
we expect that the DVD platform for the DHS will face
competition from other platforms including STBs, as well as
multi-function game boxes being manufactured and sold by large
companies. Some of our competitors may be more diversified than
us and supply chips for multiple platforms. A decline in DVD
sales may have a disproportionate effect on us as it is
currently our most important product line. Any of these
competitive factors could reduce our sales and market share and
may force us to lower our prices, adversely affecting our
business, financial condition and results of operations.

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

Our success depends to a significant degree upon
the continued contributions of Fred S.L. Chan, our Chairman of
the Board, and Robert L. Blair, our President and CEO. In
the past, Mr. Chan has served as our President and Chief
Executive Officer in addition to being our Chairman of the
Board. Mr. Chan is critical to maintaining many of our key
relationships with customers, suppliers and foundries in Asia.
The loss of the services of Mr. Chan, Mr. Blair, or
any of our other key executives could adversely affect our
business. We may not be able to retain these key personnel and
searching for their replacements could divert the attention of
other senior management and increase our operating expenses. We
currently do not maintain any key person life insurance.

Additionally, to manage our future operations
effectively, we will need to hire and retain additional
management personnel, design personnel and software engineers.
We may have difficulty recruiting these employees or integrating
them into our business. The loss of services of any of our key
personnel, the inability to attract and retain qualified
personnel in the future, or delays in hiring required personnel,
particularly design personnel and software engineers, could make
it difficult to implement our key business strategies, such as
timely and effective product introductions.

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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.

Sales through our largest distributor Dynax
Electronics (a Hong Kong based company) were approximately 63%,
57% and 56% of our net revenues in 2003, 2002 and 2001. Dynax
Electronics is not subject to any minimum purchase requirements
and can discontinue marketing any of our products at any time.
In addition, Dynax Electronics has rights of return for unsold
product and rights to pricing allowances to compensate for
rapid, unexpected price changes, therefore we do not recognize
revenue until Dynax Electronics sells through to our
end-customers. If our relationship with Dynax Electronics
deteriorates, our quarterly results could fluctuate
significantly as we experience short-term disruption to our
sales and collection processes, particularly in light of the
fact that we maintain significant accounts receivable from Dynax
Electronics. As our business grows, we may increasingly rely on
distributors, which may reduce our exposure to future sales
opportunities. Although we believe that we could replace Dynax
Electronics as our distributor for the Hong Kong and China
markets, there can be no assurance that we could replace Dynax
Electronics in a timely manner or if a replacement were found
that the new distributor would be as effective as Dynax
Electronics in generating revenue for us.

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

A substantial portion of our net revenues has
been derived from sales to a small number of our customers.
During 2003, sales to our top five end customers (including
end-customers that buy our products from our largest distributor
Dynax Electronics) were approximately 34% of our net revenues.
We expect this concentration of sales to continue along with
other changes in the composition of our customer base. The
reduction, delay or cancellation of orders from one or more
major customers or the loss of one or more major customers could
materially and adversely affect our business, financial
condition and results of operations. In addition, any difficulty
in collecting amounts due from one or more key customers could
harm our financial condition.

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 inventory to meet our customers
needs.

We have in the past and will continue to
regularly consider the expansion into new businesses and product
lines, by acquisition or otherwise. As a result of our prior
expansions into new businesses and new product lines, we
continue to sell our products to a highly concentrated customer
base. The reduction, delay or cancellation of orders from one or
more major customers or the loss of one or more major customers
in these new businesses or product lines, could have a material
adverse effect on our business, financial condition and results
of operations.

As a result of our recent acquisitions, such as
Pictos, we currently purchase custom inventory from certain of
our product lines such as image sensor modules for camera
enabled cellular phones. This custom inventory is highly
tailored to each customers specifications. In the event
that these customers reduce or cancel their orders for these
products, we may not be able to re-sell the custom inventory to
any of our other customers. We may also be forced to write off
such custom inventory which may result in a material adverse
effect on our business, financial condition and results of
operations.

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.

To protect our intellectual property rights we
rely on a combination of patents, trademarks, copyrights and
trade secret laws and confidentiality procedures. As of
December 31, 2003, we had 54 patents granted in the United
States. These patents will expire over time commencing in 2008
and ending in 2002. In addition, as of December 31, 2003,
we had 15 corresponding foreign patents, which are going to
expire over time commencing in 2005 and ending in 2020. We
cannot assure you that patents will be issued from any of our

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pending applications or applications in
preparation or that any claims allowed from pending applications
or applications in preparation will be of sufficient scope or
strength. We may not be able to obtain patent protection in all
countries where our products can be sold. Also, our competitors
may be able to design around our patents. The laws of some
foreign countries may not protect our products or intellectual
property rights to the same extent, as do the laws of the United
States. We cannot assure you that the actions we have taken to
protect our intellectual property will adequately prevent
misappropriation of our technology or that our competitors will
not independently develop technologies that are substantially
equivalent or superior to our technology.


The semiconductor industry is characterized by
vigorous protection and pursuit of intellectual property rights
or positions. Litigation by or against us could result in
significant expense and divert the efforts of our technical and
management personnel, whether or not such litigation results in
a favorable determination for us. Any claim, even if without
merit, may require us to spend significant resources to develop
non-infringing technology or enter into royalty or
cross-licensing arrangements, which may not be available to us
on acceptable terms, or at all. We may be required to pay
substantial damages or cease the use and sale of infringing
products, or both. In general, a successful claim of
infringement against us in connection with the use of our
technologies could adversely affect our business. For example,
if we lose the Townshend modem case, our results of operations
could be significantly harmed. We may initiate claims or
litigation against third parties for infringement of our
proprietary rights or to establish the validity of our
proprietary rights. In the event of an adverse result in any
such litigation our business could be materially harmed.

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

Substantially all of our sales are to customers
in Hong Kong, Taiwan, China, Korea, Japan and the Czech
Republic. During 2003, sales to customers in Hong Kong, Taiwan
and China were in excess of 81% of our net revenues. If our
sales in one of these countries, such as Hong Kong, were to
fall, our financial condition could be materially impaired. We
expect that international sales will continue to represent a
significant portion of our net revenues. In addition,
substantially all of our products are manufactured, assembled
and tested by independent third parties in Asia. There are
special risks associated with conducting business outside of the
United States, including:



| |   |                                                                                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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.

We rely on independent foundries to manufacture
all of our products. Substantially all of our products are
currently manufactured by Taiwan Semiconductor Manufacturing
Company, Ltd., United Microelectronics

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Corporation and other independent Asian foundries
in Asia. Our reliance on these or other independent foundries
involves a number of risks, including:




| |   |                                                                                                                                                                                       
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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.

Any failure of these third-party foundries to
deliver products or otherwise perform as requested could damage
our relationships with our customers and harm our sales and
financial results.

To address potential foundry capacity constraints
in the future, we may be required to enter into arrangements,
including equity investments in or loans to independent wafer
manufacturers in exchange for guaranteed production capacity,
joint ventures to own and operate foundries, or take or
pay contracts that commit us to purchase specified
quantities of wafers over extended periods. These arrangements
could require us to commit substantial capital or to grant
licenses to our technology. If we need to commit substantial
capital, we may need to obtain additional debt or equity
financing, which could result in dilution to our shareholders.

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

We depend on a limited number of suppliers to
obtain adequate supplies of quality raw materials on a timely
basis. We do not generally have guaranteed supply arrangements
with our suppliers. If we have difficulty in obtaining materials
in the future, alternative suppliers may not be available, or if
available, these suppliers may not provide materials in a timely
manner or on favorable terms. If we cannot obtain adequate
materials for the manufacture of our products, we may be forced
to pay higher prices, experience delays and our relationships
with our customers may suffer.

In addition, we license certain technology from
third parties that is incorporated into many of our key
products. If we are unable to obtain or license the technology
on commercially reasonable terms and on a timely basis, we will
not be able to deliver products to our customers on competitive
terms and in a timely manner and our relationships with our
customers may suffer.

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

Our potential customers often spend a significant
amount of time to evaluate, test and integrate our products. Our
sales cycles often last for several months and may last for up
to a year or more. These longer sales cycles require us to
invest significant resources prior to the generation of revenues
and subject us to greater risk that customers may not order our
products as anticipated. In addition, orders expected in one
quarter could shift to another because of the timing of
customers purchase decisions. Any cancellation or delay in
ordering our products after a lengthy sales cycle could
adversely affect our business.

Our products are subject to recall
risks.

The greater integration of functions and
complexity of our products increase the risk that our customers
or end users could discover latent defects or subtle faults in
our products. These discoveries could occur after substantial
volumes of product have been shipped, which could result in
material recalls and replacement costs. Product recalls could
also divert the attention of our engineering personnel from our
product development needs and could adversely impact our
customer relationships. In addition, we could be subject to
product liability claims that could distract management,
increase costs and delay the introduction of new products.

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

The semiconductor industry is subject to cyclical
variations in product supply and demand, the timing, length and
volatility of which are difficult to predict. Downturns in the
industry have been characterized by abrupt fluctuations in
product demand, production over-capacity and accelerated decline
of ASP. Upturns in the industry have been characterized by
rising costs of goods sold and lack of production capacity at
our suppliers. These cyclical changes in demand and capacity,
upward and downward, could significantly harm our business. Our
quarterly net revenue and gross margin performance could be
significantly impacted by these cyclical variations. A prolonged
downturn in the semiconductor industry could materially and
adversely impact our business, financial condition and results
of operations. We cannot assure you that the market will improve
from a cyclical downturn or that cyclical performance will
stabilize or improve.

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.

We may be required to obtain substantial
additional capital to finance our future growth, fund our
ongoing research and development activities and acquire new
technologies or companies. To the extent that our existing
sources of liquidity and cash flow from operations are
insufficient to fund our activities, we may need to seek
additional equity or debt financing from time to time. If our
performance or prospects decrease, we may need to consummate a
private placement or public offering of our capital stock at a
lower price than you paid for your shares. If we raise
additional capital through the issuance of new securities at a
lower price than you paid for your shares, you will be subject
to additional dilution. Further, such equity securities may have
rights, preferences or privileges senior to those of our
existing common stock. Additional financing may not be available
to us when needed or, if available, it may not be available on
terms favorable to us.

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

The semiconductor industry is characterized by
rapid technological changes, evolving industry standards and
product obsolescence. Our success is highly dependent upon the
successful development and timely introduction of new products
at competitive prices and performance levels. The success of new
products depends on a number of factors, including:



| |   |                                                                                           
| | - | ------------------------------------------------------------------------------------------
| |  | 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 designed to conform to current
specific industry standards, however we have no control of
future modifications to these standards. Manufacturers may not
continue to follow the current standards, which would make our
products less desirable to manufacturers and reduce our sales.
Our success is highly dependent upon our ability to develop new
products in response to these changing industry standards.

We operate in highly competitive
markets.

The markets in which we compete are intensely
competitive and are characterized by rapid technological
changes, price reductions and short product life cycles.
Competition typically occurs at the design stage, when customers
evaluate alternative design approaches requiring integrated
circuits. Because of short product life cycles, there are
frequent design win competitions for next-generation systems.

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We expect competition to increase in the future
from existing competitors and from other companies that may
enter our existing or future markets with products that may be
provided at lower costs or provide higher levels of integration,
higher performance or additional features. Advancements in
technology can change the competitive environment in ways that
may be adverse to us. For example, todays high-performance
central processing units in PCs have enough excess computing
capacity to perform many of the functions that formerly required
a separate chip set, which has reduced demand for our
PC audio chips. The announcements and commercial shipments
of competitive products could adversely affect sales of our
products and may result in increased price competition that
would adversely affect the ASP and margins of our products.

The following factors may affect our ability to
compete in our highly competitive markets:



| |   |                                                                                                        
| | - | -------------------------------------------------------------------------------------------------------
| |  | The timely shipment of our new VCD chip, the
    Visba IV;                                             
|
| |  | The price, quality and performance of our
    products and the products of our competitors;            
|
| |  | The timing and success of our new product
    introductions and those of our customers and 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.                                                

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

The price of our common stock fluctuates
significantly. Many factors influence the price of our common
stock, including:



| |   |                                                                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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;
|
| |  | 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.                                                                                                                                                         






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

We are exposed to the impact of foreign currency
fluctuations and interest rate changes which may lead to changes
in the market values of our investments.

Foreign Exchange Risks

We fund our operations with cash generated by
operations, the sale of marketable securities and short and
long-term debt. As we operate primarily in Asia, we are exposed
to market risk from changes in foreign exchange rates, which
could affect our results of operations and financial condition.
In order to reduce the risk from fluctuation in foreign exchange
rates, our product sales and all of our arrangements with our
foundries

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and test and assembly vendors are denominated in
U.S. dollars. We have not entered into any currency hedging
activities.


Interest Rate Risks

We also invest in short-term investments.
Consequently, we are exposed to fluctuation in rates on these
investments. Increases or decreases in interest rates generally
translate into decreases and increases in the fair value of
these investments. In addition, the credit worthiness of the
issuer, relative values of alternative investments, the
liquidity of the instrument, and other general market conditions
may affect the fair values of interest rate sensitive
investments. In order to reduce the risk from fluctuation in
interest rates, we invest in highly liquid governmental notes
and bonds with contractual maturities of less than two years.
All of the investments have been classified as available for
sale, and at December 31, 2003, the fair value of our
investments approximated their costs.

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

The following documents are filed as part of this
Report:

Report of Independent Auditors

Consolidated Balance Sheets as of
December 31, 2003 and 2002



| |                                                                                                             
| | ------------------------------------------------------------------------------------------------------------
| | Consolidated Statements of Operations for the
    years ended December 31, 2003, 2002 and 2001              
|
| | Consolidated Statements of Shareholders
    Equity for the years ended December 31, 2003, 2002
    and 2001
|
| | Consolidated Statements of Cash Flows for the
    years ended December 31, 2003, 2002 and 2001              

Notes to Consolidated Financial Statements

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REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Shareholders of ESS
Technology, Inc.:

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

As discussed in Note 2 to the consolidated
financial statements, effective January 1, 2002, the
Company changed its method of accounting for goodwill in
accordance with Statement of Financial Accounting Standards
No. 142, Goodwill and Other Intangible Assets.



| |                               
| | ------------------------------
| | /s/ PRICEWATERHOUSECOOPERS LLP

San Jose, California

February 27, 2004


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ESS TECHNOLOGY, INC.

CONSOLIDATED BALANCE SHEETS

|                                             |                                                                                                                                                            |                                            |        |         |         |   |         |         |         | 
|-------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | ------- | ------- | - | ------- | ------- | ------- | 
|                                             |                                                                                                                                                            |                                           
|                                             |                                                                                                                                                            | December 31,                              
|                                             |                                                                                                                                                            |                                           
|                                             |                                                                                                                                                            | 2003                                       |        | 2002   
|                                             |                                                                                                                                                            |                                            |        |        
|                                             |                                                                                                                                                            |                                           
|                                             |                                                                                                                                                            | (In thousands)                            
|ASSETS                                      
|Cash and cash equivalents                    |                                                                                                                                                            | $                                          | 98,938 |         |         | $ | 138,072 |        
|Short-term investments                       |                                                                                                                                                            |                                            | 65,908 |         |         |   | 61,030  |        
|Accounts receivable, net                     |                                                                                                                                                            |                                            | 57,393 |         |         |   | 28,435  |        
|Related party receivable  Vialta            |                                                                                                                                                            |                                            | 281    |         |         |   | 33      |        
|Inventories                                  |                                                                                                                                                            |                                            | 33,546 |         |         |   | 24,155  |        
|Prepaid expenses and other assets            |                                                                                                                                                            |                                            | 2,959  |         |         |   | 2,834   |        
|                                             |                                                                                                                                                            |                                            |        |         |         |   |         |        
|                                             |                                                                                                                                                            | Total current assets                       |        |         | 259,025 |   |         |         | 254,559 | 
|Property, plant and equipment, net           |                                                                                                                                                            |                                            | 24,629 |         |         |   | 18,985  |        
|Goodwill                                     |                                                                                                                                                            |                                            | 43,789 |         |         |   | 2,074   |        
|Other intangible assets                      |                                                                                                                                                            |                                            | 11,510 |         |         |   | 249     |        
|Other assets                                 |                                                                                                                                                            |                                            | 13,640 |         |         |   | 5,735   |        
|                                             |                                                                                                                                                            |                                            |        |         |         |   |         |        
|                                             |                                                                                                                                                            | Total assets                               |        | $       | 352,593 |   |         | $       | 281,602 | 
|                                             |                                                                                                                                                            |                                            |        |         |         |   |         |        
|LIABILITIES AND SHAREHOLDERS
    EQUITY    
|Accounts payable and accrued expenses        |                                                                                                                                                            | $                                          | 84,414 |         |         | $ | 35,084  |        
|Income tax payable and deferred income taxes |                                                                                                                                                            |                                            | 29,390 |         |         |   | 9,474   |        
|                                             |                                                                                                                                                            |                                            |        |         |         |   |         |        
|                                             |                                                                                                                                                            | Total current liabilities                  |        |         | 113,804 |   |         |         | 44,558  | 
|Non-current deferred tax liability           |                                                                                                                                                            |                                            | 11,708 |         |         |   | 7,676   |        
|                                             |                                                                                                                                                            |                                            |        |         |         |   |         |        
|                                             |                                                                                                                                                            | Total liabilities                          |        |         | 125,512 |   |         |         | 52,234  | 
|                                             |                                                                                                                                                            |                                            |        |         |         |   |         |        
|Commitments and contingencies (Note 14)      |                                                                                                                                                            |                                            |        |         |         |   |         |        
|Shareholders equity:                        |                                                                                                                                                            |                                            |        |         |         |   |         |        
|                                             | Preferred stock, no par value, 10,000 shares
    authorized; none issued and outstanding                                                                   |                                            |        |        |         |   |         |        |        
|                                             | Common stock, no par value, 100,000 shares
    authorized; 39,246 and 43,305 shares issued and outstanding
    at December 31, 2003 and 2002, respectively |                                            |        | 175,546 |         |   |         | 196,344 |        
|Accumulated other comprehensive income       |                                                                                                                                                            |                                            | 929    |         |         |   | 504     |        
|Retained earnings                            |                                                                                                                                                            |                                            | 50,606 |         |         |   | 32,520  |        
|                                             |                                                                                                                                                            |                                            |        |         |         |   |         |        
|                                             |                                                                                                                                                            | Total shareholders equity                 |        |         | 227,081 |   |         |         | 229,368 | 
|                                             |                                                                                                                                                            |                                            |        |         |         |   |         |        
|                                             |                                                                                                                                                            | Total liabilities and shareholders equity |        | $       | 352,593 |   |         | $       | 281,602 | 
|                                             |                                                                                                                                                            |                                            |        |         |         |   |         |        

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

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ESS TECHNOLOGY, INC.

