##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For Quarter Ended June 30, 2001

Commission File Number 1-4373

THREE-FIVE SYSTEMS, INC.
(Exact name of registrant as specified in its charter)

|                                                                        |  |                                                 
|----------------------------------------------------------------------- |  | ------------------------------------------------
|Delaware
(State or other jurisdiction of
incorporation or organization) |  | 86-0654102
I.R.S. Employer
Identification Number

|                                                                                 |  |                 
|-------------------------------------------------------------------------------- |  | ----------------
|1600 North Desert Drive, Tempe, Arizona
(Address of principal executive offices) |  | 85281
(Zip Code)

(602) 389-8600
(Registrants telephone number, including area code)

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 the number of shares outstanding of each of the issuers classes of
common stock, at the latest practical date.

|                                |  |                                 |            | 
|------------------------------- |  | ------------------------------- | ---------- | 
|CLASS                           |  | OUTSTANDING AS OF JUNE 30, 2001
|                                |  |                                
|Common
Par value $.01 per share |  |                                 | 21,345,330 | 





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THREE-FIVE SYSTEMS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2001
TABLE OF CONTENTS


TABLE OF CONTENTS



|                                                                                              |                                                                                                              |  |  |  |  |  |  | 
|--------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------ |  |  |  |  |  |  | 
|ITEM 1. FINANCIAL STATEMENTS                                                                 
|                                                                                              | CONDENSED CONSOLIDATED BALANCE SHEETS                                                                       
|                                                                                              | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS                                                             
|                                                                                              | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS                                                             
|                                                                                              | Three-Five Systems, Inc. and Subsidiaries (the Company) Notes to Condensed Consolidated Financial Statements
|ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK                            
|PART II. OTHER INFORMATION                                                                   
|ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS                                 
|ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURES                                                                                   
|EX-10(x)                                                                                     



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|        |  |                                                                                                           |  |     
|------- |  | --------------------------------------------------------------------------------------------------------- |  | ----
|        |  |                                                                                                           |  | Page
|        |  |                                                                                                           |  |     
|        |  | PART I FINANCIAL INFORMATION                                                                             |  |     
|       
|       
|       
|       
|ITEM 1. |  | FINANCIAL STATEMENTS:                                                                                     |  |     
|       
|       
|       
|       
|        |  | Condensed Consolidated Balance Sheets
December 31, 2000 and June 30, 2001                                |  | 1   
|       
|       
|       
|       
|        |  | Condensed Consolidated Statements of Operations
Three Months and Six Months Ended June 30, 2000 and 2001 |  | 2   
|       
|       
|       
|       
|        |  | Condensed Consolidated Statements of Cash Flows
Six Months Ended June 30, 2000 and 2001                  |  | 3   
|       
|       
|       
|       
|        |  | Notes to Condensed Consolidated Financial Statements                                                      |  | 4   
|       
|       
|       
|       
|ITEM 2. |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS                     |  | 7   
|       
|       
|       
|       
|        |  | PART II OTHER INFORMATION                                                                                |  |     
|       
|       
|       
|       
|ITEM 3. |  | QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK                                                 |  | 13  
|       
|       
|       
|       
|ITEM 4. |  | SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                      |  | 13  
|       
|       
|       
|       
|ITEM 6. |  | EXHIBITS AND REPORTS ON FORM 8-K                                                                          |  | 14  
|       
|       
|       
|       
|        |  | SIGNATURES                                                                                                |  | 14  





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##### Table of Contents








| |  |  | ITEM 1. FINANCIAL STATEMENTS
| |  |  | ----------------------------




THREE-FIVE SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)

|                                     |                                      |                      |                           |                            |         |              |         |          |         |             |         | 
|------------------------------------ | ------------------------------------ | -------------------- | ------------------------- | -------------------------- | ------- | ------------ | ------- | -------- | ------- | ----------- | ------- | 
|                                     |                                      |                      |                           |                            |         | December 31, |         | June 30,
|                                     |                                      |                      |                           |                            |         | 2000         |         | 2001    
|                                     |                                      |                      |                           |                            |         |              |         |         
|                                     |                                      |                      |                           |                            |         |              |         |          |         | (unaudited)
|ASSETS                               |                                      |                      |                           |                            |         |              |         |         
|                                    
|                                    
|                                    
|                                    
|Current Assets:                      |                                      |                      |                           |                            |         |              |         |         
|                                    
|                                    
|                                    
|                                    
|                                     | Cash and cash equivalents            |                      | $                         | 98,876                     |         |              | $       | 65,887   |        
|                                    
|                                    
|                                    
|                                    
|                                     | Short-term investments               |                      |                           | 66,695                     |         |              |         | 80,515   |        
|                                    
|                                    
|                                    
|                                    
|                                     | Accounts receivable, net             |                      |                           | 23,635                     |         |              |         | 23,002   |        
|                                    
|                                    
|                                    
|                                    
|                                     | Inventories                          |                      |                           | 20,516                     |         |              |         | 16,667   |        
|                                    
|                                    
|                                    
|                                    
|                                     | Taxes receivable                     |                      |                           |                           |         |              |         | 5,350    |        
|                                    
|                                    
|                                    
|                                    
|                                     | Deferred tax asset                   |                      |                           | 4,346                      |         |              |         | 4,346    |        
|                                    
|                                    
|                                    
|                                    
|                                     | Other current assets                 |                      |                           | 1,778                      |         |              |         | 1,994    |        
|                                     |                                      |                      |                           |                            |         |              |         |          |        
|                                     |                                      | Total current assets |                           |                            | 215,846 |              |         |          | 197,761 |            
|                                    
|                                    
|                                    
|                                    
|Long-term Investments                |                                      |                      | 4,534                     |                            |         |              | 8,015   |         
|                                    
|                                    
|                                    
|                                    
|Property, Plant and Equipment, net   |                                      |                      | 43,254                    |                            |         |              | 43,580  |         
|                                    
|                                    
|                                    
|                                    
|Other Assets                         |                                      |                      | 4,209                     |                            |         |              | 1,375   |         
|                                     |                                      |                      |                           |                            |         |              |         |          |        
|                                     |                                      | $                    | 267,843                   |                            |         | $            | 250,731 |         
|                                     |                                      |                      |                           |                            |         |              |         |          |        
|LIABILITIES AND STOCKHOLDERS EQUITY |                                      |                      |                           |                            |         |              |         |         
|                                    
|                                    
|                                    
|                                    
|Current Liabilities:                 |                                      |                      |                           |                            |         |              |         |         
|                                    
|                                    
|                                    
|                                    
|                                     | Accounts payable                     |                      | $                         | 11,404                     |         |              | $       | 10,752   |        
|                                    
|                                    
|                                    
|                                    
|                                     | Accrued liabilities                  |                      |                           | 7,005                      |         |              |         | 4,221    |        
|                                    
|                                    
|                                    
|                                    
|                                     | Current taxes payable                |                      |                           | 239                        |         |              |         |         |        
|                                    
|                                    
|                                    
|                                    
|                                     | Term loan                            |                      |                           | 2,706                      |         |              |         | 2,706    |        
|                                     |                                      |                      |                           |                            |         |              |         |          |        
|                                     |                                      |                      | Total current liabilities |                            |         | 21,354       |         |          |         | 17,679      |        
|                                     |                                      |                      |                           |                            |         |              |         |          |        
|Deferred Tax Liability               |                                      |                      | 4,487                     |                            |         |              | 4,487   |         
|                                     |                                      |                      |                           |                            |         |              |         |          |        
|Commitments and Contingencies        |                                      |                      |                           |                            |        
|                                    
|Stockholders Equity:                |                                      |                      |                           |                            |         |              |         |         
|                                    
|                                    
|                                    
|                                    
|                                     | Common stock                         |                      |                           | 217                        |         |              |         | 217      |        
|                                    
|                                    
|                                    
|                                    
|                                     | Additional paid-in capital           |                      |                           | 198,215                    |         |              |         | 198,667  |        
|                                    
|                                    
|                                    
|                                    
|                                     | Retained earnings                    |                      |                           | 48,430                     |         |              |         | 37,324   |        
|                                    
|                                    
|                                    
|                                    
|                                     | Stock subscription note receivable   |                      |                           |                           |         |              |         | (424     | )      
|                                    
|                                    
|                                    
|                                    
|                                     | Accumulated other comprehensive loss |                      |                           | (234                       | )       |              |         | (67      | )      
|                                    
|                                    
|                                    
|                                    
|                                     | Less  treasury stock, at cost       |                      |                           | (4,626                     | )       |              |         | (7,152   | )      
|                                     |                                      |                      |                           |                            |         |              |         |          |        
|                                     |                                      |                      |                           | Total stockholders equity |         |              | 242,002 |          |         |             | 228,565 | 
|                                     |                                      |                      |                           |                            |         |              |         |          |        
|                                     |                                      | $                    | 267,843                   |                            |         | $            | 250,731 |         
|                                     |                                      |                      |                           |                            |         |              |         |          |        

The accompanying notes are an integral part of these condensed consolidated
balance sheets.

