PRINCETON VIDEO IMAGE INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934

(Mark One)

|X| ANNUAL REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.

For the fiscal year ended December 31, 2002

OR

| | TRANSITION REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.

For the transition period from _____________ to _____________

Commission File Number 000-23415
Princeton Video Image, Inc.
(Exact Name of Registrant as Specified in its Charter)

Delaware 22-3062052
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)

15 Princess Road, Lawrenceville, New Jersey 08648
(Address of Principal Executive Offices) (Zip Code)

609-912-9400
(Registrant's Telephone Number, Including Area Code)

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

Name of Each Exchange
Title of Each Class on Which Registered
------------------- ---------------------

None None

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

Common Stock, $.001 par value
(Title of Each Class)

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

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

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2) Yes | | No |X|

State the aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which the common equity
was last sold, or the average bid and asked price of such common equity, as of
the last business day of the registrant's most recently completed second fiscal
quarter: $11,006,379 based on the last sales price on June 28, 2002.

Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date: 18,418,865 shares of Common
Stock, $.001 par value per share,

were outstanding on March 25, 2003.

DOCUMENTS INCORPORATED BY REFERENCE

The definitive Proxy Statement for the 2003 Annual Meeting of Stockholders is
incorporated by reference in Part III of this Form.

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PART I

ITEM 1. DESCRIPTION OF BUSINESS.

GENERAL

Princeton Video Image, Inc. ("PVI", "we", "us") is a Delaware corporation with
principal offices located in Lawrenceville, New Jersey. PVI was founded in 1990
to develop and market a real-time video insertion system. Through our patented
computer vision technology and proprietary hardware and software system, known
as the Live Video Insertion System (L-VIS(R)), we are able to place
computer-generated electronic images into live and pre-recorded television
broadcasts of sports and entertainment programming. These electronic images
range from simple corporate names or logos to sophisticated multi-media 3-D
animated productions. During the broadcast of a sports or entertainment program,
for example, an image can be placed to appear in various high visibility
locations in the stadium, on the playing field, or as part of the natural
landscape of the scene. The L-VIS(R) System has been used to insert images,
including advertising images and program enhancements, into both live and
pre-recorded television broadcasts.

We believe that our L-VIS(R) System, which is an integrated hardware and
software system, can benefit (i) advertisers, through the placement of their ads
in high visibility, in-program locations and by the ability to provide specific
advertising to specific geographical regions; (ii) broadcasters and program
producers, through a new revenue stream from additional inventory of advertising
space or program enhancements; and (iii) teams and leagues, through increased
revenue streams and greater flexibility and control over in-stadium advertising.
PVI has provided video insertion services for thousands of live telecasts
worldwide, including broadcasts of Major League Baseball, National Football
League, professional soccer, motor sports, and other live events. Since 1999,
PVI has been the exclusive virtual advertising provider for NFL International
broadcasts. The following events and advertisers are representative of PVI's
customer base; CBS, ESPN, Televisa, TV Azteca, Philadelphia Eagles, Dallas
Cowboys, Philadelphia Phillies, Indy Racing League, Volkswagen, TelCel,
Heineken, Ford, Kodak and FedEx. We market our L-VIS(R) Systems on a worldwide
basis through licensing and royalty agreements, together with our wholly-owned
subsidiary, Publicidad Virtual, S.A. de C.V. ("Publicidad"), which is
headquartered in Mexico City, Mexico.

As part of our product development program, we are developing a series of
products to allow viewers to interact with live or recorded video programming
delivered to the home via the Internet or through interactive television. These
applications will enable the viewer to influence the on-screen presentation of a
broadcast which utilizes the L-VIS(R) System by using a mouse or other pointer,
for example, to indicate areas of interest. We are also developing other
applications of technology for the sports and entertainment fields.

PVI's objective is to become the leading provider of virtual advertising to the
broadcasters of sports and entertainment programming worldwide.

This document includes certain forward-looking statements made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
In some cases, you can identify these so-called "forward-looking statements" by
such words as "may," "will," "should," "expects," "plans," "anticipates,"
"estimates," "believes," "predicts," "intends," "potential," or "continue," or
the negative of those words or phrases of similar expression. You should be
aware that these forward-looking statements are only our predictions and are
subject to various assumptions, risks and uncertainties. Actual events or
results may differ materially from those anticipated by the statements we make.
Factors described in this Annual Report on Form 10-K, including without
limitation those identified in this Item 1, "Business" and in Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" could cause our actual results to differ materially from those
expressed in any forward-looking statement we make. We do not promise to update
forward-looking information or any other information to reflect actual results
or changes in

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assumptions or other factors that could affect those statements.

We were incorporated in New Jersey on July 23, 1990 and became a Delaware
corporation on September 13, 2001.

OVERVIEW OF THE TELEVISION ADVERTISING AND SPONSORSHIP MARKET

According to the latest figures from CMR, a member of the Taylor Nelson Sofres
media company group and a leading provider of strategic advertising and
marketing communications information, total advertising expenditure for all
media in 2002 totaled $117 billion. Network, spot, cable and syndicated TV
represented approximately $48 billion of the total spending. In the IEG
Sponsorship Report, a newsletter published by IEG, Inc, it is projected that
sponsorship spending worldwide for 2003 will be $26.2 billion, of which $7.21
billion will be spent in the sports category for the sponsoring of specific
teams, stadium locations and sporting events.

The cost of a television commercial spot is normally a function of the nature
and size of the expected audience of the event to be broadcast. Accordingly, a
spot in a national broadcast of a major sporting event, such as the Super Bowl
or a World Series game, sells for a price many times that of a spot in a regular
season game broadcast only locally or regionally. Television broadcasters
(including national television and cable networks, regional cable networks, and
local television and cable operators) purchase television broadcast rights to
sporting events from the holders of those rights, which include individual teams
as well as various leagues, federations, associations and other organizations
representing both professional and amateur sports. Rights to specific games or
events may be held by teams, leagues, associations, or any combination thereof,
depending on the arrangements under which each sport is organized.

We believe that the growth of sports advertising and sponsorship is largely
driven by the desire on the part of advertisers to be "in the game" by having
their brands and products visible during the broadcast of televised live or
pre-recorded sporting events. The L-VIS(R) System enables the advertiser to be
"in the game" by exposing the television viewer to the brand or message during
an event. As the advertisement can be placed strategically to appear on the
television screen where traditional signage may not be available or practical,
the advertiser is more confident that its message will actually be seen by the
viewer and not "zapped" away during a commercial break.

Sponsorship generally entails associating the sponsor's name with the event or
stadium as well as signage rights, i.e., the prominent display of the sponsor's
name and products in specified locations in the stadium or broadcast. Sponsors
purchase sponsorship rights from the holders of those rights. Like broadcast
rights, the ownership of sponsorship rights depends on the specific sport and
the event or location. In some cases, the owner of the venue at which an event
is staged holds the sponsorship rights to the event. In other cases, the team
owner may own the sponsorship rights, including signage. Advertisers negotiate
sponsorship arrangements directly with sponsorship rights holders and not with
broadcasters. Since broadcasters historically have not shared in sponsorship
revenue, they traditionally have not assisted sponsorship programs. In order to
interest broadcasters in the capabilities of the L-VIS(R) System, we have made
program enhancements available, such as the virtual first down line in football
(which we now offer as a branded or unbranded enhancement), the virtual kick
circle and distance to goal in soccer and the speed of the pitch in baseball.

The success of the L-VIS(R) System requires that we enter into satisfactory
commercial arrangements with advertisers, rights holders and broadcasters. To
date, many of the major broadcasters and a limited number of the broadcast
rights holders and advertisers have agreed to use our L-VIS(R) System during
live and pre-recorded sports and entertainment broadcasts. Our continued
expansion will depend on, among other things, our ability to identify markets,
to manage growth, and to hire and retain skilled personnel. Some press coverage
of our technology has raised concerns about its desirability and potential
misuse relating to television tampering, ethics, and over commercialization.
There can be no assurance that the use of our L-VIS(R) System will

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be accepted by television viewers or that we will be able to combat effectively
potential future negative publicity regarding ours or similar technology. To the
extent that we are unable to more successfully market the L-VIS(R) System our
business might not develop as quickly or to the extent necessary to support our
intended level of operations.

ABILITIES OF THE L-VIS(R) SYSTEM

We believe that the L-VIS(R) System provides advantages when compared to
traditional 30-second advertising spots and other forms of advertising, because
the L-VIS(R) System:

- Allows for in-program advertising. The L-VIS(R) System allows an
advertiser to be "in the game" or broadcast, by having their brands
and products visible within the broadcast of televised live and
pre-recorded sports and entertainment programming;

- Reduces the effect of channel surfing and viewer muting. Because the
L-VIS(R) System allows for "in the game" advertising, the negative
effect of channel surfing, which often occurs during traditional
30-second advertising spots, may be reduced;

- Allows placement of advertising in high visibility locations. The
L-VIS(R) System allows for the insertion of images into places that
might otherwise not be used and have high impact and recall for
television viewers;

- Creates new inventory for advertising rights holders. The L-VIS(R)
System allows for new advertising by providing for the insertion of
images in locations that are unavailable for conventional
billboards, such as the racetrack in a motor sports event, or the
natural landscape or background during news and other entertainment
programming;

- Allows for "narrow casting" of specific advertising to specific
geographical regions. The L-VIS(R)System also allows for specific
advertising to specific geographical regions. Thus, a rights holder
can sell the same advertising space to different advertisers in
different markets; for instance, the Canadian feed of the 2003
broadcast of the Super Bowl included different inserted
advertisements on the field and in the end zone than the Mexican
broadcast of the same game;

- Provides for animation and audio-video advertising. The L-VIS(R)
System may be used, when appropriate, to insert 3-dimensional
animation and audio-video advertising within the program to enhance
the impact of the advertising;

- Allows branding of an event. Insertions made during a live broadcast
will be captured, or branded, on recordings of the event and may
then be shown around the world in re-broadcasts and highlight films
of the event. An advertiser will benefit from every re-broadcast,
such as re-broadcasts which occur during the sports segment of most
news programs; and

- Provides advertising to otherwise advertising-free environments. Our
technology can be used to insert advertising into otherwise
advertising-free environments, e.g., pay-per-view concerts, sports
and entertainment programming.

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THE L-VIS(R) SYSTEM TECHNOLOGY

Our L-VIS(R) System is a system that contains proprietary hardware and software
which we have designed to insert electronic images into live and pre-recorded
television broadcasts of sports and entertainment programming. The inserted
images may be two or three dimensional, static or animated, opaque or
semi-transparent and may be placed so that the inserted images appear to exist
on the playing field, in the stadium or venue where a game or sporting event is
being played, or in the background or natural landscape in entertainment
programming. If a player or other object moves in front of an image that is
inserted on a wall, in the background, or on a playing field, the L-VIS(R)
System is programmed so that the passing object occludes that portion of the
inserted image. The L-VIS(R) System can also be used to insert a freestanding
image so that the image will occlude a person or other object which "passes
behind" it.

