As of June 28, 2002, the last business day of the Registrant's most recently completed second fiscal quarter, there were approximately 5,961,127 shares of the Registrant's Common Stock outstanding. The aggregate market value of the Common Stock held by non-affiliates of the Registrant (based on the closing price for the Common Stock on the Nasdaq National Market on June 28, 2002) was approximately $6,569,663. Shares of the registrant's Common Stock held by each executive officer and director and by each entity that owns 5% or more of the registrant's Common Stock 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.

DOCUMENTS INCORPORATED BY REFERENCE

      Portions of the Registrant's Definitive Proxy Statement for the Registrant's 2003 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K to the extent stated herein. The Proxy Statement will be filed within 120 days of Registrant's fiscal year ended December 31, 2002.

DIGITAL VIDEO SYSTEMS, INC.

ANNUAL REPORT ON FORM 10-K
Year Ended December 31, 2002
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This Annual Report on Form 10-K includes "forward-looking statements" within the meaning of the federal securities laws, particularly statements referencing gross margin costs and operating expenses; factory utilization rates; the sufficiency of our cash balances and cash flows for the next twelve months; potential investments of cash or stock to acquire or invest in complementary businesses, products or technologies; the impact of recent changes in accounting standards; and assumptions underlying any of the foregoing. In some cases, forward-looking statements can be identified by the use of terminology such as "may," "will," "expects," "intends," "plans," "anticipates," "estimates," "potential," or "continue," or the negative thereof or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, these expectations or any of the forward-looking statements could prove to be incorrect, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to risks and uncertainties, including but not limited to the factors set forth in "Factors That May Affect Future Results" and elsewhere in this report. All forward-looking statements and reasons why results may differ included in this report are made as of the date hereof, and we assume no obligation to update any such forward-looking statements or reasons why actual results may differ.

Digital Video Systems, Inc. ("DVS" or the "Company") (NASDAQ: DVID) is a technology company specializing in the development and application of digital video technologies that enable the convergence of data, digital audio, digital video and high-end graphics. DVS's mission is to be the leading DVD (Digital Versatile Disc) solution provider and remain at the forefront of this technology convergence. Our current product offerings include DVD loaders, the principal hardware component of DVD players and DVD-ROM drives, as well as a portfolio of other related products.

DVS was founded in 1992 to develop, manufacture and market digital video compression and decompression hardware and software for entertainment, commercial and educational applications. Since our inception, we have been involved in the marketing and development of a variety of products and technologies in the digital video arena, such as video CD players, the design of decoder chips, networked video servers that provide near Video-on-Demand, digital Ad-Insertion systems that automatically insert digital video commercials into broadcasting programs, video players for commercial kiosk applications, DVD players under agreements with original equipment manufacturers (OEM's) or under the DVS brand name, and other products developed for the computer peripheral market. During the fiscal year ended March 31, 1999, we migrated our product offerings into DVD technology, while phasing out certain older discontinued product lines. Our current product offerings primarily include DVD loaders and other DVD sub-systems and components.

During the fiscal year ended on March 31, 1997, we completed our initial public offering and a follow-on public offering, generating total net proceeds of approximately $43.7 million.

In June 1998, DVS's founder, Dr. Edmund Y. Sun, introduced the opportunity to acquire Hyundai Electronics Industries, Co., Ltd's ("Hyundai") DVD operations. To aid DVS in completing the acquisition, Dr. Sun provided a $1.0 million loan to DVS as a short-term note that was converted to 190,211 shares of common stock in July 1998. With the $1.0 million cash and 285,714 shares of our common stock, DVS was able to complete the acquisition. The shares of our common stock were issued to Hyundai in exchange for a perpetual, worldwide, royalty-free license to Hyundai's DVD technologies and related intellectual properties. The $1.0 million cash was paid to Hyundai to acquire its production equipment, inventory, production supplies, test equipment, furniture and computer systems of Hyundai's DVD-ROM operations.

Pursuant to an Investment Agreement dated October 15, 1998, Oregon Power Lending Institution ("OPLI") and certain investors had the right to invest up to $12.25 million in the Company. By March 31, 1999, OPLI had provided DVS with $6.5 million in additional financing. The cash infusion from OPLI enabled us to establish the operations of DVS Korea Co., Ltd., our Korean subsidiary ("DVS Korea" or "DVSK"), provide the working capital required to expand DVS Korea's DVD production, increase sales, reduce certain liabilities, pay certain costs relating to corporate restructuring, as well as provide capital for continued marketing, R&D and corporate overhead expenses.

In late 1999, DVS and Shanghai Industrial Investment Group ("SIIG") began negotiations to establish a business relationship for the purpose of manufacturing DVD loaders in mainland China. The purpose of the proposed joint venture in Shanghai China was to allow the Company to take advantage of certain tax savings and lower production costs. Under certain Chinese tax regulations, a Chinese corporate entity may be entitled to two years of complete tax exemption and three years of 50% tax reduction thereafter, commencing from the first profit-making year, net of losses carried forward. Also, since many DVD player manufacturers are already located in China, the resulting shipping time and cost savings we expected to be substantial. The joint venture, Shanghai Fangyuan Digital Technology Ltd. ("SFDT") was formed. SFDT is 51% owned by our Korean subsidiary, 10% owned directly by DVS, and 39% owned by SIIG.

The manufacturing facilities of SFDT began operations in May 2001 and over one million units were produced in its first year of operation. At times during the year 2002, SFDT achieved a production rate as high as 500,000 units per month.

The manufacturing facilities of SFDT occupy approximately 73,000 square feet in a six-story building acquired by SFDT in 2001, located in an industrial park in Shanghai, China. The first two floors are used as warehouse space, the next three floors are used for production and the sixth floor is used as SFDT's administrative offices. Each production floor can house up to four assembly lines. We believe that this facility has dramatically increased our capacity to meet future production demands.

New Korean Factory Opened

During the fourth quarter of 2001, DVS Korea opened a new factory in Korea to produce high end products expected to have greater margins and higher quality control. The new Korea factory occupies approximately 39,000 square feet and is situated in a 155,830 square foot parcel of land. The land is owned by the Korean government, which has granted the Company a 20-year rent-free lease. The building is owned by DVS Korea. The factory can accommodate up to six assembly lines. With the addition of this production capacity, we believe DVS is well positioned to continue to expand its market share and to create certain competitive advantages.

In September 2002, DVS Korea successfully completed a public offering of 6 million common shares of DVSK on the KOSDAK Exchange (a Korean stock market) with trading beginning on October 1, 2002. The value of the proceeds to the subsidiary was approximately $11 million. The proceeds will be used to fund new product activities, including a DVD player for the automobile market, rewritable DVD drives for the computing and home markets, and establishing a new venture, MobileTouch Korea, to develop and market new products for the digital video and audio markets with a focus on mobile applications. Additionally, the proceeds will support the increasing production of our current products.

The ability to realize a higher valuation for DVSK's equity in Korea ($40 million U.S.) was a key factor in our decision to raise capital on the KOSDAQ, and reflects DVS's belief regarding its position as a leading worldwide supplier in the growing DVD market segment. Although the offering dilutes our ownership from 74.6% to 51.4%, we expect to continue to be the majority shareholder of DVSK. In March 2003, Dr. Edmund Sun, Doug Watson and Robert Baker, each an executive officer of DVS, joined the DVS Korea (DVSK) board to take a more active role in the day-to-day workings of this key subsidiary as it plans for greater margin potential through new products.

Our current product offerings consist primarily of DVD loaders and other DVD sub-systems and components. We also produce and/or market other products for the consumer, commercial video and computer peripherals markets, which are described in greater detail below. During late 1999, due to the global over-supply of DVD-ROM drives, we stopped our production of DVD-ROM drives and devoted our DVD production lines to the production of DVD loaders, which were then, and are now, more profitable and in higher demand.

We have developed a number of models of DVD loaders with the ATAPI or AV interfaces, which are offered with competitive pricing, quality, functionality and service. The ability to read imperfect discs is an important differentiating factor in this market and we believe that our DVD products have earned an excellent reputation with respect to this factor.

On a smaller scale, our product offerings include other computer peripherals, such as rewritable compact discs (CD-RWs), thin-film-transistor liquid crystal display (TFT LCD) monitors, and DVD players. Sales of these products accounted for less than 3% of our revenue in 2002 and 2001.

Because of DVS's firm position in the DVD loader market and despite a general downturn in the economy, DVS has experienced large growth in unit shipments. In recent years, DVS estimates that it has captured one third of the non-captive DVD loader market. The issue confronting DVS, however, is that with competition mounting and the precipitous decline in end-user prices for DVD players, gross margins for DVD loaders have and may continue to decline. As is typical with consumer electronic products, gross margins are inversely proportional to the growth in unit shipments.