1



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##### Table of Contents






THREE-FIVE SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share data)

|                                                                |                                        |                                           |        |                |       |                |         |        |         |      |        |        |        |   |         |        |         |  
|--------------------------------------------------------------- | -------------------------------------- | ----------------------------------------- | ------ | -------------- | ----- | -------------- | ------- | ------ | ------- | ---- | ------ | ------ | ------ | - | ------- | ------ | ------- | -
|                                                                |                                        |                                           |        | Three Months   |       | Six Months    
|                                                                |                                        |                                           |        | Ended June 30, |       | Ended June 30,
|                                                                |                                        |                                           |        |                |       |               
|                                                                |                                        |                                           |        | 2000           |       | 2001           |         | 2000   |         | 2001
|                                                                |                                        |                                           |        |                |       |                |         |        |         |     
|Net Sales                                                       |                                        | $                                         | 44,926 |                |       | $              | 25,013  |        |         | $    | 84,088 |        |        | $ | 60,629  |       
|                                                                |                                        |                                           |        |                |       |                |         |        |         |      |        |        |        |   |         |       
|Costs and Expenses:                                             |                                        |                                           |        |                |       |                |         |        |         |      |        |        |        |   |         |       
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Cost of sales                          |                                           |        | 34,157         |       |                |         | 32,160 |         |      |        | 63,517 |        |   |         | 63,403 |        
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Selling, general, and administrative   |                                           |        | 2,418          |       |                |         | 2,922  |         |      |        | 4,680  |        |   |         | 5,413  |        
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Research, development, and engineering |                                           |        | 2,989          |       |                |         | 4,795  |         |      |        | 5,752  |        |   |         | 8,456  |        
|                                                                |                                        |                                           |        |                |       |                |         |        |         |      |        |        |        |   |         |       
|                                                                |                                        |                                           | 39,564 |                |       |                | 39,877  |        |         |      | 73,949 |        |        |   | 77,272  |       
|                                                                |                                        |                                           |        |                |       |                |         |        |         |      |        |        |        |   |         |       
|                                                                |                                        | Operating income (loss)                   |        |                | 5,362 |                |         |        | (14,864 | )    |        |        | 10,139 |   |         |        | (16,643 | )
|                                                                |                                        |                                           |        |                |       |                |         |        |         |      |        |        |        |   |         |       
|Other Income (Expense):                                         |                                        |                                           |        |                |       |                |         |        |         |      |        |        |        |   |         |       
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Interest, net                          |                                           |        | 1,185          |       |                |         | 1,811  |         |      |        | 1,789  |        |   |         | 3,939  |        
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Loss on investment in start-up company |                                           |        |               |       |                |         | (3,820 | )       |      |        |       |        |   |         | (3,820 | )      
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Other, net                             |                                           |        | (20            | )     |                |         | (64    | )       |      |        | (44    | )      |   |         | (52    | )      
|                                                                |                                        |                                           |        |                |       |                |         |        |         |      |        |        |        |   |         |       
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                |                                        |                                           | 1,165  |                |       |                | (2,073  | )      |         |      | 1,745  |        |        |   | 67      |       
|                                                                |                                        |                                           |        |                |       |                |         |        |         |      |        |        |        |   |         |       
|Income (Loss) before Provision for
(Benefit from) Income Taxes: |                                        |                                           | 6,527  |                |       |                | (16,937 | )      |         |      | 11,884 |        |        |   | (16,576 | )     
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                |                                        | Provision for (benefit from) income taxes |        |                | 2,158 |                |         |        | (5,589  | )    |        |        | 3,928  |   |         |        | (5,470  | )
|                                                                |                                        |                                           |        |                |       |                |         |        |         |      |        |        |        |   |         |       
|Net Income (Loss)                                               |                                        | $                                         | 4,369  |                |       | $              | (11,348 | )      |         | $    | 7,956  |        |        | $ | (11,106 | )     
|                                                                |                                        |                                           |        |                |       |                |         |        |         |      |        |        |        |   |         |       
|Earnings (Loss) Per Common Share:                               |                                        |                                           |        |                |       |                |         |        |         |      |        |        |        |   |         |       
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Basic                                  |                                           | $      | 0.22           |       |                | $       | (0.53  | )       |      | $      | 0.41   |        |   | $       | (0.52  | )      
|                                                                |                                        |                                           |        |                |       |                |         |        |         |      |        |        |        |   |         |       
|                                                                | Diluted                                |                                           | $      | 0.21           |       |                | $       | (0.53  | )       |      | $      | 0.39   |        |   | $       | (0.52  | )      
|                                                                |                                        |                                           |        |                |       |                |         |        |         |      |        |        |        |   |         |       
|Weighted Average Number of Common Shares:                       |                                        |                                           |        |                |       |                |         |        |         |      |        |        |        |   |         |       
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Basic                                  |                                           |        | 19,807         |       |                |         | 21,342 |         |      |        | 19,370 |        |   |         | 21,385 |        
|                                                                |                                        |                                           |        |                |       |                |         |        |         |      |        |        |        |   |         |       
|                                                               
|                                                               
|                                                               
|                                                               
|                                                                | Diluted                                |                                           |        | 21,083         |       |                |         | 21,342 |         |      |        | 20,593 |        |   |         | 21,385 |        
|                                                                |                                        |                                           |        |                |       |                |         |        |         |      |        |        |        |   |         |       

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

2



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##### Table of Contents






THREE-FIVE SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)

