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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,
    2002                                             
|          
|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                       |  | 94538                                   
|(Address of principal executive
    offices)                       |  | (Zip Code)                              

Registrants telephone number, including
area code:

(510) 492-1088


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

None


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

Common Stock, no par value


(Title of Class)


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.     þ

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 $17.54, the closing price
of ESS common stock as reported on the NASDAQ National Market on
June 28, 2002, the last business day of the
registrants most recently completed second fiscal quarter,
was approximately $547,875,160. 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 March 20, 2003, registrant had
outstanding 39,637,976 shares of common stock.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for
Registrants 2003 Annual Meeting of Shareholders are
incorporated by reference in Part III of this Report.



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TABLE OF CONTENTS



|               |                                                                                                          |  |  |  |  |  |  | 
|-------------- | -------------------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I        
|               | Item 1. Business                                                                                        
|               | Item 2. Properties                                                                                      
|               | Item 3. Legal Proceedings                                                                               
|               | Item 4. Submission of Matters to a Vote of Security Holders                                             
|PART II       
|               | Item 5. Market for the Registrants Common Equity and Related Shareholder Matters                       
|               | Item 6. Selected Financial Data                                                                         
|               | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations           
|               | Item 7A. Quantitative and Qualitative Disclosures about Market Risk                                     
|               | Item 8. Financial Statements and Supplementary Data                                                     
|               | Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures           
|PART III      
|               | Item 10. Directors and Executive Officers of the Registrant                                             
|               | Item 11. Executive Compensation                                                                         
|               | Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters.
|               | Item 13. Certain Relationships and Related Transactions                                                 
|               | Item 14. Controls and Procedures.                                                                       
|PART IV       
|               | Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K                               
|SIGNATURES    
|CERTIFICATIONS
|EXHIBIT 10.48 
|EXHIBIT 10.49 
|EXHIBIT 10.50 
|EXHIBIT 10.51 
|EXHIBIT 11.01 
|EXHIBIT 21.01 
|EXHIBIT 23.01 
|EXHIBIT 99.1  
|EXHIBIT 99.2  



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ESS TECHNOLOGY, INC.

2002 FORM 10-K

TABLE OF CONTENTS

|               |  |                                                                                                    |    |      |    | 
|-------------- |  | -------------------------------------------------------------------------------------------------- | -- | ---- | -- | 
|               |  |                                                                                                    |    | Page
|               |  |                                                                                                    |    |     
|PART I        
|Item 1.        |  | Business                                                                                           |    |      | 1  | 
|Item 2.        |  | Properties                                                                                         |    |      | 9  | 
|Item 3.        |  | Legal Proceedings                                                                                  |    |      | 9  | 
|Item 4.        |  | Submission of Matters to a Vote of Security
    Holders                                            |    |      | 10 | 
|PART II       
|Item 5.        |  | Market for the Registrants Common Equity
    and Related Shareholder Matters                      |    |      | 12 | 
|Item 6.        |  | Selected Financial Data                                                                            |    |      | 12 | 
|Item 7.        |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations          |    |      | 14 | 
|Item 7A.       |  | Quantitative and Qualitative Disclosures about
    Market Risk                                     |    |      | 35 | 
|Item 8.        |  | Financial Statements and Supplementary Data                                                        |    |      | 36 | 
|Item 9.        |  | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosures          |    |      | 68 | 
|PART III      
|Item 10.       |  | Directors and Executive Officers of the Registrant                                                 |    |      | 68 | 
|Item 11.       |  | Executive Compensation                                                                             |    |      | 68 | 
|Item 12.       |  | Security Ownership of Certain Beneficial Owners
    and Management and Related Shareholder Matters |    |      | 68 | 
|Item 13.       |  | Certain Relationships and Related Transactions                                                     |    |      | 69 | 
|Item 14.       |  | Controls and Procedures                                                                            |    |      | 69 | 
|PART IV       
|Item 15.       |  | Exhibits, Financial Statement Schedules, and
    Reports on Form 8-K                               |    |      | 69 | 
|Signatures     |  |                                                                                                    | 74 |     
|Certifications |  |                                                                                                    | 75 |     



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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
Operations 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 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 digital processor chips. These chips are
the primary processors driving digital video and audio players,
including DVD, Video CD (VCD) and digital media
players. Our chips use multiple processors and a programmable
architecture that enable us to offer a broad array of features
and functionality. We have also developed an encoding processor
to address the growing demand for the digital video recorder
(DVR) and recordable DVD players. We believe that
multi-featured DVD, DVR or 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, consumer digital audio and PC Audio
products. 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,
China, Taiwan, Korea, Singapore, and Japan. 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.

ESS was 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. Vialta is reported separately as a
discontinued operation. See Note 5, Discontinued
Operation and Note 15, Related Party
Transactions with Vialta, Inc., in Notes to Consolidated
Financial Statements.

Industry Background

From large screen televisions to VCRs to
multi-featured DVD players, technology continues to improve the
home entertainment experience. Technology advancements have
enhanced the clarity, color, sound, functionality and
convenience of television home entertainment. 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





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image degradation, improving storage and
transmission efficiency. Digital formats provide users with
several benefits, including random access to data, superior
editing capabilities and enhanced security features such as
protection against unauthorized copying. The development of
digital media has created markets for new products such as VCD,
DVD and multi-featured DVD, DVR and recordable DVD players. As
digital processing and transmission technology improves, we
believe additional home entertainment products will continue to
be introduced.


Some of the more significant digital home
entertainment products include:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | DVD Players.DVD
    players provide significantly higher quality playback than is
    possible with VCR or VCD technology through the use of MPEG-2
    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 MPEG 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. We are
    currently the leading supplier of VCD processor chips.
|
| |  | Digital Set-Top Boxes (STBs).Digital STBs enable subscriber-based
    digital television through cable, terrestrial broadcast, digital
    subscriber line, or DSL, and satellite transmissions. We are
    developing a system controller chip for the STB market.                                                                                                                                                                                                                                                                                                                                                            
|
| |  | Digital Video Recorders (DVRs).DVRs provide local hard disk storage
    similar to a VCR 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. We expect to begin supplying DVR
    encoder chips to our customers in 2003.                                                                                                                                                                                                                                               
|
| |  | Recordable DVD Players.Recordable DVD players add high
    quality video and audio recording capabilities to the DVD disc.
    We expect to begin supplying recordable DVD encoder chips to our
    customers in 2003.                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  | 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.                                                                                                                                                                                                                                                                                                                                                       

The television, the telephone and the personal
computer (PC) have emerged as the three principal
home systems that manage digital entertainment and information.
The television and the PC are the principal devices for viewing
and manipulating digital content. STBs, DVD players and game
consoles connected to televisions, are emerging as the principal
platforms for viewing home entertainment, while PCs remain the
principle platform for storing data and accessing the internet.

Increasing advances in semiconductor technology
are allowing digital products to converge, resulting in cost
savings and added convenience for consumers. For example, CD
players were initially developed to play audio content in the CD
format only. Then, DVD players were introduced, combining video
with the CD audio format. Now, additional audio formats, such as
MP3, and other features are being added. Consumers can currently
buy separate STBs that provide internet connectivity, separate
DVRs as well as boxes that deliver digital programming. In the
future, all of these features and functions may become available
through a single DVD platform. At the same time, advances in
communication devices allow better distribution of information
and home entertainment content to the home and within the home,
and provide opportunities for further development of multimedia
products.

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

2



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Our Solution

Our chips are the primary processors driving
multi-featured DVD products that play DVD, CD, MP3, WMA (Windows
Media Audio), full-featured karaoke and other audio and video
formats, through home entertainment systems. Our DVD chips
support high quality video formats such as Progressive Scan, and
high quality audio formats, including Dolby Digital, DTS
Surround, DVD audio and Sonys SACD audio. Our DVD chips
also allow consumers to view digital photo CDs with the music
slideshow feature on their television. Our chips use multiple
processors and a programmable architecture that enable us to
offer a broad array of features and functionality. We have also
incorporated the recording functions by using the MPEG encoder
chip to upgrade DVD players to become DVR and recordable DVD
players. We believe that multi-featured DVD, DVR or 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 VCD players, digital media players, modem, consumer
digital audio and PC Audio products.

We believe we have the following competitive
advantages:



| |   |                                                                                                                                                                                                                                  
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Our highly programmable chips are more flexible
    allowing us to efficiently add new capabilities that address
    advances in home entertainment technologies and enable our
    customers to accelerate their time to market;
|
| |  | Our DVD chips offer a broad array of advanced
    features and functionality;                                                                                                                                                    
|
| |  | Our DVD encoder chips offer superior video and
    audio recording quality;                                                                                                                                                      
|
| |  | Our large workforce of engineers (over 60% of our
    employees) is continually developing sophisticated solutions to
    our customers evolving needs using our chips;                                                         
|
| |  | We have over 100 sales and support personnel
    worldwide delivering outstanding customer service;                                                                                                                              
|
| |  | 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; 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 system processor chips for the DHS based on a DVD platform.
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 an entire digital home
    entertainment system processor on a single chip.                                                                                                                                                                                                                                                                                                  
|
| |  | 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
    formats through software enhancements without requiring 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.



| |                                                                                                                                                                                                                                                                        
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Develop System-on-a-Chip(SOC) DVD
    Chip. We are developing a SOC DVD chip that will incorporate
    the front-end servo technology and existing high performance DVD
    system processor chip. This will enable a low cost DVD player
    with advanced features.

3



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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Develop the Next Generation CODEC Chip for the
    recordable DVD.We are developing the
    next generation of integrated DVD encoder and decoder
    (CODEC) into a single chip for both DVR and
    recordable DVD players.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| | 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.                                                                                                                        
|
| | 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 work in close
    collaboration with our customers in their product development
    process. By helping our customers design their products using
    our chips, we can lower their total manufacturing costs. We
    believe this approach enables us to provide our customers with a
    low-cost total solution.                                                                                                          
|
| | Leverage Our Relationships with Low-Cost
    Manufacturers 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 processor chips to original equipment
    manufacturers (OEMs), 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 60% 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.                                                                                                                                                                                                                                                                                                                  
|
| | 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. In
    addition, we will continue to form agreements with other
    companies to develop technologies.                                                                                                                                                                                                                                                                                                                                                               

Products

We offer a broad array of DVD chips, DVD encoder
chips, VCD chips, communication chips, consumer digital audio
chips and PC Audio chips.

DVD Chips.Our
customers can choose from a 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. At the high end, our DVD chips enable
consumers to play DVD, CD, MP3, WMA (Windows Media Audio and
Video), full-featured karaoke and other audio and video formats
through their home entertainment systems and view digital photo
CDs on their television. Our DVD chips support high quality
video formats such as Progressive Scan, and high quality audio
formats, including Dolby Digital, DTS Surround, DVD audio and
Sonys SACD 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 incorporated digital media interface that
allow consumers to view digital media content on their
television.

4



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DVD Encoder Chips.We are leveraging our existing DVD
relationship with our customers to offer our DVD encoder chips
to enable them to build DVR or recordable DVD players to broaden
their products range. The DVR and recordable DVD have VCR
functionality with enhanced picture quality.

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.

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 MPEG-1
video and audio system decoder. They deliver full-screen,
full-motion video at 30 frames per second with selectable
CD-quality audio. Our SVCD chips include MPEG-2 video and MPEG-1
audio system decoders. 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.

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/ network functions on the PC. Our
communication products enable PC manufacturers to provide fax/
modem/ network capabilities to add-on cards and directly onto
the motherboards of desktops and notebook PCs. We provide a full
line of modem chips that are compliant with current 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
|                        |  | Years Ended December 31,  
|                        |  |                           
|                        |  | 2002                       |     | 2001 |  | 2000
|                        |  |                            |     |      |  |     
|DVD                     |  |                            | 59  | %    |  |      | 37  | % |  |  | 15  | %
|VCD                     |  |                            | 31  | %    |  |      | 40  | % |  |  | 42  | %
|PC Audio                |  |                            | 4   | %    |  |      | 16  | % |  |  | 35  | %
|Communication and Other |  |                            | 6   | %    |  |      | 7   | % |  |  | 8   | %
|                        |  |                            |     |      |  |      |     |   |  |  |     |  
|Total                   |  |                            | 100 | %    |  |      | 100 | % |  |  | 100 | %
|                        |  |                            |     |      |  |      |     |   |  |  |     |  

Technology and Research and
Development

Our DVD chips incorporate a digital signal
processor (DSP) and a reduced instruction set
computer processor (RISC). The two processors work
asynchronously on separate tasks, which allows us to build a
highly integrated chip. We believe this architecture will enable
us to efficiently add many additional features and functionality
to our DVD chips as we pursue our overall DHS strategy.

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.

5



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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 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
incurred approximately $27.0 million during 2002,
$28.0 million during 2001, $27.8 million during 2000,
excluding a one-time charge of $2.6 million related to
purchased in-process research and development from the
acquisition of NetRidium Communications, Inc. in the first
quarter of 2000.

Customers

We sell our chips to distributors and OEMs of
DVD, VCD, MP3, 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 and PC
products on store shelves in the United States, Asia and Europe.
For example, our chips can be found in certain branded DVD
players, such as those sold by RCA and Philips.

A substantial portion of our net revenues has
been derived from sales to a small number of our customers.
Sales to our top five end-customers (including end-customers
that buy our products from our distributor  Dynax
Electronics (HK) LTD (Dynax Electronics)) accounted
for approximately 37% of our net revenues in 2002 and 42% of our
net revenues in 2001. One of our top end-customers, Digital AV
(formerly Shinco) accounted for approximately 8%, 9% and 10% of
our net revenues for 2002, 2001 and 2000, respectively.

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 2002, 97% of our net revenues in 2001 and
93% of our net revenues in 2000. Our international revenues in
2002, 2001 and 2000 were derived primarily from Asian customers
who manufacture DVD, VCD, 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 DVD chip products are incorporated into DVD
players that are ultimately sold into the United States. We have
direct sales personnel and technical staff located in China,
Hong Kong, Taiwan, Japan and Korea 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, Singapore, and
Japan. For fiscal 2002, net sales to customers in each region as
a percentage of our total net sales were: Hong Kong 70%, China
8%, Taiwan 7%, Korea 4%, Singapore 4%, Europe 3% and Japan 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 one of our distributors Dynax
Electronics for a significant portion of our revenues, sales
through Dynax Electronics were approximately 57%, 56% and 35% of
our net revenues in 2002, 2001 and

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2000, 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, 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, 2002, 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 are assembled and tested by
third-party vendors, primarily Advanced Semiconductor
Engineering, Orient Semiconductor Electronics and Sampo
Semiconductor in Taiwan. We have internally designed and
developed our own test software and certain test equipment,
which are provided to our test vendors. See 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 most of the
applications 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 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, Zoran, Sony, Panasonic, STMicroelectronic, LSI
Logic, and Cirrus Logic. MediaTek has taken away some of our
market share by launching a SOC DVD chip product into our
targeted low end DVD player market. 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.
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 a competitor in the VCD market.

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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; and Oak Technology acquired TeraLogic.

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, 2002, we had 17 patents granted in the United
States, which are going to expire over time commencing in 2008
and ending in 2020. In addition, as of December 31, 2002 we
had 9 corresponding foreign patents, which are going to expire
over time commencing in 2005 and ending in 2015. 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,
2002, 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. In
addition, we filed a complaint against MediaTek Incorporated,
alleging copyright infringement and unfair competition. See
Item 3, Legal Proceedings.

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 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, 2002, we had
approximately 418 full-time employees, including 176 in research
and development, 126 in marketing, sales and support, 69 in
operations, finance and administration and 47 in manufacturing.
Over 60% 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.

Backlog

Our products are generally sold pursuant to
standard purchase orders, which are frequently revised to
reflect changes in the customers 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 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.

8



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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.
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, which is currently leased to
Vialta, Inc. (our former subsidiary) under the Real Estate
Matter Agreement. This agreement will terminate initially on
December 31, 2003 and may be renewed for up to three years.
See Note 15 to the consolidated financial statements in
Item 8 of this Report, Related Party Transactions
with Vialta, Inc.

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 are building an approximately 5,000 square-foot
warehouse next to our corporate headquarters in Fremont,
California. We anticipate the warehouse will be completed in the
spring of 2003.

We are productively utilizing substantially all
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,
and no trial date has yet been set. Townshend also filed patent
infringement actions against Agere, Analog Devices, Cisco, and
Intel, alleging infringement of the same patents. Both Townshend
and ESS filed statements indicating that the new cases are
related to our case. The parties are currently scheduled to hold
a Case Management Conference on April 24, 2003, after which
initial discovery will begin. We 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
Incorporated, a Taiwanese company (MediaTek),
alleging copyright infringement and unfair competition. The
complaint seeks 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 believe 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 seek a recall order requiring MediaTek to recall all DVD
chips from its customers, distributors, retailers, and end
users. We are vigorously pursuing this litigation.

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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. (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
March 11, 2003, the Company and the individual defendants
filed a motion to dismiss the federal action pursuant to
Rule 12(b)(6) of the Federal Rules of Civil Procedure and
the provisions of the Private Securities Litigation Reform Act.
The motion is currently set for hearing on May 23, 2003.

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.

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, 2002.

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Executive Officers of the Registrant

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

|                |  |     |    |          |  |                                                         
|--------------- |  | --- | -- | -------- |  | --------------------------------------------------------
|Name            |  | Age |    | Position
|                |  |     |    |         
|Fred S.L. Chan  |  |     | 56 |          |  | Chairman of the Board of Directors                      
|Robert L. Blair |  |     | 55 |          |  | President, Chief Executive Officer and Director         
|Patrick Ang     |  |     | 43 |          |  | Chief Operating Officer and Executive Vice
    President
|James B. Boyd   |  |     | 50 |          |  | Chief Financial Officer 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 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 17 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 is serving on the boards of directors for Sunrise
Telecom, Inc. and Photoniko, Inc.

James B. Boydhas
been our Chief Financial Officer since August 2000.
Mr. Boyd was also elected 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 a B.S. degree and a MBA from the University of
Wisconsin  Madison and a J.D. from Golden Gate
University.

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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 2003 Annual Shareholders Meeting
entitled Compliance under Section 16(a) of the
Securities Exchange Act of 1934.