During fiscal 2002, most of our research and development efforts focused on enhancing our DVD technologies, improving product quality, reducing costs of manufacturing, enhancing product functionality, adopting new and improved key components, developing new product, and improving the integration of our products by our customers. Currently, we are developing more advanced DVD loaders including a front loader intended for the automobile audio and video market and a DVD-RW intended for the home video and PC market. The DVD-RW product enables users to record data to a DVD-RW disc for any application including the creation of DVD's made from home videos, high capacity data backups and the capability of copying VHS tapes (movies) to discs. Working prototypes of these products were demonstrated at the annual meeting of shareholders of DVS Korea on March 28, 2003. We are optimistic as to the rate of growth and eventual size of the world-wide DVD drive market and we hope to expand our presence in all segments of the DVD drive market.

As noted above, we have sought to diversify our product base through increased emphasis on new products such as the rewritable drive which we anticipate will enjoy much greater margins and, more importantly, will sell into the larger market and customer base that DVSK has successfully established with our DVD loader products. In merging these vital areas of development in 2003, we expect to generate losses as we invest heavily in R&D personnel and engineers.

As of December 31, 2002, we had 49 engineering personnel, some of whom focus on supporting our sales and marketing efforts in connection with customizing product applications for specific customers.

Our research and development efforts involve numerous risks. These efforts may not progress as anticipated, and we may not be able to reduce costs sufficiently to be able to compete with others marketing similar products, and our new product models may not be developed on a timely basis.

We sell our DVD loaders to original equipment manufacturers ("OEMs") of DVD players that do not independently produce the DVD loaders used in their DVD players. Many of these OEMs are located in China, including Hong Kong, Turkey, Korea and other countries. China is one of the largest markets for DVD players, and some of the DVD player manufacturers in China have been active in exporting their products outside China at very competitive prices. Some of these DVD player models have been offered in the United States and Europe under other brand names.

During fiscal 2002, due to active marketing and field engineering, the unit sales of our DVD loaders have continued to increase relative to prior periods. This increase has enabled us to hold our current market share in this market.

In the past, we sold CD-based Video Engine products to Kiosk distributors, who integrated our products as part of a complete solution that included software titles. Subject to favorable evaluation of this product line, we may develop and introduce next generation Video Engines to incorporate the current DVD technologies. We are currently preparing a proposal relating to a potential Kiosk application for the gaming industry in England.

Our sales and marketing personnel attend tradeshows to increase the awareness and interest in our product offerings. We employ ten full time marketing and sales personnel based primarily in South Korea, who travel to other parts of the world to sell our products to OEM's.

DVS has embarked on a program of diversification of product lines, expansion and ongoing support of existing its customer base, participation in standards development, rigorous patent research, patent acquisition, and patent filing, aggressive marketing, continued manufacturing process reviews to reduce costs and/or increase productivity, and ongoing research and development of new products utilizing the newest technologies.

A critical success factor for technology companies in the consumer electronics sector is the ability to judge emerging standards and extrapolate how the new standards will affect the demand and supply for current and future commercial products. DVS believes that the soon to be adopted MPEG-4AVC, or H.264AVC or MPEG-4 part 10, as it is otherwise known, is such a standard that will ultimately replace MPEG2 and MPEG4.

The practical implications of MPEG-4AVC (with a 100% or more compression improvement over current MPEG-4 technology) could allow a tenfold increase in the amount of DVD-quality video stored on a typical DVD disc; allow the storage of full-length HDTV programming on current DVDs without resorting to new hardware based on blue-laser technologies; provide the compression needed to stream high-quality video to mobile phones over the existing GPRS network; or enable DVD quality video to be streamed over current broad band connections.

Other MPEG-4AVC research involves implementing the new compression technology in devices capable of supplying HDTV programming on DVD players based on existing low-cost disc and player technologies. All other current alternatives to provide HDTV-quality video on discs, including blue laser technology, would require significant retooling in authoring, disc and player manufacturing, and would rely on expensive new technologies. The new MPEG4 AVC standard, although based on complex software technology, will require only minor changes in the existing authoring, content production and consumer electronics manufacturing. Ultimately, DVS believes that it could further develop this technology into products such as HDTV recorders for home markets.

To capitalize on products utilizing the new MPEG-4AVC technology, in November of 2002, we entered into an exclusive licensing agreement with Jeecom, Inc. to develop, market, and sell its existing and future software products aimed at the wireless mobile marketplace. Jeecom MBI, (Mobile Business Intelligence), is the primary product designed to enable users to access and interact with all types of corporate database applications from almost any mobile device, including laptop computers, PDAs, and virtually all mobile phones. Other derivative products address a variety of specialized and consumer mobile applications. Jeecom, Inc. was founded by Dr. Edmund Sun, DVS's Chief Technology Officer. Dr. Sun is the majority owner of Jeecom, Inc.

By acquiring this license we are now poised to successfully incorporate the soon-to-be-adopted standards for new MPEG4 part 10 technologies with innovative software designed for the mobile business market. The Jeecom software provides the platform for successfully integrating video and other multimedia products for the mobile market, while the next-generation video compression standard should further enhance this new effort. This agreement gives us the exclusive ability to sell and distribute Jeecom software to a majority of the world's markets. The licensing agreement also extends to hardware applications and represents the potential to generate new revenue streams for DVS, DVS Korea and our new MobileTouch subsidiaries.

MobileTouch Korea, a wholly owned subsidiary of DVS Korea, and MobileTouch, Inc. ("MobileTouch USA"), a wholly owned subsidiary of DVS, were both incorporated in January 2003. These two new wholly-owned subsidiaries are examples of diversification toward broader and more navigable revenue streams to be derived from new products based on emerging compression technologies employing the revolutionary MPEG4- Part 10 AVC-264 standard. These enterprises are expected to enable DVS to develop new products for the mobile marketplace in addition to its established DVD market.

MobileTouch USA, in partnership with Jeecom, Inc., will develop new products and applications directed at the corporate and consumer mobile applications markets and with a particular focus on media-rich applications for the consumer market. This project is part of an ongoing partnership between DVS and Jeecom, Inc. to develop software that is designed to allow mobile wireless users to access data, information, video and audio and other services from a remote PC. The initial products under development will focus primarily on consumer-oriented entertainment applications allowing mobile wireless users to access photographs, MP3 audio and video content from their personal computer.

DVS has embarked on a program of diversification of product lines; an expansion of its customer base and ongoing support of existing customer base; participation in standards development efforts; rigorous patent research, patent acquisition, and patent filing; aggressive marketing; continued manufacturing process review to reduce costs and/or increase productivity; and ongoing research and development of new products utilizing the newest technologies.

We rely on a combination of patent, copyright, trademark and trade secret rights, confidentiality procedures and licensing arrangements to establish and protect our proprietary rights. As part of our confidentiality procedures, we generally enter into non-disclosure agreements with our employees, distributors and corporate partners and into license agreements with respect to our software, documentation and other proprietary information. In addition, we have patents and design rights granted in the United States and Korea covering our intellectual property rights for periods ranging from 9 to 17 years. Our patents, design rights and other intellectual property rights are the basis for our product development efforts and are important to our overall business. These patents and design rights include areas such as DVD video, DVD ROM, and video recording to hard drive applications. We cannot be certain that these measures will adequately protect our intellectual property rights.

There are a number of foreign-based electronic manufacturers substantially larger in size and greater in financial, marketing, and other resources than us, such as, Thomson Electronics, Sanyo and Phillips that are competitors or potential competitors with respect to our DVD products. Some competitors may develop alternative products to compete with our products. They may also begin operations or expand their existing operations into our market segments. In the distribution and sales of our other products, there are also many well-known competitors with substantially greater resources.

The competitive environment is becoming more demanding due to a number of factors, including the following:  

• an increase in the number of new market entrants;
• intensifying competition in the industry;
• rapid technological progress;
• oversupply of digital products; and
• global price erosion.

We believe, however, that our product mapping and development, the high quality of our products, our reputation of innovative product introductions, product improvements and service, and our extensive sales, marketing and servicing efforts are the important factors that help us remain competitive with respect to each of the competitive factors set forth above.

From the outset, our essential strategy has been to provide each major customer with changes required of our basic design to insure compatibility with individual customer demands. Additionally we have emphasized the need to decrease "time to market", as our major competitors are very large organizations that are unable to move as rapidly to meet market demands.

In adjusting to the swiftly-evolving digital world, DVS has entered a period of exploring new avenues of enterprise as we adapt our resources to research and development of revenue streams in both technology and product areas offering higher margins. DVS is committed to further advancing these technologies and commercializing them to create profitable product lines in order to sustain its competitive advantage.