The basic L-VIS(R) System, also referred to as the "Vision" system, relies on
computer vision techniques that recognize features in the television picture and
track the motion of the scene. This L-VIS(R) System and its operator may be
located at the site of the event, at the network studios of the broadcaster or
at an individual station or cable system head-end carrying the broadcast. Before
the broadcast, the advertising images to be inserted are prepared and the
operator identifies the location in the broadcast scene where the images will be
inserted. The Vision system is designed to recognize the broadcast scene in real
time during the broadcast and to insert the image as instructed each time the
broadcast scene containing the insert location appears. The operator controls
which of several images is selected for insertion and when it will be inserted.
Since the Vision system can be used at any point in the distribution path of the
broadcast signal, a broadcaster can, by installing a system in their main
broadcast facility, use one system to insert advertising in broadcasts
originating from multiple locations. This makes the system a very efficient and
powerful tool for generating incremental advertising revenue.

We have designed software that allows for the use of the L-VIS(R) System using
this computer vision technology in the live broadcasts of soccer, football,
baseball, golf, auto racing, hockey and entertainment programming. For instance,
in baseball our software allows images to be inserted on the wall behind home
plate, the outfield wall or the area above the outfield wall. To the television
viewer, an advertisement inserted with the L-VIS(R) Vision system, such as an
advertisement on the wall behind home plate, appears to be part of the original
scene, in proper perspective and fixed in the scene as the camera pans, tilts
and zooms, and as players move in front of the image. Furthermore, because an
inserted image is not present at the actual site of a sporting event, any
distraction caused to the players by other types of advertising such as
scrolling billboards will not be present. Because the Vision system must be
powerful and fast enough to insert images in live broadcasts in real-time, it is
also extremely efficient when used to insert advertisers' logos and products in
pre-recorded programming. This permits distributors of pre-recorded
entertainment programming to offer advertisers unique, in-program product
integration that can be targeted by market or changed from year to year without
altering the master recording of the broadcast. A camera sensor enhanced version
of the L-VIS(R) System can be used on almost any live event including basketball
and tennis broadcasts.

Our iPoint(TM) technology enables advertising, promotional material and program
enhancements to be inserted locally - on the television or personal computer -
so the individual viewer will see advertising and features designed specifically
for him or herself. Using digital set top box technology developed to run our
software, Internet delivered advertisements and features can be inserted into
the individual television broadcast based on customer preferences. These
advertisements and features can be interactive, as well, allowing the viewer to
customize their viewing experience by selecting particular enhancements or
options. An iPoint(TM)enhanced baseball game, for instance, would allow viewers
to select such virtual enhancements as "clickable" player statistics or a
virtual strike zone. Entertainment programs could include interactive objects or
virtual products, giving the user instant pricing, detailed information or the
opportunity to make purchases interactively without leaving the program. This
first phase of

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development has been completed and the next step will be the incorporation of
the iPoint(TM)product into set top boxes used by cable companies to deliver
television programming into households. Our first efforts in that regard have
begun with Cablevision Systems Corporation ("Cablevision"), PVI's largest
stockholder and a major cable system operator serving over 3 million households
in the New York metropolitan area.

Because we operate in a rapidly developing commercial and technological
environment, our success will depend in part upon our ability to develop
products for the Internet and interactive television as well as product
enhancements that keep pace with continuing changes in technology and customer
preferences. Our failure to develop these products on a timely basis would limit
the growth potential of our business and thus have an adverse effect on our
business, financial condition and the results of our operations. The video,
electronics, data processing, broadcast television and cable television
industries are changing rapidly due to, among other things, technological
improvements, consolidations of companies and changes in consumer preferences.
In particular, the live video image insertion market is relatively new and
continues to adapt to the changing preferences and customs of the broadcasters,
rights holders, and the ultimate television viewer. We anticipate that as the
market develops, we will continue to be affected by technological change and
product improvements as well as changes in industry broadcast standards.

STRATEGY

Our objective is to become the leading provider of electronic advertising and
program enhancements to the broadcasters of sports and entertainment programming
as well as to television advertising markets worldwide. We are positioning PVI
not just as a technology provider, but as a company that provides media and
marketing services for television advertisers and generates incremental revenue
for broadcasters and rights holders. The key elements of our strategy are:

- Developing relationships with rights owners. We intend to continue
developing our relationships with rights owners such as the National
Football League ("NFL"), Major League Baseball ("MLB"), National
Basketball Association ("NBA"), International Federation of Football
Associations (" FIFA"), Indy Racing League (" IRL"), specific teams
and other sports governing bodies as well as the owners of first run
and syndicated entertainment programs;

- Developing relationships with television broadcasters and
distributors. We intend to continue to develop the relationships we
currently have with national network broadcasters such as NBC, CBS,
ABC, ESPN, and FOX and cable operators and programmers such as
Cablevision and their affiliated programming entities;

- Developing relationships with non-sports owners of first run and
syndicated entertainment programming. We intend to continue to
develop software used for virtual product integration in television
programming and to convince television sponsors and broadcasters to
use the L-VIS(R) System in their programming;

- Working directly with high-profile advertisers. To promote
acceptance of the L-VIS(R)System, our marketing executives are
actively discussing the unique uses and benefits of our
L-VIS(R)System directly with high-profile advertisers. Our efforts
in this area continue to expand because of the success of this
approach in building a profitable business outside the United States
working directly with the advertising community, and the potential
benefits we believe would result from the endorsement of our
technology by the advertising community; and

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- Enhancing and developing additional L-VIS(R)System software and
deploying new technology. In addition to enhancing our existing
Vision software for use of the L-VIS(R)System during soccer,
football, baseball, basketball and hockey games, we are developing
software which would allow us to use the L-VIS(R)System during the
broadcast of additional sports and other entertainment programming.
Our recent acquisition of Scidel's patented video insertion
technology will also enable us to offer video insertion to a wider
variety of clients. We are also continuing to develop our
iPoint(TM)product in cooperation with Cablevision in order to expand
the use of our technology on the Internet and in interactive
television.

OWNERSHIP OF VIDEO INSERTION RIGHTS

The broadcast of soccer, football, baseball, basketball, hockey and any other
type of sporting event is governed by agreements among the applicable teams,
leagues, broadcasters and the sports federation, if any. In the NFL, for
example, all television, video insertion and national sponsorship rights are
controlled by the league for all regular season games, the playoffs, the Super
Bowl and the Pro Bowl. Such rights are controlled by individual NFL teams with
respect to all pre-season games. In baseball, MLB holds all television,
sponsorship and video insertion advertising rights with respect to regular
season nationally broadcast games, the All Star Game, playoff games, the World
Series and the international distribution of regular season games.

The broadcast of pre-recorded, entertainment programming such as sitcoms,
variety shows and award shows can be controlled by agreements among copyright
holders, production companies, distributors, broadcasters and/or cablecasters,
and sponsors.

Impediments to the use of our L-VIS(R) System during the broadcast of programs
covered by any of these agreements could have a material adverse effect on our
business, financial condition and the results of our operations by limiting its
acceptance and use in television programming. In many instances, these
agreements provide that different persons control the copyrights to the
broadcasts in differing circumstances, for instance, regular season play versus
playoffs in sports, or first run versus syndication for situation comedies.
Agreements often govern permitted forms of advertising and modifications to the
broadcast. Use of video insertion technology is not specifically discussed in
some existing agreements and under these circumstances it is not clear whose
permission must be obtained to use the L-VIS(R) System. If we use our L-VIS(R)
System without the permission of the appropriate parties, such use can be
challenged in a court of law. The defense and prosecution of copyright suits are
both costly and time-consuming and current broadcast copyright holders might not
agree to amend current agreements to allow for or facilitate the use of our
technology on terms acceptable to us.

SALES AND MARKETING

While our emphasis is to generate increased sales from sharing advertising
revenue with rights holders and broadcasters, we expect to continue to generate
revenues from royalties received for the licensing of our technology and from
contractual or production revenue earned from fees paid by broadcasters for
program enhancements.

The L-VIS(R) System has been used during the broadcast of, among other events,
(i) hundreds of broadcasts of soccer matches in Latin America and Europe, (ii)
the international broadcast of the Super Bowl every year beginning with Super
Bowl XXXIII in January 1999, (iii) 2002 MLB World Series, 2002 MLB home games of
the Philadelphia Phillies and 2001, 2000 and 1999 MLB home games of the
Philadelphia Phillies and the San Diego Padres, (iv) NFL regular season and
playoff games broadcast by CBS Sports since 1999, (v) ESPN Sunday Night Baseball
games during the

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1999, 2000, 2001 and 2002 regular seasons, and (vi) the IRL national telecast of
the Indianapolis 500 in May of 2002 and IRL national telecasts on ABC and ESPN
for their 2000 and, 2001 series, including the Indianapolis 500 in May of both
years.

On February 14, 2001, we entered into a license agreement with Cablevision which
grants Cablevision and its affiliates the right to use our L-VIS(R) System and
related proprietary rights in its business in exchange for license fees and
royalties. Since that time, L-VIS(R) Systems were installed in two Cablevision
properties - Madison Square Garden (MSG) in New York City and Rainbow Networks
Communications (RNC) in Bethpage, New York, which is Cablevision's programming
origination and distribution center. With the installation of the system at RNC,
we have expanded the applications of our technology to include NCAA college
hockey games, where virtual advertising has been used during the game on the
glass panels behind the goal. The system at MSG has been used to test the
insertion of virtual images off-air in six New York Rangers hockey games and to
insert virtual images in one live Rangers broadcast. Cablevision owns Madison
Square Garden and the New York Rangers, as well as the New York Knicks
basketball team. On June 25, 2002, subsequent to this agreement, PVI entered
into a Note Purchase and Security Agreement (the "Note Purchase Agreement") with
PVI Holding, LLC, a subsidiary of Cablevision Systems Corporation (See Note 4 of
our Notes to the Consolidated Financial Statements).

There can be no assurance, however, that we will be successful in establishing
or maintaining a relationship with any of these parties.

As discussed above, the right to insert electronic images for advertising
purposes into a live or pre-recorded broadcast, and hence the right to sell
advertising using the L-VIS(R) System, is held by different groups depending, in
most cases, on the programming event or sport involved, the status of the game,
i.e., pre-season, regular season or post-season, and whether the programming or
game is to be broadcast internationally, nationally or locally. These rights may
be sold for specific programming events or games and/or entire seasons to
another party, most notably a broadcaster who pays the rights holder an up-front
fee for such rights. In each case, we must negotiate for the use of the L-VIS(R)
System with the rights holder or holders, typically in exchange for a percentage
of the advertising revenue generated using the L-VIS(R) System or for a
contracted fee. When the L-VIS(R) System uses the live feed from the broadcaster
to insert its electronic images, such broadcaster must also approve the use of
the L-VIS(R) System. Accordingly, arrangements with several parties including
the rights holder and the broadcaster must be established.