|                                                             |                                                                                                    |                                                 |                                                                 |                                                     |         |                  |         |         |          |        |         |  
|------------------------------------------------------------ | -------------------------------------------------------------------------------------------------- | ----------------------------------------------- | --------------------------------------------------------------- | --------------------------------------------------- | ------- | ---------------- | ------- | ------- | -------- | ------ | ------- | -
|                                                             |                                                                                                    |                                                 |                                                                 |                                                     |         | Six Months Ended
|                                                             |                                                                                                    |                                                 |                                                                 |                                                     |         | June 30,        
|                                                             |                                                                                                    |                                                 |                                                                 |                                                     |         |                 
|                                                             |                                                                                                    |                                                 |                                                                 |                                                     |         | 2000             |         | 2001   
|                                                             |                                                                                                    |                                                 |                                                                 |                                                     |         |                  |         |        
|Cash Flows From Operating Activities:                        |                                                                                                    |                                                 |                                                                 |                                                     |         |                  |         |        
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Net income (loss)                                                                                  |                                                 | $                                                               | 7,956                                               |         |                  | $       | (11,106 | )       
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities: |                                                 |                                                                 |                                                     |         |                  |         |         |         
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                                                    |                                                 | Depreciation and amortization                                   |                                                     |         | 3,087            |         |         |          | 2,855  |        
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                                                    |                                                 | Provision for accounts receivable valuation reserves            |                                                     |         | 105              |         |         |          | 185    |        
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                                                    |                                                 | Loss on disposal of assets                                      |                                                     |         |                 |         |         |          | 1,289  |        
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                                                    |                                                 | Loss on investment in start-up company                          |                                                     |         |                 |         |         |          | 3,820  |        
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Change in assets and liabilities:                                                                  |                                                 |                                                                 |                                                     |         |                  |         |         |         
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                                                    |                                                 | (Increase) decrease in accounts receivable                      |                                                     |         | (5,005           | )       |         |          | 448    |        
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                                                    |                                                 | (Increase) decrease in inventories                              |                                                     |         | (2,843           | )       |         |          | 3,849  |        
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                                                    |                                                 | Increase in other assets                                        |                                                     |         | (1,062           | )       |         |          | (216   | )      
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                                                    |                                                 | Increase (decrease) in accounts payable and accrued liabilities |                                                     |         | 1,368            |         |         |          | (3,436 | )      
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                                                    |                                                 | Increase (decrease) in taxes payable and deferred taxes, net    |                                                     |         | 1,064            |         |         |          | (5,589 | )      
|                                                             |                                                                                                    |                                                 |                                                                 |                                                     |         |                  |         |        
|                                                             |                                                                                                    |                                                 |                                                                 | Net cash provided by (used in) operating activities |         |                  | 4,670   |         |          |        | (7,901  | )
|                                                             |                                                                                                    |                                                 |                                                                 |                                                     |         |                  |         |        
|Cash Flows from Investing Activities:                        |                                                                                                    |                                                 |                                                                 |                                                     |         |                  |         |        
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                                                    | Purchase of property, plant, and equipment, net |                                                                 |                                                     | (5,254  | )                |         |         | (4,470   | )     
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                                                    | Purchase of investments                         |                                                                 |                                                     | (46,545 | )                |         |         | (151,325 | )     
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                                                    | Proceeds from maturities/sales of investments   |                                                                 |                                                     |        |                  |         |         | 134,276  |       
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                                                    | Other investments                               |                                                                 |                                                     | (500    | )                |         |         | (1,000   | )     
|                                                             |                                                                                                    |                                                 |                                                                 |                                                     |         |                  |         |        
|                                                             |                                                                                                    |                                                 |                                                                 | Net cash used in investing activities               |         |                  | (52,299 | )       |          |        | (22,519 | )
|                                                             |                                                                                                    |                                                 |                                                                 |                                                     |         |                  |         |        
|Cash Flows from Financing Activities:                        |                                                                                                    |                                                 |                                                                 |                                                     |         |                  |         |        
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                                                    | Net proceeds from equity offering               |                                                                 |                                                     | 128,638 |                  |         |         |         |       
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                                                    | Purchase of treasury stock                      |                                                                 |                                                     |        |                  |         |         | (2,526   | )     
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             |                                                                                                    | Stock options exercised                         |                                                                 |                                                     | 1,224   |                  |         |         | 42       |       
|                                                             |                                                                                                    |                                                 |                                                                 |                                                     |         |                  |         |        
|                                                             |                                                                                                    |                                                 |                                                                 | Net cash provided by (used in) financing activities |         |                  | 129,862 |         |          |        | (2,484  | )
|                                                             |                                                                                                    |                                                 |                                                                 |                                                     |         |                  |         |        
|Effect of exchange rate changes on cash and cash equivalents |                                                                                                    |                                                 | (37                                                             | )                                                   |         |                  | (85     | )      
|                                                             |                                                                                                    |                                                 |                                                                 |                                                     |         |                  |         |        
|Net increase (decrease) in cash and cash equivalents         |                                                                                                    |                                                 | 82,196                                                          |                                                     |         |                  | (32,989 | )      
|                                                            
|                                                            
|                                                            
|                                                            
|Cash and cash equivalents, beginning of period               |                                                                                                    |                                                 | 45,363                                                          |                                                     |         |                  | 98,876  |        
|                                                             |                                                                                                    |                                                 |                                                                 |                                                     |         |                  |         |        
|Cash and cash equivalents, end of period                     |                                                                                                    | $                                               | 127,559                                                         |                                                     |         | $                | 65,887  |        
|                                                             |                                                                                                    |                                                 |                                                                 |                                                     |         |                  |         |        

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

3



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##### Table of Contents






Three-Five Systems, Inc. and Subsidiaries (the Company) Notes to Condensed
Consolidated Financial Statements



|Note A |  |  | The accompanying unaudited Condensed Consolidated Financial
Statements have been prepared in accordance with accounting
principles generally accepted in the United States for interim
financial information and the instructions to Form 10-Q.
Accordingly, they do not include all the information and footnotes
required by accounting principles generally accepted in the United
States for complete financial statements. In the opinion of the
Company, all adjustments (which include only normal recurring
adjustments) necessary to present fairly the financial position,
results of operations, and cash flows for all periods presented
have been made. The results of operations for the three- and
six-month periods ended June 30, 2001 are not necessarily
indicative of the operating results that may be expected for the
entire year ending December 31, 2001. These financial statements
should be read in conjunction with the Companys December 31, 2000
financial statements and accompanying notes thereto.
|------ |  |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      
|Note B |  |  | Basic earnings (loss) per common share are computed by dividing net
income (loss) by the weighted average number of shares of common
stock outstanding during the three- and six-month month periods
ended June 30, 2000 and 2001. Diluted earnings per common share
for the three- and six-month periods ended June 30, 2000 are
determined assuming that outstanding options and warrants were
exercised at the beginning of the period or at the time of
issuance, if later. No outstanding options were assumed to be
exercised for purposes of calculating diluted earnings (loss) per
share for the three- and six-month periods ended June 30, 2001, as
their effect was anti-dilutive. Set forth below are the
disclosures for the three- and six-month periods ended June 30,
2000 and 2001.                                                                                                                                                                                                                                

|                                               |                                                   |                          |       |                                       |      |                  |         |        |       |      |       |        |      |   |         |        |       |  
|---------------------------------------------- | ------------------------------------------------- | ------------------------ | ----- | ------------------------------------- | ---- | ---------------- | ------- | ------ | ----- | ---- | ----- | ------ | ---- | - | ------- | ------ | ----- | -
|                                               |                                                   |                          |       | Three Months Ended                    |      | Six Months Ended
|                                               |                                                   |                          |       | June 30,                              |      | June 30,        
|                                               |                                                   |                          |       |                                       |      |                 
|                                               |                                                   |                          |       | 2000                                  |      | 2001             |         | 2000   |       | 2001
|                                               |                                                   |                          |       |                                       |      |                  |         |        |       |     
|                                               |                                                   |                          |       | (unaudited)                          
|                                               |                                                   |                          |       | (in thousands, except per share data)
|Basic earnings (loss) per share:               |                                                   |                          |       |                                       |      |                  |         |        |       |      |       |        |      |   |         |       
|                                              
|                                              
|                                              
|                                              
|Income (loss) available to common
stockholders |                                                   | $                        | 4,369 |                                       |      | $                | (11,348 | )      |       | $    | 7,956 |        |      | $ | (11,106 | )     
|                                               |                                                   |                          |       |                                       |      |                  |         |        |       |      |       |        |      |   |         |       
|                                               | Weighted average common shares                    |                          |       | 19,807                                |      |                  |         | 21,342 |       |      |       | 19,370 |      |   |         | 21,385 |      
|                                               |                                                   |                          |       |                                       |      |                  |         |        |       |      |       |        |      |   |         |       
|                                               |                                                   | Basic per share amount   |       | $                                     | 0.22 |                  |         | $      | (0.53 | )    |       | $      | 0.41 |   |         | $      | (0.52 | )
|                                               |                                                   |                          |       |                                       |      |                  |         |        |       |      |       |        |      |   |         |       
|Diluted earnings (loss) per share:             |                                                   |                          |       |                                       |      |                  |         |        |       |      |       |        |      |   |         |       
|                                              
|                                              
|                                              
|                                              
|Income (loss) available to common
stockholders |                                                   | $                        | 4,369 |                                       |      | $                | (11,348 | )      |       | $    | 7,956 |        |      | $ | (11,106 | )     
|                                               |                                                   |                          |       |                                       |      |                  |         |        |       |      |       |        |      |   |         |       
|                                               | Weighted average common shares                    |                          |       | 19,807                                |      |                  |         | 21,342 |       |      |       | 19,370 |      |   |         | 21,385 |      
|                                              
|                                              
|                                              
|                                              
|                                               | Options and warrants assumed exercised            |                          |       | 1,276                                 |      |                  |         |       |       |      |       | 1,223  |      |   |         |       |      
|                                               |                                                   |                          |       |                                       |      |                  |         |        |       |      |       |        |      |   |         |       
|                                               | Total common shares plus common
Stock equivalents |                          |       | 21,083                                |      |                  |         | 21,342 |       |      |       | 20,593 |      |   |         | 21,385 |      
|                                               |                                                   |                          |       |                                       |      |                  |         |        |       |      |       |        |      |   |         |       
|                                               |                                                   | Diluted per share amount |       | $                                     | 0.21 |                  |         | $      | (0.53 | )    |       | $      | 0.39 |   |         | $      | (0.52 | )
|                                               |                                                   |                          |       |                                       |      |                  |         |        |       |      |       |        |      |   |         |       



|Note C |  |  | Inventories consist of the following at:
|------ |  |  | ----------------------------------------

|                |  |                |        |          |  |             |        | 
|--------------- |  | -------------- | ------ | -------- |  | ----------- | ------ | 
|                |  | December 31,   |        | June 30,
|                |  | 2000           |        | 2001    
|                |  |                |        |         
|                |  |                |        |          |  | (unaudited)
|                |  | (in thousands)
|Raw materials   |  | $              | 15,898 |          |  | $           | 13,527 | 
|               
|               
|               
|               
|Work-in-process |  |                | 1,904  |          |  |             | 2,525  | 
|               
|               
|               
|               
|Finished goods  |  |                | 2,714  |          |  |             | 615    | 
|                |  |                |        |          |  |             |        | 
|                |  | $              | 20,516 |          |  | $           | 16,667 | 
|                |  |                |        |          |  |             |        | 