Our rapid advancement for the past four years has been fueled by an unprecedented global appetite for our primary product, the DVD loader, the chief component of the popular DVD player. The demand for the DVD loader soon eclipsed other items in our product line, such as decoder chips, networked video servers, and video players for commercial kiosk applications. During this phase of advancement, our subsidiary DVS Korea focused upon two customer driven demands: 1) the need to focus engineering expertise on cost-reduction efforts for our prime product, the DVD loader to maximize manufacturing margins and thereby maintain profits and 2) providing our existing OEM customers with custom design and value engineering options tailored to their specific needs. To maintain and enhance our existing core business, addressing these existing customer demands took precedence over the need for new product development.

As our market share in the DVD loader showed the expected attrition from encroaching competition, we have sought to diversify through increased emphasis on new products such as the rewritable drive which we anticipate will enjoy much greater margins and, more importantly, will sell into the larger market and customer base that DVSK has successfully established with our DVD loader products. In merging these vital areas of development in 2003, we expect to generate losses as we invest heavily in R&D personnel and engineers.

With the erosion in gross margins for its current product offerings, DVS is consciously shifting gears to focus on its real strength, the ability to innovate and develop leading-edge technologies and commercialize new products. DVS is ready to enter into new markets by leveraging its accumulated wealth of knowledge and experience and developing newer, bolder and more advanced products such as the DVD Loader/Player, the Car DVD Audio and Video Player, and the Recordable DVD Player. We are also developing MobileTouch products with our timely development of (1) software required to optimize the utilization of new MPEG-4 part 10 video compression in mobile wireless products and (2) software in support of the decoder chip also being developed by MobileTouch USA that we expect will provide DVS with higher margins and a sustainable competitive advantage in this market.

At March 31, 2003, we had 470 full time employees, including employees of our subsidiaries. We believe that our future prospects will depend, in part, on our ability to obtain additional management, finance, accounting, marketing, sales, manufacturing and technical personnel. Competition for such personnel is substantial and the number of persons with relevant experience is limited. None of our employees is represented by a labor union. We believe that our employee relations are good.

As of March 31, 2003, we had the following facilities leased from third parties, where our executive offices, manufacturing, engineering, research and development and testing facilities are located.

We believe these facilities are adequate and suitable to meet our needs for at least the next 12 months. Our principal executive offices are located at 1731 Technology Drive, Suite 810, San Jose, California 95110, and our telephone number at that location is (408) 392-0268. We were incorporated in Delaware in October 1992.

We may from time to time become a party to various legal proceedings arising in the ordinary course of our business. We do not believe that the outcome of any of such legal matters arising in the ordinary course of business will have a material adverse effect on our business, operating results or financial condition.

On December 4, 2001, a lawsuit was filed in United States District Court, Northern District of California against DVS and certain directors, officers and employees of DVS. The plaintiffs in the foregoing action are certain investors that purchased securities from DVS in May 2001 and July 2001 in transactions not involving a public offering. The complaint relating to these transactions purports to allege claims relating to violations of state and federal securities laws, breach of fiduciary duties, breach of contract, fraud and negligent misrepresentation. The plaintiffs seek declaratory judgment relief, compensatory damages in excess of $1,000,000, punitive damages and costs of the suit, including attorneys' fees. DVS has reached a settlement related to this matter and the Company has accrued and reflected in general and administrative expense $465,000 during December 31, 2002 related to the lawsuit.

On June 18, 2001, the Company filed a lawsuit in the Santa Clara County Superior Court against Ernst & Young, LLP, the Company's former auditors. The complaint includes claims of professional negligence, breach of contract, breach of fiduciary duty, fraud and deceit. The case was originally scheduled for mediation in October 2002. Mediation has been scheduled for April 28, 2003, pending discussion between the parties.

On June 24, 2002, the Company filed a lawsuit in the Santa Clara County Superior Court against Mali Kuo, Michael Chen, Meng Tek Ung and Doe's 1 through 50, alleging breach of fiduciary duty and seeking declaratory relief, cancellation and rescission of certain written agreements, damages, costs and attorneys' fees. Of the named defendants, Ms. Kuo and Mr. Chen, were both directors and executive officers of the Company for periods between 1999 and 2002, and Mr. Ung was an executive officer of the Company from 1999 to 2002. The complaint alleges that Ms. Kuo breached her fiduciary duties of care and loyalty when she defrauded the Company and misappropriated Company property with the purpose of furthering the private interests of all defendants. The complaint has been served on Mr. Chen and Ms. Kuo, but the Company has not yet been able to serve the other named or unnamed defendants as they reside outside of the United States. The Company believes it will obtain a favorable outcome to the suit. As of December 31, 2002, the Company has received Mr. Chen and Ms. Kuo's counter claim with respect to alleged unpaid wages and expenses. The Company has established an accrual of $650,000 for wages and expenses related to prior employment of Mr. Chen and Ms. Kuo which the Company believes is adequate.

DVS has been named as a defendant in several other lawsuits in the normal course of its business. In the opinion of management, after consulting with legal counsel, the liabilities, if any, resulting from these matters will not have a material effect on the consolidated financial statements of the Company.

While we have accrued certain amounts for the estimated legal costs associated with defending these matters, there can be no assurance that these cases and other third party assertions will be resolved without costly litigation, in a manner that is not adverse to our financial position, results of operations or cash flows or without requiring royalty payments in the future which may adversely impact gross margins. No estimate can be made of the possible loss or possible range of loss associated with the resolution of these contingencies.

No matters were submitted to a vote of security holders during the fourth quarter of fiscal 2002.

The following table sets forth certain information concerning our executive officers as of March 15, 2003:

Our executive officers are appointed by, and serve at the discretion of, the Board of Directors. Each executive officer is a full-time employee. There is no family relationship between any of our executive officers or directors.

Dr. Edmund Y. Sun founded DVS in 1992 and has served as Chief Technical Officer since June 1998, also having served as CEO, President and Chairman of the Board. In addition to his distinguished contributions to DVS, Dr. Sun was a co-founder of C-Cube Microsystems Inc., a public company involved in the development of full-color still and motion picture compression technology, and was both its CEO and Chairman of the Board. C-Cube was acquired by LSI Technologies in 2001.

Dr. Sun, who has a Ph.D. in Applied Physics and an M.S. in Electrical Engineering from California Institute of Technology and a B.S. in Electrophysics from National Chiao-Tung University in Taiwan, has played a pivotal role in the Digital Versatile Disc (DVD) advances of the last decade. Dr. Sun is also the CTO of the new DVS R&D subsidiary, MobileTouch USA, and is responsible for the leadership of a multinational team of engineers operating in the US, Ireland, Taiwan, Japan and in Korea with DVS subsidiary, DVS Korea. Dr. Sun is also the founder of Jeecom, Inc. an enterprise level software company, now working in partnership with DVS.

Douglas T. Watson, Chief Executive Officer

Douglas T. Watson has served as Chief Executive Officer of DVS since February 2002. In addition, Mr. Watson has been a member of the DVS Board of Directors since November 1998, the year in which he successfully facilitated a $6 million dollar investment from Oregon Power Institution (OPLI) enabling DVS to acquire the Hyundai Electronics DVD unit, its intellectual properties, patents and management team which later became DVS Korea. Mr. Watson served on the DVS Executive Committee from November 1998 to March 2002.

Prior to joining DVS, Mr. Watson held the role of President and CEO of Astoria Metal Corporation (AMC), a California based ship repair and dismantling firm he founded in 1992. AMC and affiliated companies were responsible for multi-million dollar contracts with major oil and gas companies such as Chevron and BP for oil tanker repair projects and other required assignments. During the 1980's Mr. Watson served in the Far East as a consultant to Exxon Corporation.

Robert Baker has served in his current role of Chief Financial Officer of DVS since June 2002. Mr. Baker previously served DVS as its Chief Financial Officer from June 1999 to April 2000 and in a consulting capacity for various projects from May 1997 to June 1999.

Mr. Baker's extensive financial career includes holding management positions with General Electric (GE) and IT&T before founding his own company, Baker Associates, Inc., a management consultant firm to the venture capital community.

Our common stock is listed on the Nasdaq SmallCap Market under the symbol "DVID." The following table sets forth, for the periods indicated, the high and low sales prices per share of our common stock as reported by the Nasdaq SmallCap Market for each quarter within the last two years.

On March 31, 2003, the last reported sale price for the common stock was $2.73 per share.

As of March 31, 2003, there were approximately 215 holders of record of our common stock. This number does not reflect the number of beneficial holders of the common stock, which we believe is more than 3,000.