The ultimate customers of our L-VIS(R) System are expected to continue to be
advertisers, sponsors, broadcasters and rights holders. Revenues flow from the
advertisers and sponsors to the rights holders who pay a share of those revenues
or a contracted fee to us. We provide the L-VIS(R) System and support services
to the rights holders and we are paid by the rights holders either a percentage
of the advertising revenues derived from use of the L-VIS(R) System or an agreed
upon fixed fee for services provided. The rights holders enter into agreements
with broadcasters to provide the services necessary for use of our L-VIS(R)
System. In some cases, advertising space using the L-VIS(R) System is then sold
either by the rights owner or by the broadcaster, depending on the specific
arrangement between such parties, and the advertising revenues are shared among
the rights owner, the broadcaster and us. As a result, we often rely upon the
marketing and advertising staffs of these rights holders and broadcasters, which
typically target the manufacturers or producers of nationally distributed
products. The broadcast rights holders have been only moderately successful in
selling L-VIS(R) System advertising. If the broadcast rights holders are unable
to enter into higher paying or a greater number of arrangements with
advertisers, this failure could inhibit the growth in our revenue stream. In
order to mitigate this dependency on third parties, we are actively promoting
the advantages of the L-VIS(R) System directly to major advertisers. We believe
that promotion is important in influencing market acceptance of the L-VIS(R)
System among potential advertisers.

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Over the past several years, we have focused our sales and marketing efforts on
those sports that account for a significant amount of the United States or
worldwide advertising and sponsorship expenditures and in a growing number of
entertainment programming applications. The following is an explanation of our
sales and marketing strategy for several of our target markets:

SOCCER

Soccer is the most popular, marketable and widely seen sport in the world.
Although sales from soccer television advertising in the United States
historically have been very small, the majority of our revenues are derived from
this sport worldwide, with Latin America being the leader. We intend to strongly
pursue and continue marketing the L-VIS(R) System for use in soccer matches in
Asia and Latin America.

The basic soccer application software was initially designed to insert an image
onto the center circle of a soccer field, but has now evolved to insert images
in the grass near the goal posts, above the billboard signs and practically
anywhere on the field that an advertiser would want, subject to FIFA's (soccer's
governing body) rules. The L-VIS(R) System has been used both nationally and
internationally in soccer broadcasts. In March 2000, our then Latin American
licensee, Publicidad (which became our wholly-owned subsidiary on September 20,
2001), entered into multi-year agreements with Televisa and TV Azteca, Mexico's
two largest television networks, for the use of the L-VIS(R) System. The
agreements include the telecast of games of the Mexican National Soccer Team.

On March 26, 2002, PVI acquired the assets of SciDel Technologies, Ltd.,
including several key agreements for virtual advertising in European soccer
league broadcasts. PVI intends to utilize the proprietary technology it acquired
from Scidel, along with our own L-VIS(R) technology, to expand the use of
virtual advertising for soccer in Europe and elsewhere.

It is our understanding that FIFA continues to evaluate its position on the use
of virtual imaging. We continue to explore ways to encourage FIFA to grant
permission for its expanded use. There can be no assurance that FIFA will grant
such expanded permission, and without the permission of FIFA, our potential
revenue from soccer would be substantially reduced.

FOOTBALL

PVI has developed several successful commercial and enhancement applications for
professional football. For the preseason games of the Dallas Cowboys, virtual
ads were placed in high impact positions in the crowd, in each end zone and
around the goalpost regions. These ads were animated for greater effect.

During the regular NFL seasons in 2002, 2001, 2000 and 1999, we used the
L-VIS(R) technology to insert a first down line in CBS national broadcasts,
including post season playoff games. The first down line appears to be popular
with the viewing audience and similar technology can be used to put advertising
on the field, in the form of a "branded" first down line, for example, when the
rights owner permits it. This was first done domestically with CBS in college
football during the 2002 college football season. Although the NFL does not
permit signage in the broadcasts of its regular season games at the present
time, we continue to pursue this possibility. PVI has inserted a branded first
down line in domestic broadcasts of championship games for NFL's Europe League
in 2000, college football's Sun Bowl in 2001 and regular season collegiate
Southeastern Conference games in 2002.

PVI also sells advertising in the international feed of the Super Bowl. In this
"feed", PVI and its partners in Canada and Mexico sell advertising intended for
their own market. This "narrowcasting" approach increases revenues and has
featured international advertisers such as FedEx, Charles Schwab, Volkswagen,
Ford and Nextel.

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BASEBALL

Baseball stadiums have perhaps the most valuable piece of real estate in
sports--the wall behind home plate. We believe that this high impact position
has great recall among viewers and is a coveted position for advertisers. Under
agreement with ESPN, PVI has placed virtual ads in their national broadcasts of
Sunday Night Baseball. The virtual ads change every half inning and have
appeared in a minimum of twenty games in each of the last two seasons.
Advertisers that have used the service include Claritin, Century 21, Gateway and
Buick. We provided the same service to MLB for the 2001 All Star Game and the
2002 World Series. The Philadelphia Phillies have used the system for several
years with advertisers such as Coca-Cola, Toyota and Mobil making use of unique
animated features like "speed of the pitch" in which a logo changes to reveal
the speed of the last pitch. We are continuing our efforts to contract with
other baseball teams to use our technology and to renew existing relationships
with the individual teams and the national broadcasters. We also intend to
develop our Internet and interactive software products for potential use in
baseball and other sports. During a Chicago Cubs broadcast against the San Diego
Padres, we provided virtual advertising insertions behind home plate, which were
made interactive by RespondTV, a leading infrastructure provider for interactive
television content. During this broadcast, viewers with internet enabled set-top
boxes were able to interact on their personal computers with the broadcast.
Despite our marketing efforts and development of such innovative products,
however, there can be no assurance that we will be successful in creating
greater interest for use of the L-VIS(R) System in MLB.

MOTOR SPORTS

The Indy Racing League (IRL) was the first major motor sport to utilize virtual
advertising during its broadcasts. Their races are telecast over either ABC or
ESPN and include the broadcast of the Indianapolis 500 in May of each year. The
L-VIS(R) System has been used to insert virtual images into the natural
landscape of the IRL race broadcast, both in the middle of the field and on the
race track. During the Indianapolis 500 in May 2002, an expanded package of
virtual enhancements was used including a virtual radar gun registering the
speed of selected cars and a virtual picture of the winning driver on the
start/finish line during the final lap of the race.

OTHER SPORTS AND ENTERTAINMENT PROGRAMMING

In addition to the major sports described above, we have also provided services
using the L-VIS(R) System in other sports and entertainment programming. The
L-VIS(R) System was used for the first time in televised golf during the
telecast of Shell's Wonderful World of Golf broadcast by ESPN in October 2000.
Virtual enhancements, including a virtual flagstick indicating where the cup is
located, and a white circle highlighting the cup when a player is putting, were
inserted onto the golf course. As part of the international broadcast of the NBA
finals in 2001, virtual signage made its debut in basketball with the insertion
of signage on the interior walls of the basketball court as well as on the
scoreboards.

During the 2000, 2001 and 2002 Grammy Awards broadcasts on CBS each February,
the L-VIS(R) System was used to insert virtual advertisements on the walkways
into the building prior to the award show. PVI also expanded its work in
entertainment programming in 2002 through our work with Comedy Central.

We are also expanding our services into the area of entertainment programming.
Unlike live sporting events, virtual product integration inserts virtual
products into half hour sitcoms, movies or other pre-recorded media. The
company has developed a post-production system based on L-VIS(R) that can add
products to pre-recorded television shows in much the same way as we do in live
sporting events. The company intends to earn revenues by selling the
opportunity to insert products or brands directly to advertisers and to share
any revenue with the broadcaster and rights holder. The company had already
completed a deal with Hallmark to insert products into some made for TV movies.

Our strategic relationship with Cablevision has also led to many new
opportunities to expand the array of applications of our technology to include
NCAA college hockey games, where virtual advertising has been used during the
game on the glass panels behind the goal. A system was installed at Madison
Square Garden which was used to test the insertion of virtual images off-air in
six New York Rangers hockey games and to insert virtual images in one live
Rangers broadcast. Cablevision owns Madison Square Garden and the New York
Rangers, as well as the New York Knicks basketball team.

11

INTERNATIONAL BUSINESS STRATEGY

Our strategy with respect to sports and entertainment programming originating
outside of the United States is to enter into revenue sharing agreements either
with foreign broadcast and sports marketing experts or by the formation of
foreign subsidiaries either majority or wholly-owned by PVI. We expect that the
largest international market for the L-VIS(R) System will be for soccer matches
and entertainment programming.

Publicidad Virtual S.A. de C.V. ("PV"), which has marketed the L-VIS(R) System
throughout Mexico, Central and South America and the Spanish-speaking markets in
the Caribbean basin since 1993, has become the largest and most successful
virtual advertising company worldwide. Televisa, one of Mexico's two largest
television networks, had been performing advertising sales functions for PV
dealing directly with advertisers selling PV's virtual insertion inventory. In
1999-2000, PV began purchasing inventory from Televisa and selling directly to
advertisers. This was part of PV's strategy to position itself not just as a
technology provider, but as a company that provides media and marketing services
for television advertisers and generates incremental revenue for broadcasters
and rights holders, and led to a dramatic increase in sales. The L-VIS(R) System
has been used by the clients of PV to place insertions into broadcasts of
hundreds of soccer matches, tennis matches, bullfights and entertainment
programming including concerts. In September 2001, we acquired PV and it is now
a wholly-owned subsidiary of PVI.

On March 26, 2002, PVI acquired the assets of SciDel Technologies, Ltd., an
Israeli virtual signage company specializing in downstream applications.
SciDel's downstream technology complements PVI's efforts in moving towards total
vision based applications. In addition, SciDel has ongoing operating
relationships with three of Europe's major soccer leagues.

In South Africa, PVI is producing advertising and game enhancements for
Sportscast, a South African sports marketing agency acting as PVI's agent, and
the South African Broadcasting Corporation (SABC), the leading public television
channel in South Africa, which are used in SABC's live broadcasts of rugby,
cricket, soccer, boxing, motor sports, horse racing, golf and other athletic
broadcasts.

See Note 25 of our Notes to the Consolidated Financial Statements for
additional industry segment, geographical and customer information.

There can be no assurance that we will be able to enter into or maintain
favorable relationships with any partners or licensees, that any partners or
licensees will establish a market for the L-VIS(R) System, that any
relationships will generate any revenue for us, or that any partners or
licensees will act in good faith and perform their obligations to us. To the
extent that we have entered into these exclusive arrangements in a particular
market, we are dependent upon these partners or licensees to generate revenues
for us. Their failure could preclude us from generating material revenues in
such geographical area or with respect to a specific sport, as the case may be.