4



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##### Table of Contents





|Note D |  |  | Property, plant, and equipment consist of the following at:
|------ |  |  | -----------------------------------------------------------

|                              |  |                |         |   |          |             |         |  
|----------------------------- |  | -------------- | ------- | - | -------- | ----------- | ------- | -
|                              |  | December 31,   |         |   | June 30, |            
|                              |  | 2000           |         |   | 2001     |            
|                              |  |                |         |   |          |            
|                              |  |                |         |   |          | (unaudited) |        
|                              |  | (in thousands) |        
|Building and improvements     |  | $              | 16,426  |   |          | $           | 16,505  |  
|                             
|                             
|                             
|                             
|Furniture and equipment       |  |                | 53,762  |   |          |             | 56,775  |  
|                              |  |                |         |   |          |            
|                              |  |                | 70,188  |   |          |             | 73,280  |  
|                             
|                             
|                             
|                             
|Less accumulated depreciation |  |                | (26,934 | ) |          |             | (29,700 | )
|                              |  |                |         |   |          |            
|                              |  | $              | 43,254  |   |          | $           | 43,580  |  
|                              |  |                |         |   |          |            



|Note E |  |  | Segment information:                                                                                                                                                                                                                                                                                                                  
|------ |  |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      
|       |  |  | The Company monitors and evaluates the financial performance of its
operations by its four operating segments located in various parts of
the world. These segments consist of three manufacturing operations,
located in the United States, China, and the Philippines, and a sales
and distribution operation in the United Kingdom.
|      
|       |  |  | The following operating segment information includes financial
information (in thousands) for all four of the Companys operating
segments.                                                                                                                                                                                           

|                                                               |  |               |        |                |  |       |        |             |  |              |        |       |  |   |     |  |  |   |         |   |  |   |        |  | 
|-------------------------------------------------------------- |  | ------------- | ------ | -------------- |  | ----- | ------ | ----------- |  | ------------ | ------ | ----- |  | - | --- |  |  | - | ------- | - |  | - | ------ |  | 
|Three Months Ended                                             |  |               |        |                |  |       |        |             |  |              |        |       |  |   |     |  |  |   |         |   |  |   |        | 
|June 30, 2000                                                  |  | United States |        | United Kingdom |  | China |        | Philippines |  | Eliminations |        | Total
|                                                               |  |               |        |                |  |       |        |             |  |              |        |      
|(unaudited)                                                    |  |               |        |                |  |       |        |             |  |              |        |       |  |   |     |  |  |   |         |   |  |   |        | 
|Net sales                                                      |  | $             | 18,321 |                |  | $     | 13,882 |             |  | $            | 12,723 |       |  | $ |    |  |  | $ |        |   |  | $ | 44,926 | 
|                                                              
|                                                              
|                                                              
|                                                              
|Intersegment sales                                             |  |               | 20,501 |                |  |       |       |             |  |              | 605    |       |  |   | 825 |  |  |   | (21,931 | ) |  |   |       | 
|                                                              
|                                                              
|                                                              
|                                                              
|Income (loss)
before provision
for (benefit from)
income taxes |  |               | 2,519  |                |  |       | 1,025  |             |  |              | 3,000  |       |  |   | 16  |  |  |   | (33     | ) |  |   | 6,527  | 

|                                                               |  |               |         |                |  |       |       |             |  |              |        |       |  |   |       |  |  |   |         |   |  |   |         |  
|-------------------------------------------------------------- |  | ------------- | ------- | -------------- |  | ----- | ----- | ----------- |  | ------------ | ------ | ----- |  | - | ----- |  |  | - | ------- | - |  | - | ------- | -
|Three Months Ended                                             |  |               |         |                |  |       |       |             |  |              |        |      
|June 30, 2001                                                  |  | United States |         | United Kingdom |  | China |       | Philippines |  | Eliminations |        | Total
|                                                               |  |               |         |                |  |       |       |             |  |              |        |      
|(unaudited)                                                    |  |               |         |                |  |       |       |             |  |              |        |       |  |   |       |  |  |   |         |   |  |   |         |  
|Net sales                                                      |  | $             | 8,656   |                |  | $     | 6,836 |             |  | $            | 9,521  |       |  | $ |      |  |  | $ |        |   |  | $ | 25,013  |  
|                                                              
|                                                              
|                                                              
|                                                              
|Intersegment sales                                             |  |               | 13,446  |                |  |       |      |             |  |              | 348    |       |  |   | 1,741 |  |  |   | (15,535 | ) |  |   |        |  
|                                                              
|                                                              
|                                                              
|                                                              
|Income (loss)
before provision
for (benefit from)
income taxes |  |               | (15,222 | )              |  |       | (101  | )           |  |              | (1,627 | )     |  |   | 34    |  |  |   | (21     | ) |  |   | (16,937 | )

|                                                               |  |               |        |                |  |       |        |             |  |              |        |       |  |   |       |  |  |   |         |   |  |   |        | 
|-------------------------------------------------------------- |  | ------------- | ------ | -------------- |  | ----- | ------ | ----------- |  | ------------ | ------ | ----- |  | - | ----- |  |  | - | ------- | - |  | - | ------ | 
|Six Months Ended                                               |  |               |        |                |  |       |        |             |  |              |        |       |  |   |       |  |  |   |         |   |  |   |        | 
|June 30, 2000                                                  |  | United States |        | United Kingdom |  | China |        | Philippines |  | Eliminations |        | Total
|                                                               |  |               |        |                |  |       |        |             |  |              |        |      
|(unaudited)                                                    |  |               |        |                |  |       |        |             |  |              |        |       |  |   |       |  |  |   |         |   |  |   |        | 
|Net sales                                                      |  | $             | 33,918 |                |  | $     | 32,478 |             |  | $            | 17,692 |       |  | $ |      |  |  | $ |        |   |  | $ | 84,088 | 
|                                                              
|                                                              
|                                                              
|                                                              
|Intersegment sales                                             |  |               | 39,564 |                |  |       |       |             |  |              | 5,328  |       |  |   | 1,524 |  |  |   | (46,416 | ) |  |   |       | 
|                                                              
|                                                              
|                                                              
|                                                              
|Income (loss)
before provision
for (benefit from)
income taxes |  |               | 4,018  |                |  |       | 2,510  |             |  |              | 5,413  |       |  |   | 30    |  |  |   | (87     | ) |  |   | 11,884 | 

5



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##### Table of Contents



|                                                               |  |               |         |                |  |       |        |             |  |              |        |       |  |   |       |  |  |   |         |   |  |   |         |  
|-------------------------------------------------------------- |  | ------------- | ------- | -------------- |  | ----- | ------ | ----------- |  | ------------ | ------ | ----- |  | - | ----- |  |  | - | ------- | - |  | - | ------- | -
|Six Months Ended                                               |  |               |         |                |  |       |        |             |  |              |        |       |  |   |       |  |  |   |         |   |  |   |         |  
|June 30, 2001                                                  |  | United States |         | United Kingdom |  | China |        | Philippines |  | Eliminations |        | Total
|                                                               |  |               |         |                |  |       |        |             |  |              |        |      
|(unaudited)                                                    |  |               |         |                |  |       |        |             |  |              |        |       |  |   |       |  |  |   |         |   |  |   |         |  
|Net sales                                                      |  | $             | 17,621  |                |  | $     | 23,718 |             |  | $            | 19,290 |       |  | $ |      |  |  | $ |        |   |  | $ | 60,629  |  
|                                                              
|                                                              
|                                                              
|                                                              
|Intersegment sales                                             |  |               | 37,791  |                |  |       |       |             |  |              | 1,041  |       |  |   | 3,977 |  |  |   | (42,809 | ) |  |   |        |  
|                                                              
|                                                              
|                                                              
|                                                              
|Income (loss)
before provision
for (benefit from)
income taxes |  |               | (16,366 | )              |  |       | 579    |             |  |              | (795   | )     |  |   | 79    |  |  |   | (73     | ) |  |   | (16,576 | )