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 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  | 
|Fiscal 2001: |                                        |      |   |       |  |  |   |      
|             | First Quarter ended March 31, 2001     |      | $ | 8.87  |  |  | $ | 4.50  | 
|             | Second Quarter ended June 30, 2001     |      | $ | 10.60 |  |  | $ | 4.75  | 
|             | Third Quarter ended September 30, 2001 |      | $ | 16.12 |  |  | $ | 5.89  | 
|             | Fourth Quarter ended December 31, 2001 |      | $ | 24.45 |  |  | $ | 9.95  | 

As of February 28, 2003, there were
approximately 207 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.






|        |                        
|------- | -----------------------
|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 Operations
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, 2002, 2001
and 2000 and the selected consolidated balance sheet data as of
December 31, 2002 and 2001 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, 1999 and 1998 and the
selected

12



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##### Table of Contents



consolidated balance sheet data as of
December 31, 2000, 1999 and 1998 from our audited
consolidated financial statements, which are not included in
this Report.


|                                                                                       |              |                                       |         |        |  |      |         |        |  |      |         |         |  |   |         |         |  |   |         |        |  
|-------------------------------------------------------------------------------------- | ------------ | ------------------------------------- | ------- | ------ |  | ---- | ------- | ------ |  | ---- | ------- | ------- |  | - | ------- | ------- |  | - | ------- | ------ | -
|                                                                                       |              |                                      
|                                                                                       |              | Years Ended December 31,(1)          
|                                                                                       |              |                                      
|                                                                                       |              | 2002                                  |         | 2001   |  | 2000 |         | 1999   |  | 1998
|                                                                                       |              |                                       |         |        |  |      |         |        |  |     
|                                                                                       |              |                                      
|                                                                                       |              | (In thousands, except per share data)
|Statement of Operations Data:                                                          |              |                                       |         |        |  |      |         |        |  |      |         |         |  |   |         |         |  |   |         |       
|Net revenues                                                                           |              | $                                     | 273,442 |        |  | $    | 271,380 |        |  | $    | 303,436 |         |  | $ | 310,651 |         |  | $ | 218,252 |       
|Cost of revenues                                                                       |              |                                       | 176,454 |        |  |      | 180,231 |        |  |      | 192,452 |         |  |   | 191,529 |         |  |   | 182,417 |       
|                                                                                       |              |                                       |         |        |  |      |         |        |  |      |         |         |  |   |         |         |  |   |         |       
|                                                                                       | Gross profit |                                       |         | 96,988 |  |      |         | 91,149 |  |      |         | 110,984 |  |   |         | 119,122 |  |   |         | 35,835 |  
|Operating expenses:                                                                    |              |                                       |         |        |  |      |         |        |  |      |         |         |  |   |         |         |  |   |         |       
|Research and development                                                               |              |                                       | 26,964  |        |  |      | 27,957  |        |  |      | 27,832  |         |  |   | 36,028  |         |  |   | 30,529  |       
|Purchased in-process research and development                                          |              |                                       |        |        |  |      |        |        |  |      | 2,625   |         |  |   |        |         |  |   |        |       
|Selling, general and administrative                                                    |              |                                       | 34,170  |        |  |      | 40,689  |        |  |      | 36,225  |         |  |   | 38,558  |         |  |   | 36,289  |       
|                                                                                       |              |                                       |         |        |  |      |         |        |  |      |         |         |  |   |         |         |  |   |         |       
|Operating income (loss)                                                                |              |                                       | 35,854  |        |  |      | 22,503  |        |  |      | 44,302  |         |  |   | 44,536  |         |  |   | (30,983 | )     
|Non-operating income (loss), net                                                       |              |                                       | 2,407   |        |  |      | (18,780 | )      |  |      | 41,810  |         |  |   | 4,666   |         |  |   | 1,478   |       
|                                                                                       |              |                                       |         |        |  |      |         |        |  |      |         |         |  |   |         |         |  |   |         |       
|Income (loss) before provision for income taxes                                        |              |                                       | 38,261  |        |  |      | 3,723   |        |  |      | 86,112  |         |  |   | 49,202  |         |  |   | (29,505 | )     
|Provision for (benefit from) income taxes                                              |              |                                       | 984     |        |  |      | (7,262  | )      |  |      | 22,946  |         |  |   | 7,877   |         |  |   | (1,489  | )     
|                                                                                       |              |                                       |         |        |  |      |         |        |  |      |         |         |  |   |         |         |  |   |         |       
|Net income (loss) from continuing operations                                           |              |                                       | 37,277  |        |  |      | 10,985  |        |  |      | 63,166  | (2)     |  |   | 41,325  |         |  |   | (28,016 | )     
|Net income (loss) per share from continuing
    operations:                            |              |                                       |         |        |  |      |         |        |  |      |         |         |  |   |         |         |  |   |         |       
|                                                                                       | Basic        |                                       | $       | 0.85   |  |      | $       | 0.26   |  |      | $       | 1.49    |  |   | $       | 1.02    |  |   | $       | (0.68  | )
|                                                                                       |              |                                       |         |        |  |      |         |        |  |      |         |         |  |   |         |         |  |   |         |       
|                                                                                       | Diluted      |                                       | $       | 0.80   |  |      | $       | 0.24   |  |      | $       | 1.37    |  |   | $       | 0.91    |  |   | $       | (0.68  | )
|                                                                                       |              |                                       |         |        |  |      |         |        |  |      |         |         |  |   |         |         |  |   |         |       
|Shares used in calculating net income
    (loss) per share from continuing operations: |              |                                       |         |        |  |      |         |        |  |      |         |         |  |   |         |         |  |   |         |       
|                                                                                       | Basic        |                                       |         | 44,044 |  |      |         | 42,274 |  |      |         | 42,548  |  |   |         | 40,640  |  |   |         | 40,955 |  
|                                                                                       |              |                                       |         |        |  |      |         |        |  |      |         |         |  |   |         |         |  |   |         |       
|                                                                                       | Diluted      |                                       |         | 46,731 |  |      |         | 45,262 |  |      |         | 45,943  |  |   |         | 45,625  |  |   |         | 40,955 |  
|                                                                                       |              |                                       |         |        |  |      |         |        |  |      |         |         |  |   |         |         |  |   |         |       
|Balance Sheet Data:                                                                    |              |                                       |         |        |  |      |         |        |  |      |         |         |  |   |         |         |  |   |         |       
|Cash, cash equivalents and short-term investments                                      |              | $                                     | 199,102 |        |  | $    | 129,034 |        |  | $    | 58,838  |         |  | $ | 68,687  |         |  | $ | 82,471  |       
|Working capital excluding net assets of
    discontinued operation (See Note 5)        |              |                                       | 210,001 |        |  |      | 156,966 |        |  |      | 138,541 |         |  |   | 85,228  |         |  |   | 81,124  |       
|Total assets                                                                           |              |                                       | 281,602 |        |  |      | 237,965 |        |  |      | 294,391 |         |  |   | 226,922 |         |  |   | 214,645 |       
|Current liabilities                                                                    |              |                                       | 44,558  |        |  |      | 54,056  |        |  |      | 73,901  |         |  |   | 72,804  |         |  |   | 72,573  |       
|Total shareholders equity                                                             |              | $                                     | 229,368 |        |  | $    | 176,978 |        |  | $    | 211,429 |         |  | $ | 183,579 |         |  | $ | 142,072 |       



---



|    |                                                                                                                                                                                                                                                                                           
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | All of the data presented has been adjusted to
    give effect to the treatment of Vialta as a discontinued
    operation. See Note 5, Discontinued Operations
    to the consolidated financial statements in Item 8 of this
    Report.                                               
|   
|(2) | Net income from continuing operations included a
    net one-time item of $2,625 purchased in-process research and
    development expense. For further details, see Note 14,
    Acquisition and Related Charges to the consolidated
    financial statements in Item 8 of this Report.

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

Certain information contained in or incorporated
by reference in the following Managements Discussion and
Analysis of Financial Condition and Results of Operations, 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, or other similar words. 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.

Overview

We are a leading designer, developer and marketer
of highly integrated digital processor chips. These chips are
the primary processors driving digital video and audio players,
including DVD, Video CD (VCD) and digital media
players. Our chips use multiple processors and a programmable
architecture that enable us to offer a broad array of features
and functionality. Our products also include an encoding
processor to address the growing demand for the digital video
recorder (DVR) and recordable DVD players. 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, consumer
digital audio and PC Audio products. 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,
China, Taiwan, Korea, Singapore, and Japan. 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.

ESS was 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 of Vialta. The
Vialta spin-off was completed on August 21, 2001.

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

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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 and Tax Reserves       
|
| |  | 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.



| |                    
| | -------------------
| | 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 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.



| |                                     
| | ------------------------------------
| | Inventory 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.

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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 have goodwill and other intangible assets
related to our previous acquisitions of NetRidium and SAS. 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. This change in accounting
treatment reduced operating expenses by $688,000 during twelve
months ended December 31, 2002 from 2001 levels. In
addition to goodwill associated with NetRidium and SAS, we
recorded goodwill amortization of approximately $1,668,000 and
$3,336,000 for the fiscal years ended December 31, 2001 and
December 31, 2000 respectively, associated with the
acquisition of Platform Technologies, Inc
(Platform). Goodwill associated with the acquisition
of Platform Technology was fully amortized in 2001.

The provisions of SFAS 142 also require us
to complete a transitional impairment test of goodwill within
six months of adoption. We completed our transitional impairment
test of goodwill as of January 1, 2002, the adoption date
of SFAS 142 and determined that goodwill was not impaired.
In addition, we completed an annual impairment test in the
fourth quarter of 2002, and determined that goodwill was not
impaired.



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

Pursuant to SFAS No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets
(SFAS 144), 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. The adoption of SFAS 144 did not have a
material effect on our financial statements.



| |                              
| | -----------------------------
| | Income Taxes and Tax Reserves

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 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.

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Recent Accounting Pronouncements

In June 2002, the Financial Accounting
Standards Board (FASB) issued Statement of Financial
Accounting Standards (SFAS) 146,
Accounting for Costs Associated with Exit or Disposal
Activities (SFAS 146). SFAS 146
addresses financial accounting and reporting for costs
associated with exit or disposal activities. SFAS 146
requires that a liability for a cost associated with an exit or
disposal activity is recognized when the liability is incurred.
In summary, SFAS 146 requires that the liability shall be
recognized and measured initially at its fair value in the
period in which the liability is incurred, except for one-time
termination benefits that meet certain requirements. Since
SFAS 146 is effective prospectively for exit or disposal
activities initiated after December 31, 2002, the adoption
of SFAS 146 will have no effect on our current financial
position or results of operations.

In November 2002, the FASB issued FASB
Interpretation No. 45, Guarantors Accounting
and Disclosures Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others
(FIN 45). FIN 45 requires that a liability
be recorded in the guarantors balance sheet upon issuance
of a guarantee. In addition, FIN 45 requires disclosures
about the guarantees that an entity has issued, including a
reconciliation of changes in the entitys product warranty
liabilities. The initial recognition and initial measurement
provisions of FIN 45 are applicable on a prospective basis
to guarantees issued or modified after December 31, 2002,
irrespective of the guarantors fiscal year-end. The
disclosure requirements of FIN 45 are effective for
financial statements of interim or annual periods ending after
December 15, 2002. We have adopted this statement. The
adoption of FIN 45 did not have a material effect on our
financial position or results of operations.

In December 2002, the FASB issued SFAS
No. 148, Accounting for Stock-Based Compensation,
Transition and Disclosure (SFAS 148).
SFAS 148 provides alternative methods of transition for a
voluntary change to the fair value based method of accounting
for stock-based employee compensation. SFAS 148 also
requires that disclosures of the pro forma effect of using the
fair value method of accounting for stock-based employee
compensation be displayed more prominently and in a tabular
format. Additionally, SFAS 148 requires disclosures of the
pro forma effect in interim financial statements. The transition
and annual disclosure requirements of SFAS 148 are
effective for fiscal years ending after December 15, 2002.
The interim disclosure requirements are effective for interim
periods beginning after December 15, 2002. We do not expect
that the adoption of SFAS 148 will have a material effect
on our financial position or results of operations.

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 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 variable interest entities created or acquired after
January 31, 2003. For variable interest entities created or
acquired prior to February 1, 2003, the provisions of
FIN 46 must be applied for the first interim or annual
period beginning after June 15, 2003. We do not expect that
the adoption of FIN 46 will have a material effect on our
financial position or results of operations.

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.

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

|                                                 |                                               |                          |       |      |  |      |       |      |  |  |       |      | 
|------------------------------------------------ | --------------------------------------------- | ------------------------ | ----- | ---- |  | ---- | ----- | ---- |  |  | ----- | ---- | 
|                                                 |                                               |                         
|                                                 |                                               | Years Ended December 31,
|                                                 |                                               |                         
|                                                 |                                               | 2002                     |       | 2001 |  | 2000
|                                                 |                                               |                          |       |      |  |     
|Net revenues                                     |                                               |                          | 100.0 | %    |  |      | 100.0 | %    |  |  | 100.0 | %   
|Cost of revenues                                 |                                               |                          | 64.5  |      |  |      | 66.4  |      |  |  | 63.4  |     
|                                                 |                                               |                          |       |      |  |      |       |      |  |  |       |     
|                                                 | Gross margin                                  |                          |       | 35.5 |  |      |       | 33.6 |  |  |       | 36.6 | 
|Operating expenses:                              |                                               |                          |       |      |  |      |       |      |  |  |       |     
|                                                 | Research and development                      |                          |       | 10.0 |  |      |       | 10.3 |  |  |       | 9.2  | 
|                                                 | Purchased In-process research and development |                          |       |     |  |      |       |     |  |  |       | 0.9  | 
|                                                 | Selling, general and administrative           |                          |       | 12.5 |  |      |       | 15.0 |  |  |       | 11.9 | 
|                                                 |                                               |                          |       |      |  |      |       |      |  |  |       |     
|Operating income                                 |                                               |                          | 13.0  |      |  |      | 8.3   |      |  |  | 14.6  |     
|Non-operating income (loss), net                 |                                               |                          | 0.9   |      |  |      | (6.9  | )    |  |  | 13.8  |     
|                                                 |                                               |                          |       |      |  |      |       |      |  |  |       |     
|Income before income taxes                       |                                               |                          | 13.9  |      |  |      | 1.4   |      |  |  | 28.4  |     
|Provision for (benefit from) income taxes        |                                               |                          | 0.3   |      |  |      | (2.6  | )    |  |  | 7.6   |     
|                                                 |                                               |                          |       |      |  |      |       |      |  |  |       |     
|Net income from continuing operations            |                                               |                          | 13.6  |      |  |      | 4.0   |      |  |  | 20.8  |     
|Discontinued operation, net of minority interest |                                               |                          |      |      |  |      | (4.7  | )    |  |  | (4.9  | )   
|                                                 |                                               |                          |       |      |  |      |       |      |  |  |       |     
|Net Income (loss)                                |                                               |                          | 13.6  | %    |  |      | (0.7  | )%   |  |  | 15.9  | %   
|                                                 |                                               |                          |       |      |  |      |       |      |  |  |       |     

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 average selling prices (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 
|                        |  | 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 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. 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
resulted in part from the entry of a new competitor that
penetrated the market faster than we previously thought possible
and in part from lower than expected consumer demand for DVD
products. We have filed a lawsuit in the United States against
this new competitor, a company based in Taiwan, requesting both
damages and an injunction to stop the importation into the
United States of DVD players containing products we believe
infringe our intellectual property rights. We expect this new
competitor to gain market share among some China-based OEMs with
respect to the current version of our DVD chip for use in DVD
players intended to be sold in the United States. Even if we are
successful in this lawsuit, we expect to lose market share among
some China-

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based OEMs that would otherwise use the current
version of our DVD chip in DVD players intended to be sold in
markets outside the United States. 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 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 for the fiscal
year 2002 at least until such time as our new product, the
Vibratto II chip, or our other new products 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 the product life, and in 2003 gross
margins may continue to shrink. We believe that in order to
maintain or increase gross profit in 2003, 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 $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, marketing

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development fund (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 ESS 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 Systems, Inc. (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 rate 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.

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.

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Comparison of Twelve Months Ended
December 31, 2001 and December 31, 2000

Net
Revenues

Net revenues were $271.4 million in 2001 and
$303.4 million in 2000. Net revenues decreased by
$32.1 million, or 10.6%, from 2000 to 2001 primarily due to
the continuing softness in the PC Audio market, which more than
offset the growth in our DVD business.

The following table summarizes revenues by our
major product categories:

|                        |  |               |     |      |  |  |     |  
|----------------------- |  | ------------- | --- | ---- |  |  | --- | -
|                        |  |              
|                        |  | Percentage of
|                        |  | Net Revenues 
|                        |  | Years Ended  
|                        |  | December 31, 
|                        |  |              
|                        |  | 2001          |     | 2000
|                        |  |               |     |     
|DVD                     |  |               | 37  | %    |  |  | 15  | %
|VCD                     |  |               | 40  | %    |  |  | 42  | %
|Communication and Other |  |               | 7   | %    |  |  | 8   | %
|PC Audio                |  |               | 16  | %    |  |  | 35  | %
|                        |  |               |     |      |  |  |     |  
|Total                   |  |               | 100 | %    |  |  | 100 | %
|                        |  |               |     |      |  |  |     |  

DVD revenues increased by $54.6 million from
2000 to 2001 primarily due to an increase in unit sales,
partially offset by a decrease in ASP per unit. Unit sales
increased by 223.8%, while ASP per unit decreased by 31.5%.

VCD revenues decreased by $16.1 million from
2000 to 2001 primarily due to a decrease in ASP per unit,
partially offset by an increase in unit sales. ASP per unit
decreased by 13.1%, while unit sales increased by 0.4%.

Communication and other revenues decreased by
$6.0 million from 2000 to 2001 due to a decrease in both
unit sales and ASP per unit. Unit sales decreased by 17.1% and
ASP per unit decreased by 7.8%.

PC Audio revenues decreased by $64.6 million
from 2000 to 2001 primarily due to a decrease in both unit sales
and ASP per unit. Unit sales decreased by 56.4% and ASP per unit
decreased by 9.0%.

International revenues accounted for
approximately 97% of net revenues in 2001 and 93% of net
revenues in 2000. Our international sales are denominated in
U.S. dollars.

Gross
Margin

Gross profit was $91.1 million in 2001 and
$111.0 million in 2000, representing corresponding gross
margins of 33.6% of net revenues in 2001 and 36.6% of net
revenues in 2000. The decrease in gross margin from 2000 to 2001
was primarily due to the under absorption of fixed overhead,
meaning that certain fixed costs remained relatively constant
for the two periods, while production levels of 2001 were lower
than that of 2000. Under absorption of fixed overhead was
partially offset by a $3.3 million decrease in excess and
obsolete inventory charges in 2001. During 2000, we purchased
inventory based on our then current sales forecast and our
intent to build up inventory on key products from our foundries
due to a forecasted industry wide tight wafer capacity. However,
during 2001, the overall market for PC products declined
significantly, and, as a result, the demand for these products
did not meet our forecasts resulting in a $7.0 million of
excess and obsolete inventory charges during 2001.

Research and
Development

Research and development expenses were
$28.0 million, or 10.3% of net revenues, in 2001 and
$27.8 million, or 9.2% of net revenues, in 2000. The
increase in research and development expenses from 2000 to 2001
was the result of normal variations in project workload.

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Purchased
In-process Research and Development

Purchased in-process research and development
expenses were zero in 2001 and $2.6 million, or 0.9% of net
revenues, in 2000 due to the acquisition of NetRidium. See
Acquisition and Related Charges.

Selling,
General and Administrative Expenses

Selling, general and administrative expenses were
$40.7 million, or 15.0% of net revenues, in 2001 and
$36.2 million, or 11.9% of net revenues, in 2000. The
increase in selling, general and administrative expenses from
2000 to 2001 resulted primarily from the increase in legal
expenses, marketing development fund (MDF) expenses,
salary, audit and accounting fees, partially offset by the
decrease in amortization and bad debt expenses. Legal, audit and
accounting expenses increased due to trademark litigations and
the filing and subsequent withdrawal of a registration statement
on Form S-3 with respect to a proposed public offering by
ESS that was abandoned in light of the market turmoil. Salary
increased due to headcount increase. MDF expense increased due
to more sales to customers who were covered under this program.

Non-operating
Income (Loss), Net

Net non-operating income (loss) was
($18.8) million in 2001 and $41.8 million in 2000. In
2001, net non-operating loss consisted primarily of a
($21.2) million loss 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. In 2000, net non-operating income
consisted primarily of a pre-tax gain of $35.0 million on
our exchange of preferred stock in Komodo Technology for
restricted shares of common stock of Cisco in
September 2000, in addition to a $2.9 million gain
from the sale of land and property, plant and equipment, and
$2.4 million of net interest income on cash, cash
equivalents and short term investments.

Provision for
(Benefit from) Income Taxes

Our effective tax rate was (241%) for 2001 and
37% for 2000. 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 2001
and 17% for 2000. We used an estimated 40% tax rate on the
($21.2) million loss from sale of Cisco stock, which
resulted in a $8.5 million tax benefit in 2001.

Our 5% tax rate for 2001 and our 17% tax rate for
2000 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 credit in 2001.



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

Net income from continuing operations was
$11.0 million in 2001 and $63.2 million in 2000. Net
income from continuing operations decreased by
$52.2 million from 2001 to 2002 primarily due to the
decrease in net revenues and the ($21.2) million loss
incurred on the sale of Cisco stock in 2001.



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

Discontinued operation, net of minority interest
was a loss of ($12.8) million in 2001 and a loss of
($14.9) million in 2000. 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. In 2000, the net loss from discontinued
operation, net of minority interest, consisted primarily of the
operating loss from Vialta.



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

Net loss was ($1.8) million in 2001 and net
income was $48.3 million in 2000. Net income decreased by
$50.1 million from 2000 to 2001 primarily due to the
decrease in net revenues and gross profit and the loss recorded
in 2001 for the discontinued operation, net of minority interest
and the sale of the Cisco stock.

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Acquisitions and Related Charges

NetRidium Communications, Inc.
(NetRidium) was founded in January 1999 and was
acquired in February 2000, when it was still a development-stage
company with no revenue. The acquisition was recorded using the
purchase method of accounting and accordingly, the results of
operations and cash flows of such acquisition have been included
from the date of acquisition. Purchased in-process research and
development aggregating $2.6 million for the NetRidium
acquisition was charged to operations in the second quarter of
2000. Technical infrastructure and covenants not to compete are
being amortized over four years. In connection with the
acquisition, we granted certain NetRidium employees stock
options to purchase a total of 500,000 shares of our stock at
$17.68 per share, the fair market value on the date of grant. In
addition, we have entered into employment contracts with certain
former NetRidium employees, which, among other things, provide
that if the employee stays with us for the applicable vesting
periods during the four-year term of the employment agreement,
the employees stock options will have a value of at least
$8.85 more than the exercise price when such options become
exercisable. Accordingly, we are accruing this additional
compensation expense over the four-year term of the agreement.
Approximately 428,000 of the options issued upon acquisition are
subject to this guarantee. We recorded approximately
$0.7 million, $0.5 million and $0.9 million as
compensation expenses under this guarantee, for fiscal year
2002, 2001 and 2000, respectively.

NetRidium was developing its intellectual
property and foundation technologies in the area of broadband
data delivery to homes and in-home data distribution.
NetRidiums first product was scheduled for release in the
summer of 2000. We expected this acquisition to provide these
foundation technologies as a turnkey solution to network
equipment manufacturers and personal computer providers. We
planned to introduce a complete line of highly integrated
technology products that would enable network manufacturers to
produce reliable HomeLAN solutions over ordinary telephone wires.

Research and development expenses incurred on
product development post acquisition were approximately
$4.0 million and $3.3 million in 2001 and 2000,
respectively. The product was not completed until February of
2002. No significant revenues have been recognized to date nor
were significant revenues originally anticipated in 2002;
however, we believe that home networking is an important future
market for us and this technology will be important to our
efforts to exploit that market. As of December 31, 2002,
net unamortized intangible assets relating to the NetRidium
acquisition were approximately $650,000, including $400,000 of
goodwill and $250,000 of technical infrastructure. We continue
to monitor the carrying value of intangible assets related to
the NetRidium acquisition in accordance with SFAS 142 and
SFAS 144.