There are certain risks inherent in doing business in international markets,
such as unexpected changes in regulatory requirements, tariffs and other trade
barriers, difficulties in staffing and managing foreign operations, political
instability, fluctuations in currency exchange rates, reduced protection for
intellectual property rights in some countries, seasonal reductions in business
activity during the summer months in Europe and certain other parts of the
world, and potentially adverse tax consequences. These and other factors,
including the failure to integrate into our operations any foreign businesses
such as Publicidad and SciDel Technologies which we have acquired or may
acquire, may prevent us from creating a material business internationally. We
have granted some parties exclusive rights to territories or specific sporting
events, which means that we must rely on their success in these areas. Their
failure could greatly reduce the potential

12

growth of our international business.

PRODUCT DEVELOPMENT

The L-VIS(R) System is designed using a Flex-Card hardware platform. This
platform is more powerful than previous platforms and allows for software
re-configuration. We have designed the Flex-Card L-VIS(R) System to provide
multiple insertion capability, multiple camera capability and an expanded zoom
range, and we have created a simplified graphical user interface. See Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Product Development", regarding the costs associated with our
product development during the year ended December 31, 2002 and in each of the
last three fiscal years.

We are continuing to improve existing software for use of the L-VIS(R) System
during the broadcast of soccer, football, baseball, basketball and hockey games,
as well as golf and motor sports. Further, we are developing software to permit
the use of our L-VIS(R) System during the broadcast of other sports. We have
also made the L-VIS(R) System available for use with other events such as award
shows, pay-per-view boxing and concerts. We intend to continue our development
of our iPoint(TM)product, as we believe there may be important applications of
our technology as it relates to entertainment and sports programs when viewed
with interactive television and/or the Internet.

The L-VIS(R) System can still only be used for some programs under certain
circumstances. During live events, we often must have the cooperation of the
broadcaster to obtain acceptable results. In the past, the L-VIS(R) System has
been operated mainly by our personnel but increasingly is operated by operators
trained by us. We are working to develop additional software and hardware and
train personnel to achieve a more user-friendly product with wider potential
use.

Recently, development of future versions of L-VIS(R) has been directed toward
vision-only applications. These applications rely primarily on computer vision
and image processing to precisely and rapidly determine the position and
orientation of the virtual insert, and do not require attachment of sensors to
the broadcast lens or tripod. Such applications therefore may be operated
remotely from the event site. When operated in this way, the cost associated
with providing this service is significantly reduced, in part because of the
reduced need to send operators to the event site. In addition, we are beginning
a slow migration of the L-VIS(R) hardware system to a hybrid structure, based in
part on the existing FLEX architecture, and in part on a desktop personal
computer ("PC"). As part of this effort, we are developing a PC based FLEX board
equivalent.

During 2002, significant progress was made in the development of the hybrid
system and the application was tested live (on air) in several CBS productions
of NFL games during the 2002 season, and several college football games in the
fall of 2002 and the first quarter of 2003. Our ability to locate the system
downstream (i.e., in the broadcast studio rather then at the venue) is a
significant cost savings over the traditional on-site production method.

On March 26, 2002, we acquired the assets of SciDel Technologies, Ltd., an
Israeli-based virtual advertising company, including their patent portfolio and
proprietary hardware and software. The acquired technology works in vision mode
by reliably recognizing lines in a television picture - such as lines on a
basketball or tennis court - and derives data there from that enables the
positioning of inserted images. The technology cannot, however, store that
information in order to ensure that the insertions continue to be properly
positioned when those lines are not visible. By adapting PVI's tracking
technology for use with this line-finding system, we can overcome this problem
and improve tracking performance in many situations. We have recently made
significant progress in merging the SciDel recognition technology with PVI's
tracking technology and have performed an on-site demonstration in a Mexican
soccer game.

13

COMPETITION

PVI believes three other companies have developed or are trying to develop
processes and equipment to pursue a business similar to our own. These
organizations are Symah Vision-SA ("Symah"), Orad Hi Tech Systems Ltd. ("Orad"),
and Sportvision, Inc. ("Sportvision").

Symah is owned by the LaGardere Group, which controls Matra-Hachette, a large
French defense and publishing company. Symah has demonstrated its system
publicly and is actively marketing its system in Europe. We believe that Symah's
system has been used in Europe during the broadcast of over 300 sporting events.

Orad was founded in 1993 as part of the ORMAT Group, an Israeli company
originally established to create alternative energy power stations. Orad's
primary business is selling virtual sets and is responsible for the worldwide
marketing of their virtual advertising system, "ImADgine". The Orad system has
been used during some live commercial broadcasts. We believe Orad has one or
more patents or patent applications relating to real-time video insertion.

Sportvision is using camera sensor technology for inserting viewer enhancements,
such as a first down line in football, into live television broadcasts. As far
as we know, Sportvision has been minimally active in the advertising part of the
business. In February 2002, PVI, FOX and Sportvision entered into a cross
license agreement, which relates to the use by each company of certain patents
of the other company.

Although we believe that use of the L-VIS(R) System does not infringe the United
States or other patents of third parties, there can be no assurance that
competitors will not initiate a patent infringement action against us.

In addition to these known competitors, we expect substantial competition from
established broadcast business participants, if the market for video insertion
technology, including virtual advertisements, proves successful. These potential
competitors will likely have substantially greater financial, technical,
marketing and other resources and many more highly skilled individuals than we
do. Furthermore, such potential competitors may have greater name recognition
and extensive customer bases that could be utilized to gain significant market
share, to our detriment. Our competitors may be able to produce superior
products, including products with new features, undertake more extensive
promotional activities, offer more attractive terms to customers and adopt more
aggressive pricing policies than we can. There is no assurance that we will be
able to compete effectively with current or future competitors.

In addition to the products of these competitors, the L-VIS(R) System will
compete with advertisers' use of traditional 30-second advertising spots, which
remain the standard in the television advertising industry, and traditional
signage and sponsorship programs. Our revenues will be partially dependent upon
television sports advertisers allocating a portion of their advertising budgets
to use the L-VIS(R) System. There can be no assurance that advertisers will
allocate their advertising expenses in the manner currently anticipated by us.
Existing advertisers may be reluctant to use a new technology. Advertisers may
not believe that their sales will increase as a result of the use of our
technology. The competition is likely to be more intense where we are competing
for television advertising and sponsorship dollars that are currently spent on
traditional media, such as 30-second spots or scrolling billboards. We need the
cooperation of the sponsorship advertising sales departments of team owners,
other rights holders and broadcasters. We rely on these entities for the sale of
our products to advertisers, but they may have incentives to sell alternative
advertising or sponsorship inventory rather than our services. The reluctance by
advertisers and sales forces to embrace our technology and assist in the sale of
virtual advertising could have a material adverse effect on our business,
financial condition and results of operations by stifling the potential growth
of our business.

14

The L-VIS(R) System will also compete with advertisers' use of conventional
billboard products, including advertising placed on playing surfaces (such as
outfield walls, football fields, ice hockey rinks and soccer fields) and
scrolling billboards, physically located at the site of an event, which can
display sequentially a series of static advertisements. These scrolling
billboards are currently marketed and used in professional baseball, basketball
and other sports. These products achieve an effect that is similar to those
L-VIS(R) System insertions that are static and two-dimensional, and their use
generally does not require broadcaster participation.

During the 2002 MLB season, 26 MLB teams had scrolling billboards located behind
home plate. The existence of these scrolling billboards and other advertising
behind home plate currently limits the marketability of the L-VIS(R) System in
baseball. We believe that one manufacturer of scrolling billboards used in
stadiums has included restraints in its contracts that inhibit or prohibit the
use of video insertion technology in television broadcasts. Other agreements
among advertisers, sponsors, syndicators, promoters, broadcasters and cable
operators may include similar provisions. These restrictions may have a material
adverse effect on our business, financial condition and results of operations by
reducing the number of potential users of the L-VIS(R) System.

In the sports advertising arena, we continue to generate revenue primarily by
attracting new advertisers and sponsors to the sports advertising and
sponsorship market and by causing existing advertisers and sponsors to use the
L-VIS(R) System. There can be no assurance that total advertising and
sponsorship expenditures will increase as a result of the availability of the
L-VIS(R) System. As we continue to compete for television advertising and
sponsorship dollars that are currently allocated to traditional media, such as
30-second spots or scrolling billboards, the competition is likely to become
more intense. We will be able to compete effectively with existing advertising
and sponsorship alternatives only with the cooperation of broadcasters and the
advertising sales departments of team owners and broadcasters, on which we must
sometimes rely for sales to advertisers. Because certain L-VIS(R) System rights
holders may also own traditional television advertising rights or sponsorship
rights, which may provide such rights holders with a greater percentage of the
revenues received from the sale of such advertising or sponsorship rights than
does the sale of L-VIS(R) System advertisements, incentives may exist in some
cases to sell alternative advertising or sponsorship inventory prior to the sale
of L-VIS(R) System advertising.

With regard to placing images in syndicated and first run television programs,
we have generated revenue through agreements with the program rights holders and
distributors to place advertising logos or products within the programs
themselves, prior to distribution. Advertising imbedded in the program may
create conflicts with the broadcasters of the programs as it may compete with
traditional 30-second spot advertising sold by the broadcasters. This in turn
may affect our ability to develop a more robust business in this area.

In the case of program enhancements, we are making available to the broadcasters
a series of enhancements, which the broadcaster can use to increase the audience
appeal of its programs. We typically get a negotiated fixed fee for each use by
the broadcaster of such enhancements. There is no assurance that the
enhancements which we have developed or may develop in the future will be of
sufficient value to the broadcasters to make this a viable business segment for
us. Furthermore, competitors may drive down the fees to levels where we cannot
cover the costs of providing the enhancement services.

Our development of products related to the Internet and potential interactive
television business is an area where a large number of creative new companies
and existing well-financed companies have a significant interest. PVI believes
that its intellectual property offers an opportunity to participate effectively
in these new businesses. Under our joint collaboration and license agreement
reached with Cablevision, we will work to develop, market and deploy innovative
digital technological applications across the full range of Cablevision's media,
sports and entertainment properties. Our ability to play a meaningful role will
depend, in part, on our forming and

15

maintaining appropriate relationships with existing industry players, including
Cablevision. There is no assurance that our potential products will be embraced
by the industry or that we can utilize and develop the relationships we have
within the sports and media industries to create a successful business.

MANUFACTURING AND SUPPLY

We have built 37 L-VIS(R) System units (each, an " L-VIS(R) Unit"), of which
approximately 34 are being used from time-to-time by customers, potential
customers or foreign marketing partners. An L-VIS(R) Unit consists of standard
electronic equipment racks, containing both standard purchased components and
our proprietary circuit boards, assembled and tested by our own personnel. We
have also modified four of our existing L-VIS(R) Units to operate in the
downstream or hybrid mode, using image processing alone to perform the virtual
insertion. The modification consists primarily of adding a programmed PC to a
standard L-VIS(R) Unit.