|Note F |  |  | Comprehensive income for the periods was as follows:
|------ |  |  | ----------------------------------------------------

|                                   |                                                    |   |       |                    |   |   |                  |      |   |      |       |     |      |   |         |     |   | 
|---------------------------------- | -------------------------------------------------- | - | ----- | ------------------ | - | - | ---------------- | ---- | - | ---- | ----- | --- | ---- | - | ------- | --- | - | 
|                                   |                                                    |   |       | Three Months Ended |   |   | Six Months Ended |     
|                                   |                                                    |   |       | June 30,           |   |   | June 30,         |     
|                                   |                                                    |   |       |                    |   |   |                  |     
|                                   |                                                    |   |       | 2000               |   |   | 2001             |      |   | 2000 |       |     | 2001 |  
|                                   |                                                    |   |       |                    |   |   |                  |      |   |      |       |     |      |  
|                                   |                                                    |   |       | (unaudited)        |  
|                                   |                                                    |   |       | (in thousands)     |  
|Net income (loss)                  |                                                    | $ | 4,369 |                    |   | $ | (11,348          | )    |   | $    | 7,956 |     |      | $ | (11,106 | )  
|                                  
|                                  
|                                  
|                                  
|Other comprehensive income
(loss): |                                                    |   |       |                    |   |   |                  |      |   |      |       |     |      |   |         |    
|                                  
|                                  
|                                  
|                                  
|                                   | Cumulative foreign currency
translation adjustment |   |       | (35                | ) |   |                  | (101 | ) |      |       | (37 | )    |   |         | (85 | )
|                                  
|                                  
|                                  
|                                  
|                                   | Unrealized gains on
securities, net
of tax         |   |       |                   |   |   |                  | 134  |   |      |       |    |      |   |         | 252 |  
|                                   |                                                    |   |       |                    |   |   |                  |      |   |      |       |    
|Comprehensive income (loss)        |                                                    | $ | 4,334 |                    |   | $ | (11,315          | )    |   | $    | 7,919 |     |      | $ | (10,939 | )  
|                                   |                                                    |   |       |                    |   |   |                  |      |   |      |       |    



|Note G |  |  | Commitments and Contingencies:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|------ |  |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      
|       |  |  | The Company is involved in certain administrative proceedings
arising in the normal course of business. In the opinion of the
Company, the ultimate settlement of these administrative
proceedings will not materially impact the Companys financial
position or results of operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|      
|Note H |  |  | Benefit Plans                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|      
|       |  |  | On April 26, 2001, the stockholders approved a proposal to amend
the Companys 1994 Automatic Stock Option Plan for Non-Employee
Directors (the 1994 Plan) to (a) adjust the automatic grants made
under the 1994 Plan for stock splits, adjustments, and other
organic changes, (b) to increase the annual grants of stock to
Directors under the 1994 Plan from 500 to 2,000 shares, (c) to
increase the initial grants to new Directors from 1,000 to 5,000
shares, and (d) to increase the period allowed for exercise of
shares when a Director retires or concludes his service with the
Company from six months to the period equal to the term of his
service with the Company.                                                                                                                                                                                                                                                                                             
|      
|Note I |  |  | Stockholder Rights Plan                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|      
|       |  |  | During the second quarter of 2001, the Companys Board of Directors
adopted a stockholder rights plan (the Rights Plan). Under the
Rights Plan, the Company will issue a dividend of one Preferred Share
Purchase Right (the Right) for each share of common stock of the
Company held by stockholders of record as of the close of business on
May 14, 2001. Each Right will entitle stockholders to buy one
one-thousandth (1/1000th) of a share of Series A Junior Participating
Preferred Stock of the Company at an exercise price of $120.00 (subject
to adjustment). The Rights Plan was not adopted in response to any
specific takeover threat. The Rights Plan, however, was designed to
assure that all of the Companys stockholders receive fair and equal
treatment in the event of any proposed takeover of the Company, and to
guard against coercive or unfair tactics to gain control of the Company
without paying all stockholders a premium for that control.

6



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##### Table of Contents





|       |  |  | In general, the Rights become exercisable when a person or group
acquires 15% or more of the Companys common stock or a tender offer or
exchange offer for 15% or more of the Companys common stock is
announced or commenced. The Companys Board of Directors may redeem
the Rights at $0.01 per Right at any time before any person or group
acquires 15% or more of the outstanding common stock of the Company.
If not redeemed, the Rights will expire on May 14, 2011.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|------ |  |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      
|Note J |  |  | Joint Venture                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|      
|       |  |  | On June 5, 2001, the Company and DuPont Displays, a business unit of
DuPont iTechnologies, announced that the companies had formed Three-D
OLED L.L.C., a new display module joint venture which will design,
assemble and market Organic Light Emitting Diode (OLED) display modules
to original equipment manufacturers worldwide. The venture will be
focused on glass substrate and passive matrix Polymer OLED displays
developed by DuPont Displays and UNIAX Corporation, a wholly owned
subsidiary of DuPont. In addition, the venture may also market and
sell glass substrate, passive matrix small molecule OLED modules. The
Company received a 51% ownership interest and DuPont Displays received
a 49% ownership interest in the venture. The Company controls the
venture as currently defined by EITF No. 96-16. Accordingly, the
venture is consolidated into the Companys financial statements, and
the DuPont interest is accounted for as a minority interest.
|      
|Note K |  |  | Other Assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|      
|       |  |  | In the second quarter of 2001, the Company wrote off its
investment of $3.8 million in Inviso, Inc. Inviso is currently in
the process of raising additional funds to operate its business in
a very difficult venture capital market. Even if this
fund-raising effort is successful, the Company believes it would
dilute the value of original investment to a negligible amount.
Therefore, the Company determined that its investment was impaired
and must be written off.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    




ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS AND FACTORS THAT MAY AFFECT RESULTS

Except for the historical information contained herein, this Report
contains forward-looking statements, including those relating to revenue,
earnings, margins, pricing pressures, quarterly fluctuations, the impact of our
moving the Arizona LCD facility, material shortages, research, development, and
engineering expense, selling, general and administrative expense, and liquidity
and anticipated cash needs that involve risks and uncertainties that could
cause actual results to differ materially.

We caution that these statements are qualified by various factors that may
affect future results, including the following: changes in the market for our
products and the success of our customers products, the failure of key
technologies to deliver commercially acceptable performance, our dependence on
one large customer, the absence of long-term purchase commitments, and our
lengthy development periods and product acceptance cycles. This Report should
be read in conjunction with our Report on Form 10-K for the fiscal year ended
December 31, 2000.

Overview

We offer advanced design and manufacturing services to original equipment
manufacturers, commonly referred to as OEMs. We specialize in custom display
modules utilizing liquid crystal display, or LCD, components and technology.
Our LCD modules have varying levels of integration. At a minimum, each module
includes an LCD, a custom LCD driver, and a flexible connector. We also
provide value-added services, which increase our competitiveness, by assembling
additional components onto the module based upon the specific needs of the
customer. These additional components include such items as keypads,
microphones, speakers, light guides, and optics.

We currently sell substantially all of our LCD modules to major OEMs. We
derived more than 80% of our net sales in 1999 and 2000 from the mobile handset
market. When we win a design program, our customer sometimes pays

7



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##### Table of Contents



all or a
portion of our nonrecurring engineering expenses to defray the costs of custom
design, as well as the costs of
nonrecurring tooling for custom components. The typical design program
life cycle of a custom-designed LCD module is three to twelve months and
includes technical design, prototyping, pilot manufacturing, and high-volume
manufacturing. We typically seek large volume programs from major OEMs. The
minimum production quantity for an LCD module typically approximates 100,000
units per year, although the production rate for some programs has been higher
than 100,000 units per week. The selling price of our LCD modules usually
ranges between $5 and $20 per unit. We recognize revenue when persuasive
evidence of an arrangement exists, delivery has occurred, the fee is fixed or
determinable, and collectability is probable. Generally, all of these
conditions are met at the time we ship products to customers.