In April 2001, we entered into a definitive
agreement to acquire Silicon Analog Systems (SAS) in
a merger transaction to be accounted for as a purchase business
combination. SAS was a Canadian start-up company engaged in
developing single chip solutions for wireless communications.
This acquisition was effective on April 12, 2001. 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
cost was primarily allocated to goodwill, based on an
independent 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, 2002, the SAS design team
is concentrating on video product development as well as radio
frequency analog design, 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.

Eight Quarters Ended December 31,
2002

The following table sets forth our statement of
operations data for each of the eight quarters from
January 31, 2001 through December 31, 2002. All of the
data presented have been restated to reflect Vialta as

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a discontinued operation. We believe that going
forward we will be more 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,
|                                                  |                                                                                     | 2001                      |         | 2001     |   | 2001      |         | 2001     |  | 2002     |        | 2002     |  | 2002      |        | 2002    
|                                                  |                                                                                     |                           |         |          |   |           |         |          |  |          |        |          |  |           |        |         
|                                                  |                                                                                     |                          
|                                                  |                                                                                     | (Unaudited, in thousands)
|Net revenues                                      |                                                                                     | $                         | 50,808  |          |   | $         | 64,909  |          |  | $        | 72,397 |          |  | $         | 83,266 |          |  | $ | 79,115 |        |  | $ | 86,037 |        |  | $ | 60,746 |       |  | $ | 47,544 |      
|Cost of revenues                                  |                                                                                     |                           | 39,606  |          |   |           | 45,970  |          |  |          | 45,930 |          |  |           | 48,725 |          |  |   | 44,839 |        |  |   | 50,817 |        |  |   | 45,665 |       |  |   | 35,133 |      
|                                                  |                                                                                     |                           |         |          |   |           |         |          |  |          |        |          |  |           |        |          |  |   |        |        |  |   |        |        |  |   |        |       |  |   |        |      
|Gross profit                                      |                                                                                     |                           | 11,202  |          |   |           | 18,939  |          |  |          | 26,467 |          |  |           | 34,541 |          |  |   | 34,276 |        |  |   | 35,220 |        |  |   | 15,081 |       |  |   | 12,411 |      
|Operating Expenses:                               |                                                                                     |                           |         |          |   |           |         |          |  |          |        |          |  |           |        |          |  |   |        |        |  |   |        |        |  |   |        |       |  |   |        |      
|                                                  | Research and development                                                            |                           |         | 6,411    |   |           |         | 7,592    |  |          |        | 7,273    |  |           |        | 6,681    |  |   |        | 6,381  |  |   |        | 7,043  |  |   |        | 7,160 |  |   |        | 6,380 | 
|                                                  | Selling, general and administrative                                                 |                           |         | 8,666    |   |           |         | 8,917    |  |          |        | 11,686   |  |           |        | 11,420   |  |   |        | 10,356 |  |   |        | 11,051 |  |   |        | 6,452 |  |   |        | 6,311 | 
|                                                  |                                                                                     |                           |         |          |   |           |         |          |  |          |        |          |  |           |        |          |  |   |        |        |  |   |        |        |  |   |        |       |  |   |        |      
|Operating income (loss)                           |                                                                                     |                           | (3,875  | )        |   |           | 2,430   |          |  |          | 7,508  |          |  |           | 16,440 |          |  |   | 17,539 |        |  |   | 17,126 |        |  |   | 1,469  |       |  |   | (280   | )    
|Non-operating income (loss), net                  |                                                                                     |                           | 325     |          |   |           | (20,795 | )        |  |          | 989    |          |  |           | 701    |          |  |   | (1,267 | )      |  |   | 1,085  |        |  |   | 1,438  |       |  |   | 1,151  |      
|                                                  |                                                                                     |                           |         |          |   |           |         |          |  |          |        |          |  |           |        |          |  |   |        |        |  |   |        |        |  |   |        |       |  |   |        |      
|Income (loss) before income taxes                 |                                                                                     |                           | (3,550  | )        |   |           | (18,365 | )        |  |          | 8,497  |          |  |           | 17,141 |          |  |   | 16,272 |        |  |   | 18,211 |        |  |   | 2,907  |       |  |   | 871    |      
|Provision for (benefit from) income taxes         |                                                                                     |                           | (382    | )        |   |           | (8,167  | )        |  |          | 425    |          |  |           | 862    |          |  |   | (114   | )      |  |   | 889    |        |  |   | 148    |       |  |   | 61     |      
|                                                  |                                                                                     |                           |         |          |   |           |         |          |  |          |        |          |  |           |        |          |  |   |        |        |  |   |        |        |  |   |        |       |  |   |        |      
|Net income (loss) from continuing operations      |                                                                                     |                           | (3,168  | )        |   |           | (10,198 | )        |  |          | 8,072  |          |  |           | 16,279 |          |  |   | 16,386 |        |  |   | 17,322 |        |  |   | 2,759  |       |  |   | 810    |      
|                                                  |                                                                                     |                           |         |          |   |           |         |          |  |          |        |          |  |           |        |          |  |   |        |        |  |   |        |        |  |   |        |       |  |   |        |      
|Discontinued operation, net of minority interest: |                                                                                     |                           |         |          |   |           |         |          |  |          |        |          |  |           |        |          |  |   |        |        |  |   |        |        |  |   |        |       |  |   |        |      
|                                                  | Loss from discontinued operation, net of minority
    interest                      |                           |         | (4,205   | ) |           |         |         |  |          |        |         |  |           |        |         |  |   |        |       |  |   |        |       |  |   |        |      |  |   |        |      | 
|                                                  | Income (Loss) from disposal of discontinued
    operation, net of minority interest |                           |         | (13,312  | ) |           |         |         |  |          |        | 4,715    |  |           |        |         |  |   |        |       |  |   |        |       |  |   |        |      |  |   |        |      | 
|                                                  |                                                                                     |                           |         |          |   |           |         |          |  |          |        |          |  |           |        |          |  |   |        |        |  |   |        |        |  |   |        |       |  |   |        |      
|Net income (loss)                                 |                                                                                     | $                         | (20,685 | )        |   | $         | (10,198 | )        |  | $        | 12,787 |          |  | $         | 16,279 |          |  | $ | 16,386 |        |  | $ | 17,322 |        |  | $ | 2,759  |       |  | $ | 810    |      
|                                                  |                                                                                     |                           |         |          |   |           |         |          |  |          |        |          |  |           |        |          |  |   |        |        |  |   |        |        |  |   |        |       |  |   |        |      

Liquidity and Capital Resources

Since inception, we have financed our cash
requirements from cash generated by operations, the sale of
equity securities, and other short-term and long-term debt. At
December 31, 2002, we had cash, cash equivalents and
short-term investments of $199.1 million and working
capital of $210.0 million. At December 31, 2002, we
had a $10.0 million unsecured line of credit with
U.S. Bank National Association, which will expire on
June 5, 2005. This line of credit requires us to maintain
certain financial ratios and operating results. As of
December 31, 2002 and as of the filing date of this Report,
we are in compliance with the borrowing criteria and there has
been no borrowing under this line of credit.

On February 1, 2002, we commenced a public
offering of 4,800,000 shares of our common stock at a price
of $19.38 per share. We sold 2,500,000 shares, and
2,300,000 shares were sold by selling shareholders. ESS did
not receive any of the proceeds from the sale of shares by the
selling shareholders: Annie M.H. Chan, the Annie M.H.
Chan Living Trust and the Shiu Leung Chan &
Annie M.H. Chan Gift Trust. The selling shareholders
further granted an over-allotment option of 720,000 shares to
underwriters, which the underwriters exercised on
February 19, 2002. Net of underwriting discount, we
received proceeds of $45,550,000 before expenses. See
Note 8, Shareholders 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

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commitments relating to Vialta as of
December 31, 2002. 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, 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. The
Real Estate Matters Agreement will terminate initially on
December 31, 2003 and may be renewed for up to three years.
Under this agreement, Vialta pays us approximately
$1.85 million per year, receivable in installments of
$154,498 per month, to lease office space for its corporate
headquarters. The Master Transitional Services Agreement
terminated on August 21, 2002. See Note 5,
Discontinued Operations and Note 15,
Related Party Transactions with Vialta, Inc. to the
consolidated financial statements in Item 8 of this report.


In February 2000, we acquired, in a transaction
accounted for as a purchase business combination, all of the
outstanding shares of capital stock of NetRidium for
$5.3 million in cash, of which approximately 90% was paid
at the closing in February 2000 and approximately 10% was paid
in November 2000. At the closing, NetRidium had
$1.0 million of cash on hand, so the net use of cash for
the purchase amounted to $4.3 million.

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
$64.8 million for the year ended December 31, 2002 and
$93.5 million for the year ended December 31, 2001,
and net cash used in operating activities was $11.1 million
for the year ended December 31, 2000. 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 inventory 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 inventory 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. The net
cash used in operating activities for the year ended
December 31, 2000 was primarily attributable to an increase
in inventory of $56.6 million, a gain from sales of
investment of $35.0 million, an increase in accounts
receivable of $17.5 million, and a decrease in accounts
payable of $2.1 million, offset by a net income of
$48.3 million, loss from discontinued operation of
$14.9 million, depreciation and amortization of
$15.0 million, an increase in income tax payable and
deferred income taxes of $15.7 million, and an income tax
benefit on disqualifying disposition of common stock options of
$4.6 million. Average days sales outstanding was
approximately 45 days for fiscal year 2002, compared to
approximately 52 days for fiscal year 2001 and
approximately 70 days for fiscal year 2000.

Net cash used in investing activities was
$35.6 million for the year ended December 31, 2002 and
$16.5 million for the year ended December 31, 2001,
and net cash provided by investing activities was $14.1 million
for the year ended December 31, 2000. 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 $2.2 million, offset by proceeds
from sales of short-term and long-term investments of
$25.7 million and $0.4 million, respectively, and
proceeds from the sale of Cisco stock of $1.0 million. 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 $2.0 million,
offset by proceeds from sales of short-term investments of
$13.8 million, and proceeds from the sale of Cisco stock of
$11.1 million. The net cash provided by investing
activities for the year ended December 31, 2000 was
primarily attributable to sales of short-term investment of
$29.9 million, and sales of property, plant and equipment
of $3.9 million, offset by purchase of short-term and
long-term investments of

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$10.2 million and $2.6 million,
respectively, cash paid for acquisition of $4.3 million,
and purchase of property, plant and equipment of
$2.6 million.


Net cash provided by financing activities was
$11.9 million for the year ended December 31, 2002,
and cash used in financing activities was $5.7 million for the
year ended December 31, 2001 and $17.7 million for the
year ended December 31, 2000. The net cash provided by
financing 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 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. The net cash used in financing activities for
the twelve months ended December 31, 2000 was primarily
attributable to cash paid for repurchase of common stock of
$27.8 million, partially offset by proceeds from the
issuance of common stock under employee stock plans of
$10.1 million.



| |                              
| | -----------------------------
| | Commitments and Contingencies

We maintain leased office space in various
locations, in addition to certain testing equipment leased from
third parties. Future minimum rental payments under these
operating leases are as follows (in thousands):

|                        |  |        |       | 
|----------------------- |  | ------ | ----- | 
|Year Ended December 31, |  | Amount
|                        |  |       
|2003                    |  | $      | 1,588 | 
|2004                    |  |        | 46    | 
|2005                    |  |        | 16    | 
|2006                    |  |        | 16    | 
|                        |  |        |       | 
|Total                   |  | $      | 1,666 | 
|                        |  |        |       | 

Lease expenses were approximately
$1.2 million, $1.5 million and $1.4 million in
2002, 2001 and 2000, respectively.

As of December 31, 2002, our commitments to
purchase inventory from the third-party contractors aggregated
approximately $10.7 million. Under these contractual
agreements, we may order inventory from time to time, depending
on our inventory needs. There is no termination date to these
agreements.

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.



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

We announced on May 7, 2002 that our Board
of Directors authorized us to repurchase up to 3.0 million
shares of ESS 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. The repurchase program is being effected
from time to time, depending on market conditions and other
factors, through open market purchases. We repurchased the
3.0 million shares for an aggregated price of
$42.8 million at market prices ranging from $5.27 to $18.20
per share under the program, including purchases of 62,172
shares made during January of 2003. Upon repurchase, these
shares were retired and no longer deemed outstanding.

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We announced on August 8, 2002, that our
Board of Directors authorized us to repurchase up to
5.0 million shares of ESS 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. There was no
purchase made under this program as of December 31, 2002
and we commenced our repurchase under this program in January
2003. We have repurchased 3,667,441 shares for an
aggregated price of $21.7 million at market prices ranging
from $5.43 to $6.30 per share under this program as of
March 20, 2003, leaving approximately 1.33 million
shares available for repurchase as of such date. Upon
repurchase, these shares were retired and no longer deemed
outstanding.

To date, we have not declared or paid cash
dividends to our stockholders 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 $5.5 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 business, 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, 2002, together with short-term investments,
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.

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 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 that the consumer
digital home entertainment market will continue to account for a
significant portion of our net revenues for the foreseeable
future. 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;                                                                                                                                              
|
| |  | 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.                                                                                                  

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 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.

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

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and development projects, our business, financial
condition and results of operations could be materially
adversely affected.


For example, we are currently developing our DVD
integrated chip solution Vibratto II, and we have incurred
significant amount of resources on this complicated project. If
we are not able to introduce Vibratto II on a timely basis
or if Vibratto II fails to attain market acceptance, we may
continue to lose market shares to competitors and 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; and                
|
| |  | The incurrence of substantial debt and assumption
    of unknown liabilities.                

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
trends may cause our quarterly operating results to fluctuate
and our inability to forecast these trends may adversely affect
the market price of our common stock. In 2002, 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 2001 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

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sell our products at cost-effective prices. We
expect the ASP of our existing products to decline significantly
over the life of each product 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.

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 we shift our
focus to this market. 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.

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.

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 2002, sales to our top five end customers (including
end-customers that buy our products from our distributor Dynax
Electronics) were approximately 37% 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.

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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 57%,
56% and 35% of our net revenues in 2002, 2001 and 2000. 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 account 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.

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, 2002, we had 17 patents granted in the
United States. These patents will expire over time commencing in
2008 and ending in 2020. In addition, as of December 31,
2002, we had 9 corresponding foreign patents, which are going to
expire over time commencing in 2005 and ending in 2015. We
cannot assure you that patents will be issued from any of our
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, China, Taiwan, Korea, Singapore and Japan. During
2002, sales to customers in Hong Kong, China and Taiwan were in
excess of 85% of our net revenues. If our sales in one of these
countries, such as China, 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

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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 taxes;                                                                                                                                                                    
|
| |  | 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 Corporation and other
independent Asian foundries. 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 purchase raw materials from a
limited number of suppliers, we could experience disruptions or
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.

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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 the 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 increases 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.

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. Downturns in the
industry have been characterized by abrupt fluctuations in
product demand, production over-capacity and accelerated decline
of ASP. Current trade association data indicate that the
semiconductor industry has experienced a severe downturn since
the third quarter of 2000 and this downturn is expected to
continue for the foreseeable future. This downturn could harm
our net revenues and gross margins if ASP continue to decline or
demand falls. We cannot assure you that the market will
stabilize or improve in the near term. A prolonged downturn in
the semiconductor industry could materially and adversely impact
our business and results of operations.

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;

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| |   |                                                                                           
| | - | ------------------------------------------------------------------------------------------
| |  | 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 rapid product obsolescence.
Competition typically occurs at the design stage, when customers
evaluate alternative design approaches requiring integrated
circuits. Because of shortened life cycles, there are frequent
design win competitions for next-generation systems.

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 anticipated DVD
    integrated chip, the Vibratto II;                       
|
| |  | The timely shipment of the next generation of our
    current DVD decoder chip, the Vibratto S;        
|
| |  | 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;                                                                                                                                                                                                                     

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| |   |                                                                                                                                
| | - | -------------------------------------------------------------------------------------------------------------------------------
| |  | Sales by our officers, directors and other
    insiders;                                                                       
|
| |  | 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

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
foundry 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
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, 2002, the fair value of our investments
approximated their costs.

35



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

The
following documents are filed as part of this Report:

Report
of Independent Accountants

Consolidated
Balance Sheets as of December 31, 2002 and 2001

Consolidated
Statements of Operations for the years ended December 31,
2002, 2001 and 2000

Consolidated
Statements of Shareholders Equity for the years ended
December 31, 2002, 2001 and 2000

Consolidated
Statements of Cash Flows for the years ended December 31,
2002, 2001 and 2000

Notes
to Consolidated Financial Statements

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REPORT OF INDEPENDENT ACCOUNTANTS

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 comprehensive
income and of cash flows present fairly, in all material
respects, the financial position of ESS Technology, Inc. and its
subsidiaries at December 31, 2002 and 2001, and the results
of their operations and their cash flows for each of the three
years in the period ended December 31, 2002, in conformity
with accounting principles generally accepted in the United
States of America. These financial statements are the
responsibility of ESS Technology, Inc.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

January 24, 2003


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ESS TECHNOLOGY, INC.

CONSOLIDATED BALANCE SHEETS

December 31, 2002 and 2001


|                                              |                                                                                                                                                            |                                            |         |         |         |   |        |         |         | 
|--------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------- | ------- | ------- | - | ------ | ------- | ------- | 
|                                              |                                                                                                                                                            |                                           
|                                              |                                                                                                                                                            | December 31,                              
|                                              |                                                                                                                                                            |                                           
|                                              |                                                                                                                                                            | 2002                                       |         | 2001   
|                                              |                                                                                                                                                            |                                            |         |        
|                                              |                                                                                                                                                            |                                           
|                                              |                                                                                                                                                            | (In thousands)                            
|ASSETS                                       
|                                             
|Cash and cash equivalents                     |                                                                                                                                                            | $                                          | 138,072 |         |         | $ | 96,995 |        
|Short-term investments                        |                                                                                                                                                            |                                            | 61,030  |         |         |   | 32,039 |        
|Accounts receivable, net                      |                                                                                                                                                            |                                            | 28,435  |         |         |   | 42,595 |        
|Related party receivable  Vialta             |                                                                                                                                                            |                                            | 33      |         |         |   | 47     |        
|Inventories, net                              |                                                                                                                                                            |                                            | 24,155  |         |         |   | 37,452 |        
|Prepaid expenses and other assets             |                                                                                                                                                            |                                            | 2,834   |         |         |   | 1,894  |        
|                                              |                                                                                                                                                            |                                            |         |         |         |   |        |        
|                                              |                                                                                                                                                            | Total current assets                       |         |         | 254,559 |   |        |         | 211,022 | 
|Property, plant and equipment, net            |                                                                                                                                                            |                                            | 18,985  |         |         |   | 22,438 |        
|Other assets                                  |                                                                                                                                                            |                                            | 8,058   |         |         |   | 4,505  |        
|                                              |                                                                                                                                                            |                                            |         |         |         |   |        |        
|                                              |                                                                                                                                                            | Total assets                               |         | $       | 281,602 |   |        | $       | 237,965 | 
|                                              |                                                                                                                                                            |                                            |         |         |         |   |        |        
|LIABILITIES AND SHAREHOLDERS
    EQUITY     
|                                             
|Accounts payable and accrued expenses         |                                                                                                                                                            | $                                          | 35,084  |         |         | $ | 49,062 |        
|Related party payable  Vialta                |                                                                                                                                                            |                                            |        |         |         |   | 111    |        
|Income tax payable and deferred income taxes  |                                                                                                                                                            |                                            | 9,474   |         |         |   | 4,883  |        
|                                              |                                                                                                                                                            |                                            |         |         |         |   |        |        
|                                              |                                                                                                                                                            | Total current liabilities                  |         |         | 44,558  |   |        |         | 54,056  | 
|Non-current deferred tax liability            |                                                                                                                                                            |                                            | 7,676   |         |         |   | 6,931  |        
|                                              |                                                                                                                                                            |                                            |         |         |         |   |        |        
|                                              |                                                                                                                                                            | Total liabilities                          |         |         | 52,234  |   |        |         | 60,987  | 
|Commitments and contingencies (Note 13)       |                                                                                                                                                            |                                            |         |         |         |   |        |        
|Shareholders equity:                         |                                                                                                                                                            |                                            |         |         |         |   |        |        
|                                              | Preferred stock, no par value, 10,000 shares
    authorized; none issued and outstanding                                                                   |                                            |         |        |         |   |        |        |        
|                                              | Common stock, no par value, 100,000 shares
    authorized; 43,305 and 42,334 shares issued and outstanding at
    December 31, 2002 and 2001, respectively |                                            |         | 196,344 |         |   |        | 153,678 |        
|Accumulated other comprehensive income (loss) |                                                                                                                                                            |                                            | 504     |         |         |   | (1,374 | )      
|Retained earnings                             |                                                                                                                                                            |                                            | 32,520  |         |         |   | 24,674 |        
|                                              |                                                                                                                                                            |                                            |         |         |         |   |        |        
|                                              |                                                                                                                                                            | Total shareholders equity                 |         |         | 229,368 |   |        |         | 176,978 | 
|                                              |                                                                                                                                                            |                                            |         |         |         |   |        |        
|                                              |                                                                                                                                                            | Total liabilities and shareholders equity |         | $       | 281,602 |   |        | $       | 237,965 | 
|                                              |                                                                                                                                                            |                                            |         |         |         |   |        |        