REGULATIONS

We do not believe that any federal or state regulations currently directly
relate to or restrict the use of the L-VIS(R) System. There are existing
regulations imposed on broadcasters, which may require disclosure that the
L-VIS(R) System is being used in a particular broadcast. In addition, there can
be no assurance that there will not be any regulations or restrictions in the
future, which either directly, or indirectly through broadcaster regulations,
adversely affect the use of the L-VIS(R) System. Further, there can be no
assurance that regulatory agencies in foreign jurisdictions have not adopted, or
will not adopt in the future, regulations or restrictions affecting the use of
the L-VIS(R) System. If adopted, such regulations or restrictions might reduce
or eliminate the market for our products in any country where these regulations
or restrictions are adopted. This could have a material impact on our ability to
expand into both domestic and international markets if it prevents us from
providing our services in a particular sport, broadcast or entertainment market.

INTELLECTUAL PROPERTY

PATENTS

We own twelve issued U.S. patents relating to proprietary technology we use in
our business. These patents expire at various times, commencing in 2012. A
number of new patent applications are pending in the United States.

To date, we have filed patent applications in the European Patent Office and in
various non-European countries around the world where we expect to do business.
In 2002, our application with the European Patent Office, on EPO Application No.
9191562.8, for a basic pattern recognition patent, was successfully challenged
by Symah Vision, a French company and subsidiary of LaGardere.

In October 1999, we filed a request with the United States Patent and Trademark
Office ("USPTO") to correct the ownership of U.S. Patent 5,917,553, licensed to
Sportvision, Inc. on the basis of our belief that the basic subject matter of
this patent belongs to PVI. After we filed this action, Sportvision, Inc. and
Fox Sports Productions, Inc. ("Fox") filed a lawsuit against us in U.S. District
Court for the Northern District in California for infringement of the disputed
U.S. Patent 5,917,553, seeking injunctive relief and compensation including
damages. On January 29, 2002, the parties entered into a Settlement Agreement
regarding this matter and a dismissal with prejudice as to all parties was filed
on March 9, 2002. Pursuant to the Settlement Agreement, the parties entered into
a patent cross-license agreement. The cross-license agreement grants both
parties a royalty free license to the patent portfolio of the other party
subject, however, to the restriction that each party may only use the other's
technology to position and stabilize inserts when the actual insertion of the
virtual object into the video stream is

16

performed at the source of the programming, which usually is at the arena site
for sporting events. This restriction prevents Sportvision from using PVI
technology in a "downstream" configuration. For example, Sportvision is not
licensed to use PVI technology in the broadcast studio to stabilize insertions
in video transmitted form a remote venue. Also, this restriction prevents
Sportvision from using PVI's iPoint(TM)technology.

The degree of protection offered by our patents is not certain, and any patents
issued to us or our licensees in a foreign country may provide less protection
than provided in the United States. In addition, it is possible that our pending
patents will not issue.

We believe our patents will be important in our future business dealings, since
we believe that any system that is able to deliver the technical capabilities of
the L-VIS(R) System will depend on image processing technology that will,
therefore, fall within the scope of PVI's issued patents.

The validity and/or breadth of PVI's owned and licensed patents generally may be
tested in post-allowance court proceedings. (See Competition above). The two
court proceedings which have been undertaken relating to PVI's patent property
have both been settled. And accordingly there has been no completed court test
of any of the issued patents, the allowed patents or any of the pending
applications or foreign counterparts. We are aware of other companies that have
patents or patent applications in the field of electronic video insertion
technology. As was the case with Sportvision, these companies or others may
claim that we infringe the patents or rights of such third parties, or these
third parties may infringe our patents. In either event, patent litigation
involves complex legal and factual issues, and the outcome, consequently, is
highly uncertain. Furthermore, patent litigation entails considerable costs,
which could divert resources that otherwise could be used for our operations. We
cannot be certain that PVI or its licensors will be successful in enforcing our
rights, or that our products or processes do not or will not infringe the patent
or intellectual property rights of a third party. An adverse outcome in the
defense of any patent infringement action could subject PVI to significant
liabilities to third parties, require PVI to license disputed technology from
third parties, if possible, force PVI to try to redesign its products or
practices, or require PVI to cease selling its products. In the event our owned
or licensed patents were successfully challenged in court, our business,
financial condition and results of operations would be materially adversely
affected by limiting our ability to do business.

It is possible that one or more products developed by a competitor may be
marketed or used in a territory where we have patent protection. Competitors or
strategic partners may copy or independently develop technologies that are the
same or similar to our technologies. Because an image inserted through use of
video insertion technology often appears as if it exists as a physical
advertisement at the site of a sporting event, it may be difficult to know
whether, and which, video insertion technology is being used with respect to any
televised sporting event. Thus, infringement of our patents may be difficult to
monitor. Our failure to detect such an infringement may have a material adverse
effect on our business, financial condition and results of operations. In the
event we become aware of a potential patent infringement, we may be forced to
litigate to enforce our patent rights. Engaging in such an enforcement action
may be protracted and expensive and, therefore, have a material adverse effect
on our business, financial condition and results of operations.

GDM, a Spanish media company that licensed the L-VIS(R) System for use in
broadcasts in Spain and Portugal during a trial period which ended December
1996, received a letter from a Symah affiliate asserting that use of the
L-VIS(R) System in Spain would infringe one of Symah's patents. Although PVI and
GDM were advised that use of the L-VIS(R) System would not infringe Symah's
patent, there can be no assurance that Symah will not assert infringement claims
against PVI or its European licensees in the future or against PVI in the United
States for infringement of the U.S. counterpart (U.S. Patent 5,353,392) of
Symah's patent. We believe that the L-VIS(R) System does not infringe U.S.
Patent 5,353,392 and infringement of this patent has not been asserted against
us.

17

If the L-VIS(R) System were found to infringe any third party patent, we might
be required to modify the L-VIS(R) System or enter into an arrangement to
license such patent, if possible. There can be no assurance that we would be
able, under such circumstance, to modify the L-VIS(R) System or enter into a
license arrangement. We also rely in large part on un-patented trade secrets,
improvements and proprietary technology. We require our employees and some third
parties to enter into confidentiality agreements. Despite our efforts to
safeguard and maintain our proprietary rights, there can be no assurance that we
will be successful in doing so or that our competitors will not independently
develop similar technology, gain access to our technology, reverse engineer or
patent technologies that are substantially equivalent or superior to our
technologies. We also use copyright, trademark and trade secret protection.
These steps may not protect our trade secrets, know-how or other proprietary
information.

LICENSE GRANTS TO PVI

PVI has entered into the following license agreements relating to the L-VIS(R)
System:

David Sarnoff Research Center, Inc. ("Sarnoff") has granted PVI a worldwide
license to utilize Sarnoff's technology related to the electronic recognition of
landmarks, including an exclusive license covering the specific fields of
television advertising and television sports. We have also been granted a
non-exclusive license for use of the Sarnoff technology in all other fields
relating to sports or advertising.

During the term of the exclusive license for television advertising and
television sports applications, we are obligated to pay Sarnoff royalties based
upon a percentage of our gross revenues. During the first several years of the
agreement, all royalties were accrued as earned. Payments for all accrued
royalties through December 31, 1998 became due in January 1999 and were paid in
full by December 1999. Commencing in January 1999, minimum quarterly royalties
of $100,000 became due in order to maintain the license. For the calendar years
1999 and 2000 and the first quarter of 2001, we had the option of paying these
minimum royalties in cash or with PVI stock at its last issue price and,
accordingly, elected to issue stock for all royalties due for the years ended
December 31, 1999 and 2000 and the quarter ended March 31, 2001. Royalties
earned subsequent to March 31, 2001 are required to be paid in cash.

On September 20, 2002, we notified Sarnoff that we are no longer using the
technology and patents licensed to us by Sarnoff effective June 30, 2002.

Theseus Research, Inc. Theseus Research, Inc. ("Theseus") has granted PVI a
non-exclusive, worldwide license to use and sell Theseus' patented technology
for the warping of images in real time. During the term of the Theseus license,
we are required to pay Theseus a royalty on net sales of products, if any, that
incorporate the Theseus technology. PVI paid Theseus an up front license fee of
$50,000, which is creditable against these future obligations. The license,
which terminates with the expiration of the last of the patents included in the
licensed technology, may be terminated by PVI at any time. The technology
licensed to PVI by Thesus under this agreement is not used by PVI in any
commercial application.

TRADEMARKS

L-VIS(R), the mark under which we are marketing our live video insertion
products is a trademark of PVI which is registered with the U.S. Patent and
Trademark Office.

C-TRAK (TM) is a trademark of PVI. We have filed a U.S. trademark registration
application for C-TRAK(TM), the mark under which we are marketing our electronic
imaging system in which a part of the picture or image in a prerecorded or live
video signal is scanned, digitized, stored and tracked to thereby maintain the
position of one or more inserted images relative to other parts of the main
picture or image. We have filed a Statement of Use with respect to the C-TRAK
mark on July 5,

18

2001 and it was accepted by the U.S. Patent and Trademark Office on September 7,
2001. The trademark registration was issued on October 16, 2001.

COPYRIGHT AND TRADE SECRET

PVI relies upon copyright and trade secret protection to maintain the
proprietary nature of the computer software it develops that is not patented.
These steps may not protect our trade secrets, know how or other proprietary
information.

EMPLOYEES

As of March 1, 2003, we (together with our wholly-owned subsidiaries) had 101
full-time employees, 18 of whom were engaged in, or directly support, PVI's
hardware and software research, development and product engineering activities,
34 of whom assemble and operate our proprietary systems, 24 of whom were engaged
in marketing activities and 25 of whom were engaged in administrative
activities. In addition, we utilize part-time and seasonal employees as well as
outside contractors and consultants as needed. None of our employees are
represented by a labor union, and we believe our relations with our employees
are good. Our success depends on our ability to attract and retain qualified
financial, technical, marketing and other management personnel for which we face
competition.

Currently, all of our employees are required to execute an agreement pursuant to
which he or she assigns to PVI all patent rights and technical or other
information which pertain to PVI's business and are developed by the employee
during his or her employment with PVI, and agrees not to disclose any trade
secret or confidential information without the prior consent of PVI.

ITEM 2. PROPERTIES

We currently lease 17,000 square feet of office space in Lawrenceville, New
Jersey. The Lawrenceville facility is our main operations center, including
product, hardware and software design, manufacturing and product assembly,
product test and documentation, post production, customer training and customer
technical support. We have recently entered into an amendment of our current
lease pursuant to which, effective April 1, 2003, the space we lease in
Lawrenceville will be reduced by approximately 25% and the rent per square foot
will be reduced by approximately 33%. As amended, the Lawrenceville lease
expires on March 31, 2006. We currently lease 4,300 square feet of office space
in New York City for our sales, marketing and art department personnel. We also
currently lease or sublease approximately 6,000 square feet of office space in
Mexico City, which has an expiration date of October 31, 2006, and 1,700 square
feet of office space in Ra-anana, Israel, which has an expiration date of
December 31, 2003. These offices are the main operations centers of Publicidad,
and Princeton Video Image Israel, Ltd., respectively.