We experienced substantial growth from 1993 through 1995, primarily as a
result of sales to OEMs in the wireless communications industry, which grew
substantially during that period. During that period, our primary customer was
Motorola. In 1996, our net sales declined, primarily as a result of the
phase-out by Motorola of a significant family of programs. In 1997, our net
sales returned to pre-1996 levels primarily as a result of several new programs
and customers. Motorola and its subcontractors accounted for 34.6% of our net
sales in 1997, 63.6% in 1998, 86.1% in 1999, and 86.9% in 2000. In the second
quarter of 2001, products shipped to Motorola and its subcontractors accounted
for 81.1% of our revenue.

During the past several years, we have experienced seasonal quarterly
fluctuations in our net sales as our OEM customers developed retail products
with shorter product life cycles and phased out older programs early in the
year following holiday sales. As a result, sales usually peak in the fourth
quarter of a calendar year and are lower in the following quarter. This
pattern did not occur in the fourth quarter of 2000 and the first quarter of
2001 as a result of supply interruptions in the fourth quarter and reduced
expectations in the mobile handset market.

Several factors impact our gross margins, including manufacturing
efficiencies, product mix, product differentiation, product uniqueness,
inventory management, and volume pricing. Currently, significant pricing
pressure exists in the LCD module market, especially in higher volume programs
in the wireless communications industry. Accordingly, as the production levels
of some of our new higher volume programs have increased, the lower standard
gross margins on those programs have impacted, and will continue to impact, our
overall margins.

We vertically integrate our manufacturing facilities. In Arizona, we
operate the front-end of our high-volume LCD production line. We generally
have used the Arizona facility for the manufacture of more technologically
complex and custom high-volume LCDs. We also purchase LCDs from second sources
to provide us an alternate source and to ensure available capacity. In order
to take advantage of lower labor costs, we ship LCDs to our facilities in
Manila, the Philippines, or Beijing, China, for assembly into modules.

During the second quarter, we made the strategic decision to move our
front-end, high-volume LCD line from Arizona to Asia. The LCD line will be
operated in Arizona through the third quarter and then we expect it will take
two to three quarters to re-install the line in Asia. We expect to incur no
interruption in our LCD module production as we will rely on built inventory
stock and second sources during the period that the line is being moved.

In Manila, we assemble LCDs into modules and perform certain back-end LCD
processing operations. Our back-end LCD processing operations are conducted in
Manila through a third-party subcontract manufacturer. The subcontractor
supplies direct labor and incidental services required to manufacture our
products. All indirect manufacturing employees, primarily technicians,
supervisors, and engineers, are our employees. Our LCD module operations are
conducted at our own factory, where we employ our own employees and do not
employ the services of a third-party subcontractor.

In Beijing, we also assemble LCDs into modules. Our LCD module operations
in Beijing are conducted at a facility we own through a wholly owned foreign
subsidiary. We employ our own employees in Beijing and do not employ the
services of a third-party subcontractor.

Selling, general, and administrative expense consists principally of
administrative and selling costs, salaries, commissions, and benefits to
personnel and related facility costs. We make substantially all of our sales
directly to OEMs, and our sales force consists of a small number of direct
technical sales persons. As a result, there is no material cost of
distribution in our selling, general, and administrative expense. Selling,
general, and administrative expense has

8



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increased as we have expanded our
business and increased our diversification efforts. In addition, we have
recently incurred substantial marketing and administrative expenses in
connection with our LCoSmicrodisplay business.

Research, development, and engineering expense consists principally of
salaries and benefits to scientists, design engineers, and other technical
personnel, related facility costs, process development costs, and various
expenses for projects, including new product development. Research,
development, and engineering expense continues to increase as we develop new
display products and technologies, especially LCoSmicrodisplays.

Since 1997, we have been working on the development of LCoSmicrodisplays.
In 1997, we entered into a strategic alliance with National Semiconductor
Corporation for the development of LCoSmicrodisplay products. Under that
alliance, National focused on the silicon technologies needed for
microdisplays, and we focused on the liquid crystal technologies. In 1999,
National decided to close its microdisplay business unit. In connection with
that closing, in July 1999, we purchased certain assets and licensed silicon
technologies from National relating to LCoSmicrodisplays. We paid
approximately $3.0 million in cash and issued warrants to purchase 140,000
shares of our common stock in the transaction, which valued the transaction at
approximately $3.6 million. No additional payments are required under the
licenses. We also hired several key technical employees of National to assist
in the implementation of the acquired technologies.

In April 1998, we entered into a strategic relationship with Inviso, Inc.,
a privately held company with numerous patents and proprietary technology
related to microdisplay development. We acquired a minority equity interest in
Inviso for approximately $3.3 million. In March 2000, we acquired an
additional interest in Inviso for $500,000, raising our total minority equity
interest to $3.8 million. As part of this strategic relationship, we provide
proprietary manufacturing capabilities and liquid crystal expertise, and Inviso
provides patented and proprietary technologies and components for the joint
development of microdisplay products.

In the second quarter of 2001, we wrote off our investment of $3.8 million
in Inviso. Inviso is currently in the process of raising additional funds to
operate its business in a very difficult venture capital market. Even if this
fund-raising effort is successful, we believe it would dilute the value of
original investment to a negligible amount. Therefore, we determined that our
investment was impaired, as that term is defined under generally accepted
accounting principles, and must be written off.

In August 2000, our wholly owned subsidiary, Three-Five Systems (Beijing)
Co., Ltd., entered into a strategic agreement with Heibei Jiya Electronics,
Co., Ltd. (Jiya), a Chinese-based manufacturer of LCD glass. Under the terms
of the agreement, Jiya will provide LCD glass to us and reserve a significant
amount of LCD glass manufacturing capacity for us. In exchange, we will assist
Jiya in further developing its LCD glass manufacturing processes. At the
conclusion of 18 months, we have the option to extend the agreement or to
acquire a majority interest in Jiya.

In March 2001, we invested $1 million in Silicon Bandwidth, Inc., a
privately held company providing unique semiconductor and optoelectronic
interconnect solutions based upon multiple, patented, proprietary technologies.
We are working closely with Silicon Bandwidth to design unique, cost-effective,
reconfigurable packaging platforms for LCoSmicrodisplays.

During the second quarter of 2001, we formed a new company, Three-D OLED
L.L.C., with DuPont Displays, a business unit of DuPont Corporation. We own 51%
of this new venture, and DuPont Displays own 49%. The companies have pledged
$3.0 million to the venture. Our share of that obligation is slightly over
$1.5 million. This new venture will design, assemble, and market OLED (Organic
Light Emitting Diode) display modules to OEMs worldwide. The venture will focus
on glass substrate, passive matrix OLED displays. OLED technology utilizes
advanced materials to produce bright, high-contrast, emissive displays. The
venture will be headquartered in Tempe, Arizona, within our existing corporate
headquarters, and controlled by us. The venture will utilize the glass panel
output of a new high-volume manufacturing plant located in Taiwan, recently
announced by DuPont and RiTdisplay Technology Corporation. The venture may also
use other OLED glass panel sources. OLED display modules will be assembled at
our display module assembly facilities in Beijing and Manila.

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Three months ended June 30, 2001 compared to three months ended June 30, 2000

Net Sales.Net sales decreased 44.3% to $25.0 million in the three months
ended June 30, 2001 from $44.9 million in the three months ended June 30, 2000.
This decrease was primarily a result of the downturn in the mobile handset
market. We derived more than 80% of our net sales from the mobile handset
market. Since the second half of 2000, weak and uncertain demand in the mobile
handset industry and continued issues with handset inventories has led to
cancellations, delays and push-outs for existing and new customers programs.
In addition, pricing pressures in the LCD module industry have led to a
reduction in average selling prices.

Cost of Sales.Cost of sales increased to 128.6% of net sales in the
three months ended June 30, 2001 from 76.0% in the three months ended June 30,
2000. The higher percentage was a result of intense pricing pressure and
operating inefficiencies caused by reduced production volumes. In addition, we
had a $2.4 million charge relating to the write-off of our inventory. The
inventory write-off occurred because of cancellations by customers of various
end-of-life programs.

Selling, General, and Administrative Expense.Selling, general, and
administrative expense, or SG&A, increased to $2.9 million in the three months
ended June 30, 2001 from $2.4 million in the three months ended June 30, 2000.
The increase in SG&A expense was a result of a variety of factors. In
addition, we wrote off $1.3 million related to our decision to abandon the
implementation of an enterprise resource planning system. That charge was
allocated to all departments, including cost of sales, SG&A, and RD&E. SG&A
expense was 11.6% of net sales in the three months ended June 30, 2001 compared
to 5.3% in the three months ended June 30, 2000. The higher percentage was
generally caused by the lower net sales.