We have never paid cash dividends on our common stock. At present, we intend to retain any earnings for use in our business and do not anticipate paying cash dividends in the foreseeable future.

1. See Note 1 of Notes to Consolidated Financial Statements for an explanation of the determination of the number of shares used to compute basic and diluted net loss per share.

The following discussion should be read in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this report. It is important to note that DVS changed its fiscal year end from March 31 to December 31, beginning with the year ended December 31, 2000. Therefore, the present report on Form 10-K covers the twelve month period for the years 2001 and 2002 and the nine month period for the year period ending December 31, 2000 and the pro-forma results for the nine month period ending December 31, 1999.

DVS derives over 95% of its revenues from the sale of loaders and components associated with DVD loaders to DVD player manufacturers. The majority of these sales are made to DVD player manufacturers in China, Korea and Turkey. Average selling prices of these products have declined rapidly over the past three years and currently are over 50% less than in the year 2000. In the year ending December 31, 2002, average loader prices declined 28%. The mix of sales continues to shift more to the components of the loader produced by the Company resulting in lower average selling prices which are also experiencing price erosion. The combination of lower prices for loaders and an unfavorable price mix has resulted in a leveling of revenues between the years 2001 and 2002. Unit shipments on the other hand have more than doubled in 2002 over 2001, allowing the Company to increase its market share to over 30% of the market for loaders sold to external player manufacturers who do not have their own loader technology. As our product line continues to mature we are likely to experience further declines in the average selling prices of our current product offerings. We are not able to predict the amount of such future change with any degree of certainty.

Our costs of goods sold which consist of purchased components representing about 90% of the loader cost have been reduced by about 40% over the past two years. Purchasing volume and lower costs of assembly in our China joint venture have allowed us to maintain some margin during this period of rapid sales price declines. At the present time gross margins have eroded to somewhere between 2% to 5%, depending on mix of products sold in the period. As previously stated, this unit price erosion and resulting reduction of gross margins is likely to continue during 2003. We are at a point where new products must be introduced if we are to experience any improvement in our rate of gross margin. The amount of engineering effort required to value engineer the loader product during the year 2002 has interrupted the "new product" programs of our Korean subsidiary, thereby causing delays in the introduction of new products such as DVD players for the automotive market and rewritable DVD drives for the computing and audio markets. The new product engineering group in Korea is currently working extended hours to get back on schedule, and we believe that the introduction of the two previously mentioned products will occur late in the third quarter of this year. Working prototypes of both these products were shown at the Korean subsidiary's annual meeting in March 2003. We are not able to predict the level of sales for these new products or their impact on our gross margins with any degree of certainty for the year 2003.

Our operating income as shown in the table below has gone from operating income of $1.8 million in fiscal year 2001 to an operating loss of $1.7 million in the year ended December 31, 2002. This unfavorable change of $3.5 million is made up of $0.7 million of increases in operating expense with the remaining $2.8 million loss accounted for by the decline in our gross margins resulting from average selling prices of loaders declining by 28%.

Additional new product activity has been initiated both in Korea and in the United States with the formation of MobileTouch Korea and MobileTouch USA, a wholly owned subsidiary of DVS Korea and the Company, respectively. The subsidiaries working in partnership with Jeecom, Inc. will develop new products and applications directed at the corporate and consumer mobile applications market, and in particular will focus on media rich applications for the consumer market. MobileTouch USA has begun the development of software required to optimize the utilization of new MPEG -4 part 10 video compression in mobile wireless products and software in support of the decoder chip also being developed by MobileTouch USA. We believe that this new standard offers substantial benefits to many potential product areas such as, low bandwidth video for mobile handsets, DVD video, broadband entertainment, and digital cinema. We do not expect any major sales activity from these developments in the year 2003.

In January 2003, the Company announced an exclusive licensing agreement with Jeecom, Inc., a company founded by, and whose majority owner is, Dr. Edmund Sun, the Company's Chief Technology Officer. The Jeecom, Inc. license and software provide the platform for integrating video and other multimedia products for the mobile market with the exclusive right to market the software to the major markets of the world.

As noted above, we have sought to diversify our product base through increased emphasis on new products such as the rewritable drive which we anticipate will enjoy much greater margins and, more importantly, will sell into the larger market and customer base that DVSK has successfully established with our DVD loader products. However, in merging these vital areas of development in 2003, we expect to generate losses as we invest heavily in R&D personnel and engineers.

Our Korean subsidiary (DVSK) raised approximately $10.7 million during the last year and coupled with its line of credit is expected to be able to fund new product programs and support the existing loader business in both Korea and China in the year 2003. The Company plans to meet its operating obligations for 2003 by raising money through private placements and receiving management fees from its Korean subsidiary.

The Company's minority interest liability increased significantly during September 2002 from the reduction of its ownership interest in DVS Korea, as a result of the $10.7 million from DVS Korea's initial public offering. The sale of the 23.2% interest in DVS Korea resulted in a gain from the sale of subsidiary common stock of $1,177,000, which has been reflected in additional paid-in capital at December 31, 2002.

The table that follows summarizes the impact of these factors on the Company's financial results (in millions):

The following table sets forth for the periods indicated certain income and expense items expressed as a percentage of the Company's total revenues for the twelve-month periods ended December 31, 2002 and 2001, the nine-month period ended December 31, 2000, and the unaudited nine months ended December 31, 1999. Please see our Consolidated Financial Statements of Operations and item 6 Selected Consolidated Financial Data for additional details.

As set forth above, total revenue in the twelve-month period ended December 31, 2002 was $157.2 million, about 1.7% less than the $159.9 million for the twelve-month period in 2001. The decrease in total revenue is primarily attributed to erosion of average selling prices for our products. Overseas sales represented over 95% of revenue for the twelve-months ended December 31, 2002, as was the case for the twelve-month period ended December 31, 2001. During the year ended December 31, 2002, Vestel was the only customer which accounted for over 10% of sales. During the twelve months ended December 31, 2001, SIIG, our joint venture partner in China, was our only customer which accounted for over 10% of sales. As mentioned previously, unit sales during 2002 more than doubled over 2001 with 4.9 million units shipped in 2002, as compared to 2.2 million units shipped in 2001.

The rapid decline in gross margin rates during the year 2001 and 2002 is almost entirely attributable to the decline in the selling prices of DVD loaders during these periods. Using the average selling price of December 2000 as the base period (100%), the following rates of decline occurred with respect to our margins:

In the fourth quarter of 2002 the average selling price of a DVD loader was only 41% of what it was in December of 2000, a reduction of 59%. The average selling price declined 43% in the year 2001 and 28% in the year 2002. Looking ahead to fiscal year ending December 31, 2003, we expect to experience continued pricing pressure as competition becomes more intense in the Company's customer base and the DVD market.

Our research and development expenses consist of salaries and related costs of employees engaged in ongoing research, design, and development activities and providing our existing OEM customers with custom design and value engineering options to meet their specific needs. R&D spending increased 20% or $0.5 million over 2001, particularly in the second half of the fiscal year as additional engineers and support staff were added to the Company in order to recover lost time in developing the new product programs and to initiate MobileTouch Korea's R&D efforts on the mobile phone hardware platform. With respect to our research and development efforts we expect to generate losses during 2003 as we invest heavily in R&D personnel and engineers.

	Twelve Months Ended December 31, 2002	Twelve Months Ended December 31, 2001	Nine Months Ended December 31, 2000	(Unaudited) Nine Months Ended December 31, 1999
	(In thousands)
Sales and marketing	$2,907	$2,173	$1,902	$1,652
As a percentage of revenue	1.8%	1.4%	2.6%	3.6%

Sales and marketing expense is comprised primarily of employee related expenses, export freight & insurance (when absorbed by the Company), and advertising/promotional costs. The Company has sales and marketing organizations in Korea, China and the U.S. These organizations have been significantly expanded due to the shift away from major distributors (Hyundai in Korea and SIIG in China) used in prior years. As a result, overall spending for sales and marketing increased 34%, or $0.7 million over 2001.

General and administrative expenses decreased in the year ended December 31, 2002 as compared to the year ended December 31, 2001 by 7% or $0.6 million. General and administrative expenses consist primarily of administrative salaries and benefits, insurance, facility, legal, accounting, investor relations and other business support costs. As reflected in the table above, general and administrative expenses as a percentage of revenue remained essentially constant when compared to the twelve-month period ended December 31, 2001.

The following table sets forth for the periods indicated certain income and expense items expressed as a percentage of the Company's total revenues for the twelve-month period ended December 31, 2001, the nine-month period ended December 31, 2000 and the fiscal year ended March 31, 2000. Please see our Consolidated Financial Statements of Operations for additional details.