CONSOLIDATED STATEMENTS OF
OPERATIONS

|                                                            |                                                                          |                                       |         |         |      |      |         |         |      |   |         |         |       |  
|----------------------------------------------------------- | ------------------------------------------------------------------------ | ------------------------------------- | ------- | ------- | ---- | ---- | ------- | ------- | ---- | - | ------- | ------- | ----- | -
|                                                            |                                                                          |                                      
|                                                            |                                                                          | Years Ended December 31,             
|                                                            |                                                                          |                                      
|                                                            |                                                                          | 2003                                  |         | 2002    |      | 2001
|                                                            |                                                                          |                                       |         |         |      |     
|                                                            |                                                                          |                                      
|                                                            |                                                                          | (In thousands, except per share data)
|Net revenues                                                |                                                                          | $                                     | 194,815 |         |      | $    | 272,039 |         |      | $ | 270,253 |        
|Net revenues from related party  Vialta                    |                                                                          |                                       | 458     |         |      |      | 1,403   |         |      |   | 1,127   |        
|                                                            |                                                                          |                                       |         |         |      |      |         |         |      |   |         |        
|                                                            | Total net revenues                                                       |                                       |         | 195,273 |      |      |         | 273,442 |      |   |         | 271,380 |      
|Cost of revenues                                            |                                                                          |                                       | 132,690 |         |      |      | 176,454 |         |      |   | 180,231 |        
|                                                            |                                                                          |                                       |         |         |      |      |         |         |      |   |         |        
|                                                            | Gross profit                                                             |                                       |         | 62,583  |      |      |         | 96,988  |      |   |         | 91,149  |      
|Operating expenses:                                         |                                                                          |                                       |         |         |      |      |         |         |      |   |         |        
|                                                            | Research and development                                                 |                                       |         | 33,184  |      |      |         | 26,964  |      |   |         | 27,957  |      
|                                                            | In-process research and development                                      |                                       |         | 2,690   |      |      |         |        |      |   |         |        |      
|                                                            | Selling, general and administrative                                      |                                       |         | 31,761  |      |      |         | 34,170  |      |   |         | 40,689  |      
|                                                            |                                                                          |                                       |         |         |      |      |         |         |      |   |         |        
|Operating income (loss)                                     |                                                                          |                                       | (5,052  | )       |      |      | 35,854  |         |      |   | 22,503  |        
|Non-operating income (loss), net                            |                                                                          |                                       | 45,946  |         |      |      | 2,407   |         |      |   | (18,780 | )      
|                                                            |                                                                          |                                       |         |         |      |      |         |         |      |   |         |        
|Income before income taxes                                  |                                                                          |                                       | 40,894  |         |      |      | 38,261  |         |      |   | 3,723   |        
|Provision for (benefit from) income taxes                   |                                                                          |                                       | 15,603  |         |      |      | 984     |         |      |   | (7,262  | )      
|                                                            |                                                                          |                                       |         |         |      |      |         |         |      |   |         |        
|Net income from continuing operations                       |                                                                          |                                       | 25,291  |         |      |      | 37,277  |         |      |   | 10,985  |        
|Discontinued operation, net of minority interest:           |                                                                          |                                       |         |         |      |      |         |         |      |   |         |        
|                                                            | Loss from discontinued operation, net of minority
    interest           |                                       |         |        |      |      |         |        |      |   |         | (4,205  | )    
|                                                            | Loss on disposal of discontinued operation, net
    of minority interest |                                       |         |        |      |      |         |        |      |   |         | (8,597  | )    
|                                                            |                                                                          |                                       |         |         |      |      |         |         |      |   |         |        
|Net income (loss)                                           |                                                                          | $                                     | 25,291  |         |      | $    | 37,277  |         |      | $ | (1,817  | )      
|                                                            |                                                                          |                                       |         |         |      |      |         |         |      |   |         |        
|Net income (loss) per share:                                |                                                                          |                                       |         |         |      |      |         |         |      |   |         |        
|                                                            | Basic:                                                                   |                                       |         |         |      |      |         |         |      |   |         |         |      
|                                                            |                                                                          | Continuing operations                 |         | $       | 0.64 |      |         | $       | 0.85 |   |         | $       | 0.26  |  
|                                                            |                                                                          | Discontinued operation                |         |         |     |      |         |         |     |   |         |         | (0.30 | )
|                                                            |                                                                          |                                       |         |         |      |      |         |         |      |   |         |        
|                                                            |                                                                          | $                                     | 0.64    |         |      | $    | 0.85    |         |      | $ | (0.04   | )      
|                                                            |                                                                          |                                       |         |         |      |      |         |         |      |   |         |        
|                                                            | Diluted:                                                                 |                                       |         |         |      |      |         |         |      |   |         |         |      
|                                                            |                                                                          | Continuing operations                 |         | $       | 0.61 |      |         | $       | 0.80 |   |         | $       | 0.24  |  
|                                                            |                                                                          | Discontinued operation                |         |         |     |      |         |         |     |   |         |         | (0.28 | )
|                                                            |                                                                          |                                       |         |         |      |      |         |         |      |   |         |        
|                                                            |                                                                          | $                                     | 0.61    |         |      | $    | 0.80    |         |      | $ | (0.04   | )      
|                                                            |                                                                          |                                       |         |         |      |      |         |         |      |   |         |        
|Shares used in calculating net income
    (loss) per share: |                                                                          |                                       |         |         |      |      |         |         |      |   |         |        
|                                                            | Basic                                                                    |                                       |         | 39,517  |      |      |         | 44,044  |      |   |         | 42,274  |      
|                                                            |                                                                          |                                       |         |         |      |      |         |         |      |   |         |        
|                                                            | Diluted                                                                  |                                       |         | 41,238  |      |      |         | 46,731  |      |   |         | 45,262  |      
|                                                            |                                                                          |                                       |         |         |      |      |         |         |      |   |         |        

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

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ESS TECHNOLOGY, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS
EQUITY

|                             |                                                                                       |                |        |                   |   |               |         |               |   |        |        |        |   |   |        |         |   |   |         |         |  
|---------------------------- | ------------------------------------------------------------------------------------- | -------------- | ------ | ----------------- | - | ------------- | ------- | ------------- | - | ------ | ------ | ------ | - | - | ------ | ------- | - | - | ------- | ------- | -
|                             |                                                                                       |                |        |                   |   |               |         |              
|                             |                                                                                       | Common Stock   |        | Accumulated Other |   |               |         | Total        
|                             |                                                                                       |                |        | Comprehensive     |   | Retained      |         | Shareholders
|                             |                                                                                       | Shares         |        | Amount            |   | Income (Loss) |         | Earnings      |   | Equity
|                             |                                                                                       |                |        |                   |   |               |         |               |   |       
|                             |                                                                                       |               
|                             |                                                                                       | (In thousands)
|Balance at December 31, 2000 |                                                                                       |                | 42,133 |                   |   | $             | 149,197 |               |   | $      | (7,378 | )      |   | $ | 69,610 |         |   | $ | 211,429 |        
|                             | Issuance of common stock upon exercise of options                                     |                |        | 1,772             |   |               |         | 8,174         |   |        |        |       |   |   |        |        |   |   |         | 8,174   |  
|                             | Issuance of common stock for employee stock
    purchase plan                         |                |        | 69                |   |               |         | 405           |   |        |        |       |   |   |        |        |   |   |         | 405     |  
|                             | Income tax benefit on disqualifying disposition
    of common stock options           |                |        |                  |   |               |         | 1,670         |   |        |        |       |   |   |        |        |   |   |         | 1,670   |  
|                             | Repurchase of common stock                                                            |                |        | (1,640            | ) |               |         | (5,768        | ) |        |        |       |   |   |        | (8,544  | ) |   |         | (14,312 | )
|                             | Unrealized loss on marketable securities                                              |                |        |                  |   |               |         |              |   |        |        | (6,705 | ) |   |        |        |   |   |         | (6,705  | )
|                             | Net loss                                                                              |                |        |                  |   |               |         |              |   |        |        |       |   |   |        | (1,817  | ) |   |         | (1,817  | )
|                             | Loss on sale of marketable security                                                   |                |        |                  |   |               |         |              |   |        |        | 12,709 |   |   |        |        |   |   |         | 12,709  |  
|                             | Net book value of discontinued operation on date
    of spin-off                      |                |        |                  |   |               |         |              |   |        |        |       |   |   |        | (34,575 | ) |   |         | (34,575 | )
|                             |                                                                                       |                |        |                   |   |               |         |               |   |        |        |        |   |   |        |         |   |   |         |        
|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     |  
|                             | Net income                                                                            |                |        |                  |   |               |         |              |   |        |        |       |   |   |        | 37,277  |   |   |         | 37,277  |  
|                             | Write-down of Cisco shares                                                            |                |        |                  |   |               |         |              |   |        |        | 1,573  |   |   |        |        |   |   |         | 1,573   |  
|                             | Loss on sale of marketable security                                                   |                |        |                  |   |               |         |              |   |        |        | 45     |   |   |        |        |   |   |         | 45      |  
|                             |                                                                                       |                |        |                   |   |               |         |               |   |        |        |        |   |   |        |         |   |   |         |        
|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 benefit (reverse) 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     |  
|                             | Net income                                                                            |                |        |                  |   |               |         |              |   |        |        |       |   |   |        | 25,291  |   |   |         | 25,291  |  
|                             |                                                                                       |                |        |                   |   |               |         |               |   |        |        |        |   |   |        |         |   |   |         |        
|Balance at December 31, 2003 |                                                                                       |                | 39,246 |                   |   | $             | 175,546 |               |   | $      | 929    |        |   | $ | 50,606 |         |   | $ | 227,081 |        
|                             |                                                                                       |                |        |                   |   |               |         |               |   |        |        |        |   |   |        |         |   |   |         |        

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

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ESS TECHNOLOGY, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                         |                                                                                              |                                                                             |                                              |                                                         |       |         |         |         |       |         |         |         |        |         |         |  
|-------------------------------------------------------- | -------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------- | -------------------------------------------- | ------------------------------------------------------- | ----- | ------- | ------- | ------- | ----- | ------- | ------- | ------- | ------ | ------- | ------- | -
|                                                         |                                                                                              |                                                                            
|                                                         |                                                                                              | Years Ended December 31,                                                   
|                                                         |                                                                                              |                                                                            
|                                                         |                                                                                              | 2003                                                                        |                                              | 2002                                                    |       | 2001   
|                                                         |                                                                                              |                                                                             |                                              |                                                         |       |        
|                                                         |                                                                                              |                                                                            
|                                                         |                                                                                              | (In thousands)                                                             
|Cash flows from operating
    activities:                |                                                                                              |                                                                             |                                              |                                                         |       |         |         |         |       |         |         |        
|Net income (loss)                                        |                                                                                              | $                                                                           | 25,291                                       |                                                         |       | $       | 37,277  |         |       | $       | (1,817  | )      
|                                                         | Adjustments to reconcile net income
    (loss) to net cash provided by operating activities: |                                                                             |                                              |                                                         |       |         |         |         |       |         |         |         |       
|                                                         |                                                                                              | Loss from discontinued operation                                            |                                              |                                                         |      |         |         |         |      |         |         |         | 12,802 |        
|                                                         |                                                                                              | Depreciation and amortization                                               |                                              |                                                         | 6,847 |         |         |         | 6,080 |         |         |         | 14,640 |        
|                                                         |                                                                                              | (Gain) loss on sale of property, plant and
    equipment                    |                                              |                                                         | 54    |         |         |         | (85   | )       |         |         |       |        
|                                                         |                                                                                              | Charges for purchased in-process research and
    development               |                                              |                                                         | 2,690 |         |         |         |      |         |         |         |       |        
|                                                         |                                                                                              | (Gain) loss from sale of investments                                        |                                              |                                                         | (185  | )       |         |         | 189   |         |         |         | 12,709 |        
|                                                         |                                                                                              | Write-down of investments                                                   |                                              |                                                         | 1,986 |         |         |         | 3,612 |         |         |         |       |        
|                                                         |                                                                                              | Stock-related compensation charge                                           |                                              |                                                         |      |         |         |         | 301   |         |         |         |       |        
|                                                         |                                                                                              | Income tax benefit on disqualifying disposition
    of common stock options |                                              |                                                         | 331   |         |         |         | 1,025 |         |         |         | 1,670  |        
|                                                         |                                                                                              | Changes in assets and liabilities:                                          |                                              |                                                         |       |         |         |         |       |         |         |         |        |        
|                                                         |                                                                                              |                                                                             | Accounts receivable, net                     |                                                         |       | (27,421 | )       |         |       | 14,160  |         |         |        | 9,289   |        
|                                                         |                                                                                              |                                                                             | Related party receivable  Vialta            |                                                         |       | (248    | )       |         |       | 14      |         |         |        | (47     | )      
|                                                         |                                                                                              |                                                                             | Inventories                                  |                                                         |       | (6,381  | )       |         |       | 13,297  |         |         |        | 61,488  |        
|                                                         |                                                                                              |                                                                             | Prepaid expenses and other assets            |                                                         |       | (1,786  | )       |         |       | (1,208  | )       |         |        | 286     |        
|                                                         |                                                                                              |                                                                             | Accounts payable and accrued expenses        |                                                         |       | 40,958  |         |         |       | (13,978 | )       |         |        | (19,677 | )      
|                                                         |                                                                                              |                                                                             | Related party payable  Vialta               |                                                         |       |        |         |         |       | (111    | )       |         |        | (599    | )      
|                                                         |                                                                                              |                                                                             | Income tax payable and deferred income taxes |                                                         |       | 14,071  |         |         |       | 4,179   |         |         |        | 4,042   |        
|                                                         |                                                                                              |                                                                             | Net assets of discontinued operation         |                                                         |       |        |         |         |       |        |         |         |        | (1,246  | )      
|                                                         |                                                                                              |                                                                             |                                              |                                                         |       |         |         |         |       |         |         |        
|                                                         |                                                                                              |                                                                             |                                              | Net cash provided by operating activities               |       |         | 56,207  |         |       |         | 64,752  |         |        |         | 93,540  |  
|                                                         |                                                                                              |                                                                             |                                              |                                                         |       |         |         |         |       |         |         |        
|Cash flows from investing
    activities:                |                                                                                              |                                                                             |                                              |                                                         |       |         |         |         |       |         |         |        
|                                                         | Purchase of property, plant and equipment                                                    |                                                                             |                                              | (7,962                                                  | )     |         |         | (2,147  | )     |         |         | (1,844  | )     
|                                                         | Purchase of short-term investments                                                           |                                                                             |                                              | (50,084                                                 | )     |         |         | (55,406 | )     |         |         | (35,433 | )     
|                                                         | Sale of short-term investments                                                               |                                                                             |                                              | 44,734                                                  |       |         |         | 26,741  |       |         |         | 24,922  |       
|                                                         | Purchase of long-term investments                                                            |                                                                             |                                              | (5,298                                                  | )     |         |         | (5,212  | )     |         |         | (2,100  | )     
|                                                         | Sale of long-term investments                                                                |                                                                             |                                              |                                                        |       |         |         | 440     |       |         |         |        |       
|                                                         | Cash paid for acquisitions, net of cash acquired                                             |                                                                             |                                              | (52,052                                                 | )     |         |         |        |       |         |         | (2,072  | )     
|                                                         |                                                                                              |                                                                             |                                              |                                                         |       |         |         |         |       |         |         |        
|                                                         |                                                                                              |                                                                             |                                              | Net cash used in investing activities                   |       |         | (70,662 | )       |       |         | (35,584 | )       |        |         | (16,527 | )
|                                                         |                                                                                              |                                                                             |                                              |                                                         |       |         |         |         |       |         |         |        
|Cash flows from financing
    activities:                |                                                                                              |                                                                             |                                              |                                                         |       |         |         |         |       |         |         |        
|                                                         | Repurchase of common stock                                                                   |                                                                             |                                              | (29,301                                                 | )     |         |         | (42,659 | )     |         |         | (14,312 | )     
|                                                         | Issuance of common stock from secondary public
    offering                                  |                                                                             |                                              |                                                        |       |         |         | 45,181  |       |         |         |        |       
|                                                         | Issuance of common stock under employee stock
    purchase plan and stock option plans       |                                                                             |                                              | 4,622                                                   |       |         |         | 9,387   |       |         |         | 8,579   |       
|                                                         |                                                                                              |                                                                             |                                              |                                                         |       |         |         |         |       |         |         |        
|                                                         |                                                                                              |                                                                             |                                              | Net cash provided by (used in) financing
    activities |       |         | (24,679 | )       |       |         | 11,909  |         |        |         | (5,733  | )
|                                                         |                                                                                              |                                                                             |                                              |                                                         |       |         |         |         |       |         |         |        
|Net increase (decrease) in cash and cash
    equivalents |                                                                                              |                                                                             | (39,134                                      | )                                                       |       |         | 41,077  |         |       |         | 71,280  |        
|Cash and cash equivalents at beginning of year           |                                                                                              |                                                                             | 138,072                                      |                                                         |       |         | 96,995  |         |       |         | 25,715  |        
|                                                         |                                                                                              |                                                                             |                                              |                                                         |       |         |         |         |       |         |         |        
|Cash and cash equivalents at end of year                 |                                                                                              | $                                                                           | 98,938                                       |                                                         |       | $       | 138,072 |         |       | $       | 96,995  |        
|                                                         |                                                                                              |                                                                             |                                              |                                                         |       |         |         |         |       |         |         |        
|Supplemental disclosure of cash flow
    information     |                                                                                              |                                                                             |                                              |                                                         |       |         |         |         |       |         |         |        
|                                                         | Cash paid for income taxes                                                                   |                                                                             | $                                            | (2,926                                                  | )     |         | $       | (237    | )     |         | $       | (3,300  | )     
|                                                         | Cash refund for income taxes                                                                 |                                                                             | $                                            | 1,566                                                   |       |         | $       | 4,520   |       |         | $       | 6,684   |       

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

48



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##### Table of Contents



ESS TECHNOLOGY, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

Note 1.     Nature
of Business

We are a leading designer, developer and marketer
of highly integrated analog and digital processor chips, imaging
sensor chips, digital amplifiers, and camera lens modules. Our
digital processor chips are the primary processors driving
digital video and audio devices, including DVD, Video CD
(VCD), digital cameras, digital camcorders, consumer
digital audio players, and digital media players. Our imaging
chips utilize advanced Complimentary Metal Oxide Semiconductor
(CMOS) sensor technology to capture an image for
digital still cameras and cellular camera phone applications.
Our camera lens modules are made up of a lens, image sensor
chip, housing and flex cable necessary to provide camera
capabilities to electronic devices such as cellular phones and
Personal Digital Assistants (PDAs). Our digital
amplifiers boost the digital sound to a level required to drive
loudspeakers, in such applications as DVD and CD players, home
theater systems, audio receivers, boom boxes and televisions
sets. We have also developed encoding processors to address the
growing demand for digital video recorders (DVRs),
recordable DVD players, digital still cameras and digital
camcorders. We believe that multi-featured DVD, DVR and
recordable DVD players will serve as a platform for the digital
home system (DHS), integrating various digital home
entertainment and information delivery products into a single
box. We are also a supplier of chips for use in modems, other
communication devices, and PC audio products. Our chips use
multiple processors and a programmable architecture that enable
us to offer a broad array of features and functionality. We
outsource all of our chip fabrication and assembly as well as
the majority of our test operations, allowing us to focus on our
design and development strengths. The terms Company,
we, us, our, and similar
terms refer to ESS Technology, Inc. and its subsidiaries, unless
the context otherwise requires.