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, 2002, 2001 and
2000


|                                                            |                                                                          |                                       |         |         |      |      |         |         |       |   |         |         |       |  
|----------------------------------------------------------- | ------------------------------------------------------------------------ | ------------------------------------- | ------- | ------- | ---- | ---- | ------- | ------- | ----- | - | ------- | ------- | ----- | -
|                                                            |                                                                          |                                      
|                                                            |                                                                          | Years Ended December 31,             
|                                                            |                                                                          |                                      
|                                                            |                                                                          | 2002                                  |         | 2001    |      | 2000
|                                                            |                                                                          |                                       |         |         |      |     
|                                                            |                                                                          |                                      
|                                                            |                                                                          | (In thousands, except per share data)
|Net revenues                                                |                                                                          | $                                     | 272,039 |         |      | $    | 270,253 |         |       | $ | 302,433 |        
|Net revenues from related party  Vialta                    |                                                                          |                                       | 1,403   |         |      |      | 1,127   |         |       |   | 1,003   |        
|                                                            |                                                                          |                                       |         |         |      |      |         |         |       |   |         |        
|                                                            | Total net revenues                                                       |                                       | $       | 273,442 |      |      | $       | 271,380 |       |   | $       | 303,436 |      
|Cost of revenues                                            |                                                                          |                                       | 176,454 |         |      |      | 180,231 |         |       |   | 192,452 |        
|                                                            |                                                                          |                                       |         |         |      |      |         |         |       |   |         |        
|                                                            | Gross profit                                                             |                                       |         | 96,988  |      |      |         | 91,149  |       |   |         | 110,984 |      
|Operating expenses:                                         |                                                                          |                                       |         |         |      |      |         |         |       |   |         |        
|                                                            | Research and development                                                 |                                       |         | 26,964  |      |      |         | 27,957  |       |   |         | 27,832  |      
|                                                            | Purchased in-process research and development                            |                                       |         |        |      |      |         |        |       |   |         | 2,625   |      
|                                                            | Selling, general and administrative                                      |                                       |         | 34,170  |      |      |         | 40,689  |       |   |         | 36,225  |      
|                                                            |                                                                          |                                       |         |         |      |      |         |         |       |   |         |        
|Operating income                                            |                                                                          |                                       | 35,854  |         |      |      | 22,503  |         |       |   | 44,302  |        
|Non-operating income (loss), net                            |                                                                          |                                       | 2,407   |         |      |      | (18,780 | )       |       |   | 41,810  |        
|                                                            |                                                                          |                                       |         |         |      |      |         |         |       |   |         |        
|Income before income taxes                                  |                                                                          |                                       | 38,261  |         |      |      | 3,723   |         |       |   | 86,112  |        
|Provision for (benefit from) income taxes                   |                                                                          |                                       | 984     |         |      |      | (7,262  | )       |       |   | 22,946  |        
|                                                            |                                                                          |                                       |         |         |      |      |         |         |       |   |         |        
|Net income from continuing operations                       |                                                                          |                                       | 37,277  |         |      |      | 10,985  |         |       |   | 63,166  |        
|Discontinued operation, net of minority interest:           |                                                                          |                                       |         |         |      |      |         |         |       |   |         |        
|                                                            | Loss from discontinued operation, net of minority
    interest           |                                       |         |        |      |      |         | (4,205  | )     |   |         | (14,860 | )    
|                                                            | Loss on disposal of discontinued operation, net
    of minority interest |                                       |         |        |      |      |         | (8,597  | )     |   |         |        |      
|                                                            |                                                                          |                                       |         |         |      |      |         |         |       |   |         |        
|Net income (loss)                                           |                                                                          | $                                     | 37,277  |         |      | $    | (1,817  | )       |       | $ | 48,306  |        
|                                                            |                                                                          |                                       |         |         |      |      |         |         |       |   |         |        
|Net income (loss) per share:                                |                                                                          |                                       |         |         |      |      |         |         |       |   |         |        
|                                                            | Basic:                                                                   |                                       |         |         |      |      |         |         |       |   |         |         |      
|                                                            |                                                                          | Continuing operations                 |         | $       | 0.85 |      |         | $       | 0.26  |   |         | $       | 1.49  |  
|                                                            |                                                                          | Discontinued operation                |         |         |     |      |         |         | (0.30 | ) |         |         | (0.35 | )
|                                                            |                                                                          |                                       |         |         |      |      |         |         |       |   |         |        
|                                                            |                                                                          | $                                     | 0.85    |         |      | $    | (0.04   | )       |       | $ | 1.14    |        
|                                                            |                                                                          |                                       |         |         |      |      |         |         |       |   |         |        
|                                                            | Diluted:                                                                 |                                       |         |         |      |      |         |         |       |   |         |         |      
|                                                            |                                                                          | Continuing operations                 |         | $       | 0.80 |      |         | $       | 0.24  |   |         | $       | 1.37  |  
|                                                            |                                                                          | Discontinued operation                |         |         |     |      |         |         | (0.28 | ) |         |         | (0.32 | )
|                                                            |                                                                          |                                       |         |         |      |      |         |         |       |   |         |        
|                                                            |                                                                          | $                                     | 0.80    |         |      | $    | (0.04   | )       |       | $ | 1.05    |        
|                                                            |                                                                          |                                       |         |         |      |      |         |         |       |   |         |        
|Shares used in calculating net income (loss) per
    share: |                                                                          |                                       |         |         |      |      |         |         |       |   |         |        
|                                                            | Basic                                                                    |                                       |         | 44,044  |      |      |         | 42,274  |       |   |         | 42,548  |      
|                                                            |                                                                          |                                       |         |         |      |      |         |         |       |   |         |        
|                                                            | Diluted                                                                  |                                       |         | 46,731  |      |      |         | 45,262  |       |   |         | 45,943  |      
|                                                            |                                                                          |                                       |         |         |      |      |         |         |       |   |         |        

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

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##### Table of Contents



ESS TECHNOLOGY, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS
EQUITY

AND COMPREHENSIVE INCOME


Years Ended December 31, 2002, 2001 and
2000


|                             |                                                                             |                |        |                   |   |               |         |               |   |        |        |        |   |   |        |         |   |   |         |         |  
|---------------------------- | --------------------------------------------------------------------------- | -------------- | ------ | ----------------- | - | ------------- | ------- | ------------- | - | ------ | ------ | ------ | - | - | ------ | ------- | - | - | ------- | ------- | -
|                             |                                                                             |                |        |                   |   |               |         |              
|                             |                                                                             | Common Stock   |        | Accumulated Other |   |               |         | Total        
|                             |                                                                             |                |        | Comprehensive     |   | Retained      |         | Shareholders
|                             |                                                                             | Shares         |        | Amount            |   | Income (Loss) |         | Earnings      |   | Equity
|                             |                                                                             |                |        |                   |   |               |         |               |   |       
|                             |                                                                             |               
|                             |                                                                             | (In thousands)
|Balance at December 31, 1999 |                                                                             |                | 41,372 |                   |   | $             | 140,597 |               |   |        |       |        |   | $ | 42,982 |         |   | $ | 183,579 |        
|                             | Issuance of common stock upon exercise of options                           |                |        | 2,660             |   |               |         | 9,290         |   |        |        |       |   |   |        |        |   |   |         | 9,290   |  
|                             | Issuance of common stock for employee stock
    purchase plan               |                |        | 74                |   |               |         | 837           |   |        |        |       |   |   |        |        |   |   |         | 837     |  
|                             | Income tax benefit on disqualifying disposition
    of common stock options |                |        |                  |   |               |         | 4,639         |   |        |        |       |   |   |        |        |   |   |         | 4,639   |  
|                             | Repurchase of common stock                                                  |                |        | (1,973            | ) |               |         | (6,166        | ) |        |        |       |   |   |        | (21,678 | ) |   |         | (27,844 | )
|                             | Unrealized loss on marketable securities                                    |                |        |                  |   |               |         |              |   |        |        | (7,378 | ) |   |        |        |   |   |         | (7,378  | )
|                             | Net income                                                                  |                |        |                  |   |               |         |              |   |        |        |       |   |   |        | 48,306  |   |   |         | 48,306  |  
|                             |                                                                             |                |        |                   |   |               |         |               |   |        |        |        |   |   |        |         |   |   |         |        
|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 |        
|                             |                                                                             |                |        |                   |   |               |         |               |   |        |        |        |   |   |        |         |   |   |         |        

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

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##### Table of Contents



ESS TECHNOLOGY, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

Years Ended December 31, 2002, 2001 and
2000


|                                                         |                                                                                                            |                                                                             |                                              |                                                         |       |         |         |         |        |         |         |         |         |         |         |  
|-------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------- | -------------------------------------------- | ------------------------------------------------------- | ----- | ------- | ------- | ------- | ------ | ------- | ------- | ------- | ------- | ------- | ------- | -
|                                                         |                                                                                                            |                                                                            
|                                                         |                                                                                                            | Years Ended December 31,                                                   
|                                                         |                                                                                                            |                                                                            
|                                                         |                                                                                                            | 2002                                                                        |                                              | 2001                                                    |       | 2000   
|                                                         |                                                                                                            |                                                                             |                                              |                                                         |       |        
|                                                         |                                                                                                            |                                                                            
|                                                         |                                                                                                            | (In thousands)                                                             
|Cash flows from operating
    activities:                |                                                                                                            |                                                                             |                                              |                                                         |       |         |         |         |        |         |         |        
|Net income (loss)                                        |                                                                                                            | $                                                                           | 37,277                                       |                                                         |       | $       | (1,817  | )       |        | $       | 48,306  |        
|                                                         | Adjustments to reconcile net income
    (loss) to net cash provided by (used in) operating
    activities: |                                                                             |                                              |                                                         |       |         |         |         |        |         |         |         |        
|                                                         |                                                                                                            | Loss from discontinued operation                                            |                                              |                                                         |      |         |         |         | 12,802 |         |         |         | 14,860  |        
|                                                         |                                                                                                            | Depreciation and amortization                                               |                                              |                                                         | 6,080 |         |         |         | 14,640 |         |         |         | 15,005  |        
|                                                         |                                                                                                            | Gain on sale of property, plant and equipment                               |                                              |                                                         | (85   | )       |         |         |       |         |         |         | (2,911  | )      
|                                                         |                                                                                                            | Charges for purchased in-process research and
    development               |                                              |                                                         |      |         |         |         |       |         |         |         | 2,625   |        
|                                                         |                                                                                                            | (Gain) loss from sale of investments                                        |                                              |                                                         | 189   |         |         |         | 12,709 |         |         |         | (35,045 | )      
|                                                         |                                                                                                            | Write-down of investments                                                   |                                              |                                                         | 3,612 |         |         |         |       |         |         |         |        |        
|                                                         |                                                                                                            | Stock-related compensation charge                                           |                                              |                                                         | 301   |         |         |         |       |         |         |         |        |        
|                                                         |                                                                                                            | Income tax benefit on disqualifying disposition
    of common stock options |                                              |                                                         | 1,025 |         |         |         | 1,670  |         |         |         | 4,639   |        
|                                                         |                                                                                                            | Changes in assets and liabilities:                                          |                                              |                                                         |       |         |         |         |        |         |         |         |         |        
|                                                         |                                                                                                            |                                                                             | Accounts receivable                          |                                                         |       | 14,160  |         |         |        | 9,289   |         |         |         | (17,524 | )      
|                                                         |                                                                                                            |                                                                             | Related party receivable  Vialta            |                                                         |       | 14      |         |         |        | (47     | )       |         |         |        |        
|                                                         |                                                                                                            |                                                                             | Inventories                                  |                                                         |       | 13,297  |         |         |        | 61,488  |         |         |         | (56,593 | )      
|                                                         |                                                                                                            |                                                                             | Prepaid expenses and other assets            |                                                         |       | (1,208  | )       |         |        | 286     |         |         |         | 1,153   |        
|                                                         |                                                                                                            |                                                                             | Accounts payable and accrued expenses        |                                                         |       | (13,978 | )       |         |        | (19,677 | )       |         |         | (2,114  | )      
|                                                         |                                                                                                            |                                                                             | Related party payable  Vialta               |                                                         |       | (111    | )       |         |        | (599    | )       |         |         | 842     |        
|                                                         |                                                                                                            |                                                                             | Income tax payable and deferred income taxes |                                                         |       | 4,179   |         |         |        | 4,042   |         |         |         | 15,687  |        
|                                                         |                                                                                                            |                                                                             | Net assets of discontinued operations        |                                                         |       |        |         |         |        | (1,246  | )       |         |         |        |        
|                                                         |                                                                                                            |                                                                             |                                              |                                                         |       |         |         |         |        |         |         |        
|                                                         |                                                                                                            |                                                                             |                                              | Net cash provided by (used in) operating
    activities |       |         | 64,752  |         |        |         | 93,540  |         |         |         | (11,070 | )
|Cash flows from investing
    activities:                |                                                                                                            |                                                                             |                                              |                                                         |       |         |         |         |        |         |         |        
|                                                         | Purchase of property, plant and equipment                                                                  |                                                                             |                                              | (2,232                                                  | )     |         |         | (2,036  | )      |         |         | (2,568  | )      
|                                                         | Sale of property, plant and equipment                                                                      |                                                                             |                                              | 85                                                      |       |         |         | 192     |        |         |         | 3,949   |        
|                                                         | Purchase of short-term investments                                                                         |                                                                             |                                              | (55,406                                                 | )     |         |         | (35,433 | )      |         |         | (10,155 | )      
|                                                         | Sale of short-term investments                                                                             |                                                                             |                                              | 25,732                                                  |       |         |         | 13,788  |        |         |         | 29,869  |        
|                                                         | Purchase of long-term investments                                                                          |                                                                             |                                              | (5,212                                                  | )     |         |         | (2,100  | )      |         |         | (2,640  | )      
|                                                         | Sale of long-term investments                                                                              |                                                                             |                                              | 440                                                     |       |         |         |        |        |         |         |        |        
|                                                         | Cash paid for acquisitions                                                                                 |                                                                             |                                              |                                                        |       |         |         | (2,072  | )      |         |         | (4,266  | )      
|                                                         | Purchase of Vialta stock                                                                                   |                                                                             |                                              |                                                        |       |         |         |        |        |         |         | (100    | )      
|                                                         | Proceeds from sale of Cisco stock                                                                          |                                                                             |                                              | 1,009                                                   |       |         |         | 11,134  |        |         |         |        |        
|                                                         |                                                                                                            |                                                                             |                                              |                                                         |       |         |         |         |        |         |         |        
|                                                         |                                                                                                            |                                                                             |                                              | Net cash provided by (used in) investing
    activities |       |         | (35,584 | )       |        |         | (16,527 | )       |         |         | 14,089  |  
|Cash flows from financing
    activities:                |                                                                                                            |                                                                             |                                              |                                                         |       |         |         |         |        |         |         |        
|                                                         | Repurchase of common stock                                                                                 |                                                                             |                                              | (42,659                                                 | )     |         |         | (14,312 | )      |         |         | (27,844 | )      
|                                                         | Issuance of common stock from secondary public
    offering                                                |                                                                             |                                              | 45,181                                                  |       |         |         |        |        |         |         |        |        
|                                                         | Issuance of common stock under employee stock
    purchase plan and stock option plans                     |                                                                             |                                              | 9,387                                                   |       |         |         | 8,579   |        |         |         | 10,127  |        
|                                                         |                                                                                                            |                                                                             |                                              |                                                         |       |         |         |         |        |         |         |        
|                                                         |                                                                                                            |                                                                             |                                              | Net cash provided by (used in) financing
    activities |       |         | 11,909  |         |        |         | (5,733  | )       |         |         | (17,717 | )
|                                                         |                                                                                                            |                                                                             |                                              |                                                         |       |         |         |         |        |         |         |        
|Net increase (decrease) in cash and cash
    equivalents |                                                                                                            |                                                                             | 41,077                                       |                                                         |       |         | 71,280  |         |        |         | (14,698 | )      
|Cash and cash equivalents at beginning of year           |                                                                                                            |                                                                             | 96,995                                       |                                                         |       |         | 25,715  |         |        |         | 40,413  |        
|                                                         |                                                                                                            |                                                                             |                                              |                                                         |       |         |         |         |        |         |         |        
|Cash and cash equivalents at end of year                 |                                                                                                            | $                                                                           | 138,072                                      |                                                         |       | $       | 96,995  |         |        | $       | 25,715  |        
|                                                         |                                                                                                            |                                                                             |                                              |                                                         |       |         |         |         |        |         |         |        
|Supplemental disclosure of cash flow
    information     |                                                                                                            |                                                                             |                                              |                                                         |       |         |         |         |        |         |         |        
|                                                         | Cash paid for income taxes                                                                                 |                                                                             | $                                            | 237                                                     |       |         | $       | 3,300   |        |         | $       | 5,795   |        
|                                                         | Cash refund for income taxes                                                                               |                                                                             | $                                            | 4,520                                                   |       |         | $       | 6,684   |        |         | $       | 3,975   |        

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

41



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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 digital processor chips. These chips are
the primary processors driving digital video and audio players,
including DVD, Video CD (VCD) and digital media
players. Our chips use multiple processors and a programmable
architecture that enable us to offer a broad array of features
and functionality. We have also developed an encoding processor
to address the growing demand for the digital video recorder
(DVR) and recordable DVD players. 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, consumer digital audio and PC Audio
products. 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,
China, Taiwan, Korea, Singapore, and Japan. 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.

ESS was incorporated in California in 1984 and
became a public company in 1995. In April 1999, we expanded our
business in 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. Vialta is reported separately as a
discontinued operation. See Note 5, Discontinued
Operation and Note 15, Related Party
Transactions with Vialta, Inc.



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



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

The preparation of financial statements in
conformity with accounting principles generally accepted 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.

42



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                                                       
| | ------------------------------------------------------
| | 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
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.



| |          
| | ---------
| | Inventory

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.



| |                       
| | ----------------------
| | 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.



| |             
| | ------------
| | Other Assets

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.

Technical infrastructure and covenants not to
compete are amortized over estimated useful lives that range
from 3 to 4 years.

Goodwill and
Other Intangible Assets

Effective January 1, 2002, we adopted
Statement of Financial Accounting Standards
(SFAS) 142, Goodwill and Other Intangible
Assets (SFAS 142) which addresses the
accounting that must be applied

43



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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 have goodwill and other intangible assets
related to our previous acquisitions of NetRidium and SAS. 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. This change in accounting
treatment reduced operating expenses by $688,000 for the year
ended December 31, 2002 from 2001 levels. In addition to
goodwill associated with NetRidium and SAS, we recorded goodwill
amortization of approximately $1,668,000 and $3,336,000 during
the fiscal years ended December 31, 2001 and
December 31, 2000, respectively, associated with the
acquisition of Platform Technologies, Inc
(Platform). Goodwill associated with the acquisition
of Platform Technology was fully amortized in 2001.

The provisions of SFAS 142 also require us
to complete a transitional impairment test of goodwill within
six months of adoption. We completed our transitional impairment
test of goodwill as of January 1, 2002, the adoption date
of SFAS 142 and determined that goodwill was not impaired.
In addition, we completed our first annual impairment test in
the fourth quarter of 2002, and determined that goodwill was not
impaired.

A reconciliation of previously reported net
income and loss per share for the twelve months ended
December 31, 2001 and December 31, 2000 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, are as
follows (after we adopted SFAS 142 effective
January 1, 2002, we discontinued our practice of amortizing
goodwill):

|                                               |                            |                          |        |       |       |   |        |       |       |  
|---------------------------------------------- | -------------------------- | ------------------------ | ------ | ----- | ----- | - | ------ | ----- | ----- | -
|                                               |                            |                         
|                                               |                            | Years Ended December 31,
|                                               |                            |                         
|                                               |                            | 2001                     |        | 2000 
|                                               |                            |                          |        |      
|                                               |                            |                         
|                                               |                            | (In thousands,          
|                                               |                            | except per share data)  
|Reported net income (loss)                     |                            | $                        | (1,817 | )     |       | $ | 48,306 |      
|                                              
|                                               | Add: Goodwill amortization |                          |        | 2,243 |       |   |        | 3,533 |      
|                                               |                            | Tax impact               |        |       | (271  | ) |        |       | (601  | )
|                                               |                            |                          |        |       |       |   |        |      
|Adjusted net income (loss)                     |                            | $                        | 155    |       |       | $ | 51,238 |      
|                                               |                            |                          |        |       |       |   |        |      
|Reported Basic and diluted earnings per share: |                            |                          |        |       |       |   |        |      
|                                               | Basic                      |                          | $      | (0.04 | )     |   | $      | 1.14  |      
|                                               | Diluted                    |                          | $      | (0.04 | )     |   | $      | 1.05  |      
|                                              
|Add: Goodwill amortization                     |                            |                          | 0.05   |       |       |   | 0.08   |      
|                                               |                            | Tax impact               |        |       | (0.01 | ) |        |       | (0.01 | )
|                                               |                            |                          |        |       |       |   |        |      
|Adjusted earnings per share                    |                            |                          |        |       |       |   |        |      
|                                               | Basic                      |                          | $      |      |       |   | $      | 1.21  |      
|                                               |                            |                          |        |       |       |   |        |      
|                                               | Diluted                    |                          | $      |      |       |   | $      | 1.12  |      
|                                               |                            |                          |        |       |       |   |        |      



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

Pursuant to SFAS No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets
(SFAS 144), 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. The adoption of SFAS 144 did not have a
material effect on our financial statements.