Research, Development, and Engineering Expense.Research, development,
and engineering, or RD&E, expense increased 60.0% to $4.8 million in the three
months ended June 30, 2001 from $3.0 million in the three months ended June 30,
2000. RD&E expense overall increased as the result of the development of new
display products and technologies, primarily LCoSmicrodisplays. The increase
in LCoSmicrodisplays was generally as a result of the increased initial
production of LCoSmicrodisplays because many of the production start-up
expenses are included as RD&E expense. Also included in RD&E are costs
associated with our decision to abandon the implementation of an ERP system
described above.

Other Income/Expense, Net.Other expense in the three months ended June
30, 2001 was $2.1 million compared to other income of $1.2 million in the three
months ended June 30, 2000. The write-off of our $3.8 million Inviso
investment, described earlier, was the principal reason for the difference.
The write-off was offset by interest income of $1.8 million.

Provision for (Benefit from) Income Taxes.We had a benefit from income
taxes of $5.6 million in the three months ended June 30, 2001 compared to a
provision for income taxes of $2.2 million in the three months ended June 30,
2000. The tax benefit rate was 33.0% in the three months ended June 30, 2001
compared to the tax provision rate of 33.1% in the three months ended June 30,
2000.

Net Income (Loss).Net loss was $11.3 million, or $0.53 per diluted
share, in the three months ended June 30, 2001 compared to net income of $4.4
million, or $0.21 per diluted share, in the three months ended June 30, 2000.
We had several special charges this quarter, including the write-off of our
investment in Inviso, the write-off of certain inventory, and the write-off of
an ERP system implementation. Excluding those special charges, our net loss
for the three months ended June 30, 2001 was approximately $6.3 million, or
$0.29 per diluted share.

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Six months ended June 30, 2001 compared to six months ended June 30, 2000.

Net Sales.Net sales decreased 27.9% to $60.6 million in the six months
ended June 30, 2001 from $84.1 million in the six months ended June 30, 2000.
This decrease was primarily a result of the downturn in the mobile handset
market. We derived more than 80% of our net sales from the mobile handset
market. Since the second half of 2000, weak and uncertain demand in the mobile
handset industry and continued issues with handset inventories has led to
cancellations, delays and push-outs for existing and new customers programs.
In addition, pricing pressures in the LCD module industry have led to a
reduction in average selling prices.

Cost of Sales.Cost of sales increased to 104.6% of net sales in the six
months ended June 30, 2001 from 75.5% in the six months ended June 30, 2000.
The higher percentage was a result of intense pricing pressure and operating
inefficiencies due to reduced production volumes. In addition, we had a $2.4
million charge in the second quarter relating to the write-off of our
inventory. The inventory write-off occurred because of cancellations by
customers of various end-of-life programs.

Selling, General, and Administrative Expense.Selling, general, and
administrative expense increased 14.9% to $5.4 million in the six months ended
June 30, 2001 from $4.7 million in the six months ended June 30, 2000. The
increase in SG&A expense was the result of a variety of factors. In addition,
we wrote off $1.3 million related to our decision to abandon the implementation
of an enterprise resource planning system. That charge was allocated to all
departments, including cost of sales, SG&A, and RD&E. SG&A expense was 8.9% of
net sales in the six months ended June 30, 2001 compared to 5.6% in the six
months ended June 30, 2000. The higher percentage was generally caused by the
lower net sales.

Research, Development, and Engineering Expense.Research, development,
and engineering expense increased 46.6% to $8.5 million in the six months ended
June 30, 2001 from $5.8 million in the six months ended June 30, 2000. RD&E
expense overall increased as the result of the development of new display
products and technologies, primarily microdisplays. The increase in LCoS
microdisplays was generally as a result of the increased production of LCoS
microdisplays because many of the production start-up expenses are included as
RD&E expense. Also included in RD&E are costs associated with our decision to
abandon the ERP implementation described above. RD&E expense was 14.0% of net
sales in the six months ended June 30, 2001 compared to 6.9% in the six months
ended June 30, 2000. The higher percentage was generally caused by lower net
sales.

Other Income (Expense), Net.Other income in the six months ended June
30, 2001 was $67,000 compared to other income of $1.7 million in the six months
ended June 30, 2000. The write-off of our $3.8 million Inviso investment,
described earlier, was the principal reason for the difference. The write-off
was offset by interest income of $3.9 million.

Provision for (Benefit from) Income Taxes.We had a benefit from income
taxes of $5.5 million for the six months ended June 30, 2001 compared to a
provision for income taxes of $3.9 million for the six months ended June 30,
2000.

Net Income (Loss).The net loss was $11.1 million, or $0.52 per diluted
share, in the six months ended June 30, 2001 compared to net income of $8.0
million, or $0.39 per diluted share, in the six months ended June 30, 2000. We
had several special charges in the second quarter, including the write-off of
our investment in Inviso, the write-off of certain inventory, and the write-off
of an ERP system implementation. Excluding those special charges, our net loss
for the six months ended June 30, 2001 was approximately $6.1 million, or $0.28
per diluted share.

Quarterly Results of Operations

The following table presents unaudited consolidated statement of
operations data for each of the five quarters in the period ended June 30,
2001. We believe that all necessary adjustments have been included to present
fairly the quarterly information when read in conjunction with the Condensed
Consolidated Financial Statements. The operating results for any quarter are
not necessarily indicative of the results for any subsequent quarter.

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|                                                               |                                        |   |                |        |         |   |         |        |         |   |         |        |  |   |        |        |  |   |         |        | 
|-------------------------------------------------------------- | -------------------------------------- | - | -------------- | ------ | ------- | - | ------- | ------ | ------- | - | ------- | ------ |  | - | ------ | ------ |  | - | ------- | ------ | 
|                                                               |                                        |   | Quarters Ended
|                                                               |                                        |   |               
|                                                               |                                        |   | (unaudited)   
|                                                               |                                        |   | (in thousands)
|                                                               |                                        |   | Jun
30,        |        | Sep 30, |   | Dec 31, |        | Mar 31, |   | Jun 30,
|                                                               |                                        |   | 2000           |        | 2001   
|                                                               |                                        |   |                |        |        
|Net sales                                                      |                                        | $ | 44,926         |        |         | $ | 40,231  |        |         | $ | 36,365  |        |  | $ | 35,616 |        |  | $ | 25,013  |       
|                                                               |                                        |   |                |        |         |   |         |        |         |   |         |        |  |   |        |        |  |   |         |       
|Cost and expenses:                                             |                                        |   |                |        |         |   |         |        |         |   |         |        |  |   |        |        |  |   |         |       
|                                                              
|                                                              
|                                                              
|                                                              
|                                                               | Cost of sales                          |   |                | 34,157 |         |   |         | 31,115 |         |   |         | 30,092 |  |   |        | 31,243 |  |   |         | 32,160 | 
|                                                              
|                                                              
|                                                              
|                                                              
|                                                               | Selling, general, and administrative   |   |                | 2,418  |         |   |         | 2,453  |         |   |         | 2,368  |  |   |        | 2,491  |  |   |         | 2,922  | 
|                                                              
|                                                              
|                                                              
|                                                              
|                                                               | Research, development, and engineering |   |                | 2,989  |         |   |         | 3,734  |         |   |         | 3,809  |  |   |        | 3,661  |  |   |         | 4,795  | 
|                                                               |                                        |   |                |        |         |   |         |        |         |   |         |        |  |   |        |        |  |   |         |       
|                                                               |                                        |   | 39,564         |        |         |   | 37,302  |        |         |   | 36,269  |        |  |   | 37,395 |        |  |   | 39,877  |       
|                                                               |                                        |   |                |        |         |   |         |        |         |   |         |        |  |   |        |        |  |   |         |       
|Operating income (loss)                                        |                                        |   | 5,362          |        |         |   | 2,929   |        |         |   | 96      |        |  |   | (1,779 | )      |  |   | (14,864 | )     
|                                                              
|                                                              
|                                                              
|                                                              
|Other income (expense), net                                    |                                        |   | 1,165          |        |         |   | 2,736   |        |         |   | 2,703   |        |  |   | 2,140  |        |  |   | (2,073  | )     
|                                                               |                                        |   |                |        |         |   |         |        |         |   |         |        |  |   |        |        |  |   |         |       
|Income (loss) before provision for (benefit
from) income taxes |                                        |   | 6,527          |        |         |   | 5,665   |        |         |   | 2,799   |        |  |   | 361    |        |  |   | (16,937 | )     
|                                                              
|                                                              
|                                                              
|                                                              
|Provision for (benefit from) income taxes                      |                                        |   | 2,158          |        |         |   | 1,320   |        |         |   | 266     |        |  |   | 119    |        |  |   | (5,589  | )     
|                                                               |                                        |   |                |        |         |   |         |        |         |   |         |        |  |   |        |        |  |   |         |       
|Net income (loss)                                              |                                        | $ | 4,369          |        |         | $ | 4,345   |        |         | $ | 2,533   |        |  | $ | 242    |        |  | $ | (11,348 | )     
|                                                               |                                        |   |                |        |         |   |         |        |         |   |         |        |  |   |        |        |  |   |         |       

Liquidity and Capital Resources

At June 30, 2001, we had cash, cash equivalents, and liquid investments of
$154.4 million compared to $170.1 million at December 31, 2000. This decrease
was due primarily from our operating cash outflow, the purchase of capital
equipment, and our stock buyback program.