We market our products worldwide through our
direct sales force, distributors and sales representatives.
Substantially all of our sales are to customers in Hong Kong,
Taiwan, China, Korea, Japan, and the Czech Republic. We employ
sales and support personnel located outside of the United States
in China, Hong Kong, Taiwan, Japan and Korea to support these
international sales efforts. We expect that international sales
will continue to represent a significant portion of our net
revenue. In addition, substantially all of our products are
manufactured, assembled and tested by independent third parties
in Asia. We also have a limited number of employees engaged in
research and development efforts outside of the United States.
There are special risks associated with conducting business
outside of the United States. See Item 7, Factors
That May Affect Future Results  We have significant
international sales and operations that are subject to the
special risks of doing business outside the United States.

We were incorporated in California in 1984 and
became a public company in 1995. In April 1999, we expanded our
business beyond the semiconductor segment by establishing
Vialta, Inc. (Vialta), a subsidiary that would
operate in the internet segment. In April 2001, our Board of
Directors adopted a plan to distribute to our shareholders all
of our shares in Vialta. The Vialta spin-off was completed on
August 21, 2001. On June 9, 2003, we acquired 100% of
the outstanding shares of Pictos Technologies, Inc., a Delaware
corporation (Pictos). On August 15, 2003, we
acquired 100% of the outstanding shares of Divio, Inc., a
California corporation (Divio). See Note 5,
Acquisition and Related Charges, to the consolidated
financial statements.

Note 2.     Summary
of Significant Accounting Policies



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

Certain items previously presented in specific
financial statement captions have been reclassified to conform
to the 2003 presentations.

49



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



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

The preparation of financial statements in
conformity with generally accepted accounting principles in the
United States requires management to make estimates and
assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes. Actual results
could differ materially from those estimates.



| |                            
| | ---------------------------
| | Principles of Consolidation

The consolidated financial statements include the
accounts of ESS and its subsidiaries. All significant
inter-company accounts and transactions have been eliminated.



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

Our subsidiaries primarily use the U.S. dollar as
their functional currency. Accordingly, assets and liabilities
of these subsidiaries are translated using exchange rates in
effect at the end of the period, except for non-monetary assets
that are translated using historical exchange rates. Revenues
and costs are translated using average exchange rates for the
period, except for costs related to those balance sheet items
that are translated using historical exchange rates. The
resulting translation gains and losses are included in the
Consolidated Statement of Operations as incurred.



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

We consider all highly liquid investments with an
initial maturity of 90 days or less to be cash equivalents and
investments with original maturity dates of greater than
90 days to be short-term investments.

Short-term investments are comprised of primarily
debt instruments and marketable securities. Short-term
investments are accounted for as available-for-sale and are
reported at fair value with unrealized gains and losses, net of
related tax, recorded as accumulated other comprehensive income
in shareholders equity until realized in accordance with
Statement of Financial Accounting Standards
(SFAS) 115, Accounting for Certain
Investments in Debt and Equity Securities. Gains and
losses on securities sold are based on the specific
identification method and are included in our Consolidated
Statement of Operations as non-operating income (loss).



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

The reported amounts of certain of our financial
instruments, including cash and cash equivalents, short-term
investments, accounts receivable, accounts payable, accrued
expenses and other current liabilities approximate fair value
due to their short maturities.



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

Our inventory is comprised of raw materials,
work-in-process and finished goods, all of which are
manufactured by third-party contractors. Inventory is valued at
the lower of standard cost (which approximates actual cost on a
first-in, first-out basis) or market. We reduce the carrying
value of inventory for estimated slow-moving, excess, obsolete,
damaged or otherwise unmarketable products by an amount that is
the difference between cost and estimated market value based on
forecasts of future demand and market conditions.

50



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



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

Property and equipment are stated at cost less
accumulated depreciation and amortization. Depreciation is
generally computed using the straight-line method over the
estimated useful lives of the assets.

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

Repairs and maintenance costs are expensed as
incurred.



| |            
| | -----------
| | Investments

Investment in over 50% owned companies are
consolidated. Investments in 20% to 50% owned companies are
accounted for using the equity method. Investments in less than
20% owned companies are accounted for using the cost method
unless we can exercise significant influence over the
investees operations or the investee is economically
dependent upon us, in which case the equity method is used. We
currently do not have any unconsolidated investments for which
we account for the equity method. We periodically review the
performance of these investments to ascertain if any adjustment
to their carrying value is required.



| |                                         
| | ----------------------------------------
| | Goodwill and Other Intangible
    Assets

Effective January 1, 2002, we adopted
SFAS 142, Goodwill and Other Intangible Assets
(SFAS 142) which addresses the accounting that
must be applied to goodwill and intangible assets subsequent to
their initial recognition. SFAS 142 requires that goodwill
no longer be amortized, and instead, be tested for impairment at
the reporting unit level at least annually.

The following table summarizes the activity in
goodwill and other intangible assets during the year ended
December 31, 2003:

|                        |  |                |       |           |  |              |        |              |  |  |        |   |  |   |        | 
|----------------------- |  | -------------- | ----- | --------- |  | ------------ | ------ | ------------ |  |  | ------ | - |  | - | ------ | 
|                        |  | December 31,   |       |           |  |              |        | December 31,
|                        |  | 2002           |       | Additions |  | Amortization |        | 2003        
|                        |  |                |       |           |  |              |        |             
|                        |  |               
|                        |  | (In thousands)
|Goodwill                |  | $              | 2,074 |           |  |              | 41,715 |              |  |  |       |   |  | $ | 43,789 | 
|Other intangible assets |  | $              | 249   |           |  |              | 14,160 |              |  |  | (2,899 | ) |  | $ | 11,510 | 

51



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

A reconciliation of previously reported net
income and loss per share for the year ended December 31,
2001 to the amounts adjusted for the exclusion of goodwill and
workforce amortization, net of the effects of continued
amortization of technical infrastructure and related income tax
effect, is as follows:

|                             |                            |                       |        |       |       |  
|---------------------------- | -------------------------- | --------------------- | ------ | ----- | ----- | -
|                             |                            | Year Ended           
|                             |                            | December 31, 2001    
|                             |                            |                      
|                             |                            | (In thousands, except
|                             |                            | per share data)      
|Reported net loss            |                            | $                     | (1,817 | )    
|                             | Add: Goodwill amortization |                       |        | 2,243 |      
|                             |                            | Tax impact            |        |       | (271  | )
|                             |                            |                       |        |      
|Adjusted net income          |                            | $                     | 155    |      
|                             |                            |                       |        |      
|Reported earnings per share: |                            |                       |        |      
|                             | Basic and Diluted          |                       | $      | (0.04 | )    
|Add: Goodwill amortization   |                            |                       | 0.05   |      
|                             |                            | Tax impact            |        |       | (0.01 | )
|                             |                            |                       |        |      
|Adjusted earnings per share  |                            |                       |        |      
|                             | Basic and Diluted          |                       | $      | 0.00  |      
|                             |                            |                       |        |      

We completed our annual impairment test in the
fourth quarter of 2003, and determined that goodwill was not
impaired. We have goodwill and other intangible assets related
to our acquisitions of NetRidium Communications, Inc. in 2000,
Silicon Analog Systems (SAS) in 2001, and Pictos and
Divio in 2003. In accordance with SFAS 142, we reclassified
acquired workforce intangible assets, which were previously
recognized apart from goodwill, as goodwill and ceased
amortization of goodwill as of January 1, 2002.



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

Pursuant to SFAS No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets, we
review the recoverability of long-lived assets based upon our
estimates of the future undiscounted cash flows to be generated
by the long-lived assets and will reserve for impairment
whenever such estimated future cash flows indicate the carrying
amount of the assets may not be fully recoverable.



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

Revenue is primarily generated by product sales
and is generally recognized at the time of shipment when
persuasive evidence of an arrangement exists, the price is fixed
or determinable and collection of the resulting receivable is
reasonably assured, except for products sold to certain
distributors with certain rights of return and allowance, in
which case, revenue is deferred until such a distributor resells
the products to a third party. Such deferred revenues related to
distributor sales, net of deferred cost of goods sold are
included in accrued expenses on our balance sheets.

We provide for rebates based on current
contractual terms and future returns based on historical
experiences at the time revenue is recognized as reductions to
product revenue. Actual amounts may be different from
managements estimates. Such differences, if any, are
recorded in the period they become known.

Income from MediaTek royalties for the sale of
products utilizing licensed technology is reported as revenue
based on the number of units sold as reported to us by MediaTek.

52



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



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

We expense research and development costs as
incurred.



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

We account for income taxes under an asset and
liability approach that requires the recognition of deferred tax
liabilities and assets for the expected future tax consequences
of timing differences between the carrying amounts and the tax
bases of assets and liabilities. U.S. deferred income taxes are
not provided on all un-remitted earnings of our foreign
subsidiaries as such earnings are considered permanently
invested. Assumptions underlying recognition of deferred tax
assets and non-recognition of U.S. income tax on un-remitted
earnings can change if our business plan is not achieved or if
Congress adopts changes in the Internal Revenue Code of 1986, as
amended.



| |                          
| | -------------------------
| | Earnings (Loss) Per Share

Basic earnings per share (EPS) is
computed by dividing net income by the weighted average number
of common stock outstanding for the period. Diluted EPS reflects
the potential dilution that would occur if securities or other
contracts to issue common stock were exercised or converted into
common stock.



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

We account for stock-based compensation,
including stock options granted under our various stock option
plans and shares issued under the 1995 Employee Stock Purchase
Plan (Purchase Plan), using the intrinsic value
method prescribed in APB No. 25, Accounting for Stock
Issued to Employees, and related interpretations.
Compensation cost for stock options, if any, is recognized
ratably over the vesting periods. Our policy is to grant options
under our stock option plans with an exercise price equal to the
fair market value of our common stock based on the closing price
on the grant date, except as otherwise provided by law. Our
policy is to grant purchase options under the Purchase Plan with
a purchase price equal to 85% of the lesser of the fair market
value of the common stock on the enrollment date or on the
purchase date. The enrollment date is on the first business day
of May and November of each year. Unless otherwise specified,
the purchase dates under the Purchase Plan are on the first
business day of May or November, or the last business date of
April or October. We provide additional pro forma disclosures as
required under SFAS No. 123, Accounting for
Stock-Based Compensation (SFAS 123) and
SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure 
an Amendment of FAS No. 123.

The Purchase Plan, as amended, permits eligible
employees to acquire shares of our common stock through payroll
deductions at a price equal to the lower of 85% of the fair
market value of our common stock at the beginning of the
offering period or on the purchase date. The Purchase Plan, as
amended, provides a 24-month rolling period beginning on each
enrollment date and the purchase price is automatically adjusted
to reflect the lower enrollment price. As of December 31,
2003, 813,267 shares have been issued under the Purchase
Plan, as amended.

53



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Our reported net income (loss) and pro forma net
income (loss) would have been as follows had compensation costs
for options granted under our stock option plans and shares
purchased under our Purchase Plan been determined based on the
fair value at the grant dates, as prescribed in SFAS 123:

|                                           |                                                                             |                                       |   |         |   |      |   |         |   |  |   |         |  
|------------------------------------------ | --------------------------------------------------------------------------- | ------------------------------------- | - | ------- | - | ---- | - | ------- | - |  | - | ------- | -
|                                           |                                                                             |                                      
|                                           |                                                                             | Years Ended December 31,             
|                                           |                                                                             |                                      
|                                           |                                                                             | 2003                                  |   | 2002    |   | 2001
|                                           |                                                                             |                                       |   |         |   |     
|                                           |                                                                             |                                      
|                                           |                                                                             | (In thousands, except per share data)
|Net income (loss):                         |                                                                             |                                       |   |         |   |      |   |         |   |  |   |        
|                                           | As reported                                                                 |                                       | $ | 25,291  |   |      | $ | 37,277  |   |  | $ | (1,817  | )
|                                           | Stock-Based Compensation expense included in
    reported net income (loss) |                                       |   |        |   |      |   |        |   |  |   |        |  
|                                           | Amortization of stock compensation expense, net
    of tax                  |                                       |   | (10,142 | ) |      |   | (10,827 | ) |  |   | (11,282 | )
|                                           |                                                                             |                                       |   |         |   |      |   |         |   |  |   |        
|                                           | Pro forma net income (loss)                                                 |                                       | $ | 15,149  |   |      | $ | 26,450  |   |  | $ | (13,099 | )
|                                           |                                                                             |                                       |   |         |   |      |   |         |   |  |   |        
|Net income (loss) per share  basic:       |                                                                             |                                       |   |         |   |      |   |         |   |  |   |        
|                                           | As reported                                                                 |                                       | $ | 0.64    |   |      | $ | 0.85    |   |  | $ | (0.04   | )
|                                           | Pro forma                                                                   |                                       | $ | 0.38    |   |      | $ | 0.60    |   |  | $ | (0.31   | )
|Net income (loss) per share 
    diluted: |                                                                             |                                       |   |         |   |      |   |         |   |  |   |        
|                                           | As reported                                                                 |                                       | $ | 0.61    |   |      | $ | 0.80    |   |  | $ | (0.04   | )
|                                           | Pro forma                                                                   |                                       | $ | 0.37    |   |      | $ | 0.57    |   |  | $ | (0.31   | )

The fair value of each option granted under our
stock option plans is estimated on the date of grant using the
Black-Scholes option-pricing model with the following
assumptions for the years ended December 31, 2003, 2002 and
2001:

|                                          |  |                        |      |      |  |      |      |   |  |   |      |  
|----------------------------------------- |  | ---------------------- | ---- | ---- |  | ---- | ---- | - |  | - | ---- | -
|                                          |  |                       
|                                          |  | Employee Stock Options
|                                          |  |                       
|                                          |  | 2003                   |      | 2002 |  | 2001
|                                          |  |                        |      |      |  |     
|Expected dividend yield                   |  |                        | 0.0  | %    |  |      | 0.0  | % |  |   | 0.0  | %
|Weighted average risk-free interest rate  |  |                        | 2.13 | %    |  |      | 3.69 | % |  |   | 4.43 | %
|Expected volatility                       |  |                        | 94   | %    |  |      | 102  | % |  |   | 90   | %
|Weighted average expected life (in years) |  |                        | 4    |      |  |      | 4    |   |  |   | 3    |  
|Weighted average grant date fair value    |  | $                      | 5.79 |      |  | $    | 9.70 |   |  | $ | 3.75 |  

Shares purchased under the Purchase Plan in 2003,
2002 and 2001 were approximately 159,000, 216,000 shares
and 69,000 shares, respectively, at an average price per
share of $4.69, $6.74 and $5.78, respectively. Pro forma
compensation expense for the grant date fair value, as defined
by SFAS 123, of the purchase rights granted under the
Purchase Plan was calculated using the Black-Scholes model with
the following assumptions for 2003, 2002 and 2001:

|                                       |  |                     |      |      |  |      |      |   |  |   |      |  
|-------------------------------------- |  | ------------------- | ---- | ---- |  | ---- | ---- | - |  | - | ---- | -
|                                       |  |                    
|                                       |  | 1995 Employee Stock
|                                       |  | Purchase Plan      
|                                       |  |                    
|                                       |  | 2003                |      | 2002 |  | 2001
|                                       |  |                     |      |      |  |     
|Expected dividend yield                |  |                     | 0.0  | %    |  |      | 0.0  | % |  |   | 0.0  | %
|Risk-free interest rate                |  |                     | 0.97 | %    |  |      | 3.69 | % |  |   | 4.43 | %
|Expected volatility                    |  |                     | 60   | %    |  |      | 102  | % |  |   | 90   | %
|Expected life (in months)              |  |                     | 6    |      |  |      | 6    |   |  |   | 6    |  
|Weighted average grant date fair value |  | $                   | 2.01 |      |  | $    | 3.45 |   |  | $ | 3.92 |  

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Because additional option grants are expected to
be made from our stock option plans and additional shares are
expected to be purchased under the Purchase Plan each year, the
above pro forma disclosures are not representative of pro forma
effects on reported net income (loss) for future years.



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

We operate in one business segment that is
characterized by rapid technological advances, changes in
customer requirements and evolving industry standards. Our
failure to anticipate or respond to such advances and changes
could have a material adverse effect on our business and
operating results. See Item 7, Factors That May Affect
Future Results.



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

SFAS No. 130, Reporting Comprehensive
Income (SFAS 130), establishes a standard
for the reporting and display of comprehensive income and its
components within the financial statements. Comprehensive
income, as defined, includes all changes in equity during a
period from non-owner sources. Included in other comprehensive
income are unrealized gains and losses on marketable securities,
net of tax. This adjustment is accumulated within the
Consolidated Statement of Shareholders Equity under the
caption Accumulated Other Comprehensive Income
(Loss).



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

Financial instruments, which potentially subject
us to concentrations of credit risk, consist primarily of cash
equivalents, short-term investments, and accounts receivable. By
policy, we place our investments, other than U.S. Government
Treasury instruments, only with financial institutions meeting
our investment guidelines. Almost all of our accounts receivable
are derived from sales to customers and distributors, in the
consumer electronics, computer and communications markets. See
Note 13, Business and Geographical Segment.