44



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                    
| | -------------------
| | 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 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.



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

We expense research and development costs as
incurred.



| |                              
| | -----------------------------
| | Income Taxes and Tax Reserves

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 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 with an exercise
price equal to the quoted market price of our stock on the grant
date. 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.

45



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Our pro forma net income (loss) and pro
forma net income (loss) per share 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,             
|                                           |                                            |                                      
|                                           |                                            | 2002                                  |   | 2001    |   | 2000
|                                           |                                            |                                       |   |         |   |     
|                                           |                                            |                                      
|                                           |                                            | (In thousands, except per share data)
|Net income (loss):                         |                                            |                                       |   |         |   |      |   |         |   |  |   |        
|                                           | As reported                                |                                       | $ | 37,277  |   |      | $ | (1,817  | ) |  | $ | 48,306  |  
|                                           | Amortization of stock compensation expense |                                       |   | (10,827 | ) |      |   | (11,282 | ) |  |   | (21,768 | )
|                                           |                                            |                                       |   |         |   |      |   |         |   |  |   |        
|                                           | Pro forma                                  |                                       | $ | 26,450  |   |      | $ | (13,099 | ) |  | $ | 26,538  |  
|                                           |                                            |                                       |   |         |   |      |   |         |   |  |   |        
|Net income (loss) per share 
    basic:   |                                            |                                       |   |         |   |      |   |         |   |  |   |        
|                                           | As reported                                |                                       | $ | 0.85    |   |      | $ | (0.04   | ) |  | $ | 1.14    |  
|                                           | Pro forma                                  |                                       | $ | 0.60    |   |      | $ | (0.31   | ) |  | $ | 0.62    |  
|Net income (loss) per share 
    diluted: |                                            |                                       |   |         |   |      |   |         |   |  |   |        
|                                           | As reported                                |                                       | $ | 0.80    |   |      | $ | (0.04   | ) |  | $ | 1.05    |  
|                                           | Pro forma                                  |                                       | $ | 0.57    |   |      | $ | (0.29   | ) |  | $ | 0.58    |  

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:

|                         |  |                        |      |      |  |      |      |   |  |  |      |  
|------------------------ |  | ---------------------- | ---- | ---- |  | ---- | ---- | - |  |  | ---- | -
|                         |  |                       
|                         |  | Employee Stock Options
|                         |  |                       
|                         |  | 2002                   |      | 2001 |  | 2000
|                         |  |                        |      |      |  |     
|Expected dividend yield  |  |                        | 0.0  | %    |  |      | 0.0  | % |  |  | 0.0  | %
|Risk-free interest rate  |  |                        | 3.69 | %    |  |      | 4.43 | % |  |  | 6.00 | %
|Expected volatility      |  |                        | 102  | %    |  |      | 90   | % |  |  | 60   | %
|Expected life (in years) |  |                        | 4    |      |  |      | 3    |   |  |  | 4    |  

Shares purchased under the Purchase Plan in 2002,
2001 and 2000 were approximately 216,000, 69,000 shares and
74,000 shares, respectively, at an average price per share
of $6.74, $5.78 and $11.24, 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 2002, 2001 and 2000:

|                                       |  |                     |      |      |  |      |      |   |  |   |      |  
|-------------------------------------- |  | ------------------- | ---- | ---- |  | ---- | ---- | - |  | - | ---- | -
|                                       |  |                    
|                                       |  | 1995 Employee Stock
|                                       |  | Purchase Plan      
|                                       |  |                    
|                                       |  | 2002                |      | 2001 |  | 2000
|                                       |  |                     |      |      |  |     
|Expected dividend yield                |  |                     | 0.0  | %    |  |      | 0.0  | % |  |   | 0.0  | %
|Risk-free interest rate                |  |                     | 3.69 | %    |  |      | 4.43 | % |  |   | 6.00 | %
|Expected volatility                    |  |                     | 102  | %    |  |      | 90   | % |  |   | 60   | %
|Expected life (in months)              |  |                     | 6    |      |  |      | 6    |   |  |   | 6    |  
|Weighted average grant date fair value |  | $                   | 3.45 |      |  | $    | 3.92 |   |  | $ | 4.30 |  

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.

46



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                        
| | -----------------------
| | 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.



| |                            
| | ---------------------------
| | 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 deferred 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 12, Industries and Geographical Segment.

Substantially all of our sales are to customers
in Hong Kong, China, Taiwan, Korea, Singapore and Japan. Dynax
Electronics is our largest distributor, sales through Dynax
Electronics accounted for approximately 57%, 56% and 35% of our
net revenues in 2002, 2001 and 2000, respectively. Dynax
Electronics percentage of trade accounts receivable was
82% and 79% as of December 31, 2002 and December 31,
2001. Digital AV, our most significant direct customer,
accounted for 8%, 9% and 10% of our net revenues in 2002, 2001
and 2000, respectively.



| |         
| | --------
| | 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 FASB
Interpretation No. 45, Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, for the year ended
December 31, 2002.

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

47



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Recent Accounting Pronouncements

In June 2002, the Financial Accounting Standards
Board (FASB) issued SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal
Activities (SFAS 146). SFAS 146
addresses financial accounting and reporting for costs
associated with exit or disposal activities. SFAS 146
requires that a liability for a cost associated with an exit or
disposal activity is recognized when the liability is incurred.
In summary, SFAS 146 requires that the liability be
recognized and measured initially at its fair value in the
period in which the liability is incurred, except for one-time
termination benefits that meet certain requirements. Since
SFAS 146 is effective prospectively for exit or disposal
activities initiated after December 31, 2002, the adoption
of SFAS 146 will have no effect on our current financial
position or results of operations.

In November 2002, the FASB issued FASB
Interpretation No. 45, Guarantors Accounting
and Disclosures Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others
(FIN 45). FIN 45 requires that a liability
be recorded in the guarantors balance sheet upon issuance
of a guarantee. In addition, FIN 45 requires disclosures
about the guarantees that an entity has issued, including a
reconciliation of changes in the entitys product warranty
liabilities. The initial recognition and initial measurement
provisions of FIN 45 are applicable on a prospective basis
to guarantees issued or modified after December 31, 2002,
irrespective of the guarantors fiscal year-end. The
disclosure requirements of FIN 45 are effective for
financial statements of interim or annual periods ending after
December 15, 2002. We have adopted this statement. The
adoption of FIN 45 did not have a material effect on our
financial position or results of operations.

In December 2002, the FASB issued SFAS
No. 148, Accounting for Stock-Based Compensation,
Transition and Disclosure (SFAS 148).
SFAS 148 provides alternative methods of transition for a
voluntary change to the fair value based method of accounting
for stock-based employee compensation. SFAS 148 also
requires that disclosures of the pro forma effect of using the
fair value method of accounting for stock-based employee
compensation be displayed more prominently and in a tabular
format. Additionally, SFAS 148 requires disclosures of the
pro forma effect in interim financial statements. The transition
and annual disclosure requirements of SFAS 148 are
effective for fiscal years ending after December 15, 2002.
The interim disclosure requirements are effective for interim
periods beginning after December 15, 2002. We do not expect
that the adoption of SFAS 148 will have a material effect
on our financial position or results of operations.

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 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 variable interest entities created or acquired after
January 31, 2003. For variable interest entities created or
acquired prior to February 1, 2003, the provisions of
FIN 46 must be applied for the first interim or annual
period beginning after June 15, 2003. We do not expect that
the adoption of FIN 46 will have a material effect on our
financial position or results of operations.

48



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|        |                         
|------- | ------------------------
|Note 3. | Balance Sheet Components

|                               |                                                 |                |         |         |   |   |        |         |  
|------------------------------ | ----------------------------------------------- | -------------- | ------- | ------- | - | - | ------ | ------- | -
|                               |                                                 |               
|                               |                                                 | December 31,  
|                               |                                                 |               
|                               |                                                 | 2002           |         | 2001   
|                               |                                                 |                |         |        
|                               |                                                 |               
|                               |                                                 | (In thousands)
|Cash and cash equivalents:     |                                                 |                |         |         |   |   |        |        
|                               | Cash and money market accounts                  |                | $       | 14,121  |   |   | $      | 29,327  |  
|                               | U.S. government and corporate debt securities   |                |         | 123,951 |   |   |        | 67,541  |  
|                               | Certificates of deposit                         |                |         |        |   |   |        | 127     |  
|                               |                                                 |                |         |         |   |   |        |        
|                               |                                                 | $              | 138,072 |         |   | $ | 96,995 |        
|                               |                                                 |                |         |         |   |   |        |        
|Short-term investments:        |                                                 |                |         |         |   |   |        |        
|                               | U.S. government and corporate debt securities   |                | $       | 60,426  |   |   | $      | 30,931  |  
|                               | Marketable equity securities                    |                | $       | 46      |   |   |        | 3,615   |  
|                               | Unrealized gain (loss) on marketable securities |                |         | 558     |   |   |        | (2,507  | )
|                               |                                                 |                |         |         |   |   |        |        
|                               |                                                 | $              | 61,030  |         |   | $ | 32,039 |        
|                               |                                                 |                |         |         |   |   |        |        
|Accounts receivable, net:      |                                                 |                |         |         |   |   |        |        
|                               | Accounts receivable                             |                | $       | 29,384  |   |   | $      | 43,494  |  
|                               | Less: Allowance for doubtful accounts           |                |         | (949    | ) |   |        | (899    | )
|                               |                                                 |                |         |         |   |   |        |        
|                               |                                                 | $              | 28,435  |         |   | $ | 42,595 |        
|                               |                                                 |                |         |         |   |   |        |        
|Inventories:                   |                                                 |                |         |         |   |   |        |        
|                               | Raw materials                                   |                | $       | 12,569  |   |   | $      | 20,807  |  
|                               | Work-in-process                                 |                |         | 7,138   |   |   |        | 10,918  |  
|                               | Finished goods                                  |                |         | 4,448   |   |   |        | 5,727   |  
|                               |                                                 |                |         |         |   |   |        |        
|                               |                                                 | $              | 24,155  |         |   | $ | 37,452 |        
|                               |                                                 |                |         |         |   |   |        |        
|Property, plant and equipment: |                                                 |                |         |         |   |   |        |        
|                               | Land                                            |                | $       | 2,860   |   |   | $      | 2,860   |  
|                               | Building and building improvements              |                |         | 23,339  |   |   |        | 22,766  |  
|                               | Machinery and equipment                         |                |         | 31,905  |   |   |        | 31,013  |  
|                               | Furniture and fixtures                          |                |         | 13,482  |   |   |        | 13,080  |  
|                               |                                                 |                |         |         |   |   |        |        
|                               |                                                 |                | 71,586  |         |   |   | 69,719 |        
|                               | Less: Accumulated depreciation and amortization |                |         | (52,601 | ) |   |        | (47,281 | )
|                               |                                                 |                |         |         |   |   |        |        
|                               |                                                 | $              | 18,985  |         |   | $ | 22,438 |        
|                               |                                                 |                |         |         |   |   |        |        
|Other assets:                  |                                                 |                |         |         |   |   |        |        
|                               | Investments                                     |                | $       | 4,266   |   |   | $      | 677     |  
|                               | Covenants not to compete                        |                |         | 2,074   |   |   |        | 1,937   |  
|                               | Technical infrastructure                        |                |         | 249     |   |   |        | 533     |  
|                               | Other                                           |                |         | 1,469   |   |   |        | 1,358   |  
|                               |                                                 |                |         |         |   |   |        |        
|                               |                                                 | $              | 8,058   |         |   | $ | 4,505  |        
|                               |                                                 |                |         |         |   |   |        |        

49



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                       |                                                                                       |                |        |        |  |   |        |        | 
|-------------------------------------- | ------------------------------------------------------------------------------------- | -------------- | ------ | ------ |  | - | ------ | ------ | 
|                                       |                                                                                       |               
|                                       |                                                                                       | December 31,  
|                                       |                                                                                       |               
|                                       |                                                                                       | 2002           |        | 2001  
|                                       |                                                                                       |                |        |       
|                                       |                                                                                       |               
|                                       |                                                                                       | (In thousands)
|Accounts payable and accrued expenses: |                                                                                       |                |        |        |  |   |        |       
|                                       | Accounts payable                                                                      |                | $      | 10,045 |  |   | $      | 10,285 | 
|                                       | Accrued compensation costs                                                            |                |        | 4,033  |  |   |        | 5,927  | 
|                                       | Accrued commission and royalties                                                      |                |        | 10,842 |  |   |        | 18,655 | 
|                                       | Marketing and advertising related accruals                                            |                |        | 1,876  |  |   |        | 5,945  | 
|                                       | Deferred revenue related to distributor sales,
    net of deferred cost of goods sold |                |        | 818    |  |   |        | 1,571  | 
|                                       | Other accrued liabilities                                                             |                |        | 7,470  |  |   |        | 6,679  | 
|                                       |                                                                                       |                |        |        |  |   |        |       
|                                       |                                                                                       | $              | 35,084 |        |  | $ | 49,062 |       
|                                       |                                                                                       |                |        |        |  |   |        |       

Depreciation expenses were approximately
$5.7 million, $9.6 million and $10.9 million in
2002, 2001 and 2000, respectively.



|        |                      
|------- | ---------------------
|Note 4. | Marketable Securities

The amortized costs and estimated fair value of
securities available-for-sale as of December 31, 2002 and
December 31, 2001 are as follows:

|                                     |                          |                |         |            |  |            |     |            |  |   |    |    |   |   |         |         | 
|------------------------------------ | ------------------------ | -------------- | ------- | ---------- |  | ---------- | --- | ---------- |  | - | -- | -- | - | - | ------- | ------- | 
|                                     |                          |                |         | 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 | 
|Less: Cash Equivalents               |                          |                | 124,080 |            |  |            |    |            |  |   |   |    |   |   | 124,080 |        
|Short-term
    marketable securities |                          |                | 60,472  |            |  |            | 563 |            |  |   | (5 | )  |   |   | 61,030  |        
|                                     |                          |                |         |            |  |            |     |            |  |   |    |    |   |   |         |        
|Long-term marketable securities      |                          | $              | 1,012   |            |  | $          | 104 |            |  | $ |   |    |   | $ | 1,116   |        
|                                     |                          |                |         |            |  |            |     |            |  |   |    |    |   |   |         |        

50



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                 |                          |                |        |            |  |            |    |       |  |   |        |        |   |   |        |        | 
|-------------------------------- | ------------------------ | -------------- | ------ | ---------- |  | ---------- | -- | ----- |  | - | ------ | ------ | - | - | ------ | ------ | 
|                                 |                          |                |        | Gross      |  | Gross      |    |      
|                                 |                          | Amortized      |        | Unrealized |  | Unrealized |    | Fair 
|December 31, 2001                |                          | Cost           |        | Gains      |  | Loss       |    | Value
|                                 |                          |                |        |            |  |            |    |      
|                                 |                          |               
|                                 |                          | (In thousands)
|Money market accounts            |                          | $              | 87     |            |  | $          |   |       |  | $ |       |        |   | $ | 87     |       
|Certificate of Deposit           |                          |                | 127    |            |  |            |   |       |  |   |       |        |   |   | 127    |       
|Corporate debt securities        |                          |                | 77,505 |            |  |            |   |       |  |   | (29    | )      |   |   | 77,476 |       
|Corporate equity securities      |                          |                | 3,615  |            |  |            |   |       |  |   | (2,508 | )      |   |   | 1,107  |       
|Government agency bonds          |                          |                | 20,967 |            |  |            | 30 |       |  |   |       |        |   |   | 20,997 |       
|                                 |                          |                |        |            |  |            |    |       |  |   |        |        |   |   |        |       
|                                 | Total available-for-sale |                | $      | 102,301    |  |            | $  | 30    |  |   | $      | (2,537 | ) |   | $      | 99,794 | 
|Less: Cash Equivalents           |                          |                | 67,755 |            |  |            |   |       |  |   |       |        |   |   | 67,755 |       
|                                 |                          |                |        |            |  |            |    |       |  |   |        |        |   |   |        |       
|Short-term marketable securities |                          | $              | 34,546 |            |  | $          | 30 |       |  | $ | (2,537 | )      |   | $ | 32,039 |       
|                                 |                          |                |        |            |  |            |    |       |  |   |        |        |   |   |        |       

The contractual maturities of debt securities
classified as available-for-sale as of December 31, 2002
regardless of the consolidated balance sheet classification are
as follows:

|                                                        |  |                |         | 
|------------------------------------------------------- |  | -------------- | ------- | 
|                                                        |  | Estimated     
|December 31, 2002                                       |  | Fair Value    
|                                                        |  |               
|                                                        |  | (In thousands)
|Maturing 90 days or less from purchase                  |  | $              | 123,951 | 
|Maturing between 90 days and one year from
    purchase |  |                | 9,073   | 
|Maturing more than one year from purchase               |  |                | 51,876  | 
|                                                        |  |                |         | 
|Total available-for-sale                                |  | $              | 184,900 | 
|                                                        |  |                |         | 

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, 2002 and 2001 were not material to our
financial position or results of operations.

Note
5.                     Discontinued
Operation

As of December 31, 2000, we had a 62.1%
ownership and voting interest in Vialta. On April 21, 2001,
ESS Board of Directors adopted a plan to distribute all of
our Vialta shares to our shareholders within twelve months
thereafter. 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. For
all periods presented, Vialta is accounted for as a discontinued
operation in our financial statements in accordance with APB
No. 30. Amounts in the financial statements and related
notes for all periods shown have been reclassified to reflect
the discontinued operation.

For the period up to March 31, 2001,
operating results for the discontinued operation are reported,
net of minority interest, under Loss from discontinued
operation, net of minority interest in the accompanying
Statements of Operations. Gain (loss) on disposal of
discontinued operation, net of minority interest in the
accompanying Statements of Operations includes the initially
estimated anticipated loss on the disposal of the discontinued
operation and operating losses incurred between the measurement
date and the estimated disposal date. Upon the distribution of
Vialta shares on August 21, 2001, we recognized a
$4.7 million gain within Gain (loss) on disposal of
discontinued operation, net of minority interest because
the Vialta spin-off occurred sooner than initially estimated.

We had initially estimated that the disposal of
Vialta, assuming a tax-free distribution, would result in a
total loss of $21.4 million, of which $13.3 million
was assigned to us due to our 62.1% share ownership.

51



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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Included in the estimate were a $1.1 million
charge, net of minority interest, related to the spin-off of
Vialta and a $12.2 million charge of anticipated operating
losses, net of minority interest, from operating the Vialta
business between April 1, 2001 and September 30, 2001,
the initially estimated completion date for the spin-off.