In the quarter ended June 30, 2001, we had about $700,000 in net cash
outflow from operations compared to $1.9 million in net cash flow from
operations in the quarter ended June 30, 2000. Despite the large net loss for
the quarter, operating cash outflow was minimal due primarily to the one-third
reduction in the companys inventory or $8.8 million during the quarter.

Depreciation expense was $1.4 million for the second quarter of 2001
compared to $1.5 million for the second quarter of 2000. Inventory turns were
7.8 in the second quarter of 2001 compared to 8.9 in the second quarter of
2000. Accounts receivable DSOs (Day Sales Outstanding) were 65 days in the
second quarter of 2001 compared to 52 days in the second quarter of 2000. DSOs
have increased because our largest OEM customer has extended the terms on
existing invoices..

In the first six months of 2001, we had $7.9 million in net cash outflow
from operations compared to $4.7 million in positive net cash flow from
operations during 2000. Our cash flow was negatively impacted during the first
six months of 2001 primarily as a result of decreased net income.

Our working capital was $180.1 million at June 30, 2001 compared with
$194.5 million at December 31, 2000. Our current ratio increased to 11.2-to-1
at June 30, 2001 from 10.1-to-1 at December 31, 2000. Our working capital
decreased as a result of our cash outflow. Our current ratio improved from
December 2000 due to our lower current liabilities.

In January 2001, we amended and revised our credit facility with Imperial
Bank to reduce it to $15.0 million. There are no other participating lenders
on that facility. Advances under the facility may be made as prime rate
advances, which accrue interest payable monthly at the banks prime lending
rate, or as LIBOR rate advances, which bear interest at 150 basis points in
excess of the LIBOR base rate. Our Three-Five Systems Limited subsidiary has
established an annually renewable credit facility with a United Kingdom bank in
order to fund its working capital requirements. The credit facility, which
expires January 15, 2002, provides $350,000 of borrowing capacity secured by
accounts receivable of Three-Five Systems Limited. No borrowings are
outstanding under this facility. As of June 30, 2001, our Beijing subsidiary
had an outstanding $2.7 million term loan due May 4, 2002 to the Bank of China,
which was secured by a $3.0 million stand-by letter of credit issued by
Imperial Bank.

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Capital expenditures during the three months ended June 30, 2001 were
approximately $2.9 million. These capital expenditures primarily consisted of
equipment for our operations in Manila, Beijing, and Arizona, including
manufacturing and test equipment for LCoSmicrodisplays.

Under our $30 million stock buy-back program announced in December 2000,
we purchased almost 150,000 shares of our common stock for a total of $2.5
million in the first quarter of 2001. No shares were purchased in the second
quarter of 2001. Since the start of the buy-back program, we have purchased
just over 390,000 shares for $7.2 million.

We believe that our existing balances of cash and cash equivalents,
short-term investments, anticipated cash flows from operations, and available
credit lines will provide adequate sources to fund our operations and planned
expenditures through 2001; however, we may have to expand our loan commitments
or pursue alternate methods of financing or raise capital should we encounter
additional cash requirements. For example, accounts receivable and inventory
could rise faster than anticipated. In addition, we will continue to seek
other alliances or acquisitions and additional relationships with regard to the
strategic development of various new technologies, especially LCoS
microdisplays, which may also require us to make additional capital
investments. We cannot provide assurance that adequate additional loan
commitments or alternative methods of financing will be available or, if
available, that they will be on terms acceptable to us.




ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

There are no material changes in reported market risks since the Companys
most recent filing on Form 10-K for the year ended December 31, 2000.




PART II. OTHER INFORMATION




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

Our Annual Meeting of Stockholders was held on April 26, 2001. All of the
nominees were elected to our Board of Directors as set forth in the Proxy
Statement as follows:

|                    |  |                |            |               |  |  |           | 
|------------------- |  | -------------- | ---------- | ------------- |  |  | --------- | 
|Nominees            |  | Votes in Favor |            | Votes Against
|                    |  |                |            |              
|David C. Malmberg   |  |                | 16,619,837 |               |  |  | 139,475   | 
|                   
|                   
|                   
|                   
|Jack L. Saltich     |  |                | 15,134,600 |               |  |  | 1,624,712 | 
|                   
|                   
|                   
|                   
|Jeffrey D. Buchanan |  |                | 15,094,620 |               |  |  | 1,664,692 | 
|                   
|                   
|                   
|                   
|Thomas H. Werner    |  |                | 16,619,257 |               |  |  | 140,055   | 
|                   
|                   
|                   
|                   
|Kenneth M. Julien   |  |                | 16,415,678 |               |  |  | 343,834   | 
|                   
|                   
|                   
|                   
|David P. Chavoustie |  |                | 13,697,241 |               |  |  | 3,252,071 | 
|                   
|                   
|                   
|                   
|Murray A. Goldman   |  |                | 16,581,256 |               |  |  | 178,056   | 

The following items were also voted upon and approved by the stockholders:

(a)  To approve the Amended and Restated 1994 Automatic Stock Option Plan
for Non-Employee Directors.

|               |  |         |           |         |  |  |        | 
|-------------- |  | ------- | --------- | ------- |  |  | ------ | 
|Votes in Favor |  | Opposed |           | Abstain
|               |  |         |           |        
|14,913,493     |  |         | 1,777,020 |         |  |  | 68,779 | 

(b)  To ratify the appointment of Arthur Andersen LLP as our independent
auditors for the fiscal year ending December 31, 2001.

|               |  |         |         |         |  |  |        | 
|-------------- |  | ------- | ------- | ------- |  |  | ------ | 
|Votes in Favor |  | Opposed |         | Abstain
|               |  |         |         |        
|16,612,090     |  |         | 112,083 |         |  |  | 35,139 | 

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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)  Exhibits:

|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                           
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit 4(b):  |  | Rights Agreement, dated as of April 26, 2001, between
Three-Five Systems, Inc. and Bank of New York, as Rights Agent,
together with the following exhibits thereto: Exhibit A  Form
of Certificate of Designation of Series A Junior Participating
Preferred Stock of Three-Five Systems, Inc.; Exhibit B  Form
of Right Certificate; Exhibit C  Summary of Rights to Purchase
Shares of Preferred Stock of Three-Five Systems, Inc.(1)
|              
|              
|              
|              
|Exhibit 10(x): |  | Amended and Restated 1994 Stock Option Plan for
Non-Employee Directors.                                                                                                                                                                                                                                                                                                                                                                   

(b)  Reports on Form 8-K:



| |  |  | Report on Form 8-K on May 10, 2001 reporting declaration
of preferred share purchase right dividend.
| |  |  | ----------------------------------------------------------------------------------------------------



---

| | (1) | Incorporated by reference to the Registrants Form 8-A as filed with
the Commission on May 10, 2001.
| | --- | ----------------------------------------------------------------------------------------------------




SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

THREE-FIVE SYSTEMS, INC.
(Registrant)

|                     |  |       |  |                                                  
|-------------------- |  | ----- |  | -------------------------------------------------
|Dated: July 26, 2001 |  | By:   |  | /s/ Jeffrey D. Buchanan;                         
|                     |  | Name: |  | Jeffrey D. Buchanan                              
|                     |  | Its:  |  | Executive Vice President; Chief Financial Officer

14