Substantially all of our sales are to customers
in Hong Kong, Taiwan, China, Korea, Japan, and the Czech
Republic. Dynax Electronics is our largest distributor. Sales
through Dynax Electronics (HK) LTD (Dynax
Electronics) accounted for approximately 63%, 57% and 56%
of our net revenues in 2003, 2002 and 2001, respectively. Dynax
Electronics percentage of trade accounts receivable was
63% and 82% as of December 31, 2003 and December 31,
2002. Celestica Kladnos percentage of trade accounts
receivable was 12% as of December 31, 2003. We acquired
this customer through the Pictos acquisition in June 2003. No
other customers accounted for greater than 10% of trade accounts
receivable as of December 31, 2003 and 2002, respectively.

A substantial portion of our net revenues have
been derived from sales to a small number of our customers.
Sales to our top five end-customers accounted for approximately
34% of our net revenues in 2003 compared to 37% of our net
revenues in 2002. ATLM, one of our top end-customers, accounted
for approximately 12% and 3% of our net revenues for 2003 and
2002, respectively. Rikai, another one of our top end-customers,
accounted for approximately 11% and 7% of our net revenues for
2003 and 2002, respectively. No other end-customers accounted
for more than 10% of our net revenues during 2003 and 2002.

55



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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



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

We provide standard warranty coverage for twelve
months. We account for the general warranty cost as a charge to
cost of goods sold when revenue is recognized. The estimated
warranty cost is based on historical product performance and
field expenses. In addition to the general warranty reserves, we
also provide specific warranty reserves for certain parts if
there are potential warranty issues. The following table shows
the details of the product warranty accrual, as required by
Financial Accounting Standards Board (FASB)
Interpretation No. 45, Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, for the years ended
December 31, 2003 and December 31, 2002, respectively.

|                                                 |  |                |      |              |  |   |        |  
|------------------------------------------------ |  | -------------- | ---- | ------------ |  | - | ------ | -
|                                                 |  | Year Ended     |      | Year Ended  
|                                                 |  | December 31,   |      | December 31,
|                                                 |  | 2003           |      | 2002        
|                                                 |  |                |      |             
|                                                 |  |               
|                                                 |  | (In thousands)
|Beginning balance                                |  | $              | 550  |              |  | $ | 544    |  
|Accruals for warranties issued during the period |  |                | 628  |              |  |   | 1,067  |  
|Settlements made during the period               |  |                | (378 | )            |  |   | (1,061 | )
|                                                 |  |                |      |              |  |   |        |  
|Ending balance                                   |  | $              | 800  |              |  | $ | 550    |  
|                                                 |  |                |      |              |  |   |        |  



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

In January 2003, the FASB issued FASB
Interpretation No. 46, Consolidation of Variable
Interest Entities, an Interpretation of ARB No. 51
(FIN 46). FIN 46 requires certain variable
interest entities (VIEs) to be consolidated by the
primary beneficiary of the entity if the equity investors in the
entity do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for
the entity to finance its activities without additional
subordinated financial support from other parties. FIN 46
is effective immediately for all new VIEs created or acquired
after January 31, 2003. For arrangements entered into with
VIEs created prior to February 1, 2003, the provisions of
FIN 46 were originally effective as of July 1, 2003,
however, the FASB subsequently delayed the effective date of
this provision until the first interim or annual period ending
after December 15, 2003. In December 2003, the FASB issued
a revision to FIN 46 to address certain implementation
issues. The adoption of FIN 46 and revised FIN 46 did
not have an impact on our results of operations or financial
position.

In December 2003, the SEC issued Staff Accounting
Bulletin (SAB) No. 104, Revenue
Recognition, (SAB 104) which supersedes
SAB 101, Revenue Recognition in Financial
Statements (SAB 101). SAB 104s
primary purpose is to rescind accounting guidance contained in
SAB 101 related to multiple element revenue arrangements,
superseded as a result of the issuance of Emerging Issues Task
Force (EITF) 00-21, Accounting for
Revenue Arrangements with Multiple Deliverables.
Additionally, SAB 104 rescinds the SECs Revenue
Recognition in Financial Statements Frequently Asked Question
and Answers issued with SAB 101 that had been codified in
SEC Topic 13. The revenue recognition principles of
SAB 101 remain largely unchanged by the issuance of
SAB 104. The adoption of SAB 104 did not have a
material effect on our financial condition or results of
operations.

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Note 3.     Balance
Sheet Components

|                               |                                                 |                |        |         |   |   |         |         |  
|------------------------------ | ----------------------------------------------- | -------------- | ------ | ------- | - | - | ------- | ------- | -
|                               |                                                 |               
|                               |                                                 | December 31,  
|                               |                                                 |               
|                               |                                                 | 2003           |        | 2002   
|                               |                                                 |                |        |        
|                               |                                                 |               
|                               |                                                 | (In thousands)
|Cash and cash equivalents:     |                                                 |                |        |         |   |   |         |        
|                               | Cash and money market accounts                  |                | $      | 27,318  |   |   | $       | 14,121  |  
|                               | U.S. government and corporate debt securities   |                |        | 71,620  |   |   |         | 123,951 |  
|                               |                                                 |                |        |         |   |   |         |        
|                               |                                                 | $              | 98,938 |         |   | $ | 138,072 |        
|                               |                                                 |                |        |         |   |   |         |        
|Short-term investments:        |                                                 |                |        |         |   |   |         |        
|                               | U.S. government and corporate debt securities   |                | $      | 65,859  |   |   | $       | 60,426  |  
|                               | Marketable equity securities                    |                |        |        |   |   |         | 46      |  
|                               | Unrealized gain on marketable securities        |                |        | 49      |   |   |         | 558     |  
|                               |                                                 |                |        |         |   |   |         |        
|                               |                                                 | $              | 65,908 |         |   | $ | 61,030  |        
|                               |                                                 |                |        |         |   |   |         |        
|Accounts receivable, net:      |                                                 |                |        |         |   |   |         |        
|                               | Accounts receivable                             |                | $      | 58,383  |   |   | $       | 29,384  |  
|                               | Less: Allowance for doubtful accounts           |                |        | (990    | ) |   |         | (949    | )
|                               |                                                 |                |        |         |   |   |         |        
|                               |                                                 | $              | 57,393 |         |   | $ | 28,435  |        
|                               |                                                 |                |        |         |   |   |         |        
|Inventories:                   |                                                 |                |        |         |   |   |         |        
|                               | Raw materials                                   |                | $      | 1,735   |   |   | $       | 12,569  |  
|                               | Work-in-process                                 |                |        | 9,516   |   |   |         | 7,138   |  
|                               | Finished goods                                  |                |        | 22,295  |   |   |         | 4,448   |  
|                               |                                                 |                |        |         |   |   |         |        
|                               |                                                 | $              | 33,546 |         |   | $ | 24,155  |        
|                               |                                                 |                |        |         |   |   |         |        
|Property, plant and equipment: |                                                 |                |        |         |   |   |         |        
|                               | Land                                            |                | $      | 2,860   |   |   | $       | 2,860   |  
|                               | Building and building improvements              |                |        | 24,139  |   |   |         | 23,339  |  
|                               | Machinery and equipment                         |                |        | 34,406  |   |   |         | 31,905  |  
|                               | Furniture and fixtures                          |                |        | 18,754  |   |   |         | 13,482  |  
|                               |                                                 |                |        |         |   |   |         |        
|                               |                                                 |                | 80,159 |         |   |   | 71,586  |        
|                               | Less: Accumulated depreciation and amortization |                |        | (55,530 | ) |   |         | (52,601 | )
|                               |                                                 |                |        |         |   |   |         |        
|                               |                                                 | $              | 24,629 |         |   | $ | 18,985  |        
|                               |                                                 |                |        |         |   |   |         |        

Depreciation expenses were approximately
$3.9 million, $5.7 million and $9.6 million in
2003, 2002 and 2001, respectively.

|              |             |                |        |       |  |   |       |       | 
|------------- | ----------- | -------------- | ------ | ----- |  | - | ----- | ----- | 
|              |             |               
|              |             | December 31,  
|              |             |               
|              |             | 2003           |        | 2002 
|              |             |                |        |      
|              |             |               
|              |             | (In thousands)
|Other assets: |             |                |        |       |  |   |       |      
|              | Investments |                | $      | 9,076 |  |   | $     | 4,266 | 
|              | Other       |                |        | 4,564 |  |   |       | 1,469 | 
|              |             |                |        |       |  |   |       |      
|              |             | $              | 13,640 |       |  | $ | 5,735 |      
|              |             |                |        |       |  |   |       |      

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                                                                      |  |   |        |  |  |   |        | 
|------------------------------------------------------------------------------------- |  | - | ------ |  |  | - | ------ | 
|Accounts payable and accrued expenses:                                                |  |   |        | 
|Accounts payable                                                                      |  | $ | 47,672 |  |  | $ | 10,045 | 
|Accrued compensation costs                                                            |  |   | 6,887  |  |  |   | 4,033  | 
|Accrued commission and royalties                                                      |  |   | 12,290 |  |  |   | 10,842 | 
|Marketing and advertising related accruals                                            |  |   |       |  |  |   | 1,876  | 
|Deferred revenue related to distributor sales,
    net of deferred cost of goods sold |  |   | 8,229  |  |  |   | 818    | 
|Other accrued liabilities                                                             |  |   | 9,336  |  |  |   | 7,470  | 
|                                                                                      |  |   |        |  |  |   |        | 
|                                                                                      |  | $ | 84,414 |  |  | $ | 35,084 | 
|                                                                                      |  |   |        |  |  |   |        | 

Note
4.     Marketable Securities

The amortized costs and estimated fair value of
securities available-for-sale as of December 31, 2003 and
December 31, 2002 are as follows:

|                                 |                          |                |        |            |  |            |       |            |  |   |     |     |   |   |         |         | 
|-------------------------------- | ------------------------ | -------------- | ------ | ---------- |  | ---------- | ----- | ---------- |  | - | --- | --- | - | - | ------- | ------- | 
|                                 |                          |                |        | Gross      |  | Gross      |       |           
|                                 |                          | Amortized      |        | Unrealized |  | Unrealized |       |           
|December 31, 2003                |                          | Cost           |        | Gains      |  | (Loss)     |       | Fair Value
|                                 |                          |                |        |            |  |            |       |           
|                                 |                          |               
|                                 |                          | (In thousands)
|Money market accounts            |                          | $              | 10,486 |            |  | $          |      |            |  | $ |    |     |   | $ | 10,486  |        
|Certificate of Deposit           |                          |                |       |            |  |            |      |            |  |   |    |     |   |   |        |        
|Municipal bonds                  |                          |                | 64,120 |            |  |            | 26    |            |  |   |    |     |   |   | 64,146  |        
|Corporate debt securities        |                          |                | 62,575 |            |  |            | 24    |            |  |   | (21 | )   |   |   | 62,578  |        
|Corporate equity securities      |                          |                | 1,310  |            |  |            | 1,618 |            |  |   |    |     |   |   | 2,928   |        
|Government agency bonds          |                          |                | 10,784 |            |  |            | 20    |            |  |   |    |     |   |   | 10,804  |        
|                                 |                          |                |        |            |  |            |       |            |  |   |     |     |   |   |         |        
|                                 | Total available-for-sale |                | $      | 149,275    |  |            | $     | 1,688      |  |   | $   | (21 | ) |   | $       | 150,942 | 
|                                 |                          |                |        |            |  |            |       |            |  |   |     |     |   |   |         |        
|Cash Equivalents                 |                          |                |        |            |  |            |       |            |  |   |     |     |   | $ | 82,106  |        
|Short-term marketable securities |                          |                |        |            |  |            |       |            |  |   |     |     |   |   | 65,908  |        
|Long-term marketable securities  |                          |                |        |            |  |            |       |            |  |   |     |     |   |   | 2,928   |        
|                                 |                          |                |        |            |  |            |       |            |  |   |     |     |   |   |         |        
|                                 |                          |                |        |            |  |            |       |            |  |   |     |     |   | $ | 150,942 |        
|                                 |                          |                |        |            |  |            |       |            |  |   |     |     |   |   |         |        

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                 |                          |                |         |            |  |            |     |            |  |   |    |    |   |   |         |         | 
|-------------------------------- | ------------------------ | -------------- | ------- | ---------- |  | ---------- | --- | ---------- |  | - | -- | -- | - | - | ------- | ------- | 
|                                 |                          |                |         | Gross      |  | Gross      |     |           
|                                 |                          | Amortized      |         | Unrealized |  | Unrealized |     |           
|December 31, 2002                |                          | Cost           |         | Gains      |  | (Loss)     |     | Fair Value
|                                 |                          |                |         |            |  |            |     |           
|                                 |                          |               
|                                 |                          | (In thousands)
|Money market accounts            |                          | $              | 129     |            |  | $          |    |            |  | $ |   |    |   | $ | 129     |        
|Certificate of Deposit           |                          |                |        |            |  |            |    |            |  |   |   |    |   |   |        |        
|Municipal bonds                  |                          |                | 142,341 |            |  |            | 61  |            |  |   |   |    |   |   | 142,402 |        
|Corporate debt securities        |                          |                | 36,108  |            |  |            | 374 |            |  |   | (5 | )  |   |   | 36,477  |        
|Corporate equity securities      |                          |                | 1,058   |            |  |            | 139 |            |  |   |   |    |   |   | 1,197   |        
|Government agency bonds          |                          |                | 5,928   |            |  |            | 93  |            |  |   |   |    |   |   | 6,021   |        
|                                 |                          |                |         |            |  |            |     |            |  |   |    |    |   |   |         |        
|                                 | Total available-for-sale |                | $       | 185,564    |  |            | $   | 667        |  |   | $  | (5 | ) |   | $       | 186,226 | 
|                                 |                          |                |         |            |  |            |     |            |  |   |    |    |   |   |         |        
|Cash Equivalents                 |                          |                |         |            |  |            |     |            |  |   |    |    |   | $ | 124,080 |        
|Short-term marketable securities |                          |                |         |            |  |            |     |            |  |   |    |    |   |   | 61,030  |        
|Long-term marketable securities  |                          |                |         |            |  |            |     |            |  |   |    |    |   |   | 1,116   |        
|                                 |                          |                |         |            |  |            |     |            |  |   |    |    |   |   |         |        
|                                 |                          |                |         |            |  |            |     |            |  |   |    |    |   | $ | 186,226 |        
|                                 |                          |                |         |            |  |            |     |            |  |   |    |    |   |   |         |        

The contractual maturities of debt securities
classified as available-for-sale as of December 31, 2003,
regardless of the consolidated balance sheet classification are
as follows:

|                                                        |  |                |         | 
|------------------------------------------------------- |  | -------------- | ------- | 
|                                                        |  | Estimated     
|December 31, 2003                                       |  | Fair Value    
|                                                        |  |               
|                                                        |  | (In thousands)
|Maturing 90 days or less from purchase                  |  | $              | 71,620  | 
|Maturing between 90 days and one year from
    purchase |  |                | 21,363  | 
|Maturing more than one year from purchase               |  |                | 44,545  | 
|                                                        |  |                |         | 
|Total available-for-sale debt securities                |  | $              | 137,528 | 
|                                                        |  |                |         | 

Actual maturities may differ from contractual
maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties,
and we may need to sell the investment to meet our cash needs.
Net realized gains and losses for the twelve months ended
December 31, 2003 and 2002 were not material to our
financial position or results of operations.

Note
5.     Acquisitions and Related
Charges



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

On August 15, 2003, we acquired 100% of the
outstanding shares of Divio for $27.1 million in cash plus
transaction costs. Divio, formerly a privately held company
based in Sunnyvale, California, designs, manufactures and
markets digital encoding semiconductor products. The acquisition
expands our product lines in the digital consumer electronics
market with advanced MPEG 1, 2 and 4 encoders and
DV codecs for digital video recorders, digital still
cameras and solid-state digital camcorders. The acquisition was
accounted for as a purchase combination under SFAS No. 141,
Business Combination, (SFAS 141).
Accordingly, the estimated fair value of assets acquired and
liabilities assumed were included in our consolidated balance
sheet as of August 15, 2003, the effective date of the
purchase. The results of operations of Divio have been included
in our consolidated results of operations since the effective
date of the purchase. There were no significant differences
between our accounting policies and those of Divio.

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

We allocated the purchase price of
$27.1 million and $3.1 million of legal, other
professional expenses and other costs directly associated with
the acquisition as follows, based on managements estimates
and appraisal:

|                                    |                       |                |        |        | 
|----------------------------------- | --------------------- | -------------- | ------ | ------ | 
|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 |       
|                                    |                       |                |        |       

The following table lists the components of
$6.3 million identifiable intangible assets and their
respective useful lives.

|                                             |                                      |                      |       |                |  |  |          |  | 
|-------------------------------------------- | ------------------------------------ | -------------------- | ----- | -------------- |  |  | -------- |  | 
|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          |  |  |          |  | 
|                                             |                                      |                      |       |                |  |  |          | 

Amortization expenses related to those
identifiable intangible assets were $858,000 for the year ended
December 31, 2003. The following table summarizes the
annual amortization expenses through 2006.

|                          |  |                |       | 
|------------------------- |  | -------------- | ----- | 
|Amortization Expenses for |  |               
|Year Ending December 31,  |  | Amounts       
|                          |  |               
|                          |  | (In thousands)
|2004                      |  | $              | 2,077 | 
|2005                      |  |                | 2,077 | 
|2006                      |  |                | 1,298 | 
|                          |  |                |       | 
|Total                     |  | $              | 5,452 | 
|                          |  |                |       | 



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

On June 9, 2003, we acquired 100% of the
outstanding shares of Pictos for $27.0 million in cash plus
transaction costs. Pictos, formerly a privately held company
based in Newport Beach, California, designs, manufactures and
markets digital imaging semiconductor products. The acquisition
expands our business into the digital imaging consumer
electronics market with advanced CMOS sensor and image processor
solutions for digital still cameras and cellular camera phones.
The acquisition was accounted for as a purchase combination
under SFAS 141. Accordingly, the estimated fair value of
assets acquired and liabilities assumed were included in our
consolidated balance sheet as of June 9, 2003, the
effective date of the purchase. The

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

results of operations have been included in our
consolidated results of operations since the effective date of
the purchase. There were no significant differences between our
accounting policies and those of Pictos.