ITEM 3. LEGAL PROCEEDINGS

PVI is not a party to any material legal proceedings.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

Our Annual Meeting of Stockholders (the "Annual Meeting") was held on December
19, 2002. At the Annual Meeting, our stockholders (i) elected each of the
persons listed below to serve as one of our directors until the Annual Meeting
of Stockholders to be held in 2003 and until their successors have been duly
elected and qualify, (ii) ratified the appointment of PricewaterhouseCoopers LLP
as our independent public accountants for the fiscal year ending December 31,
2002, and (iii) approved an amendment to our Amended 1993 Stock Option Plan to
increase the number of shares of our common stock which may be issued pursuant
to options granted under the Plan from 5,160,000 to

19

7,000,000 shares.

As of November 22, 2002, the record date for our Annual Meeting, 18,487,802
shares of our common stock were issued and outstanding and entitled to vote.
Present at our Annual Meeting, either in person or by proxy, were holders of
10,134,850 shares of our common stock. The following sets forth information
regarding the results of the voting at our Annual Meeting:

Election of Directors:

Voting Shares
DIRECTOR Voting Shares in Favor Withheld

Lawrence J. Burian 10,114,465 20,385

Joseph Decosimo 10,114,465 20,385

Donald P. Garber 10,020,665 114,185

Wilt Hildenbrand 10,020,665 114,185

Lawrence Lucchino 10,020,665 114,185

Jerome J. Pomerance 10,020,665 114,185

Emilio Romano 10,020,665 114,185

Eduardo Sitt 10,114,465 20,385

John B. Torkelsen 10,020,665 114,185

Brown F Williams 10,114,465 20,385

Ratification of Appointment of Independent Public Accountants:

Votes in Favor: 10,013,060
Votes Against: 121,730
Abstentions: 60

Approval of amendment to our Amended 1993 Stock Option Plan:

Votes in Favor: 9,940,797
Votes Against: 178,880
Abstentions: 15,173
Non-Votes: 0

PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

(a) Our common stock traded on The Nasdaq National Market (the "National
Market") from December 17, 1997 to January 6, 2003, and on the Nasdaq SmallCap
Market (the "SmallCap Market") from January 7, 2003 to March 12, 2003 under the
symbol "PVII." The following table sets forth, for the calendar periods
indicated, the range of high and low sale prices for our common stock on the
National Market:

20

Period High Low
-------------------------------- ----- -----

2001 January 1 - March 31 6.469 1.438
April 1 - June 30 5.230 3.090
July 1 - September 30 5.100 2.040
October 1 - December 31 2.990 1.910

2002 January 1 - March 31 2.380 1.381
April 1 - June 30 1.992 .880
July 1 - September 30 1.051 .571
October 1 - December 31 .712 .330

Since March 13, 2003, our common stock has been quoted on the Over-the-Counter
(OTC) Bulletin Board and continues to trade under the ticker symbol PVII. Our
common stock was transferred from the National Market to the SmallCap Market on
January 7, 2003 pursuant to a Nasdaq decision, which required that, to maintain
the listing on the SmallCap Market, our common stock must evidence a closing bid
price of at least $1.00 per share on or before March 10, 2003. Our common stock
failed to achieve that bid price and effective with the close of business on
March 12, 2003, our common stock was delisted from The Nasdaq Stock Market. The
effects of this delisting may include limited news coverage and the limited
release of the market prices of our common stock. Delisting may diminish
investors' interest in our common stock, restrict the trading market and reduce
the price for our common stock. Delisting may also restrict us from issuing
additional securities or securing additional financing.

As of March 12, 2003, there were 325 holders of record of our common stock. On
March 12, 2003, the last sale price reported on the SmallCap Market for our
common stock was $.25 per share. The market prices of equity securities of
technology companies, such as PVI, have experienced substantial price volatility
in recent years for reasons both related and unrelated to the individual
performance of specific companies. Future sales of restricted securities (as
defined under Rule 144 of the Securities Act of 1933, as amended), common stock
under PVI's Stock Option Plan, and common stock issued upon the exercise of
outstanding warrants, in the public market could adversely affect the stock
price and our ability to raise funds in new stock offerings. To date, the
trading volume of our common stock has remained relatively small. As a result,
shareholders may experience difficulty selling or otherwise disposing of shares
of common stock at favorable prices, or at all.

Companies with low price stocks are governed by additional federal and state
regulatory requirements and could lose an effective trading market for their
stock. For instance, since our common stock has been delisted from The Nasdaq
Stock Market and the price of our common stock is less than $5.00 per share, the
sale or purchase of our common stock is subject to Rule 15g-9 under the
Securities Exchange Act of 1934. This rule requires that broker-dealers satisfy
special sales practice requirements before any transaction, including
suitability determinations and receiving a purchaser's written consent. The
additional burdens imposed upon broker-dealers may discourage broker-dealers
from effecting transactions in our common stock. This would reduce the liquidity
of our common stock. If these rules become applicable to our common stock, they
could have a material adverse effect on the trading market for our common stock.
In addition, our common stock could be deemed "penny stock" under the Securities
Enforcement and Penny Stock Reform Act of 1990. If this occurs, additional
disclosure would be required if a person wishes to make a trade in our common
stock. The disclosure includes the delivery of a disclosure schedule explaining
the nature and risks of the penny stock market. These requirements could
severely limit the liquidity of our common stock and the ability of purchasers
to sell their shares of our common stock in the secondary market.

We have neither paid nor declared any dividends on our common stock since our
inception. We expect to retain all earnings, if any, generated by our operations
for the development and growth of our business and do not anticipate paying any
cash dividends to our shareholders in the foreseeable future. The payment of
future dividends on the common stock and the rate of such dividends, if any,
will be determined in light of any applicable contractual restrictions limiting
our ability to pay dividends, our earnings, financial condition, capital
requirements and other factors deemed relevant by our Board of Directors.
Furthermore, pursuant to our Certificate of Incorporation, we are prohibited
from paying any dividends on the common stock until all accumulated dividends in
respect of the Series A preferred stock and Series B preferred stock have been
paid. As of December 31, 2002, the accrued dividends with respect to the shares
of Series A preferred stock and

21

Series B preferred stock totaled $30,686 and $34,643, respectively.

We are required to redeem the Series A preferred stock on a pro rata basis, at a
price of $4.50 per share plus all accrued but unpaid dividends, out of 30% of
the amount, if any, by which our annual net income after taxes in any year
exceeds $5 million, as shown on our audited financial statements. Subject to the
prior redemption of all of the Series A preferred stock, we are required to
redeem the Series B preferred stock, on a pro rata basis, at a price of $5.00
per share plus all accrued but unpaid dividends out of 20% of the amount, if
any, by which our annual net income after taxes in any year exceeds $5 million,
as shown on our audited financial statements. As of December 31, 2002, 11,363
shares of Series A preferred stock and 12,834 of Series B preferred stock were
outstanding. See Note 22 of our Notes to the Consolidated Financial Statements.

In December 2000, we entered into a reorganization agreement (the
"Reorganization Agreement") with Presencia en Medios S.A. de C.V. ("Presencia")
and certain of its affiliates, which agreement was later amended on February 4,
2001. On September 20, 2001 we completed the transaction contemplated by the
Reorganization Agreement (the "Presencia Transaction"), whereby Presencia and
its affiliates sold their shares of Publicidad to us and our affiliate Princeton
Video Image Latin America, LLC ("PVI Latin America"), and Publicidad became our
wholly-owned subsidiary. The acquisition, which was a stock-for-stock
transaction, was recorded using the purchase method of accounting. The total
purchase price of Publicidad was $6.4 million and consisted of the following
costs to PVI:

Shares of PVI stock exchanged for Publicidad stock 2,678,353
PVI average stock price a few days before
and after the acquisition was agreed to $ 1.518
Value of PVI stock issued for the acquisition $4,065,740
Fair value of warrants issued as for the acquisition 1,455,553
Acquisition costs 979,299
----------
Total purchase price $6,500,592
==========

On November 8, 2001, we sold 615,385 shares of our common stock to Presencia for
an aggregate purchase price of $2,000,001. This sale was exempt from
registration under the Securities Act by virtue of Section 4(2) as a transaction
not involving a public offering. The securities were issued for investment only
and not for purposes of distribution. A legend to such effect was affixed to the
stock certificate issued. The purchaser received adequate information about our
business.

On February 27, 2002, we entered into an asset purchase agreement with SciDel
Technologies, Ltd., an Israeli corporation, and its subsidiary, SciDel USA Ltd
(collectively, "SciDel"). On March 26, 2002, we completed the transaction,
whereby Adco Imaging Ltd. ("Adco"), a newly created Israeli wholly owned
subsidiary of PVI, obtained certain assets and liabilities of SciDel in exchange
for the issuance of 1,288,000 shares of our common stock and warrants to
purchase 670,500 shares of our common stock. In April 2002, Adco changed its
name to Princeton Video Image Israel, Ltd. ("PVI Israel"). SciDel, which had
been engaged in the development and marketing of a system that enables
television broadcasters and the Internet to integrate advertisements into live
and pre-recorded televised sports events, sold certain of its assets to us and
we intend to continue to use the assets for this same purpose. PVI's primary
reasons for acquiring these assets included the value of SciDel's patent
portfolio, its sales relationships, including existing contracts in Europe, and
the know-how of the R&D personnel we retained. The acquisition, which was a
stock-for-assets transaction, was recorded using the purchase method of
accounting. The total purchase price of SciDel was approximately $3.7 million
and consisted of the following:

Shares of PVI stock 1,288,000
PVI average stock price three days before
and after the acquisition was agreed to $ 1.99
Value of PVI stock issued for the acquisition $2,560,176
Fair value of warrants issued as
part of the acquisition (670,500) 775,557
Acquisition costs 349,231
----------
Total purchase price $3,684,964
==========

22

The warrants issued to SciDel vest over three years and may be exercised at an
initial exercise price of $9.00 per share. Our issuance of securities to SciDel
in connection with this transaction was exempt from registration under the
Securities Act by virtue of Section 4(2) as a transaction not involving a public
offering. The securities were issued for investment only and not for purposes of
distribution. A legend to such effect was affixed to the stock certificate and
warrant certificate issued. SciDel received adequate information about our
business.

On June 25, 2002, PVI entered into a Note Purchase and Security Agreement (the
"Note Purchase Agreement") with PVI Holding, LLC ("PVI Holding"), a subsidiary
of Cablevision Systems Corporation. Pursuant to the Note Purchase Agreement, PVI
issued to PVI Holding a $5,000,000 secured convertible promissory note (the
"Note"). The Note was amended and restated on February 18, 2003. As amended, the
Note is initially convertible into common stock of PVI at $.75 per share. In the
event that PVI sells any security (equity, debt or otherwise) in a qualifying
transaction (a "New Financing"), the holder of the Note would have the right to
convert the Note to PVI common stock at $.75 per share or into the security
being issued by PVI in the New Financing, on the same terms as such security is
being sold in the New Financing. Following the first New Financing, the common
stock conversion price of $.75 per share is increased to $2.50 per share. In
addition, the holder will have the right to convert the Note into any security
issued in any New Financing that occurs while the Note is outstanding, subject
to all of the terms of such New Financing. The holder of the Note is prohibited
from converting the Note under any circumstances at a price below $.38 per
share, the closing price of PVI's common stock on February 14, 2003. The
issuance of the Note was exempt from registration under the Securities Act by
virtue of Section 4(2) as a transaction not involving a public offering. The
Note was issued for investment only and not for purposes of distribution. A
legend to such effect was affixed to the Note issued. PVI Holding, LLC received
adequate information about our business.