Operating results through March 31, 2001
were recorded as Loss from discontinued operation, net of
minority interest. Vialtas operating loss from
April 1, 2001 through April 21, 2001 (the measurement
date) has been included in the estimated loss on the disposal of
the discontinued operation, net of minority interest, under
Gain (loss) on disposal of discontinued operation, net of
minority interest in the accompanying Statements of
Operations in the first quarter of 2001.

|                                                                            |  |                 |         |              |  |   |         |  
|--------------------------------------------------------------------------- |  | --------------- | ------- | ------------ |  | - | ------- | -
|                                                                            |  | Period From     |         |             
|                                                                            |  | January 1, 2001 |         |             
|                                                                            |  | Through         |         | Year Ended  
|                                                                            |  | August 20,      |         | December 31,
|                                                                            |  | 2001            |         | 2000        
|                                                                            |  |                 |         |             
|                                                                            |  |                
|                                                                            |  | (In thousands) 
|Operating expenses                                                          |  | $               | 21,482  |              |  | $ | 29,555  |  
|Net loss before minority interest                                           |  |                 | (18,468 | )            |  |   | (23,289 | )
|Loss attributable to minority interest                                      |  |                 | (6,912  | )            |  |   | (8,429  | )
|                                                                            |  |                 |         |              |  |   |         |  
|Loss from Vialta operation, net of minority
    interest                    |  |                 | (11,556 | )            |  |   | (14,860 | )
|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 | )            |  | $ | (14,860 | )
|                                                                            |  |                 |         |              |  |   |         |  



|        |     
|------- | ----
|Note 6. | Debt

We have a $10.0 million unsecured line of
credit with U.S. Bank National Association, which will expire on
June 5, 2005. 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, 2002, we were in
compliance with the borrowing criteria. There were no borrowings
under this line of credit as of December 31, 2002.



|        |             
|------- | ------------
|Note 7. | Income Taxes

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

|         |  |                          |        |      |  |      |         |   |  |   |        | 
|-------- |  | ------------------------ | ------ | ---- |  | ---- | ------- | - |  | - | ------ | 
|         |  |                         
|         |  | Years Ended December 31,
|         |  |                         
|         |  | 2002                     |        | 2001 |  | 2000
|         |  |                          |        |      |  |     
|         |  |                         
|         |  | (In thousands)          
|Domestic |  | $                        | (2,297 | )    |  | $    | (24,886 | ) |  | $ | 44,024 | 
|Foreign  |  |                          | 39,574 |      |  |      | 28,609  |   |  |   | 42,088 | 
|         |  |                          |        |      |  |      |         |   |  |   |        | 
|         |  | $                        | 37,277 |      |  | $    | 3,723   |   |  | $ | 86,112 | 
|         |  |                          |        |      |  |      |         |   |  |   |        | 

52



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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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

|         |         |                          |       |       |     |      |         |         |        |   |        |        |        | 
|-------- | ------- | ------------------------ | ----- | ----- | --- | ---- | ------- | ------- | ------ | - | ------ | ------ | ------ | 
|         |         |                         
|         |         | Years Ended December 31,
|         |         |                         
|         |         | 2002                     |       | 2001  |     | 2000
|         |         |                          |       |       |     |     
|         |         |                         
|         |         | (In thousands)          
|Current: |         |                          |       |       |     |      |         |         |        |   |        |       
|         | Federal |                          | $     | 1,086 |     |      | $       | 4,310   |        |   | $      | 4,630  |       
|         | State   |                          |       | 11    |     |      |         | 29      |        |   |        | 904    |       
|         | Foreign |                          |       | 141   |     |      |         | 42      |        |   |        |       |       
|         |         |                          |       |       |     |      |         |         |        |   |        |       
|         |         |                          | 1,238 |       |     |      | 4,381   |         |        |   | 5,534  |       
|         |         |                          |       |       |     |      |         |         |        |   |        |       
|Deferred |         |                          |       |       |     |      |         |         |        |   |        |       
|         | Federal |                          |       | (224  | )   |      |         | (10,505 | )      |   |        | 15,169 |       
|         | State   |                          |       | (30   | )   |      |         | (1,138  | )      |   |        | 2,243  |       
|         |         |                          |       |       |     |      |         |         |        |   |        |       
|         |         |                          | (254  | )     |     |      | (11,643 | )       |        |   | 17,412 |       
|         |         |                          |       |       |     |      |         |         |        |   |        |       
|         |         | Total                    |       | $     | 984 |      |         | $       | (7,262 | ) |        | $      | 22,946 | 
|         |         |                          |       |       |     |      |         |         |        |   |        |       

Reconciliation between the provisions for
(benefit from) income taxes computed at the federal statutory
rate of 35% for the years ended December 31, 2002, 2001 and
2000 and the provision for (benefit from) income taxes is as
follows:

|                                               |  |                          |         |      |  |      |         |   |  |   |         |  
|---------------------------------------------- |  | ------------------------ | ------- | ---- |  | ---- | ------- | - |  | - | ------- | -
|                                               |  |                         
|                                               |  | Years Ended December 31,
|                                               |  |                         
|                                               |  | 2002                     |         | 2001 |  | 2000
|                                               |  |                          |         |      |  |     
|                                               |  |                         
|                                               |  | (In thousands)          
|Provision at statutory rate                    |  | $                        | 13,047  |      |  | $    | 1,303   |   |  | $ | 21,988  |  
|Tax benefit related to foreign jurisdictions   |  |                          | (15,007 | )    |  |      | (11,275 | ) |  |   | (16,672 | )
|State income taxes, net of federal tax benefit |  |                          | 1745    |      |  |      | 171     |   |  |   | 2,898   |  
|General business credit                        |  |                          | (1,111  | )    |  |      | (800    | ) |  |   | (227    | )
|Nondeductible research and development costs   |  |                          | 99      |      |  |      | 812     |   |  |   | 5,474   |  
|Vialta valuation allowance                     |  |                          |        |      |  |      |        |   |  |   | 9,485   |  
|Other                                          |  |                          | 2,211   |      |  |      | 2,527   |   |  |   |        |  
|                                               |  |                          |         |      |  |      |         |   |  |   |         |  
|Provision for (benefit from) income taxes      |  | $                        | 984     |      |  | $    | (7,262  | ) |  | $ | 22,946  |  
|                                               |  |                          |         |      |  |      |         |   |  |   |         |  

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

|                                                                   |                                        |                |      |      |  |   |        |       | 
|------------------------------------------------------------------ | -------------------------------------- | -------------- | ---- | ---- |  | - | ------ | ----- | 
|                                                                   |                                        |               
|                                                                   |                                        | December 31,  
|                                                                   |                                        |               
|                                                                   |                                        | 2002           |      | 2001
|                                                                   |                                        |                |      |     
|                                                                   |                                        |               
|                                                                   |                                        | (In thousands)
|Current:                                                           |                                        |                |      |      |  |   |        |      
|State income taxes                                                 |                                        | $              | 1    |      |  | $ | 1      |      
|Accounts receivable and inventory reserves                         |                                        |                | 25   |      |  |   | 1,083  |      
|Accrued liabilities                                                |                                        |                | 882  |      |  |   | 2,015  |      
|Legal reserves and other                                           |                                        |                | 69   |      |  |   | (764   | )    
|Deferred tax asset arising from unrealized loss
    on investments |                                        |                | (234 | )    |  |   | 1,018  |      
|Deferred stock gain                                                |                                        |                |     |      |  |   | (1,466 | )    
|                                                                   |                                        |                |      |      |  |   |        |      
|                                                                   | Current deferred tax asset (liability) |                | $    | 743  |  |   | $      | 1,887 | 
|                                                                   |                                        |                |      |      |  |   |        |      

53



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                              |                                    |                |        |        |   |  |        |        |  
|--------------------------------------------- | ---------------------------------- | -------------- | ------ | ------ | - |  | ------ | ------ | -
|                                              |                                    |               
|                                              |                                    | December 31,  
|                                              |                                    |               
|                                              |                                    | 2002           |        | 2001  
|                                              |                                    |                |        |       
|                                              |                                    |               
|                                              |                                    | (In thousands)
|Non-current:                                  |                                    |                |        |        |   |  |        |       
|Depreciation and amortization                 |                                    |                | 1,463  |        |   |  | 2,208  |       
|Un-remitted earning from a foreign subsidiary |                                    |                | (9,139 | )      |   |  | (9,139 | )     
|                                              |                                    |                |        |        |   |  |        |       
|                                              | Non-current deferred tax liability |                | $      | (7,676 | ) |  | $      | (6,931 | )
|                                              |                                    |                |        |        |   |  |        |       



|        |                     
|------- | --------------------
|Note 8. | Shareholders Equity



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

On February 1, 2002, we commenced a public
offering of 4,800,000 shares of our common stock at a price
of $19.38 per share. ESS sold 2,500,000 shares, and an
additional 2,300,000 shares were sold by selling
shareholders. ESS did not receive any of the proceeds from the
sale of shares by the selling shareholders: Annie M.H. Chan, the
Annie M.H. Chan Living Trust and the Shiu Leung Chan &
Annie M.H. Chan Gift Trust. The selling shareholders further
granted an over-allotment option of 720,000 shares to
underwriters, which the underwriters exercised on
February 19, 2002. Net of underwriting discount, we
received proceeds of $45,550,000 before expenses.

We announced on May 7, 2002 that our Board
of Directors authorized us to repurchase up to 3.0 million
shares of ESS 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. The repurchase program is being effected
from time to time, depending on market conditions and other
factors, through open market purchases. 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 under the program as of December 31, 2002. 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 ESS 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. There was no
purchase made under this program as of December 31, 2002.



| |                       
| | ----------------------
| | 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. In December
1999, we modified the vesting schedule for options granted
subsequently such that initial grants would 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. Other grants would vest ratably over the vesting term.

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.

54



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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
April 21, 2001, authorizes the issuance of 925,000 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,
2002, 653,498 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 Directors Plan, as amended in April 2001,
authorizes the issuance of 600,000 shares under the Directors
Stock Option Plan. The Directors Plan allows for granting of
stock options to non-employee members of the Board of Directors
of the Company. The plan was 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 2002, authorizes the issuance of 12,000,000 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 shall be Nonstatutory 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, 2002.

55



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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, 1999 |            |                | 1,455 |             |   |                | 7,529 |        |   | $ | 5.14 |      
|                             | Authorized |                |       | 2,500       |   |                |       |       |   |   |      |      | 
|                             | Granted    |                |       | (3,150      | ) |                |       | 3,150  |   |   |      | 15.36 | 
|                             | Exercised  |                |       |            |   |                |       | (2,660 | ) |   |      | 3.49  | 
|                             | Canceled   |                |       | 1,867       |   |                |       | (1,867 | ) |   |      | 8.77  | 
|                             |            |                |       |             |   |                |       |        |   |   |      |      
|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 |      
|                             |            |                |       |             |   |                |       |        |   |   |      |      

The weighted average fair value of options
granted during the years ended December 31, 2002, 2001 and
2000 were $9.70, $3.75 and $9.37, respectively.

The following table summarizes information about
stock options outstanding at December 31, 2002:

|                |       |                     |       |                     |  |                  |      |                |  |                  |       |      |  |  |       |       |  |   |       |      | 
|--------------- | ----- | ------------------- | ----- | ------------------- |  | ---------------- | ---- | -------------- |  | ---------------- | ----- | ---- |  |  | ----- | ----- |  | - | ----- | ---- | 
|                |       |                     |       |                    
|                |       | Options Outstanding |       | Options Exercisable
|                |       |                     |       |                    
|                |       | Number              |       |                     |  | Number           |      |               
|                |       | Outstanding at      |       | Average             |  |                  |      | Exercisable at |  |                 
|Range of        |       | December 31,        |       | Remaining           |  | Weighted Average |      | December 31,   |  | Weighted Average
|Exercise Prices |       | 2002                |       | Contractual Life    |  | Exercise Price   |      | 2002           |  | Exercise Price  
|                |       |                     |       |                     |  |                  |      |                |  |                 
|                |       | (In thousands)      |       | (In years)          |  |                  |      | (In thousands) |  |                 
|$ 0.03 - $ 4.69 |       |                     | 413   |                     |  |                  | 4.47 |                |  | $                | 2.98  |      |  |  | 348   |       |  | $ | 2.72  |     
|4.70 -   4.89   |       |                     | 2,344 |                     |  |                  | 5.67 |                |  |                  | 4.88  |      |  |  | 1,156 |       |  |   | 4.88  |     
|4.90 -  10.49   |       |                     | 1,161 |                     |  |                  | 7.92 |                |  |                  | 7.32  |      |  |  | 499   |       |  |   | 6.46  |     
|10.50 -  13.19  |       |                     | 1,231 |                     |  |                  | 6.75 |                |  |                  | 12.72 |      |  |  | 338   |       |  |   | 12.61 |     
|13.20 -  14.09  |       |                     | 1,109 |                     |  |                  | 9.20 |                |  |                  | 13.88 |      |  |  | 67    |       |  |   | 13.44 |     
|$14.10 - $29.25 |       |                     | 1,105 |                     |  |                  | 5.69 |                |  |                  | 16.98 |      |  |  | 544   |       |  |   | 17.33 |     
|                |       |                     |       |                     |  |                  |      |                |  |                  |       |      |  |  |       |       |  |   |       |     
|                | Total |                     |       | 7,363               |  |                  |      | 6.67           |  |                  | $     | 9.64 |  |  |       | 2,952 |  |   | $     | 8.27 | 
|                |       |                     |       |                     |  |                  |      |                |  |                  |       |      |  |  |       |       |  |   |       |     

At December 31, 2002, 2001 and 2000, options
to purchase approximately 2,952,000, 1,546,000 and
2,069,000 shares, were exercisable at an average exercise
price of $8.27, $8.76 and $5.68, respectively.

56



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Note 9.     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 earnings
per share, which is based on the weighted average number of
common stock outstanding and all dilutive potential common stock
outstanding.

In addition to net income (loss) per share,
we have also reported per share data on the separate income
statement components required by Accounting Principles Board
Opinion No. 30, Reporting the 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):

|                                              |  |                                       |         |        |  |           |        |  |  |   |       |  
|--------------------------------------------- |  | ------------------------------------- | ------- | ------ |  | --------- | ------ |  |  | - | ----- | -
|                                              |  | Net                                   |         |        |  | Per Share
|                                              |  | Income (Loss)                         |         | Shares |  | Amount   
|                                              |  |                                       |         |        |  |          
|                                              |  |                                      
|                                              |  | (In thousands, except per share data)
|Year Ended December 31, 2002                  |  |                                       |         |        |  |           |        |  |  |   |       |  
|Basic EPS from continuing operations          |  | $                                     | 37,277  |        |  |           | 44,044 |  |  | $ | 0.85  |  
|Basic EPS from discontinued operation         |  |                                       |        |        |  |           | 44,044 |  |  |   |      |  
|                                              |  |                                       |         |        |  |           |        |  |  |   |       |  
|Basic EPS                                     |  |                                       | 37,277  |        |  |           | 44,044 |  |  |   | 0.85  |  
|                                              |  |                                       |         |        |  |           |        |  |  |   |       |  
|Effects of dilutive securities: Stock options |  |                                       |         |        |  |           | 2,687  |  |  |   |       |  
|Diluted EPS from continuing operations        |  |                                       | 37,277  |        |  |           | 46,731 |  |  |   | 0.80  |  
|Diluted EPS from discontinued operation       |  |                                       |        |        |  |           | 46,731 |  |  |   |      |  
|                                              |  |                                       |         |        |  |           |        |  |  |   |       |  
|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  |  |  |   |       |  
|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 | )
|                                              |  |                                       |         |        |  |           |        |  |  |   |       |  
|Year Ended December 31, 2000                  |  |                                       |         |        |  |           |        |  |  |   |       |  
|Basic EPS from continuing operations          |  | $                                     | 63,166  |        |  |           | 42,548 |  |  | $ | 1.49  |  
|Basic EPS from discontinued operation         |  |                                       | (14,860 | )      |  |           | 42,548 |  |  |   | (0.35 | )
|                                              |  |                                       |         |        |  |           |        |  |  |   |       |  
|Basic EPS                                     |  |                                       | 48,306  |        |  |           | 42,548 |  |  |   | 1.14  |  
|                                              |  |                                       |         |        |  |           |        |  |  |   |       |  
|Effects of dilutive securities: Stock options |  |                                       |         |        |  |           | 3,395  |  |  |   |       |  
|Diluted EPS from continuing operations        |  |                                       | 63,166  |        |  |           | 45,943 |  |  |   | 1.37  |  
|Diluted EPS from discontinued operation       |  |                                       | (14,860 | )      |  |           | 45,943 |  |  |   | (0.32 | )
|                                              |  |                                       |         |        |  |           |        |  |  |   |       |  
|Diluted EPS                                   |  | $                                     | 48,306  |        |  |           | 45,943 |  |  | $ | 1.05  |  
|                                              |  |                                       |         |        |  |           |        |  |  |   |       |  

For the years ended December 31, 2002, 2001
and 2000, there were options to purchase approximately
1,089,000, 2,540,000 and 157,000 shares of our common stock,
respectively, with exercise prices greater than the
weighted-average market value of such common stock. These
options were excluded from the calculation of diluted earnings
per share.

57



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|         |                                 
|-------- | --------------------------------
|Note 10. | Non-Operating Income (Loss), Net

The following table lists the major components of
Non-Operating Income (Loss) for the years ended
December 31, 2002, 2001 and 2000, respectively:

|                                                  |  |                          |        |      |  |      |         |   |  |   |        | 
|------------------------------------------------- |  | ------------------------ | ------ | ---- |  | ---- | ------- | - |  | - | ------ | 
|                                                  |  |                         
|                                                  |  | Years Ended December 31,
|                                                  |  |                         
|                                                  |  | 2002                     |        | 2001 |  | 2000
|                                                  |  |                          |        |      |  |     
|                                                  |  |                         
|                                                  |  | (In thousands)          
|Interest income                                   |  | $                        | 3,586  |      |  | $    | 2,019   |   |  | $ | 2,428  | 
|Gain on exchange of Komodo shares to Cisco shares |  |                          |       |      |  |      |        |   |  |   | 35,045 | 
|Loss on sale of Cisco Stock                       |  |                          | (61    | )    |  |      | (21,187 | ) |  |   |       | 
|Loss on sale of other investments                 |  |                          | (128   | )    |  |      |        |   |  |   |       | 
|Write-down on investments                         |  |                          | (3,612 | )    |  |      |        |   |  |   |       | 
|Vialta rental income                              |  |                          | 1,852  |      |  |      | 640     |   |  |   |       | 
|Gain on sale of property, plant and equipment     |  |                          | 85     |      |  |      |        |   |  |   | 2,911  | 
|Other                                             |  |                          | 685    |      |  |      | (252    | ) |  |   | 1,426  | 
|                                                  |  |                          |        |      |  |      |         |   |  |   |        | 
|Total non-operating income (Loss)                 |  | $                        | 2,407  |      |  | $    | (18,780 | ) |  | $ | 41,810 | 
|                                                  |  |                          |        |      |  |      |         |   |  |   |        | 



|         |                            
|-------- | ---------------------------
|Note 11. | Comprehensive Income (loss)

Comprehensive income (loss) is comprised of
net income (loss) and the unrealized loss on marketable
securities. Comprehensive income (loss) was
$39.2 million, $4.2 million and $40.9 million for
the years ended December 31, 2002, 2001 and 2000,
respectively. The following table reconciles Net Income (Loss)
to Comprehensive Income (Loss) for the years ended
December 31, 2002, 2001 and 2000:

|                                                                     |  |                          |        |      |  |      |        |   |  |   |        |  
|-------------------------------------------------------------------- |  | ------------------------ | ------ | ---- |  | ---- | ------ | - |  | - | ------ | -
|                                                                     |  |                         
|                                                                     |  | Years Ended December 31,
|                                                                     |  |                         
|                                                                     |  | 2002                     |        | 2001 |  | 2000
|                                                                     |  |                          |        |      |  |     
|                                                                     |  |                         
|                                                                     |  | (In thousands)          
|Net income (loss)                                                    |  | $                        | 37,277 |      |  | $    | (1,817 | ) |  | $ | 48,306 |  
|Change in unrealized gain (loss) on marketable
    equity securities |  |                          | 1,878  |      |  |      | 6,004  |   |  |   | (7,378 | )
|                                                                     |  |                          |        |      |  |      |        |   |  |   |        |  
|Total comprehensive income                                           |  | $                        | 39,155 |      |  | $    | 4,187  |   |  | $ | 40,928 |  
|                                                                     |  |                          |        |      |  |      |        |   |  |   |        |  

The following table shows the individual
components of the Accumulated Other Comprehensive Income (Loss)
on the Consolidated Balance Sheet as of December 31, 2002
and 2001:

|                                                |  |                |     |      |  |   |        |  
|----------------------------------------------- |  | -------------- | --- | ---- |  | - | ------ | -
|                                                |  |               
|                                                |  | December 31,  
|                                                |  |               
|                                                |  | 2002           |     | 2001
|                                                |  |                |     |     
|                                                |  |               
|                                                |  | (In thousands)
|Unrealized loss on Cisco shares                 |  |                |    |      |  | $ | (1,527 | )
|Unrealized gain on marketable equity securities |  |                | 504 |      |  |   | 153    |  
|                                                |  |                |     |      |  |   |        |  
|Accumulated other comprehensive income (loss)   |  | $              | 504 |      |  | $ | (1,374 | )
|                                                |  |                |     |      |  |   |        |  



|         |                                    
|-------- | -----------------------------------
|Note 12. | Industries and Geographical Segment



| |                  
| | -----------------
| | Industry Segments

In 1998, we adopted SFAS No. 131
Disclosures About Segments of an Enterprise and Related
Information (SFAS 131). SFAS 131
supersedes SFAS 14, Financial Reporting for Segments
of a Business Enterprise and requires segment information
be reported on the basis that it is used internally for
evaluating segment performance and deciding how to allocate
resources to segments.

58



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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

We operate in one reportable business segment:
the semiconductor segment. We design, develop, support,
manufacture and market highly integrated mixed-signal
semiconductor, hardware, software and system solutions for DVD,
internet related, communications, VCD/SVCD, Consumer Digital
Audio and PC Audio applications.

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.