We allocated the purchase price of
$27.0 million and $453,000 of legal and other professional
expenses directly associated with the acquisition as follows,
based on managements estimates and appraisal.

|                                    |                       |                |        |        | 
|----------------------------------- | --------------------- | -------------- | ------ | ------ | 
|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 |       
|                                    |                       |                |        |       

The following table lists the components of
$7.9 million identifiable intangible assets and their
respective useful lives.

|                               |                                      |                      |       |                |  |  |          |  | 
|------------------------------ | ------------------------------------ | -------------------- | ----- | -------------- |  |  | -------- |  | 
|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          |  |  |          |  | 
|                               |                                      |                      |       |                |  |  |          | 

Amortization expenses related to these
identifiable intangible assets were $1,841,000 for the year
ended December 31, 2003. The following table summarizes the
annual amortization expenses through 2006.

|                          |  |                |       | 
|------------------------- |  | -------------- | ----- | 
|Amortization Expenses for |  |               
|Year Ending December 31,  |  | Amounts       
|                          |  |               
|                          |  | (In thousands)
|2004                      |  | $              | 2,670 | 
|2005                      |  |                | 2,385 | 
|2006                      |  |                | 954   | 
|                          |  |                |       | 
|Total                     |  | $              | 6,009 | 
|                          |  |                |       | 

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Summarized below are our unaudited pro forma
results, reflecting the results of the Pictos and Divio
acquisitions had they been consolidated from the beginning of
all periods indicated. Adjustments have been made for the
estimated increases in amortization of intangibles, amortization
of stock-based compensation and other appropriate pro forma
adjustments. The charges for purchased in-process research and
development are not included in the pro forma results, because
they are non-recurring.

|                        |         |                          |         |      |  |   |         |      | 
|----------------------- | ------- | ------------------------ | ------- | ---- |  | - | ------- | ---- | 
|                        |         |                         
|                        |         | 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 | 

The above amounts are based upon certain
assumptions and estimates, which we believe are reasonable, and
they do not reflect any potential benefit from the economy of
size, which may result from our combined operations. The pro
forma financial information presented above is not necessarily
indicative of either the results of operations that would have
occurred had the acquisitions taken place at the beginning of
the periods indicated or of future results of operations of the
combined companies.



| |    
| | ---
| | SAS

On April 12, 2001, we acquired SAS in a
merger transaction accounted for as a purchase business
combination. SAS was a Canadian start-up company engaged in
developing single chip solutions for wireless communications. We
paid $1.0 million on the effective date and an additional
$1.0 million on April 12, 2002. The total purchase
price of $2.0 million along with $75,000 of acquisition
costs, were primarily allocated to goodwill and other intangible
assets, based on managements estimates and appraisal. The
assets, liabilities and operating expenses for SAS were not
material to our financial position or results of operations.

At the time of acquisition, SAS had generated
approximately $300,000 in consulting revenue. SAS had also
developed intellectual property in wireless communications as
well as analog circuit design, areas of key interest to us.
Because of our experience with mixed signal products, we
expected that this acquisition would advance our expertise in
advanced analog design enabling us to develop intellectual
property for key products.

As of December 31, 2003, the SAS design team
is concentrating on video product development, and designs from
this group have been integrated into several video products. SAS
has several patent applications pending and intends to seek
further U.S. and international patents on its technology
whenever possible.

Note
6.     Discontinued Operation

In April 1999, we expanded our business beyond
the semiconductor segment by establishing Vialta, Inc.
(Vialta), a subsidiary that would operate in the
internet segment. In April 2001, our Board of Directors adopted
a plan to distribute to our shareholders all of our shares in
Vialta. The Vialta spin-off was completed on August 21,
2001. As of December 31, 2000, we had a 62.1% ownership and
voting interest in Vialta. Effective as of August 21, 2001,
we spun off Vialta by distributing to our shareholders all the
Vialta common stock then held by the Company. For the period
presented, Vialta is accounted for as a discontinued operation
in our financial statements in accordance with Accounting
Principles Board Opinion No. 30, Reporting the

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Results of Operation  Reporting the Effects
of Disposal of a Segment of a Business and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions
(APB No. 30).

The components of the loss from discontinued
operations for the period from January 1, 2001 to the date
of disposal of August 21, 2001 and the loss on disposal
were as follows:

|                                                                            |  |                 |         |  
|--------------------------------------------------------------------------- |  | --------------- | ------- | -
|                                                                            |  | Period From    
|                                                                            |  | January 1, 2001
|                                                                            |  | Through        
|                                                                            |  | August 20, 2001
|                                                                            |  |                
|                                                                            |  | (In thousands) 
|Operating expenses                                                          |  | $               | 21,482  |  
|                                                                            |  |                 |         |  
|Net loss before minority interest                                           |  |                 | (18,468 | )
|Less: loss attributable to minority interest                                |  |                 | 6,912   |  
|                                                                            |  |                 |         |  
|Loss from Vialta operation, net of minority
    interest                    |  |                 | (11,556 | )
|Expenses incurred in connection with spin-off of
    Vialta                 |  |                 | (1,246  | )
|                                                                            |  |                 |         |  
|Loss from and on disposal of Vialta operation,
    net of minority interest |  | $               | (12,802 | )
|                                                                            |  |                 |         |  

Note
7.     Debt

We have a $10.0 million unsecured line of
credit with a bank, which will expire on June 5, 2006.
Under the terms of the agreement, we may borrow at a fixed rate
of LIBOR plus 1.5% or prime rate. The line of credit requires us
to achieve certain financial ratios and operating results. As of
December 31, 2003, we were in compliance with the borrowing
criteria and had $10.0 million of borrowing capability
under this line of credit. There were no borrowings under this
line of credit as of December 31, 2003.



|        |             
|------- | ------------
|Note 8. | Income Taxes

Income before provision for (benefit from) income
taxes consisted of the following:

|         |  |                          |        |      |  |      |        |   |  |   |         |  
|-------- |  | ------------------------ | ------ | ---- |  | ---- | ------ | - |  | - | ------- | -
|         |  |                         
|         |  | Years Ended December 31,
|         |  |                         
|         |  | 2003                     |        | 2002 |  | 2001
|         |  |                          |        |      |  |     
|         |  |                         
|         |  | (In thousands)          
|Domestic |  | $                        | (5,211 | )    |  | $    | (2,248 | ) |  | $ | (24,886 | )
|Foreign  |  |                          | 46,105 |      |  |      | 40,509 |   |  |   | 28,609  |  
|         |  |                          |        |      |  |      |        |   |  |   |         |  
|         |  | $                        | 40,894 |      |  | $    | 38,261 |   |  | $ | 3,723   |  
|         |  |                          |        |      |  |      |        |   |  |   |         |  

Provision for (benefit from) income taxes
consisted of the following:

|         |         |                          |        |        |  |      |       |       |  |  |       |       | 
|-------- | ------- | ------------------------ | ------ | ------ |  | ---- | ----- | ----- |  |  | ----- | ----- | 
|         |         |                         
|         |         | Years Ended December 31,
|         |         |                         
|         |         | 2003                     |        | 2002   |  | 2001
|         |         |                          |        |        |  |     
|         |         |                         
|         |         | (In thousands)          
|Current: |         |                          |        |        |  |      |       |       |  |  |       |      
|         | Federal |                          | $      | 13,815 |  |      | $     | 1,086 |  |  | $     | 4,310 | 
|         | State   |                          |        | 2,749  |  |      |       | 11    |  |  |       | 29    | 
|         | Foreign |                          |        | 140    |  |      |       | 141   |  |  |       | 42    | 
|         |         |                          |        |        |  |      |       |       |  |  |       |      
|         |         |                          | 16,704 |        |  |      | 1,238 |       |  |  | 4,381 |      
|         |         |                          |        |        |  |      |       |       |  |  |       |      

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|         |         |                          |        |      |        |      |      |      |     |  |         |         |        |  
|-------- | ------- | ------------------------ | ------ | ---- | ------ | ---- | ---- | ---- | --- |  | ------- | ------- | ------ | -
|         |         |                         
|         |         | Years Ended December 31,
|         |         |                         
|         |         | 2003                     |        | 2002 |        | 2001
|         |         |                          |        |      |        |     
|         |         |                         
|         |         | (In thousands)          
|Deferred |         |                          |        |      |        |      |      |      |     |  |         |        
|         | Federal |                          |        | (980 | )      |      |      | (224 | )   |  |         | (10,505 | )     
|         | State   |                          |        | (121 | )      |      |      | (30  | )   |  |         | (1,138  | )     
|         |         |                          |        |      |        |      |      |      |     |  |         |        
|         |         |                          | (1,101 | )    |        |      | (254 | )    |     |  | (11,643 | )      
|         |         |                          |        |      |        |      |      |      |     |  |         |        
|         |         | Total                    |        | $    | 15,603 |      |      | $    | 984 |  |         | $       | (7,262 | )
|         |         |                          |        |      |        |      |      |      |     |  |         |        

Reconciliation between the provisions for
(benefit from) income taxes computed at the federal statutory
rate of 35% for the years ended December 31, 2003, 2002 and
2001 and the provision for (benefit from) income taxes is as
follows:

|                                                           |  |                          |        |      |  |      |         |   |  |   |         |  
|---------------------------------------------------------- |  | ------------------------ | ------ | ---- |  | ---- | ------- | - |  | - | ------- | -
|                                                           |  |                         
|                                                           |  | Years Ended December 31,
|                                                           |  |                         
|                                                           |  | 2003                     |        | 2002 |  | 2001
|                                                           |  |                          |        |      |  |     
|                                                           |  |                         
|                                                           |  | (In thousands)          
|Provision at statutory rate                                |  | $                        | 14,313 |      |  | $    | 13,047  |   |  | $ | 1,303   |  
|Tax expense (benefit) related to foreign
    jurisdictions |  |                          | 581    |      |  |      | (15,007 | ) |  |   | (11,275 | )
|State income taxes, net of federal tax benefit             |  |                          | 2,351  |      |  |      | 1,745   |   |  |   | 171     |  
|General business credit                                    |  |                          | (423   | )    |  |      | (1,111  | ) |  |   | (800    | )
|Nondeductible research and development costs               |  |                          | 1,096  |      |  |      | 99      |   |  |   | 812     |  
|Other                                                      |  |                          | 2,315  |      |  |      | 2,211   |   |  |   | 2,527   |  
|                                                           |  |                          |        |      |  |      |         |   |  |   |         |  
|Provision for (benefit from) income taxes                  |  | $                        | 15,603 |      |  | $    | 984     |   |  | $ | (7,262  | )
|                                                           |  |                          |        |      |  |      |         |   |  |   |         |  

Deferred tax assets (liabilities) are comprised
of the following:

|                                                                   |                                        |                |        |         |   |   |        |        |  
|------------------------------------------------------------------ | -------------------------------------- | -------------- | ------ | ------- | - | - | ------ | ------ | -
|                                                                   |                                        |               
|                                                                   |                                        | December 31,  
|                                                                   |                                        |               
|                                                                   |                                        | 2003           |        | 2002   
|                                                                   |                                        |                |        |        
|                                                                   |                                        |               
|                                                                   |                                        | (In thousands)
|Current:                                                           |                                        |                |        |         |   |   |        |       
|Accrued liabilities and reserves                                   |                                        | $              | 1,055  |         |   | $ | 976    |       
|Deferred tax asset arising from unrealized loss
    on investments |                                        |                | (713   | )       |   |   | (234   | )     
|Other                                                              |                                        |                | 90     |         |   |   | 1      |       
|                                                                   |                                        |                |        |         |   |   |        |       
|                                                                   | Current deferred tax asset (liability) |                | $      | 432     |   |   | $      | 743    |  
|                                                                   |                                        |                |        |         |   |   |        |       
|Non-current:                                                       |                                        |                |        |         |   |   |        |       
|Depreciation and amortization                                      |                                        | $              | 1,738  |         |   | $ | 1,463  |       
|Acquired intangible assets                                         |                                        |                | (4,657 | )       |   |   |       |       
|Credit carry forwards                                              |                                        |                | 350    |         |   |   |       |       
|Un-remitted earning from a foreign subsidiary                      |                                        |                | (9,139 | )       |   |   | (9,139 | )     
|                                                                   |                                        |                |        |         |   |   |        |       
|                                                                   | Non-current deferred tax liability     |                | $      | (11,708 | ) |   | $      | (7,676 | )
|                                                                   |                                        |                |        |         |   |   |        |       

64



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|        |                     
|------- | --------------------
|Note 9. | Shareholders Equity



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



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

In February 2002, we completed a public offering
of 5,520,000 shares of our common stock at a price of
$19.38 per share. We sold 2,500,000 shares, and
3,020,000 shares were sold by the selling shareholders. Net
of the underwriting discount, we received proceeds of
approximately $45.6 million before expenses.



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

We announced on May 7, 2002 that our Board
of Directors authorized us to repurchase up to 3.0 million
shares of our common stock, inclusive of all shares that then
remained available for repurchase under previously announced
programs, on the same terms and conditions as our prior
repurchase programs. During 2002, we repurchased
2,937,828 shares for an aggregated price of
$42.5 million at market prices ranging from $5.27 to $18.20
per share. In the period from January 1, 2003 through
December 31, 2003, we repurchased 62,172 shares of our
common stock at an average market price of $5.43 per share to
complete the program. Upon repurchase, these shares were retired
and no longer deemed outstanding.

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, in addition to all
shares that remain available for repurchase under previously
announced programs, on the same terms and conditions as these
prior repurchase programs. The repurchase program is being
effected from time to time, depending on market conditions and
other factors, through open market purchases. In the period from
January 1, 2003 through December 31, 2003, we
repurchased 4,797,764 shares of our common stock for an
aggregate price of $29.0 million at market prices ranging
from $5.43 to $6.70 per share under this program. Upon
repurchase, these shares were retired and no longer deemed
outstanding. As of December 31, 2003, we have approximately
202,000 shares available for repurchase under this program.

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, in addition to all
shares that remained available for repurchase under previously
announced programs, on the same terms and conditions as those
prior repurchase programs. No purchase was made in 2003 under
this program. As of December 31, 2003, we had an aggregate
5,202,000 shares available for repurchase under our stock
repurchase programs.



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

In January 1992, we adopted the 1992 Stock Option
Plan (the 1992 Plan). We authorized
6,966,000 shares to be reserved for issuance under the 1992
Plan. Under the 1992 Plan, options granted generally vest 25% at
the end of the first year, after the anniversary date of the
date of grant, and ratably thereafter over the remaining vesting
period.

This plan is no longer active and we will no
longer issue options under this plan. The 1992 Plan terminated
in January 2002, however, outstanding options issued under this
plan will remain exercisable until they expire.



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

In August 1995, we adopted the 1995 Equity
Incentive Plan (the 1995 Incentive Plan), which
provides for the grant of stock options and stock bonuses and
the issuance of restricted stock to our employees, directors and
others. We have reserved 3,000,000 shares of our common
stock for issuance under the 1995 Incentive Plan. The terms of
the 1995 Incentive Plan are generally similar to those of the
1992 Plan outlined above.

65



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



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

In August 1995, we adopted the 1995 Employee
Stock Purchase Plan (the Purchase Plan) and reserved
a total of 225,000 shares of our common stock for issuance
thereunder. The Purchase Plan, as most recently amended on
May 29, 2003, authorizes the aggregate issuance of
1,425,000 shares under the Purchase Plan. The Purchase
Plan, as amended, permits eligible employees to acquire shares
of our common stock through payroll deductions at a price equal
to the lower of 85% of the fair market value of our common stock
at the beginning of the offering period or on the purchase date.
The Purchase Plan, as amended, provides a 24-month rolling
period beginning on each enrollment date and the purchase price
is automatically adjusted to reflect the lower enrollment price.
As of December 31, 2003, 813,267 shares have been issued
under the Purchase Plan, as amended.



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

In August 1995, we adopted the 1995 Directors
Stock Option Plan (the Directors Plan) and reserved
a total of 300,000 shares of our common stock for issuance
thereunder. The Directors Plan, as amended in April 2001,
authorizes the issuance of 600,000 shares under the
Directors Plan. The Directors Plan, as amended allows for
granting of stock options to non-employee members of the Board
of Directors of the Company. The plan was most recently amended
as of April 21, 2001 to increase the number of options
granted to new Board members and options granted subsequent to
their initial appointment to the Board.



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

In May 1997, we adopted the 1997 Equity Incentive
Plan (the 1997 Incentive Plan) and reserved a total
of 3,000,000 shares of our common stock for issuance
thereunder. The 1997 Incentive Plan, as most recently amended in
May 2003, authorizes the issuance of 13,000,000 shares
under the 1997 Incentive Plan. The vesting schedule of the 1997
Incentive Plan is generally similar to those of the 1992 Plan
outlined above.



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

In May 2002, we adopted the 2002 Non-Executive
Stock Option Plan (the 2002 Plan) and reserved a
total of 2,000,000 shares of our common stock for issuance
thereunder. The 2002 Plan allows for granting of stock options
to our non-executive employees and consultants, and options
granted under the 2002 Plan are Non-statutory Stock Options. The
vesting schedule of the 2002 Plan is generally similar to those
of the 1992 Plan outlined above.



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

In June 1997, in connection with the acquisition
of Platform Technologies, Inc. (Platform), we
assumed the Platform Stock Option Plan (the Platform
Plan). We reserved and granted approximately
954,000 shares of ESS common stock under the Platform Plan
pursuant to the outstanding options at the time of the Platform
acquisition. The Platform options vest ratably over four years
and we did not issue any additional options under the Platform
Plan. The Platform plan is no longer active, however,
26,146 shares of outstanding options issued under this plan
remain exercisable at December 31, 2003.

66



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



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

Transactions under our various stock option plans
are summarized as follows:

|                             |            |                |       |             |   |                |       |        |   |   |      |       | 
|---------------------------- | ---------- | -------------- | ----- | ----------- | - | -------------- | ----- | ------ | - | - | ---- | ----- | 
|                             |            |                |       |             |   | Weighted      
|                             |            | Available      |       | Options     |   | Average       
|                             |            | for Grant      |       | Outstanding |   | Exercise Price
|                             |            |                |       |             |   |               
|                             |            |               
|                             |            | (In thousands)
|Balance at December 31, 2000 |            |                | 2,672 |             |   |                | 6,152 |        |   | $ | 9.99 |      
|                             | Authorized |                |       | 2,800       |   |                |       |       |   |   | $    |      | 
|                             | Granted    |                |       | (4,184      | ) |                |       | 4,184  |   |   | $    | 6.42  | 
|                             | Exercised  |                |       |            |   |                |       | (1,772 | ) |   | $    | 4.74  | 
|                             | Canceled   |                |       | 1,045       |   |                |       | (1,045 | ) |   | $    | 9.00  | 
|                             |            |                |       |             |   |                |       |        |   |   |      |      
|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 |      
|                             |            |                |       |             |   |                |       |        |   |   |      |      

The weighted average fair value of options
granted during the years ended December 31, 2003, 2002 and
2001 were $5.79, $9.70 and $3.75, respectively.