ITEM 6. SELECTED FINANCIAL DATA

In December 2001, our board of directors elected to change our fiscal year end
from June 30 to December 31, commencing with the six month period ended December
31, 2001.

We have selected the following data derived from our consolidated financial
statements. The information set forth below is not necessarily indicative of the
results of future operations and should be read in conjunction with our
consolidated financial statements and notes thereto and Management's Discussion
and Analysis of Financial Condition and Results of Operations appearing
elsewhere in this report.

Fiscal
Year Ended Six months ended
December 31, December 31, Fiscal Year Ended June 30
('000s except for loss per share) 2002 (4) 2001 (1) 2001 (2) 2000 1999 1998
------------ ---------------- -------- -------- -------- --------

Statement of Operations Data:

Total revenue $ 10,812 $ 5,578 $ 4,664 $ 3,046 $ 1,222 $ 696

Impairment, restructuring and
other charges (3)(7) $ 4,887 $ 1,061 $ -- $ -- $ -- $ --

Total costs and expenses $ 28,699 $ 12,353 $ 17,375 $ 16,793 $ 11,852 $ 8,828

Operating loss $(17,886) $ (6,776) $(12,711) $(13,748) $(10,630) $ (8,132)

Other (expense) income, net $ (31) $ 135 $ (52) $ 2 $ -- $ --

Interest expense $ (2,714) $ (16) $ (2) $ (5) $ -- $ --

Interest income $ 95 $ 75 $ 609 $ 684 $ 976 $ (952)

Net loss applicable
to common stock $(21,215) $ (6,994) $(11,692) $(12,489) $ (9,698) $ (9,128)

Basic and diluted net
loss per share $ (1.17) $ (0.48) $ (1.09) $ (1.33) $ (1.18) $ (1.55)

Weighted average number of
shares - basic and diluted 18,198 14,721 10,732 9,374 8,186 5,891

Balance Sheet Data:

Cash and cash equivalents $ 937 $ 8,360 $ 2,672 $ 8,388 $ 12,494 $ 21,553

Accounts receivable $ 1,547 $ 2,299 $ 1,308 $ 829 $ 379 $ 193

Property and equipment, net $ 1,839 $ 2,857 $ 2,996 $ 3,685 $ 3,807 $ 2,547

Patents, net $ 795 $ 528 $ 556 $ 587 $ 547 $ 493

Identifiable intangibles, net $ 2,328 $ 3,024 $ -- $ -- $ -- $ --

Goodwill $ 3,896 $ 5,339 $ -- $ -- $ -- $ --

Total assets $ 14,099 $ 31,220 $ 11,295 $ 15,725 $ 18,891 $ 25,426

Secured convertible debt (5) $ 5,137 $ -- $ -- $ -- $ -- $ --

Notes Payable (6) $ 671 $ 1,091 $ -- $ -- $ -- $ --

Refundable Cablevision advance
payment (5) $ 3,628 $ -- $ -- $ -- $ -- $ --

Redeemable preferred stock $ 181 $ 174 $ 170 $ 1,036 $ 992 $ 948

Minority interest $ -- $ -- $ 94 $ 312 $ -- $ --

Total stockholders'
(deficit)/equity $ (3,245) $ 11,052 $ 3,390 $ 9,273 $ 12,143 $ 22,034

Other Data:

Capital expenditures $ 323 $ 389 $ 1,170 $ 1,495 $ 2,514 $ 2,094

23

(1) Results reflect the acquisition of Publicidad in September 2001 and the
second closing of the Cablevision transaction as described in Note 4 of
the Notes to the Consolidated Financial Statements.

(2) Results reflect the first closing of the Cablevision transaction as
described in Note 4 of the Notes to the Consolidated Financial Statements.

(3) Reflects severance payment to a former member of management and costs
associated with streamlining our domestic, Israeli and European operations
as described in Note 6 of the Notes to the Consolidated Financial
Statements as well as the SFAS 142 and 144 Goodwill and identifiable
intangible asset impairment charges.

(4) Results reflect the acquisition of SciDel in March 2002 as described in
Note 5 of the Notes to the Consolidated Financial Statements.

(5) Results reflect the Note Purchase and Security Agreement in June 2002 (the
"Note Purchase Agreement) as described in Note 4 of the Notes to the
Consolidated Financial Statements.

(6) Publicidad obtained a short-term loan, denominated in Mexican pesos, from
a Mexican bank as described in Note 18 of the Notes to the Consolidated
Financial Statements.

(7) Results reflect the impairment of goodwill and certain identifiable
intangible assets as described in Note 6 of the Notes to the Consolidated
Financial Statements.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

The following discussion should be read in conjunction with our consolidated
financial statements, the notes there to and the other financial information
included elsewhere in this report.

OVERVIEW

Since our inception in 1990, we have devoted substantially all of our resources
to developing, testing, building and marketing the L-VIS(R) System, an
electronic video insertion system based on patented proprietary technology that
was designed to modify broadcasts to television viewers by inserting electronic
video images. We have incurred substantial operating losses since our inception
and as of December 31, 2002, December 31, 2001, June 30, 2001 and 2000, we had
an accumulated deficit of approximately $90,603,384, $69,395,675,
$62,405,000,and $50,725,000, respectively. This deficit is the result of product
development expenses incurred in the development and commercialization of the
Live Video Insertion System ("L-VIS(R) System") and iPoint(TM), an advanced
application of PVI's patented technology that supports state of the art
in-program advertising over the Internet or interactive television, expenses
related to field testing of the L-VIS(R) System and its deployment pursuant to
customer contracts, operating expenses relating to our field operations and
sales and marketing activities, and general administrative costs. We expect to
incur additional losses in the next fiscal year as we strive to evolve into a
sports and entertainment focused global, media services company. We will
continue our business strategy of developing new products and increasing our
penetration in both the domestic and international markets in the field of
real-time virtual image insertion.

24

We intend to focus our efforts on increasing market acceptance of the L-VIS(R)
System by continuing to develop software applications, such as animated
insertions in event video streams. Such insertions include the virtual
first-down line in football, the virtual off sides line in soccer, and virtual
product placement in pre-recorded programming. Other software applications being
developed include Internet applications which will allow television viewers to
interact with live or recorded video programming. Under a joint collaboration
and license agreement entered into with Cablevision Systems Corporation, we
intend to work together to develop technology to create virtual, in-content,
interactive and targeted advertising and enhancement products for use with
television distribution. In order to increase our revenue generating user base
and to expand into domestic and international markets, we are marketing our
systems on a worldwide basis through licensing and royalty agreements and
through our wholly owned subsidiary, Publicidad Virtual, S.A. de C.V.
("Publicidad").

Our sales and marketing staff is responsible not only for reaching agreements
with teams, leagues and broadcasters, but also for promoting the L-VIS(R) System
to advertisers in order to create market awareness and acceptance and to
negotiate with potential licensees in yet untapped markets worldwide. While
purchases of advertising will typically be done through the rights holder or the
broadcaster, we hope to create advertiser interest and demand by promoting the
L-VIS(R) System directly to potential advertisers as well as third party
licensees. Therefore, we expect to incur substantial additional losses and to
experience substantial negative cash flow from operating activities through the
next 12 months or until such later time as we achieve revenues sufficient to
finance our ongoing capital expenditures and operating expenses. Our ability to
produce positive cash flow will be determined by numerous factors, including our
ability to reach agreements with, and retain, customers for use of the L-VIS(R)
System, as well as various factors outside of our control. Such factors may
include contractual restrictions on the use of video insertion technology,
adverse publicity and news coverage and the inability of third party sales
forces to sell L-VIS(R) System advertising.

We expect to continue generating revenue from ads sold by rights holders that
use the L-VIS(R) System. These revenues are expected to be shared with the
rights holders. Accordingly, in order to grow revenues from the use of the
L-VIS(R) System, we will need to enter into additional agreements with rights
holders. The agreements can take various forms, including revenue sharing
agreements under which we receive a percentage of the fee paid by the
advertisers and contractual arrangements whereby we receive an agreed upon fee
for our services. We recognize revenues when the respective advertisement is
inserted into a television broadcast. Due to the seasonal nature of sporting
events, the revenue generated from the insertion of advertising or program
enhancements in sports programming will fluctuate seasonally. This seasonality
is moderated by the multi-sport capabilities of the L-VIS(R) System and its
increasing use in entertainment and other non-sports related programming.

In addition to the revenue arising from advertising and contractual
arrangements, a second revenue source is the strategic licensing of the L-VIS(R)
System to third parties. These licenses may be territorial in nature or they may
cover individual major broadcast events. In the case of a territorial license,
the licensee is responsible for generating business within the territory and we
share in the business through one or more means including royalties, license
fees, and/or equity participation in the licensee. In the case of individual
events, we receive a flat fee or a fee based on revenues generated by the
licensee, depending on the nature of the license. These license fees are
recognized as revenue when all related commitments have been satisfied and the
fee is considered collectible.

A third revenue source is fees paid for the services provided by the L-VIS(R)
System which support the electronic insertion of visual aids in live sports and
entertainment programming, such as a virtual first-down line in football games,
and the use of logo and name branding during live weekday news programming. We
also offer an advanced post-production product whereby the L-VIS(R) System
technology can place products or logos within existing, pre-recorded television
programs, movie scenes or live television broadcasts. We recognize these
revenues when earned, which is when the enhancement or visual aid is inserted
into a live or pre-recorded television broadcast.

Because our operations relate to the continuing development and marketing of the
L-VIS(R) System, we work to convince advertisers, broadcasters and broadcast
rights holders of the value of the L-VIS(R) System. If we do not generate enough
revenues to cover our operating expenses, we will have to either raise
additional money or substantially reduce the scale of our operations. We may not
be able to obtain additional financing on acceptable terms, or at all. If we
cannot raise money, our business, financial condition and the results of our
operations will be adversely affected.