As set forth above, total revenue in the twelve-month period ended December 31, 2001 was $159.9 million, about 119% higher than the $73.1 million for the nine-month period in 2000. This significant increase of $86.8 million was in part due to the additional three months of the current year period coupled with the additional manufacturing brought on-line in Korea and in Shanghai. Overseas sales represented almost 100% of revenue for the twelve months ended December 31, 2001, as was the case for the nine-month period ended December 31, 2000. During the twelve months ended December 31, 2001, SIIG, our joint venture partner in China accounted for over 10% of sales.

Net income of $0.9 million for the twelve-month period ended December 31, 2001 was lower than the $1.1 million for the nine-month period ended December 31, 2001, primarily because of increased expenses relating to the establishment of new manufacturing facilities in Korea and China.

The sharp reduction in gross margin was principally due to the opening of a new plant in Korea and the opening of the factory in Shanghai, China, which increased our manufacturing costs significantly during this period. The costs relate primarily to training personnel and establishing efficient manufacturing processes. Additionally, the Company increased its monthly output, as measured by net sales, an average of about 70%, from the prior period and had to absorb the transition costs associated with such a sharp increase. And as previously mentioned, the increased pricing pressure from competition also contributed to the decline in gross margin.

Research and development expenses as a percentage of revenue decreased to 1.6% for the twelve-month period ended December 31, 2001, compared with 3.4% for the nine-month period ended December 31, 2000. The decrease in these expenses as a percentage of revenues is principally attributable to an increase in sales volume while maintaining essentially the same level of spending.

Sales and marketing expenses as a percentage of net revenues decreased from 2.6% in the nine months ended December 31, 2000 to 1.4% in the year ended December 31, 2001. The decrease in these expenses as a percentage of revenue was also the result of a sharp increase in sales volume while accompanied only by a slight increase in spending of approximately 10%.

As reflected in the table above, general and administrative expenses as a percentage of revenue remained essentially constant when compared to the nine-month period ended December 31, 2000. The actual rate of spending increased about 60% from the period ended December 31, 2000, reflecting costs associated with the establishment of SFDT and the additional manufacturing facility in Korea.

The following table sets forth for the periods indicated certain income and expense items expressed as a percentage of the Company's total revenues for the nine-month period ended December 31, 2000 and the unaudited nine-month period ended December 31, 1999. Please see item 6 Selected Consolidated Financial Data for details.

As reflected above, total revenue in the nine-month period ended December 31, 2000 was $73.1 million, about 60% higher than the $45.6 million for the same nine-month period in 1999. This significant increase of $27.5 million was primarily the result of the Company's decision to focus its resources on the DVD product line, which accounted for approximately 98% of total revenue in 2000, as compared to 93% in 1999. Overseas sales represented almost 100% for the nine-months ended December 31, 2000, as compared to about 91% for the nine-months ended December 31, 1999.

Gross margin increased from 12.5% of revenue for the nine months ended December 31, 1999 to 13.8% of revenue for the nine-month period ended December 31, 2000. The improvement reflects the continuing efforts of the Company to lower its costs of revenue by implementing more cost efficient production processes.

Research and development expenses as a percentage of revenue decreased to 3.4% for the nine-month period ended December 31, 2000, compared with 3.7% for the nine-months period ended December 31, 1999. The decrease in these expenses as a percentage of net revenues is attributable to reducing non-performing operations and focusing the engineering resources on the DVD product line, which has generated substantial growth in revenues. The increased revenue and improved margins allowed the Company to increase its research and development expenses, from $1.7 million for the nine-month period ended December 31, 1999 to $2.5 million for the same period in 2000.

Sales and marketing expenses as a percentage of revenues decreased from 3.6% in the nine-months ended December 31, 1999 to 2.6% in the nine-month period ended December 31, 2000. The decrease in these expenses as a percentage of revenue was also the result of the restructuring of the Company's product lines that took place in this period to focus the sales and marketing resources on the DVD product line, which resulted in substantial increase in revenues. The increase in revenue and improvement in margins also allowed increased allocation of capital for sales and marketing expenses, from $1.7 million for the nine-month period ended December 31, 1999 to $1.9 million for the same period in 2000.

General and administrative expenses increased $0.5 million for the nine-month period ended December 31, 2000 over the same period in 1999. The increase of $0.5 million was primarily attributable to increased spending in professional fees for both legal and accounting services.

At December 31, 2002 the Company had $18.2 million of cash and cash equivalents of which $5.9 million was restricted as collateral for lines of credit.

Our operating activities used cash of $17.3 million during 2002. The principal uses of cash were increased inventory of $13.9 million resulting from the sales forecasts, which are the basis for material procurement. During the fourth quarter, our sales did not meet forecasts and volume purchases of major components beyond requirements were made in order to maximize price rebates on certain purchased components. During 2002, accounts receivable increased $8.6 million, which was consistent with the change in terms from principally letters of credit in the year 2001 to open credit terms in 2002. We experienced a net loss in 2002 of $3.0 million, as adjusted by non-cash impact of depreciation and amortization of $2.6 million, the impairment charge of goodwill of $0.2 million, the issuance of common stock for services provided with a fair value of $0.4 million, all of which was partially offset by the non-cash reduction in the majority interest of the investors of our Korean Subsidiary (DVSK) and Chinese Joint Venture, totaling $1.0 million. Reduction in other short and long term liabilities totaling $3.0 million were made during the year 2002, which included $1.5 million primarily representing amounts originally provided for obligations of dormant foreign operation which are no longer required. Cash provided by operating activities in 2002 was provided by an increased accounts payable and accounts payable - related party of $11.7 million and the return of the $1.0 million deposit required during the settlement of litigation with a previous Korean employee.

Net cash used in investing activities was $4.9 million, principally resulting from an increase in restricted cash of $2.7 million used as collateral for the Korean subsidiary's lines of credit, and $1.6 million for molds (tooling) for the factory opened in the fourth quarter of 2001 in Korea. Additionally the China joint venture acquired plant equipment totaling $0.9 million and spent $0.7 million for leasehold improvements. Offsetting the above was $1.1 million written-down of a note receivable from a related party due to non-payment, and the maturity of marketable securities totaling $0.3 million.

During 2002, net cash provided by financing activities was $22.7 million, with $10.7 million in proceeds from the sale of the Korean subsidiary's stock in an initial public offering in September 2002, $9.6 million from Korean line of credit borrowings, and $2.4 million in proceeds from a note payable from Shanghai bank and secured by the joint venture facility in China.

We believe that with working capital of $11.4 million at December 31, 2002, and the renewal of our existing lines of credit in Korea, now totaling $52.3 million of which we have taken down $26.1 million, that our operations in Asia have sufficient resources to manage both their new product plans and production requirements for the year 2003. Our operations in the U.S. will require the raising of additional capital to finance MobileTouch USA. The Company is currently in discussions with investment firms and hopes to have agreements reached for this funding in the next sixty to ninety days. Additionally, the Company anticipates obtaining management fees from its subsidiaries to be advanced on a monthly basis.

In August 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 144, Accounting for the Impairment or Disposal of Long Lived Assets, which addresses financial accounting and reporting for the impairment and disposal of long-lived assets. The Company adopted SFAS No. 144 on January 1, 2002. The adoption of SFAS No. 144 did not have a material impact on the Company's consolidated financial position or results of operations.

In June 2002, the FASB issued No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 addresses the timing and amount of costs recognized as a result of restructuring and similar activities. The Company will apply SFAS No. 146 to activities initiated after December 31, 2002. The adoption of SFAS No. 146 is not expected to have a material impact on the Company's consolidated statements of income or financial position.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure." This Statement amends SFAS No. 123, "Stock-Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The alternative methods of transition of SFAS No. 148 are effective for fiscal years ended after December 15, 2002. The Company follows APB 25 in accounting for employee stock options. The disclosure provisions of SFAS No. 148 is effective for fiscal years ending after December 15, 2002 and have been incorporated into these financial statements and accompanying footnotes.

In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others," which requires a guarantor to recognize and measure certain types of guarantees at fair value. In addition, Interpretation No. 45 requires the guarantor to make new disclosures for these guarantees and other types of guarantees that are not subject to the initial recognition and initial measurement provisions. The disclosure requirements are effective for financial statements for interim or annual periods ended after December 15, 2002, while the recognition and measurement provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The Company is in the process of evaluating the impact the initial recognition and initial measurement provisions will have on its consolidated financial position and results of operations.

The Company does not believe that any of these recent accounting pronouncements will have a material impact on their financial position or results of operations.

Management's discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to product returns, accounts receivable, inventories, investments, intangible assets, income taxes, warranty obligations, restructuring, contingencies and litigation. Actual results may differ from these estimates under different assumptions or conditions. These estimates and judgments are reviewed by senior management on an ongoing basis, and by the Audit Committee at the end of each quarter prior to the public release of our financial results. We believe the following critical accounting policies affect our more significant judgments and estimates used in preparation of our consolidated financial statements.