The following table summarizes information about
stock options outstanding at December 31, 2003:

|                         |       |                     |       |                     |  |          |      |                |  |          |       |      |  |  |       |       |  |   |       |      | 
|------------------------ | ----- | ------------------- | ----- | ------------------- |  | -------- | ---- | -------------- |  | -------- | ----- | ---- |  |  | ----- | ----- |  | - | ----- | ---- | 
|                         |       |                     |       |                     |  |         
|                         |       | 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 |       | 2003                |       | Life                |  | Price    |      | 2003           |  | Price   
|                         |       |                     |       |                     |  |          |      |                |  |         
|                         |       | (In thousands)      |       | (In years)          |  |          |      | (In thousands) |  |         
|$0.03 - $4.69            |       |                     | 287   |                     |  |          | 3.82 |                |  | $        | 3.08  |      |  |  | 253   |       |  | $ | 2.89  |     
|$4.70 - $4.89            |       |                     | 2,034 |                     |  |          | 4.74 |                |  | $        | 4.88  |      |  |  | 1,394 |       |  | $ | 4.88  |     
|$4.90 - $10.49           |       |                     | 3,054 |                     |  |          | 8.72 |                |  | $        | 8.23  |      |  |  | 732   |       |  | $ | 7.36  |     
|$10.50 - $13.19          |       |                     | 1,108 |                     |  |          | 5.67 |                |  | $        | 12.70 |      |  |  | 524   |       |  | $ | 12.68 |     
|$13.20 - $14.09          |       |                     | 982   |                     |  |          | 8.21 |                |  | $        | 13.86 |      |  |  | 151   |       |  | $ | 13.51 |     
|$14.10 - $29.25          |       |                     | 1,101 |                     |  |          | 5.08 |                |  | $        | 16.79 |      |  |  | 798   |       |  | $ | 17.07 |     
|                         |       |                     |       |                     |  |          |      |                |  |          |       |      |  |  |       |       |  |   |       |     
|                         | Total |                     |       | 8,566               |  |          |      | 6.69           |  |          | $     | 9.58 |  |  |       | 3,852 |  |   | $     | 9.15 | 
|                         |       |                     |       |                     |  |          |      |                |  |          |       |      |  |  |       |       |  |   |       |     

At December 31, 2003, 2002 and 2001, options
to purchase approximately 3,852,000, 2,952,000 and 1,546,000
shares, were exercisable at average exercise prices of $9.15,
$8.27 and $8.76, respectively.

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|         |                   
|-------- | ------------------
|Note 10. | Earnings Per Share

Earnings Per Share (EPS) is
calculated in accordance with the provisions of
SFAS No. 128, Earnings Per Share
(SFAS 128). SFAS 128 requires us to report
both basic EPS, which is based on the weighted average number of
common stock outstanding, and diluted EPS, which is based on the
weighted average number of common stock outstanding and all
dilutive potential common stock outstanding. A reconciliation of
basic and diluted income per shares is presented below.

In addition to net income (loss) per share,
we have also reported per share data on the separate income
statement components required by APB No. 30:

|                                              |  |                                       |         |        |  |           |        |  |  |   |       |  
|--------------------------------------------- |  | ------------------------------------- | ------- | ------ |  | --------- | ------ |  |  | - | ----- | -
|                                              |  | Net Income                            |         |        |  | Per Share
|                                              |  | (Loss)                                |         | Shares |  | Amount   
|                                              |  |                                       |         |        |  |          
|                                              |  |                                      
|                                              |  | (In thousands, except per share data)
|Year Ended December 31, 2003                  |  |                                       |         |        |  |           |        |  |  |   |       |  
|Basic EPS                                     |  | $                                     | 25,291  |        |  |           | 39,517 |  |  | $ | 0.64  |  
|Effects of dilutive securities: Stock options |  |                                       |        |        |  |           | 1,721  |  |  | $ | (0.03 | )
|                                              |  |                                       |         |        |  |           |        |  |  |   |       |  
|Diluted EPS                                   |  | $                                     | 25,291  |        |  |           | 41,238 |  |  | $ | 0.61  |  
|                                              |  |                                       |         |        |  |           |        |  |  |   |       |  
|Year Ended December 31, 2002                  |  |                                       |         |        |  |           |        |  |  |   |       |  
|Basic EPS                                     |  | $                                     | 37,277  |        |  |           | 44,044 |  |  | $ | 0.85  |  
|Effects of dilutive securities: Stock options |  |                                       |        |        |  |           | 2,687  |  |  | $ | (0.05 | )
|                                              |  |                                       |         |        |  |           |        |  |  |   |       |  
|Diluted EPS                                   |  | $                                     | 37,277  |        |  |           | 46,731 |  |  | $ | 0.80  |  
|                                              |  |                                       |         |        |  |           |        |  |  |   |       |  
|Year Ended December 31, 2001                  |  |                                       |         |        |  |           |        |  |  |   |       |  
|Basic EPS from continuing operations          |  | $                                     | 10,985  |        |  |           | 42,274 |  |  | $ | 0.26  |  
|Basic EPS from discontinued operation         |  |                                       | (12,802 | )      |  |           | 42,274 |  |  |   | (0.30 | )
|                                              |  |                                       |         |        |  |           |        |  |  |   |       |  
|Basic EPS                                     |  | $                                     | (1,817  | )      |  |           | 42,274 |  |  | $ | (0.04 | )
|                                              |  |                                       |         |        |  |           |        |  |  |   |       |  
|Effects of dilutive securities: Stock options |  |                                       |        |        |  |           | 2,988  |  |  | $ | (0.02 | )
|Diluted EPS from continuing operations        |  | $                                     | 10,985  |        |  |           | 45,262 |  |  | $ | 0.24  |  
|Diluted EPS from discontinued operation       |  |                                       | (12,802 | )      |  |           | 45,262 |  |  |   | (0.28 | )
|                                              |  |                                       |         |        |  |           |        |  |  |   |       |  
|Diluted EPS                                   |  | $                                     | (1,817  | )      |  |           | 45,262 |  |  | $ | (0.04 | )
|                                              |  |                                       |         |        |  |           |        |  |  |   |       |  

For the years ended December 31, 2003, 2002
and 2001, there were options to purchase approximately
3,751,683, 1,089,000 and 2,540,000 shares of our common stock,
respectively, with exercise prices greater than the average
market value of such common stock. These options were excluded
from the calculation of diluted earnings per share.

Note
11.     Non-Operating Income (Loss),
Net

The following table lists the major components of
Non-Operating Income (Loss) for the years ended
December 31, 2003, 2002 and 2001, respectively:

|                                                |  |                          |        |      |  |      |   |  |  |   |   | 
|----------------------------------------------- |  | ------------------------ | ------ | ---- |  | ---- | - |  |  | - | - | 
|                                                |  |                         
|                                                |  | Years Ended December 31,
|                                                |  |                         
|                                                |  | 2003                     |        | 2002 |  | 2001
|                                                |  |                          |        |      |  |     
|                                                |  |                         
|                                                |  | (In thousands)          
|Licensing fee from MediaTek settlement          |  | $                        | 45,000 |      |  | $    |  |  |  | $ |  | 
|Legal fee related to MediaTek settlement        |  |                          | (515   | )    |  |      |  |  |  |   |  | 
|Taiwanese tax exemption application related fee |  |                          | (1,500 | )    |  |      |  |  |  |   |  | 

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                   |  |                          |        |      |  |      |        |   |  |   |         |  
|---------------------------------- |  | ------------------------ | ------ | ---- |  | ---- | ------ | - |  | - | ------- | -
|                                   |  |                         
|                                   |  | Years Ended December 31,
|                                   |  |                         
|                                   |  | 2003                     |        | 2002 |  | 2001
|                                   |  |                          |        |      |  |     
|                                   |  |                         
|                                   |  | (In thousands)          
|Interest income                    |  |                          | 2,486  |      |  |      | 3,586  |   |  |   | 2,019   |  
|Loss on sale of Cisco stock        |  |                          |       |      |  |      | (61    | ) |  |   | (21,187 | )
|Income (loss) on other investments |  |                          | 774    |      |  |      | (128   | ) |  |   |        |  
|Write-down on investments          |  |                          | (1,986 | )    |  |      | (3,612 | ) |  |   |        |  
|Vialta rental income               |  |                          | 1,182  |      |  |      | 1,852  |   |  |   | 640     |  
|Other                              |  |                          | 505    |      |  |      | 770    |   |  |   | (252    | )
|                                   |  |                          |        |      |  |      |        |   |  |   |         |  
|Total non-operating income (loss)  |  | $                        | 45,946 |      |  | $    | 2,407  |   |  | $ | (18,780 | )
|                                   |  |                          |        |      |  |      |        |   |  |   |         |  



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

On June 11, 2003, we entered into a License
Agreement and Mutual Release (the Settlement
Agreement) with MediaTek Incorporation
(MediaTek) relating to a copyright infringement
lawsuit. Under the terms of the Settlement Agreement, both
parties terminated all claims against each other and MediaTek
received a non-exclusive worldwide license of our proprietary
DVD user interface and other key DVD software. Under the
Settlement Agreement, MediaTek paid us a one-time license fee of
$45.0 million related to sales of certain DVD products and
is required to pay ongoing royalties with a quarterly cap of
$5.0 million and lifetime cap of $45.0 million. The
maximum total payments under the Settlement Agreement are
$90.0 million. Income from MediaTek royalty payments
resulting from future sales of products utilizing the licensed
technology is reported as revenues based on the number of units
sold. During the year ended December 31, 2003,
$5.0 million in revenues were recognized from MediaTek
royalty payments. In connection with the Settlement Agreement,
we recorded a one-time, pre-tax gain of $45.0 million less
related costs of $2.0 million in other non-operating income
during the three months ended June 30, 2003.

Note
12.     Comprehensive Income

Comprehensive income is comprised of net income
(loss) and the changes in unrealized gain on marketable
securities. Comprehensive income was $25.7 million,
$39.2 million and $4.2 million for the years ended
December 31, 2003, 2002 and 2001, respectively. The
following table reconciles Net Income to Comprehensive Income
for the years ended December 31, 2003, 2002 and 2001:

|                                                   |  |                          |        |      |  |      |        |  |  |   |        |  
|-------------------------------------------------- |  | ------------------------ | ------ | ---- |  | ---- | ------ |  |  | - | ------ | -
|                                                   |  |                         
|                                                   |  | Years Ended December 31,
|                                                   |  |                         
|                                                   |  | 2003                     |        | 2002 |  | 2001
|                                                   |  |                          |        |      |  |     
|                                                   |  |                         
|                                                   |  | (In thousands)          
|Net income (loss)                                  |  | $                        | 25,291 |      |  | $    | 37,277 |  |  | $ | (1,817 | )
|Change in unrealized gain on marketable securities |  |                          | 425    |      |  |      | 1,878  |  |  |   | 6,004  |  
|                                                   |  |                          |        |      |  |      |        |  |  |   |        |  
|Total comprehensive income                         |  | $                        | 25,716 |      |  | $    | 39,155 |  |  | $ | 4,187  |  
|                                                   |  |                          |        |      |  |      |        |  |  |   |        |  

The Accumulated Other Comprehensive Income on the
Consolidated Balance Sheet as of December 31, 2003 and 2002
were $929,000 and $504,000, respectively. They consisted of
unrealized gain on marketable securities.

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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Note 13.     Business
and Geographical Segment

Business
Segment

We operate in one reportable business segment:
the semiconductor segment. We design, develop, support,
manufacture and market highly integrated analog and digital
processor chips, imaging sensor chips, digital amplifiers, and
camera lens modules.

From April 1999 to August 2001, we operated in
two reportable segments  the semiconductor segment and the
internet segment through our majority-owned subsidiary Vialta.
Effective as of August 21, 2001, we spun off Vialta by
distributing to our shareholders all 50.6 million shares of
Vialta Class A common stock then held by us. Prior to 1999,
we operated in a single business segment, semiconductor.

The following table summarizes revenues for the
years ended December 31, 2003, 2002 and 2001 by major
product category:

|                        |  |                            |     |      |  |      |     |   |  |  |     |  
|----------------------- |  | -------------------------- | --- | ---- |  | ---- | --- | - |  |  | --- | -
|                        |  |                           
|                        |  | Percentage of Net Revenues
|                        |  | for Years Ended           
|                        |  | December 31,              
|                        |  |                           
|                        |  | 2003                       |     | 2002 |  | 2001
|                        |  |                            |     |      |  |     
|DVD                     |  |                            | 43  | %    |  |      | 59  | % |  |  | 37  | %
|VCD                     |  |                            | 38  | %    |  |      | 31  | % |  |  | 40  | %
|Digital imaging         |  |                            | 8   | %    |  |      |    |   |  |  |    |  
|Recordable              |  |                            | 6   | %    |  |      |    |   |  |  |    |  
|Consumer digital media  |  |                            | 2   | %    |  |      |    |   |  |  |    |  
|Communication and other |  |                            | 2   | %    |  |      | 6   | % |  |  | 7   | %
|PC audio                |  |                            | 1   | %    |  |      | 4   | % |  |  | 16  | %
|                        |  |                            |     |      |  |      |     |   |  |  |     |  
|Total                   |  |                            | 100 | %    |  |      | 100 | % |  |  | 100 | %
|                        |  |                            |     |      |  |      |     |   |  |  |     |  

DVD revenue includes revenue from sales of DVD
decoder chips. VCD revenue includes revenue from sales of VCD
and SVCD chips. Digital imaging revenue includes revenue from
sales of image sensor chips and image processor chips.
Recordable revenue includes revenue from sales of integrated
encoder and decoder chipsets. Consumer digital media revenue
includes revenue from sales of consumer digital audio chips.



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

We sell and market to leading consumer OEMs
worldwide. International sales comprise a significant portion of
our revenues. The following geographic location of our revenues
for 2003, 2002 and 2001 were based upon destination of the
shipment. Thus, our sales to Dynax Electronics were categorized
as sales to Hong Kong, even though Dynax Electronics eventually
sells through a lot of the products to other parts of China.

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Most of the long-lived assets located outside the
United States are in the Asia Pacific region. The following
table summarizes net sales and long-lived assets for the years
ended December 31, 2003, 2002 and 2001:

|                             |       |                |         |                   |  |   |        |        | 
|---------------------------- | ----- | -------------- | ------- | ----------------- |  | - | ------ | ------ | 
|                             |       | Net Sales      |         | Long-Lived Assets
|                             |       |                |         |                  
|                             |       |               
|                             |       | (In thousands)
|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 | 
|                             |       |                |         |                   |  |   |        |       
|Year Ended December 31, 2001 |       |                |         |                   |  |   |        |       
|United States                |       | $              | 6,885   |                   |  | $ | 21,800 |       
|                             |       |                |         |                   |  |   |        |       
|Hong Kong                    |       |                | 186,394 |                   |  |   | 638    |       
|Taiwan                       |       |                | 43,567  |                   |  |   |       |       
|Japan                        |       |                | 6,661   |                   |  |   |       |       
|Singapore                    |       |                | 1,975   |                   |  |   |       |       
|Rest of the world            |       |                | 25,898  |                   |  |   |       |       
|                             |       |                |         |                   |  |   |        |       
|Total foreign                |       |                | 264,495 |                   |  |   | 638    |       
|                             |       |                |         |                   |  |   |        |       
|                             | Total |                | $       | 271,380           |  |   | $      | 22,438 | 
|                             |       |                |         |                   |  |   |        |       

Note
14.     Commitments and
Contingencies

As of December 31, 2003, our commitments to
purchase inventory from the third-party contractors aggregated
approximately $88.1 million. Under these contractual
agreements, we may order inventory from time to time, depending
on our needs. There is no termination date to these agreements.
Additionally, in the ordinary course of business, we enter into
various arrangements with vendors and other business partners,

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

principally for service, license and other
operating supplies. As of December 31, 2003, commitments
under these arrangements totaled $1.3 million. There are no
material commitments for these arrangements extending beyond
2006.

From time to time, we are subject to legal
proceedings and claims, including claims of alleged infringement
of trademarks, copyrights and other intellectual property rights
and other claims arising out of the ordinary course of business.
Further, we are currently engaged in certain shareholder class
action and derivative lawsuits. We intend to defend these suits
vigorously and we may incur substantial expenses in litigating
claims against third parties and defending against existing and
future third-party claims that may arise. In the event of a
determination adverse to us, we may incur substantial monetary
liability and be required to change our business practices.
Either of these results could have a material adverse effect on
our financial position, results of operations and cash flows.
See Part I, Item 3, Legal Proceedings.

The Company enters into various agreements in the
ordinary course of business. Pursuant to these agreements, the
Company may agree to indemnify its customers for losses suffered
or incurred by them as a result of any patent, copyright, or
other intellectual property infringement claims by any third
party with respect to the Companys products. These
indemnification obligations may have perpetual terms. The
Companys normal business practice is to limit the maximum
amount of indemnification to the license fees received. On
occasion, the maximum amount of indemnification the company may
be required to make may exceed its normal business practices.
The Company estimates the fair value of its indemnification
obligations as insignificant, based upon its history of
litigation concerning product and patent infringement claims.
Accordingly, the Company has no liabilities recorded for
indemnification under these agreements as of December 31,
2003.

The Company has agreements whereby our officers
and directors are indemnified for certain events or occurrences
while the officer or director is, or was serving, at our request
in such capacity. The maximum potential amount of future
payments we could be required to make under these
indemnification agreements is unlimited. However, we have a
directors and officers insurance policy that may reduce
our exposure and enables us to recover a portion of any future
amounts paid. As a result of our insurance policy coverage, we
believe the estimated fair value of these indemnification
agreements is minimal. Agreements entered into prior to December
31, 2002 were grandfathered under the provisions of FASB
Interpretation No. 45, Guarantors Accounting and
Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of others  an
Interpretation of FASB Statements No. 5, 57 and 107 and
rescission of FASB Interpretation No. 34.

Note 15.     Related
Party Transactions with Vialta, Inc.

Fred S.L. Chan, our Chairman of Board of
Directors, also serves as the Chairman of the Board for Vialta.
Each company pays Fred S.L. Chan a base salary separately.

In connection with the spin-off of Vialta in
August 2001, we entered into a Master Distribution
Agreement that outlines the general terms and conditions of the
distribution and a number of ancillary agreements that govern
the various relationships between Vialta and us following the
spin-off. The spin-off agreements, which include the Master
Distribution Agreement and its ancillary agreements, consisting
of the Master Technology Ownership and License Agreement, the
Employee Matters Agreement, the Tax Sharing and Indemnity
Agreement, the Real Estate Matters Agreement, the Master
Confidential Disclosure Agreement, and the Master Transitional
Services Agreement, provide for contractual obligations between
the parties that are not expected to have any material impact on
our revenues, operating results or cash flows.