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

We sell and market to leading PC and consumer
OEMs worldwide. International sales comprise a significant
portion of our revenues. The following geographic location of
our revenues is based upon destination of the shipment, thus our
sales to Dynex Electronics is categorized as sales to Hong Kong;
even though Dynex Electronics eventually sells through a lot of
the products to China. Most of the long-lived assets located
outside the United States are in Asia Pacific. The following is
a summary of our geographic locations:

|                             |       |                |         |                   |  |   |        |        | 
|---------------------------- | ----- | -------------- | ------- | ----------------- |  | - | ------ | ------ | 
|                             |       | Net Sales      |         | Long Lived Assets
|                             |       |                |         |                  
|                             |       |               
|                             |       | (In thousands)
|Year Ended December 31, 2002 |       |                |         |                   |  |   |        |       
|United States                |       | $              | 2,453   |                   |  | $ | 18,366 |       
|                             |       |                |         |                   |  |   |        |       
|                            
|Hong Kong                    |       |                | 191,510 |                   |  |   | 619    |       
|Taiwan                       |       |                | 19,346  |                   |  |   |       |       
|Singapore                    |       |                | 11,973  |                   |  |   |       |       
|Japan                        |       |                | 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 | 
|                             |       |                |         |                   |  |   |        |       

59



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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                             |       |                |         |                   |  |   |        |        | 
|---------------------------- | ----- | -------------- | ------- | ----------------- |  | - | ------ | ------ | 
|                             |       | Net Sales      |         | Long Lived Assets
|                             |       |                |         |                  
|                             |       |               
|                             |       | (In thousands)
|Year Ended December 31, 2000 |       |                |         |                   |  |   |        |       
|United States                |       | $              | 20,551  |                   |  | $ | 30,344 |       
|                             |       |                |         |                   |  |   |        |       
|                            
|Hong Kong                    |       |                | 149,925 |                   |  |   | 689    |       
|Taiwan                       |       |                | 79,302  |                   |  |   |       |       
|Japan                        |       |                | 15,138  |                   |  |   |       |       
|Singapore                    |       |                | 6,157   |                   |  |   |       |       
|Canada                       |       |                |        |                   |  |   | 28     |       
|Rest of the world            |       |                | 32,363  |                   |  |   | 20     |       
|                             |       |                |         |                   |  |   |        |       
|Total foreign                |       |                | 282,885 |                   |  |   | 737    |       
|                             |       |                |         |                   |  |   |        |       
|                             | Total |                | $       | 303,436           |  |   | $      | 31,081 | 
|                             |       |                |         |                   |  |   |        |       



|         |                              
|-------- | -----------------------------
|Note 13. | Commitments and Contingencies

We maintain leased office space in various
locations, in addition to certain testing equipment leased from
third parties. Future minimum rental payments under these
operating leases are as follows:

|                         |  |                |       | 
|------------------------ |  | -------------- | ----- | 
|Years Ended December 31, |  | Amount        
|                         |  |               
|                         |  | (In thousands)
|2003                     |  | $              | 1,588 | 
|2004                     |  |                | 46    | 
|2005                     |  |                | 16    | 
|2006                     |  |                | 16    | 
|                         |  |                |       | 
|Total                    |  | $              | 1,666 | 
|                         |  |                |       | 

Lease expenses were approximately
$1.2 million, $1.5 million and $1.4 million in
2002, 2001 and 2000, respectively.

As of December 31, 2002, our commitments to
purchase inventory from the third-party contractors aggregated
approximately $10.7 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.

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. 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.



|         |                                 
|-------- | --------------------------------
|Note 14. | Acquisitions and Related Charges

NetRidium Communications, Inc.
(NetRidium) was founded in January 1999 and was
acquired in February 2000, when it was still a development-stage
company with no revenue. The acquisition was recorded using the
purchase method of accounting and accordingly, the results of
operations and cash flows of such acquisition have been included
from the date of acquisition. Purchased in-process research and
development

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

aggregating $2.6 million for the NetRidium
acquisition was charged to operations in the second quarter of
2000. Technical infrastructure and covenants not to compete are
being amortized over four years. In connection with the
acquisition, we granted certain NetRidium employees stock
options to purchase a total of 500,000 shares of our stock at
$17.68 per share, the fair market value on the date of grant. In
addition, we have entered into employment contracts with certain
former NetRidium employees, which, among other things, provide
that if the employee stays with us for the applicable vesting
periods during the four-year term of the employment agreement,
the employees stock options will have a value of at least
$8.85 more than the exercise price when such options become
exercisable. Accordingly, we are accruing this additional
compensation expense over the four-year term of the agreement.
Approximately 428,000 of the options issued upon acquisition are
subject to this guarantee. We recorded approximately
$0.7 million, $0.5 million and $0.9 million as
compensation expenses under this guarantee, for fiscal year
2002, 2001 and 2000, respectively.

NetRidium was developing its intellectual
property and foundation technologies in the area of broadband
data delivery to homes and in-home data distribution.
NetRidiums first product was scheduled for release in the
summer of 2000. We expected this acquisition to provide these
foundation technologies as a turnkey solution to network
equipment manufacturers and personal computer providers. We
planned to introduce a complete line of highly integrated
technology products that would enable network manufacturers to
produce reliable HomeLAN solutions over ordinary telephone wires.

Research and development expenses incurred on
product development post acquisition were approximately
$3.3 million and $4.0 million in 2000 and 2001,
respectively. The product was not completed until February of
2002. No significant revenues have been recognized to date nor
were significant revenues originally anticipated in 2002;
however, we believe that home networking is an important future
market for us and this technology will be important to our
efforts to exploit that market. As of December 31, 2002,
net unamortized intangible assets relating to the NetRidium
acquisition were approximately $650,000, including $400,000 of
goodwill and $250,000 of technical infrastructure. We continue
to monitor the carrying value of intangible assets related to
the NetRidium acquisition in accordance with SFAS 142 and
SFAS 144.

In April 2001, we entered into a definitive
agreement to acquire Silicon Analog Systems (SAS) in
a merger transaction to be accounted for as a purchase business
combination. SAS was a Canadian start-up company engaged in
developing single chip solutions for wireless communications.
This acquisition was effective on April 12, 2001. 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
cost was primarily allocated to goodwill, based on an
independent 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, 2002, the SAS design team
is concentrating on video product development as well as radio
frequency analog design, 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 15. | Related Party Transactions with Vialta,
    Inc

In early January 2003, Fred S.L. Chan,
Chairman of Board of Directors paid off a Company cash advance
of $40,000, a loan made in 1999. Mr. Fred S.L. Chan
also serves as the Chairman of the Board for Vialta, each
company pays Mr. Fred Chan a base salary separately.

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

In connection with the spin-off of Vialta, 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 ESS and Vialta 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 supercedes the prior Intellectual Property and
Research and Development Agreements between ESS and Vialta and
allocates ownership rights generally along the product lines of
each of ESS and Vialta. In the Master Technology Ownership and
License Agreement, we 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, ESS
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 ESS employees who held ESS options, based on ESS 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 will vest, become
exercisable, expire and otherwise be treated under terms that
essentially mirror the provisions of the corresponding ESS
option held by the ESS employee.

The Tax Sharing and Indemnity Agreement allocate
responsibilities for tax matters between ESS and Vialta. 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 real
estate matters relating to property owned by ESS that ESS leases
to Vialta, as well as other properties already leased by Vialta.
The Real Estate Matters Agreement also amends and restates the
terms of the lease from ESS to Vialta for the Fremont facility
that currently serves as Vialtas corporate headquarters.
The Real Estate Matters Agreement will terminate initially on
December 31, 2003 and may be renewed for up to three years.
Under this agreement, Vialta pays us approximately
$1.85 million per year, receivable in installments of
$154,498 per month, to lease office space for its corporate
headquarters.

The Master Confidential Disclosure Agreement
provides that Vialta and ESS 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 ESS has 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

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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 charge
Vialta on a usage basis for IT hardware support, the
cafeteria and the corporate dormitory.

The only other agreement between Vialta and us is
a supply agreement under which ESS agrees to give Vialta the
best price available to any other customers. ESS supplies 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.

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

|                                                                                                |  |                |       |      |  |   |       |  
|----------------------------------------------------------------------------------------------- |  | -------------- | ----- | ---- |  | - | ----- | -
|                                                                                                |  |               
|                                                                                                |  | Years Ended   
|                                                                                                |  | December 31   
|                                                                                                |  |               
|                                                                                                |  | 2002           |       | 2001
|                                                                                                |  |                |       |     
|                                                                                                |  |               
|                                                                                                |  | (In thousands)
|Research and Development services provided to
    Vialta                                        |  | $              |      |      |  | $ | 1,895 |  
|Selling, General and Administrative services
    provided to Vialta, net of charges from Vialta |  |                | (38   | )    |  |   | 3,042 |  
|Lease charges to Vialta under Real Estate Matters
    Agreement                                 |  |                | 1,852 |      |  |   | 640   |  
|Chip purchases by Vialta                                                                        |  |                | 1,403 |      |  |   | 1,127 |  
|Products (purchased from) Vialta                                                                |  |                | (61   | )    |  |   | (74   | )
|                                                                                                |  |                |       |      |  |   |       |  
|Total charges to Vialta, net of charges from
    Vialta                                         |  | $              | 3,156 |      |  | $ | 6,630 |  
|                                                                                                |  |                |       |      |  |   |       |  

Charges by ESS to Vialta under the Master
Transitional Services Agreement for research and development and
selling, general and administrative services provided by us to
Vialta are recorded in ESS statements of operation as an
offset to its applicable operating expenses. Charges from us to
Vialta under the Real Estate Matters Agreement are recorded in
ESS Statements of Operations as other income. Product
purchased from Vialta is recorded in ESS Statements of
Operations as selling, general and administrative expenses.
Charges for chip purchase by Vialta are recorded in ESS
Statements of Operations under Net revenues from related party
 Vialta.

In the years ended December 31, 2000, ESS
incurred approximately $260,000 of inter-company charges for
sharing Vialtas tax credit resulting from Vialtas
net operating loss in 2000.

On December 18, 2000, Vialta received a
$30.0 million loan from an entity controlled by Annie M.H.
Chan, a then director of ESS and the spouse of Fred S.L. Chan.
The $30.0 million short-term loan along with $194,000
accrued interest at 5.25% was repaid on January 31, 2001.

In September 1999, Vialta issued 40 million
shares of Series A Convertible Preferred Stock at $0.25 per
share to us for $10.0 million in cash. In October 1999,
Mr. Fred S.L. Chan, Chairman of ESS and Vialta,
purchased 4 million shares of Vialta common stock at $0.25
per share for $1.0 million by issuing a full recourse
promissory note to Vialta, which bore interest at a market rate.
The principal and accrued interest under this promissory note
was paid in full in March 2000. Also in October 1999, Vialta
issued 400,000 and 1,820,000 common shares at $0.25 per share to
us and certain employees, respectively, for full recourse
promissory notes in the aggregate principal amount of $555,000.
These notes were fully paid in cash to Vialta in the first
quarter of 2000.

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

In December 1999, Vialta issued 40.3 million
shares of Series B Preferred Stock at $2.60 per share for
$104.8 million: 20 million shares to ESS for
$52.0 million and 20.3 million shares to third-party
investors for $52.8 million in cash. In January 2000,
Vialta received $20.8 million in the form of a full
recourse promissory note, which bore interest at a market rate,
from a party controlled by Mr. Fred S.L. Chan and his wife
Ms. Annie Chan, a former director of ESS, for the purchase
of 8 million shares of Series B Preferred Stock at
$2.60 per share. The principal and accrued interests under this
promissory note were paid in full in March 2000. During the
first quarter of 2000, Vialta received $7.0 million in cash
from third-party investors for subscriptions to purchase
2.7 million shares of its Series B Preferred Stock.

Note 16.     Significant
Customers

We sell to both direct customers and
distributors. We use both a direct sales force as well as sales
representatives to help us sell to our direct customers. The
following table summarizes the percentage of our net revenues
accounted for by our significant direct customer who accounted
for 10% or more of our revenues in any of the past three years.

|                             |  |                          |   |      |  |      |   |   |  |  |    |  
|---------------------------- |  | ------------------------ | - | ---- |  | ---- | - | - |  |  | -- | -
|                             |  |                         
|                             |  | Years Ended December 31,
|                             |  |                         
|                             |  | 2002                     |   | 2001 |  | 2000
|                             |  |                          |   |      |  |     
|Digital AV (formerly Shinco) |  |                          | 8 | %    |  |      | 9 | % |  |  | 10 | %
|                             |  |                          |   |      |  |      |   |   |  |  |    |  

Note 17.     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,
who 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. However, since the title
and risk of loss for the inventory are transferred to Dynax
Electronics upon shipment of inventory to Dynax Electronics,
Dynax Electronics is legally responsible for all of our invoices
regardless of when the inventory is sold to an end-customer.
Revenues on sales to Dynax Electronics are deferred until Dynax
Electronics sells the products to end-customers.

The following table summarizes Dynax
Electronics percentage of net revenues for the year ended
December 31, 2002, 2001 and 2000, respectively:

|                                    |  |                                        |         |      |  |      |         |   |  |   |         |  
|----------------------------------- |  | -------------------------------------- | ------- | ---- |  | ---- | ------- | - |  | - | ------- | -
|                                    |  |                                       
|                                    |  | Years Ended December 31,              
|                                    |  |                                       
|                                    |  | 2002                                   |         | 2001 |  | 2000
|                                    |  |                                        |         |      |  |     
|                                    |  |                                       
|                                    |  | (In thousands, except percentage data)
|Net revenues                        |  | $                                      | 273,442 |      |  | $    | 271,380 |   |  | $ | 303,436 |  
|Net revenues from Dynax Electronics |  | $                                      | 156,963 |      |  | $    | 151,972 |   |  | $ | 106,203 |  
|Percentage of net revenues          |  |                                        | 57      | %    |  |      | 56      | % |  |   | 35      | %

The following table summarizes Dynax
Electronics percentage of trade accounts receivable as of
December 31, 2002 and 2001:

|                                                 |  |                       |        |      |  |   |        |  
|------------------------------------------------ |  | --------------------- | ------ | ---- |  | - | ------ | -
|                                                 |  |                      
|                                                 |  | December 31,         
|                                                 |  |                      
|                                                 |  | 2002                  |        | 2001
|                                                 |  |                       |        |     
|                                                 |  |                      
|                                                 |  | (In thousands, except
|                                                 |  | percentage data)     
|Trade accounts receivable                        |  | $                     | 29,523 |      |  | $ | 42,799 |  
|Trade accounts receivable from Dynax Electronics |  | $                     | 24,318 |      |  | $ | 33,811 |  
|Percentage of trade accounts receivable          |  |                       | 82     | %    |  |   | 79     | %

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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Note 18.     Investments

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, a privately held company, is
a product design and manufacturing house for OEMs with expertise
in broadband network access equipment technologies. The
investment in Broadmedia was accounted for using the cost method
of accounting. We recorded charges of $1,050,000 during the year
ended December 31, 2002 to reduce the carrying value of our
investment in Broadmedia to our estimate of its fair value. As a
result of a corporate restructuring, Broadmedias former
wholly owned subsidiary Archtek Telecom Corporation became the
parent company of Broadmedia and we effectively exchanged our
Broadmedia shares for Archtek shares on December 31, 2002.
A merger is anticipated between Broadmedia/ Archtek and C-Com
Corporation (C-Com), a publicly traded company in
Taiwan. In light of the pending Archtek/C-Com merger, instead of
receiving a stock certificate of Archtek stock for our
Broadmedia stock, we expect to receive a C-Com stock certificate
upon completion of the Archtek and C-Com merger, currently
expected to occur in mid-2003 when the shareholders of those
companies approve the transaction.

In April 2002, we acquired 1,600,000 shares
of MosChip Semiconductor Technology Limited
(MosChip) common stock for approximately $988,000 in
cash, representing approximately 7% equity interest in MosChip.
MosChip is a publicly traded company listed under Bombay Stock
Exchange  one of Indians two major stock exchanges.
MosChip, based in Hyderabad, India, specializes in designing,
manufacturing and marketing very large integrated circuits
(ICs), with particular focus on consumer and data
communication ICs. We account for our investment in MosChip as
available-for-sale securities under SFAS 115. This
investment resulted in an unrealized gain of $64,000 recorded in
accumulated other comprehensive income at December 31, 2002.

Note 19.     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. No contributions were
made by ESS through December 31, 2002.

Note 20.     Subsequent
Events

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,
representing less than a 1% equity interest in Best Elite on a
diluted basis. Best Elite is organized under the laws of the
British Virgin Islands, as an investment vehicle for the purpose
of establishing a foundry in mainland China.

In the period from January 1, 2003 through
March 20, 2003, we repurchased 62,172 shares of our common
stock at market price of $5.43 per share to complete the
3.0 million share repurchase program announced by Board of
Directors on May 7, 2002. During the same period, we
repurchased 3,667,441 shares of our common stock for an
aggregate price of $21.7 million at market prices ranging
from $5.43 to $6.30 per share under the 5.0 million share
repurchase program approved by our Board of Directors and
announced on August 8, 2002. Upon repurchase, these shares
were retired and no longer deemed outstanding. As of
March 20, 2003, we have approximately 1.33 million
shares available of repurchase.

65



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##### Table of Contents



ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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.

|                                                  |                                                                                     |                         |         |         |       |                                       |         |         |      |         |        |         |      |          |        |         |      |   |        |        |      |   |        |        |      |   |        |        |      |   |        |        |      | 
|------------------------------------------------- | ----------------------------------------------------------------------------------- | ----------------------- | ------- | ------- | ----- | ------------------------------------- | ------- | ------- | ---- | ------- | ------ | ------- | ---- | -------- | ------ | ------- | ---- | - | ------ | ------ | ---- | - | ------ | ------ | ---- | - | ------ | ------ | ---- | - | ------ | ------ | ---- | 
|                                                  |                                                                                     |                         |         |        
|                                                  |                                                                                     | 2001                    |         | 2002   
|                                                  |                                                                                     |                         |         |        
|                                                  |                                                                                     | 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                                      |                                                                                     | $                       | 50,808  |         |       | $                                     | 64,909  |         |      | $       | 72,397 |         |      | $        | 83,266 |         |      | $ | 79,115 |        |      | $ | 86,037 |        |      | $ | 60,746 |        |      | $ | 47,544 |       
|Cost of revenues                                  |                                                                                     |                         | 39,606  |         |       |                                       | 45,970  |         |      |         | 45,930 |         |      |          | 48,725 |         |      |   | 44,839 |        |      |   | 50,817 |        |      |   | 45,665 |        |      |   | 35,133 |       
|                                                  |                                                                                     |                         |         |         |       |                                       |         |         |      |         |        |         |      |          |        |         |      |   |        |        |      |   |        |        |      |   |        |        |      |   |        |       
|                                                  | Gross profit                                                                        |                         |         | 11,202  |       |                                       |         | 18,939  |      |         |        | 26,467  |      |          |        | 34,541  |      |   |        | 34,276 |      |   |        | 35,220 |      |   |        | 15,081 |      |   |        | 12,411 |     
|Operating expenses:                               |                                                                                     |                         |         |         |       |                                       |         |         |      |         |        |         |      |          |        |         |      |   |        |        |      |   |        |        |      |   |        |        |      |   |        |       
|                                                  | Research and development                                                            |                         |         | 6,411   |       |                                       |         | 7,592   |      |         |        | 7,273   |      |          |        | 6,681   |      |   |        | 6,381  |      |   |        | 7,043  |      |   |        | 7,160  |      |   |        | 6,380  |     
|                                                  | Selling, general and administrative                                                 |                         |         | 8,666   |       |                                       |         | 8,917   |      |         |        | 11,686  |      |          |        | 11,420  |      |   |        | 10,356 |      |   |        | 11,051 |      |   |        | 6,452  |      |   |        | 6,311  |     
|                                                  |                                                                                     |                         |         |         |       |                                       |         |         |      |         |        |         |      |          |        |         |      |   |        |        |      |   |        |        |      |   |        |        |      |   |        |       
|Operating income (loss)                           |                                                                                     |                         | (3,875  | )       |       |                                       | 2,430   |         |      |         | 7,508  |         |      |          | 16,440 |         |      |   | 17,539 |        |      |   | 17,126 |        |      |   | 1,469  |        |      |   | (280   | )     
|Non-operating income, net                         |                                                                                     |                         | 325     |         |       |                                       | (20,795 | )(1)    |      |         | 989    |         |      |          | 701    |         |      |   | (1,267 | )(2)   |      |   | 1,085  |        |      |   | 1,438  |        |      |   | 1,151  |       
|                                                  |                                                                                     |                         |         |         |       |                                       |         |         |      |         |        |         |      |          |        |         |      |   |        |        |      |   |        |        |      |   |        |        |      |   |        |       
|Income (loss) before income taxes                 |                                                                                     |                         | (3,550  | )       |       |                                       | (18,365 | )       |      |         | 8,497  |         |      |          | 17,141 |         |      |   | 16,272 |        |      |   | 18,211 |        |      |   | 2,907  |        |      |   | 871    |       
|Provision for (benefit from) income taxes         |                                                                                     |                         | (382    | )       |       |                                       | (8,167  | )       |      |         | 425    |         |      |          | 862    |         |      |   | (114   | )      |      |   | 889    |        |      |   | 148    |        |      |   | 61     |       
|                                                  |                                                                                     |                         |         |         |       |                                       |         |         |      |         |        |         |      |          |        |         |      |   |        |        |      |   |        |        |      |   |        |        |      |   |        |       
|Net income (loss) from continuing operations      |                                                                                     |                         | (3,168  | )       |       |                                       | (10,198 | )       |      |         | 8,072  |         |      |          | 16,279 |         |      |   | 16,386 |        |      |   | 17,322 |        |      |   | 2,759  |        |      |   | 810    |       
|                                                  |                                                                                     |                         |         |         |       |                                       |         |         |      |         |        |         |      |          |        |         |      |   |        |        |      |   |        |        |      |   |        |        |      |   |        |       
|Discontinued operation, net of minority interest: |                                                                                     |                         |         |         |       |                                       |         |         |      |         |        |         |      |          |        |         |      |   |        |        |      |   |        |        |      |   |        |        |      |   |        |       
|                                                  | Loss from discontinued operation, net of minority
    interest                      |                         |         | (4,205  | )     |                                       |         |        |      |         |        |        |      |          |        |        |      |   |        |       |      |   |        |       |      |   |        |       |      |   |        |       |     
|                                                  | Income (Loss) from disposal of discontinued
    operation, net of minority interest |                         |         | (13,312 | )     |                                       |         |        |      |         |        | 4,715   |      |          |        |        |      |   |        |       |      |   |        |       |      |   |        |       |      |   |        |       |     
|                                                  |                                                                                     |                         |         |         |       |                                       |         |         |      |         |        |         |      |          |        |         |      |   |        |        |      |   |        |        |      |   |        |        |      |   |        |       
|Net income (loss)                                 |                                                                                     | $                       | (20,685 | )       |       | $                                     | (10,198 | )       |      | $       | 12,787 |         |      | $        | 16,279 |         |      | $ | 16,386 |        |      | $ | 17,322 |        |      | $ | 2,759  |        |      | $ | 810    |       
|                                                  |                                                                                     |                         |         |         |       |                                       |         |         |      |         |        |         |      |          |        |         |      |   |        |        |      |   |        |        |      |   |        |        |      |   |        |       
|Net income (loss) per share:                      |                                                                                     |                         |         |         |       |                                       |         |         |      |         |        |         |      |          |        |         |      |   |        |        |      |   |        |        |      |   |        |        |      |   |        |       
|                                                  | Basic                                                                               |                         |         |         |       |                                       |         |         |      |         |        |         |      |          |        |         |      |   |        |        |      |   |        |        |      |   |        |        |      |   |        |        |     
|                                                  |                                                                                     | Continuing operations   |         | $       | (0.07 | )                                     |         | $       | 0.24 |         |        | $       | 0.19 |          |        | $       | 0.39 |   |        | $      | 0.37 |   |        | $      | 0.38 |   |        | $      | 0.06 |   |        | $      | 0.02 | 
|                                                  |                                                                                     | Discontinuing operation |         |         | (0.42 | )                                     |         |         |     |         |        |         | 0.11 |          |        |         |     |   |        |        |     |   |        |        |     |   |        |        |     |   |        |        |     | 
|                                                  |                                                                                     |                         |         |         |       |                                       |         |         |      |         |        |         |      |          |        |         |      |   |        |        |      |   |        |        |      |   |        |        |      |   |        |       
|                                                  |                                                                                     | $                       | (0.49   | )       |       | $                                     | 0.24    |         |      | $       | 0.30   |         |      | $        | 0.39   |         |      | $ | 0.37   |        |      | $ | 0.38   |        |      | $ | 0.06   |        |      | $ | 0.02   |       
|                                                  |                                                                                     |                         |         |         |       |                                       |         |         |      |         |        |         |      |          |        |         |      |   |        |        |      |   |        |        |      |   |        |        |      |   |        |       
|                                                  | Diluted                                                                             |                         |         |         |       |                                       |         |         |      |         |        |         |      |          |        |         |      |   |        |        |      |   |        |        |      |   |        |        |      |   |        |        |     
|                                                  |                                                                                     | Continuing operations   |         | $       | (0.07 | )                                     |         | $       | 0.24 |         |        | $       | 0.18 |          |        | $       | 0.35 |   |        | $      | 0.34 |   |        | $      | 0.36 |   |        | $      | 0.06 |   |        | $      | 0.02 | 
|                                                  |                                                                                     | Discontinuing operation |         |         | (0.42 | )                                     |         |         |     |         |        |         | 0.10 |          |        |         |     |   |        |        |     |   |        |        |     |   |        |        |     |   |        |        |     | 
|                                                  |                                                                                     |                         |         |         |       |                                       |         |         |      |         |        |         |      |          |        |         |      |   |        |        |      |   |        |        |      |   |        |        |      |   |        |       
|                                                  |                                                                                     | $                       | (0.49   | )       |       | $                                     | 0.24    |         |      | $       | 0.28   |         |      | $        | 0.35   |         |      | $ | 0.34   |        |      | $ | 0.36   |        |      | $ | 0.06   |        |      | $ | 0.02   |       
|                                                  |                                                                                     |                         |         |         |       |                                       |         |         |      |         |        |         |      |          |        |         |      |   |        |        |      |   |        |        |      |   |        |        |      |   |        |       