25

RESULTS OF OPERATIONS

In 2001, we changed our fiscal year from June 30 to December 31, effective with
the six months ended December 31, 2001. For comparative purposes, the following
is a presentation of our statement of operations for the years ended December
31, 2002 and 2001:

For the years ended
December 31,
2002 2001
------------ ------------
(unaudited)

Advertising and production revenue $ 10,108,170 $ 5,440,830
Royalties and license fees 704,200 2,199,604
------------ ------------
Total revenue 10,812,370 7,640,434
Costs and expenses:
Sales and marketing 8,728,018 5,773,031
Product development 3,667,877 3,008,883
Field operations and support 4,949,792 5,662,634
General and administrative 6,466,416 5,400,768
Impairment, restructuring and other charges 4,886,513 1,060,832
------------ ------------
Total costs and expenses 28,698,616 20,906,148
Operating loss (17,886,246) (13,265,714)
Other (expense) income, net (31,242) 106,211
Interest expense (2,713,727) (44,818)
Interest income 94,734 450,268
Losses from equity investment (578,598) (290,271)
Loss from securities available for sale -- (500,000)
------------ ------------
Net loss before tax benefit and minority interest (21,115,079) (13,544,324)
Tax (expense) benefit, net (92,630) 173,269
Minority interest -- 241,932
------------ ------------
Net loss (21,207,709) (13,129,123)
Accretion of preferred stock dividends (6,918) (6,919)
------------ ------------
Net loss applicable to common stock $(21,214,627) $(13,136,042)
============ ============

COMPARISON OF THE YEAR ENDED DECEMBER 31, 2002 TO THE YEAR ENDED DECEMBER 31,
2001 (UNAUDITED)

REVENUES. Revenues are earned from both advertisers' use of the L-VIS(R) System
and under the terms of contractual arrangements for visual program enhancements,
as well as by license and royalty fees earned from use of the L-VIS(R) System
outside the United States. Total revenues for the year ended December 31, 2002
increased 42% to $10,812,370 from $7,640,430 for the year ended December 31,
2001 primarily due to the acquisition of Publicidad Virtual, S.A. de C.V. in
September 2001. Total royalties and license fees decreased 68% to $704,200 from
$2,199,604 for the year ended December 31, 2002 and 2001, respectively. Due to
the acquisition of Publicidad, we no longer receive royalties on the revenues
earned by Publicidad, but rather consolidate its revenues as a component of our
total advertising and production revenue, thus accounting for a significant
portion of these fluctuations. Royalty fees for the year ended December 31, 2001
include $1,590,173 from Publicidad. Advertising and production revenues for the
years ended December 31, 2002 and 2001 include Publicidad revenues of $7,747,719
and $3,217,143, respectively. In 2002, we recorded $403,462 of future license
fees revenue as a result of the termination of the agreements with Pineapplehead
Limited and our Korean Licensee. Total advertising and production revenue
increased 86% to $10,108,170 for the year ended December 31, 2002 from
$5,440,830 for the year ended December 31, 2001. The increase in advertising and
production revenues is due to revenue increases of approximately $5,348,000
primarily resulting from the consolidation of Publicidad and PVI Israel,
increased ad sales by the Philadelphia Phillies, virtual

26

advertisements behind home plate during FOX' broadcasts of the 2002 World
Series, and an increase in CBS football revenue as a result of the introduction
of the branded first down line in the Southeastern Conference college games.
These increases in advertising and production revenue were partially offset by
reductions of approximately $782,000, primarily due to reduced advertising
revenue from the Indy Racing League for the 2002 season, reduced ad revenue from
Super Bowl XXXVI and the non-renewal of our agreement with the San Diego Padres.

TOTAL COSTS AND EXPENSES. Total costs and expenses for the year ended December
31, 2002 increased 37% to $28,698,616 from $20,906,148 for the year ended
December 31, 2001.

SALES AND MARKETING. Sales and marketing expenses include salaries and travel
expenses of sales and marketing personnel, sales commissions, public relations,
trade shows, promotion, support personnel and allocated operating costs. Total
sales and marketing expenses for the year ended December 31, 2002 increased 51%
to $8,728,018 from $5,773,031 for the year ended December 31, 2001. This
resulted primarily from our consolidation of Publicidad's sales and marketing
expenses of approximately $5,384,000 for the year ended December 31, 2002, which
includes $4,710,000 for television airtime for virtual advertising in both
sports and entertainment programming along with $674,000 in other marketing
expenses compared to $2,125,000 for the year ended December 31, 2001, which
included $1,600,000 for television airtime along with $525,000 in other
marketing expenses. Also contributing to the increase was $665,000 of
amortization expense related to the value of the intangible assets, including
customer and distribution relationships and the Publicidad trade name, acquired
in the acquisitions of Publicidad and SciDel, and $168,000 in marketing charges
for warrants issued in connection with an agreement PVI entered into on
September 1, 2002 to provide digital product insertion (see Note 23 of our Notes
to the Consolidated Financial Statements). These increases were partially offset
by a decrease of approximately $488,000 in fees charged to obtain certain
international broadcast and programming rights, $119,000 in lower trade show
activities, and approximately $483,000 due to the reduction in staff and the use
of outside consultants.

PRODUCT DEVELOPMENT. Product development expenses include the costs associated
with all personnel, materials and contract personnel engaged in product
development activities to increase the capabilities of our hardware platforms,
including platforms for overseas use, and to create improved software programs
for individual sports and program enhancement services as well as for the
Internet and interactive television. Total product development costs increased
22% to $3,667,877 for the year ended December 31, 2002 from $3,008,883 for the
year ended December 31, 2001 primarily due to the inclusion of approximately
$332,000 for PVI Israel research costs, along with an increase of approximately
$327,000 in salaries, bonus, and overhead-related costs due to the redeployment
of resources.

FIELD OPERATIONS AND SUPPORT. Field operations and support expenses include the
costs associated with the material production, depreciation and operational
support of our systems for both domestic and international use, including
training costs for operators, maintenance of our mobile production units, and
support of our systems in the field. Total field operations and support costs
for the year ended December 31, 2002 decreased 13% to $4,949,792 from $5,662,634
for the year ended December 31, 2001. The decrease was due to reduced business
with the Indy Racing League, non-renewal of the San Diego Padres for the 2002
season, and streamlining our operations which resulted in shorter on-site setup
time required and the ability to provide our services with a reduced number of
personnel resulting in a production cost savings of approximately $663,000. Also
contributing to the decrease is the reduction of $149,000 in license fees and
lower depreciation expense for field equipment of $682,000. This decrease is
offset by the inclusion of approximately $944,000 for Publicidad's production
costs in 2002 compared to $307,000 in 2001, $144,000 for PVI Israel's production
costs, the costs associated with the sale of two L-VIS(R) systems to
Cablevision, and an increase in football production costs due to the increased
use by CBS in Southeastern Conference college games.

GENERAL AND ADMINISTRATIVE. Total general and administrative expenses increased
20% to $6,466,416 for the year ended December 31, 2002 from $5,400,768 for the
year ended December 31, 2001. This resulted primarily from the inclusion of
approximately $1,897,000 for Publicidad's general and administrative costs in
2002 compared to $310,000 in 2001, and $323,000 for PVI Israel. These increases
were offset by a reduction in salaries of $275,000 due to the redeployment and
reduction of resources, along with a reduction in Investor Relations of
$278,000 and Legal and Administrative Fees of $291,000.

IMPAIRMENT, RESTRUCTURING, AND OTHER CHARGES. During the year ended December 31,
2002, we recorded impairment, restructuring and other charges in the amount of
$4,886,513 compared to $1,060,832 for the year ended December 31, 2002. The

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increase of $3,825,681 is primarily the result of a $4,444,876 charge relating
to the impairment of goodwill and certain identifiable intangibles, which was
partially mitigated by a $523,788 reduction relating to a settlement reached in
October 2002 with a former executive of the company, whereby the terms of the
severance package were renegotiated.

The following table displays the activity and balances of the restructuring
reserve account from December 1, 2001 to December 31, 2002:

OTHER (EXPENSE) INCOME, NET. Total other (expense), net was an expense of
$31,242 for the year ended December 31, 2002 as compared to $106,211 for the
year ended December 31, 2001. The increase was primarily a result of
Publicidad's foreign exchange loss on its US dollar denominated intercompany
payable to the parent company, which was offset by PVI Europe's foreign exchange
gain on its US dollar denominated intercompany payable to the parent company.

INTEREST EXPENSE. Total interest expense was $2,713,727 for the year ended
December 31, 2002 as compared to $44,818 for the year ended December 31, 2001.
This increase is primarily due to the $2,578,131 of interest expense related to
the Cablevision transaction dated June 25, 2002 (see Note 4 of our Notes to the
Consolidated Financial Statements), of which, $2,318,930 is non-cash, and the
balance of which will either be paid in cash or PVI common stock.

INTEREST INCOME. Total interest income was $94,734 for the year ended December
31, 2002 as compared to $450,268 of interest income for the year ended December
31, 2001. This decrease is a result of lower cash balances available for
investment.

LOSSES FROM EQUITY INVESTMENT. Losses from equity investment increased 99% to
$578,598 for the year ended December 31, 2002 from $290,271 for the year ended
December 31, 2001 primarily as a result of recording the write off of our
investment in the Revolution Company, LLC, which began operations in January
2001. In December, 2002, the Board concluded that the carrying amount of the
investment is not recoverable based on its undiscounted cash flows from
Revolution Company, LLC, and as such, the remaining investment balance of
$578,598 was written off.

LOSSES FROM SECURITIES INVESTMENT. Losses from securities available for sale was
$500,000 for the year ended December 31, 2001, related to an
other-than-temporary impairment loss. The investment was written down to $0 as
of December 31, 2001.

TAX (EXPENSE) BENEFIT, NET. Tax (expense) benefit, net was an expense of $92,630
for the year ended December 31, 2002 compared to a net benefit of $173,269 for
the year ended December 31, 2001. In the year ended December 31, 2001, the net
tax benefit comprised of a tax benefit of $333,993, net of $160,724 of other tax
expenses, of which, $126,348 was foreign withholding taxes based on our royalty
revenue from Publicidad. In the year ended December 2002, no tax benefit was
recognized, while incurring other tax expenses of $92,630, of which, $77,380
was related to the foreign withholding taxes based on our royalty revenue from
Publicidad. The tax benefit in 2001, was received from the sale of a portion of
our state net operating loss and research and development tax credits. The sale
was made under a plan developed by the State of New Jersey Economic Development
Authority and the amount received is a function of the total dollars available
under the plan and the number of companies applying for the tax benefit.

MINORITY INTEREST. Accumulated losses in PVI Europe have reduced the minority
interest to zero as of December 31, 2001. As such, no additional losses have
been allocated to the minority interest in the year ended December 31, 2002.

NET LOSS. As a result of the foregoing factors, our net loss increased 62% to
$21,207,709 for the year ended December 31, 2002 from $13,129,123 for the year
ended December 31, 2001.

OPTION REPRICING. On February 2, 2001, the Board of Directors voted to offer all
current employees who held outstanding stock options with an exercise price
greater than $5.00 the opportunity to reprice such options to $4.375. A total of
1,186,998 options held by employees were repriced. In addition, a total of
220,000 options held by directors were repriced. In accordance with FIN No. 44,
the repriced options are subject to variable accounting and thereby have been
adjusted to fair value at December 31, 2002, December 31, 2001 and June 30,
2001. A charge to earnings in the amount of $309,087 was recorded