The Master Technology Ownership and License
Agreement supersedes the prior Intellectual Property and
Research and Development Agreements between Vialta and us and
allocates ownership rights generally along our product lines and
those of Vialta. In the Master Technology Ownership and License
Agreement, we

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

acknowledge Vialtas exclusive ownership of
specific technology and trademarks related to Vialtas
products. Vialta has unrestricted rights to use the assigned
technology and related trademarks that Vialta alone owns. The
Master Technology Ownership and License Agreement does not
obligate either Vialta or ESS to provide to the other
improvements that it makes to its own technology.

The Employee Matters Agreement allocates
responsibilities relating to current and former employees of
Vialta and their participation in any benefits plans that ESS
has sponsored and maintained. Prior to the distribution, we
transferred to Vialta approximately 9,839,672 shares of Vialta
Class A common stock. This same number of shares of Vialta
Class A common stock has been authorized and reserved for
issuance under the Vialta 2001 Non-Statutory Stock Option Plan.
Immediately prior to the distribution, Vialta granted options to
all of our employees who held our options, based on our options
outstanding as of the record date for the spin-off distribution.
As a result, on the date of the distribution, approximately
9,839,672 of the total shares authorized under the 2001
Non-Statutory Stock Options Plan became subject to outstanding
options. The resulting Vialta options vest, become exercisable,
expire and otherwise are treated under terms that essentially
mirror the provisions of our corresponding options held by our
employees.

The Tax Sharing and Indemnity Agreement allocate
responsibilities for tax matters between Vialta and us. Vialta
will indemnify ESS in the event the distribution initially
qualifies for tax-free treatment and later becomes disqualified
as a result of actions taken by Vialta or within Vialtas
control. The Tax Sharing and Indemnity Agreement also assigns
responsibilities for administrative matters such as the filing
of returns, payment of taxes due, retention of records and
conduct of audits, examinations and similar proceedings.

The Real Estate Matters Agreement addresses
matters relating to the properties we lease to Vialta, including
the Fremont facility, which currently serves as the corporate
headquarters of Vialta. On July 1, 2003, we entered into
the First Amendment to the Amended and Restated Commercial Lease
Agreement with Vialta to reduce the size of the Fremont facility
subject to the lease and adjust the rental amount. To rent the
Fremont facility pursuant to the amendment, effective
July 1, 2003, Vialta pays us approximately $312,000 per
year, payable in monthly installments of approximately $26,000.

The Master Confidential Disclosure Agreement
provides that Vialta and us agree not to disclose confidential
information of the other except in specific circumstances or as
may be permitted in an ancillary agreement.

The Master Transitional Services Agreement
governs corporate support services that we have agreed to
provide to Vialta, including, without limitation, information
technology systems, human resources administration, product
order administration, customer service, buildings and facilities
and finance and accounting services, each as specified and on
the terms set forth in the Master Transitional Services
Agreement and in the schedules to the Master Transitional
Services Agreement. The Master Transitional Services Agreement
also provides for the provision of additional services
identified from time to time after the distribution date that
Vialta reasonably believes were inadvertently or unintentionally
omitted from the specified services, or that are essential to
effectuate an orderly transition under the Master Distribution
Agreement, so long as the provision of such services would not
significantly disrupt our operations or significantly increase
the scope of our obligations under the agreement. The Master
Transitional Services Agreement expired on August 21, 2002,
although we intend to continue to provide and charge Vialta on a
per usage basis for IT hardware support, cafeteria and the
corporate dormitory.

Our only other agreement with Vialta is a supply
agreement under which we agree to give Vialta the best price
available to any other customers. We supply chips to Vialta from
time to time pursuant to standard purchase orders issued under
this supply agreement. We anticipate that we will continue to
provide products and services to Vialta under the terms of this
supply agreement.

73



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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following is a summary of major transactions
between Vialta and us for the periods presented:

|                                                                                                       |  |                          |       |      |  |      |       |   |  |   |       |  
|------------------------------------------------------------------------------------------------------ |  | ------------------------ | ----- | ---- |  | ---- | ----- | - |  | - | ----- | -
|                                                                                                       |  |                         
|                                                                                                       |  | Transactions Between    
|                                                                                                       |  | ESS and Vialta          
|                                                                                                       |  |                         
|                                                                                                       |  |                         
|                                                                                                       |  | Years Ended December 31,
|                                                                                                       |  |                         
|                                                                                                       |  | 2003                     |       | 2002 |  | 2001
|                                                                                                       |  |                          |       |      |  |     
|                                                                                                       |  |                         
|                                                                                                       |  | (In thousands)          
|Selling, general, administrative and other
    services provided to Vialta, net of charges from Vialta |  | $                        | 70    |      |  | $    | (38   | ) |  | $ | 4,937 |  
|Lease charges to Vialta under Real Estate Matters
    Agreement                                        |  |                          | 1,182 |      |  |      | 1,852 |   |  |   | 640   |  
|Chip purchases by Vialta                                                                               |  |                          | 458   |      |  |      | 1,403 |   |  |   | 1,127 |  
|Products purchased from Vialta                                                                         |  |                          | (2    | )    |  |      | (61   | ) |  |   | (74   | )
|                                                                                                       |  |                          |       |      |  |      |       |   |  |   |       |  
|Total charges to Vialta, net of charges from
    Vialta                                                |  | $                        | 1,708 |      |  | $    | 3,156 |   |  | $ | 6,630 |  
|                                                                                                       |  |                          |       |      |  |      |       |   |  |   |       |  

We record in our Statements of Operation as an
offset to our applicable operating expenses the fees we charge
Vialta for the selling, general and administrative services we
provide Vialta pursuant to the Master Transitional Services
Agreement. We record in our Statements of Operations as other
income the rent we charge Vialta pursuant to the Real Estate
Matters Agreement and related agreements. Charges from us to
Vialta under the Real Estate Matters Agreement are recorded in
our Statements of Operations as other income. Charges for
product purchases by Vialta are recorded in our Statements of
Operations under Net revenues from related party 
Vialta.

Note
16.     Transactions with Dynax
Electronics

We sell our products through distributors. Dynax
Electronics is our largest distributor. We work directly with
many of our customers in Hong Kong and China on product design
and development. However, whenever one of these customers buys
our products, the order is processed through Dynax Electronics,
which functions much like a trading company. Dynax Electronics
manages the order processing, arranges shipment into China and
Hong Kong, manages the letters of credit, and provides credit
and collection expertise and services. The title and risk of
loss for the inventories are transferred to Dynax Electronics
upon shipment of inventories to Dynax Electronics. Dynax
Electronics is legally responsible to pay our invoices
regardless of when the inventories are sold to end-customers.
Revenues on sales to Dynax Electronics are deferred until Dynax
Electronics sells the products to end-customers.

The following table summarizes the percentage of
our net revenues for the year ended December 31, 2003, 2002
and 2001, respectively, which were attributable to sales made
through Dynax Electronics:

|                                                  |  |                                        |         |      |  |      |         |   |  |   |         |  
|------------------------------------------------- |  | -------------------------------------- | ------- | ---- |  | ---- | ------- | - |  | - | ------- | -
|                                                  |  |                                       
|                                                  |  | Years Ended December 31,              
|                                                  |  |                                       
|                                                  |  | 2003                                   |         | 2002 |  | 2001
|                                                  |  |                                        |         |      |  |     
|                                                  |  |                                       
|                                                  |  | (In thousands, except percentage data)
|Net revenues                                      |  | $                                      | 195,273 |      |  | $    | 273,442 |   |  | $ | 271,380 |  
|Net revenues from Dynax Electronics               |  | $                                      | 122,701 |      |  | $    | 156,963 |   |  | $ | 151,972 |  
|Percentage of net revenues from Dynax Electronics |  |                                        | 63      | %    |  |      | 57      | % |  |   | 56      | %

74



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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following table summarizes Dynax
Electronics percentage of our trade accounts receivable as
of December 31, 2003 and 2002:

|                                                                   |  |                       |        |      |  |   |        |  
|------------------------------------------------------------------ |  | --------------------- | ------ | ---- |  | - | ------ | -
|                                                                   |  |                      
|                                                                   |  | December 31,         
|                                                                   |  |                      
|                                                                   |  | 2003                  |        | 2002
|                                                                   |  |                       |        |     
|                                                                   |  |                      
|                                                                   |  | (In thousands, except
|                                                                   |  | percentage data)     
|Trade accounts receivable                                          |  | $                     | 58,322 |      |  | $ | 29,523 |  
|Trade accounts receivable from Dynax Electronics                   |  | $                     | 36,605 |      |  | $ | 24,318 |  
|Percentage of trade accounts receivable from
    Dynax Electronics |  |                       | 63     | %    |  |   | 82     | %

Note
17.     Investments



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

In January 2003, we acquired 4,545,400 shares of
Convertible Non-Cumulative Preference Series B shares of
Best Elite International Limited (Best Elite) for
approximately $5,000,000 in cash. On January 30, 2004, we
acquired an additional 4,545,455 shares for approximately
$5,000,000 in cash, on the same terms and price as the initial
investment. Our investments represent less than a 1.3% equity
interest in Best Elite on a fully diluted basis. The investments
were recorded using the cost method of accounting. Best Elite
was organized under the laws of the British Virgin Islands as an
investment vehicle for the purpose of establishing a foundry in
Mainland China.



| |                 
| | ----------------
| | Broadmedia, Inc.

In March 2002, we acquired 2,750,000 shares of
Broadmedia, Inc. (Broadmedia) common stock for
approximately $4,200,000 in cash, representing an 8% equity
interest in Broadmedia. Broadmedia is a dynamic product design
and manufacturing house for OEMs with expertise in broadband
network access equipment technologies. In December 2002, our
Broadmedia common stock was exchanged for stock of Archtek
Corporation (Archtek) as a result of corporate
restructuring by Broadmedia and Archtek.

In May 2003, the merger between Broadmedia/
Archtek and C-Com Corporation (C-Com), a publicly
traded company in Taiwan, was approved by the shareholders of
both companies. In connection with the merger between these two
companies, we were given a right to receive 5,578,571 shares of
C-Com common stock in exchange for our investment in Broadmedia.
As of December 31, 2003, we received 3,905,000 shares of
C-Com common stock. The remaining 1,673,571 shares will be
received over the next four years. During the twelve months
ended December 31, 2003, we recorded a pre-tax
non-operating loss of $2.0 million as a result of receiving
the C-Com common stock in exchange for stock of Archtek based on
the fair market value of the C-Com common stock.

Note 18.     ESS
401(K) Plan

We have a 401(K) Plan (the 401(K)
Plan), which covers substantially all employees. Each
eligible employee may elect to contribute to the 401(K) Plan,
through payroll deductions, up to 25% of their compensation,
subject to current statutory limitations. We made no
contributions through December 31, 2003.

75



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Selected Quarterly Financial Data
(un-audited)

The following table presents un-audited quarterly
financial information for each of our last eight quarters. This
information has been derived from our audited financial
statements and has been prepared on the same basis as the
audited Consolidated Financial Statements appearing elsewhere in
this Form 10-K. Historical financial information has been
reclassified to present consistently the discontinued operation
of Vialta. In the opinion of management, all necessary
adjustments, consisting only of normal recurring adjustments,
have been included to present fairly the quarterly results.

|                                                            |                                     |                                       |        |         |  |          |        |         |  |         |        |         |  |          |        |         |  |   |        |        |   |   |        |        |  |   |        |        |  |   |        |        | 
|----------------------------------------------------------- | ----------------------------------- | ------------------------------------- | ------ | ------- |  | -------- | ------ | ------- |  | ------- | ------ | ------- |  | -------- | ------ | ------- |  | - | ------ | ------ | - | - | ------ | ------ |  | - | ------ | ------ |  | - | ------ | ------ | 
|                                                            |                                     |                                       |        |        
|                                                            |                                     | 2002                                  |        | 2003   
|                                                            |                                     |                                       |        |        
|                                                            |                                     | Mar. 31                               |        | June 30 |  | Sept. 30 |        | Dec. 31 |  | Mar. 31 |        | June 30 |  | Sept. 30 |        | Dec. 31
|                                                            |                                     |                                       |        |         |  |          |        |         |  |         |        |         |  |          |        |        
|                                                            |                                     |                                      
|                                                            |                                     | (In thousands, except per share data)
|Statement of Operations Data:                               |                                     |                                       |        |         |  |          |        |         |  |         |        |         |  |          |        |         |  |   |        |        |   |   |        |        |  |   |        |        |  |   |        |       
|Net revenues                                                |                                     | $                                     | 79,115 |         |  | $        | 86,037 |         |  | $       | 60,746 |         |  | $        | 47,544 |         |  | $ | 33,151 |        |   | $ | 31,011 |        |  | $ | 48,243 |        |  | $ | 82,868 |       
|Cost of revenues                                            |                                     |                                       | 44,839 |         |  |          | 50,817 |         |  |         | 45,665 |         |  |          | 35,133 |         |  |   | 23,376 |        |   |   | 20,982 |        |  |   | 33,281 |        |  |   | 55,051 |       
|                                                            |                                     |                                       |        |         |  |          |        |         |  |         |        |         |  |          |        |         |  |   |        |        |   |   |        |        |  |   |        |        |  |   |        |       
|                                                            | Gross profit                        |                                       |        | 34,276  |  |          |        | 35,220  |  |         |        | 15,081  |  |          |        | 12,411  |  |   |        | 9,775  |   |   |        | 10,029 |  |   |        | 14,962 |  |   |        | 27,817 | 
|Operating expenses:                                         |                                     |                                       |        |         |  |          |        |         |  |         |        |         |  |          |        |         |  |   |        |        |   |   |        |        |  |   |        |        |  |   |        |       
|                                                            | Research and development            |                                       |        | 6,381   |  |          |        | 7,043   |  |         |        | 7,160   |  |          |        | 6,380   |  |   |        | 6,256  |   |   |        | 8,750  |  |   |        | 11,360 |  |   |        | 9,508  | 
|                                                            | Selling, general and administrative |                                       |        | 10,356  |  |          |        | 11,051  |  |         |        | 6,452   |  |          |        | 6,311   |  |   |        | 6,674  |   |   |        | 6,660  |  |   |        | 8,874  |  |   |        | 9,553  | 
|                                                            |                                     |                                       |        |         |  |          |        |         |  |         |        |         |  |          |        |         |  |   |        |        |   |   |        |        |  |   |        |        |  |   |        |       
|Operating income (loss)                                     |                                     |                                       | 17,539 |         |  |          | 17,126 |         |  |         | 1,469  |         |  |          | (280   | )       |  |   | (3,155 | )      |   |   | (5,381 | )      |  |   | (5,272 | )      |  |   | 8,756  |       
|Non-operating income, net                                   |                                     |                                       | (1,267 | )       |  |          | 1,085  |         |  |         | 1,438  |         |  |          | 1,151  |         |  |   | 944    |        |   |   | 44,187 |        |  |   | (659   | )      |  |   | 1,474  |       
|                                                            |                                     |                                       |        |         |  |          |        |         |  |         |        |         |  |          |        |         |  |   |        |        |   |   |        |        |  |   |        |        |  |   |        |       
|Income (loss) before income taxes                           |                                     |                                       | 16,272 |         |  |          | 18,211 |         |  |         | 2,907  |         |  |          | 871    |         |  |   | (2,211 | )      |   |   | 38,806 |        |  |   | (5,931 | )      |  |   | 10,230 |       
|Provision for (benefit from) income taxes                   |                                     |                                       | (114   | )       |  |          | 889    |         |  |         | 148    |         |  |          | 61     |         |  |   | (98    | )      |   |   | 22,905 |        |  |   | (8,680 | )      |  |   | 1,476  |       
|                                                            |                                     |                                       |        |         |  |          |        |         |  |         |        |         |  |          |        |         |  |   |        |        |   |   |        |        |  |   |        |        |  |   |        |       
|Net income (loss) from continuing operations                |                                     |                                       | 16,386 |         |  |          | 17,322 |         |  |         | 2,759  |         |  |          | 810    |         |  |   | (2,113 | )      |   |   | 15,901 |        |  |   | 2,749  |        |  |   | 8,754  |       
|                                                            |                                     |                                       |        |         |  |          |        |         |  |         |        |         |  |          |        |         |  |   |        |        |   |   |        |        |  |   |        |        |  |   |        |       
|Net income (loss)                                           |                                     | $                                     | 16,386 |         |  | $        | 17,322 |         |  | $       | 2,759  |         |  | $        | 810    |         |  | $ | (2,113 | )      |   | $ | 15,901 |        |  | $ | 2,749  |        |  | $ | 8,754  |       
|                                                            |                                     |                                       |        |         |  |          |        |         |  |         |        |         |  |          |        |         |  |   |        |        |   |   |        |        |  |   |        |        |  |   |        |       
|Net income (loss) per share:                                |                                     |                                       |        |         |  |          |        |         |  |         |        |         |  |          |        |         |  |   |        |        |   |   |        |        |  |   |        |        |  |   |        |       
|                                                            | Basic                               |                                       | $      | 0.37    |  |          | $      | 0.38    |  |         | $      | 0.06    |  |          | $      | 0.02    |  |   | $      | (0.05  | ) |   | $      | 0.41   |  |   | $      | 0.07   |  |   | $      | 0.22   | 
|                                                            |                                     |                                       |        |         |  |          |        |         |  |         |        |         |  |          |        |         |  |   |        |        |   |   |        |        |  |   |        |        |  |   |        |       
|                                                            | Diluted                             |                                       | $      | 0.34    |  |          | $      | 0.36    |  |         | $      | 0.06    |  |          | $      | 0.02    |  |   | $      | (0.05  | ) |   | $      | 0.40   |  |   | $      | 0.07   |  |   | $      | 0.21   | 
|                                                            |                                     |                                       |        |         |  |          |        |         |  |         |        |         |  |          |        |         |  |   |        |        |   |   |        |        |  |   |        |        |  |   |        |       
|Shares used in calculating net income
    (loss) per share: |                                     |                                       |        |         |  |          |        |         |  |         |        |         |  |          |        |         |  |   |        |        |   |   |        |        |  |   |        |        |  |   |        |       
|                                                            | Basic                               |                                       |        | 44,209  |  |          |        | 45,147  |  |         |        | 43,484  |  |          |        | 43,378  |  |   |        | 41,662 |   |   |        | 38,683 |  |   |        | 38,694 |  |   |        | 39,014 | 
|                                                            |                                     |                                       |        |         |  |          |        |         |  |         |        |         |  |          |        |         |  |   |        |        |   |   |        |        |  |   |        |        |  |   |        |       
|                                                            | Diluted                             |                                       |        | 48,331  |  |          |        | 48,446  |  |         |        | 45,706  |  |          |        | 44,188  |  |   |        | 41,662 |   |   |        | 39,842 |  |   |        | 40,579 |  |   |        | 42,169 | 
|                                                            |                                     |                                       |        |         |  |          |        |         |  |         |        |         |  |          |        |         |  |   |        |        |   |   |        |        |  |   |        |        |  |   |        |       






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

Not applicable.