66



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ESS TECHNOLOGY, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                                            |         |         |  |         |  |                                       |  |         |  |         |  |         |  |          |  |         |  |  |  |        |  |  |  |        |  |  |  |        |  |  |  |        | 
|----------------------------------------------------------- | ------- | ------- |  | ------- |  | ------------------------------------- |  | ------- |  | ------- |  | ------- |  | -------- |  | ------- |  |  |  | ------ |  |  |  | ------ |  |  |  | ------ |  |  |  | ------ | 
|                                                            |         |         |  |        
|                                                            |         | 2001    |  | 2002   
|                                                            |         |         |  |        
|                                                            |         | Mar. 31 |  | June 30 |  | Sept. 30                              |  | Dec. 31 |  | Mar. 31 |  | June 30 |  | Sept. 30 |  | Dec. 31
|                                                            |         |         |  |         |  |                                       |  |         |  |         |  |         |  |          |  |        
|                                                            |         |         |  |         |  |                                       |  |         |  |        
|                                                            |         |         |  |         |  | (In thousands, except per share data) |  |         |  |        
|Shares used in calculating net income (loss) per
    share: |         |         |  |         |  |                                       |  |         |  |         |  |         |  |          |  |         |  |  |  |        |  |  |  |        |  |  |  |        |  |  |  |       
|                                                            | Basic   |         |  | 42,370  |  |                                       |  | 42,375  |  |         |  | 42,380  |  |          |  | 41,976  |  |  |  | 44,209 |  |  |  | 45,147 |  |  |  | 43,484 |  |  |  | 43,378 | 
|                                                            |         |         |  |         |  |                                       |  |         |  |         |  |         |  |          |  |         |  |  |  |        |  |  |  |        |  |  |  |        |  |  |  |       
|                                                            | Diluted |         |  | 42,370  |  |                                       |  | 42,375  |  |         |  | 45,375  |  |          |  | 45,867  |  |  |  | 48,331 |  |  |  | 48,446 |  |  |  | 45,706 |  |  |  | 44,188 | 
|                                                            |         |         |  |         |  |                                       |  |         |  |         |  |         |  |          |  |         |  |  |  |        |  |  |  |        |  |  |  |        |  |  |  |       



---

(1)     Includes a
($21,187) loss due to sale of Cisco shares.



|    |                                                                                                                        
|--- | -----------------------------------------------------------------------------------------------------------------------
|(2) | Includes a ($2,545) loss due to write down of the
    remaining Cisco shares for other than temporary decline in value.

67



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##### Table of Contents






Item 9.     Changes
in and Disagreements with Accountants on Accounting and
Financial Disclosures

Not applicable.






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 2003 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.






|         |                       
|-------- | ----------------------
|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 and Related Shareholder
    Matters.

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.

The following table summarizes information with
respect to options under ESS equity compensation plans at
December 31, 2002:

Equity Compensation Plan
Information(1)

|                                                               |       |                         |           |                      |  |                                    |      |      |  |  |           |           | 
|-------------------------------------------------------------- | ----- | ----------------------- | --------- | -------------------- |  | ---------------------------------- | ---- | ---- |  |  | --------- | --------- | 
|                                                               |       |                         |           |                      |  | Number of Securities Remaining    
|                                                               |       | Number of Securities to |           | Weighted-average     |  | Available for Future Issuance     
|                                                               |       | be Issued Upon Exercise |           | Exercise Price of    |  | Under Equity Compensation Plans   
|                                                               |       | of Outstanding Options, |           | Outstanding Options, |  | (excluding securities reflected in
|                                                               |       | Warrants and Rights     |           | Warrants and Rights  |  | column (a))                       
|Plan Category                                                  |       | (a)(3)                  |           | (b)                  |  | (c)                               
|                                                               |       |                         |           |                      |  |                                   
|Equity compensation plans approved by security
    holders     |       |                         | 7,340,416 |                      |  | $                                  | 9.65 |      |  |  | 3,308,927 | (2)      
|Equity compensation plans not approved by
    security holders |       |                         | 22,500    |                      |  | $                                  | 4.40 |      |  |  | 1,977,500 |          
|                                                               |       |                         |           |                      |  |                                    |      |      |  |  |           |          
|                                                               | Total |                         |           | 7,362,916            |  |                                    | $    | 9.64 |  |  |           | 5,286,427 | 
|                                                               |       |                         |           |                      |  |                                    |      |      |  |  |           |          



---



|    |                                                                                                                                                  
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes only options outstanding under ESS
    stock option plans, as no stock warrants or rights were
    outstanding as of December 31, 2002.
|   
|(2) | Includes 271,502 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.

68



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##### Table of Contents



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 8,
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. | Controls and Procedures.



| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (a) | Evaluation of disclosure controls and procedures.
    Our chief executive officer and our chief financial officer,
    after evaluating the effectiveness of our disclosure
    controls and procedures (as defined in the Securities
    Exchange Act of 1934 Rules 13a-14(c) and 15d-14(c)) as of a
    date (the Evaluation Date) within 90 days
    before the filing date of this Annual Report, have concluded
    that as of the Evaluation Date, our disclosure controls and
    procedures were adequate and designed to ensure that material
    information relating to us and our consolidated subsidiaries
    would be made known to them by others within those entities. It
    should be noted that the design of any system of controls is
    based in part upon certain assumptions, and there can be no
    assurance that any design will succeed in achieving its stated
    goals.
|
| | (b) | Changes in internal controls. There were no
    significant changes in our internal controls or to our knowledge
    other factors that could significantly affect our disclosure
    controls and procedures subsequent to the Evaluation Date.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              




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

69



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##### Table of Contents



REPORT OF INDEPENDENT ACCOUNTANTS 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 24, 2003
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

January 24, 2003


70



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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, 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 | 
|                             | Valuation allowance on deferred tax assets |                | $ |           |  |            | $ |           |  |  | $ |       |   |  | $ |       | 
|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 | 
|                             | Valuation allowance on deferred tax assets |                | $ | 9,485      |  |            | $ |           |  |  | $ | 9,485  |   |  | $ |       | 
|Year Ended December 31, 2000 |                                            |                |   |            |  |            |   |            |  |  |   |        |   |  |   |       
|                             | Allowance for doubtful accounts            |                | $ | 2,459      |  |            | $ | 1,534      |  |  | $ | 1,600  |   |  | $ | 2,393  | 
|                             | Allowance for sales returns                |                |   | 315        |  |            |   | 7,110      |  |  |   | 6,505  |   |  |   | 920    | 
|                             | Inventory reserves                         |                |   | 18,147     |  |            |   | 10,236     |  |  |   | 1,343  |   |  |   | 27,040 | 

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 37 and page 70,
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.                            
|        | 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.                                                   
|        | 4.01  |               |  | Registrants Registration Rights Agreement
    dated May 28, 1993 among the Registrant and certain
    shareholders, incorporated herein by reference to
    Exhibit 10.07 to the Form S-1 (file no. 33-95388).                                                                       
|        | 10.02 |               |  | Registrants 1992 Stock Option Plan and
    related documents, incorporated herein by reference to
    Exhibit 10.02 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).*                                                                                                                                                     

71



---



##### Table of Contents



|        |       |               |  |                                                                                                                                                                                                                                                                                                                                                                                  
|------- | ----- | ------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       |              
|Number  |       | Exhibit Title
|        |       |              
|        | 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 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 Registrant and
    TSMC dated November 30, 1995, incorporated herein by
    reference to Exhibit 10.22 to the 1995 Form 10-K (file
    no. 000-26660).**                                                                                                                                                                                             
|        | 10.23 |               |  | Foundry Venture Agreement between 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 21, 2001, incorporated herein by
    reference to Exhibit 10.35 to the Registrants
    Quarterly Report on Form 10-Q (file no. 000-26660)
    filed August 15, 2001.                                                                                                                                     
|        | 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 1977 Equity Incentive Plan,
    amended and restated as of April 20, 2002, incorporated
    herein by reference to Exhibit 10.36 to the
    Registrants Quarterly Report on Form 10-Q (file
    no. 000-26660) filed August 15, 2001.*                                                                                                                             
|        | 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 ESS Technology,
    Inc. 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.*                                                                                                                                                                                                                                                                                                   
|        | 10.49 |               |  | Registrants 1995 Director Stock
    Option Plan and related documents as amended.*                                                                                                                                                                                                                                                                                             
|        | 10.50 |               |  | Joint Development Agreement dated
    December 14, 2001.**                                                                                                                                                                                                                                                                                                                       
|        | 10.51 |               |  | Amendment to Joint Development Agreement dated
    January 18, 2003.**                                                                                                                                                                                                                                                                                                           
|        | 11.01 |               |  | Computation of Net Income Per Share.                                                                                                                                                                                                                                                                                                                                             
|        | 21.01 |               |  | List of Registrants subsidiaries.                                                                                                                                                                                                                                                                                                                                               
|        | 23.01 |               |  | Consent of Independent Accountants.                                                                                                                                                                                                                                                                                                                                              

72



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##### Table of Contents



|        |      |               |  |                                                                                                                                
|------- | ---- | ------------- |  | -------------------------------------------------------------------------------------------------------------------------------
|Exhibit |      |              
|Number  |      | Exhibit Title
|        |      |              
|        | 99.1 |               |  | Certification Pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002.
|        | 99.2 |               |  | 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:



| |                                                                                                                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | None.                                                                                                                                                                                                                                                               
|
| | With the exception of the information
    incorporated by reference to the our Proxy Statement for the
    2003 Annual Meeting of Shareholders in Items 10, 11, 12 and
    13 of Part III, the Proxy Statement is not deemed to be
    filed as part of this Report.

73



---



##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13 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 31, 2003

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 31, 2003
|                                  
|/s/ JAMES B. BOYDJames B. Boyd     |  | Chief Financial Officer and Assistant Secretary
    (principal financial officer) |  | March 31, 2003
|                                  
|/s/ FRED S.L. CHANFred S.L. Chan   |  | Chairman of the Board of Directors                                                |  | March 31, 2003
|                                  
|/s/ PETER T. MOKPeter T. Mok       |  | Director                                                                          |  | March 31, 2003
|                                  
|/s/ DAVID S. LEEDavid S. Lee       |  | Director                                                                          |  | March 31, 2003
|                                  
|/s/ DOMINIC NGDominic Ng           |  | Director                                                                          |  | March 31, 2003

74



---



##### Table of Contents






CERTIFICATIONS

I, Robert L. Blair, certify that:



| |                                                                                                                                                                                                                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1.     I have reviewed
    this annual report on Form 10-K of ESS Technology, Inc.;                                                                                                                                                                                                                                                                    
|
| | 2.     Based on my
    knowledge, this annual report does not contain any untrue
    statement of a material fact or omit to state a material fact
    necessary to make the statements made, in light of the
    circumstances under which such statements were made, not
    misleading with respect to the period covered by this annual
    report;
|
| | 3.     Based on my
    knowledge, the financial statements, and other financial
    information included in this annual report, fairly present in
    all material respects the financial condition, results of
    operations and cash flows of the registrant as of, and for, the
    periods presented in this annual report;                       
|
| | 4.     The
    registrants other certifying officers and I are
    responsible for establishing and maintaining disclosure controls
    and procedures (as defined in Exchange Act Rules 13a-14 and
    15d-14) for the registrant and have:                                                                                                          



| |                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this annual report is being prepared;
|
| | b) evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this annual
    report (the Evaluation Date); and                                                                                                      
|
| | c) presented in this annual report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date;                                                                                                                                



| |                                                                                                                                                                                                                                                                           
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 5.     The
    registrants other certifying officers and I have
    disclosed, based on our most recent evaluation, to the
    registrants auditors and the audit committee of
    registrants board of directors (or persons performing the
    equivalent functions):



| |                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) all significant deficiencies in the
    design or operation of internal controls which could adversely
    affect the registrants ability to record, process,
    summarize and report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | b) any fraud, whether or not material, that
    involves management or other employees who have a significant
    role in the registrants internal controls; and                                                                                                                                                    



| |                                                                                                                                                                                                                                                                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 6.     The
    registrants other certifying officers and I have indicated
    in this annual report whether there were significant changes in
    internal controls or in other factors that could significantly
    affect internal controls subsequent to the date of our most
    recent evaluation, including any corrective actions with regard
    to significant deficiencies and material weaknesses.



| |                                          
| | -----------------------------------------
| | /s/ ROBERT L. BLAIR                      
| |                                          
| | Robert L. Blair                          
| | President and Chief Executive
    Officer

Date: March 31, 2003

75



---



##### Table of Contents



I, James B. Boyd, certify that:



| |                                                                                                                                                                                                                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1.     I have reviewed
    this annual report on Form 10-K of ESS Technology, Inc.;                                                                                                                                                                                                                                                                    
|
| | 2.     Based on my
    knowledge, this annual report does not contain any untrue
    statement of a material fact or omit to state a material fact
    necessary to make the statements made, in light of the
    circumstances under which such statements were made, not
    misleading with respect to the period covered by this annual
    report;
|
| | 3.     Based on my
    knowledge, the financial statements, and other financial
    information included in this annual report, fairly present in
    all material respects the financial condition, results of
    operations and cash flows of the registrant as of, and for, the
    periods presented in this annual report;                       
|
| | 4.     The
    registrants other certifying officers and I are
    responsible for establishing and maintaining disclosure controls
    and procedures (as defined in Exchange Act Rules 13a-14 and
    15d-14) for the registrant and have:                                                                                                          



| |                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this annual report is being prepared;
|
| | b) evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this annual
    report (the Evaluation Date); and                                                                                                      
|
| | c) presented in this annual report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date;                                                                                                                                



| |                                                                                                                                                                                                                                                                           
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 5.     The
    registrants other certifying officers and I have
    disclosed, based on our most recent evaluation, to the
    registrants auditors and the audit committee of
    registrants board of directors (or persons performing the
    equivalent functions):



| |                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) all significant deficiencies in the
    design or operation of internal controls which could adversely
    affect the registrants ability to record, process,
    summarize and report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | b) any fraud, whether or not material, that
    involves management or other employees who have a significant
    role in the registrants internal controls; and                                                                                                                                                    



| |                                                                                                                                                                                                                                                                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 6.     The
    registrants other certifying officers and I have indicated
    in this annual report whether there were significant changes in
    internal controls or in other factors that could significantly
    affect internal controls subsequent to the date of our most
    recent evaluation, including any corrective actions with regard
    to significant deficiencies and material weaknesses.



| |                        
| | -----------------------
| | /s/ JAMES B. BOYD      
| |                        
| | James B. Boyd          
| | Chief Financial Officer

Date: March 31, 2003

76



---



##### Table of Contents



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.                                                                                                                       
|        | 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.                                                                                                                                               
|        | 4.01  |               |  | Registrants Registration Rights Agreement
    dated May 28, 1993 among the Registrant and certain
    shareholders, incorporated herein by reference to
    Exhibit 10.07 to the Form S-1 (file no. 33-95388).                                                                                                                                                                  
|        | 10.02 |               |  | Registrants 1992 Stock Option Plan and
    related documents, incorporated herein by reference to
    Exhibit 10.02 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 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 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 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 21, 2001, incorporated herein by
    reference to Exhibit 10.35 to the Registrants
    Quarterly Report on Form 10-Q (file no. 000-26660)
    filed August 15, 2001.                                                                                                                                     
|        | 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 1977 Equity Incentive Plan,
    amended and restated as of April 20, 2002, incorporated
    herein by reference to Exhibit 10.36 to the
    Registrants Quarterly Report on Form 10-Q (file
    no. 000-26660) filed August 15, 2001.                                                                                                                              



---



##### Table of Contents



|        |       |               |  |                                                                                                                                                                                                                                                                                            
|------- | ----- | ------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       |              
|Number  |       | Exhibit Title
|        |       |              
|        | 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 ESS Technology,
    Inc. 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.*                                                                                                                                                                                                             
|        | 10.49 |               |  | Registrants 1995 Director Stock
    Option Plan and related documents as amended.*                                                                                                                                                                                                       
|        | 10.50 |               |  | Joint Development Agreement dated
    December 14, 2001.**                                                                                                                                                                                                                                 
|        | 10.51 |               |  | Amendment to Joint Development Agreement dated
    January 18, 2003.**                                                                                                                                                                                                                     
|        | 11.01 |               |  | Computation of Net Income Per Share.                                                                                                                                                                                                                                                       
|        | 21.01 |               |  | List of Registrants subsidiaries.                                                                                                                                                                                                                                                         
|        | 23.01 |               |  | Consent of Independent Accountants.                                                                                                                                                                                                                                                        
|        | 99.1  |               |  | Certification Pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002.                                                                                                                                                            
|        | 99.2  |               |  | 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.