Net revenues include product and component sales. The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collection is probable. These criteria are met at the time the product is shipped to the customer. Shipping terms are freight on board shipping point. Returns and discounts on sales are deducted from revenue upon issuance of a credit memo. Returns for products under warranty are repaired and returned to the customer at the company's cost. The Company provides for an estimate of costs that may be incurred under its warranty at the time product revenue is recognized. The Company had a warranty reserve of $130,000 at December 31, 2002.

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers or channel partners were to deteriorate, resulting in an impairment of their ability to make payments, additional allowance may be required. The Company had a warranty reserve of $130,000 at December 31, 2002.

We write down our excess and obsolete inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future product life-cycles, product demand, and market conditions. If actual product life cycles, product demand and market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

We estimate our actual current tax exposure together with our temporary differences resulting from differing treatment of items for tax and accounting purposes. These temporary differences result in deferred tax assets and liabilities. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. At December 31, 2002 we had provided a valuation allowance for the entire amount of tax assets net of tax liabilities. To the extent that we increase or decrease a valuation allowance in a period, the resulting expense or benefit is included within the tax provision. Significant management judgment is required in determining the provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against net deferred tax assets.

We assess the impairment of goodwill and other identifiable intangibles, whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Significant under performance relative to projected operating result, changes is the manner of our use of the acquired assets and significant negative industry or economic trends are the more significant indicators that we consider. Any resulting impairment loss could have a material adverse impact on our financial condition and results of operations. The Company after assessment has, as of December 31, 2002, written off its remaining balance of goodwill totaling $175, net of amortization.

Our majority owned foreign subsidiary and joint venture represent the vast majority of our revenues, assets, and liabilities at December 31, 2002. In preparing our consolidated statements, we are required to translate the financial statements of the foreign entity from the currency in which they keep their accounting records, generally the local currency, into United States dollars. This process results in exchange gains and losses which, under the relevant accounting guidance are either included within the statement of operations or as a separate part of our net equity under the caption "cumulative translation adjustment."

Our recent growth rate may not be sustainable and you should not use our past financial performance to predict future operating results. In addition to the losses incurred during the year ended December 31, 2002, we have incurred substantial net losses in the past, as recently as, among others, fiscal years ended March 31, 1999, 1998 and 1997. We also expect to generate losses as we invest heavily in R&D personnel and engineers in connection with our research and development efforts related to new product development during 2003. Our recent quarterly and annual operating results have fluctuated, and will continue to fluctuate, due to the following factors, all of which are difficult to forecast and many of which are not within our control:

• the availability, timely delivery and cost of components from our suppliers;
• competitive pressures and related changes in selling prices;
• fluctuations in manufacturing yields and significant yield losses which affect our ability to fulfill orders;
• new product announcements and introductions for competing products by us or our competitors;
• the rate at which our products become obsolete;
• unpredictability of changes in demand for, or in the mix of, our products;
• the gain or loss of significant customers;
• market acceptance of products utilizing our technologies;
• changes in the channels through which our products are distributed and the timeliness of receipt of distributor resale information;
• exchange rate fluctuations;
• general economic, political and environmental-related conditions, such as natural disasters;
• difficulties in forecasting, planning and management of inventory levels, which may trigger lower of cost or market inventory adjustments;
• unanticipated research and development expenses associated with new product introductions;
• the timing of significant orders and of license and royalty revenue; and
• the seasonality in our business.

A downturn in the market for consumer products such as personal computers and DVD players that incorporate our products can also harm our operating results. In addition, some of our customers may place orders at or near the end of a quarter. As a result, we may not learn of revenue shortfalls until late in a quarter and may not be able to predict future revenues with accuracy. Additionally, a large portion of our costs consists of salaries for personnel and materials that must be ordered several months in advance. These costs are based in part on our expectations for future revenues and are relatively fixed in the short term. As a result, any revenue shortfall below expectations could harm our business.

Since our inception, we have periodically experienced negative cash flow from operations and could experience significant negative cash flow from operations in the future. Our current and future capital requirements are substantial and we cannot be certain that cash generated from operations will be sufficient or that financing will be available at favorable terms when required, or at all. If our capital resources are insufficient to meet future capital requirements, we may not meet our financial obligations to our creditors when they become due or we may have to curtail or cease certain operations.

We currently buy certain key components, including optical pick-ups, motors, central processing units and certain other integrated circuits from a limited number of suppliers including, Zoran, Mediatech, and Hitachi. We anticipate that these suppliers will manufacture sufficient quantities of these key components to meet our production requirements. If these suppliers fail to satisfy our requirements on a timely basis and at competitive prices, we could suffer manufacturing delays, a possible loss of revenues or higher than anticipated costs of revenues, any of which could seriously harm our operating results. Any constraints on worldwide manufacturing capacity of these key components may affect our ability to obtain adequate supplies from these manufacturers. In certain instances, we have failed to meet the demand for our products or the scheduled shipment dates due to our inability to obtain a sufficient supply of certain key components from our suppliers. The suppliers with which we currently are working with, together with any additional supplier at which capacity might be obtained, may not be willing or able to satisfy all of our manufacturing requirements on a timely basis at favorable prices. In addition, we have encountered delays in qualifying new products and increasing new product production and could experience these delays in the future. We are also subject to the risks of service disruptions, raw material shortages and price increases by our suppliers. Such disruptions, shortages and price increases could seriously harm our operating results.

Notwithstanding our recent expansion efforts, in order to grow, we need to increase our present manufacturing capacity. Events that we have not foreseen could arise which would limit our manufacturing capacity. In addition, if we cannot satisfactorily increase our manufacturing capacity, our ability to grow will be severely impaired and this may harm our operating results.

To obtain additional manufacturing capacity, we may be required to make deposits, equipment purchases, loans, joint ventures, equity investments or technology licenses in or with other companies. These transactions could involve a commitment of substantial amounts of our capital and technology licenses in return for production capacity. We may be required to seek additional debt or equity financing if we need substantial capital in order to secure this capacity and we cannot assure you that we will be able to obtain such financing on terms acceptable to us, if at all.

The fabrication of our products requires certain components produced in a highly controlled and clean environment. Companies that supply our components sometimes have experienced problems achieving acceptable manufacturing yields. Low yields may result from marginal design or manufacturing process drift. Yield problems may not be identified until the components are well into the production process, which often makes them difficult, time consuming and costly to correct. Furthermore, we rely on overseas suppliers of certain key components, which increases the effort and time required to identify, communicate and resolve manufacturing yield problems. If our suppliers fail to achieve acceptable manufacturing yields, we will experience higher costs of revenues and reduced product availability, which would harm our operating results.

Our products' requirements may represent a small portion of the total production of the suppliers that manufacture our components. As a result, we are subject to the risk that a supplier may cease production on an older or lower-volume manufacturing process that it uses to produce our parts. Additionally, we cannot be certain our suppliers will continue to devote resources to advance the production technologies on which the manufacturing of our parts is based. Each of these events could increase our costs and harm our ability to deliver our products on time.

During the last three years, a substantial amount of revenues have been generated by the DVD product line, which is central to our growth strategy. The market for this line of products has experienced intense competition and is highly price sensitive. The average unit selling price for our DVD loader products has decreased and we expect it to continue to decrease in the foreseeable future. Unless we obtain an equally reduced cost of revenues, our gross margins will continue to decline. Successful development and commercialization of new products is essential to our growth and future profitability. While we are currently developing and introducing new products in this product line, we cannot assure you that these products will reach the market in a timely manner, satisfactorily address customer needs, be sold in high volume, or be sold at profitable margins. In addition, we expect to generate losses as we invest heavily in R&D personnel and engineers during 2003.

Our operating expenses are relatively fixed, and we order materials in advance of anticipated customer demand; therefore, we have limited ability to reduce expenses quickly in response to any revenue shortfalls.

Our operating expenses are relatively fixed, and we therefore have limited ability to reduce expenses quickly in response to any revenue shortfalls. Consequently, our operating results will be harmed if our revenues do not meet our revenue projections. We may experience revenue shortfalls for the following reasons:

• significant pricing pressures that occur due to competition, over-supply, or other reasons;
• sudden shortages of raw materials or fabrication, test or assembly capacity constraints that lead our suppliers to allocate available supplies or capacity to other customers which, in turn, harm our ability to meet our sales obligations; and
• the reduction, rescheduling or cancellation of customer orders.