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

The Company maintains disclosure controls
and procedures, as such term is defined under Exchange Act
Rules 13a-15(e) and 15d-15(e), that are designed to ensure
that information required to be disclosed in the Companys
Exchange Act reports is recorded, processed, summarized and
reported within the time periods specified in the SECs
rules and forms, and that such information is accumulated and
communicated to the Companys management, including its
Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required
disclosures.

76



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We also established a disclosure committee that
consists of certain members of the Companys senior
management. The disclosure committee, under the supervision and
with the participation of the Companys management,
including the Companys Chief Executive Officer and Chief
Financial Officer, carried out an evaluation of the
effectiveness of the design and operation of the Companys
disclosure controls and procedures as of the end of the period
covered by this report. Based upon their evaluation and subject
to the foregoing, the Chief Executive Officer and Chief
Financial Officer concluded that the Companys disclosure
controls and procedures were effective in ensuring that material
information relating to the Company is made known to the Chief
Executive Officer and Chief Financial Officer by others within
the Company during the period in which this report was being
prepared.

There have been no changes in the Companys
internal control over financial reporting that occurred during
the Companys fourth fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the
Companys internal control over financial reporting.




PART III

Certain information required by Part III is
omitted from this Report since we plan to file with the
Securities and Exchange Commission the definitive proxy
statement for our 2004 Annual Meeting of Shareholders (the
Proxy Statement) not later than 120 days after
the end of the fiscal year covered by this Report, and certain
information included therein is incorporated herein by reference.






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

The information concerning our directors and
certain information concerning our Executive Officers required
by this Item are incorporated by reference from our Proxy
Statement, which we will file with the Commission not later than
120 days after our fiscal year-end. The notes concerning
our executive officers required by this Item is set forth at the
end of Part I in a section captioned Executive
Officers of the Registrant, above.

The Company has adopted a Code of Ethics that
applies to its principal executive officer, principal financial
and accounting officer, controller and certain other senior
financial management. The Code of Ethics is posted on the
Companys website at http://www.ESSTECH.com.If any
substantive amendments are made to the Code of Ethics or grant
of any waiver, including any implicit waiver, from a provision
of the Code of Ethics to the Companys Chief Executive
Officer, Chief Financial Officer or Controller, the Company will
disclose the nature of such amendment or waiver on its website
or in a report on Form 8-K.






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

The information required by this Item is
incorporated by reference from the sections in our Proxy
Statement entitled Executive Compensation, which we
will file with the Commission not later than 120 days after
our fiscal year-end.






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

The security ownership information required by
this Item is incorporated by reference from the Proxy Statement,
which we will file with the Commission not later than
120 days after our fiscal year-end.

77



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##### Table of Contents



The following table summarizes information with
respect to options under our equity compensation plans at
December 31, 2003:

Equity Compensation Plan
Information(1)

|                                                               |       |                         |           |                      |  |                                |      |      |  |  |           |           | 
|-------------------------------------------------------------- | ----- | ----------------------- | --------- | -------------------- |  | ------------------------------ | ---- | ---- |  |  | --------- | --------- | 
|                                                               |       |                         |           |                      |  | Number of Securities          
|                                                               |       | Number of Securities to |           | Weighted-average     |  | Remaining Available for Future
|                                                               |       | be Issued Upon          |           | Exercise Price of    |  | Issuance Under Equity         
|                                                               |       | Exercise of Outstanding |           | Outstanding Options, |  | Compensation Plans (excluding 
|                                                               |       | Options, Warrants and   |           | Warrants and         |  | securities reflected in       
|Plan Category                                                  |       | Rights(a)(3)            |           | Rights(b)            |  | column(a))(c)                 
|                                                               |       |                         |           |                      |  |                               
|Equity compensation plans approved by security
    holders     |       |                         | 8,364,250 |                      |  | $                              | 9.58 |      |  |  | 3,256,646 | (2)      
|Equity compensation plans not approved by
    security holders |       |                         | 201,850   |                      |  | $                              | 9.62 |      |  |  | 1,795,900 |          
|                                                               |       |                         |           |                      |  |                                |      |      |  |  |           |          
|                                                               | Total |                         |           | 8,566,100            |  |                                | $    | 9.58 |  |  |           | 5,552,546 | 
|                                                               |       |                         |           |                      |  |                                |      |      |  |  |           |          



---



|    |                                                                                                                                                  
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes only options outstanding under ESS
    stock option plans, as no stock warrants or rights were
    outstanding as of December 31, 2003.
|   
|(2) | Includes 611,733 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.

The equity compensation plans not approved by
security holders have generally the same features as those
approved by security holders. For further details regarding
ESS equity compensation plans, see Note 9,
Shareholders Equity, in the consolidated
financial statements in Item 8 of this Report.






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

The information required by this Item is
incorporated by reference from the Proxy Statement, which we
will file with the Commission not later than 120 days after
our fiscal year-end.






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

The information required by this Item is
incorporated by reference from the Proxy Statement, which we
will file with the Commission not later than 120 days after
our fiscal year-end.




PART IV






|         |                                                                     
|-------- | --------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules,
    and Reports on Form 8-K

(a)(1) Financial Statements



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

(a)(2) Financial Statement Schedule

78



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##### Table of Contents



REPORT OF INDEPENDENT AUDITORS ON

FINANCIAL STATEMENT SCHEDULE


To the Board of Directors of ESS Technology, Inc.:

Our audits of the consolidated financial
statements referred to in our report dated January 30, 2004
appearing in this Form 10-K also included an audit of the
financial statement schedule listed in Item 15(a)(2) of
this Form 10-K. In our opinion, this financial statement
schedule presents fairly, in all material respects, the
information set forth therein when read in conjunction with the
related consolidated financial statements.



| |                               
| | ------------------------------
| | /s/ PRICEWATERHOUSECOOPERS LLP

San Jose, California

February 27, 2004


79



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##### Table of Contents



Schedule II

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, 2003 |                                 |                |   |            |  |            |   |            |  |  |   |        |   |  |   |       
|                             | Allowance for doubtful accounts |                | $ | 949        |  |            | $ | 369        |  |  | $ | 328    |   |  | $ | 990    | 
|                             | Allowance for sales returns     |                | $ | 1,048      |  |            | $ | 1,324      |  |  | $ | 661    |   |  | $ | 1,711  | 
|                             | Inventory reserves              |                | $ | 30,662     |  |            | $ | 9,881      |  |  | $ | 14,010 |   |  | $ | 26,533 | 
|Year Ended December 31, 2002 |                                 |                |   |            |  |            |   |            |  |  |   |        |   |  |   |       
|                             | Allowance for doubtful accounts |                | $ | 899        |  |            | $ | 50         |  |  | $ |       |   |  | $ | 949    | 
|                             | Allowance for sales returns     |                | $ | 1,430      |  |            | $ | 1,008      |  |  | $ | 1,390  |   |  | $ | 1,048  | 
|                             | Inventory reserves              |                | $ | 35,059     |  |            | $ | 10,275     |  |  | $ | 14,672 |   |  | $ | 30,662 | 
|Year Ended December 31, 2001 |                                 |                |   |            |  |            |   |            |  |  |   |        |   |  |   |       
|                             | Allowance for doubtful accounts |                | $ | 2,393      |  |            | $ |           |  |  | $ | 1,494  |   |  | $ | 899    | 
|                             | Allowance for sales returns     |                | $ | 920        |  |            | $ | 6,044      |  |  | $ | 5,534  |   |  | $ | 1,430  | 
|                             | Inventory reserves              |                | $ | 27,040     |  |            | $ | 6,964      |  |  | $ | (1,055 | ) |  | $ | 35,059 | 

All other schedules for which provision is make
in applicable accounting regulations of the Securities and
Exchange Commission are omitted because they are not required
under the related instructions or are applicable.

The independent accountants reports with
respect to the above listed financial statements and financial
statement schedule listed in Item 15(a)(1) and 15(a)(2),
respectively, are filed on page 44 and page 79,
respectively on Form 10-K.

(a)(3) 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).                                                                             

80



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|        |       |               |  |                                                                                                                                                                                                                                                                                                                                                                                      
|------- | ----- | ------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       |              
|Number  |       | Exhibit Title
|        |       |              
|        | 10.06 |               |  | Registrants Amended 401(k) Plan,
    incorporated herein by reference to Exhibit 10.06 to the
    Form S-1 (file no. 33-95388).*                                                                                                                                                                                                                                                    
|        | 10.11 |               |  | 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).                                                                                                                                                                         
|        | 10.21 |               |  | 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).**
|        | 10.22 |               |  | 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.**                                                                                                                                                                                                                      
|        | 10.23 |               |  | 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).**                                                                                                               
|        | 10.35 |               |  | 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.                                                                                                                                         
|        | 10.38 |               |  | 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.                                                                                                      
|        | 10.39 |               |  | 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.                                                                                                                             
|        | 10.40 |               |  | 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.                                                                                                                    
|        | 10.41 |               |  | 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.                                                                                                                          
|        | 10.42 |               |  | 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.                                                                                                               
|        | 10.43 |               |  | 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.                                                                                                                        
|        | 10.44 |               |  | 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.                                                                                                                                  
|        | 10.45 |               |  | 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.*                                                                                                                                                                                     
|        | 10.46 |               |  | Loan Agreement by and between the Registrant and
    U.S. Bank National Association dated as of August 14,
    2002, incorporated herein by reference to Exhibit 10.46 to
    the Registrants Quarterly Report on Form 10-Q (file
    no. 000-26660) filed on November 14, 2002.                                                                                                    
|        | 10.48 |               |  | Registrants 1995 Equity Incentive Plan and
    related documents as amended, incorporated herein by reference
    to Exhibit 10.48 to the Registrants Annual Report on
    Form 10-K (file no. 000-26660) filed on March 31,
    2003.*                                                                                                                                            

81



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##### Table of Contents



|        |       |               |  |                                                                                                                                                                                                                                                                                                                                                 
|------- | ----- | ------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       |              
|Number  |       | Exhibit Title
|        |       |              
|        | 10.49 |               |  | Registrants 1995 Directors Stock
    Option Plan and related documents as amended, incorporated
    herein by reference to Exhibit 10.49 to the
    Registrants Annual Report on form 10-K (file
    no. 000-26660) filed March 31, 2003.*                                                                                                   
|        | 10.50 |               |  | 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.**                                                                                                                              
|        | 10.51 |               |  | 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.**                                                                                                                  
|        | 10.52 |               |  | 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.**                 
|        | 10.53 |               |  | 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.**
|        | 10.54 |               |  | Amendment Number One to Loan Agreement dated
    July 17, 2003, by and between ESS Technology, Inc. and
    U.S. Bank National Association, incorporated herein by
    reference to Exhibit 10.53 to the Registrants
    Quarterly Report on Form 10-Q (file no. 000-26660)
    filed November 14, 2003.                                       
|        | 10.55 |               |  | First Amendment to the Amended and Restated
    Commercial Lease Agreement dated July 1, 2003, by and
    between ESS Technology, Inc. and Vialta, Inc.                                                                                                                                                                                         
|        | 11    |               |  | Computation of Net Income Per Share.                                                                                                                                                                                                                                                                                                            
|        | 21    |               |  | List of Registrants subsidiaries.                                                                                                                                                                                                                                                                                                              
|        | 23    |               |  | Consent of Independent Accountants.                                                                                                                                                                                                                                                                                                             
|        | 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 of arrangement.



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

(b) Reports on Form 8-K:



| |                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | On October 29, 2003, the Company furnished a
    Form 8-K under Item 12 to announce its consolidated
    financial results for the third quarter of the fiscal year 2003,
    attaching unaudited consolidated financial statements for the
    third quarter of the fiscal year 2003.                                                                                                                                               
|
| | On October 31, 2003, the Company filed a
    Form 8-K/ A under Items 2 and 7 to amend its Current Report
    on Form 8-K filed September 2, 2003, to include
    audited consolidated financial statements of Divio for the
    fiscal years ended September 30, 2002 and
    September 30, 2001, and unaudited interim consolidated
    financial statements of Divio as of June 30, 2003 and for
    the nine months ended June 30,

82



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##### Table of Contents



| |                                                                                                                                                                                                                                                                         
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 2003 and June 30, 2002, as well as unaudited
    pro forma condensed combined financial information of the
    Company and Divio.                                                                                                                                       
|
| | With the exception of the information
    incorporated by reference to the our Proxy Statement for the
    2004 Annual Meeting of Shareholders in Items 10, 11,
    12, 13 and 14 of Part III, the Proxy Statement is not
    deemed to be filed as part of this Report.

83



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##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) of the Securities Exchange Act of 1934, the Registrant
has duly caused this Annual Report on Form 10-K to be
signed on its behalf by the undersigned, thereunto duly
authorized.



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



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

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

Date: March 15, 2004

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each
person whose signature appears below hereby constitutes and
appoints Robert L. Blair and James B. Boyd, and each of them
severally, his or her true and lawful attorneys-in-fact, each
with full power of substitution, for him or her in any and all
capacities, to sign any and all amendments to this Annual Report
on Form 10-K, and to file the same, with all exhibits
thereto and all documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and
confirming all each of said attorneys-in-fact or any of them, or
his or their substitute or substitutes, may lawfully do or cause
to be done or by virtue hereof.

Pursuant to the requirements of the Securities
Exchange Act of 1934, this registration statement has been
signed by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.

|                                   |  |                                                                                                          |  |                |  | 
|---------------------------------- |  | -------------------------------------------------------------------------------------------------------- |  | -------------- |  | 
|                                   |  |                                                                                                          |  |               
|Signature                          |  | Title                                                                                                    |  | Date          
|                                   |  |                                                                                                          |  |               
|                                  
|/s/ ROBERT L. BLAIRRobert L. Blair |  | President and Chief Executive Officer
    (principal executive officer)                                  |  | March 15, 2004
|                                  
|/s/ JAMES B. BOYDJames B. Boyd     |  | Chief Financial Officer, Senior Vice President
    and Assistant Secretary (principal financial officer) |  | March 15, 2004
|                                  
|/s/ FRED S.L. CHANFred S.L. Chan   |  | Chairman of the Board of Directors                                                                       |  | March 15, 2004
|                                  
|/s/ PETER T. MOKPeter T. Mok       |  | Director                                                                                                 |  | March 15, 2004
|                                  
|/s/ DAVID S. LEEDavid S. Lee       |  | Director                                                                                                 |  | March 15, 2004
|                                  
|/s/ DOMINIC NGDominic Ng           |  | Director                                                                                                 |  | March 15, 2004
|                                  
|/s/ ALFRED J. STEINAlfred J. Stein |  | Director                                                                                                 |  | March 15, 2004

84



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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).                                                                                                                                                                  
|        | 10.06 |               |  | Registrants Amended 401(k) Plan,
    incorporated herein by reference to Exhibit 10.06 to the
    Form S-1 (file no. 33-95388).*                                                                                                                                                                                                                                                        
|        | 10.11 |               |  | 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).                                                                                                                                                                             
|        | 10.21 |               |  | 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).**
|        | 10.22 |               |  | 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.**                                                                                                                                                                                                                          
|        | 10.23 |               |  | 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).**                                                                                                                   
|        | 10.35 |               |  | 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.                                                                                                                                             
|        | 10.38 |               |  | 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.                                                                                                          
|        | 10.39 |               |  | 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.                                                                                                                                 
|        | 10.40 |               |  | 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.                                                                                                                        



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##### Table of Contents



|        |       |               |  |                                                                                                                                                                                                                                                                                                                                                  
|------- | ----- | ------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       |              
|Number  |       | Exhibit Title
|        |       |              
|        | 10.41 |               |  | 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.                                                                                      
|        | 10.42 |               |  | 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.                                                                           
|        | 10.43 |               |  | 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.                                                                                    
|        | 10.44 |               |  | 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.                                                                                              
|        | 10.45 |               |  | 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.*                                                                                                                                                 
|        | 10.46 |               |  | Loan Agreement by and between the Registrant, and
    U.S. Bank National Association dated as of August 14,
    2002, incorporated herein by reference to Exhibit 10.46 to
    the Registrants Quarterly Report on Form 10-Q (file
    no. 000-26660) filed on November 14, 2002.                                                               
|        | 10.48 |               |  | Registrants 1995 Equity Incentive Plan and
    related documents as amended, incorporated herein by reference
    to Exhibit 10.48 to the Registrants Annual Report on
    Form 10-K (file no. 000-26660) filed on March 31,
    2003.*                                                                                                        
|        | 10.49 |               |  | Registrants 1995 Directors Stock
    Option Plan and related documents as amended, incorporated
    herein by reference to Exhibit 10.49 to the
    Registrants Annual Report on form 10-K (file
    no. 000-26660) filed March 31, 2003.*                                                                                                    
|        | 10.50 |               |  | 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.**                                                                                                                               
|        | 10.51 |               |  | 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.**                                                                                                                   
|        | 10.52 |               |  | 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.**                  
|        | 10.53 |               |  | 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. **
|        | 10.54 |               |  | Amendment Number One to Loan Agreement dated
    July 17, 2003, by and between ESS Technology, Inc. and
    U.S. Bank National Association, incorporated herein by
    reference to Exhibit 10.53 to the Registrants
    Quarterly Report on Form 10-Q (file no. 000-26660)
    filed November 14, 2003.                                        
|        | 10.55 |               |  | First Amendment to the Amended and Restated
    Commercial Lease Agreement dated July 1, 2003, by and
    between ESS Technology, Inc. and Vialta, Inc.                                                                                                                                                                                          
|        | 11    |               |  | Computation of Net Income Per Share.                                                                                                                                                                                                                                                                                                             
|        | 21    |               |  | List of Registrants subsidiaries.                                                                                                                                                                                                                                                                                                               
|        | 23    |               |  | Consent of Independent Auditors.                                                                                                                                                                                                                                                                                                                 



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##### Table of Contents



|        |      |               |  |                                                                                                                                
|------- | ---- | ------------- |  | -------------------------------------------------------------------------------------------------------------------------------
|Exhibit |      |              
|Number  |      | Exhibit Title
|        |      |              
|        | 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.



---



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



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