In addition, we typically plan our production and inventory levels based on customers' advance orders, commitments or forecasts, as well as our internal assessment and forecasts of customer demand, which are highly unpredictable and can fluctuate substantially, especially if competition becomes more intense or the demand is reduced due to seasonal or other factors. From time to time, in response to anticipated long lead times to obtain inventory and materials from our suppliers, we may order materials in advance of anticipated customer demand. This advance ordering may result in excess inventory levels or unanticipated inventory write-downs if expected orders fail to materialize.

It usually requires a number of months to realize volume shipments after we first contact a customer. We first work with customers to achieve a design win, which may take months or longer. Our customers then complete the design, testing and evaluation process and begin to ramp up production, over a period which typically lasts months or longer. As a result, a significant period of time may elapse between the time we incur expenses from our research and development efforts and our realization of revenue, if any, from volume purchasing of our products by our customers.

We compete with major international electronics companies, many of which have substantially greater financial, technical, marketing, distribution, and other resources than we do. Many of our competitors have their own facilities for the production of semiconductor components and have been active in increasing their market shares and their capacity for the production of competing products. Our DVD products presently account for substantially all of our revenues. Our competitors or potential competitors include Hitachi, Toshiba, Sony, Pioneer, Teac, Sanyo, Samsung, Philips, LG, and many others. Some of our competitors or potential competitors are also suppliers of key components for some of our products. In these cases, our competitors may have divisions making competing DVD products that have access to some of our proprietary information through the divisions supplying components to us, or exert influence on the parts supplying divisions in ways that may adversely affect our parts supply. These actions would adversely affect our competitiveness and sales. Competition may also come from alternative technologies being developed by these companies.

The markets for our products are characterized by:

• rapidly changing technologies;
• evolving and competing industry standards;
• changing customer needs;
• frequent new product introductions and enhancements;
• increased integration with other functions; and
• rapid product obsolescence.

To develop new products for our target markets, we must develop, gain access to and use leading technologies in a cost-effective and timely manner and continue to expand our technical and design expertise. In addition, we must have our products designed into our customers' future products and maintain close working relationships with key customers in order to develop new products that meet their changing needs. In addition, DVD products involve continually evolving industry standards. Our ability to compete will depend on our ability to identify and ensure compliance with these industry standards. As a result, we could be required to invest significant time and effort and incur significant expense to redesign our products and ensure compliance with relevant standards. We cannot assure you that we will be able to identify new product opportunities successfully, develop and bring to market new products, achieve design wins or respond effectively to new technological changes or product announcements by our competitors. In addition, we may not be successful in developing or using new technologies or in developing new products or product enhancements that achieve market acceptance. Our pursuit of necessary technological advances may require substantial time and expense. Failure in any of these areas could harm our operating results.

We are highly dependent on our principal management and engineering staff. There is intense competition for qualified personnel in our industry, in particular the highly skilled technical personnel involved in the development of DVD technologies and the production of DVD products. Competition is especially intense in Silicon Valley, where our corporate headquarters are located, and in South Korea, where our DVD products have been designed and where most of our manufacturing takes place. We may not be able to continue to attract and retain engineers or other qualified personnel necessary for the development of our business or to replace engineers or other qualified personnel who may leave our employ in the future. Our anticipated growth is expected to place increased demands on our resources and will likely require the addition of new management and engineering personnel and the development of additional expertise by existing management personnel. The failure to recruit and retain key technical and management personnel could harm our business.

We rely on a combination of patent, trade secrets, copyright and mask work production laws and rights, nondisclosure agreements and other contractual provisions and technical measures to protect our intellectual property rights. Policing unauthorized use of our products, however, is difficult, especially in foreign countries, such as China and South Korea, where the laws may not protect our proprietary rights as fully as in the United States. Litigation may continue to be necessary in the future to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Litigation could result in substantial costs and diversion of resources and could harm our business, operating results and financial condition regardless of the outcome of the litigation. We have acquired ownership or license to a number of patents or patent applications related to our products. However, we cannot assure you that any pending patent application will be granted, or that such patents will provide adequate protection for our intellectual property. Since our competitors may design around our patents or otherwise independently develop competing technology, our operating results would be seriously harmed by the failure to protect our intellectual property.

Third parties may assert that our products infringe their proprietary rights, or may assert claims for indemnification resulting from infringement claims against us. Any such claims may cause us to delay or cancel shipment of our products or pay damages, which could seriously harm our business, financial condition and results of operations. In addition, irrespective of the validity or the successful assertion of such claims, we could incur significant costs in defending against such claims. In addition, we receive from time to time letters or communications from other companies stating that such companies have patent rights relating to our products. Any legal finding that we infringe the patent of another company would have a significantly negative effect on our operating results. Furthermore, if such a finding were made, there can be no assurance that we could license the other company's technology on commercially reasonable terms or that we could successfully operate without such technology. Moreover, if we are found to infringe, we could be required to pay damages to the owner of the protected technology and could be prohibited from making, using or selling any products that infringe the protected technology. In addition, the management attention consumed by and legal cost associated with any litigation could have a negative effect on our operating results. During the course of lawsuits there may be public announcements of the results of hearings, motions, and other interim proceedings or developments in the litigation. If securities analysts or investors perceive these results to be negative, it could have a substantial negative effect on the trading price of our stock. Whether or not we are successful in any litigation, we expect the litigation to consume substantial amounts of our financial and managerial resources. Further, because of the substantial amount of discovery required in connection with this type of litigation, there is a risk that some of our confidential information could be compromised by disclosure.

As our business has grown, we have become increasingly subject to the risks arising from adverse changes in domestic and global economic conditions. Because of the recent economic slowdown in the United States, many industries are delaying or reducing technology purchases. The impact of this slowdown on us is difficult to predict, but it may result in reductions in purchases of products by our end-user customers, longer sales cycles and increased price competition. As a result, if the current economic slowdown continues or worsens, we may fall short of our revenue expectations for any given quarter in 2003 or for the entire year.

Sales of products overseas accounted for 90.8%, 99.7%, 98.1% and 99.0% of our revenues in the fiscal year ended March 31, 2000, the nine-month period ended December 31, 2000, the fiscal year ended December 31, 2001 and the fiscal year ended December 31, 2002, respectively. Our international business activities are subject to a number of risks, each of which could impose unexpected costs on us that would have an adverse effect on our operating results. These risks include:

• difficulties in complying with foreign regulatory requirements and standards;
• tariffs and other trade barriers relating to cross border transactions;
• costs and risks of localizing products for foreign countries;
• longer accounts receivable payment cycles from customers located in foreign countries;
• potentially adverse tax consequences resulting from changes in international tax regulations;
• limits on repatriation of earnings from our foreign operations; and
• limited ability to effect quality-control measures associated with our foreign operations.

We derived most of our product revenue from Asia during the last three years. Additionally, our major suppliers and assembly subcontractors are all located in Asia. Any kind of economic, political or environmental instability in this region of the world can have a severe negative impact on our operating results due to the large concentration of our production and sales activities in this region. For example, during 1997 and 1998, several Asian countries where we currently do business, such as Japan, Taiwan and South Korea, experienced severe currency fluctuation and economic deflation. If such situations reoccur, it may negatively impact our total revenues and our ability to collect payments from customers in these regions. During such situations, the lack of capital in the financial sectors of these countries can make it difficult for our customers to open letters of credit or other financial instruments that are guaranteed by foreign banks. Finally, the economic situation during such periods may exacerbate a decline in selling prices for our products as our competitors may reduce product prices to generate needed cash.

In addition, we are greatly impacted by the political, economic and military conditions in Taiwan and China, and North Korea and South Korea, which are continuously engaged in political disputes. These countries have recently conducted military exercises in or near the other's territorial waters and airspace. Such disputes may continue and even escalate, resulting in an economic embargo, a disruption in shipping or even military hostilities. This could severely harm our business by interrupting or delaying production or shipment of our products. Any kind of activity of this nature or even rumors of such activity could severely negatively impact our operations, revenues, operating results, and stock price.

As a substantial portion of our operations are located in Asia and subject to foreign laws and regulations, our operations in Asia may be adversely affected by changes in local laws and regulations, such as those relating to accounting practices, taxation, import and export tariffs, environmental regulations, land use rights, property and other matters. Local governments may impose new, stricter regulations or interpretations of existing regulations, which would require additional expenditures. Asian economies may also differ in terms of structure, government involvement, level of development, growth rate, capital reinvestment, allocation of resources, self-sufficiency and rate of inflation, among others. As a result, we may encounter significant difficulties in understanding and addressing local business practices that may require us to incur additional expenses in connection with our international operations.

Products sold to our top five customers accounted for approximately 47% of our revenues during the year ended December 31, 2002. Products sold to our top 10 customers accounted for approximately 75% 88% and 67% of our revenues during the nine-month period ended December 31, 2000, the fiscal year ended December 31, 2001, and the fiscal year ended December 31, 2002, respectively. In the fiscal year ended December 31, 2002, Vestel accounted for 23% of our revenue. In the fiscal year ended December 31, 2001, SIIG accounted for about 37% of our revenue. In the fiscal year ended March 31, 2000, Hyundai accounted for about 36% of our revenue. In the nine-month period ended December 31, 2000, Hyundai accounted for about 42% of our revenue. No other customers accounted for more than 10% of our revenues during these three periods. If we were to lose any of these customers or experience any substantial reduction in orders from these customers, our revenues and operating results would suffer.

We do not typically enter into long-term contracts with our customers, and we cannot be certain as to future order levels from our customers. When we do enter into a long-term contract, the contract is generally terminable at the convenience of the customer. An early termination by one of our major customers would harm our financial results, as it is unlikely that we would be able to rapidly replace that revenue source.

Due to possible customer changes in delivery schedules and cancellations of orders, our backlog at any particular date is not necessarily indicative of actual sales for any succeeding period. A reduction of backlog during any particular period, or the failure of our backlog to result in future revenue, could harm our business.

Our operations are vulnerable to interruptions by fire, earthquake, power loss, telecommunications failure and other events beyond our control. We do not have a detailed disaster recovery plan. Our facilities in Northern California may be subject to electrical blackouts as a consequence of a shortage of available electrical power. In the event these blackouts occur, continue or increase in severity, they could disrupt the operations of our affected facilities. In connection with the shortage of available power, prices for electricity have risen dramatically, and may continue to increase for the foreseeable future. Such price changes will increase our operating costs, which could in turn hurt our profitability. In addition, we do not carry sufficient business interruption insurance to compensate us for losses that may occur, and any losses or damages incurred by us could harm our business.

To permit the growth of our business operations in the future, we need to expand our production capacity and bring new products to market, which will likely require significant working capital. We have established credit facilities with certain Korean banks with a total borrowing limit of about $52 million as of December 31, 2002. We have also formed alliances with state-run businesses in China, which have committed to substantial amounts of trade credit and financing for production in China under certain terms. However, there is no assurance that these credit facilities will always be available. We may also need to sell shares of our common stock or seek additional borrowings or outside capital infusions in the future. We cannot assure you that such financing options will be available on terms acceptable to us, if at all, and at the time and place that we need them. In addition, if we issue shares of our common stock, our shareholders will experience dilution with respect to their investment.

Our business is experiencing rapid growth which has strained our internal systems and will require us to develop or adopt more sophisticated information management systems in order to manage the business effectively. Although we have implemented an ERP system, there is no guarantee that this system and any new systems implemented in the future will be adequate to address our expected growth, or that management will be able to foresee in a timely manner other infrastructure needs before they arise. Our success depends on the ability of our executive officers to effectively manage our growth. If we are unable to manage our growth effectively, our results of operations will be seriously harmed.

Our stock has closed at prices ranging from a high of $6.23 on December 11, 2001 to a low of $1.08 on June 24, 2002. If our revenues do not grow or grow more slowly than we anticipate, or if operating or capital expenditures exceed our expectations or cannot be adjusted accordingly, the market price of our common stock could be materially and adversely affected. In addition, the market price of our common stock has been in the past and could in the future be materially and adversely affected for reasons unrelated to our specific business or results of operations. General market price declines or volatility in the future could adversely affect the price of our common stock. In addition, short-term trading strategies of certain investors can also have a significant effect on the price of specific securities.

There are a significant number of warrants and options to purchase our common stock outstanding. Holders may sell the common stock acquired upon exercise of the warrants and options at a market price that exceeds the exercise price of the warrants and options paid by the holders. Sales of a substantial number of shares of common stock in the public market by holders of warrants or options may depress the prevailing market price for our common stock and could impair our ability to raise capital through the future sale of our equity securities.

We have never paid any cash dividends on our common stock, and we do not anticipate paying any cash dividends in the foreseeable future. We currently intend to retain any future earnings for funding growth and therefore, do not expect to pay any dividends on our common stock in the foreseeable future. Therefore, you may not receive any return on an investment in our common in the form of dividends.

Our Certificate of Incorporation grants our board of directors the authority to determine the relative rights and preferences of our preferred stock and gives the board the authority to issue such shares, all without further stockholder approval. As a result, our board of directors could authorize the issuance of a series of preferred stock that would grant to holders preferred rights to our company's assets upon liquidation, the right to special voting privileges, the right to receive dividends before dividends would be declared upon the common stock and the right to redemption of such shares, together with a premium, prior to the redemption of common stock. Our common stockholders have no redemption rights. The ability of the board to issue large blocks of preferred stock could have a potential anti-takeover effect, and the issuance of preferred stock in accordance with such authority may delay or prevent a change of control of our company. 

With a focus on the DVD product line, most of our revenues in the last three years were generated from DVD products. Most of our new products currently being developed are in the DVD product line, particularly DVD loaders. The sales of our DVD loaders are related to the markets for DVD video discs and DVD video players. If we experience an unforeseen downturn in the markets for DVD video discs and DVD video players or a global over-supply in the production of DVD loaders, our results of operations from our DVD loaders business will be adversely affected. Our business could be harmed by such industry-wide fluctuations in the future.

The semiconductor industry has historically been cyclical, characterized by wide fluctuations in product supply and demand. From time to time, there are shortages or over-production of memory or other types of devices. Our business could be harmed by such industry-wide fluctuations in the future because our products incorporate these technologies. When a shortage occurs with one or more key components, it may be difficult for us to produce enough quantities of products to fill customers' orders, and it may require us to pay a higher price for the components in the event of a shortage, adversely affecting our margin and profitability.

Sales of our products in the computer peripherals market and consumer electronics market are subject to seasonality. Seasonal purchasing patterns generally lead to higher sales occurring in the second half of each calendar year although there may be a sharp decline of sales near the Christmas and New Year's holidays. Sales to China and certain other Asian regions may also decline near the lunar New Year's holidays in January or February.

 Item 7A. Quantitative and Qualitative Disclosure About Market Risk

The following discusses our exposure to market risk related to changes in interest rates and foreign currency exchange rates. This discussion contains forward-looking statements that are subject to risks and uncertainties. Actual results could vary materially as a result of a number of factors including those set forth in "Factors That May Affect Future Results."

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. We do not use derivative financial instruments in our investment portfolio. The primary objective of our investment activities is to preserve principal while maximizing yields without significantly increasing risk. Our investments consist primarily of commercial paper and certificates of deposits. Due to the nature of our investments, we believe that there is no material risk exposure. Cash equivalents and short-term investment are carried at cost, which approximated market value, and investments in marketable debt securities are carried at amortized cost, which approximates market value.

We develop products in the United States, Korea and China and market our products in North America and the Asia-Pacific region. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. As our sales are primarily in U.S. dollars, a strengthening of the dollar could make our products less competitive in foreign markets. 

The financial statements required pursuant to this item are included in Part IV, Item 15 of this Form 10-K.

Not applicable.

Information with respect to Directors is included under the caption "Proposal One-Election of Directors" in the Proxy Statement for the 2003 Annual Meeting to be held on June 27, 2003 (the "2003 Proxy Statement") and is incorporated herein by reference. Information with respect to Executive Officers is included under the caption "Executive Officers" in Part I hereof after Item 4.

Information regarding delinquent filers pursuant to Item 405 of Regulation S-K is included under the heading "Section 16(a) Beneficial Ownership Reporting Compliance" in the 2003 Proxy Statement and is incorporated herein by reference.

The information required by this item is included under the caption "Proposal One - Election of Directors - Director Compensation" and "Executive Officer Compensation" in the 2003 Proxy Statement and is incorporated herein by reference.

The information required by this item is included under the caption "Security Ownership of Principal Stockholders and Management" in the 2003 Proxy Statement and is incorporated herein by reference.

The information required by this item is included under the caption "Transactions with Management" in the 2003 Proxy Statement and is incorporated herein by reference.

To the Board of Directors and Stockholders of
Digital Video Systems, Inc.

We have audited the accompanying consolidated balance sheets of Digital Video Systems, Inc. and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of operations, stockholders' equity, and cash flows for the year ended December 31, 2002, December 31, 2001, and the nine months ended December 31, 2000. Our audit also included the financial statement schedule listed at Item 14(a)(2). The consolidated financial statements and schedule are the responsibility of the Digital Video Systems, Inc. management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Digital Video Systems, Inc. and subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for the year ended December 31, 2002, December 31, 2001, and nine months ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

/s/ Burr, Pilger & Mayer LLP

Palo Alto, California
April 4, 2003

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